Air
date: February 25, 2005
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Digital databases and privacy
GEOFF COLVIN: Most people had never heard of ChoicePoint until this past week, when the firm announced it had inadvertently sent information files on 145,000 Americans to scam artists. Now the Senate Judiciary Committee says it will hold hearings, which will likely reveal the shocking facts of just how much is known about you by organizations you've never heard of. In the digital age, can you keep even a shred of privacy? In the post-9/11 world, is there anything the government won't know about you? And what about the benefits of having so much data freely available? Robert O'Harrow, Jr. is a Washington Post investigative reporter specializing in data privacy and author of No Place to Hide. He joins us from Washington. Brian W. Ruttenbur is a stock analyst with Morgan Keegan covering homeland security technologies. He joins us from Stanford University.
Bob, just who is ChoicePoint and how bad is this bungle for the people whose records were sent out?
ROBERT O'HARROW Jr.: ChoicePoint is one of the largest background screeners in the nation. They also are a marketer and provide a lot of services to police, intelligence agencies, major corporations, and government agencies. They have in the last eight years acquired something like 58 other companies that help them process and collect and sell public records, biometrics, genetic information, and they do it very efficiently.
It's a bad thing for a lot of reasons. It's not the biggest identity theft, but it is, it comes at a really difficult time when people are very sensitive about where information is going. So it seems to be having a big impact.
COLVIN: Brian, ChoicePoint has been a darling of Wall Street, recommended by all kinds of analysts, but the stock plunged after this latest problem. Could this problem damage all the companies in this sector?
BRIAN RUTTENBUR: I think all the background checking companies are taking note of what's going on with ChoicePoint, and I cover a couple of those, First Advantage being one of those, and a company I used to follow that just got acquired earlier this year by Marsh & McLennan, and that's called Kroll, and they're one of the larger background checking companies. So I've been involved in the industry, and those companies have not had any problems. The problem seems to be with the biggest company, and that's ChoicePoint.
COLVIN: It is a fascinating company, though little known by most people until this week, and in fact there was a recent television program with Peter Jennings based on Bob O'Harrow's book that looked in part at that firm:
(video segment begins)
PETER JENNINGS voiceover: This has become a profitable and very competitive business. One of the biggest companies is called ChoicePoint, and Derek Smith is the CEO.
DEREK SMITH: Well the business premise behind ChoicePoint is the fact that the world's becoming a riskier place to live, work, and do business.
JENNINGS: ChoicePoint absorbs information from 40,000 new public records everyday.
O'HARROW: Since 1997, ChoicePoint's bought more than 50 other companies, and they've got some 20 billion records on -virtually every adult in America.
JENNINGS: ChoicePoint still does background checks for corporations, but increasingly, it works with the nation's intelligence agencies, looking for people who might threaten the country. Smith says that Americans have got to rethink their historic attachment to privacy.
SMITH: I believe that you have the right to privacy, but not the right to anonymity. And I believe in our free society as you seek rights and privileges in that society, then we have to know who you are. We need to establish the identity of who you are as an individual, and then for the greater good of society, be able to determine whether or not you should be extended that right or privilege.
JENNINGS: This is an attitude that drives privacy advocate Chris Hoofnagle crazy.
CHRIS HOOFNAGLE, Electronic Privacy Information Center: When Derek Smith says that people don't have a right to anonymity, he's talking about in his business model. His business model is one where everyone is identified, where everyone is fingerprinted. That's not America.
The companies that collect your personal information, operate in
a regulatory system where they don't have to really guarantee you anything. They can take your information and sell it to other people. If law enforcement shows up and they want to know about you, they can hand over your data. They can make inferences about you, and make decisions about you.
JENNINGS: Many observers worry that private companies are not accountable in the same way that government is, and yet government is increasingly counting on these private companies.
(video segment ends)
COLVIN: Bob, if we gave ChoicePoint the home phone number of any American, what would they know about that person?
O'HARROW: If you have a phone number or other identifying information, they can know a lot of stuff; where you live, where you've lived as an adult, your entire adult life, who your roommates were. They can find out who your families are. They can know at some level, depending on the company, your estimated income, political donations, the kind of car you drive, the value of your house. The list really goes on and on.
COLVIN: Brian, we've been talking about the data companies and so forth, but there are many other sectors to this whole industry, and you look at all of them, or nearly all of them. What are the other most important ones that affect average Americans?
RUTTENBUR: Well, biometrics is on the upswing, and we're seeing the biometric passport, the biometric ID. All those things are coming of age. Another area would be digital video surveillance, communications intercept, otherwise known as wiretapping. All those post-9/11 have grown dramatically, and we've seen the power of the government post-9/11 really expand in those areas where the pendulum has swung from the left to the far right in terms of our rights being fewer and fewer out there.
COLVIN: Bob, there is a sort of double standard here. I mean people get upset by the big brother aspects of all this. On the other hand, they want terrorists identified and caught before they do anything. They want their soccer coaches and daycare workers screened as thoroughly as absolutely possible. How significantly will that affect public attitudes towards these firms?
O'HARROW: When I did my homework, I found that there were some old fashioned themes that really had nothing to do with computers and networks and bits and bytes, and it had to do with the government doing things with private companies in ways that it wasn't accountable and in ways that we couldn't really track very well. There wasn't a transparency. These are issues that have been around forever, and I think that we need to figure out where those exist and then make some decisions about how do we get the benefits from technology without allowing this unaccountable source of surveillance and power to intrude in our lives. It's a balancing test that involves being informed.
COLVIN: Brian, what about the possibility of public backlash hurting many companies in this sector? As you try to evaluate them and make your best recommendations to investors, is that a significant factor or not?
RUTTENBUR: I think that it's focused right now on the background checking companies, not the companies that are doing the biometrics or the companies that are doing the digital video surveillance and some of the other, the communications intercept. So I think that's where the big concern is, is about the data privacy and our personal data getting out there. I don't think that most people that are law-abiding citizens are really worried about cameras being up or communications intercept, being wiretapped. If you're not doing anything wrong, then there's nothing to be worried about is my opinion.
COLVIN: Bob, you understand much better than most people what is known and what is knowable about you. Have you made any changes in your own life or your own behavior as a result of all this?
O'HARROW: It's funny, it's a good question. Not really. To me I've come to conclude that this isn't so much about privacy, which is a very vague word. I call it a tofu word, because you can apply any flavor to it you want. I see this more as a question of that core autonomy, which is very old fashioned. It's this notion that we expect the government to brush up against us and we expect to have to follow the rules and so on, but are these companies intruding into our lives and is the government intruding into our lives in ways that kind of violates this sense of autonomy? And so I really haven't changed my behavior, but I have been trying to study this enormous and amazing change.
COLVIN: Brian, what about you? Have you made any changes as you have studied and learned more about this industry?
RUTTENBUR: No, not at all. One thing I would like to point out, though, is that on the background checking, I think that it was a software error and maybe the company should have reacted quicker, ChoicePoint reacted quicker to the situation and informed people quicker on the problem. I would like to point out that we as a society is still in this post-9/11 world are very concerned about additional terrorist attacks and I think are going to be willing to let the government take a little bit more leeway and videotaping and digital video surveillance and communications intercept and those kinds of covert activities to protect the society as a whole.
COLVIN: What about the other benefits? Because people may not realize them either. Bob, go ahead.
O'HARROW: Well, the benefits are obvious in many cases. If you walk into a store and you want credit, you can get instant credit, and people love that. The background checks, the fact is that ChoicePoint background checks have identified murderers, rapists, and other criminals who were looking for jobs or trying to be volunteers. They've helped in law enforcement. The marketing is, it's led to huge numbers of sales in the direct marketing world, so that even though we may complain about the letters that we get and the phone calls at home, we obviously respond at some level because the revenues have skyrocketed in the last decade.
COLVIN: Brian, I want to ask you another angle of the investment side of all this. This is an industry in which there are an awful lot of small players, especially on the technology side. Consolidation is going on. It's probably going to continue going on. As you look over the sector broadly, who do you expect the ultimate survivors will be?
RUTTENBUR: There's going to be three or four, in my opinion, and I think ChoicePoint is going to survive. First Advantage is a number two or number three in here. Marsh & McLennan with their acquisition of Kroll, they're a big player in all this. There's a couple of big private players, US Investigations Services, USIS. They're a major player in the government background checking in terms of top secret clearances and things like that. But there's still a ton, literally thousands of Mom & Pop players that will more than likely because of regional and focus be acquired by those bigger companies I just mentioned.
COLVIN: It's a fascinating topic and obviously much more remains to be heard and done about it. Robert O'Harrow, Jr., Brian Ruttenbur, thank you for your views.
McCulley on bonds
KAREN GIBBS: This is a very interesting time to be a bond investor. For months economists, market strategists and assorted financial pundits have warned that with interest rates heading higher bonds are the wrong place to be. But despite the best efforts of Alan Greenspan and the Fed to boost interest rates, they've remained stubbornly low, and all Alan Greenspan can do is scratch his head and wonder! So if Greenspan is puzzled, what in the world are the rest of us to do? Paul McCulley is a leading bond strategist for PIMCO, the world's largest bond fund, and he joins us from Newport Beach.
Well, Paul, what is an investor to do when probably the most powerful man in the financial world doesn't understand long bond rates this low either?
PAUL McCULLEY: It was truly fascinating to hear Mr. Greenspan say that the long end of the bond market is a conundrum. It's the most memorable phrase I think since irrational exuberance, because Mr. Greenspan likes to come across as all-knowing. He isn't and he knows he isn't, but he's sort of the grandfather of the financial markets, and when you have your grandfather say that life has become a conundrum, it makes you question life. I think what Mr. Greenspan was trying to do is actually inject a bit more fear into the marketplace. The failure, if I can put it that way, and I really hate to put it that way because it's wonderful to have low long-term interest rates, but the failure, in quotation marks, of long rates to rise means that the risk of a housing bubble is growing, and I think that's really what Mr. Greenspan is concerned about. So he's trying to talk up long-term interest rates by saying that they're a conundrum. And also a phrase that is not as widely reported, that they may turn out to be a short-term aberration. Any time the central bank chief says that an asset price may be a short-term aberration, I think wise investors should get a firm grip on their wallet.
GIBBS: It seems pretty implicit in that comment that long-term rates are an aberration means they're going to go higher. But we continue to see investors pour money into bond funds. If the Fed doesn't understand why rates are so low, and higher rates generally erode the value of bonds, why are investors doing that?
McCULLEY: There's a great deal of momentum in investing I think, and investors effectively look at asset classes that have done well. It is the stuff of bubbles. We saw that obviously in the late 1990s, when you'd ask the question why are people buying stocks at P/E multiples half the distance to the moon? And the answer is because they're going up. So I think there's a degree of momentum investing. Someone also called that complacency. And I think Mr. Greenspan did a service for the marketplace to say that sweet, wonderful, perfectly coordinated economies rarely exist, and therefore there should be risk premiums in the marketplace for the inevitable possibility if not inevitability of stuff happening. So I think investors are complacent, and complacency is really the Achilles' heel of a lot of people's portfolios. If something is doing well, they don't look at it, whereas when something is doing well it may become rich and needs to be sold.
GIBBS: Paul, what do you think the cause of this complacency is? Is it that they believe that inflation is under control? Or on the other side of the coin, do they believe this economic strength isn't as strong as Friday's Gross Domestic Product numbers show?
McCULLEY: I think there's probably a little bit of both, though I think the notion of low inflation expectations is critical. I think it's in some respects the paradox of confidence in the Fed. The more confident we are in the Fed's ability to hold down inflation, the less likely we need to build in a risk premium for that. So it's a unique circumstance. Away from the issue of domestic growth and domestic inflation, I think a lot of the explanation for what's going on in the overall yield curve is a global explanation. I've written a great deal about it and so has my partner, Bill Gross, and we're living in a world of a de facto Bretton Woods arrangement between the United States and the rest of the world, anchored by that fixed exchange rate between the United States and China. And the rest of the world has a surplus of savings that they are recycling back into the American bond market. So in that instance, the answer to the conundrum is that long rates would be higher if the rest of the world would discover the joy of consumption and quit saving so much.
GIBBS: Well, if they did discover the joy of consuming everything in sight as we in the United States seem to do, doesn't that portend higher rates and then bad news for bond holders and bad news for stock prices?
McCULLEY: I think that's correct. I mean America is living in a unique sweet spot where our job is to be the designated hedonist for the world, and we do it very, very well. The rest of the world is happy to provide us vendor financing, if you will, for our hedonism, and it's a symbiotic relationship that Americans certainly win from, and the rest of the world wins as well to the extent that they get access to the American market, access to American know how, and are able to bootstrap themselves up the development chain. So it's a symbiotic relationship between America and the emerging world. But if and when the emerging world decides that rather than providing vendor finance for American cars they'd like to have a car in their own driveway, then it spells a period of stagflation for America, which is negative for bonds, but also as you note, the death knell for stocks, because stagflation is truly a depressant on P/E multiples.
GIBBS: Well, if those chickens that you're talking about come home to roost, what's the bottom line for PIMCO clients and others that want to invest in the bond market?
McCULLEY: I think a good motto in the bond market is that pleasure at some times is about avoiding pain, and I think bond investors at current valuations in the American market need to be defensive, and they should not be apologetic about it. The market is fairly to richly valued, more on the rich side with respect to spread markets than fair, and accordingly I think people should be risk adverse. They should also be using global markets that aren't nearly as rich as the American market. But I think a key issue here is that investors should not feel they have to be in it to win it. Sometimes there's nothing to be won except pain, in which case I think you're suppose to exit the party early.
GIBBS: Can you explain to us that defensive posture and how it's reflected in the fund you manage?
McCULLEY: Well, I mean you have three particular types of risk that you can take in a variety of funds in the bond land. It's interest rate risk, credit risk, and volatility risk, and I think on all three investors should be trying to pick a fund that is on the defensive side; less interest rate risk, less credit risk, and less volatility risk. That means less yield of course, because duration risk, credit risk, and volatility risk gives you yield, but yield comes at a cost, which is the downside of a negative scenario. And I think investors should be willing to sacrifice some yield in order to preserve capital going forward.
GIBBS: We've been talking broadly about bonds, but there are different types of bonds. Most everyone knows about Treasuries and corporates, but you talked about credit risk. And I'm looking now at the junk bond market, which has seen an explosive return for investors, but that could be getting a little long in the tooth. What's your take on the different types of bonds?
McCULLEY: Well, I think the junk bond market has had a marvelous run, based upon the fact that the American corporate sector truly has repaired its balance sheet. Credit quality has improved. The American corporate sector checked itself into the Betty Ford center for balance sheet rehabilitation, and it has emerged sober. So credit spreads should be tighter. But I think we're at valuations now where the risk/reward doesn't look particularly attractive, or as I tell our younger people around here sometimes, you don't get to go to heaven twice for the same good deed, and junk bonds have already gone to heaven. So when I look at that space of higher yielding product, I much prefer emerging market bonds as opposed to junk bonds, though I have to say that emerging market bonds are not cheap. I just think that they are cheap relative to high yield.
GIBBS: Are there any emerging markets that you do think are attractive or at least worth some attention of investors?
McCULLEY: Well, I think the two key emerging markets that are on a path of ascendancy in credit quality are Brazil and Russia. They are very circumspect in their financial matters. They're very different countries, but I think both of those countries should be on anybody's buy list. Brazil is proving that the concept of principle populism is not a contradiction in terms. Mr. Lula is doing a great job and the fiscal house is in order. The private sector is growing nicely, and reserves are growing intensely. So I like the Brazil story because it is the success of principle populism. And the Russia story is different. I like it, but it is actually a little bit more oil-driven than it is the domestic economy. But there's no question that Russia is winning a huge windfall from the oil price and has a tremendous financial cushion in foreign exchange reserves. So those would be two stories that I think still have legs.
GIBBS: Are you concerned at all about Russia's move away from democracy? It seemed to be a big issue in meetings this week between President Bush and President Putin.
McCULLEY: I think everyone should always be concerned about that, which means that if you're going to invest in Russia, I think you should invest in the sovereign as opposed to the private sector. As recent developments have shown, the sovereign sometimes can muck around in the private sector and the concept of private property rights are not nearly as secure as we Western investors would like. But if you're lending to the sovereign, then effectively you're taking that risk out of the equation. The sovereign has over $100 billion worth of reserves itself.
GIBBS: By sovereign, do you mean the government versus private corporations there?
McCULLEY: Yes, exactly.
GIBBS: Okay. Any other pictures that you see as we go through 2005? The numbers from Friday's Gross Domestic Product report shows quite a bit of momentum going into 2005. Can we expect that to continue?
McCULLEY: I wish I knew, quite frankly. I'm anticipating that the economy will slow down this year as effectively the waning effects of both monetary and fiscal stimulus come through. Remember the economy the last couple of years has been on Keynesian steroids with respect to fiscal and monetary policy. The Fed is obviously removing monetary accommodation, and on the fiscal front whether or not we actually get some fiscal restraint, I don't know, but at least we're not going to get another round of fiscal stimulus. So I think the economy is going to slow down, but I think we've got a good, sturdy economy in America. We've recovered from the bubble years. We might have a little bit of bubble going on in the property market, but I don't want to be betting on any Armageddon scenarios for America. We're still quite strong.
GIBBS: Paul McCulley, great to see you. Thanks very much for joining us.
McCULLEY: My pleasure.
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