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Wednesday 4 February 2009
Obama to Limit Executive Pay at Companies Getting Aid
President Barack Obama will announce today that he’s imposing a cap of $500,000 on the compensation of top executives at companies that receive significant federal assistance in the future, responding to a public outcry over Wall Street excess.
Obama to Limit Executive Pay at Companies Getting Aid
By Heidi Przybyla and Christopher Stern 4 February 2009
(Bloomberg) -- President Barack Obama will announce today that he’s imposing a cap of $500,000 on the compensation of top executives at companies that receive significant federal assistance in the future, responding to a public outcry over Wall Street excess.
Any additional compensation will be in restricted stock that won’t vest until taxpayers have been paid back, according to an administration official, who requested anonymity. The rules will force greater transparency on the use of corporate jets, office renovations and holiday parties as well as golden parachutes offered to executives when they leave companies.
Public outrage over compensation has been building since October, when Congress passed a $700 billion financial-rescue plan. An $18.4 billion bonus payout in 2008 to Wall Street executives and employees further inflamed Americans.
“People are still getting huge bonuses despite the fact that they’re getting taxpayer money, which I think infuriates the public,” Obama said in an interview last night with CNN.
Obama and Treasury Secretary Timothy Geithner will announce the plan at 11 a.m. today. The guidelines will focus on companies that, going forward, take “exceptional” amounts of bailout money from the Treasury, as Citigroup Inc. and American International Group Inc. have in the past.
They won’t be retroactive to companies that have already taken rescue money, although those companies must agree to strict monitoring and oversight, the official said.
Populist Fury
The populist backlash is hitting the halls of Congress.
Senator Claire McCaskill, a Missouri Democrat who proposed last week a bill to limit compensation, has been inundated with messages from voters fuming over corporate executives. Senator Jeff Sessions, an Alabama Republican, said small-business owners are calling the bonuses “obscene.” Senator Dianne Feinstein, a California Democrat, said her constituents are “really upset,” and Senator Sam Brownback, a Kansas Republican, said he’s hearing about it at the grocery store.
The anger has been fuelled by accounts of bonuses, the use of private jets and the purchase of luxury goods.
Those headlines collide with reports of the U.S. losing an average of almost half a million jobs every month, 1.1 million homes being foreclosed upon in the last four months, retirement savings dwindling and bankruptcies mounting.
Severance-Pay Ban
McCaskill’s legislation would block companies from paying executives more than the U.S. president’s $400,000 annual salary as long as the companies rely on federal aid. The compensation cap would cover salary, bonuses and stock options.
“These people are idiots,” McCaskill, 55, said Jan. 30 on the Senate floor. “You can’t use taxpayer money to pay out $18 billion in bonuses. What planet are these people on?”
Senator Byron Dorgan, a North Dakota Democrat, said he plans to introduce an amendment requiring companies that accept bailout money to make their bonuses public.
The complaints over executive compensation have sparked a backlash from at least one executive.
JPMorgan Chase & Co. Chief Executive Officer Jamie Dimon said this week that it’s wrong for politicians to criticize Wall Street pay without differentiating between companies where compensation is commensurate with performance.
“It’s unfair to talk about us as one,” Dimon, who was paid $1 million last year and didn’t accept a bonus, said at a conference in New York. “Not every company was responsible.”
Bad Tradeoff
Still, lawmakers are responding to anger among constituents like Carol Brata, a secretary from Dearborn, Michigan. Michigan has shed 319,700 jobs over the past three years, more than any other state and has the highest unemployment rate, at 10.6 percent.
“They ended up with excessive pay, and the tradeoff was that families had to go without insurance or a job and their homes tumbled,” Brata said.
Thomas Mann, a scholar at the Brookings Institution in Washington, said the anger hasn’t been this pronounced since Franklin Roosevelt took office during the depths of the Great Depression in 1933.
Roosevelt gave voice to a public rage against “a generation of self-seekers,” in his inaugural address. “Practices of the unscrupulous money changers stand indicted in the court of public opinion,” said Roosevelt.
$145 Billion
Goldman Sachs Group Inc., Morgan Stanley, Merrill Lynch & Co., Lehman Brothers Holdings Inc. and Bear Stearns Cos. awarded their employees a cumulative $145 billion in bonuses from 2003 through 2007, according to estimates based on company reports.
That’s more than the annual gross domestic product of the Philippines. Lehman has since gone bankrupt, while Bear Stearns and Merrill have been taken over by commercial banks.
Wall Street firms’ pay has traditionally been tied to performance of the companies. As the bonus portion of employees’ pay has grown, many started to expect it regardless of performance. Some employees have been receiving incentives “for basically turning up,” Barclays Plc Chairman Marcus Agius said last week at the World Economic Forum in Davos.
