July 16, 2008 6:16

Howell Raines, energy expert

It's Raines-bashing day here at the Curious Capitalist! First Frank, now my old friend Howell (full disclosure: the man bought me lunch once, and has always been very nice to me). In his newish incarnation as media critic for Conde Nast Portfolio, Howell has written a column arguing that the "children of Reaganomics" now populating newsrooms are way too willing to swallow the oil company line that high gas prices are merely the result of supply and demand. If only, he says, today's reporters would dig deep for explanations the way the great Don Barlett and Jim Steele did in the pages of TIME in 2003.

What did Barlett and Steele find back then? Well, some appalling stuff about the U.S. government blowing zillions of dollars on energy boondoggles that's still worth reading today. But here's their explanation for high oil prices:

While the world is swimming in crude oil, it already trades at an inflated price of $30 a bbl., a level essentially dictated by Saudi Arabia with the approval of the U.S. government.

Now, I wrote something similarly boneheaded in 2002, so I'm not holding that against Barlett and Steele. But it seems pretty clear in retrospect that (a) $30 a bbl. wasn't an inflated price and (b) it probably wasn't being dictated by Saudi Arabia. By far the biggest story in global oil markets since 2003 has been sharply rising demand from China, India and other emerging economies, coupled with lots of declining big oilfields and more and more questions about whether Saudi Arabia really does have enough excess capacity to manipulate oil prices. In other words, it's a supply and demand story. Do I think this because I'm a child of Reagonomics? Maybe that plays a role. But the supply-demand thing also happens to be the only credible explanation for why Barlett and Steele were so wrong in 2003 and why oil prices have gone up so much since then. Yes, some of the price premium right now seems to be the product of a futures market feeding frenzy. How much? We'll find out over the next year or so.

ExxonMobil and the other big Western oil companies are of course happy spectators to this price rise. They certainly aren't doing much to thwart it. I wrote a column last year about how ExxonMobil now spends more money on dividends and share buybacks than it does on exploration and capacity improvements. But that's partly because so much of the world's oil is now off limits to Big Oil (countries would rather exploit it themselves), and I certainly can't believe that a company that produces only 3% of the world's oil is capable of pushing prices from $30 a bbl. to $140.

When it comes to the domestic gasoline market, ExxonMobil and its cohorts do have some pricing power, especially during the summer when high demand exceeds U.S. refining capacity. But while that drives up gas prices most summers, it's not so much of an issue this year because demand is falling. Raines does make an interesting point about prices at the pump being set by the latest spot prices for bulk gasoline, not how much it actually cost to make the gasoline. That would presumably deliver a windfall to refiners when oil prices are rising. But it would cut into profits when oil prices fall.

Where the oil companies are very much culpable is in their influence on U.S. energy policy, which has been a joke for decades. Even a child of Reaganomics like me can see that.

July 16, 2008 4:04

The SEC's campaign to git the short sellers

The SEC, which has been watching this financial crisis mostly from the sidelines so far, is suddenly on the warpath. First it announced emergency rules meant to make it harder to short-sell certain financial stocks, among them Fannie Mae and Freddie Mac. Now it's reportedly flinging subpoenas around the offices of Goldman Sachs, Deutsche Bank, Merrill Lynch and more than 50 hedge funds in an effort to find out if manipulators, whatever those are, were behind the collapse of Bear Stearns and the troubles of Lehman Brothers.

This sudden offensive has gotten a lot of criticism, mainly along the lines that it's
a) political pandering to powerful bankers,
b) an exercise in shooting the messenger and
c) will interfere with the exchange of information and setting of prices in markets

I'm sympathetic to all three of these points. But let me defend SEC Chairman Chris Cox for a moment. First on the short-selling rule: Short selling, as we people who write about business for a general audience almost always feel necessitated to explain, is borrowing a share of stock, then selling it in hopes you can buy it back cheaper later. For several years a few people--most loudly Overstock.com CEO Patrick Byrne--have been claiming that some dastardly hedge fund managers take advantage of the ethereal nature of modern stock markets to sell shares that they never actually get around to borrowing. This practice is called naked shorting, and Byrne's accounts of it are so over-the-top that I've always tended to dismiss them (I still do). But naked shorting is, in theory at least, problematic: If you could get away with selling 100 million shares of a company that only has 80 million shares outstanding, you could definitely drive the price down.

In response to these concerns, the SEC in 2005 adopted a rule (Regulation SHO) that says you have to "locate" the stock you plan to borrow before selling it. This spring it proposed penalties for lying about whether you located the stock. And now it's saying that, for the stock of 19 financial companies, you actually have to have borrowed the stock before you can sell it. My own hunch is that naked shorting is not a major factor in the sharp stock price drops of banks and other financial firms (fear and bad loans are). If that's the case, the SEC's rule will silence the whiners who say naked shorts are a big problem. And if the whiners are right, well, this will have turned out to be a landmark piece of regulation.

As for the hunt for supposed spreaders of false rumors about Bear and Lehman, it has been depicted as an assault on free speech. Yeah, but it would be shouting-fire-in-a-crowded-theater speech. And the SEC already goes after people for pump-and-dump operations where scammers buy shares in some thinly traded company, send out a bunch of e-mails saying the stock's about to pop, then sell. What we're talking about here is essentially a dump-and-let-the-air-out. I get that it's going to be really hard to parse what's "false" (if you were whispering that Bear was going under you were right, after all). But it's not as if this investigation is way out of line for the SEC.

July 16, 2008 1:00

Frank Raines thinks 'private capital is essentially unlimited.' Has he tried to get a loan lately?

