Will We Ever Learn? Risky Mortgages are Back!

September 3rd, 2019

Just over 10 years ago, the US experienced a recession like none it had seen since the Great Depression of the 1930s.  Much of the blame for the recession fell on the mortgage industry.  Our brilliant politicians supposedly put checks and balances in place to prevent people from taking out mortgages they could not afford.  Apparently, lenders and borrowers have figured out ways around these regulations.  From the Wall Street Journal:

More than a decade after home loans triggered the worst financial crisis in a generation, the strict lending requirements put in place during its aftermath are starting to erode. Home buyers with low credit scores or high debt levels as well as those lacking traditional employment are finding it easier to get credit.

The loans have been rebranded. Largely gone are the monikers subprime and Alt-A, a type of mortgage that earned the nickname “liar loan” because so many borrowers faked their income and assets. Now they are called non-qualified, or non-QM, because they don’t comply with post crisis standards set by the Consumer Financial Protection Bureau for preventing borrowers from getting loans they can’t afford. (Emphasis added.)

Borrowers took out $45 billion of these unconventional loans in 2018, the most in a decade, and origination is on track to rise again in 2019, according to Inside Mortgage Finance, an industry research group. Such mortgages aren’t guaranteed by government agencies and typically charge higher interest rates than conventional loans. https://www.wsj.com/articles/mortgage-market-reopens-to-risky-borrowers-11566379802?mod=searchresults&page=1&pos=9

As I read this article, I thought about a meeting that occurred early in my career at I.D. Images.  We were talking about rebranding our “error” reports.  Internally, they had developed a bad reputation and we were considering using a different name to report mistakes we made.  We were debating the issue and a colleague finally said, “You can call it what you want but poop is still poop.” 

We can call these mortgages what we want but they’re still not conventional mortgages.  At the peak in 2005, over $600 billion in subprime mortgages were originated in the US.  That didn’t end well in 2007.  We’re a long way from that number, but the trend is not our friend.  Pay attention to subprime mortgage originations.  If they keep going up, it will be time to get worried. 


Are There Any Fiscal Conservatives Left?

August 26th, 2019

Last week, the US Treasury Department released its Monthly Treasury Statement.  Our federal government has spent $867 billion more than it has taken in during fiscal 2019 (October 2018 – September 2019 is the fiscal year).  That amount is almost $100 billion more than the comparable period in fiscal 2018.  If you want to learn more, follow this link. https://fiscal.treasury.gov/files/reports-statements/mts/mts0719.pdf

Bear with me while I do a little math.   Gross Domestic Product (GDP) is released quarterly on a calendar basis.  The latest release was for calendar Q2.  Seasonally adjusted annual GDP came in at $21.338 trillion for the quarter ended June 30, 2019.  Seasonally adjusted annual GDP for Q2 2018 was $20.51 trillion.  If I subtract 2018 from 2019, GDP grew $828 billion over that time period.  GDP data can be seen here.  https://apps.bea.gov/iTable/iTable.cfm?reqid=19&step=2#reqid=19&step=2&isuri=1&1921=survey

Over that same time period (July 1, 2018 to June 30, 2019), the government ran a deficit of $919.0 billion according to the data from the US Treasury.  So the government (meaning us, the citizens and taxpayers) borrowed $919 billion to grow the economy $828 billion?  I know some of the money the government borrows is invested in long term assets and some is saved by recipients of government funds.  I also know my analysis is very simplistic, but does anyone else see a problem here?  We are in a good economy.  What will the deficit look like when the economy turns? 

Fiscal conservatism is dead.  The burden of our current consumption will fall on future generations.  They will pay for our sins.   Unfortunately, neither political party appears to have a reasonable conversation about our spending. 