“There’s this fallacy that everybody will leave” if bonuses are restricted, said William Cohan, a former investment banker at Lazard Ltd. and JPMorgan and author of “The Last Tycoons” about Lazard. “What do they do? They push paper around. Where else can you get paid $500,000 to do that?”
Congressional Hearings
Senate Banking Committee Chairman Christopher Dodd plans to summon executives whose companies received taxpayer aid to testify before his committee and explain their bonuses.
Representative Barney Frank, chairman of the House Financial Services Committee, said executives must accept compensation limits if they want more government aid.
Frank, whose panel will also hold a hearing next week on the subject, said the government’s handling of the crisis “has helped bring public anger to a fever pitch, to the point where it would prevent us from going forward in a lot of ways unless we alleviate it, and you can’t alleviate it with hocus pocus.”
As the public outcry over Wall Street pay escalated, top executives at Morgan Stanley, Bank of America Corp., Goldman Sachs Group Inc. and Citigroup Inc. have agreed to forego bonuses. Governments in the U.K., Switzerland and France have pressured banks, including UBS AG and Royal Bank of Scotland Group, Plc to limit executive pay after taxpayer-funded bailouts.
‘Too Draconian’
Bank of America CEO Kenneth Lewis, who was paid $24.8 million in total compensation in 2007, won’t receive a bonus this year after the lender reported a $1.8 billion loss in the fourth quarter, its first deficit since 1991.
Efforts to curb executive pay may backfire, said Scott Minerd, chief executive officer and chief investment officer of Guggenheim Partners Asset Management, who helps oversee more than $30 billion in stocks and bonds.
The Obama measure is “too draconian and too arbitrary, and doesn’t take into account free-market forces,” said Minerd. “Companies that need the most talented people to fix their problems won’t be able to pay them.”
TO MOST casual observers, the fact that the Dow Jones Industrial Average (DJIA) has bounced back every time it dipped below 8,000 points over the past few months - even when there is bad news - suggests that the 8,000 mark is where the 'support' or the magical 'market bottom' lies. This means that as soon as the index nears 8,000 on the downside, chartists and traders will start calling a 'buy' on the market.
Closer examination, however, reveals that the bounces around the 8,000 mark are simply a function of the way the index is constructed. Because the Dow is price-weighted, it is also inherently flawed.
In Thoughts from the Frontline weekly newsletter dated Jan 23, writer John Mauldin correctly points out that the divisor for the DJIA is 7.964782, which means that for every dollar an index stock falls, the DJIA falls 7.964782 points, regardless of the stock's capitalisation.
As a result, if the stock of Microsoft, with a price of US$17 and a market cap of US$156 billion, was to crash to zero, the DJIA would only lose 135 points (17x7.964782). But if the same was to happen to IBM, with a smaller market cap of US$124 billion but a higher share price of US$92, it would cost the index to lose a whopping 700 points.
Now consider the four financial stocks currently in the DJIA - Citigroup (US$3.90), Bank of America (US$6.78) Amex (US$16.70) and JPMorgan (US$25.43) - using last Thursday's prices.
If all four stocks were to crash to zero, the DJIA would only lose 300 plus points, not that huge a loss in the context of the market, yet imagine the repercussions on the US and global economies if these four institutions collapsed totally.
Most of the news on Wall Street these days centres on the crippled financial and auto sectors. But because the share prices of these companies are now so low, these stocks do not affect the DJIA by much (General Motors' shares, for example, are now just above US$3).
In other words, because the index stocks most affected by bad news are already battered to rock-bottom levels, the DJIA doesn't seem to fall much when bad news is released, thus giving the mistaken impression of resilience to adverse news and of strong support around 8,000 points.
By right, these financial and auto stocks should have been removed from the index, given that it has been past practice to replace stocks whose prices drop below US$10.
For some reason, the DJIA's guardians have been reluctant to do the same now, possibly because of the political fallout that might ensue - imagine the repercussions of removing pillars like Citigroup or General Motors.
This then leads to the inevitable conclusions: the DJIA is not comparable over time; the only reason the DJIA appears well-supported around 8,000 is because the collapsed financial and auto components have not been replaced as they should have been; and that movements in large-price stocks are magnified because the index is heavily skewed in favour of these counters.
If the index was to be correctly re-balanced by removing the battered financials and autos and replacing them with stocks with prices above US$10, you'd have to wonder whether the 8,000 mark would hold as well as it has.
You'd also have to dismiss arguments that it is safe to buy since the index is at its lowest level in many years because historical comparisons are invalid - unless, of course, the same re-balancings that were done in the past are performed now.
How to overcome such a large distortion? The most commonly accepted solution is to use market-cap weights, but this too has its drawbacks.
Last Thursday, the market-cap weighted Straits Times Index (STI) rose 0.64 of a point to 1,766.72, a move that a casual observer might interpret to indicate a mixed or quiet session. Far from it - if you stripped out warrants, the rest of the market only recorded 95 rises against 188 falls, a gain/loss ratio that indicated market weakness rather than a mixed session.
