This article appeared in the Perspective section of the Clarion Ledger:

July 26, 2009

Primer: Cap and trade

Waxman-Markey cap and trade bill can 'sink a big chunk' of the U.S. economy

Ashby M. Foote III
Contributing columnist, The Clarion-Ledger

You may have missed it in the blitzkrieg of legislative action the past few months, but if you intend to purchase gasoline or electricity in the years ahead, you had better burn some midnight oil on House Resolution 2454.

"The American Clean Energy and Security Act" (HR2454), also know as the Waxman-Markey cap and trade bill, passed the U.S. House of Representatives on June 26 by a vote of 219 to 212. That two House barons like Henry Waxman and Ed Markey could only muster a seven-vote margin for legislation promising clean and secure energy and a solution to global warming suggests that there must be some devilish details in its 1,300 pages. Devilish, indeed, this bill could well sink a big chunk of America's economy into economic purgatory for some time to come.

The journey of HR 2454 began over two decades ago with the United Nations' creation in 1988 of the Intergovernmental Panel on Climate Change. IPCC's mission statement is straightforward: "The role of the IPCC is to assess on a comprehensive, objective, open and transparent basis the scientific, technical and socio-economic information relevant to understanding the scientific basis of risk of human-induced climate change, its potential and options for adaptation and mitigation."

Skeptics point out the inherent bias of a government-funded mission to identify human-induced climate change. If you don't find it, does your funding go away?

Twenty years later the IPCC has issued four assessment reports, accompanied by the more important Summary for Policymakers. Each report served to raise the ante on the alarming dangers of anthropogenic (man-made) global warming, resulting from increased concentrations of greenhouse gases.

At the heart of the IPCC's work are computer models used to simulate global climate and weather. Any TV weatherman will tell you that predicting next week's local weather is an iffy proposition even with the latest first-alert-Doppler-whiz-bang-Vipir radars.

The IPCC's ever-more-confident and apocalyptic warnings rest on the near-impossible task of simulating with computers climate conditions for the whole planet and not for next week but for 50 to 100 years in the future. This, while science still struggles to explain exactly how clouds work.

World-renowned mathematician Freeman Dyson, who in his early years worked alongside Einstein and is now professor of physics at the Institute for Advanced Study at Princeton, had this to say about climate models: "The models solve the equations of fluid dynamics, and they do a very good job of describing the fluid motions of the atmosphere and the oceans. They do a very poor job of describing the clouds, the dust, the chemistry and the biology of fields and farms and forests. They do not begin to describe the real world that we live in."

Falling in line with IPCC thinking, the primary goal of HR 2454 is significant reduction in carbon dioxide and other greenhouse gases. The proposed methodology to accomplish this is "cap and trade." It is similar to the program instituted in the 1990s to reduce the threat of acid rain.

In that program, the culprit was sulfur dioxide emissions from 503 coal-burning plants in and around the Northeast. The "cap" refers to the aggregate limit of SO2 emissions to be allowed from the plants in the program.

The "trade" refers to the credits or allowances that each plant requires to match their SO2 output. An investment in technology that reduced SO2 emissions for one plant would allow that plant to sell its allowances to another plant.

The arrangement provides flexibility and market incentives in lowering the aggregate SO2 emissions. The program succeeded in reducing those SO2 emissions by 40 percent. Whether a successful program focused on 503 plants can scale up to one targeting tens of thousands of plants, and tens of millions of exhaust pipes is yet to proven.

The U.S. is four years behind Europe in implementing a CO2 cap and trade program and based on the European experience that may be a very good thing. Started with great fanfare in 2004, the European program to date has not reduced CO2 but has been a windfall for Europe's utilities and other smokestack industries.

After heavy industry lobbying, the European Union scrapped plans to sell permits and instead gave them out for free. But that didn't stop utilities across Europe from raising rates they charged to reflect the "putative costs" of those credits.

