Bentzen’s Blog

Are You Ready for Conficker?
by Brian Bentzen

Conficker is a widely distributed worm, a computer virus that came into being after Microsoft updated their software on October 23, 2008 to close a flaw that could be exploited to allow remote code execution.  As a result, only PC users can be infected and 10 million PCs are estimated to be infected.  Apple users are still safe.  This bug takes advantage of people who weren’t timely in updating Windows to keep a security flaw in the Windows code open.  This security flaw allows the virus to remotely take over certain actions on your computer.  CA says, ”Win32/Conficker.C is a worm capable of blocking security related websites, terminating system security services and downloading component files using time-based generated URLs.”  As a result, this worm leaves your system open to additional malware attacks, and it can be very difficult to remove.  In it’s current form, it doesn’t seem to steal data, passwords, send spam, or attempt to overload websites but it does have the capability to receive additional instructions.  Additionally, it deletes restore points and blocks your ability to upgrade your security, leaving you more vulnerable to other malware. 

The first version, Win32/Conficker.A was reported to Microsoft on November 21, 2008.  On December 29, 2008 Win32/Conficker.B was discovered.  These versions of the virus exploit the previously mentioned security flaw.  The program then downloads a version of itself that integrates the virus into the Windows startup files.  Once it has infected your computer, it can infect removable drives including USB flash drives, and it will attempt to hack your network administrator password.  If you don’t have a password on your network, it will try to infect your network.  It will prevent your computer from downloading certain security upgrades in order to prevent its eradication.  To prevent spread to your computer by removable media, you will need to disable autorun (Windows link).

The third version Win32/Conficker.C was reported to Microsoft on February 20, 2009.  This version was developed in response to an attempt to shut down the random webpages that were being propagated by the virus.  Rather than attempt to access 1 of 250 pages, the virus now attempts to access 1 of 50,000 pages.  This increases the likelihood of the virus being able to receive the next update, which will occur on April 1, 2009.  

I scanned my computer and was lucky enough not to be one of the millions of people at risk due to this worm.  After seeing the 60 minutes segment on Sunday night, I’m concerned that I could still be at risk.  The larger the network it seems the greater the risk.  Although my personal computer is safe, my information is stored by various corporations across the country and the world.  My personal information could be accessed with a mere keystroke.  So could yours.  Luckily, The United States Computer Emergency Readiness Team (US-CERT), a division of the Department of Homeland Security, developed a tool that can detect and remove the virus.  From this website you can access several tools that will help you to detect and remove the virus from your computer.  Additionally you can call 1-866-PCSAFETY to speak to Microsoft’s PC Safety Hotline.  The Department of Homeland Security recommends you disable autorun (DHS link), install the critical security patch, keep up to date with Windows update, anti-virus and anti-spyware, and enable a firewall.  

With a little luck and a few days notice, our responsible corporate friends will largely eliminate this threat.  Nonetheless, we are all still at risk from future attacks. I plan to follow the DHS advice.  Watch the 60 minutes piece and you may be surprised at how the authors of malicious software are treated around the world.  Good luck!

Bonusgate
by Brian Bentzen

AIG has done it again.  The American people are angry, the Obama administration is scrambling, and the AIG executives are rich.  The truth is buried in the stimulus bill, the Declaration of Independence, and in Supreme Court decisions.  These bonus contracts are valid, and the government cannot force AIG to abrogate them, despite the bad politics.  As a citizen, you have a right to enter into such contracts without fear of government intervention.  Only under bankruptcy procedings can a corporation be forced to renegiotiate contracts.  By infusing capital into AIG and effectively preventing their bankruptcy for the time being, our federal government has allowed AIG to honor its contracts.  If there had been foresight to demand renegotiation of such contracts in exchange for the bailout, the current political mess and public outrage might have been avoided.  Any intervention on the part of the government will serve to alienate a large population, but failure to do so will anger everyone else.

First, let us examine the so-called reasoning for these bonuses.  These bonuses are not performance bonuses.  They are retention bonuses, designed to keep the employees who caused the problems working at AIG so they can unravel the complex contracts they created.  To fix the problem quickly, AIG decided these people need to keep their jobs, and rewarded them more than handsomely to keep them at work.  According to Wikianswers.com, “A Retention bonus is an incentive paid to a key employee to retain them through a critical business cycle. This could be a transitional period (such as mergers and acquisitions) to ensure productivity or to meet a critical milestone. It has proven to be a very good tool in persuading employees to stay.”  The ethics of this sitation can be debated but it is legal.

The Obama administration and Congress want to prevent these bonuses.  They can’t, however, intervene and break the contracts.  Remember that we are first a country of free people with certain unalienable rights, including Life, Liberty and the Pursuit of Happiness.  The pursuit of happiness includes your right to freely enter into business contracts and any legal business of your choosing. 

As in our intercourse with our fellow men, certain principles of morality are assumed to exist without which society would be impossible, so certain inherent rights lie at the foundation of all action and upon a recognition of them alone can free institutions be maintained. These inherent rights have never been more happily expressed than in the declaration of independence, that new evangel of liberty to the people: “We hold these truths to be self-evident” — that is, so plain that their truth is recognized upon their mere statement — “that all men are endowed” — not by edicts of emperors, or decrees of Parliament, or acts of Congress, but “by their Creator with certain inalienable rights” — that is, rights which cannot be bartered away, or given away, or taken away, except in punishment of crime — “and that among these are life, liberty, and the pursuit of happiness, and to secure these” — not grant them, but secure them — “governments are instituted among men, deriving their just powers from the consent of the governed.”

Among these inalienable rights, as proclaimed in that great document, is the right of men to pursue their happiness, by which is meant the right to pursue any lawful business or vocation, in any manner not inconsistent with the equal rights of others, which may increase their prosperity or develop their faculties, so as to give to them their highest enjoyment.
 - U.S. Supreme Court Associate Justice Stephen Johnson Field, Butchers’ Union Co. v. Crescent City Co., 111 U.S. 746 (1884)

Any intervention to force AIG to break the contracts would almost certainly lead to a long court battle that might make its way to the Supreme Court.  The alternative currently in discussion is passing a law that would essentially create an AIG bonus tax.  This again is a poor precedent, but the bill will probably pass easily.

HR 1, the American Recovery and Reinvestment Act of 2009 attempts to set limits on executive compensation.  One amendment states, ‘‘(iii) The prohibition required under clause (i) shall not be construed to prohibit any bonus payment required to be paid pursuant to a written employment contract executed on or before February 11, 2009, as such valid employment contracts are determined by the Secretary or the designee of the Secretary.  The bonuses that are causing a public uprising and death threats against AIG employees are valid, so long as they were signed before February 11, 2009.  The amendment that protects these bonuses was supposedly written by Senator Dodd (Dem – CT), although he denies including this in the bill.  If Congress hadn’t been in such a rush to pass the bill, perhaps more members would have actually read the bill they passed before voting on it.

It appears there is little that the government can do to stop these bonuses.  If they intervene illegally, any American who cares about his rights will reject the current majority.  If they fail to intervene, they will illicit the anger of the current majority of voters.  It seems that the right thing to do is to let the AIG employees receive their bonuses.  Whether they deserve the money or not is not up to our government.  The US government cannot and should not intervene.  The AIG executives who are receiving their bonuses should decide what is best and perhaps a few will refuse their pay.

The Recession is Over
by Brian Bentzen

Although I have no evidence to prove this, I believe this recession has either hit bottom or come close to it.  The savings rate has increased drastically, from less than zero percent, to 5% last report I read.  That is a major shift, and when spending drops by 5% in an economy that is largely driven by consumer spending, it makes sense that the GDP would decrease.  Add on to that the falling housing prices and loss of trillions of dollars of asset values on bank balance sheets and you have a recipe for a deep recession.  But can things get worse?  I’m reminded of an old joke.  The optimist looks at a bad situation and says, “Things couldn’t be worse.”  The pessimist slaps him on the back and with a smile says, “Of course it could!” 

The problem with saying the recession is over is that you can’t determine when the recession ends until long after the fact.  We probably won’t know until it has been over for months.  We didn’t know that it started in December of 2007 until late in 2008.  We do know that in February we lost 697,000 jobs, home sales decreased by 7.7% in January, and consumer spending rose by 0.6% in January.  GDP shrunk by 3.8% last quarter.  Maybe I should rethink my premise.  There is fear about job loss, unrest about the stimulus package and bailing out troubled homeowners, anger at banks and government.  This all adds up to a ton of negative sentiment about where our country is going.  But we will recover from this. 

The recession could have ended yesterday and you wouldn’t know about it until August 2009.  Thirty years from now, we’ll look back on this recession as we look back on the recessions of the early 1980s.  Our economy has grown.  Our standard of living has increased.  Our lifespan has increased.  Our technology has improved.  Our investments have paid off.  Continue to believe in Americans and American companies and we’ll continue to improve.  Encourage your children to stay in school, become skilled workers, start a business, accept challenges and take appropriate risks.  Take your unemployment or underemployment as an opportunity to improve yourself.  Learn a new skill, volunteer to help others in worse situations, plant a garden, get rid of luxuries, move to a new location.  Do what you have to do.  When we rebound from this recession there will be new job openings.

If you are a homeowner who is underwater, Uncle Sam will help you, even if it makes a lot of people angry.  Most underwater homeowners are not speculators trying to get a reward with no risk.  Most are hard-working Americans who made the assumption that home prices would not decrease and got screwed over.  We’ll help you, and even if we gripe about it, we understand you need help.  And if Uncle Sam doesn’t help, there are plenty of private investors who want to help you break even, or come close by buying your mortgage at a fraction of what it is worth on the bank balance sheet.  Again, this beats the alternative of declairing bankruptcy.

When things turn around, will you be ready to take advantage or will you get left behind?  New businesses will start to replace those that went under.  Investors are keeping their money on the sidelines waiting for indicators that they should move back into equities.  Will you get in on the way down, on the way back up, or invest after the recovery has already occurred.

The recession is over (maybe).  If you still have your job, continue to save and invest in America.  In thirty years you’ll be glad you did.  If you are unemployed, this is a good time for a change.  If you are mobile, there are a lot of jobs.  If you are stuck in your current home, stay there and keep trying.  Things could be worse, honestly.  When we regain the optimism we had just a few years ago, we’ll see things turn around.

Truth be told, I’m not all that optimistic.  I’m continuing to invest every single paycheck and even if the Dow drops to 1000 I’ll continue to put my money into companies with good balance sheets, cash balances, low debt and a large moat.  And I’ll continue to invest in index funds.  I’m just going to continue going about my life as I normally would, with the exception being that I’m trying to save even more than usual.  I’m not saving because I’m scared of the recession or fearful of my job.  I’m more scared of missing out on all of the great deals available on the stock exchange. Is the recession over?  Who knows.  It could last for years.  It could be the worst depression we’ve ever had.  But I’m going to choose to hope for the best and I hope others will choose to make the most of their situations as well.

Start a Bank
by Brian Bentzen

With banks still in such great distress it seems to me like it might be a good time to start a bank. Unfortunately I do not have the $6 million in capital needed to start a bank in Pennsylvania.

Last week, NPR’s This American Life played a great one hour piece (transcript) that described exactly what the problem is with banks, simplified.  And here is my summary:

In the simplified world, it doesn’t take $6 in capital to start a bank.  You can start one with just 10 bucks.  After that you can get depositors by promising them interest of around 3%.  After getting $90 in deposits you now have $100 on your balance sheet.  You lend this $100 to someone for the worlds cheapest mortgage at a rate of 6%.  Now lets take a look at the bank balance sheet. 

$100 Assets 
____________________
$10 Capital
$90 Liabilities
____________________
$100 = $100

On the basic balance sheet, the left and right sides have to add up.  When you look at the Citigroup balance sheet, the same is true

$1.95 Trillion Assets
____________________
$150 Billion Capital
$1.8 Trillion Liabilities
____________________
$1.95 Trillion = $1.95 Trillion 

Now, lets say our pretend bank’s single mortgage has defaulted.  The mortgage holder can no longer make payments, and if the current market, the home’s value has decreased by 10%.  Now we have to readjust our balance sheet.  It has to be equal at the end of the day.  Since we can’t get more than $90 for the home, and we have to pay back our depositors (plus interest), we have to take the loss from our capital.  Now our capital decreases to zero.

$90 Assets (mortgage)
____________________
$0 Capital
$90 Liabilities 
____________________
$90 = $90

The problem is that in most places, the home values are depressed more than 10%.  If the value of the home dropped by 30% to just $70, the bank would have negative capital (ie insolvent or bankrupt).  Additionally the bank wouldn’t have enough money to pay its liabilities to depositors.

$70 Assets (mortgage)
____________________
$(-20) Capital
$90 Liabilities
____________________
$70 = $70

But if the bank just assumes the value of its asset will return to its normal value if given a little bit of time, the bank doesn’t have any problems at all.  They would still have their original balance sheet as illustrated above, and they would still have their original capital.   Obviously, banks like this scenario.  They just choose to believe that the actual value of their forclosed properties are still 100%.  If they are forced to “mark to market” (adjust their assets to market value), the banks will have the bottom balance sheet, and all of the big banks would be forced to file for bankruptcy.  Citibank claims it is world $150 Billion, but at the close of market on March 6, the market capitalization was $5.64 Billion.  There is a clear descrepancy.  

The solution to the problem depends on whether you believe Citibank is worth $150 Billion or $5.64 Billion.  The market is designed to evaluate what a business is worth according to the  efficient market hypothesis, but at this point when there is so much fear and uncertainty, it might be possible to vastly undervalue Citibank’s capital.  

Under the TARP (Troubled Assets Relief Program), the government agrees with banks that prices will go back up, and essentially buys the bad assets for enough to keep the banks’ balance sheets positive.  If the $100 mortgage was bought for $92 (an $8 discount), the banks capital would decrease from $10 to $2 (an 80% loss) but the bank would remain solvent and in business.  The problem with this solution is that prices might not go back up.  Then government is stuck with a bill for $92 for an asset that is worth $70 now, and might decrease further in price.  The banks that made the loans to people who can’t afford them are still afloat and can continue to operate.  

The banks love this prospect.  Deutsch bank published a note that said, “”Ultimately, the tax payer will pay, one way or another, either through greatly diminished job prospects and/or significantly higher taxes down the line. We think the government should do the following: estimate the highest price it can pay for the various toxic assets residing on financial institution balance sheets, which would still return the principle to the taxpayers.”  They don’t want the government to pay the lowest price that will keep the bank afloat.  

Then Adam Davidson from NPR called Joe Lavorgna, author of the above letter.  Joe comes out and says he believes that ultimately the burden of the great decrease in asset values will affect the taxpayers one way or another.  The other way involves the scenario where banks go under, and the government is liable via FDIC for the insured deposits.  The government then steps in and pays all of the losses, replaces the initial capital and effectively owns the banks.  The government plugs the holes in the bank and sells it to someone who can run the bank profitably again.  Lost of bankers lose their jobs, and this makes some happy as a form of revenge, but also leads to unemployment and suffering for people who didn’t necessarily do anything wrong.  

Government ownership is the way that many other countries have solved their problems with bank collapse in the past.  The IMF has helped Indonesia in 1997, Korea in 1997-98, Russia several times, Argentina in 2002.  The US has nationalized regional banks in the past, back in the 80s in Texas and Oklahoma.  The problem might be finding enough people to do the work and enough money to buy the banking system of the entire country.  Of course, we know that if we really want something to happen, it will happen.  There would be a lot of jobs created by this process at a time when creating jobs is a high priority for our government.  So far, our government has accomplished a mix of the two.  While firmly stating the government does not wish to own banks, it has poured money into the banking system.  This isn’t a new concept.  They use an example from Rome, circa 37 AD.  When the banking system there was in trouble due to a run, the Emporer has gold coins delivered to the banks to keep them afloat while the people made a run on their deposits.  The alternative is to just let the banking system fail, but this would most likely put us in a deeper Depression than any of our grandparents can remember.  This is a bad option.

So, what about getting lending going again.  The banks have all this money on their books now, but essentially the money is just a stop-gap.  It allows them to break even.  If they lent this money out, they would be repeating the exact process that caused them to require a bailout in the first place.  

Professor David Beim from Columbia Business School explains another reason why banks shouldn’t lend.  American debt has reached 100% of GDP.  The only other time this happened was in 1929.  The problem might just be our overextended lifestyles and McMansions.  

Solutions

There are already companies attempting to buy up bad debt and renegotiate loans with homeowners.  The problem with this deal is that in order to buy the mortgage at a discount, the bank must take an actual loss, which is perhaps worse than a paper loss, depending on how the government eventually deals with the problem.  This seems like a good business to be in, and is why I would start a bank right now if I had the money.  

Additionally, the government wants to guarantee investors who buy up mortgage based securities.  If you put down 10%, the government will loan you 90% so you can buy the security.  You keep any profits, and if you lose, you only lose what you put in.  This gives you all of the benefits of buying on margin, with a lot less risk.