Peer beyond the numbers and it would have been readily evident that an 11-cent rise by big-cap SingTel to $2.76 pushed the STI up 11 points, thus creating the mistaken impression of a slightly firm or mixed market. Assuming SingTel had not risen and everything else remained the same, the STI would have recorded an 11-point fall, leading a casual observer to correctly surmise that the market had been weak that day.
Similarly, on Dec 29 last year, a sudden 87 per cent surge by CapitaMall Trust in the final minute of trading helped push the STI up 54 points, once again creating the mistaken impression of a session that was much stronger than it really was.
Still, using market-cap weights is probably a much better way to capture what's going in a stock market, at least for most of the time and over longer time periods. The alternative is to use price weights, which has been shown to lead to even more inaccurate conclusions.
On this last point, local investors - chartists and fundamentalists alike - would do well to take into account just how distorted a picture the price-weighted DJIA paints of the US economy and market, while also pondering whether 8,000 is really where its 'support' lies. If Dow at 8,000 is artificial, where does this leave the STI?
The US can still be an economic superpower and have much influence in the world, but the days of being a globe-girdling military power are over. The US foreign policy elite just hasn’t accepted it yet, notes Ivan Eland.
When you stop to think about it, people measure how well their lives are going not by their absolute state of being but by their situation relative to their expectations.
For example, a poor person in a developing country may be ecstatic about getting a pair of shoes for the first time; in contrast, a billionaire may commit suicide after he loses $100 million in a down market.
The same is true for nations. The American elite has enjoyed the United States’ dominant status in the world since World War II and became thoroughly drunk with US superiority in the last two decades after the demise of the Soviet Union left the country as the only superpower.
This elite is resistant to accepting the reality that a multi-polar world will soon be at hand.
This reality will arrive much sooner if the US does not retract its informal overseas empire, reduce the bloated defense budget, and act with more humility overseas.
Even before the US-led global financial meltdown, the far-flung US empire of overseas military bases, US-dominated alliances, and profligate military meddling in other nations’ affairs was terribly overextended. The US accounted for 20 percent of the world’s GDP but 43 percent of its defense spending.
Yet like the elites of the British and French Empires, which became exhausted by being on the winning side of two world wars, the US elite refuses to realize that the country needs to retract its cost-ineffective empire if it wants to avoid demise as a great power.
After being occupied by the Nazis through much of World War II, the French ignored their post-war financial precariousness and tried to rekindle their imperial glory by retaking Indochina.
When the spent French were not up to the task in the mid-1950s, Harry Truman and his successors made the foolish commitments for the United States to finance them, assist them, and later take over for them. Reluctant even then to give up their colonial mindset, the French then tried and failed to militarily suppress Algerian independence in the 1950s and 1960s.
Similarly, the British attempted to keep their Middle East dominance long after the sun had set on the British Empire. Even after their ill-fated invasion of Egypt in 1956 — with the help of Israel and the irrepressible France — the British didn’t pull back from the Middle East until the early 1970s.
Currently, the United States has its finger in the dike in two pointless nation-building quagmires in Iraq and Afghanistan, while Osama bin Laden is most likely in Pakistan and the US is being severely debilitated by an economic meltdown at home.
Of course, Barack Obama was not responsible for any of this mess but may become captive of the interventionist US elite in trying to deal with these calamities.
Economically, the Bush/Obama period ominously resembles the Hoover/FDR period, when a common recession was converted into a Great Depression by interventionist government policies that refused to let natural market mechanisms bring the country out of the economic slump.
Let’s hope the current economic calamity doesn’t get this bad; but that we can no longer afford to maintain an extensive overseas empire hasn’t yet seemed to sink into the minds of the US elite.
Another historical parallel is the Vietnam period, when Lyndon Johnson tried to run a guns-and-butter policy — funding the Vietnam War and expanding the government’s reach domestically by funding Great Society programs.
Now, the Bush/Obama governments are trying to fund two wars while also spending at least $1.5 trillion to trick American consumers into thinking the government can save them from an inevitable recession — all the while making that downturn worse. On top of that, the bulge of baby boomers will soon begin retiring, thus putting pressure on collapsing Social Security and Medicare systems.
During Vietnam and the Great Society, LBJ honestly — if irresponsibly — funded the ballooning government with a 10-percent surtax on corporate and income taxes.
No such honesty has come from the Bush administration, as it cut taxes while raising federal spending dramatically. Now that an economic meltdown has occurred, Obama is understandably reluctant to increase taxes — and has proposed lowering them further — while continuing Bush’s spending spree to try to fool the country out of its economic collapse.
So we are staring trillion-dollar budget deficits in the face. The federal budget is $3.1 trillion dollars a year but two-thirds of that is on autopilot — that is, guaranteed payments to people regardless of economic conditions under Social Security, Medicare, Medicaid, Food Stamps, and unemployment compensation or interest payments on the already staggering national debt.
