Last night I read an article about the difficulty students are having borrowing money to fund their education (see No Funds to Lend to 40,000 Students). This is not a new story. Bernanke testified on the topic back in February (see Bernanke on Student Loans). There have even been ongoing conversations on the topic at my institution for the better part of eight months now. But this is the first I’ve heard of the crunch putting students at immediate risk for the upcoming semester (which starts in as little as 5 weeks).

According to the Boston Globe article:

The Massachusetts Educational Financing Authority yesterday said it will not be able to provide student loans this fall for the first time in its 26-year history, leaving more than 40,000 families without an important source of tuition funds just weeks before college classes begin.

“As a result of our problems and the continued dislocation of the capital markets, we have been unable to raise funds for the coming academic year,” said Thomas M. Graf, the authority’s executive director.

Across the country, more than 50 lenders have stopped making federal or private student loans this year, largely because of the turmoil in the nation’s credit markets that began with the subprime mortgage crisis last summer.

This news saddens me. I am saddened that the financial crisis has had such extensive a reach that financial institutions are not able to fund one of our nation’s most valuable investments - education. I am also saddened that otherwise qualified students, who might not be able to afford the substantial costs of tuition on their own, may be forced to accept uncompetitive loans at very high rates, or in the extreme, forced to sit out of school until the economy improves.

I have one proposal.

Since many universities have amassed fantastic endowments (see Wikipedia on Endowments), now might be the time for them to tap those endowments to make loans on a temporary basis (until conditions improve) to their own students. Now there are obviously large disparities across universities in their endowments; however, I suspect that many universities are in a position to support such programs. After all, it would not represent a pure expense for the school (in the form of a non-repayable grant), but rather, an investment with a potentially healthy return.

My wife and I had dinner over the weekend with some close friends who were visiting from Washington DC. One of our friends just so happens to be Chief of Staff for a U.S. Congressman. He was interested in my views of the financial crisis, and the conversation quickly turned to the recent SEC-imposed ban of naked short-selling on a host of financial institutions (see SEC Restricts Shorting 19 Financial Stocks for background).

My friend and I agree on many issues. This was not one.

It is his view (and by extension, that of his boss) that short-sellers (UPDATE FOR CLARITY: He meant short-sellers in general, naked or otherwise) are to blame for much of the ills that have befallen U.S. banking stocks. He believes that by talking their books, hedge fund managers have effectively caused runs on banks. Moreover, he suggested that rumors passed from fund managers to CNBC, then reported on CNBC as fact (even if only as “alleged” fact), exacerbate the problem.

C’mon now, are you kidding me???

As much respect as I have for this friend, who is quite intelligent, I think he’s misguided on this issue. Blaming short-sellers for the failure of banks is as ludicrous as blaming Charles Schumer for the failure of IndyMac.

It is not the short-sellers that have caused the problems, but the banks themselves for lending irresponsibly thereby impairing their own balance sheets. Short-sellers are simply calling it as they see it, making logical deductions from the information at their disposal.

Now this does not mean that there are not instances of fraud, and I agree that fraud and attempts at outright manipulation should be prosecuted to the fullest extent of the law. However, to make a well-reasoned case for why certain banks are not healthy (even if consistent with your underlying trading position) is not fraud. Concerns about the health of banks not only should be raised - they deserve to be raised. The public ought to know what professionals truly believe about a company, for good and for bad. And for whatever it’s worth, the short-sellers often have it right (see Nasty, Brutish and Short).

Short-sellers provide a vital service to the functioning of our capital markets. Restricting their behavior is not only myopic, but also raises questions about the legality of those restrictions, and the “fairness” of the system (see Naked Fear for a nice summary of key issues).

And the point about how information relayed by CNBC can lead to a run - again, who’s joking whom? By the time information is disseminated by CNBC, it’s old news.

If you truly want to know about the health of a bank, there are two places to look - its balance sheet (if you’re so inclined to pore over such minutiae) and/or the credit default swap market (as bond traders are fairly keen at evaluating the health of corporations).

