At best, we have seen a pause in the economic decline. It is too early to call a trough.

Surging unemployment will act like Agent Orange on those “green shoots”. While we have every reason to be worried about a swine flu pandemic, the recovery was at risk well before the first reported cases. That is, the economic fundamentals suggest a second wave of hardship.

The Past

The first quarter of 2009 is behind us and it was a disaster with GDP plunging at a 6.3% annual rate. While consumption stabilized, investment was slashed by 16.7%. That’s not an annual rate! The annualized change in private domestic investment was an astonishing -66.7%. We thought that the previous quarter was bad at -24.2%. The freefall in investment has more than doubled.

The Future

The IMF recently revised their estimates of losses in the U.S. to a staggering $2.7 trillion. The report can be viewed here. These are deeper losses than one would be led to expect by statements from our government.

But I think we are missing something.

We are bleeding jobs to the tune of 600,000 per month. In addition, we know that even after a trough in economic activity, job losses continue. We are not factoring into the economic equation the impact of the job losses.

To be more clear, the first wave of subprime losses were caused by loans being made to people that had jobs but their income was insufficient to pay their mortgage payments. Banks made these loans assuming either their incomes would increase by the time the reverse amortization ended (for example, the end of the low teaser rate) or their house would appreciate by enough so that a mortgage equity withdrawal could be made to pay the interest on the original loan (in true Ponzi fashion). Note, in both cases, the homeowner has a job.

The situation is different today. We have a wave of people that will not be able to pay their mortgages because they are unemployed. It is not critical right now because these homeowners are drawing down what little savings they have. However, time is running out as these saving are depleated.

The market is seizing whatever little piece of good news. However, it will soon be reckonning time for the second wave.

The Trouble

There are three other troubling developments.

1. The Stress Test is Bogus

On Monday we will get the first official results of the stress test.

The so-called “adverse” scenario assumes an unemployment rate of 8.9% in 2009. That is a sham. We will likely have that rate for April! It effectively assumes a dramatic end to job losses in May 2009. Who believes that?

Equally bogus is the fact that we are relying on the bank’s own models to run the stress test. These are precisely the failed risk management models that got us into this mess.

To make things even worse, the Treasury secretary has said that anybody who fails will get recapitalized. Whatever happened to the idea that if you take a bad bet, you lose. If you are reckless, you go out of business. All of that is gone. You get bailed no matter what you do. We reward incompetence with hard earned taxpayer money.

2. No Transparency

There is no transparency. I have no idea what these bank “earnings” announcements mean. Accounting “earnings” depend on the loan loss reserve assumptions as well as the valuations of their assets. I have no way to assess the quality of the bank assumptions – but I have strong suspicion of low quality.

FASB has recently said that banks don’t need to use market prices. What does this mean? It means that if you don’t like the market price (i.e. too low), then you can use your model price (which is likely too high). If you think about it, you could easily argue that the so-called fire-sale price is too high. You observe a price but that’s before you need to sell your asset. When you put your asset on the market, that will likely cause the price to fall even more. All of this makes the financial statements impossible to interpret. Right now, I have little idea of who is solvent and who is insolvement. However, I have a strong suspicion that there are many insolvement banks.

3. Too Big to Fail

Pass the barf bag. I don’t think I am the only one. This policy encourgages reckless risk taking on the part of large banks. They know they will be bailed out so there is no risk for them – it is the American taxpayer that bears the cost of their mistakes.

We need to end this policy. There are two ways. First, you let some big players fail – but do it in an orderly way (i.e. no repeat of the Lehman fiasco). The alternative is to break up these firms. Either way, we put our financial institutions and our economy in a stronger position for the future.

Weird Zombie Game

Yes, it is true that some credit spreads have improved. Consumer confidence has also increased. But these are fleeting. A recovery must be sustainable. On the financial side, there are two prerequisties to the proper functioning of financial markets and a sustainable recovery: transparency and purging. Right now, we have neither. The stress test will provide little or worse — potentially misleading information. The losers are rewarded with bailouts, guarantees — and bonuses. The taxpayer is shafted. The economy is sloshing around is a sea of Zombies.

Just seeing a salad on the menu seems to push some consumers to make a less healthy meal choice, according a Duke University researcher.

It’s an effect called “vicarious goal fulfillment,” in which a person can feel a goal has been met if they have taken some small action, like considering the salad without ordering it, said Gavan Fitzsimons, professor of marketing and psychology at Duke’s Fuqua School of Business, who led the research.

In a lab experiment, participants possessing high levels of self-control related to food choices (as assessed by a pre-test) avoided french fries, the least healthy item on a menu, when presented with only unhealthy choices. But when a side salad was added to this menu, they became much more likely to take the fries.
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The new issue of Insights, the research newsletter of Duke’s Health Sector Management program, focuses on conflicts of interest in medical research.

Take a look at the newsletter to learn more about Professor Kevin Weinfurt’s findings on disclosure practices in medical literature.  Also featured are HSM Director Kevin Schulman and alumnus Matthew Kirchner, Director of Marketing at Medtronic, who provided reactions to the research.

Operations Management Professor Paul Zipkin offers the following suggestions for easing the credit crisis with a supply chain management approach to banking.

Who needs banks, anyway? The enormous recent damage to the economy has been caused mainly by the disappearance of working capital for supply chains, plus consumer panic. Maybe firms in supply chains need to become their own banks, much as they do in impoverished countries. This is already happening on a small scale.1

Seriously, our economic civilization works much better with banks. The current crisis has amply demonstrated this fact. Various remedies have been proposed to unfreeze the financial system. Here is another one: Banks can fund whole supply chains, not just individual firms. This practice already exists, again on a small scale. It’s called supply-chain finance.2

To appreciate this notion, some background will help. Why did the subprime crisis lead to a full-blown credit crisis? Why did banks stop lending? Various plausible stories have been put forth, but none of them is based on convincing facts, and none is entirely satisfactory. Right, the banks own “toxic” assets of questionable worth, but the money already injected by the government should suffice to sustain a reasonable level of commercial lending. The banks are not talking. They say they are indeed lending, despite abundant evidence to the contrary.3

I don’t have any facts, either. But here’s a better story than any I’ve heard: Banks don’t trust each other. Each one can see only its own financial condition. Even that is not so certain. There have been lots of stories over the last year of seemingly solid banks, which turned out in fact to be broke, to their own surprise as well as to others’. Still, why should that prevent a bank from lending to a real business? The reason is, banks are tied to each other in part through real businesses. Read the rest of this entry »

With all the hype before product launch, why were the sales of the Segway scooter so disappointing?  According to research by Duke alumnus David Alexander of the University of St. Thomas, John Lynch of Duke University, and Qing Wang of Warwick University, the highly-touted, innovative product may have been just too new and unfamiliar.

While novelty may create advertising buzz, when it comes time to part with their money, consumers prefer the familiar over the really new—especially when using the new product requires a behavior change.

The research, reported in “As Time Goes By: Warm Intentions and Cold Feet for Really New versus Incrementally New Products,” was funded by the Marketing Science Institute (MSI).  It was recently awarded the Robert D. Buzzell MSI Best Paper Award, chosen by MSI trustees for its lasting value to marketing executives.
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