Tag Archives: investment

Wall Street Whine with Cheesy Job Creators Argument

 Wall Street Pig

It is inevitable. When anyone suggests that the top 1% pay a bit more for the comforts of life in a civilized society – comforts like defense, police protection, firefighting services, a judicial system for the resolution of complaints and the enforcement of contracts, to name but a few – someone will wail, “You Can’t Tax The Job Creators.” [C&L] There is a philosophical side to the refutation of this old whopper:

“Great success should be celebrated, but not institutionalized. When we tax working Americans at a higher rate than billionaires, it is bad for business. When we tax the small business more than our largest corporations, it is similarly bad for business. When we give tax breaks to the wealthiest while excluding those in the middle and the bottom, we slow down our economy by slowing down the rate of idea creation, because so many are excluded from the process of solving our nation’s problems.

Small adjustments in how we run our system can make a huge difference to our economy and our country. A truly capitalist system structured to maximize the participation of the many rather than the advantages of the few will generate more jobs, growth, and prosperity. Additionally, being fairer and more inclusive will increase solidarity in our country, creating yet another positive feedback loop of ever-increasing cohesiveness and patriotism.” [Atlantic]

One might have hoped this old “Job Creator” canard had dissipated along with the four excuses Republicans always bring to the fore, however that’s not to be. The Voodoo Economics and attendant statistical gymnastics associated with the Trick Down Hoax are nothing if not tenacious.  The tenacity is impressive since it has maintained a hold on media types long past its sell-by date.

The hard truth is that the ultra-rich do not create jobs. Wall Street financiers do not create jobs.  Investment bankers do not create jobs. In fact, no single segment of our economic ecosystem creates jobs. Jobs are the result of a combination of elements which taken together form our capitalist system.

The classic Capitalist chain begins with a person who has  an idea.  Investors may be induced to support this idea with some money.  The idea (product or service) hits the market. Now comes the important part – it doesn’t matter how good the idea might be, or how much investment is poured into the project – IF there are no customers for the product or service.  All three legs of the stool have to be solid before any weight can be placed on it.

The “Job Creator” notion works IF and only IF we take the third leg off the stool. Until someone buys the product or service, and that someone is joined by enough other customers to make the idea profitable there are no real jobs created – only paper prospects.   Let’s look at some real world examples.

Some products are too far ahead of their time.  Witness the fate of Norman Bel Geddes’ 1933 Roadster design for the Graham-Paige Company. [RoadTrack] The Depression didn’t help – there weren’t customers for the stylish automobile, and Graham-Paige was eventually sold to Kaiser-Frazier. However, our best example for “too far ahead of the customer curve” may well be the 1898 Lohner-Porsche hybrid – yes, that’s HYBRID as in combination gasoline and electric car. [Wired] All the investment in the manufacturing capacity of Graham-Paige or Lohner-Porsche couldn’t bring the idea to fruition and to profitability without customers. Ultimately, the investors in these ideas didn’t create a single job.

Some products are behind the curve.  Remaining in the automotive realm, there’s the venerable Edsel example. The Flop Heard Round The World.  When the car without customers was finally euthanized in November 1959, some $250 million (or about $2 billion in today’s dollars) had been sunk into  the flop.  Again, lots of investment, lots of marketing, and ultimately no permanent jobs created by this machine which hit a saturated market.

Some products glitched. Apple poured a ton of money into the Newton. Remember the Newton? Not too many people do, but this personal assistant tool was the predecessor of the Palm Pilot.  Two major problems beset the early model PA, the writing recognition was literally laughable, and the price was too high.  [DailyFin] Customers stayed away in droves. Apple’s employment numbers didn’t increase because of the investment in the good old Newton.

Some products fail because of poor marketing. All we might have to say here is “BetaMax,” or “New Coke?” Herein we have products, especially the BetaMax, which were essentially good products, for which there was a market, but the corporations never connected the customers and the products in a way to make the launch profitable.  At least the two gave business schools some quality examples of marketing failures to add to their curricula.