For what it’s worth, the credit default swap market has recently been sounding the alarm over Washington Mutual (see WaMu: Liquidity Options Running Low, Credit Default Swaps on WaMu, Uninsured Depositors at WaMu Begging for Trouble, or Death Spiral Financing at WaMu), among others.

To my knowledge, there has been no run on WaMu yet reported by CNBC. But if WaMu were to fail, I would not be surprised.

And that would have nothing to do with this post.

I’m not much of a macro guy (my specialty is firm strategy), and I do not pay too much attention to oil prices. After all, I live in NYC, so I don’t drive all that much. Further, I rent, so I don’t have to think too much about the cost of heating, cooling, and powering my apartment.

Not only that, but in some ways, I would almost prefer oil cost $1,000 per barrel. I don’t mean to be cavalier about that. It’s not because I feel like we should stick it to the little guy, whose life depends so much on the availability, and use, of oil. I get that, and I understand how much strain high oil prices have caused to the economy. However, my view is that $1,000 oil would incentivize us to find an alternative to fossil fuels, …and quick.

My philosophical bent is that we need to find, and encourage, alternatives to fossil fuel-based energy, for the end of our dependence on oil (foreign or domestic) can’t come quickly enough. It is my hope that we can reverse the degradation that years of carbon pollution has caused to our environment for the sake of future generations.

Now you know my bias.

But given that information, what do I make of oil’s precipitous drop from nearly $150 to $120?

Frankly, I think many who have made inferences in the wake of oil’s drop have gotten it wrong. I’m tired of hearing what a wonderful thing it is for our economy that the price of oil has been going down - as if it will cure all our ills and will help us avert a recession. Analysts have used this to explain why the market has gone up in recent days. For example, as reported just yesterday by Yahoo! news (see Stocks Advance Following Sharp Drop in Oil Prices):

Investors expect that a sustained pullback in oil prices would give a crucial boost to the economy.

Hogwash!

People are confusing cause and effect. People are buying into the story that lower oil prices causes increased economic activity. In normal times, sure. I buy that. However, in my opinion, this is not what has caused oil’s recent slide, nor is it what will likely drive oil’s continued decline in price (barring escalation of geo-political tensions in Iran, Nigeria, etc.).

What has caused oil to tumble is a drop in demand. Plain and simple.

American consumers are obviously in a bad way (see Rising Household Debts, Defaults Straining US Economy). My view is that we are currently in recession. During recessions, demand for a whole host of goods drops, oil included. But now that much of Europe is in, or near, recession (see Roubini’s excellent post on Global Recession Watch), European demand for oil (and other goods) is waning as well. Add the double-whammy of recessionary US and European economies, and it becomes obvious why the price of oil has dropped.

So the erroneous inference is that decreased oil prices will lead to increased economic activity. The correct inference is that decreased economic activity has caused a drop in the demand for oil, which causes oil prices to drop.

The drop in oil prices is therefore neither good news for the US economy nor Europe’s economy; but rather, bad news that indicates just how fragile those economies have become.

I’ve never been fond of the distinction that folks make between Main Street and Wall Street, as if there were some actual divide between the “real” economy and the “financial” economy. My hunch is that the correlation between the performance of our financial institutions and the performance of our economy is fairly strong (and positive). And if anything, that correlation is becoming stronger as we move toward an increasingly service-based economy (with more than 80% of our economy now devoted to services).

Nevertheless, if there were ever a company that speaks to the general health of our economy, it is American Express. Amex is a consumer and business finance company, and scrutinizing the behavior of its customers can provide insight into the direction of the broader economy. So where the adage once was, “As General Motors goes, so goes our economy”, my guess is that could be changed to, “As American Express goes, so goes our economy.” After all, consumer spending accounts for something like 70% of GDP.

It is for this reason that I was troubled by the earnings presented by American Express (see American Express Falls), and also by subsequent comments made in the conference call.

Don’t get me wrong. I am not troubled by what Kenneth Chenault said. Just the opposite. I applaud him for being honest about current conditions. Rather, I was troubled by the content, and what it likely means for the U.S. economy.