Franklin Delano Raines, who ran Fannie Mae before being forced to resign amid an accounting scandal in 2004, and still owns stock in the company, has a very strange op-ed today in the Washington Post.

Raines starts out by arguing that the loan losses so far at Fannie Mae and Freddie Mac are actually pretty manageable. He may be right about that, he may be wrong. I'm really not the one to judge, although Bert Ely told me pretty much the same thing and Bert's no friend of the Fanniefreddieplex. But then Raines writes something that seems patently wrong:

The Treasury proposals, curiously, substitute government capital for private capital. Fannie and Freddie have served their housing mission for decades by marshalling private equity from around the world. Federal capital funds are inherently limited, while private capital is essentially unlimited.

Fannie was created as the Federal National Mortgage Association in 1938 because some other guy named Franklin Delano and his allies in Congress concluded that private capital needed government help to find its way into the mortgage market. The reason that Fannie and Freddie have subsequently been able to marshal private funds from around the world so successfully is in large part because investors assume that, if things go really wrong, U.S. taxpayers will take care of them. That is what has enabled the Fanniefreddieplex to outbid purely private rivals over the decades and build such a dominant role in the mortgage business. And perhaps more important, it is what has enabled them to keep funding loans even after private investors soured on non-Fannie-Freddie (and let's not forget Ginnie) mortgage securities last summer. (More after the break.)

July 16, 2008 6:28

Mackey, Tindell, yoga, Abe Lincoln and corporate branding vs. reality

My column on and Q&A; with John Mackey of Whole Foods and Kip Tindell of the Container Store, who were housemates in college and now both run companies on the principle that employees and customers come before shareholders, has been generating some intriguing responses.

I heard from another of their University of Texas housemates, an economist-turned-yoga-association-director (a career path to emulate) who knew all about Mackey but had no idea Tindell had turned into some kinda big cheese too.

I heard from a reader who wrote:

Tindell and Mackey might be interested that Abe Lincoln had this to say about their business philosophy. "Inasmuch as most good things are produced by labor, it follows that all such things of right belong to those whose labor produced them. But it has so happened in all ages of the world that some have labored and others have without labor enjoyed a large proportion of the fruits. This is wrong and should not continue. To secure to each laborer the whole product of his labor, or as nearly as possible, is a worth object of any good government." I wonder how many business leaders and others who venerate Lincoln as an icon to emulate, including Mr. Bush, know this was his view. I wonder if Tindell and Mackey know it...even though they practice it.

And via the magic of Google Alerts, I heard from my long-ago Fortune colleague Rob Walker (Hi Rob!), who wrote in his Murketing blog:

Maybe these companies are exceptions, but I think there’s some value in at least considering the idea that Fox is writing about. And also about the broader idea underneath it, which is one I’ve thought about a lot lately as I’ve been out and about talking to some manager-and-executive-type people about Buying In. That broader issue is that I think a lot of companies that sense the need for a change are way more focused on changing their image (via marketing) than in changing their business practices.

Then Rob quoted something he'd written elsewhere:

There’s a widespread tendency to think “branding” just means logos and slogans and ads. I see branding more broadly, as the process of attaching an idea to a product. That idea lives in consumers’ heads and can come from an ad campaign—but it can also come from direct experiences. It doesn’t matter if the advertising for a drugstore chain depicts kindly pharmacists going out of their way to help—and the actual experience you or I have at that chain in real life involves a dirty store and a rude pharmacist who makes you wait around for no reason and screws up your prescription—well, the idea that gets attached to that drugstore chain’s brand is going to be the one that comes from real life.

July 15, 2008 11:04

Don't regulate lending, regulate how lenders get paid

Among the most remarkable (I know, because I've already remarked upon it, and I'm not the only one) of the new rules on home mortgage lending finalized Monday by the Federal Reserve is the one that aims to:

Prohibit a lender from making a loan without regard to borrowers' ability to repay the loan from income and assets other than the home's value.

Lenders need the government to tell them not to make mortgage loans to people who can't pay them back? Actually, they probably won't for the next 10 or 15 years. But there will come a time when the bulk of bankers, mortgage brokers, mortgage securitizers and mortgage investors will have no memory of the Housing Debacle of '07 and '08 (and '09 and '10?), and somebody will need to rein them if a rerun is to be prevented.

Will the Fed rule actually do that? It sounds both breathtakingly obvious and dangerously vague, although it does subsequently get into specifics:

A lender complies, in part, by assessing repayment ability based on the highest scheduled payment in the first seven years of the loan. To show that a lender violated this prohibition, a borrower does not need to demonstrate that it is part of a "pattern or practice."

When I talked the other day to Louis Pizante, CEO of Mavent, "the mortgage industry's foremost provider of automated regulatory compliance solutions," and himself a former mortgage investment banker, he wondered if maybe the Fed wasn't taking the wrong approach. "The regulators are encroaching more and more on the actual underwriting of the loans and they’re getting more and more subjective in their requirements," he said--a recipe for confusion, legal wrangling, and poor compliance.

What Pizante would like to see instead are government rules on how mortgage brokers are paid. "To me it would seem that it would be much easier to regulate broker compensation," he said. For example: "You’re not going to get a lump-sum fee, you’re going to get a percentage of the cash flows from that loan."

There's been an awful lot of talk over the past year about changing compensation both on Wall Street and in the mortgage business to better reflect the risks inherent in transactions that deliver a big up-front payday. But the standard retort is that any firm that tries to enforce such pay arrangements would quickly lose its best producers to competitors. Which, in Pizante's view, is exactly why government needs to step in.

"That’s where regulation is supposed to come in," he says. "You don’t want to stifle innovation, but you do want to insure that there’s a level playing field."