Archive for October, 2009
Friday, October 30th, 2009
“By the middle of next year, Internet surfers will be allowed to use Web addresses written completely in Chinese, Arabic, Korean, and other languages using non-Latin alphabets,” The New York Times reports. “In an action billed as one of the biggest changes in the Web’s history, the board of the Internet Corporation for Assigned Names and Numbers—or Icann—voted Friday during its annual meeting, held in Seoul, to allow such scripts in Internet addresses.”
Smeal’s John Jordan weighs in on the business implications and historical significance of this decision:
The expansion of the Internet domain name system from 37 Latin characters (26 letters, 10 digits, and a hyphen) to include character-based languages is a landmark event for the globalization of communications. More than 100,000 characters will eventually be added, so at one level the decision by Icann to accept the technical challenge (particularly, but not exclusively, at the level of the root name servers) is noteworthy. From a business standpoint, the decision marks a recognition of the growing importance of such character-based languages as Arabic, Chinese, Japanese, and Korean. Billions more people will be able to connect to the Internet using their native language and keyboards.
The decision raises a variety of fascinating questions. Given the rapid adoption of mobile Internet in the developing world, how will the availability of domain names in numerous character sets affect the design of smartphones for these markets? Given that Chinese relies on about 6,000 characters, for example, a RIM Blackberry-style keyboard would be difficult or impossible to implement. On the marketing front, how will global brands adapt to the wider availability of non-Latin representation online? How will native-language Internet naming affect literacy efforts and measurements? How will a vastly multiplied character set affect security efforts?
At another level, the action is a splendid piece of historical timing: The first Internet message was sent 40 years ago this week, and the Netscape Navigator browser launched 15 years ago this month. Predicting where the international, mobile Internet will be in even five years is impossible; coping with change of this magnitude at this speed is unprecedented in human experience.
Thursday, October 29th, 2009
With the housing bubble burst and the real estate economy forever changed, Smeal’s Austin Jaffe recently outlined ten principles to consider regarding the new real estate market. From his post on the Pennsylvania Association of Realtors’ blog, Just Listed:
1. The valuation of homes will no longer be a function of the appreciation potential (or growth option) in house prices. We expect an extended period of no price appreciation.
2. In markets where appreciation was a primary selling point, prices have sunk the fastest and declined by the largest percentages. These markets were where speculative fever struck the hardest (e.g., Arizona, California, Nevada and Florida).
3. Mortgage interest deductibility has little, if anything, to do with the returns to owning housing since tax shelter benefits are already capitalized into prices. The opportunity to deduct mortgage interest is likely to have benefitted the initial owners when the tax law was implemented in 1917; subsequent buyers just passed along the premium built into the price.
4. In the next several years, the market for residential real estate will be based primarily on the housing services available to its owners. Housing is all about housing services once again rather than about chasing tax shelter benefits, capital gains and refinancing to free up new equity.
5. Supply constraints on location will remain important. Special locations will continue to be in demand.
6. The decision to purchase a home will be based upon household consumption expectations and needs which are provided by this long-term, depreciating consumer durable. Housing has always been a consumer durable.
7. The real estate business will live on and prosper in this new world since households will continue to spend large portions of their budgets on housing services. The market for housing will remain strong without the inflated financial parameters of the past decade.
8. The speculative fever and over-leveraging of housing budgets, especially by low- and moderate-income households, will largely be a remnant of the past. Easy availability of credit will settle in as part of the history of the housing bubble.
9. If inflation and inflationary expectations are low, mortgage rates can be low. If economic growth is limited, mortgage rates can also be low. Historically low mortgage interest rates do not mean housing will be a good investment.
10. Over time, real estate prices will not likely change much but there will still be an active market for both new and existing housing stock. Housing will remain a major sector in the U.S.
Friday, October 23rd, 2009
“The Vatican announced a stunning decision Tuesday to make it easier for Anglicans to convert, reaching out to those who are disaffected by the election of women and gay bishops to join the Catholic Church’s conservative ranks,” The Associated Press reports. Smeal’s Glen Kreiner, who has conducted several studies on the organizational identity of the Episcopal Church, sees three ways this play out within the Anglican Church:
This week’s offer by the Pope to accept certain Anglican priests into the Catholic Church is an interesting and complicated turn of events.