As reported by Bloomberg:

American Express Co., the biggest U.S. credit card company by purchases, fell the most in New York trading since the Sept. 11, 2001, terrorist attacks after earnings missed analysts’ estimates and the lender withdrew its 2008 forecast.

Chief Executive Officer Kenneth Chenault said yesterday in a conference call that the business climate was “much weaker” than earlier this year and American Express was hurt in the second quarter by rising U.S. unemployment and falling house prices.

Moreover, as reported by Calculated Risk from Amex’s conference call (see here and here):

“Fallout from a weaker U.S. economy accelerated during June with consumer confidence dropping, unemployment rates moving sharply higher and home prices declining at the fastest rate in decades,” said Kenneth I. Chenault, chairman and chief executive officer. “Consumer spending slowed during the latter part of the quarter and credit indicators deteriorated beyond our expectations.“

“In light of the weakening economy, we are no longer tracking to our prior forecast of 4-6 percent earnings per share growth. That outlook was based on business and economic conditions in line with, or moderately worse than, January 2008. The environment has weakened significantly since then, particularly during the month of June.”

“Over the past month or so, we have seen clear signs that the US economy is weakening. Unemployment rates, as we know, took the largest jump in over 20 years. Home prices declined at the fastest rate in decades, and consumer confidence is at one of its all-time low points. Card member spending particularly among consumers slowed sharply during the latter part of the quarter. Credit indicators as we signaled a few weeks ago deteriorated beyond our expectations, and by almost any measure the US economy and business environment are much weaker than the assumptions we first spoke to you about back in January and the conditions that existed in early June. Now this fallout was evident across all consumer segments, even our longer-term super prime card members.”

“Affluent customers in some situations are cutting back on discretionary spending…we’re seeing a slowdown in spend across the board…The severe decline in home prices and the marked rise in oil prices have had a fundamental impact on consumer budgets and behavior. Not just as it relates to mortgages and home-related spending, but also across the full spectrum of the consumer economy…we now believe the economic weakness in the US will likely worsen throughout the remainder of the year…” (emphases added by Calculated Risk)

Given this information, my expectations are that the chances for a second-half rebound are extremely remote, irrespective of what happens to oil prices (see Mish’s excellent posts on Deflation here and here). Moreover, I now expect conditions similar to those experienced by Amex to spillover to a broader swath of corporations, …not limited to housing, finance, and consumer discretionary.

For me then, this news speaks to the breadth of impact that we should expect from this recession - on both Main Street and Wall Street. My call therefore is still for long-and-deep versus short-and-shallow.

One month ago, in reference to Inbev’s offer for Anheuser Busch, I wrote (see Ambush by Inbev?):

…no way, ain’t gonna happen.

It was my opinion that the proposed takeover of Anheuser by Inbev would not be a successful one. I had several reasons for such a view. First, I thought that the deal involved far too much debt (Inbev had proposed to put only around 13% down), and in the current credit environment I thought they’d have difficulty arranging the financing. Second, it was clear that top management, and certain members of the Busch family (including August Busch, the CEO) did not want AB to be acquired. It looked as if they would attempt just about anything to thwart the deal. And third, I felt that there were so many interested parties running interference (e.g., politicians, unions, consumers) that they would eventually scuttle any deal.

OK, so back to the present. On Monday, Anheuser Busch agreed to a $52 Billion takeover by Inbev (see Anheuser-Busch Accepts $52 Billion Inbev Offer). Boy was I wrong…

That’s ok though - I’ve been wrong before and I’m certain I’ll be wrong again. However, as I mentioned in a follow-on post last week (see Inbev and Anheuser: Cooler Heads Prevail), I thought it was great news that executives at AB agreed to discuss the deal with Inbev. They finally put the interests of the shareholders before their own. As I also mentioned in that post, I have an inkling that Adolphus Busch IV (uncle to August Busch) had a little something to do with AB’s change of heart.

Now that the two parties have reached an agreement in principle, the deal is still not quite out of the woods. It must go through the regulatory channels to receive approval. But at this point, with the support of AB, I think that the Anheuser Inbev deal is likely to get the go-ahead.