The examples lead to a rational conclusion:

“Investment capital is an important part of the economic ecosystem, as are entrepreneurs. But investment capital alone cannot create sustainable jobs. Investors do not keep investing in businesses that don’t produce products the market wants and will pay for. And, eventually, no matter how much money is invested up front, unless the ecosystem supports a company, whatever jobs it temporarily adds will disappear.” [BusinessInsider]

Along with the 1933 Roadster, the 1898 Porsche Hybrid, the Newton, BetaMax, New Coke, and the Edsels.  The emphasis on investment to the exclusion of focus on the real economy kicks at another leg of the stool. It’s not like we haven’t been warned; there is this comment from James Tobin, a member of President Kennedy’s Council of Economic Advisers, from back in 1984:

“I confess to an uneasy Physiocratic suspicion…that we are throwing more and more of our resources…into financial activities remote from the production of goods and services, into activities that generate high private rewards disproportionate to their social productivity.” [MonthlyReview]

What happens if “more and more of our resources (capital)” is directed toward “financial activities remote from the production of goods and services?”  Financialism.  Our financialists would have us believe that not only are they the ultimate essential feature of the free market system, but that their wealth is creating wealth for everyone. Leaping to that insular conclusion means a long swim back. 

The accumulation of corporate cash under the financialist perspective, combined with the Shareholder Value Theory of Everything, is a recipe for stagnant wages, which translates all too quickly into decreased demand for goods and services.  But, the people on top are doing nicely, thank you very much.

“When firms do use this money, as opposed simply to piling up cash, it is frequently to pay dividends to stockholders, buy up other companies, or else to buy company stock in the hope of driving share prices up: a pure speculative endeavor. In 2013 corporations authorized $755 billion to buy back shares of stock.  Failure to absorb the enormous economic surplus and its use instead for speculation means that the actual rate of growth of the economy slows down in relation to its potential rate of growth. To the extent that corporations do continue to invest in this kind of economic environment it often serves to displace labor and decrease their unit costs of production, increasing the overall surplus at their disposal. The capital formation that does occur under these circumstances is therefore unable to lift the economy out of its general listlessness.” [MonthlyRev 5/14] (Emphasis added)

Or, those who are primarily interested in “capital formation” are missing the point – and they cannot create “jobs” much less “general prosperity.”  The self same interests which are slowing down the economy’s rate of growth are exactly those who are trying to tell us they are responsible for it.  Good Grief.  This is all rather like having the man who has tied a thick elastic band to the rear axle of your vehicle tell you that any forward progress you make is due to his exertions.  

And the level of the capital gains tax on all this speculation? What does that do?  Economics professor Leonard Burman dropped this little bombshell in the midst of a joint meeting of the Senate Finance Committee and the House Ways and Means Committee in 2012:

Burman Chart

Go ahead, try to find a statistically valid relationship between the rate of the capital gains tax and the economic growth line.  Good luck. Professor Burman’s conclusion:

“Does this prove that capital gains taxes are unrelated to economic growth? Of course not. Many other things have changed at the same time as tax rates on capital gains and many other factors affect economic growth. But the graph should dispel the notion that capital gains taxes are a very important factor in the health of the economy. Cutting capital gains taxes will not turbocharge the economy and raising them would not usher in a depression.”

What Do We Know?

We know that a generally more prosperous economy encourages ideas (for new economic enterprises), and that while investment is a key element in the process it is not exclusive – product timing, development, and marketing also play crucial roles.  We know that vast capital accumulation doesn’t automatically mean economic growth.  We know that capital accumulation diverted into speculation in exotic financial paper can be a drag on the overall economy; and, we know that there’s no statistically valid correlation between the level of the capital gains tax and the level of economic growth.

So, taxing those self-anointed  “Job Creators” may not be so bad an idea after all.

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Filed under Economy, Taxation

Cracks in the Economic Mirror

cracked glassWhy not come out and say it? Wall Street is not your friend. At least it’s not your friend if you are among the group casually known as American Workers.  I know, much has been said about our “Nation of Investors” and how millions of Americans have a stake in the financial markets.  [SEC] However, all that palaver papers over the obvious.  Wall Street’s financial markets are dominated by institutional investors, and such connection as the average American does have is often limited to the tertiary strings which attach to retirement savings accounts and pension funds.