First, and most readily apparent, is that it gives a certain subgroup of disaffected Anglican priests a place to go where they find themselves more “at home” with their beliefs.
Second, thinking with a longer-term view, it could provide added incentive for the global Anglican leadership to find palatable solutions for the conservatives in the Communion. Knowing that the Catholic option is on the table might make it even more important to have a viable, attractive option within the Communion.
Third, it should be noted that there would be considerable difficulties for the vast majority of Anglican priests to make this shift. Although conservative Anglicans find themselves aligned on many issues with Rome (e.g., homosexuality), there are many substantial issues of dissimilarity, especially that of authority—Anglicans are not accustomed to having a strong, central leader. Additionally, Anglicans cherish their history and identity, and a considerable aspect of that identity is blending elements of Catholicism and Protestantism rather than being one or the other.
Kreiner’s most recent research on the Episcopal Church has just been released as part of the church’s Around One Table initiative, which focuses on the main aspects of Episcopal identity, or what it means to be Episcopalian. Kreiner recently shared the results of another study with Smeal’s Research with Impact Web site. In this study, Kreiner explains how Episcopal priests manage work-life balance and what the rest of us can learn from them.
Thursday, October 22nd, 2009
As the H1N1 pandemic continues its spread around the world, many businesses, governments, and NGOs are learning that they are ill-prepared to handle such a disease outbreak. Earlier this year on Business Casual, Smeal’s Fariborz Ghadar warned of this scenario:
Some developed countries have systems to track, identify, and quarantine outbreaks such as this, but many developing countries simply cannot do it. Compounding the problem is the fact that very few national entities talk to one another. The current infrastructure leaves much to be desired. To manage potential pandemics, we need global mechanisms in place beforehand to handle situations like this as they arise, not after.
In his book Global Tectonics: What Every Business Needs to Know, co-authored by Erik Peterson of the Center for Strategic and International Studies, Ghadar elaborates on the weaknesses in our global health infrastructure and offers some solutions:
Countries need a global health infrastructure that responds quickly and effictively to epidemics … or to terrorist-induced disease outbreaks. In this era of increased economic and social integration, an outbreak in one country can develop into a global pandemic in a matter of days. As a result, governments, nongovernment organizations (NGOs), and private companies must devise health care solutions that cross borders as effectively as the infectious agents they work to contain.
International disease control will present vast opportunities and challenges to businesses operating in afflicted countries or working to provide containment products and services. The ability of these corporations, along with governments and NGOs, to react and respond to outbreaks, and to devise solutions that meet the health care needs of the world’s population, will be critical to continued global prosperity.
More specifically, what should businesses be doing to prepare for contingencies arising from natural or deliberate epidemics and disease-related volatility? First, they need to engage in scenario-analysis in order to begin to define their reactions in the event of an epidemic. Second, they should assess the extent to which international and national institutions are prepared for such contingencies—especially because public-private sector partnership is critical to defining and implementing solutions. Finally, the growing threat of bioterrorism suggests new possibilities for the private sector to marshal its resources and technological innovation in support of new biodefenses and procedures.
Wednesday, October 21st, 2009
The New York Times reports today that former Fed Chair Paul Volcker’s call to forbid commercial banks from mixing with investment banks is falling on deaf ears within the Obama administration. Volcker, head of the president’s Economic Recovery Advisory Board, believes keeping banks from owning and trading securities will keep them out of the trouble they have experienced in the current recession.
According to Smeal’s Jean Helwege, Volcker’s plan would likely make future economic crises less costly than this most recent one, however, it won’t keep the Fed from spending taxpayer dollars to bail out poorly run banks in the future.
More from Helwege:
Paul Volcker, former Federal Reserve chairman and adviser to President Obama, recommends that we go back to the good old days when commercial banks and investment banks were kept separate. The logic now, as it was in the 1930s when Glass-Steagall was enacted, is that investment banking is too risky a business to mix with consumer deposits. In a speech earlier this fall Volcker stated, “I do not think it reasonable that public money—taxpayer money—be indirectly available to support risk-prone capital market activities simply because they are housed within a commercial banking organization.” Volcker recognizes that his views are hardly “progressive,” noting that “people say I’m old-fashioned and banks can no longer be separated from nonbank activity.” But he points out, “That argument brought us to where we are today.”