Taxes, Taxes, Everywhere There’s Taxes

August 19th, 2019

France recently passed a 3% digital tax that is supposed to apply to companies with over $845 million in worldwide digital service revenue and at least $28 million of revenue in France.  Online shopping, including Amazon’s marketplace, is included in the definition of digital revenue.  The hope of the tax was to “level the playing field” between large tech companies (especially those headquartered in the US) and small companies.  The US has complained that the tax unfairly targets US companies. 

Guess what?  Amazon just announced it is raising fees for its small business customers in France by 3%!  Shocking!  Did the French government really think Amazon and other large companies would pay more taxes and, as a result, accept a lower profit margin?  Amazon’s small business customers, like the jeweler profiled in the second link below, need Amazon more than Amazon needs them.  Somehow, the French government forgot who had the power in that relationship. 

When costs go up, the end user consumer ultimately ends up paying them.  It might take a while, but eventually companies pass increases on.  Taxes are a cost.  So are tariffs, even if Peter Navarro and President Twitter pretend they are not. 



What is the Ultimate Impact of the Changes in Shopping Habits?

August 12th, 2019

Every week, a new announcement is made by a chain store that it is closing locations.  Last week, Pizza Hut announced it is closing 500 locations to focus on “growing its carryout and delivery service.” (https://www.today.com/food/pizza-hut-closing-hundreds-its-dine-restaurants-t160225)

Many mall based retailers have shut down completely as online sales continue to grow.  Since the 1950s, shopping has become almost a sport in the US.  We went from shopping at large downtown department stores to suburban strip malls to suburban malls.  It seemed like retail development would never end.  And then the internet arrived.

Currently, the US has significantly more retail space per person than any country in the world.  The US has 23.5 square feet of retail per person.  Canada is second with 16.8 SF per person.  Australia is third with 11.2 SF per person.  No other country in the world has more than 4.6 SF per person of retail space!  The US has over 5 times the retail space per person than the UK does! 

(Source:  https://www.businessinsider.com/retail-apocalypse-is-still-in-early-innings-cowen-says-2018-10)

One reason for the big difference in retail square feet per person between the US and other countries is our population is more spread out.  But our big cities are growing faster than our rural areas.  Retailers will close rural locations as more people move to large cities.  People living in rural areas will have to order more online or drive farther to find what they want.  That will push more people to move closer to urban areas, exacerbating the trend of retailers closing rural locations.  That will leave a lot of vacant space throughout the country.  Some will be repurposed as fulfillment centers for online retailers, as has been happening.  Some will be redeveloped into more interactive spaces.  Some will be torn down. 

The biggest impact the changing retail landscape will have is on the workforce.  Customer facing jobs are going away, replaced by automation and people sorting packages.  It is already challenging to find people capable of interacting with another person in a professional way.  That is only going to get worse. 

Why the $&#(# is the Department of Justice Worried about Consolidation in the Print Industry?

August 5th, 2019

I am generally a believer in free markets.  However, I understand that sometimes regulations are needed to create “fairness” in certain markets.  “Fair” is my least favorite word in the English language.  Everyone has a different definition of fair.  I use that term purposefully, as the Department of Justice recently indicated it would not be fair to magazine publishers and other long run print customers if Quad/Graphics completed its proposed acquisition of LSC Communications.  Because of the DOJ’s stance, the companies recently called off their proposed merger.  The following link summarizes the DOJ’s lawsuit seeking to block the acquisition.  https://www.justice.gov/opa/pr/justice-department-sues-block-quad-s-acquisition-lsc

I pulled a little financial data and employment data on both companies.  For fun, I decided to compare their financials to Facebook.  I consider Facebook and other online media/social media sites as direct threats to Quad and LSC.  As we spend more time online, less and less magazines, catalogs, and books are printed.  More advertising moves online, reducing demand for print.  My source for all data is Seekingalpha.com.  All data is in millions of US Dollars except percentages.

