The Lessons of Chicago

Just thinking--Chicago teachers said they shouldn't be responsible for student improvement since 85% of the kids were poor and there were too many outside variables. Guess they've been doing a real great job in those schools the last 40 years getting those folks educated and out of poverty--huh? And wasn't Obama a community organizer in those neighborhoods--maybe his program for reducing poverty in those neighborhoods didn't work either?

BP Settlement?

Both British Petroleum and the Obama administration have a problem. They need to extricate themselves from the relationship they have been forced into due to the Gulf oil spill. And they need to do it quickly.

The issue is simple. The administration views the cleanup and payment of economic damages as instruments of social and political policy. BP approaches the process from a point of view of balancing legal, financial, and public perception aspects.

Obama needs a solution that will stop some of the bleeding before the mid-term elections. BP needs a solution that will restore confidence among lenders and business partners. Who wants to do business with a company facing an open-ended liability? Lenders will balk, and governments and other oil companies will be reticent to enter into long-term deals with a company facing such an uncertain future.

For its part, the Obama administration relies on the technique of ruling by fiat, taking money from hapless taxpayers (and Chinese bond buyers) to fund largess for which it takes credit. It seems to be taking the same tack with BP, continually making bolder demands.
While the claims settlement process is basically an insurance operation, however, the administration is unhappy with the speed and frugality of BP’s process. In addition, the administration is demanding an escrow fund administered by an “independent” panel. Would the government demand such a thing from an insurance company? The government has also put a moratorium on deep drilling in the Gulf, and wants BP to pay for the costs resulting from it. BP is balking. The Obama administration is already running into Margaret Thacher’s admonition that the problem with using other people’s money is that you soon run out of it.

The issue of the responsibility for the moratorium is a dangerous one for the administration. If regulations were adequate and BP made a mistake, there is no reason for a moratorium, and BP should not be liable for the costs of it. If the regulation was inadequate and BP followed the rules, there is an argument that the government bears not only the responsibility for the moratorium but also the cost of part of the cleanup or broader damages. Remember that offshore leasing is a $13 billion annual revenue source for the government. Given that revenue stream, it would make sense for the government to have disaster recovery procedures in place, including dispersant and boom inventories. It is more efficient for the government to do this than the individual drillers. If individual drillers provided this backup, the redundant costs would lower their bids and reduce government revenues to a greater degree. Similarly, bills in Congress calling for unlimited liability would have the effect of lowering revenues dramatically as fewer companies would bid smaller amounts for leases.

For the administration and BP, the current claims settlement system is a no-win situation. If BP pays a satisfied claimant, the government gets no credit. Unhappy claimants, most likely the vast majority, will wonder why the government isn’t “doing something.” And the more the government tries to expand the definition of relief, the more BP will pull back.

There may be international issues too. The British might not be happy to see the US legal system destroy an iconic British company that pays over 10% of the dividends of a major British stock index.

What’s the solution? Why not have BP pay the US government a large sum of money, say $30-50 billion, in exchange for the government taking on the cleanup liability? The administration can quickly claim a win before the elections. It can then set up a claims process and get credit for the largess that flows from it. It can freely use the military to assist in the cleanup. Over the years this process will take, the political process will allow the government to move expenses around so that it can be seen to have made a very shrewd deal, while once again using the hapless taxpayer’s money to pay for the broad social policy embedded in the settlement process.

If there is no settlement, there is a real chance that BP would be forced to file for bankruptcy, throwing sand into the gears and ensuring plenty of voter, as well as shareholder disenchantment. A settlement would also allow BP shareholders to survive with a reasonable valuation and dividend.

Both sides win—the right basis for any deal.

Obama in Copenhagen

It will be interesting to see how Obama does in Copenhagen. A big part of his campaign was about regaining respect for America abroad. Internationally, he doesn't have official authority, nor any legislative majorities. He must operate on the strength of his ideas, and the concept of American leadership. He wants to succeed at Copenhagen. Secretary of State Clinton threatened that no deal meant no money. Americans should be concerned that Obama, hungry for a win, gives away the store.

The worrisome thing is that an agreement in Copenhagen may both spur further migration of industrial jobs from the US and Europe to the emerging markets, and that we will subsidize this process, and find no net greenhouse gas emission reduction.

Electronic Trading Debate

The Wall Street Journal published our rebuttal to Senator Schumer's response to our editorial: http://online.wsj.com/article/SB10001424052970203440104574404581166261194.html

Investment management is a business that is easy to leverage, except in the area of trading, where size creates a disadvantage as lack of liquidity can penalize performance. For this reason, I believe managers and their clients all have an interest in defending innovation in trading markets. Innovation provides investors more opportunities to handle their orders according to their preferences, rather than in some monolithic, one-size-fits-all product that we wouldn't even accept for laundry soap. Customers, not Senators, should be the ones to choose which innovations to reward with market share.

WSJ Op-Ed

This morning's Wall Street Journal carried an op-ed co authored by my former colleague Don Luskin and me. The subject is "Flash Trading" which is under regulatory attack in electronic markets, despite its existence in traditional markets for as long as I can remember. The op-ed can be found at:

http://online.wsj.com/article/SB10001424052970203706604574374431720968204.html#articleTabs%3Darticle

If you don't subscribe to the Journal, let me know and I'll email you a copy.

National Health Care

We've got quite a dilemma as a country. We worry over the cost of universal health care, but it's probably something we should have as part of a process of rationalizing the system. Yet the addition of 40 million new customers will pur a big strain on primary care doctors. I reckon there are about 300,000 of those, and if each new client took 2 hours a year of their time, we'd need another 40,000 or so. Massachusetts has gone to universal health care and has this problem. If we pass universal care, this could create problems for baby boomers looking to retire and move to a new location--they might not be able to find a primary care provider--especially since the growing resorts are often heavily populated by uninsured workers and the undocumented. Ironically, it may be easier to get into the emergency room.

So rationing of some sort has to come, because the price of care will likely be too low for many new customers. Many people want ot cut down those expenses that occure in the last 6 months of life. Problem is, we don't always know when the last six months of life begins. Also, we don't want it to be our grandma, our ourselves!

And finally, there's a genuine concern about a "national option" run by the same people who run the post office, with potential for coercive legislation to ensure it's competitive position, bloat its cost, and further redistribute income.

I'm praying the Bue Dogs can resist their own party's attack dogs and move the plan in a semi-rational direction. Semi-rational--that's all I can expect from the goverment these days...

Decoupling: Has the Time Come?

Decoupling may have finally arrived, a little too late for the believers of two years ago. The "this time its different" crowd argued that the emerging markets could stand alone without the US and Europe. It didn't work that way, and emerging market equities were hit even worse than those in the developed markets. Lately the Asian emerging markets have been moving up faster than the US market, but it also seem the economies are as well. And, funny thing, the Eurozone is growing faster than the US--at least for now. There should be concern for the Chinese market after the big rally--lots of IPOs, bank loans up at high rates, and maybe some of that money flooding into stocks. Global banks are considering listing in Shanghai and floating stock there. Of course, hot foreign markets are always the last place Wall Street goes to sell junk, when they've run out of locals who haven't heard the news. While playing the Chinese market in the short term given the current liquidity bubble is not for the faint of heart, especially with the government warning against speculation and bank loans finally slowing, continued economic decoupling may lead to returns exceeding those in the developed markets over a longer horizon.