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Thursday, August 06, 2009


Goodfellas Redux

Our most frequent commenter, Rufus T. Firefly (possibly a pseudonym) left an interesting question in his comment after our last post, asking about the legality and ability of health insurance companies to sell their products across state lines.

Insurance, perhaps surprisingly, is one of the few businesses which is still regulated by the individual states. Though federal regulators could easily make the case that the business is interstate commerce, Congress passed the McCarran Ferguson Act that explicitly assigns regulatory responsibility to the states. The state insurance commissioners have a national association, the NAIC, but it has no regulatory authority.

State jurisdiction is jealously guarded not only by the commissioners but by the state legislators through their own national association, NCOIL. Health insurance products are approved by each state for sale in that state, but often, the legislators mandate certain coverages be included in any approved state plans. This means that even when a national company such as Metropolitan Life operates in all 50 states, they have to sell many different versions of their product to meet these various mandates. So if NY requires group health insurance to include coverage (and a charge) for elective hysterectomies, your NY employer's package will include that (even if you are a guy and probably will never have a hysterectomy, elective or otherwise).

Republicans have proposed that employers and individuals should be free to purchase their insurance in any state in order to avoid paying for mandated coverages they don't want but currently that cannot be done. A company cannot sell a product in NY or to a NY employer unless it is approved by the New York Insurance Department, and they can only approve products with the legislated mandates.

The insurance industry has proposed having the optional right to a federal charter, and to be regulated federally, an option banks have. Most Dems and even many R's oppose this because they believe such an option will set off a "race to the regulatory bottom." This is one of many causes for the high cost of insurance and health care in this country. Fixing this, curtailing high malpractice awards, and incentivizing users of health care to care about price are all potential cost reduction strategies. The Obama program, in contrast, will just add more cost while reducing quality and access. This is the message the 75% of the insured population that is satisfied with its coverage but is concerned about rising costs should be delivering to their Congressmen during the current recess. It is not the message that Dems want to hear though.
Some readers may wonder why I haven't had much to say about the Sotomayor nomination. Basically, I think the vetting process has become a farce so I don't get all emotional about the politics of it anymore. I think the public understands what's going on even thought he politicians seem to think we are all jerks.

It doesn't bother me that she is going to be confirmed. What were you expecting Obama to come up with anyway? It also doesn't bother me that most Republicans will vote against her. Everything is played to the base in these situations. Hispanic Americans, who vote majority Democrat anyway, will not resent this either. They are learning faster than most how the game is played here.

We should recall that many Dems voted against Alito, arguably the most obviously competent selection since Scalia. That was OK too, they had to play to their base. If I have a beef with Sotomayor, it is that she is a mediocrity, like Harriet Myers or Carswell (remember him) or Souter who has displayed little understanding of constitutional issues. That is reason enough to oppose her, but not reason enough to engage in all-out character destruction.

When I worked at GE during the Welch era, the company was proud of its record for delivering highly predictable earnings quarter after quarter. From the inside, I thought that pride was misplaced. There was no way an organization of that size and complexity could be that consistent unless the numbers were being managed. And it wasn't as if Wall Street didn't know that too. GE's numbers were greeted habitually with smirks, winks and nods. However, no one could buck Welch in those days, and after a short sell-off after reporting day, the stock would move blissfully higher.

Of course what was happening was that units that had surplus earnings were socking them away for the quarter when they would "need" them to make their number. If a unit was going to miss their number anyway, and especially if the overall company was in danger of missing, a major fire drill would commence with the CFO of each affected business unit being required to scurry around until he "found" the needed net income. Some of these accounting adjustments were pretty creative and highly questionable.

Now finally, the company has owned up to these accounting shenanigans and forked over a $50 million fine for its accounting maneuvers, without admitting or denying guilt, of course. Happily, the CFO as profit center is a concept that is deservedly dead. The CFO should be a scorekeeper, an umpire. I was always amazed that people inside the company who should have known better used to argue with me about the CFO role. I would never knowingly buy stock in a company whose CFO came out of the GE finance area. That rule served me well, for instance, by keeping me out of Washington Mutual.


This is not to say that Corporate ethics are a problem of the past. Today it was reported that Goldman Sachs CEO (another ethically challenged company) Blankfein told employee recipients of large bonuses (averaging about a million dollars or so per) to avoid large purchases that would attract attention. Doesn't that sound a little too much like the mob boss in Goodfellas after the Lufthansa caper? Anyway, I guess the cultural norm there is that there's nothing wrong with the bonuses themselves, as long as they don't attract attention.

Keep in mind that G-S was the actual beneficiary of the AIG bailout since they were on the other side of many of the CDS transactions.


The virtual flood of earnings reports has swamped Wall Street and happily, company cost cutting and other conservative financial and operating tactics have made for more surprises than disappointments. However, no one should be fooled that this economy is out of the woods. Revenues are in the toilet, no one is really hiring, and even though inventories have been drawn down, companies will be very careful about rebuilding them. The success of "cars for clunkers" has caused dealers to complain that they are low on stock. Can you imagine, the auto industry is flat on its back and yet it can't keep up with even a modest (and artificial) uptick in demand. Oh and by the way, why was it necessary for Congress to authorize $2 billion in additional funds for this program when they have about a $700 billion stimulus authorization that has still not been spent? Couldn't cars for clunkers come out of the stimulus?

Anyway. the Musings portfolio had five earnings reports just this morning! Our old favorite Petroquest (PQ) held up OK despite the recession, its reduction in shareholder equity more than accounted for by its healthy depreciation charge. Boyd Gaming (BYD) delivered solid earnings under the circumstances, but I was disappointed that its press release contained no balance sheet info. That's a serious shortcoming. The Street loved Devon Energy's (DVN) earnings, but I did not. Debt was up some and shareholder equity down. That's the difference between having an earnings orientation like analysts do and a balance sheet orientation like I do. Quanta's (PWR) report was steady as she goes. The wind business will never reach the critical mass that environmentalists would like, but it should be a steady factor. Finally, we got a great report from another old favorite, the oft maligned Safeguard Scientifics (SFE) with shareholder equity more than doubling thanks to better stock prices for its start-up companies. This is one stock where the Street understands that the balance sheet is everything.


On Monday, we sold 300 more shares of BAMM from the IRA for 9.16. Never mind that the stock briefly hit the 11's last week before fading. We bought these shares for 2.20 on 11/19/08. We know we won't often catch the top, but we are happy to sell high. On Wednesday, we sold 300 shares of Marine Max (HZO) from the IRA at 6.80. We bought these at 5.32 on 7/14/08.

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