Of the $1.1 trillion that can be more easily altered (discretionary spending), more than half of that is the monstrous defense budget. Thus, defense spending should and will eventually become a big target for Obama’s promised future fiscal restraint.
Obama has good instincts on withdrawing from Iraq but is slowly being co-opted by the foreign policy elites and military bureaucracy. His instincts on Afghanistan are likely to be “unhelpful.” He wants to double down on a nation-building conflict that is stoking Islamist fundamentalism and will be much harder to “win” than Iraq (although the US hasn’t won Iraq by a long shot).
Obama needs to wise up, totally withdraw from both Iraq and Afghanistan, focus on finding bin Laden in Pakistan, withdraw from the US Empire, and dramatically slash the US defense budget.
The US needs to take this revolutionary tack as one step toward renewing what is still the world’s largest economy — that on which all indices of US national power ultimately depend.
The US can still be an economic superpower and have much influence in the world, but the days of being a globe-girdling military power are over. The US foreign policy elite just hasn’t accepted it yet.
Ivan Eland is Director of the Center on Peace & Liberty at The Independent Institute. Dr. Eland has spent 15 years working for Congress on national security issues, including stints as an investigator for the House Foreign Affairs Committee and Principal Defense Analyst at the Congressional Budget Office. His books include The Empire Has No Clothes: US Foreign Policy Exposed, and Putting “Defense” Back into US Defense Policy.
BP, the UK-based oil and gas group, faces “challenging” times but its leaders are determined to “hold our course”, Tony Hayward, chief executive, said on Tuesday as the company reported a 39 per cent rise in profits to a record $25.6bn for 2008.
He also warned that the company needed an oil price of $50-$60 a barrel to be able to pay for its capital spending and dividends without borrowing, compared with a price of about $40 on Tuesday morning.
However, the fall in oil and gas prices since the summer cut BP’s fourth-quarter profits to $2.6bn on a replacement cost basis, stripping out the effect of price changes on the valuation of inventories.
That was a fall of 24 per cent from the equivalent period of 2007, and 74 per cent from the record profit of more than $10bn in the third quarter of last year.
The shares initially fell 4.5 per but recovered through the day to end the session 2½p higher at 487¼p.
Excluding $900m one-off costs, mostly related to tax charges on TNK-BP, the Russian joint venture, the performance was in line with the consensus of analysts’ forecasts, however.
Mr Hayward said the company’s underlying performance was “continuing to show powerful recovery”.
He added: “We have established very strong momentum in 2008 in our drive to strip out overhead costs and to make BP simpler and more efficient. There will be no let-up in that momentum, which gives me great confidence that we are well positioned for the challenge of the next few years.”
BP cut 3,000 jobs last year, and plans to exceed 5,000 by the middle of this year, from a workforce that was 98,000 at the end of 2007.
Mr Hayward said the group’s priorities were clear: to “continue to invest in safe and reliable operations, pay the dividend, and invest to grow our upstream business.”
BP suggested there could be a modest reduction in capital spending this year, forecasting organic spending of $20bn-$22bn for the year, compared with $21.7bn last year.
That is a more cautious stance than Royal Dutch Shell, BP’s leading European rival, which plans a slight increase in organic capital spending to $31bn-$32bn this year.
BP’s dividend has been rising faster than Shell’s: it was up 22 per cent in US dollar terms for last year as a whole, compared with an 11 per cent rise for Shell, although BP’s most recent quarterly rise was an increase of just 3.5 per cent to 14 cents.
BP will need oil prices of $50-$60 a barrel for cash flows to cover those capital spending and dividend plans, although it expects that break-even point will fall as a result of cost-cutting, higher production and performance improvements in the refineries.
If oil stays below that level, then BP’s debts will rise, although its net debt at about $25bn is at the lower end of what it considers to be acceptable gearing – as measured by the ratio of debt to debt plus equity – of 20-30 per cent.
Mr Hayward also hailed what he described as “exceptional performance” in securing access to new resources in North America. The year had been “one of the best in the last decade for exploration,” he added, with significant discoveries in the US Gulf of Mexico, Angola, Algeria, Egypt and the North Sea.
Those discoveries would mean BP had replaced more than the total of last year’s production in its oil and gas reserves.
In the refineries business, which in the US has suffered from a succession of problems and poor performance, Mr Hayward said BP was “working hard to restore earnings momentum.”
He said BP had closed “about $2bn of the performance gap we saw a year ago between us and our competitors.” The business has recovered sharply after making losses in 2007. However, it made a $416m profit in the fourth quarter, compared with a $1.97bn profit in the third quarter, as refining margins were squeezed.
In alternative energy, BP’s wind power capacity more than doubled over the year to 432 megawatts in the fourth quarter. However, its solar cell manufacturing capacity fell, as a result of a fire at its Tata BP joint venture in India.