There are forces which generate revenue for Wall Street investment houses that have a negative impact on those American Workers, for example — when Walgreen Inc. decided to eschew a corporate inversion, keeping its headquarters in Chicago the Market pounced and instead of rewarding the company for maintaining its American identity and retaining its American workforce at the Chicago HQ the Wall Street Wizards dumped its stock. [CBS]  More examples?

Merck, Cisco Systems, AOL, HP, Citigroup, Bank of America, and Wells Fargo — all companies which were rewarded by Wall Street for cutting expenses (read employees). [MoneyCNN] Cost cutting (read layoffs) will be rewarded because…? If revenues are at least stable and expenses are reduced there will obviously be more profits for shareholders.  If Wall Street has an anthem it must be “Onward Shareholder Value.”

The problem with marching to this tune is a loss of corporate focus.  Henry Ford’s big idea was to manufacture automobiles.  Merck may be the oldest pharmaceutical company in the world, beginning with Friedrich Merck’s purchase of an apothecary shop in 1668 — a firm which grew to sell the first commercial small pox vaccine in the United States in 1898. [Merck]  Henry Wells and William Fargo started their San Francisco business in 1852 offering banking and express services. [WF] In each of these instances the founders, whether a middle western mechanic, the descendents of an apothecary owner, or the bankers during the Gold Rush, opened their doors to provide products or to deliver a service.

A firm gets to be an institution by providing goods or services, sold to people who need or want them. There is no other way to build a business.  However, when the management of a company is more interested in the stock price than in the goods or services rendered to the public we start to see the cracks in the system.

The mythology takes over — We, say the managers, must guarantee to our shareholders (owners) the highest possible return on their investment.

Crack Number One:  How long must one wait for the return on the investment?  We have a relatively recent example of what happens when the management of a commercial enterprise decides to cash in on quick returns instead of waiting for long term results. Back in 2003 CBS News asked “Who killed Montana Power?”  The short answer is the management. Montana Power management took a blue chip company, a formerly solid investment, a source of economical electric power, and transformed it into … a disaster.

Crack Number Two: Institutional and professional investors aren’t investing in long term corporate strategies which they expect to grow over the next 90 years. They are instead attuned to the quarterly reports, the earnings estimates, and the pronouncements of the analysts.  Volatility, not stability, is the key to high and quick returns. Stability protects long term investors, volatility rewards short term speculation. [BusIns]

Crack Number Three:  When the Finance Department meets the Production Department who wins?   In the 1990s the financial sector accounted for about 20% of all corporate profits, by 2011 the sector rebounded from the Mortgage Meltdown and accounted for approximately 29% of all corporate profits. [HuffPo] The process happens in the remainder of the economy as well. Consider the recent information coming from General Electric.

The company’s industrial division (medical equipment, oil & gas drilling equipment, aircraft engines, locomotives, and gas turbines) reported revenue increases of 9%, its oil and gas revenues were up an impressive 25%, its financial services were up 7%.  In fact, the financial services end of the business, Synchrony Financial, is to be spun off getting GE out of the private label credit card business by 2015. Oh, and by the way — the corporation is planning to get rid of its appliance manufacturing. “Mr. Immelt made a promise to investors that the company would expand its industrial businesses and get rid of non-core segments.” [MBN]

The company formerly synonymous with nearly all things electrical is going to profit from selling off its private label credit card operations and dropping the appliances end of the business.  There’s nothing intrinsically wrong with the evolution of a corporation moving with the tides to stay profitable — but this does illustrate how a firm can move from manufacturing into financials as a core segment of its business.

Meanwhile there are several Wall Street investment banks no longer in existence that were enamored of generating fast revenue in derivatives markets and moved with another tide — out to sea.

Crack Number Four: Insert the hedge fund managers here.  Its one thing to argue for shareholder activism when speaking of the managers of pension funds, 401(k) funds, or the like, it’s quite another when the shareholder activists are hedge and wealth management types.  The Harvard Business School issued a report (July 9, 2014) coming to the following, rather depressing conclusion:

“As in prior research, we find positive announcement-period returns of around 4% to 5% when a firm is targeted by activists and a 2% increase in return on assets over the subsequent one to five years. We find that activist directors are associated with significant strategic and operational actions by firms. We find evidence of increased divestiture, decreased acquisition activity, higher probability of being acquired, lower cash balances, higher payout, greater leverage, higher CEO turnover, lower CEO compensation, and reduced investment.”

We can lump “increased divestiture, decreased acquisition, higher probability of being taken over, more debt, and less investment” under the general category of short term interests.

What is a pension fund or 401(k) administrator to do?  If pension funds, both public and private, are to be invested in corporations increasingly likely to be managed for short term revenue results, and those results are all too likely to be hinged on a swinging door of price volatility; and, if corporations are more likely to be managed with an eye toward the financials, coupled with increased divestiture and greater leverage — how does one invest for the long term in a short term environment?

So, here comes the dilemma.  The fund managers and administrators may decide to swim with the sharks — to go along with the short term investment strategies and applaud the volatility of the financial markets.  However, we’d have to ask: Does the very volatility of the markets or the acquisition of more indebtedness actually work against the best interests of the people who are paying into those retirement or pension funds?

Those who are now working, expecting retirement benefits or pension payments, seem to be at the mercy of a financial sector which rewards their layoffs and applauds the divestiture of their firms.  The message is reflecting from a cracked mirror: If you are lucky and the financial markets are up on your 65th birthday you can retire — If not?

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Filed under Economy, Nevada economy, Nevada politics

Income in America – The Hurrier We Go The Behinder We Get?

The average worker’s pay in the state of Nevada is $35,206 per year. The average CEO pay is $5,130,077.  That’s a ratio of 146-1 in favor of the CEO, a figure which rockets up to 299-1 if CEO compensation is compared to our minimum wage earners.   [Paywatch]  If we look to the 89101 Zip code specifically, the median annual compensation for a CEO is $736,318 or 21 times the earnings of the average worker.  The range in that area goes from $396,391 to $1.059,652. [SalWiz]  If we look north, the average CEO compensation in the 89501 Zip code is $732,846, with a range of $394,522 to $1,054,657. [SalWiz]  The problem isn’t that some individuals are paid more than others — the core issue is that there are economic pressures which continue to put a drag on our economic recovery, and some of these are the result of wage and tax policies which favor financialism over good old fashioned capitalism.

The first argument launched from the conservative side of the spectrum is that these numbers are necessarily flawed, and therefore of little utility in debate about wages, salaries, and compensation in general.  However many issues the Center on Executive Compensation , allied with the U.S. Chamber of Commerce, and the National Association of Corporate Directors, may have with the methodology, and with the proposed SEC rules on ratios, [Blmbrg]  the points remain — (1) Multinational and other large corporations really don’t want to disclose their CEO pay packages, and (2) They really don’t want the issue of executive compensation tied into the discussions of tax equity and fairness.

This is an interesting line because corporations generally have no problem reducing almost any issue by quantification, be it allocation of purchasing orders or labor costs and productivity.  One easily reached conclusion is that the quantification called for by the SEC under the terms of the Dodd Frank Act isn’t something the corporations want to do.

The second common assertion is that these are the “job creators,” and therefore should be immune from any additional taxation, and certainly from any increase in the taxation of capital gains.  We are continually told that any attempts to adjust the inequities via minimum wage increases or tax policy will have dire effects on small business.  Testing this contention requires looking more carefully at the old common ‘wisdom’ that small companies are the driving force in job creation.  There’s some evidence this may not necessarily be the case.

While it’s still true that businesses with 49 employees or less create the most jobs, the trend since 1990 indicates that large employers (over 500 employees) added 29% more workers between 1990 and 2011, while those with 50 or less added 10.9% more. [NYT BLS]  In short, what the large corporations do in terms of compensation of CEOs and employees is important, and become more so as additional jobs are the result of hiring decisions made by large firms.

Practical Matters

## As a practical matter, income inequality only becomes a problem when such a large portion of wealth is tied up in the hands of so few that the savings capacity of individual workers is reduced.  Obviously, at the theoretical level, the more workers save the more money becomes available for investment.  Practically, the more workers are able to save the less reliance there is on social safety net programs, and the more savings accounts of all varieties are available for (a) consumer spending — such as in retirement, and (b) investment by the banks and mutual funds which hold them.

One way to observe this in the real world is to look at what people are doing with their 401(k) accounts.  Now that housing isn’t the most apparent source of income, individuals and families are increasingly tapping their retirement accounts to meet necessary expenses.  In 2011, for example, Americans withdrew about $57 billion from their retirement accounts while home equity loans were down by 38%. [Blmbrg]*

At the consumer debt level, the Federal Reserve’s report on Household Debt Service and Financial Obligations ratios shows consumer debt which bottomed at 4.97 in the first quarter of 2012 is now back up to 5.14.  People who are borrowing aren’t saving, and if they aren’t saving then those funds are not available for investment.

Our debt levels are back up and our personal savings rates are headed back down.  The Federal Reserve chart shows an increase in personal savings during recessionary periods, a spike in December 2012, and then back down we went.

Personal Savings RateNothing says “squeezing the middle’ quite like watching (a) dipping into retirement accounts, (b) increasing consumer debt, and (c) declining personal savings.

## Income inequality becomes a problem when the funds which should be invested in the expansion or improvement of capital projects is diverted into ‘manufacturing’ financial products which add wealth to their holders and traders, but do not add assets, fixed or short term, to corporate enterprises.  Look at the following chart showing the trends in how banks earn their income:

US investment banking fee composition

(See Capital Markets Outlook – Deloitte Israel, Global Investment Banking Review – Thomson Reuters, both in pdf)

Trading in “equities” is earning a larger portion of banking revenues in recent days, from 17% to 48%, while loans have contracted since 2005.  And bonds, the old staple of the investment banking sector? Improving, but not as well as the equities column of the ledger.

If the tax on capital gains is only 15% then what incentive does an investor have to invest for the long term in manufacturing capacity?  For that matter, if funds are in the hands of institutional investors what incentive is there for long term investment instead of seeking short term gains?  In 1995 institutional investors held 140.8% of our GDP, in 2011 that number had increased to 211.2%.  In 1995 institutional investors held $11,223 billion in financial assets, by 2011 that figure stood at $24,220 billion. [OECD pdf]  And then there’s this chart — notice the increase in the column representing investment funds compared to that of pension funds:

Investment Institutions by typeIt isn’t a stretch to conclude that recent trends indicate there are more institutional investors and those investors are increasingly in the form of ‘investment funds.’  The small chart below shows the the increase in the number of hedge funds since 2000:

Hedge Funds

 

 

 

 

 

And, as we might guess, the smaller, newer funds are doing well, but they’re also more likely to ‘blow up.’ [FTAlphaville]  It’s necessary to remember that what’s good for the hedge funds and asset managers (short term gains) is not necessarily good for the rest of the economy (long term stable prosperity).   The focus of the money managers is, predictably, money. Money becomes the ultimate measure of wealth, not the fixed and other assets of other enterprises.

If we’re looking for the barriers to economic growth in the U.S. some attention needs to be paid to (1) the growing income inequality which puts pressure on individual and family saving capacity; (2) tax policy which rewards investment for the sake of ‘money’ rather than investment for the sake of long term corporate viability; (3) the role of institutional investors and their agendas in the financial markets; and (4) the declining role of retirement funds for their original purpose (retirement) and in the overall institutional investor landscape.

We’ll do better when we can return to the traditions of capitalism — in which wealth is measured not only by bank accounts, but by what those bank accounts can provide for the businesses and industries who build them.

* See also: Angry Bear Blog “Americans Raid 401(k)s” May 8, 2014; EPI, “The State of U.S. Retirement,” March 12, 2014; Naked Capitalism, “Even Harsh Frontline Program on Retirement Investments Understates How Bad They Are,” April 24, 2013.  CAP “What Can We Do About Retirement Fees Straining Middle Class,” April 15, 2014.

 

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Follow The Money: How To Play The Traveling Money Game

I think I get it. How to play the Traveling Money Game — Romney Style.  Political Carnival provides the explanation, and because I tend to think in charts and graphs, this is my rendition of that explication.

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Filed under 2012 election, banking, Economy, financial regulation, Politics, Romney, Taxation