It’s tough for a business or even an estate to survive past the second generation. A good case in point is Forbes magazine and the empire assembled by Malcolm Forbes. Malcolm actually was the second generation. His father B.C. founded the magazine, but Malcolm built it into a very profitable enterprise that allowed him to buy Faberge eggs, a Fiji island, a large Colorado ranch, and a lot of other assets. Since Malcolm’s death, the family has sold a lot of the trinkets. But it’s biggest deal was to sell a minority stake in the company to Elevation Partners. The publishing business was fading when the deal was made in 2006. The deal had a few advantages. It put cash in the company, allowed the family to take over $100 million in cash out, and supposedly brought Elevation’s expertise in “new media” to help Forbes prosper in the digital age.
Somehow rival Fortune received some internal documents between Forbes and its lenders. The documents show what a bust the deal was for all concerned. Forbes ran in to cash flow problems, and Elevation’s investment is well under water. A line of credit had to be restructured in 2010 because Forbes was in default of key terms. It’s an interesting story.
J.P. Morgan (JPM) and six other lenders agreed to amend the loan in August 2010, lowering the monthly payment and adjusting the financial targets that Forbes Media would have to hit to be in compliance. In a twist of the knife, the amendment also set tough conditions for getting rid of Alvarez & Marsal. It stipulated that one of three things had to happen: the sale of Investopedia, an online financial dictionary; the replacement of Steve Forbes as CEO; or the achievement of certain financial targets. That month Forbes sold Investopedia for $39.6 million. Steve Forbes stepped down in November, replaced by Mike Perlis, a media investor who had worked at Playboy and Ziff-Davis Publishing. Forbes met the stipulated financial targets. Alvarez & Marsal was dismissed.
The co-founder of Home Depot is the rare public figure who thinks carefully and speaks his mind without worrying about how people might react. He stood up to disgraced New York Attorney General and Governor Elliott Spitzer when almost no one else would criticize Spitzer. He’s one of the most popular guests on CNBC’s Squawk Box morning show. He appeared on Thursday morning and delivered another series of candid comments on the debt crisis, the political culture, the President, and more. You can catch his opening monologue here. A few of his thoughts:
I’m only assuming and maybe it’s a bad assumption, I’m assuming the president and his wife both went to college on scholarships because when you read the background, there was no enormous wealth to pay for tuition after tax. you know where that money comes from? it comes from rich people because every single day, every university in America loses money on every single student they admit. costs more to educate — so if you don’t endowments or annual giving by alumni, if you don’t have fat cats, it’s a perjorative in his mind, I wear it as a badge of honor, I say to a kid I did it a kid I did it you can do it.
The second monologue is here, and here’s an excerpt:
look at the earnings coming out of dupont, dow, look at these earnings coming out of these solid companies. they are doing it by learning how to leverage their expenses. if you want to hit expenses hard, head count. the single biggest — these health care plans and everything you’re making it even more imperative to take head count out because if you haven’t got head count you haven’t got free benefit costs.
Most people are fretting over the possibility of a failure to raise the debt limit leading to a U.S. default and perhaps a credit downgrade. Christopher Whalen isn’t worried. Whalen is a very astute banking analyst. He was well ahead of the crowd in identifying the problems and financial crisis before they occurred and has been on top of things since. Now, he says a crisis over the debt ceiling wouldn’t be such a bad thing. There would be pain for a lot of people, he acknowledges. But the overall results would be good, especially for the long term. He sees three benefits from a crisis. Among them:
But the third and most important side effect of the fiscal crisis in Washington is that people around the world will start to diversify both commerce and financial transactions out of dollars and into other currencies. Far from being a threat, I welcome such an evolution. The less of world trade and finance that flows through dollars, the less easy it will be for the Treasury to issue debt or for the Fed to monetize this borrowing on the backs of US consumers and businesses via steady, unrelenting inflation.