Assuming that they do get the go-ahead, the issue then becomes: Will this acquisition work?

According to Bloomberg, Inbev will finance the purchase with $45 Billion in debt (see Inbev May Raise $4.6 Billion). That’s a whole heck of a lot of debt, leaving them little margin for error, and likely forcing them to dispose of assets to raise capital (most likely the theme parks).

The St. Louis Post-Dispatch had a nice article on some of the other cost-saving measures that Inbev will likely implement (see Inbev Faces Challenges). They acknowledge (and I agree) that it will not be an easy task for Inbev to generate value out of this acquisition. They write:

The deal is based largely on the premise that Budweiser will succeed when sent to the far reaches of the globe, and that two companies with dramatically different cultures can merge into a smoothly running global powerhouse.

My comment: As I’ve written before on this blog, culture can be the key to making/breaking a union. In this case, the cultural component is especially complex. The two firms obviously have different corporate cultures. However, because this is an international deal, those corporate culture differences are compounded by differences in national culture - how the Belgian, Brazilian, and American managers get on.

The article continues:

…the beer industry carries high-profile examples of beer not crossing borders easily, said Roman Shuster, an analyst with Euromonitor in Chicago. Brahma, for example, is a cautionary tale as InBev plans to send Budweiser into untapped markets. Brahma is a top beer in Latin America but much less prevalent elsewhere. InBev planned earlier in the decade to take Brahma worldwide, but the effort fizzled…

My comment: I do not expect Budweiser to suffer the same fate as Brahma. American-made products still carry caché abroad. They are a status symbol (for good or bad) for consumers from many countries, and a signal that a country (especially a developing country) has “arrived”.

In addition to the cross-distributional synergies that Inbev will try to generate, they will also attempt to rationalize AB’s operations:

Anheuser-Busch is expected to become considerably leaner when InBev applies its trademark cost-cutting. In a conference call Monday morning, victorious InBev executives laid out their plans to expand cost-cutting already under way at Anheuser-Busch. InBev envisions a deeper cost-cutting plan than the one A-B unveiled last month, when it was trying to fend off InBev. Anheuser-Busch’s plan to cut $1 billion in expenses through 2010 will be expanded to a $1.5 billion effort over the next three years.

The ramped-up cost cuts will include about $360 million from greater leverage with suppliers, more aggressive production efficiencies and “elimination of corporate overlapping functions” — which likely will lead to job losses at A-B’s corporate headquarters in St. Louis.

One thorny issue is whether — and to what extent — InBev executives will shake up A-B’s network of more than 600 beer distributors in the U.S. …InBev may see those distributors as ripe for cost-cutting, some analysts said. InBev has a record of tough dealings with distributors in Brazil, one of its main markets.

All told, I’m pretty happy I’ve been forced to eat my words on this one. I’m glad the two firms are coming together; otherwise, how would we get to see the fun part - how the Anheuser Inbev integration plays out. Buckle up.

Leave it to The Onion to come up with this amusing, yet sadly accurate, story (hat tip, Gene).

Recession-Plagued Nation Demands New Bubble:

A panel of top business leaders testified before Congress about the worsening recession Monday, demanding the government provide Americans with a new irresponsible and largely illusory economic bubble in which to invest.

“What America needs right now is not more talk and long-term strategy, but a concrete way to create more imaginary wealth in the very immediate future,” said Thomas Jenkins, CFO of the Boston-area Jenkins Financial Group, a bubble-based investment firm. “We are in a crisis, and that crisis demands an unviable short-term solution.”

…According to investment experts, now that the option of making millions of dollars in a short time with imaginary profits from bad real-estate deals has disappeared, the need for another spontaneous make-believe source of wealth has never been more urgent.

“…The manner of bubble isn’t important—just as long as it creates a hugely overvalued market based on nothing more than whimsical fantasy and saddled with the potential for a long-term accrual of debts that will never be paid back, thereby unleashing a ripple effect that will take nearly a decade to correct…The U.S. economy cannot survive on sound investments alone,” [Greg] Carlisle added.

