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My perspectives as an investor and consumer

So you’re saying, “There’s a chance.”

zebraOne of the many funny scenes in the movie, “Dumb and Dumber” involves an exchange between Lloyd (Jim Carrey) and Mary (Lauren Holly).  Lloyd is wondering about the probability of a future with Mary:

Lloyd: What are my chances?

Mary: Not good.

Lloyd: You mean, “Not good” like one out of a hundred?

Mary: I’d say, more like one out of a million.

Lloyd: So you’re telling me there’s a chance.  Yeah!

The reaction of investors on March 18th seemed similar to that of Lloyd’s as they digested the statement by Ken Lewis, the CEO of Bank of America.  He stated that his company could pay back the $45 billion it received from the Troubled Assets Relief Program (TARP) by the end of 2009 or early 2010.  The price of the stock shot up 22% that day.

This got me thinking about “rhetoric” and the perception it creates in the minds of the audience.  Notice the use of the phrase, “could pay back.”  The intended effect here was that of using the phrase, “will pay back” without the negative legal and psychological ramifications of actually making such a definitive statement.

The reaction that such a statement generated in the stock price of Bank of America is what elicited this post.  Executives of corporations and politicians see it as their job to put as positive a spin on an issue as possible while staying within the legal bounds.  Corporate and political public relations (PR) departments are in the business of using the imagination of the audience and causing them to project what is possible as something that is probable or even highly probable.

What does this mean?  There is a distinction between possibility and probability.  Simply put, that which is possible may not be probable, while that which is probable has to be possible.  In other words, the likelihood of an outcome increases when you move it from the realm of the possible to that of the probable.

What does this have to do with rhetoric?  The intent of rhetoric in the world of business and politics is two fold:

  1. To get people to perceive that which is merely possible as actually being probable
  2. To minimize or eliminate liability from the statements that are made

Let’s take a look at a couple of examples, one from the corporate world and the other from politics:

Corporate.  Ken Lewis, the CEO of Bank of America says that the company could pay back $45 billion by the end of 2009.  This is actually within the realm of possibility.  But things that are merely within this realm do not provide enough actionable information for an investor.  I cannot make an investment decision based solely on this information because the company could just as well not pay back the money.  However, if the executive can make me think that this is highly probable, then I have something to build an investment thesis on.  It would go something like this…

The company pays back the TARP money.  They are excluded from discussions about banks that are going to be nationalized.  Management is, therefore, free to run the company in a manner that’s in the best interest of the shareholder as opposed to the government.  Bonuses for highly talented people are dictated by the company’s compensation committee, not the government.  This becomes a tool for poaching talent from other nationalized or semi-nationalized banks.  The company, as a result, is able to run a business that is more efficient than their nationalized counterparts.  As an investor, this would make the company a candidate for my investment dollars.  Therefore the spring-loaded effect on Bank of America’s stock price on March 18th.

If this does not pan out and the company is unable to pay back the money, they minimize their liability by saying that they never made a definitive statement to that effect.  It was only a possibility.  The company has succeeded in capturing current upside and minimizing future downside.

Politics.  Here is a case with similar intentions but contrasting results to the corporate example.  I remember even when the recession was underway, President George W. Bush and Senator John McCain were sounding like a broken record emphasizing that the fundamentals of the economy were strong.  Their intention was to keep the country, as a whole ,from going into panic mode.  It is possible that the country would not go into a deep recession, but probability showed otherwise.  They were trying to get the American people to project what was possible as that being highly probable.  If called to account, they would try to minimize liability by saying that the “fundamentals of the economy” actually referred to something like the integrity, optimism, entrepreneurial spirit, and work ethic of the American people.  However, as the popular saying goes, “The road to hell is paved with good intentions.”  The administration and Senator’s intentions were instead seen as ignorance, arrogance, and subterfuge and contributed significantly to the results of the subsequent elections.

Here are the lessons for consumers/citizens/investors:

  • Realize that it is the job of corporate executives and politicians to present any situation in a positive light.
  • It is not your job to receive it at face value.
  • The explicit statements may not contain much actionable material.
  • The interesting material is implicit as is the case with the work of art shown above by Victor Vasarely, considered by many to be the father of Optical Art (Op-Art).
  • Learn to read between the lines and be diligent about it.
  • Ask yourself questions like, “What is the real information here?” and “What is intended merely as a projection?”

“One in a million” could mean that you have a chance or very little chance.  Which one, as a consumer or investor, are you going to pick as being actionable?

Filed under: Business, Politics, Psychology, , , , ,

Do you know where your money is?

paper_money_macroOn February 26th, President Obama laid out his administration’s budget proposal for 2010.  The entire document, with a great marketing title of “A New Era of Responsibility,” contains 112 pages of words and an additional 21 pages of tables.  Believe it or not, this is actually a summary of the detailed version that will be released in April.  Ironically this administration makes it no easier to understand how our government is spending our money.  In fact, the US Government Accountability Office has complained about this ambiguity in budget proposals for the past twelve years.  I point this out to you because we should not confuse strategy with ineptitude.  I would probably employ ambiguity as well, if I were they.  In the chapter, “On Military Strategy,” the Huainanzi has this to say about the use of ambiguity:

“It is important that strategy be unfathomable, that form be concealed, and that movements be unexpected, so that preparedness against them is impossible.  What enables a good general to win without fail is always having unfathomable wisdom and a modus operandi that leaves no tracks.”