Europe's biggest CO2 emitter, RWE, has come under fire for raising rates while also receiving $6.5 billion in carbon credits for free. Bjorn Lomborg, author of Cool It: The Skeptical Environmentalist's Guide to Global Warming, points out that the biggest U.S. electric utilities spent over $51 million on lobbyists over the past six months. They have watched the European system unfold and they no doubt want their credits for free, too.

If some form of cap and trade becomes law, the carbon credits (a carbon credit represents one metric ton of CO2 emissions) will be on its way as a new form of global currency with a wide array of regulators and issuers and, no doubt, any number of unintended consequences.

Entrepreneurial types have been planning for this possibility for some time. The Chicago Climate Exchange has been trading carbon credits since 2003 and has over 400 corporate partners.

One of the earliest planners was the now-deceased Ken Lay of Enron fame. He got some new notoriety for a 1997 internal memo that said: "If implemented (the Kyoto Protocol) will do more to promote Enron's business than almost any other regulatory business."

As we dig our way out of the rubble and wreckage of last year's financial crisis, the visage of a confident Ken Lay is not comforting. Even more disturbing is the common thread linking the best and brightest of the recently busted and bailed-out Wall Street and the best and brightest of the IPCC.

The thread is computer models seeking to simulate extraordinarily complex systems. Wall Street's most prestigious firms watched firsthand in 1998 as the premier hedge fund, Long Term Capital, with the guidance of two Nobel Laureates, collapsed, a victim of computer simulations that failed to capture the real world. Did Wall Street lose faith in computer simulations? Far from it - within 10 years Wall Street had magnified the simulation fiasco a hundred-fold.

The Heartland Institute's exhaustive analysis of the IPCC's most recent report entitled "Climate Change Reconsidered" includes this critique: "Scientists working in fields characterized by complexity and uncertainty are apt to confuse the output of models - which are nothing more than a statement of how the modeler believes a part of the world works - with real-world trends and forecasts. Computer climate modelers fall into this trap, and they have been criticized for failing to notice that their models fail to replicate real world phenomena."

Some final considerations: The climate glass may be half full. CO2 is not a pollutant in the way that we normally think of pollution.

In fact, CO2 is vital to our ecosystem and as we learned in 10th-grade Biology, CO2 is a crucial part of the photosynthesis process that turns sunlight into carbohydrates.

Even with the increase over the past 50 years CO2 still only makes up .4 percent of the atmosphere and the increase actually improves the planets potential for plant growth as greenhouses are want to do. Water vapor has a much bigger greenhouse effect but it is excluded from the models because like clouds, it is too hard to model.

Improved plant growth will make it easier to feed the planet's 6 billion residents. Contrary to IPCC predictions, the Earth's temperatures have been dropping since 1998.

In fact, this June was the coolest June in New York City in half a century - let those UN bureaucrats out of their cubicles and into the real world of Central Park. Many scientists think temperature swings have more to do with solar flares and sunspots than with CO2 concentrations.

Lastly: Government funding, political agendas and computer models make for a dangerous concoction; just ask Fannie Mae and Freddie Mac.

Mother Nature can take care of herself and so can the rest of us.

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Midyear 2009 outlook on youtube.com

Vector's Second Half Outlook 

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This commentary appreared in the Clarion Ledger on 21 Sep. 2008

September 21, 2008

COMMENTARY — Historic Wall Street woes: Building back from bust

Three of nation's top five investment banks collapsed with two more in merger talks

Ashby M. Foote III
Special to The Clarion-Ledger

Watching the conflagration that is consuming Wall Street one is reminded of the famous words of New York baseball manager and philosopher, Casey Stengel: "Can anybody here play this game?"

Casey was describing his 1962 Mets team, arguably the worst baseball team in major league history, but compared to today's Wall Street investment banks the 1962 Mets look like all-stars. 2008 began with five top tier investment banks and less than 10 months later only two are left standing on their own with one of those in merger discussions.

Bear Stearns collapsed in March and was sold for pennies on the dollar to J.P. Morgan. On Sept. 14, Lehman Brothers declared bankruptcy and that same day Merrill Lynch, under duress, accepted a buyout offer from Bank of America for half of its Jan. 1 value.