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Obama to Limit Executive Pay at Companies Getting Aid
By Heidi Przybyla and Christopher Stern
4 February 2009
(Bloomberg) -- President Barack Obama will announce today that he’s imposing a cap of $500,000 on the compensation of top executives at companies that receive significant federal assistance in the future, responding to a public outcry over Wall Street excess.
Any additional compensation will be in restricted stock that won’t vest until taxpayers have been paid back, according to an administration official, who requested anonymity. The rules will force greater transparency on the use of corporate jets, office renovations and holiday parties as well as golden parachutes offered to executives when they leave companies.
Public outrage over compensation has been building since October, when Congress passed a $700 billion financial-rescue plan. An $18.4 billion bonus payout in 2008 to Wall Street executives and employees further inflamed Americans.
“People are still getting huge bonuses despite the fact that they’re getting taxpayer money, which I think infuriates the public,” Obama said in an interview last night with CNN.
Obama and Treasury Secretary Timothy Geithner will announce the plan at 11 a.m. today. The guidelines will focus on companies that, going forward, take “exceptional” amounts of bailout money from the Treasury, as Citigroup Inc. and American International Group Inc. have in the past.
They won’t be retroactive to companies that have already taken rescue money, although those companies must agree to strict monitoring and oversight, the official said.
Populist Fury
The populist backlash is hitting the halls of Congress.
Senator Claire McCaskill, a Missouri Democrat who proposed last week a bill to limit compensation, has been inundated with messages from voters fuming over corporate executives. Senator Jeff Sessions, an Alabama Republican, said small-business owners are calling the bonuses “obscene.” Senator Dianne Feinstein, a California Democrat, said her constituents are “really upset,” and Senator Sam Brownback, a Kansas Republican, said he’s hearing about it at the grocery store.
The anger has been fuelled by accounts of bonuses, the use of private jets and the purchase of luxury goods.
Those headlines collide with reports of the U.S. losing an average of almost half a million jobs every month, 1.1 million homes being foreclosed upon in the last four months, retirement savings dwindling and bankruptcies mounting.
Severance-Pay Ban
McCaskill’s legislation would block companies from paying executives more than the U.S. president’s $400,000 annual salary as long as the companies rely on federal aid. The compensation cap would cover salary, bonuses and stock options.
“These people are idiots,” McCaskill, 55, said Jan. 30 on the Senate floor. “You can’t use taxpayer money to pay out $18 billion in bonuses. What planet are these people on?”
Senator Byron Dorgan, a North Dakota Democrat, said he plans to introduce an amendment requiring companies that accept bailout money to make their bonuses public.
The complaints over executive compensation have sparked a backlash from at least one executive.
JPMorgan Chase & Co. Chief Executive Officer Jamie Dimon said this week that it’s wrong for politicians to criticize Wall Street pay without differentiating between companies where compensation is commensurate with performance.
“It’s unfair to talk about us as one,” Dimon, who was paid $1 million last year and didn’t accept a bonus, said at a conference in New York. “Not every company was responsible.”
Bad Tradeoff
Still, lawmakers are responding to anger among constituents like Carol Brata, a secretary from Dearborn, Michigan. Michigan has shed 319,700 jobs over the past three years, more than any other state and has the highest unemployment rate, at 10.6 percent.
“They ended up with excessive pay, and the tradeoff was that families had to go without insurance or a job and their homes tumbled,” Brata said.
Thomas Mann, a scholar at the Brookings Institution in Washington, said the anger hasn’t been this pronounced since Franklin Roosevelt took office during the depths of the Great Depression in 1933.
Roosevelt gave voice to a public rage against “a generation of self-seekers,” in his inaugural address. “Practices of the unscrupulous money changers stand indicted in the court of public opinion,” said Roosevelt.
$145 Billion
Goldman Sachs Group Inc., Morgan Stanley, Merrill Lynch & Co., Lehman Brothers Holdings Inc. and Bear Stearns Cos. awarded their employees a cumulative $145 billion in bonuses from 2003 through 2007, according to estimates based on company reports.
That’s more than the annual gross domestic product of the Philippines. Lehman has since gone bankrupt, while Bear Stearns and Merrill have been taken over by commercial banks.
Wall Street firms’ pay has traditionally been tied to performance of the companies. As the bonus portion of employees’ pay has grown, many started to expect it regardless of performance. Some employees have been receiving incentives “for basically turning up,” Barclays Plc Chairman Marcus Agius said last week at the World Economic Forum in Davos.
“There’s this fallacy that everybody will leave” if bonuses are restricted, said William Cohan, a former investment banker at Lazard Ltd. and JPMorgan and author of “The Last Tycoons” about Lazard. “What do they do? They push paper around. Where else can you get paid $500,000 to do that?”
Congressional Hearings
Senate Banking Committee Chairman Christopher Dodd plans to summon executives whose companies received taxpayer aid to testify before his committee and explain their bonuses.