Well what do you know, if you give people incentives to do something (e.g., behave irrationally), they will do it, …in excess even.

Bottom-line: Incentives work.

There’s more of the story on The Onion site. Good fun!

The New York Times and Wall Street Journal are reporting that Inbev agreed to raise its bid for Anheuser Busch to $70 per share (see Inbev Raises its Offer, Inbev Boosts Offer). This raises the premium offered for AB from about 30% to nearly 40%. As a consequence, AB has agreed to consider the offer, and has opened lines of communication with Inbev.

I applaud the two firms for ratcheting down the hostilities. I also applaud them for recognizing that this is a deal worth discussing (and considering) rather than bickering over. AB’s rebuke of Inbev’s initial offer was a blunder. Inbev followed that blunder with one of their own, by taking the issue directly to the AB shareholders, drawing the ire of U.S. politicians and consumers in the process.

Personally, I think much of the credit for bringing the two parties together belongs to Adolphus Busch IV (uncle to August Busch IV, the current CEO). When this deal turned hostile, Inbev decided to offer its own slate of directors to oust AB’s current board. It so happens that one of those proposed directors was Adolphus Busch IV (I’d actually be interested to know the back-story for why he agreed to serve as a director on the competing slate). As reported by The Economist last week (business brief, sorry no link):

InBev, a Belgian brewer, intensified its efforts to win Anheuser-Busch by nominating an alternative board. The slate included Adolphus Busch IV, who wants the Busch family to negotiate with InBev. He is an uncle of Anheuser’s chief executive.

Provided that talks between Inbev and AB do not breakdown, we can now all turn our attention to where it rightfully belongs - to the issue of how Inbev will create value by bringing these two firms together. As I have mentioned in previous posts (see Ambush by Inbev and Anheuser’s First Ploy), there are lots of reasons to bring these firms together - there are some real distributional and operational synergies. However, as with any deal, achieving synergies can be difficult (see Why M&A Deals Go Bad), …especially for cross-border mega-deals of this sort (see DaimlerChrysler Post Mortem for a case in point).

Then there’s also the issue of whether or not the deal has become too rich - whether the achieved synergies will more than compensate for the premium.

Although the deal is getting friendlier, it has also gotten pricier…

I’ve been a little slow this week in keeping up with corporate news. I have been busy trying to catch up with e-mails and other, more pressing, assignments after a week’s vacation.

I spent the holiday week with my family in Cape Cod. We had a blast! And given the state of the economy, I feel very fortunate for the luxury of being able to take that kind of trip.

Although I will not bore you with the details of my trip, I do have several economic observations to share:

1. I have never in my life seen as many “For Sale” signs as I did last week, Cape-wide. Although this is not news to most of you, to behold it with your own eyes is astounding. In Manhattan, we don’t get to see many “For Sale” signs. There’s really no place to put them. So I only gain a full appreciation for the state of the housing market when I take trips outside the city. And even though I do get out of the city frequently and have seen conditions across many towns in the New York tri-state areas, I have never seen anything as bad as what I saw in Cape Cod.
2. My wife and I have been making the drive between New York and Cape Cod for the last 10 years. We have family up there, so we try to go as much as possible during the summer (at least every other weekend), and for several full weeks during the year. In my 10 years making that trip (the Deegan to the Merritt to I-95 to I-195 to Rt. 25 and then the Mid-Cape Hwy in case anyone is interested), I have never, ever encountered such light traffic en route. We frequently hit traffic around New Haven, CT; we almost always hit traffic at the Sagamore Bridge (leading onto, and off of, the Cape); and without fail, we get stuck on the FDR (both outgoing and incoming). We have not hit traffic this year at all - not on Memorial Day weekend, and not on July 4th. Again, this is probably no surprise to most of you since the highway miles driven by Americans are down for the first time in 17 years (see Americans Drive Less); however, it’s so strange to me to be able to make that drive at full speed (and in the time yahoo or google tells you it ought to take).
3. We are creatures of habit. We go to the same places every year. We like the Lobster Roll at Cooke’s. We live for the ice cream at the Four Seas. It’s ordinarily not easy to find an open table at Cooke’s during the height of the season during prime hours (12-2pm, 5-7pm). This year the restaurant was half empty - every time we went. Four Seas (a place where the line is usually out the door and around the corner) was uncharacteristically quiet. P-town was even relatively uncrowded. We saw empty parking spaces on Commercial St., the stores looked to have little traffic, the streets were not as lively, and it was even fairly easy to drive (yes drive) from one side of Commercial St. to the other. It was as if the entire island/peninsula seemed to have 1/2-2/3rds of its normal summertime population.