The two remaining investment banks, Goldman Sachs and Morgan Stanley, have lost 44 percent and 56 percent of their market value respectively.

Add to that carnage the demise of the insurance giant AIG and mortgage titans Fannie Mae and Freddie Mac and you have the biggest bank panic that anyone can remember.

Investment banks have taken the biggest fall in this financial panic but there is plenty of blame and pain to spread around. In short, there has been a systemic breakdown in the fiduciary checks and balances that govern the relationships from borrowers to mortgage brokers to appraisers to underwriters to securitizers to rating agencies to bond insurers to investors.

At the nub of this crisis is a glut in residential real estate and what is now a two-year decline in home prices. The Case-Shiller U.S. home price index peaked in the Spring of 2006 and has declined 18 percent since then.

In the early 1980s a hot political issue was the plight of the homeless. Twenty-five years later, America is the best-housed and, unfortunately, the most over-housed country in the world. Don't let it be said that capitalism can't deliver the goods.

Alas, grand production untethered from prudence and market disciplines can result in gross oversupply and the busts that inevitably follow.

What makes this bust so insidious and seemingly intractable is the large role residential real estate plays as collateral for trillions of dollars of complex pools of debt in bank, insurance and pension portfolios. This is how a housing bust has become a credit calamity.

The genesis of this over-build of residential real estate can be traced back to 2003-2004 when the Federal Reserve, fearing deflation, dropped its key interest rate, the Federal Funds Rate, to 1 percent and kept it there for a year.

Ben Bernanke had presaged this move with a November 2002 speech entitled, Deflation: Making Sure "It" Doesn't Happen Here.

With stocks still suffering from post bear market blues and bonds offering paltry returns, super cheap money gushed into the asset class that was performing best and seemed the most reliable - real estate, especially residential real estate.

This gusher of investment into tangible assets was further supercharged by new levels of clever financial engineering in the form of complex pools of securities with acronyms like CDOs (collateralized debt obligations) and SIVs (structured investment vehicles).

No discussion of today's panic would be complete without mention of the credit rating agencies Standard & Poor's, Moody's and Fitch and the complicit role they have played.

These are public companies compensated by the underwriters to provide ratings on securities being issued but because of rules governing bank and insurance portfolios the rating companies become de-facto regulators.

When the market for CDOs and SIVs took off in 2004 and 2005 the rating agencies gave investment-grade ratings to most of these new structures that included large chunks of junk debt and sub-prime loans.

With yields 4 to 5 percent higher than similar rated corporate bonds, sales of CDOs mushroomed to $500 billion by 2006.

By the end of 2006, CDOs had become the most profitable and fastest-growing portion of the rating agencies business.

The symbiotic relationship between underwriters and rating agencies is an unhealthy one and a major contributor to the proliferation of CDOs in institutional portfolios worldwide. It is fair to say that we are witnessing in real time the end of an era. Investment banks and their bankers have been the castles and crown princes of Wall Street. Need advice for corporate strategy, mergers and acquisitions or how to invest a billion?

It was to investment banks that big companies and big investors turned. Investment bankers have had their detractors as well - portrayed in movies like Wall Street and books like Bonfire of the Vanities as masters of the universe, the egotistical key-masters and gatekeepers to the really big money of capitalism.

As events and companies have unfolded and unraveled over the past eight months it has become clear that investment banks have been pushed to reinvent their business models over the past five years. For some it worked, but mostly it didn't.

Information technologies and especially the Internet have flattened the investment arena, squeezing profits in some areas and allowing hedge funds, private equity and boutique research firms to compete in areas investment banks once dominated.

In a classic response to such disruptive innovation, the investment banks moved up market to more complex products where better profit margins could still be maintained. In retrospect it is clear now that in many cases they were pursuing complexity for complexities sake rather than for improvement in their product or service offering. In so doing they violated the old G.I. axiom "keep it simple, stupid," and they have paid the consequences. Lastly is leverage. Lehman Brothers and Bear Stearns succumbed to the same fatal flaw: making outsized bets with outsized debt.