LSC Communications (LKSD) 2016 2017 2018
Sales 3,654 3,603 3,826
Earnings from Continuing operations 106 (57) (23)
EBITDA 359 319 264
EBITDA Margin 9.8% 8.9% 6.9%
Quad/Graphics (QUAD) 2016 2017 2018
Sales 4,329.5 4,131.4 4,193.7
Earnings from Continuing operations 44.9 107.2 7.9
EBITDA 473.1 452.8 391.4
EBITDA Margin 10.9% 11.0% 9.3%
Facebook (FB) 2016 2017 2018
Sales 27,638 40,653 55,838
Earnings from Continuing operations 10,217 15,934 22,112
EBITDA 14,769 23,228 29,228
EBITDA Margin 53.4% 57.1% 52.3%

After a taking a long moment to ponder my career choice, I snapped back into reality.  From the DOJ press release:

“The magazine, catalog, and book printing services offered by Quad and LSC include the printing, finishing, and distribution of publications to newsstands, retail facilities, or the postal service for delivery to consumers’ homes.  Quad and LSC are by far the largest printers in the United States and are relied upon by many of the largest publishers and retailers to ensure that high-quality products are printed and distributed on time.

According to the Department’s complaint, Quad and LSC view each other as their “#1 competitor,” and intense head-to-head competition between them has directly benefitted their customers through lower prices and better-quality services.”

The DOJ decided to define Quad and LSC’s markets as printed material.  How is that “fair?”  Their customers are continually moving their communications and advertising online.  Not a week doesn’t go by in which a newspaper or magazine does not stop printing physical copies.  ESPN the Magazine is stopping its print edition next month.  Glamour is no longer printed.  (Poor George Costanza!) 

As I’ve written in the past, print is not going away.  Catalogs are coming back, as advertisers have found that physical catalogs help online sales.  But the traditional print market continues to shrink.  Shrinking businesses require consolidation to remove non-productive assets.  The DOJ took a narrow view of Quad and LSC’s markets.  Long run print margins will stay low while online media companies, such as Facebook, will continue to make incredible profits.  Is that fair?  (Full disclosure:  The DOJ has indicated it is “reviewing the practices of market-leading online platforms.”  https://www.justice.gov/opa/pr/justice-department-reviewing-practices-market-leading-online-platforms That Microsoft fine really had an impact on consumers, didn’t it?)     

Will Lowering Interest Rates Help the Economy?

July 29th, 2019

It is anticipated the US Federal Reserve will cut interest rates this week.  This is the first interest rate cut since 2008.  This cut is a reversal of the Fed’s decision to raise rates in December 2018.  When the Fed last cut rates in December 2008, the unemployment rate was 7.2%.  As of June, the US unemployment rate stood at 3.7%.  The world economy was quite different in 2008 than it is today.  So what is going on? 

As I wrote about last week, manufacturing has slowed across the globe.  But I don’t think adding more money to the system will help that problem.  I think the Fed knows that as well.  Demographics and the trade war are the leading causes of the manufacturing slowdown.  Lower interest rates can’t solve those problems.  I think the Federal Reserve knows that.

The Federal Reserve also knows that over $13 trillion in debt across the world has a negative yield.  That is not a typo.  Investors are handing money to governments and companies across the world with the expectation that they will receive less money in the future.  That blows up virtually every economic model ever created.  Most models assume capital has a cost.  All of this money has to go somewhere.  Right now, it seems like it is chasing returns in the stock market.

Currently, the US has among the highest interest rates of any developed country in the world.  Higher US rates create demand for dollars, as investors want a return on their capital.  Demand for dollars pushes up the cost for the rest of the world to buy US goods and lowers the cost for US buyers to buy foreign goods.  A certain president with a Twitter account thinks lower rates will help reverse this trend. 

That is why the Fed is cutting rates – because the rest of the world has.  Lowering rates might help the financial economy but it is going to have little to no effect on the real economy.  I hope I’m wrong.    

Sources and further reading








Has the Industrial Recession Already Started?