Representative Barney Frank, chairman of the House Financial Services Committee, said executives must accept compensation limits if they want more government aid.
Frank, whose panel will also hold a hearing next week on the subject, said the government’s handling of the crisis “has helped bring public anger to a fever pitch, to the point where it would prevent us from going forward in a lot of ways unless we alleviate it, and you can’t alleviate it with hocus pocus.”
As the public outcry over Wall Street pay escalated, top executives at Morgan Stanley, Bank of America Corp., Goldman Sachs Group Inc. and Citigroup Inc. have agreed to forego bonuses. Governments in the U.K., Switzerland and France have pressured banks, including UBS AG and Royal Bank of Scotland Group, Plc to limit executive pay after taxpayer-funded bailouts.
‘Too Draconian’
Bank of America CEO Kenneth Lewis, who was paid $24.8 million in total compensation in 2007, won’t receive a bonus this year after the lender reported a $1.8 billion loss in the fourth quarter, its first deficit since 1991.
Efforts to curb executive pay may backfire, said Scott Minerd, chief executive officer and chief investment officer of Guggenheim Partners Asset Management, who helps oversee more than $30 billion in stocks and bonds.
The Obama measure is “too draconian and too arbitrary, and doesn’t take into account free-market forces,” said Minerd. “Companies that need the most talented people to fix their problems won’t be able to pay them.”
Why the Dow is holding at 8,000
By R SIVANITHY
February 2, 2009
TO MOST casual observers, the fact that the Dow Jones Industrial Average (DJIA) has bounced back every time it dipped below 8,000 points over the past few months - even when there is bad news - suggests that the 8,000 mark is where the 'support' or the magical 'market bottom' lies. This means that as soon as the index nears 8,000 on the downside, chartists and traders will start calling a 'buy' on the market.
Closer examination, however, reveals that the bounces around the 8,000 mark are simply a function of the way the index is constructed. Because the Dow is price-weighted, it is also inherently flawed.
In Thoughts from the Frontline weekly newsletter dated Jan 23, writer John Mauldin correctly points out that the divisor for the DJIA is 7.964782, which means that for every dollar an index stock falls, the DJIA falls 7.964782 points, regardless of the stock's capitalisation.
As a result, if the stock of Microsoft, with a price of US$17 and a market cap of US$156 billion, was to crash to zero, the DJIA would only lose 135 points (17x7.964782). But if the same was to happen to IBM, with a smaller market cap of US$124 billion but a higher share price of US$92, it would cost the index to lose a whopping 700 points.
Now consider the four financial stocks currently in the DJIA - Citigroup (US$3.90), Bank of America (US$6.78) Amex (US$16.70) and JPMorgan (US$25.43) - using last Thursday's prices.
If all four stocks were to crash to zero, the DJIA would only lose 300 plus points, not that huge a loss in the context of the market, yet imagine the repercussions on the US and global economies if these four institutions collapsed totally.
Most of the news on Wall Street these days centres on the crippled financial and auto sectors. But because the share prices of these companies are now so low, these stocks do not affect the DJIA by much (General Motors' shares, for example, are now just above US$3).
In other words, because the index stocks most affected by bad news are already battered to rock-bottom levels, the DJIA doesn't seem to fall much when bad news is released, thus giving the mistaken impression of resilience to adverse news and of strong support around 8,000 points.
By right, these financial and auto stocks should have been removed from the index, given that it has been past practice to replace stocks whose prices drop below US$10.
For some reason, the DJIA's guardians have been reluctant to do the same now, possibly because of the political fallout that might ensue - imagine the repercussions of removing pillars like Citigroup or General Motors.
This then leads to the inevitable conclusions: the DJIA is not comparable over time; the only reason the DJIA appears well-supported around 8,000 is because the collapsed financial and auto components have not been replaced as they should have been; and that movements in large-price stocks are magnified because the index is heavily skewed in favour of these counters.
If the index was to be correctly re-balanced by removing the battered financials and autos and replacing them with stocks with prices above US$10, you'd have to wonder whether the 8,000 mark would hold as well as it has.
You'd also have to dismiss arguments that it is safe to buy since the index is at its lowest level in many years because historical comparisons are invalid - unless, of course, the same re-balancings that were done in the past are performed now.
How to overcome such a large distortion? The most commonly accepted solution is to use market-cap weights, but this too has its drawbacks.
Last Thursday, the market-cap weighted Straits Times Index (STI) rose 0.64 of a point to 1,766.72, a move that a casual observer might interpret to indicate a mixed or quiet session. Far from it - if you stripped out warrants, the rest of the market only recorded 95 rises against 188 falls, a gain/loss ratio that indicated market weakness rather than a mixed session.