Both firms morphed into huge hedge funds, at times utilizing 30- to-1 ratios of debt to equity in an effort to juice returns. Markets and leverage mixed with hubris makes for a powerful concoction. But get the recipe wrong and it can wipe you out. Stengel had counsel for such folly: "Been in this game 100 years, but I see new ways to lose 'em I never knew existed before."

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This column appeared in the Clarion Ledger on 6 July, 2008

July 6, 2008
'Dirty' work has some companies cleaning up

Ashby M. Foote III /
Special to The Clarion-Ledger

Career advice for 2008 college grads: Want to get filthy rich? Find a dirty job! Michael Rowe and the Discovery Channel stumbled across this goldmine of an idea three years ago with their surprise hit TV show Dirty Jobs. Lost, Survivor and Fear Factor are other TV hits that found similar success by offering viewers escape from their air-conditioned Dilbert cubicles with settings heavy in sweat, dirt, slime and bugs.

This counterintuitive media magic harkens back to the 1930s when motion picture-goers mired in the drudgery of Dust Bowl and Depression lived vicariously at the Bijou with the glitz and glamour of box office champs Fred Astaire and Ginger Rogers.

This would be a quirky showbiz footnote were it not for a similar phenomenon now roiling through the American economy.

'Dirty' jobs in demand

Stock market action the past 12 months provides some insight into which industries are shedding workers and which need to expand. Of the S&P 500 top 25 performing stocks (all up more than 44 percent) for the past year, 24 are related to the dirty work of extracting forms of carbon out of the Earth. Of the bottom 20 stocks (all down more than 66 percent), 18 are in the white-collar world of high finance.

It comes as no surprise that the world of high finance is now writing off assets by the tens of billions and laying off workers by the tens of thousands. Meanwhile, dirty industries from oil and gas to mining to steel mills to fertilizer production to row crop farming are enjoying their biggest boom in memory.

Such wide disparities in returns usually indicate serious mismatches between demand and capacity and that is the case here. The term "glut" fails to capture the magnitude of gross excesses in credit creation that are now piled up on the doorstep and back alleys of Wall Street and the major banks.

The boom in the dirty sectors of the economy is the flip side - too much demand from here and abroad and woefully insufficient capacity to meet that demand.

The 1970s saw the passage of the Clean Air Act (1970) and Clean Water Act (1977) and the creation of Environmental Protection Agency (1970) and Department of Energy (1977). In the intervening decades the quest to clean up America for both health and esthetic reasons has enjoyed extraordinary success.

Put on some overalls

The dirty little secret of economics version 2008 is that necessary parts of the economy are by definition messy and dirty. We outlaw, offshore or ostracize them at our peril and cost. Bugged about the meteoric rise in gasoline and copper prices? Try getting a permit to build a new refinery or copper mine. Over the past 30 years, there has been one new copper mine built in the U.S. and no new refineries.

Further complicating the "dirty" capital investment arena is the entanglement between the political legal and scientific communities over the contentious issue of climate change and global warming. In April of 2007, the U.S. Supreme Court in a 5-4 decision ruled that carbon dioxide was a pollutant and subject to regulation by EPA.

The key promoter of anthropogenic (man-made) global warming, which is the rationale for declaring carbon dioxide a pollutant, is the United Nations' Intergovernmental Panel on Climate Change. Yes, the same organization that mangled the Food for Oil program and seems incapable of paying its parking tickets in New York City is now angling to become the global manager of the world's supply of carbon dioxide. Citizens of the world, take heed.

All of which leads us to a brave new world of carbon offsets, carbon sequestration, carbon footprints and carbon credits. In an ironic twist to the "carbon cycle," carbon credit trading may breathe new life into the now moribund trading desks of Wall Street. The same folks whose financial engineering brought us securitized sub-prime mortgages may soon be cooking up for sale collateralized carbon credits. Caveat emptor.

