What’s wrong with Big?

On Friday I mentioned that the “too big to fail” doctrine could seriously fail to deliver the kinds of financial services we need in a dynamic economy because when banks act like utilities, they just don’t keep up with changing times.

There’s another reason that the big banks have problems: conflict.

Not the kind of conflict where boss tells the line worker that his tie isn’t right. No the conflicts of interest that inevitably arise when a bank becomes a financial supermarket.

For example, what happens when a bank has a corporate client with a depository relationship, a book of bank loans, a corporate pension, and a stock underwriter? It may help the company get lower fees, but who’s gonna give the bad news when the stock analyst wants to downgrade the shares? What happens when the pension fund underperforms? Does the bank offer better CD rates to keep the business?

Bigger banks offer many more opportunities for conflicts of interest. These conflicts aren’t just uncomfortable. They lead to economic inefficiencies that can waste billions of dollars.


Douglas R. Tengdin, CFA
Chief Investment Officer
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Too Big, Too Slow

Too big to fail. That’s how the major banks have been characterized. And as we enter a new wave of financial stresses, it looks like we’re poised for a new round of forced financial mergers.

That’s a good thing, right? I mean, who wants the hassle of dealing with government deposit insurance. Much better to fold a failing small bank into a “too big to fail” large bank. That way the depositors are all protected.

But not so fast. If we consolidate too far we end up with banks that look and act like utilities. Government regulations, not business opportunities, will determine what kinds loans we can take out, what kinds of deposits we can make, and how we can invest. But is that what this country needs?

We have the most adaptive and flexible economy in the world, in part based on an entrepreneurial multi-tier banking system that is highly customized and customer-focused. If banks join up until they look and act like public utilities, that flexibility is lost. Here’s hoping that the small banks can stay small and independent.


Douglas R. Tengdin, CFA
Chief Investment Officer
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Fed Musings

By now everyone knows that the Fed is standing to and leaving interest rates on hold. Of particular interest to me was their official statement. While the economy is slow right now, the outlook for inflation is far from clear. Rising energy and food prices could sneak their way into the core CPI numbers that the Fed watches so closely.

Of equal interest was the substance of the vote. Dallas Fed president Richard Fisher dissented and voted for a rate increase. The regional bank presidents are getting more powerful as the Board of Governors shrinks. This is happening because the Bush administration can’t get its nominees past a resistant Congress.

This Fed is a far cry from the monolith that Alan Greenspan led. Bernanke’s style is to stimulate discussion and encourage dissent. While that tends to provide better outcomes over time, it can lead to more uncertainty in the short run.


Douglas R. Tengdin, CFA
Chief Investment Officer
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Window Dressing

When quarter-end rolls around, everybody wants to make things look nice. But new flowers in the window boxes can’t disguise rot that may be in the window casings.

At quarter-end, many public companies try to dress up their financials. They increase the amount of cash on hand, or pump up sales to show a better financial statement. Even blue-chip companies get caught in this trap.

Gillette is famous for having “stuffed” their customers with product by moving cases from one warehouse to another. When Warren Buffet showed up at noon one quarter-end he asked the loading dock foreman how it was going. The man replied that he couldn’t say, since by noon the quarter was only half over!

And that’s the lesson. Diligent investors look beyond the headline number to what’s going on inside a company. Channels may get stuffed, but the imbalance shows up somewhere else. They may be boring, but some of the juiciest tidbits in corporate America are buried in the financials.


Douglas R. Tengdin, CFA
Chief Investment Officer
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Comic Wisdom

Everybody wants to get into the act.

Jimmy Durante made this line famous. While the comedian’s sense of timing was legendary, he noted that nothing succeeds like success, and once he had earned his audience, lots of other wannabes started to crowd in. But it didn’t help their performance one bit.

It’s not that different in the investing world. People love a star. And they figure that if they hang with some famous investor or pay a thousand bucks for a seminar some of that success will rub off. But it never does. Successive 20% returns just aren’t all that easy. And the guys that can make them aren’t giving seminars—they’re managing billions.

The only way to get to Carnegie Hall is to practice. And the only way consistently to grow an investment portfolio is through disciplined savings and a consistent approach—not by chasing the latest investment fad.


Douglas R. Tengdin, CFA
Chief Investment Officer
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The Turning of the Tide

Warren Buffet has said that a rising tide may lift all boats, but when the tide goes out you get to see who’s been swimming naked.