The $64,000 question is whether we would be where we are today had we pursued different regulatory policies leading up to this recession. Whatever the policies regarding mergers of banks and investment houses, we would have experienced a housing bubble and it would still have popped, bringing massive losses to homeowners across the nation and a retrenchment in homebuilding that would last years. Fannie Mae and Freddie Mac would still be in conservatorship, having overleveraged themselves to peddle the American dream of home ownership. Investors would still have lost money on mortgage-backed securities built on subprime mortgages. Those losses would still have led to concerns that safer mortgages might default, expanding the breadth of losses in the MBS market. We would be in a deep recession as a result of the housing downturn regardless of whether banking activities are segregated.
However, Volcker’s arguments are more geared toward preventing the next near-Great Depression and redefining the policy responses to such crises. If we still had Glass-Steagall, we would not have seen the merger of JPMorgan Chase (a bank) with Bear Stearns (an investment bank) in 2008, which might have prevented people from expecting a similar deal with Lehman and some other commercial bank and thus the fallout when Lehman was dropped like a stone from the list of firms “too big to fail.” If we still had Glass-Steagall, Goldman would never have decided to convert to a bank holding company and potentially would not have received the largesse it did. Nor would Bank of America have had its arm twisted into acquiring Merrill Lynch. Bringing back Glass-Steagall might bring us back to the days of more narrowly defined policy responses by the Federal Reserve. And it might mean that the next crisis will not be worse than today’s now that the investment banks are so strongly encased in the regulatory womb of the Federal Reserve.
Reinstating Glass-Steagall is a simple response to a complex issue. While simple may be all we can swallow, it remains the case that the Federal Reserve has not been successful in striking a balance between helping out the economy and condoning bad behavior by financial firms. The Fed identified AIG as strong enough to get a loan (i.e., the Fed was sure it would get paid back) and Lehman as incapable of repaying new funds. It deemed CIT too unimportant to deserve aid but was willing to help out the entire money market mutual fund industry. The Fed’s willingness to extend its hand to all manner of poorly run firms is a concern and Volcker’s efforts to rein in this independent agency may help, but unfortunately it’s more likely that the Fed will find another way to expand its role as lender of last resort regardless of whether we revert to Glass-Steagall.
Tuesday, October 20th, 2009
The Securities and Exchange Commission is appealing a federal judge’s dismissal of an insider-trading case against Dallas Mavericks owner Mark Cuban. The Wall Street Journal reports:
In July, a federal judge in Dallas threw out the SEC’s case against Mr. Cuban that centered on trading in 2004. The SEC alleged Mr. Cuban sold his entire 6 percent stake in Mamma.com, an Internet-search company, after learning from company executives of a plan to raise money in a private stock offering. Such offerings often result in a drop in the stock price. By selling, the SEC alleged, Mr. Cuban avoided $750,000 in losses.
Mr. Cuban and his lawyers denied that he was under any obligation not to trade on the information he received.
Below, Smeal’s Steven Huddart breaks down the case against Cuban and explains how insider trading law applies:
The United States Securities and Exchange Commission (SEC) argues that Mark Cuban committed fraud when he sold stock in Mamma.com at a high price just after he had been told by Mamma.com’s CEO that more stock would soon be offered at a low price. Cuban’s position is that, notwithstanding a promise to keep the information confidential, he had no obligation to refrain from trading in Mamma.com stock.
Whether such trading is legal depends on how the rules apply to circumstances. From the complaint, it seems Cuban initially thought it was against the rules for him to trade: After the CEO told him about the offering, Cuban said, “Well, now I’m screwed. I can’t sell.” Cuban must have changed his mind, because he later sold the stock and thereby avoided a loss.
The Cuban case is interesting because it is near the frontier between what is permissible and impermissible use of “material non-public information”—this is the wording used in rules promulgated by the SEC. Those rules have changed over time and are often subject to new interpretations.
One way for the SEC to affect the interpretation of these rules is to launch an action [Securities and Exchange Commission v. Mark Cuban, Civil Action No. 3-08-CV-2050-D (SF)] against a trader that the Commission believes broke them.