Peer beyond the numbers and it would have been readily evident that an 11-cent rise by big-cap SingTel to $2.76 pushed the STI up 11 points, thus creating the mistaken impression of a slightly firm or mixed market. Assuming SingTel had not risen and everything else remained the same, the STI would have recorded an 11-point fall, leading a casual observer to correctly surmise that the market had been weak that day.
Similarly, on Dec 29 last year, a sudden 87 per cent surge by CapitaMall Trust in the final minute of trading helped push the STI up 54 points, once again creating the mistaken impression of a session that was much stronger than it really was.
Still, using market-cap weights is probably a much better way to capture what's going in a stock market, at least for most of the time and over longer time periods. The alternative is to use price weights, which has been shown to lead to even more inaccurate conclusions.
On this last point, local investors - chartists and fundamentalists alike - would do well to take into account just how distorted a picture the price-weighted DJIA paints of the US economy and market, while also pondering whether 8,000 is really where its 'support' lies. If Dow at 8,000 is artificial, where does this leave the STI?
Accepting the End of the US Empire
2009-02-03
The US can still be an economic superpower and have much influence in the world, but the days of being a globe-girdling military power are over. The US foreign policy elite just hasn’t accepted it yet, notes Ivan Eland.
When you stop to think about it, people measure how well their lives are going not by their absolute state of being but by their situation relative to their expectations.
For example, a poor person in a developing country may be ecstatic about getting a pair of shoes for the first time; in contrast, a billionaire may commit suicide after he loses $100 million in a down market.
The same is true for nations. The American elite has enjoyed the United States’ dominant status in the world since World War II and became thoroughly drunk with US superiority in the last two decades after the demise of the Soviet Union left the country as the only superpower.
This elite is resistant to accepting the reality that a multi-polar world will soon be at hand.
This reality will arrive much sooner if the US does not retract its informal overseas empire, reduce the bloated defense budget, and act with more humility overseas.
Even before the US-led global financial meltdown, the far-flung US empire of overseas military bases, US-dominated alliances, and profligate military meddling in other nations’ affairs was terribly overextended. The US accounted for 20 percent of the world’s GDP but 43 percent of its defense spending.
Yet like the elites of the British and French Empires, which became exhausted by being on the winning side of two world wars, the US elite refuses to realize that the country needs to retract its cost-ineffective empire if it wants to avoid demise as a great power.
After being occupied by the Nazis through much of World War II, the French ignored their post-war financial precariousness and tried to rekindle their imperial glory by retaking Indochina.
When the spent French were not up to the task in the mid-1950s, Harry Truman and his successors made the foolish commitments for the United States to finance them, assist them, and later take over for them. Reluctant even then to give up their colonial mindset, the French then tried and failed to militarily suppress Algerian independence in the 1950s and 1960s.
Similarly, the British attempted to keep their Middle East dominance long after the sun had set on the British Empire. Even after their ill-fated invasion of Egypt in 1956 — with the help of Israel and the irrepressible France — the British didn’t pull back from the Middle East until the early 1970s.
Currently, the United States has its finger in the dike in two pointless nation-building quagmires in Iraq and Afghanistan, while Osama bin Laden is most likely in Pakistan and the US is being severely debilitated by an economic meltdown at home.
Of course, Barack Obama was not responsible for any of this mess but may become captive of the interventionist US elite in trying to deal with these calamities.
Economically, the Bush/Obama period ominously resembles the Hoover/FDR period, when a common recession was converted into a Great Depression by interventionist government policies that refused to let natural market mechanisms bring the country out of the economic slump.
Let’s hope the current economic calamity doesn’t get this bad; but that we can no longer afford to maintain an extensive overseas empire hasn’t yet seemed to sink into the minds of the US elite.
Another historical parallel is the Vietnam period, when Lyndon Johnson tried to run a guns-and-butter policy — funding the Vietnam War and expanding the government’s reach domestically by funding Great Society programs.
Now, the Bush/Obama governments are trying to fund two wars while also spending at least $1.5 trillion to trick American consumers into thinking the government can save them from an inevitable recession — all the while making that downturn worse. On top of that, the bulge of baby boomers will soon begin retiring, thus putting pressure on collapsing Social Security and Medicare systems.
During Vietnam and the Great Society, LBJ honestly — if irresponsibly — funded the ballooning government with a 10-percent surtax on corporate and income taxes.
No such honesty has come from the Bush administration, as it cut taxes while raising federal spending dramatically. Now that an economic meltdown has occurred, Obama is understandably reluctant to increase taxes — and has proposed lowering them further — while continuing Bush’s spending spree to try to fool the country out of its economic collapse.
So we are staring trillion-dollar budget deficits in the face. The federal budget is $3.1 trillion dollars a year but two-thirds of that is on autopilot — that is, guaranteed payments to people regardless of economic conditions under Social Security, Medicare, Medicaid, Food Stamps, and unemployment compensation or interest payments on the already staggering national debt.