When the economy sours, it seems that the scandals come out. A couple years ago it was Enron and WorldCom. The latest news is about a couple of Bear Stearns fund managers, who told investors that all was well even while they were panicking over the sub-prime meltdown. They join a rogues gallery who thought that the good times could be just a little better for them if they shaded the truth.

As bees are drawn to honey, crooks are drawn to money. When times are good, no one wants to hear about Wall Street’s peccadilloes. But when times get tough this crowd gets no sympathy.

I’ll never condone wrongdoing, but the sad fact is that these guys are small potatoes. Why was Bob Rubin paid $10 million by Citigroup if not to warn them about the sub-prime shuffle? Citi has lost $150 billion in market cap since last summer; now Rubin’s at the trough arguing for a bigger bailout.

That’s a crime that will never be prosecuted.


Douglas R. Tengdin, CFA
Chief Investment Officer
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He’s Baaack

Ross Perot is back. Charts and all.

The spoiler of the 1992 election is on the web with a presentation of the national debt. He’s concerned that future budget deficits will grow out of control and that interest on the deficit will destroy our future.

Perot’s agenda is to focus on reforming Social Security and Medicare. He’s right that that’s where the money is. He thinks we need either to raise taxes or cut benefits.

Well I’ve got some news for old Ross: Bush tried that in ‘05. It didn’t work. And Republicans lost Congress in 2006, in part because actively voting Social Security recipients turned out to defeat the reformers.

Social Security is still the third rail of politics. Anyone who runs for office promising to change it is probably going to get killed.


Douglas R. Tengdin, CFA
Chief Investment Officer
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Banking Blues

Are banks the new tech? It sure seems that way.

After the internet bubble burst, quarter after quarter went by where tech companies would lower their revenue outlooks, the stocks would dive, and people would buy in. Now quarter after quarter goes by where banks announce that they have to raise capital, the stocks dive, and new investors dive in. The latest news about smaller regional banks fits this pattern

But if you averaged into Tech stocks throughout 2002 you would have received a 7% annual return through today—about 1% better than the market. And Tech stocks hardly pay any dividends. Today you’re getting paid over 4% just to own the banks. And if they recover, their total returns should be great.

The moral of the story is that it’s usually profitable to be buying an asset that nobody else wants. And the best time to buy is when the blood is running in the streets.


Douglas R. Tengdin, CFA
Chief Investment Officer
Leave a comment if you have any questions—I read them all!

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Infrastructure Ideas

Everyone complains about government. Why?

Take roads, for example. They’re either full of potholes or under repair. And the repairs seem to come in late and over budget.

Much of this can be traced to what Adam Smith call the “agency problem.” People always look after their own money more carefully than they care for the cash of someone else. And in the case of the government, it’s always someone else’s money.

One way out of the pothole problem, is private toll roads. They tend to be well-maintained at an effective cost. Why? The private company has its own money at risk and it works like a phone company: by maintaining private ownership under local regulation. The system isn’t perfect, but we find fewer potholes in the phone system than in our roadways.

I don’t think we’ll see variable toll charges based on GPS tracking of our driving any time soon. But we could. And it could mean better roads at lower costs. That would be a good thing.


Douglas R. Tengdin, CFA
Chief Investment Officer
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Performance Under Pressure

Tiger’s performance yesterday was inspiring.

The 32 year-old golf great was ahead, then behind, and when it mattered, he birdied the 18th hole to come up even and force a sudden death round, which he eventually won.

Tiger putted in front of thousands of cheering fans and millions of TV viewers to win the match. I’m not much of a golfer, but I know that it’s a game of inches and concentration. And when the stakes are high, nothing is more important than the fundamentals.

But Tiger really won that match in the years and months before, when he readied himself physically and mentally for the stress of world-class competition. The key to performance is preparation.

It’s not all that different from investing. Having a plan, and sticking to that plan–when market volatility and world-changing headlines are as distracting as roaring fans–is critical to reaching your investment goals. That plan should be based on fundamentals that don’t change with market jiggles: your income, your expenses, and your expectations.

Solid preparation is essential to perform in world class markets. That’s Tiger’s lesson for all of us.


Douglas R. Tengdin, CFA
Chief Investment Officer
Leave a comment if you have any questions—I read them all!

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