Can our post industrial, Dilbert-cubicled economy find and release its inner Li'l Abner and Popeye? Can we don overalls, gulp down some spinach and tackle the dirty work that needs to be done? We have little choice: The planet's carbon-based ecosystem compels it.

- this article appeared in the Clarion Ledger on May 25, 2008

Tap our own resources? Food, fuel and foreign policy

Antiquated domestic farm, energy policies contributing to growing world food prices

Ashby M. Foote III
Special to The Clarion-Ledger

in the past six months there have been riots over food prices or food shortages in Mexico, Haiti, Ivory Coast, Cameroon, Indonesia, Bangladesh, Uzbekistan and the Philippines.

In Egypt, riots erupted over the price of cooking oil. Josette Sheeran, head of the United Nation's World Food Program warns that global food reserves are at the lowest level in 30 years - 53 days of emergency supplies versus 169 days worth in 2007. If market prices are a reliable indicator of supply-demand imbalances there could be severe challenges for the food supplies in 2008 and beyond.

Consider that over the past two years the price of corn is up 148 percent, soybeans up 136 percent, soy oil (marketed as vegetable oil) up 140 percent and wheat up 66 percent, as a group easily surpassing the 86 percent rise in crude oil during the same period.

Rice, the primary food staple for half the world, is also in tight supply as major exporters like India and Vietnam restricted exports to ensure sufficient supplies locally. This reached U.S. shores when Sam's and Costco stores in California began rationing rice sales this spring.

Before stockpiling our pantries, breaking ground on Victory gardens or adding another expensive government "solution," we should re-examine existing agriculture policies for their relevance in today's riot hungry world.

Three old policies that stand out like scarecrows in a cornfield are the Conservation Reserve Program, ethanol and the Arctic Natural Wildlife Refuge.

Conservation reserve

The Conservation Reserve Program, first authorized in the 1985 farm bill allows previously cultivated farmland to be "retired" by way of contracts with the Farm Service Agency that run from 10 to 15 years. There are almost 35 million acres now under CRP contracts with annual rental payments from the government estimated at $2 billion at an average of $60 an acre. The penalty for resuming cultivation before the contract expires is payback of all past rental income plus interest.

With corn and soybeans doubling in price the past two years, you don't have to attend a food riot to find frustration with the CRP program. In January, 45 associations from across the U.S. including the American Bakers Association, the National Grain and Feed Association and the Mississippi Poultry Association, petitioned Secretary of Agriculture Ed Schafer requesting that farmers who wished to put "retired acres" back into cultivation could do so without contract penalties.

With this year's plantings coming to an end, all penalties remain in place and the acres remain retired. Of the 34.7 million acres of U.S. farmland under CRP contract, 900,575 acres are in Mississippi.

It is worth noting that since the CRP was signed into law 23 years ago the world's population has grown by 36 percent to 6.6 billion, while the world's arable land remains static at about 3.7 billion acres. Add to that fact the billion or so folks striving mightily to join the middle class and enjoy the improving lifestyles and diets that come with such status.

Corn-based ethanol

The first subsidy for ethanol-blended gasoline appeared in the Energy Tax Act of 1978. In the subsequent 30 years, government has expanded the program to include mandated use, bigger subsidies and tariffs against imported ethanol.

This past December, the bi-partisan "Energy Independence and Security Act of 2007" was signed into law which extended and expanded mandates for production of renewable fuels to 36 billion gallons by 2022, of which 15 billion gallons must be corn-based. The American Coalition for Ethanol estimates it will require 35.7 million acres of corn to produce those 15 billion gallons.

That would equal 41 percent of the 86 million acres corn growers plan to plant in 2008. Such huge mandates require huge capital investment and the private sector has stepped up, investing over $5 billion in ethanol processing plants in recent years.

There are now 139 plants in production with capacity to produce 7.2 billion gallons with another 62 plants under construction.

Alas, the skyrocketing price of corn has made many of the ethanol business plans uneconomic. As a result, some of the plants have been closed waiting and hoping for lower corn prices.