Of course Nobel Prize winning economist Paul Krugman rightly notes that a reduction in federal spending will result in pain for many Americans. But what he fails to tell these Americans, especially low income working people he pretends to love, is that the cost of the borrow and spend policies advocated by second generation New Dealers is persistent inflation, a diminution of purchasing power that is just as surely killing the hopes and dreams of all Americans.
John Hussman of the Hussman Funds says it all in his latest weekly commentary. Investment returns are low, and the prospects for higher returns from traditional investments for the next few years aren’t very good:
I continue to believe that the main window of inflation risk will begin in the back-half of this decade – not yet. Even so, we are already observing a sustained shift away from fiat currencies toward alternatives like gold (though there will certainly be fits and starts to that trend). Meanwhile, bond yields continue to offer very low yields-to-maturity, while credit spreads on corporate debt (even the riskiest types) have been squeezed as thin as they were in 2007. In stocks, on the basis of a wide variety of fundamentals, we expect the total return on the S&P 500 to average about 3.6% annually over the coming decade.
We’ve been minimizing our holdings of these traditional investments as the year as gone in. Instead, we seek investments with good value and above average but safe yields. We’re in investments such as mortgage securities purchased at discounts, preferred securities. and non-dollar investments. If you want to earn decent, safe returns in coming months, you need to get out of the usual comfort zone and consider unconventional assets and strategies.
There are a lot of people who say a ratings downgrade by one or more of the ratings firms would be disastrous for the U.S. and for holders of treasury debt. That could be, but there are good reasons to think it won’t be. It’s true that the debt of countries such as Greece declined sharply on the markets after ratings downgrades. But we need to make a distinction between countries that control their own currencies and those that don’t. Greece is tied into the European Monetary Union, so it doens’t control the currency. Investors seem to distinguish between the two types of sovereigns when analyzing their debt.
For example, Japan suffered ratings downgrades several times in the late 1990s and early 2000s. The market response was modest immediate increases in yields on the bonds. Six months after each downgrade, Japan’s yields were only a little higher than before the downgrades. Canada had a similar experience when it was downgraded in 1993. Its yields didn’t move much, either in absolute terms or relative to U.S. yields.
The main risk in the market is that a ratings downgrade causes a lot of selling, primarily because investment guidelines require various funds to sell. But a downgrade of treasury debt isn’t likely to cause such selling. Few investment guidelines or state laws require pension funds or others to sell treasuries immediately if they are downgraded. Foreign central banks that hold the bonds also aren’t going to sell suddenly. Federal banking regulators also aren’t likely to tell banks that downgraded treasury bonds aren’t sufficient capital. They did require banks to sell a lot of their mortgage securities during the crisis, but I think it’s unlikely they’ll do that with treasury bonds.
Markets tend to react in advance. Stocks and treasury bonds seem already to be pricing in the potential that there won’t be a debt ceiling deal by Aug. 2. Gold’s recent rise also seems to reflect that view. So, it’s likely that the potential for no deal and for a downgrade already are reflected in the markets.
You need to think like a fox, not like a hedgehog. That means you need to adapt to changes, test assumptions, and be ready to change. PIMCO’s Bill Benz applies this thinking to how global markets and investments changed over the years. The article makes a number of good points investors should consider. Some of the points are better for the large institutional investors that are PIMCO’s major clients, but most of the points apply to all investors. Benz suggests allocating assets based on risk instead of asset classes. You don’t want a traditional portfolio in which all or most of the risk is tied to major stock market indexes.
While Harvard, Yale and many of the more sophisticated players probably knew what they were doing, when it came to understanding and preparing for the tail risk scenarios that did in fact hit in 2008, many others – particularly those with shorter-term horizons and more immediate liquidity needs – were caught by surprise as events unfolded. What happened? Quite simply, while their portfolios appeared to be very well-diversified on paper, they in fact had enormous equity factor risk as their different public equity components (U.S., non-U.S., large-cap, small-cap, value, growth), along with their private equity, hedge fund, alternative, commodity, real estate, high yield and emerging market bond allocations, all became highly correlated and sold off simultaneously. The pain was even more acute for the highly leveraged players who were even less equipped to handle the heightened volatility.