Insider trading prohibitions must strike a balance between two public interests: (1) maintaining investor confidence and (2) promoting price efficiency.
Markets with a lot of fraud lack integrity and investor confidence suffers. The Supreme Court has opined that “although informational disparity is inevitable in the securities markets, investors likely would hesitate to venture their capital in a market where trading based on misappropriated nonpublic information is unchecked by law.”
On the other hand, if informed traders do not buy undervalued assets and sell (or short) overvalued assets, then the economic force that moves price toward worth is stymied. Mark Cuban exemplifies this force. He dumped his Mamma.com stock when he found out it was overvalued. And, he funds Sharesleuth.com, “an independent Web-based reporting aimed at exposing securities fraud and corporate chicanery.” Cuban gets the information Sharesleuth uncovers before it is published on the Web. He trades on this information, too.
The policy question to ask in each case is: Are we better for Mark Cuban’s actions?
Wednesday, October 14th, 2009
New York’s highest court today is hearing arguments in a case to decide whether the state constitution prevents the government from seizing private property, including homes and small businesses, to turn it over to a private developer. About a dozen property owners in Brooklyn are fighting to protect their properties, which the New York State Urban Development Corp., a government agency, wants to confiscate and turn over to the owners of the New Jersey Nets to build a new arena for the NBA team.
The case mirrors the 2005 U.S. Supreme Court case Kelo v. City of New London, which resulted in a 5-4 decision stating that the U.S. Constitution allows the government to seize private property and turn it over to redevelopment companies.
In a 2006 op-ed, Smeal’s Austin Jaffe wrote about the Kelo case and weighed in on the importance of private property rights:
Susette Kelo purchased a home in Connecticut in 1997 and the next year the city of New London decided to allow the New London Development Corp.—a private organization—to condemn Kelo’s and six other families’ homes for the purpose of “economic development.” The plan was to assemble these sites as part of a $270 million global research facility to be built by Pfizer, which had a plant nearby.
Kelo argued that her property rights were violated because eminent domain is a power reserved only for government and only when it meets the public use requirement in the Fifth Amendment’s takings clause. Ultimately, the court decided that local governments have the right to take private property and give these rights to other private parties in the interest of economic development. The decision outraged spectators across the political spectrum, and for good reason.
Private property is a vital part of our economy. Without the protection of property and the rights associated with it, families are uprooted, small businesses are bankrupted, and entire communities are destroyed in favor of newer, more profitable enterprises that benefit wealthy investors and enrich public coffers. Even worse, our entire economic prosperity becomes vulnerable.
Monday, October 12th, 2009
An editorial in today’s Wall Street Journal takes aim at proposals floating in Washington to offer tax credits to firms that hire new empoyees. “One plan would grant a $3,000 tax credit to employers for each new hire in 2010,” according to the editorial. ”Under another, two-year plan, employers would receive a credit in the first year equal to 15.3 percent of the cost of adding a new worker, an amount that would be reduced to 10.2 percent in the second year and then phased out entirely.”
Smeal’s Charles Enis argues that these tax incentives, which were tried once in the late 1970s resulting in mixed reviews, are unfair to firms who resisted layoffs during the recession, essentially punishing them for keeping their employees working. By making the tax code even more complicated, however, the tax credits will likely succeed in creating some jobs—in tax accounting.
More from Enis:
Imagine buying a car and learning that you could have made the purchase a week later and received a generous rebate. Firms that resisted layoffs may have a similar sentiment if one of the proposed credits is enacted. These credits reward firms that increase the size of their workforce or add significant hours of work. Firms that laid off many workers will likely increase their hiring when the economy improves and thus benefit from the credit. What about firms that absorbed the cost of keeping excess people? What do they get?
The income tax regime is one of many policy tools available to combat economic difficulties. However, the tax code has been summoned to remedy virtually all of our problems (e.g., pollution, health care, energy, etc.). These well intentioned provisions have contributed to the complexity of a tax system described as “a national disgrace” as far back as President Carter.