Of the $1.1 trillion that can be more easily altered (discretionary spending), more than half of that is the monstrous defense budget. Thus, defense spending should and will eventually become a big target for Obama’s promised future fiscal restraint.
Obama has good instincts on withdrawing from Iraq but is slowly being co-opted by the foreign policy elites and military bureaucracy. His instincts on Afghanistan are likely to be “unhelpful.” He wants to double down on a nation-building conflict that is stoking Islamist fundamentalism and will be much harder to “win” than Iraq (although the US hasn’t won Iraq by a long shot).
Obama needs to wise up, totally withdraw from both Iraq and Afghanistan, focus on finding bin Laden in Pakistan, withdraw from the US Empire, and dramatically slash the US defense budget.
The US needs to take this revolutionary tack as one step toward renewing what is still the world’s largest economy — that on which all indices of US national power ultimately depend.
The US can still be an economic superpower and have much influence in the world, but the days of being a globe-girdling military power are over. The US foreign policy elite just hasn’t accepted it yet.
Ivan Eland is Director of the Center on Peace & Liberty at The Independent Institute. Dr. Eland has spent 15 years working for Congress on national security issues, including stints as an investigator for the House Foreign Affairs Committee and Principal Defense Analyst at the Congressional Budget Office. His books include The Empire Has No Clothes: US Foreign Policy Exposed, and Putting “Defense” Back into US Defense Policy.
BP ahead 39% to record $25.6bn
By Ed Crooks
February 3 2009
BP, the UK-based oil and gas group, faces “challenging” times but its leaders are determined to “hold our course”, Tony Hayward, chief executive, said on Tuesday as the company reported a 39 per cent rise in profits to a record $25.6bn for 2008.
He also warned that the company needed an oil price of $50-$60 a barrel to be able to pay for its capital spending and dividends without borrowing, compared with a price of about $40 on Tuesday morning.
However, the fall in oil and gas prices since the summer cut BP’s fourth-quarter profits to $2.6bn on a replacement cost basis, stripping out the effect of price changes on the valuation of inventories.
That was a fall of 24 per cent from the equivalent period of 2007, and 74 per cent from the record profit of more than $10bn in the third quarter of last year.
The shares initially fell 4.5 per but recovered through the day to end the session 2½p higher at 487¼p.
Excluding $900m one-off costs, mostly related to tax charges on TNK-BP, the Russian joint venture, the performance was in line with the consensus of analysts’ forecasts, however.
Mr Hayward said the company’s underlying performance was “continuing to show powerful recovery”.
He added: “We have established very strong momentum in 2008 in our drive to strip out overhead costs and to make BP simpler and more efficient. There will be no let-up in that momentum, which gives me great confidence that we are well positioned for the challenge of the next few years.”
BP cut 3,000 jobs last year, and plans to exceed 5,000 by the middle of this year, from a workforce that was 98,000 at the end of 2007.
Mr Hayward said the group’s priorities were clear: to “continue to invest in safe and reliable operations, pay the dividend, and invest to grow our upstream business.”
BP suggested there could be a modest reduction in capital spending this year, forecasting organic spending of $20bn-$22bn for the year, compared with $21.7bn last year.
That is a more cautious stance than Royal Dutch Shell, BP’s leading European rival, which plans a slight increase in organic capital spending to $31bn-$32bn this year.
BP’s dividend has been rising faster than Shell’s: it was up 22 per cent in US dollar terms for last year as a whole, compared with an 11 per cent rise for Shell, although BP’s most recent quarterly rise was an increase of just 3.5 per cent to 14 cents.
BP will need oil prices of $50-$60 a barrel for cash flows to cover those capital spending and dividend plans, although it expects that break-even point will fall as a result of cost-cutting, higher production and performance improvements in the refineries.
If oil stays below that level, then BP’s debts will rise, although its net debt at about $25bn is at the lower end of what it considers to be acceptable gearing – as measured by the ratio of debt to debt plus equity – of 20-30 per cent.
Mr Hayward also hailed what he described as “exceptional performance” in securing access to new resources in North America. The year had been “one of the best in the last decade for exploration,” he added, with significant discoveries in the US Gulf of Mexico, Angola, Algeria, Egypt and the North Sea.
Those discoveries would mean BP had replaced more than the total of last year’s production in its oil and gas reserves.
In the refineries business, which in the US has suffered from a succession of problems and poor performance, Mr Hayward said BP was “working hard to restore earnings momentum.”
He said BP had closed “about $2bn of the performance gap we saw a year ago between us and our competitors.” The business has recovered sharply after making losses in 2007. However, it made a $416m profit in the fourth quarter, compared with a $1.97bn profit in the third quarter, as refining margins were squeezed.
In alternative energy, BP’s wind power capacity more than doubled over the year to 432 megawatts in the fourth quarter. However, its solar cell manufacturing capacity fell, as a result of a fire at its Tata BP joint venture in India.
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