Unless someone knows clearly what you are up to, they cannot hold you accountable.  When it comes to the democratic process, an uninformed electorate is one that can be easily swayed.  Rhetoric is a politician’s friend, whereas clearly delineated items in a financial statement are not.  This is not to say that financial statements are immune to manipulation but the task is more cumbersome than the spin of a wordsmith.

I looked around the web to see if anyone had succinctly presented all the information contained in the budget proposal.  I could not find any that were comprehensive enough.  So I decided to undertake the task.  My goal was to distill everything down to two or three tables which can be understood by anyone within a few minutes.  I must confess that this task took me days to reasonably connect the dots.

The federal fiscal year starts on October 1st and runs through September 30th of the following year.  The budget has a spending side (outlays) and a tax revenue side (receipts).  There are two basic categories of spending: mandatory and discretionary.  Mandatory spending contains entitlement programs, such as Social Security and Medicare, which are provided by law.  This accounts for approximately 60% of annual outlays.  Discretionary spending is appropriated annually by Congress and can be split into defense and non-defense spending.  Defense spending typically absorbs 50-60% of the discretionary outlays.

Table 1 itemizes federal outlays by governmental agencies.  obamabudgetoutlays2009Click on the table to see it in detail.  The agencies are listed in decreasing order of the amount allocated to them annually.  Federal spending is projected to be $3.9 trillion in 2009, an increase of ~$1 trillion from 2008.  $497 billion of it is allocated to the Treasury Department for the Troubled Asset Relief Program (TARP) and a placeholder for potential financial stabilization.  Even after the one-time allocation to the Treasury expires, federal outlays only settle to the ~$3.6 trillion level for the remainder of President Obama’s current term.  The slack is going to be picked up by mandatory spending for the departments of Health and Human Services, Social Security Administration, and “Other Mandatory Programs,” which are conveniently not listed.  The Department of Defense will see spending levels drop from ~$700 billion (including the cost of Iraq and Afghanistan war) to $670 billion in 2010, a decrease of less than 1% of total federal spending.

Actual spending amounts for “Other Mandatory Programs” are not listed anywhere.  obamabudgetmandatory2009The best I could do was look at the contribution of mandatory spending by various agencies to the budget deficit.  Table 2 lists these contributions.  This is an example of the ambiguity that I am referring to.  You’ll notice several agencies with “No Significant Change.”  From a strategy perspective, this looks much better than listing the actual amounts of spending.  Spending cuts can be made to look rather large when actual spending amounts are not given.  For example, a $500 million spending cut seems large but is insignificant if the reduction comes from an agency that sees $500 billion in annual spending (0.1% spending cut).  The biggest contributor to the increase in 2009 deficit, from the mandatory spending category, is the Department of Treasury.  Notice how convoluted this statement sounds.  Ambiguity.  The less we know, the fewer questions we ask.

$250 billion is allocated to the Treasury in 2009 as a placeholder for the potential stabilization of financial markets.  The Department of Education will see some changes, as well.  Pell grants will be converted from the discretionary category to the mandatory.  Entitlements for financial intermediaries under the Family Federal Education Loan Program will be eliminated.

Health reform initiatives will begin in 2011 and be ramped up during the President’s second term (2013-2016).  During this period savings will be wrung to the tune of $75 billion annually through Health Savings and limiting tax liability from itemized deductions to 28 percent.

Table 3 summarizes the Federal Budget and compares it with the last two obamabudgetsummary2009years of the previous administration.  The revenue side of the budget (receipts) comes mainly from taxes of various forms.  Individual income taxes (45%), Social Insurance taxes like Social Security and Medicare (36%), and Corporate taxes (12%) contribute the bulk of receipts.  They are estimated to decrease this year and the next primarily due to job losses and shrinking of corporate profits.  Couple that with increased federal spending and deficits are projected to increase almost four fold to $1.7 trillion in 2009 and settle around $600 billion by 2012.  Even more shocking are the numbers associated with our federal debt, which is projected to increase by 60% from $10 trillion in 2008 to $16 trillion in 2012.

If I told you that my personal financial plan over the next four years is to live increasing below my means (greater deficits) and increasing my debt by 60% would you consider this era of mine as being responsible?  If a publicly traded corporation told you that it is going to be losing money on its operations at a greater rate and increasing its debt load by 60% over the next four years, would you consider this management to be responsible and the company to be a highly attractive investment?  Yet our government considers this to be “A New Era of Responsibility.”

My advise to you would be to pay NO ATTENTION to the words.  Follow the numbers instead and let them narrate the true story.  At least you will be in a position to decide whether you like the story or not.

Filed under: Economy, Government, , , , , , ,