The tax system as a policy tool raises cost-benefit dilemmas. Straightforward provisions result in benefits to unintended taxpayers at substantial costs to the Treasury relative to the economic goals achieved. Provisions targeted toward intended taxpayers must be laden with many complex features (e.g., phase-outs, caps, restrictions, uncertainties regarding extensions, etc.). Such features frustrate small businesses, which are important job creators. The jobs credit that was enacted for 1977-1978 had a mathematical specification too complex to explain in this short blog post. The former credit was tied to the federal unemployment tax regime, while the proposed credit is tied to the Social Security tax regime, and is likely to be even more complex after it is “tweaked” by political compromises.
Whether the ’77-‘78 jobs credit was successful depends more on one’s political perspective then on evidence from rigorous economic analyses. The complexity and poor promotion of the ’77-’78 credit rendered the findings of traditional analyses tenuous and mixed. Economists believe that the new hires from the ’77-’78 credit were largely lower-skilled workers, which is not a bad thing. However, the tax code already contains the Work Opportunity Tax Credit, a provision aimed at encouraging businesses to hire individuals who are disadvantaged in the labor market. Is another credit really necessary or can the existing credit be updated?
The enactment of the proposed jobs credit will significantly increase the hours of work for tax practitioners, IRS personnel, tax form printers, HR departments, software writers, and hopefully many otherwise unemployed Americans.
Wednesday, October 7th, 2009
The Wall Street Journal reports that “the Obama administration’s pay czar is planning to clamp down on compensation at firms receiving large sums of government aid by cutting annual cash salaries for many of the top employees under his authority.”
However, according to Smeal’s Tim Pollock, it’s going to take a cultural shift, not a government edict, to really rein in exorbitant CEO salaries:
The problems with executive compensation can’t be solved with regulation, or by a pay czar, because they are deeply embedded in the culture of Wall Street, in the case of financial services, and in the culture and belief systems of the executive suite and boardroom, more generally.
CEOs and senior executives, while always well compensated, were not always as lavishly compensated as they are today. What we see now largely began in the 80s when stock options began to be used more widely as a consequence of proscriptions derived from the logic of agency theory, which argues that executives will act in a risk averse and self-interested manner unless provided with incentives to behave otherwise.
The problems with stock options are that, unlike actual stock, which can go down in value as well as up, stock options can’t go below zero in value. And until recently they received favored accounting treatments that essentially made them a “free good”. As a consequence of the former problem, executives really face no downside risk from stock options. Thus, rather than take reasonable risks, they are more likely to take excessive risks because they bear no real costs from failure; they just might not (in theory) make any gains. However, even this rarely comes to pass, because boards swoop in to reprice the options, or to give the executives new grants at lower exercise prices, in order to keep them sufficiently “motivated.”
This problem was exacerbated by the Clinton administration’s well-meaning but disastrous attempt to limit executive pay by limiting its tax deductibility unless it was tied to firm performance, which meant more stock options. Further, the favored-accounting treatment options received made them a cheap form of compensation, so it was easy for boards to load CEOs up with huge option grants that turned into phenomenal amounts of compensation in the 1990s’ bull market, which, by the way, raised all boats, even those of marginal and incompetent CEOs. Because it was easier to ascertain the value of an executive’s compensation package due to the new reporting requirements implemented in 1993, CEO pay packages could be compared to each other, and the executive pay arms race was off and running.
Today, the use of stock options, and the phenomenal levels of pay that CEOs, investment bankers, and traders receive, have become taken-for-granted parts of the corporate landscape. Restricting or modifying the pay of a few executives and firms by the government will not lead to a sustained change in pay practices, and could lead to the poaching of the competent individuals left at the troubled firms by firms not bound by these restrictions. We’ve already seen that it’s business as usual again at most Wall Street firms.
Until executives feel real pressure from shareholders, and each other, to rein in pay, not much is going to change, I’m afraid. This isn’t going to happen as long as the mantra of “maximize shareholder value” (And what does this even mean? Over what time frame? In what way? If firms compete successfully in delivering the best products and services, won’t this happen anyway?) continues to drive decision making.
Thursday, October 1st, 2009
Smeal’s Fariborz Ghadar appeared on public television’s “World Focus” recently to discuss Iran’s recently revealed uranium enrichment plant and its implications for today’s talks in Geneva on Tehran’s nuclear ambitions: