Archive for September, 2009

If It Aint Broke Then…Destroy It!!

The cars lined the lot of the dealership awaiting their final destination.  The mechanics approached the cars shaking their heads with a sense of bewilderment. 

The cars are taken into the center garage bay and the oil is drained out of them.  A mystery liquid is then added to the crankcase and the engine revved.  After a few minutes the liquid solidifies and the engine seizes.  The cars are then given to the scrap dealer and the VIN number blacklisted so the vehicle can never be registered again.  

There was no discrimination in the destruction.  There were great looking SUVs, useful pickups, comfortable full size turnpike cruisers, and perhaps most quixotically, a perfectly preserved 1985 Pontiac Parisienne with the factory cigarette lighter still intact and working.  

This story was relayed to me by my brother, an ace mechanic at a dealership in Connecticut.  A mechanic who spends his days destroying cars?  This is but one of the strange phenomena created by misguided economic policy.  

Amongst the various “stimulus” programs none defies common sense more than the “Cash for Clunkers” program.  

For those blessed enough not to know the details of this program, they are as follows.  The government will give a credit of $4,500 to car buyers if they trade in an older less fuel efficient vehicle for a new vehicle that meets certain fuel efficiency standards.  As described above, the older vehicle must then be destroyed.  

Geez…where do I start? 

First off, consumers are typically trading in fully paid off cars and going into debt to buy supposedly fuel efficient vehicles.   Encouraging people to take on more debt in troubled economic times doesn’t strike me as prudent financial advice or good for the consumer.  

Second, the environmental angle is just plain silly.  The amount of energy that taking these older cars off the road would save is miniscule compared to the energy that went into manufacturing the new vehicle.  Wouldn’t it be better for the environment to simply allow the older cars to be driven rather than expending the energy required to manufacture a new car? 

Thirdly (and I’ll stop here) people at the bottom of the economic ladder are being hurt.  For example, college students, part time workers, and households needing a second hand car.  These are all constituencies that historically have relied on the used car market to obtain inexpensive vehicles.  This program has greatly diminished the supply of these cheaper vehicles.  

Most everyone agrees that these stimulus policies don’t make sense when looked at from a common sense or “man on the street” point of view.  

So why then do people acquiesce to the policies? 

We tend to think that policies that don’t make sense on the individual level somehow make sense in some grand sweeping scheme of things.  We believe that somewhere in the complexities of macro economics, it all just works out. 

Indeed, if one were to point out the contradictions of the policy he is likely to be immediately branded as unsophisticated and unable to grasp complex concepts. 

These two forces allow ridiculous statements to go unchallenged and failed policies to continue.  Take following quote from Vice President Biden for example: 

“Well, people when I say that look at me and say, ‘What are you talking about? You’re telling me we have to go spend money to keep from going bankrupt?’” Biden said. “The answer is yes, I’m telling you.” 

Huh? 

We can apply Warren Buffet’s advice to not invest in companies where you can’t understand the business model to economic policy as well.  If someone describes a policy to you and it doesn’t make sense….then it really doesn’t make sense.  Deploying the flawed policy on a large scale only compounds the illogic.  

Attempts to manipulate prices and/or artificially stimulate demand are nothing new of course.  For example, many of us have read about FDR’s policy of slaughtering hogs in the 1930s because the price of pork was deemed too low.  

These attempts fail because no one can effectively set prices or judge the appropriate level of demand for a product.  What should the price of pork be?  How many cars should be manufactured and sold?  How about interest rates…well that’s for another discussion.  

I relayed the car destruction story to my wife as I was doing some work around the house.  As she handed me hammers, screwdrivers and other tools, she half listened as I gave all of the reasons why “Cash for Clunkers” didn’t make sense.  Throughout my speech she interjected her list of the things that needed fixing/updating in the house, the bedroom door, the dishwasher, etc.  

As I reached the crescendo of my tirade, I finished by saying, “Can you imagine destroying something that works just to get people to buy something new?”  Her soft brown eyes alternated between the sledgehammer lying on the floor and the dishwasher.  My wife smiled sweetly and said, “I think it’s a wonderful policy.” 

 

Have a great week,

 

 

Michael Bechara, CPA

Managing Director

Granite Consulting Group Inc.

mbechara@consultgranite.com

www.consultgranite.com

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Legislating Morality

Some time ago I read former Secretary of State James A. Baker’s book on his time at the State Department.  Baker served under the first President Bush during the tumultuous years of the late 80s and early 90s.  

The book was fascinating to me on many fronts, not least of which was discovering that some of the future stars of diplomacy were key members of Baker’s team.  Prominent figures such as future US Trade Representative Robert Zoellick, future Secretary of State Lawrence Eagleburger and future Chief Middle East Peace Negotiator Dennis Ross were key players in Baker’s inner circle.  

There was one point Baker made which, although not surprising, was unusually candid for a diplomat to make.  One of major challenges Baker faced during his tenure was “managing the building” as he put it.  What Baker meant by this was the management challenges of directing the people, processes and systems of the State Department itself. 

Not that the fall of the Soviet Union and the first Gulf War were insignificant topics for the Secretary of State to think through, but Baker clearly believed that management of the State Department bureaucracy was important enough to be mentioned alongside these momentous events as a major challenge.  

Anyone who has directed a medium or large scale project knows the challenges of managing people, processes and systems.  Indeed there comes a point in a manager’s life where he must become adept at “managing the building” as Baker put it.  

Look, we all know that generally the best lawyer does not become General Council, the best accountant does not become CFO and the best salesman does not become VP of Sales.  Sure technical skill is important to a certain level, but beyond that it’s the ability to “get things done” in an often chaotic, conflicted and ambiguous world that becomes a key differentiator amongst leaders.  

The most technically competent manager is doomed to a spectacular failure if he cannot convince, cajole, motivate or otherwise coerce the “machinery” underneath him to support his vision for his department or business. 

So the question begs, “How is this best accomplished?” 

A key device for getting the orchestra of people, processes and systems to play in tune is a well understood and followed set of policies.  

Now before we go any further, we need to state clearly that most corporate policies are grossly overgrown, disfigured beyond recognition by each successive “administration” and generally poorly followed and understood by most.  

When it comes to policies we have lost our way.  There are a few reasons why polices have degraded to the state described above, but one particular reason stands out.  We have falsely designed our policies to address all situations that they could possibly be faced in a business environment.  

How can companies allow this to happen? 

The narrative explaining this phenomenon goes something like this.  An employee makes a mistake or simply handles a situation in a way that those above him would have handled differently.  Rather than examine the character of the decision and the judgment of the employee, a policy is issued that attempts to address the specific situation the employee dealt with.  

Over time this cycle is repeated ad infinitum until corporate policies have proliferated to the point where their sheer volume cannot be digested, they conflict with one another and any attempt to follow them becomes a pursuit that drains attention away from the core business.  

The following is a partial laundry list of symptoms that occur when policies are used to manage daily behavior: 

  • Employees become conditioned to being overwhelmed with directives.  Being unaware of some missive from Corporate is now seen as acceptable and inevitable. 
  • Professional judgment is discarded in favor of “rule following.”   This in turn leads to myopic management in the best case and management paralysis in the worst case
  • The excessively detailed policies rarely comport with circumstances on the ground and a voluminous amount of policies typically begin to contradict one another.  This creates a sense of confusion and a feeling that, “Whatever I do will be the wrong thing.” 

 Aggregating these symptoms breeds a dangerous phenomenon that those in law enforcement call “contempt for the law.”  

When laws become so voluminous, unfair and contradictory, people do not follow them anymore.  In addition, when people become accustomed to not following policies or laws it can set the stage for greater departures from the policy or norms.  Conversely, when laws/policies makes sense and are enforced it creates an atmosphere of order.  

Mayor Giuliani’s administration in New York City was famous for bringing down violent crime in general by cracking down on lower level crimes such as vandalism, loitering and small time drug dealing.   

The best approach is to have a small number of well crafted policies that deal with approaches to business problems at a high level and then vigorously enforce them.  Attempts to prophesize all potential situations employees may encounter and then develop prescriptive remedies for each of these situations will rarely be successful.  

After all did James Baker have a policy for how to deal with the disintegration of the USSR?  How about a policy describing the steps to take after the invasion of Kuwait? 

Certainly not.  

Baker’s primary focus, like any good manager, was to select top talent, establish communication protocols and make sure everyone understood the goals of the Department.  Everything else was left to professional judgment.  

Have a great week, 

 

Michael Bechara, CPA

Managing Director

Granite Consulting Group Inc.

mbechara@consultgranite.com

www.consultgranite.com

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Infinite Desire

We all want things. 

Some things we need to survive; food, water, shelter, a 1970 Chevelle SS Convertible.  

Other things are not required for survival but make our life easier, central heating, dishwashers, communications equipment, a 1970 Chevelle SS Convertible. 

Finally there are the luxuries in life… like well.. a 1970 Chevelle SS Convertible.  

It is an inescapable, and for many, a very unbearable fact that resources are finite on this planet.  This does not comport well with human nature where desires and wants are infinite.  

Reconciling our infinite desires with our finite resources is accomplished through the resource allocation process.  The resource allocation process is founded on the comparison of costs and benefits.  This comparison stated colloquially is, “How much of what I want can I get with what I have.”  

An unfortunate development in recent years has been the severing of the relationship between costs and benefits and the slavish devotion to the benefit side of the equation.  

Some of the most egregious examples of this behavior can be found in housing.  For example, I have been to people’s homes where they have spent fortunes on setting up a commercial kitchen in their McMansion.  A six burner Viking stove, heavy duty stainless steel dishwasher, Grohe faucet and the nearly walk in refrigerators.  When inquiring about what they like to cook, one receives the stupefying answer, “Oh we usually just eat out.”  

The kitchen described above can cost easily over $100,000.  The benefit of all of this commercial equipment is not that it will produce large quantities of food to feed large numbers of people.  The sole benefit seems to be that it is pretty to look at.  

For another example, try asking any home builder which construction package upgrade sells better; the 2X6 exterior construction or the German Limestone floor upgrade? 

The 2X6 exterior construction results in a sturdier house and allows the walls to be filled with thicker insulation thereby reducing heating and cooling costs.  The German Limestone floor?  It looks pretty to walk on and if you get down on your hands and knees and carefully feel the surface you may detect that it is a tad smoother than regular ceramic tile.  

We all know which upgrade sells better. 

Perhaps the ultimate example of the single minded focus on benefits to the exclusion of costs is debt fueled consumer spending.  Proponents of this farcical approach to household management make many arguments why it is financially savvy to have ones balance sheet dominated by debt.  “I use debt smartly” and “Why should I spend my money when I can spend their (the bank’s) money!” are some of the more commonly heard justifications.  

It’s true that in the short run, if one doesn’t have enough money to buy what they want debt can be used to fulfill the purchase desire.  This works for awhile.  But sooner or later the debt must be paid back..with interest.   By subordinating our long terms interests to our short term desires, we succeed only in destroying our chances for long term prosperity.  

Permanent debt is slavery.  There are no two ways about it.  When one carries debt he is forced to work twice as hard, for he must not only pay back the principal, but also the interest. 

As we have continued descending from the peak of the “I want it and I want it now” years, the subject of resource allocation has suddenly become fashionable once again.  

Our clients have been asking us for more and more help in this area.  In fact, we are currently involved in a project where we are helping a company allocate their limited resources in the most effective manner.  

Companies are increasingly focused on how they can obtain the maximum benefits with better streamlined processes, simple automation and better trained people.  Many “facts of business” are being questioned.  For example, the idea of buying large expensive IT systems as a silver bullet for solving all process problems is slowly going out of fashion.  

Even the much counted on consumer has shifted towards paying down debt rather than its relentless accumulation.  See the following chart courtesy of the “Market Ticker” blog.  

Courtesy of Market Ticker

Courtesy of Market Ticker

 

http://market-ticker.denninger.net/uploads/KeyCharts/IncomeAssetsAndDebt.png

A couple of things to gather from this chart: 

  • A sharp drop in consumer debt at the tail end of the trend line
  • The relatively flat income over the past decades
  • A precipitous rise in government debt 

Consumers have begun to change their behavior.  As further evidence of this change, try doing an Internet search on topics of thrift and/or frugality.  The number of responses will amaze you.  

The internet is simply budding with websites about how to clip coupons and get more for your money.  This was one of my favorites: 

How to Shop For Free

We are seeing a shift towards rebalancing the cost benefit equation…with far more focus on the cost side.  

My dear friends, this is not a shift forward but rather a shift backwards.  Traditional American values encompassed quality, value and thrift.  Waste and excess were considered a negative trait and really a character flaw.  

We are currently reading the Little House on the Prairie series of books to the children.  For those who are unfamiliar with the series, they tell the story of families in rural America during the mid and late 1800s.  I leave you today with a quote from one of the books in the series; Farmer Boy.  In this scene Almanzo, a nine year old boy, is admiring the huge Belgian horses at the county fair with his Father.  

Father said, “Look at that muscle!  They pull a barn if hitched to it.”   

Almanzo asked him, “What’s the good of a horse that can pull a barn.  We don’t want to pull a barn.” 

“You’re right son”, Father said.  “It would be a waste to feed all that muscle.  You’re right”  

Have great week, 

 

Michael Bechara

Managing Director

Granite Consulting Group Inc.

mbechara@consultgranite.com

www.consultgranite.com

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In Honor of Labor Day

We rest. 

Hope everyone had a great Labor Day.  As for us, we were out of town until late last night.  

We look forward to writing next week’s post. 

Regards,

 

Michael Bechara, CPA
Managing Director

Granite Consulting Group Inc.

mbechara@consultgranite.com

www.consultgranite.com

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Cruel Summer

“A woman worries about the future until she gets married.  A man never worries about the future until he gets married.” – Unknown

The summer has nearly ended.  

This summer was strange.  We had cool rainy weather for days on end and even when the weather was warm there was a nagging feeling of coolness in the air.  From our vantage point here in New York’s Hudson Valley, after the day was spent and the sun was setting there was a coolness, a hint of icy air, that hung over the lake, the houses and the playgrounds.  

It certainly was not a traditional summer.  Then again, traditional behavior is something in very short supply these days.  

Our economic picture has been very similar to the summer.  Politicians, pundits and economists were telling us all summer that we have recovered from the recession and we should go back to spending freely and taking on new debt.  

There certainly was a lot of good news to be found during the summer.  We had a scorching run up in the stock market, existing home sales increased for four months in a row and Ben Bernanke was congratulated by many for “saving” the economy.  

But outside the strange micro climates of Washington DC and Lower Manhattan, people are hearing the good news but are still feeling that iciness hanging the air.  “Why doesn’t this feel like a recovery”, I hear many asking.  

As we sit here in Granite Consulting Group’s lavish headquarters overlooking Route 22, we share this unease.  Maybe we’ve been working too much, maybe we’re too dumb to realize that the boom times are here again or maybe, as the Shakespearean saying goes, “Something is rotten in the state of Denmark.”  

Our concern is, of course, not purely academic.  Like many of us we have investment decisions to make on behalf of our business and on behalf of the family.  Debt or Equities? Real Estate or Commodities? US Dollar or Foreign Currencies? 

Ah my friends, the Crown of State is indeed heavy.  

I am neither an investment expert nor a professionally trained economist.  I do know; however, that the most successful moments in my life are when I have relied on my intellect, formed my own views by thinking for myself, and trusted my gut feelings.  

With these thoughts as a framework, let’s analyze where we are today.  

Relying on intellect….. 

We fail to see any substantive reason for such a quick turnaround.  Let’s take a look at some of the recent “evidence” that we are headed for a recovery: 

1.  The stock market has risen approximately 50% in past few months.  Despite the many cries of, “the rally lives!” amongst the stock market sycophants, corporate insiders have been unloading stock at very high levels.  See this: 

Insider Trading and Investor Sentiment Signaling U.S. Stock Market Top

2.  The banks have recovered and are paying back TARP funds.  Actually, the delinquency rate is above 5% at many institutions, a level sufficient enough to wipe out a bank’s equity.  See this: 

Toxic Loans Topping 5% May Push 150 Banks to Point of No Return

3.  For the first time in five years, existing-home sales have increased for four months in a row, according to the National Association of Realtors.   

The housing market had been massively subsidized by the Fed.  The Fed has added to its balance sheet billions of housing debt on order to keep mortgages cheap and available.  In addition, there is the housing version of the “Cash for Clunkers” program where first time buyers are given $8,000 toward the purchase of their home.  This artificially support will not continue forever.  See this: 

http://www.moneymorning.com/2009/09/01/u.s.-housing-market/ 

  1. Finally, I stared at this chart for some time: 

http://www.ritholtz.com/blog/wp-content/uploads/2009/08/history-repeat.jpg

 

Thinking for one’s self…. 

We seem to be in a period of unreality.  The major TV network news programs seem desperate to report that everything is OK and will only get better.  The reality on the ground is a bit different.  

Everyone I am in contact with is preparing for bad times.  Clients are cutting costs right and left; friends and acquaintances incessantly talk about how they are scaling back and cutting down on expenses.  

From a wider pint of view, is this really just a recession?  There are too many major shifts happening in consumer behavior, energy supplies and international relations.  These major shifts typically take years to play out.  

The shrewd understand this and look ahead to what may come; alternatively, the myopic simply cannot imagine life without the old structures in place.  They vehemently believe that gross levels of consumer spending & debt, stable and cheap energy supplies and deficits being funded by countries in East Asia are permanent fixtures of life.  

As an example of what we are referring to, take a look at this: 

Rise of a New Era in Japan

The political party that ruled Japan for 50 years was swept aside in the recent election.  The new party’s agenda is to promote domestic demand for Japan’s products.  This means that Japanese savings may not be allocated toward the purchases of US Treasuries.  Moreover, the new party wants to spend money on social programs.  Japan’s massive US Treasury holdings may be a ripe source of funds for these programs.  

 

Now for the gut feelings….. 

This part of the equation is the most difficult to analyze objectively.  There is something specific about right now, the late summer looking into the fall that makes me uneasy about the next few weeks.  

I suppose I will just have to listen to my wife who often advises me, “Why worry, you’re not the President!” 

Perhaps the best way to sum it up would be to leave you with that old Phil Collins song and say, “I can feel it coming in the air tonight.” 

http://www.youtube.com/watch?v=3vYsy4LvyX8 

Have a great Labor Day,

 

Michael Bechara

Managing Director

Granite Consulting Group Inc.

mbechara@consultgranite.com

www.consultgranite.com

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