February 11, 2009


There’s a curious debate taking place these days that pits those who believe that economy can be saved through tax cuts and those who believe it can be saved though targeted spending. I have to admit as a Portfolio Manager I’ve always sought the most convenient solutions within the division that generally differentiates problems. So, let me try to outline what I believe are the merits of the debate and why in spite of them the markets took a hit yesterday because of the solutions that Sec. Geitner didn’t come up with.

TAX CUTS ARE AN IDEA WITH GREAT MERIT. This is because it specifically puts capital in the hands of consumers. Now the cut can go to the idle class who generously (and often gluttonously) spend it merrily on oddles of stuff they don’t need. The more austere logic goes that if the cuts are given to the class who provide most of the jobs it will be spent on efforts to start a business or give an existing business a much needed infusion and thereby revive the need for help. If there’s anything lost in the debate it’s the dismissal of the variable environments that would benefit one kind of cut over another. If companies are weathering a recession it’s likely they have (or should have) contingency plans on dealing with the reduction of expenses while not undermining the productivity necessary to maintain the business model. That’s why Regan tax cuts in the eighties worked, because the capital they produced for the corporate sector (through the high bracket earners) has specific targets that would be carried along the wave re-inflating economy. Unfortunately I don’t see that happening now. In fact the future is so murky that traditional crises plans all the way to highest levels of government are being tested. And if you believe in the Black Swan theories by Nicolas Taleb it’s becoming increasingly clear to me that the rules for dealing with these crises haven’t been written yet. Does that mean I wouldn’t favor tax cuts for the high bracket earners, now? I think tax cuts are especially important now and should include all brackets. Put into the hand of consumers will produce an effort that would stimulate business and put into the hand of business (assuming it trickles into it). While it likely won’t be enough to revive the economy by itself it should make some difference in combination. And therein lay the rub.

IN AMERICA THE CONSUMER IS KING. We are a consumer driven economy that is the envy and focus of the rest of the world. But right now our consumers are distracted from their favorite pastime because of the cloud of uncertainty that is ravaging their generally rosy outlooks. The sharp rises in unemployment and the ensuing media blitz to that effect are by design paralyzing that group hungry for answers before they spend another dime. In this light the only known remedy has been for the government to assume the role and take up the slack. Therefore the idea of government spending capital to help re-inflate the economy is no so far fetched if it’s aimed to produce results that are more logically targets. For example, the government should not be buying every household a 60 inch plasma HDTV with surround sound and the Cosco (COST) size cases of caramel corn and Budweiser. What they should buy is education credits, to empower future generations and maybe even produce jobs in academia (which can go either way). Kidding aside educating the population has never been more important if one considers the alternative knowing what a future with so much uncertainty will need in the way of innovation. Spend on energy, and when I say that I don’t care what energy. If you think energy, as I do, that oil will rise again to ravage the world’s consumers than alternative energies are a crucial solution. In the meantime, why not consider uncovering some of our domestic supplies to keep prices stable while new energy sources are tapped and brought in use. Spend on infrastructure and build bridges, roads AND museums, they all produce jobs and enrich the society!

THE TREASURY SHOULD USE THE REST OF THE TARP TO BUY TOXIC ASSETS. I forgive Timothy Geitner not because he was vague about his ideas for solving the banking crises, but because I’m not surprised. If anybody pays attention to the release of corporate earnings each quarter, near the end of the slew of numbers the CEO or higher makes a statement referred to as Guidance. Even companies with lean balance sheets, stable cash flows, low debt and historically strong management are cautious of the impact their statements make about future returns. Many in the market think that there is too much optimism in these statements, but not nowadays. Even John Chambers of Cisco (CSCO) appeared overwhelmed by the uncertainty of future events. In short executives have been lining up to tell us that the economy is showing no sign of recovery. The conventional wisdom is that if you fix the housing problems you fix the original cause of the crisis, and that is accomplished by making the banks more solvent. In my judgment the first step should involve taking toxic assets (which are probably not as toxic as is generally assumed) off the books of the banks. The reason is simple, bank earnings are not judged by price to sales expectations and results, they’re judged by book to sales results. That’s because banks traditionally have heavy loads complicating their balance sheets. The theory anyway is if those loads are released the ensuing space on the balance sheet can be used for new loans. Sec. Geitner knows this is how it’s supposed to work but he’s stuck between knowing what the load is worth and where it will ultimately end up. Somebody should remind the Secretary that his hesitation is called risk, any good portfolio manager has been faced with that and most of them have half the brains to support their decisions that Geitner does.

Rule: Peace is carved out between enemies, not friends.

No comments: