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Fleck Rap



Options-Expensing Brings Out the Bogus in Barrett

Overnight equity markets were a nonevent, but the same cannot be said for currency markets (more about that below). After opening essentially unchanged, our stock indices were driven lower when the Chicago purchasing manager's opinion poll missed the number at 57.6, vs. expectations of 61 and last month's reading of 63.6. There was also some consternation about a rumor that Greenspan had suffered a heart attack. I almost hesitate to bring it up, because it looked rather spurious. The world would be a far better place if Greenspan were not in his present position, though if he were to leave, one way or the other, in all likelihood we would just get more of the same, in the form of Bernanke or McTeer.

The Greenspan/Bernanke/McTeer Musketeers

The good news about those two clowns is that they're so bad, the appointment of either would hasten the day of reckoning that Greenspan & Co. have been trying to postpone for so long. Thanks to their decision-making, an epic bear market in stocks and real estate, and a bone-jarring recession in the economy, still lie in our future. The sooner we bring it on and get it over with, the better off we'll be. All the Fed has done in the last few years is to ensure that when it finally hits with full force, the impact will be much worse, because so many people's balance sheets have so much more debt. In any case, that little diatribe is food for thought for another day, as the Fed denied that Greenspan was ill. But the day will come when it will pay to have prepared for the outcomes I described.

Back to the action, the market meandered as the day wore on, spurted briefly to the upside, and closed not terribly far from where it opened. As the box scores show, the indices did little of anything. Likewise, the action beneath the surface was short on drama.

What to Fear in a New Fiscal Year

Away from stocks, the big news was that last night, the Bank of Japan said no mas (Spanish for "no more"). Once the yen blew through 105, it traded down to 103.5, before stabilizing and then closing at 104.3. It's important to know that tonight is the first day of Japan's new fiscal year, which could be the start of a significant change and the end (recently rumored) to its currency-intervention policies.

I say could be, because it's too early to tell. But, if the Japanese are no longer going to print yen to suppress its appreciation -- and therefore no longer be obliged to accumulate dollars as the other part of that trade -- then they will no longer be buying Treasuries in the same quantities as they have in the past. That will leave the Chinese as the buyer of last resort, which raises the question: How many will they or can they absorb? The net of all that, if it comes to pass (and I emphasize if), would obviously be a weaker dollar and a rise in rates here. Should that occur, it likely would be the start of a problem with housing.

An Inflection Point from Points East?

A lot of folks seem to forget that in the old days, before this present band of lunatics started running the Fed so irresponsibly, rates could rise simply because of inflationary expectations. That could be where we are headed, i.e., very little growth, but still plenty of inflation. Thus, the bond market could experience rising rates because of supply and inflation concerns, even with the Fed (and especially because of the Fed) pegging the funds' rate at 1%. It will be very important, I think, to keep an eye on the Japanese yen and our bond market to see if this is a true inflection point. If so, as I've described, it will have very major ramifications.

Meanwhile, other major foreign currencies were also quite strong, where today marks the end of the quarter here. Perhaps that may have exacerbated the move in the euro and Australian dollar, both of which were up better than 1%. The precious metals also got into the act, as you might imagine, with gold up $5.50 to $428.30 and silver up 17 cents to $7.94, both new (spot) closing highs for this move.

Quicksand for QLogic

Back to stock land, I have noted many times in the last month or so that stocks have not really gone up well on good news. I have been assuming that the first company to mention bad news this quarter would really get thumped. Sure enough today, QLogic (QLGC) was down about 20% after disappointing Wall Street in the game of beat-the-number and expectation guidance. (Best Buy and Circuit City, though, won at beat-the-number, demonstrating that spending is still all consumer, not corporate.) Folks who own companies involved in that game should be forewarned that any miss could be met with a beating. My two favorite picks to click in the big-tech area for potential disappointment would be Nokia and Intel.

Mr. Barrett's High-Tech Kvetch

Speaking of Intel, its disingenuous CEO was whining in today's Wall Street Journal, as he has in the past, about the "impossible" task of valuing stock options, and how if the Financial Accounting Standards Board (FASB) forces it to do just that, lo and behold, the class-action brigade (a.k.a., lawyers) will be after corporate America, since improperly valued stock options could invite lawsuits.

I guess we could give Barrett an "A" for imagination in coming up with that yarn. As anyone who's been paying attention knows, he and other foes of option-expensing are the very folks who helped to pass the Private Securities Litigation Reform Act of 1995, whereby the aforementioned brigade could not sue corporations for lying. Also known as the "Safe Harbor" act, this legislation basically permits corporations to say: We might be lying to you, but since we're telling you we might be lying, you can't sue us, even if we do lie to you. Falling stock prices had unleashed an onslaught of frivolous class-action lawsuits, but in some ways, this legislative "cure" was worse than the problem. In any case, most folks realize how difficult it is to successfully sue a corporation for anything it says that might be misleading. Therefore, this is a complete stretch on Barrett's part.

Deconstructing the 'No-Can-Do' Defense

Further, he builds his case on a purely nonsensical premise: "No one has ever figured out a model that can value options with any degree of accuracy." Warren Buffett has written about how relatively straightforward it would be to put an options-expense estimate together. Yes, there is a degree of guesswork involved, and options can be mispriced, but that can be dealt with. It's not the Armageddon scenario that Mr. Barrett suggests.

As to his protestation -- "In 1972, the Accounting Principles Board, faced with the same problem, issued an opinion that said no compensation expense need be recognized for options to employees 'because of the concern that stock options could not be reliably valued'" -- I would respond: The options industry is a tiny bit more sophisticated than it was 32 years ago. Not least of what's helped that along? The computers that Intel's engineers have engineered. To think these engineers can't do "options math" is laughable.

A CEO Stews in His Own Spuriousness

Some of Barrett's other claims are so outlandish that only direct quotes will do them "justice." Concerning the further ill effects of expensing options, he says, "Some companies may cut back drastically on the options they issue, or forgo them entirely. This in turn will hurt the economy and punish companies that practice good corporate governance." (Earth to Craig: No one, FASB included, said you can't issue options. They're just saying you must account for them.) It's absurd that he should stoop to this, since another business operating within the PC landscape -- Microsoft -- no longer expenses options, practices good governance, at least as far as its financial statements go, and it has taken the opposite approach. It doesn't take a genius to see how completely and totally bogus that complaint is.

Finally, to show that he has no shame, Barrett maintains that if this expense is included, "companies will be forced to use pro-forma reporting." Now that bit of disingenuousness really takes the cake. In the last few years, Intel has reported all sorts of flavors of pro-forma numbers. Even more galling, during the mania when Intel was making money in the stock market, it included those one-off gains as part of its operating income. Folks like Fred Hickey and myself jumped up and down yelling about that, but redefining operating income to suit its needs was no problem for Intel when it helped boost its numbers.

A Big Cheese Takes the Cake

The moral of the story? Here's a well-known corporate chieftain using all kinds of sleight-of-hand and disingenuous arguments to try to have his own way. And what is his own way? To have his cake and eat it, too. That brings me to the real problem with the option-expensing issue: Corporations don't want to claim options are an expense, but they want to be able to deduct the tax that their own employees pay the government when they make money after exercising their options. At no time, is this discussed in his or anyone else's anti-option-expensing article.

In theory, I could be sympathetic to corporations averse to expensing options if they give up the tax deduction (though I think they should probably be expensed). But if you're not going to expense them, you shouldn't be able to get the tax benefit. You can't have it both ways. That lies at the root of this wrongheaded treatment. Corporations continue to want to have their cake and eat it, too. This particular corporate chieftain is willing to make up all kinds of ludicrous arguments to try to get his own way.

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