Now I realize that the anecdotes that I’ve shared simply represent one person’s observations (an n of 1 as we like to say in the business), but if my experiences thus far this summer are any indication, I think we’re in for a long and difficult slog. I have never seen anything quite like it…

Well, the MillerCoors venture officially kicked off yesterday (see MillerCoors Officially Launches). It certainly will be an adventure.

As I’ve written (and detailed) on this blog before, I believe that the joint venture governance structure will strain their union (see Good Luck Miller Coors, Update: Miller Coors JV, and Now Introducing Miller Coors, JV???). At the time, I suggested that “management problems” were likely to plague the venture for years to come. We now have some details that better indicate why and how:

For example, the St. Louis Business Journal writes:

SABMiller and Molson Coors each named five members to the MillerCoors board.

From the SABMiller side:

• Graham Mackay, CEO
• Malcolm Wyman, CFO
• Nick Fell, group marketing director
• Johann Nel, group human resources director
• Sue Clark, corporate affairs director

From the Molson Coors side:

• Pete Coors, vice chairman
• Peter Swinburn, president and CEO
• Sam Walker, global chief legal officer and corporate secretary
• Stewart Glendinning, global CFO
• Dave Perkins, president of global brand and market development

MY COMMENT: Since when does an organization need two CEO’s and two CFO’s? And how long will that arrangement last? Extra managerial staff comes with extra managerial cost, …and top-level management ain’t cheap. Also, extra managers create extra managerial conflict. And with 5 representatives on the board from each side, how will they achieve consensus on critical strategic and operational decisions? The 10 final arbiters of any conflict will likely split down party lines. Managing in that environment sounds like fun! Just ask the folks from DaimlerChrysler how all that went for them.

The article continued:

While announcing the closing of the merger, the brewers did not announce a location for the headquarters of MillerCoors. The decision on where MillerCoors will locate its corporate headquarters will be a “first-level agenda issue” for the joint venture’s leadership team…

MY COMMENT: I take some comfort in knowing that location is a “first-level” agenda issue. But might that divert managerial attention away from what they’re supposed to be doing - say, running a company? Having two sets of management negotiate where the headquaters should be is not costless. Moreover, given the location of the parents’ US headquarters (Golden, CO and Milwaukee, WI), whatever location they choose will necessarily result in increased costs. For example, let’s say they choose Dallas (a rumored HQ city under consideration). If that’s the case, what happens when management from the Coors side of the business needs to coordinate with management from the Miller side of the business? It will require a whole heck of a lot of increased travel back and forth to Dallas. That ain’t free. Similarly, what happens when operations folks in Colorado and/or Wisconsin need support from management? You got it. More travel! Essentially, all they are doing by creating a new headquarters apart from the existing Colorado and/or Wisconsin operations is adding another layer of management costs on top of each of their individual operating structures. 

As I concluded in my previous posts - this deal should have been structured as an outright acquisition.

if this were an outright acquisition in which one party were able to direct the activities of the other so as to make operating decisions unilaterally and shut facilities down, then sure, I think this marriage of firms would have a fighting chance at creating a formidable competitor to Anheuser-Busch. If it were structured as an acquisition, I’d also be willing to bet that the headquarters would end up exactly where it should - in either Golden, CO or Milwaukee, WI - and not in some silly neutral site palatable to both sets of management.

Not only that, but if the deal were structured as an acquisition, the combined entity would be able to reduce management costs by eliminating duplicate managerial activities.

So once again, congratulations MillerCoors. And good luck achieving those $500 million per year in promised cost-saving synergies.