Drilling ANWR?

When the government mandated corn ethanol for fuel, the Arctic Natural Wildlife Refuge became a farm policy issue. The political battle over ANWR has been long and tortuous. In 1960, President Dwight D. Eisenhower declared 8.9 million acres in northeast Alaska as a protected wildlife refuge. The size was increased to 19.6 million acres in the 1980s. In 1995, Congress authorized oil drilling on the coastal plain portion of ANWR, but the bill was vetoed by President Bill Clinton.

Numerous attempts since then to open ANWR for drilling have been defeated by vote or filibuster. ANWR's 19.6 million acres sits on 16 billion barrels of crude oil and 10 trillion cubic feet of natural gas, making it one of the largest untapped reservoirs of oil and gas on the planet.

The few hearty inhabitants (260 Inupiat Eskimos) of ANWR reside in the village of Kaktovik. The Inupiat strongly favor drilling in ANWR. George Tagarook, the vice-mayor of Kaktovik, has harsh words for those opposed to drilling: "Step by insidious step, outsiders pushed us aside, set up rules that made it harder and harder for us to use our lands and waters. The worst thing they have done is to declare part of our homelands 'wilderness.' The management rules for such places make it impossible for us to continue to use them.

"Now they want the entire coastal plain made 'wilderness.' That is code for finally removing us from our homelands. That is code for genocide," said Tagarook. Russia's version of ANWR is called Siberia and is famous as a locale for gulags and dissidents.

In an irony worthy of Tolstoy, George Tagarook and his fellow Inupiats now find themselves in a "green" gulag, modern day dissidents stymied by forces far away and beyond their control.

In summary: CRP, ANWR and corn-based ethanol are policies ill suited for today's resource hungry world. In fact they manifest a level of dysfunction that would make Rube Goldberg grin.

For readers born after 1970, Rube Goldberg was a Pulitzer Prize-winning cartoonist famous for his depictions of complicated machinery that performed very simple tasks in an indirect and convoluted way. They put America on the wrong side of history, mandating meager existences for Eskimos while our president travels to Arabia asking kings to pump more oil. What the people of Cameroon, Haiti and Bangladesh grasp that we have yet to, is that in the world of 2008, arable land is the precious scarce resource in the food and energy debate.

Rather than something to be retired and sent out to pasture, arable land is a vital and strategic resource, valuable for both economic and humanitarian reasons. Rather than flying across the globe, our president should ride across town and notify the bean counters at the U.S. Department of Agriculture to set aside the "set asides" and let America's farmers make hay while the sun is shining.

There is a whole lot to be said for fruited plains and amber waves of grain.

Article on the Clarion Ledger's Website

 On November 27 & 28, 2007, the Communication Information Technology Organization of Mississippi held a conference on High Technology at the Telecom Center in Jackson, MS.  Ashby was asked and honored to give a presentation on the Future of the National Technology and Innovation Economy.

The PowerPoint presentation (slides only) from Ashby's presentation can be accessed by clicking the following link:

Ashby's Slides

and then clicking on

"Conference on High Technology presentation on the Future of Technology by Ashby Foote."

Click on the link below to read Ashby's article on the May 2007 market rally which appeared on the American Spectator website:

American Spectator Article

Read Ashby's thoughts on the recent market volatility in the linked article that ran in the Clarion Ledger on March 30, 2007:

Clarion Ledger Article: March 2007

The following commentary by Ashby on the AT&T BellSouth merger ran in the Clarion Ledger on 11 January 2007:

Clarion Ledger Article: January 2007

October 2006 Jobs report:

The highly anticipated Labor Dept. Jobs Report was released today (11/3/06) with a big upside surprise in positive revisions and the lowest unemployment rate in 5 years at 4.4%.  This along with rising tax receipts, strong corporate profit growth and even rising stock prices, supports the case for a continued economic expansion well into 2007.  The bond market, which has been pricing in rate cuts by early next year, sold off sharply on the news.  AMF

THIRD QUARTER 2006 INVESTMENT UPDATE