July 22nd, 2019

CSX, a large railroad company, reported earnings last week that greatly missed expectations.  Their CEO had a memorable quote regarding the economy: “The present economic backdrop is one of the most puzzling I have experienced in my career,” says Chief Executive James Foote.  He elaborated and said a reduction in volume from industrial customers was a key driver behind their earnings miss and concern for the rest of the year.

The Cass Freight Index also indicates that the economy has slowed.  If you have an interest in understanding the economy, I highly recommend subscribing to their newsletter.  It is free and a link is below. 

It is clear that the industrial economy has slowed.  Has it slowed enough to the point of contraction is the open question.  Recall that a major inventory build contributed to the reported 3.1% GDP growth in Q1 2019.  Part of the reason for the inventory build was the threat of tariffs.  The tariffs are now in place. 

I had a conversation with a friend who owns a manufacturing business.  Tariffs have impacted his business both from a supply standpoint and for his export business.  He said, albeit a little more colorfully than my paraphrasing, “Why would I invest with all of this uncertainty?  I’m not buying equipment and I’m not hiring until there is some clarity.”  Uncertainty leads to risk aversion.  Risk aversion leads to economic slowdowns.  I think we’re there for the industrial segment of the economy. 



Employees Matter

July 15th, 2019

I was boarding a flight last week.  As we were about to board, we all received a text saying the gate had changed and our flight was now delayed.  A few people asked the gate agent about the text.  She made an announcement saying the text was wrong and we started to board.  I got on the plane and noticed boarding stopped shortly after I took my seat.  All of the passengers on the plane, the “elite” customers of this particular airline, knew something was wrong.  About five minutes later, one of the flight attendants announced, “It looks like the gate for this flight did change but no one bothered to inform the gate crew or the flight crew.  Please gather your belongings and proceed to Gate B16.”  I wish I were making this up. 

Airlines have a history of poor relationships with their employees.  I’m sure this situation did not help.  It also did not inspire confidence among the airline’s customers.   I am glad the major airlines give us real time information but I’d like the pilot to know where the plane is supposed to go! 

A wise person once said, “Your customers can only be as happy as your least happy employee.”  If you want your customers treated well, treat your employees well. 

Spend the Time to Show You Care

July 8th, 2019

Last week, I got together with two of my oldest friends.  I met one when I was 5 and we played on the same flag football team.  The other moved to my town when he was in 7th grade.  We’ve stayed in close touch over the years with the help of technology as we went through different stages of our lives and moved around the country. 

Our conversation started with the usual banter – reminiscing, updates, and of course, the obligatory put downs.  But we quickly got into much deeper subjects regarding health, families, and careers – the stuff that really matters.  We spent a couple of hours in very serious conversations.  Those deeper conversations would have never happened over the phone or via email or text. 

Technology gives us opportunities to communicate with each other but nothing replaces an in person conversation.  Staying in touch with your clients via email and phone calls is important.  In person visits are priceless.  That’s how you find out what is really going on with your clients.  If you want to stand out against your competitors, take the time to visit someone.  That’s how you show you care. 

Remember the Real Reason Behind July 4th?

July 1st, 2019

Every year around this time, an email circulates about the signers of the Declaration of Independence.  It has slight variations but the message’s focus is on the sacrifices the signers of the Declaration of Independence made.  Historians have questioned the accuracy of some of the signers’ fates.  A popular version, “The Price They Paid,” is posted on the website of singer Michael W. Smith.  A link to the Snopes response is included as well. 

Regardless of the details, the signers took significant personal risk by signing the Declaration.  We think we have political division in our country today.  Imagine the 1700s.  Half the country wanted to remain a colony of England.  Half wanted to leave.  Both sides were willing to fight for their way.  

As you enjoy your cookouts and fireworks, take a moment to read the Declaration of Independence.  Take a moment to be grateful for our Founding Fathers.  Take a moment to cherish our right to disagree.  Never forget we are all Americans.