Benz also suggests invests reconsider the assets they consider risk-free and those that are risky and also focus more on credit risk than interest rate risk when considering income investments.
Most of the world is focused on debt problems in the U.S. and Europe. But China, despite its fast-growing economy and new weight in the global economy, has its own debt problems, say researchers at Standard Charter. Local governments have debt loads that the analysts believe can’t be paid, and China’s banks that hold the debt aren’t in a position to absorb the losses. But the report isn’t predicting a new debt crisis that will roil the economy. Instead, the analysts believe China’s central government can step in to resolve the problem and pay the debt without causing a great deal of financial distress. China also is in need of reforms so the problem will not recur. From an article on AdvisorOne.com:
According to provisional figures from the China Banking Regulatory Commission (CBRC), about 2 trillion to 3 trillion renminbi ($300 billion to $450 billion) or 6% of GDP) of local government investment vehicle (or LGIV) loans are in trouble.
“We believe that repayment problems will likely spread across the country, and that a formal central-government led LGIV debt-resolution mechanism will soon be required. There are signs that Beijing is already considering some kind of bailout mechanism,” Green said.
In the short term, increased MoF transfers to local governments could be “a relatively easy way” to support these projects and maintain financial-sector stability, according to the report.
Take a look at this slideshow on Forbes web site. There’s nothing earthshaking here. It’s a compendium of one-time purchases and things many people don’t know how to calculate the value of. Examples include wedding gowns, graduation caps and gowns, travel-size products, and banking fees. There also are some of Forbes favorites: many mutual funds and efficient chariteis.
There’s a growing belief among politicians and market participants that default by the federal government isn’t the problem to worry about. Instead, the prospect of a ratings downgrade by the rating firms, especially Standard & Poor’s, is more likely and would be more costly.
A single downgrade might have limited market impact. But a move by all three main ratings agencies — S&P, Moody’s Investor Service and Fitch Ratings — would likely force huge investment funds that must hold only the safest of bonds to sell en masse. The scary headlines associated with a first-in-history downgrade also could cause smaller investors to panic and dump stocks.
A downgrade would mean the U.S. would pay higher interest rates instantly and indefinitely. That would have the ironic effect of increasing the budget deficit and debt, perhaps leading to another downgrade. There’s also a fear that a U.S. downgrade would lead to downgrades of many state and local governments. The thinking is those governments depend on federal money for part of their budgets. If the federal government has to reduce spending, the money going to state and local governments could be part of the reduction, causing them budget problems.
The real question is
how did these firms get into the position that they can dictate policy matters to our elected leaders? S&P says it will downgrade the U.S. unless any budget deal meets their definition of “credible.” While they frequently are referred to as “ratings agencies,” they’re not government entities. They’re private firms that were certified by the SEC as being the only firms whose credit ratings could be relied on by regulated investors such as money market funds and mutual funds. They don’t have the resources to analyze the federal government’s finances, just as they didn’t have the resources to evaluate all the mortgage securities to which they give AAA ratings before the financial crisis. Congress had the opportunity to take the power away from these failed entities in the Dodd-Frank Financial Reform law last year, but it chose not to do so. Now, it and the rest of us could be paying the price for this failure.
The administration publicly has been warning of the dire consequences of a failure to raise the debt limit while privately telling leading bank executives that a default isn’t going to happen, even if the limit is not raised by August 2, according to Fox News. But a default isn’t the only thing to worry about.
A senior banking official told FOX Business that administration officials have provided guidance to them that even though a default is off the table, a downgrade “is a real possibility for no other reason than S&P and Moody’s have to cover (themselves) since they’ve been speaking out on the debt cap so much.”
This guidance is a big reason why Wall Street has largely dismissed the possibility of default, and though the markets have been jittery amid the talk of default, they haven’t imploded as would be the case, many economists fear, if the nation missed a payment on its debt.
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