In addition to the political benefits for Obama, another interesting dynamic is that attention to Romney’s career in the financial sector is, I think, prompting some additional attention to dubious practices in that sector. John posted on Bain’s interactions with Dade International, and mistermix posted on the NYT story about how Goldman screwed Dragon Systems. But there is an even bigger issue here that I want to raise.
Let me use Ezra Klein as a foil. He writes about the founding of Bain Capital:
Bill Bain’s idea was simple. His firm, Bain & Co., was making lots of money by advising companies in exchange for fees. The fact that it was making money was proof that its staff understood what it took to make struggling companies successful. So why not eliminate the middleman? Rather than advising companies for a fee only to watch the current management reap the big profits, Bain Capital would take over troubled companies, manage them to profitability and reap the rewards itself.
That is an curious spin, and one that Romney himself might offer. According to this model, corporate raiders like Romney are just turnaround specialists. They take over “troubled” companies, and right them.
And yes, this does happen. But this is only part of the story.
“Troubled” companies have a particular meaning on Wall Street. Sure, sometimes they refer to companies that are just muddled, have over-expanded, and are badly managed. But more often, what they are talking about is companies that do not seem to providing a large enough return to shareholders — a stagnating stock price in particular. But that does not mean a company is “troubled.” It can be quite profitable, have productive and loyal employees, have satisfied customers, and cash on hand.
What players like Bain do is enforce a Wall Street preference. There is a bias against companies that seek a “quiet life.” They are shunned by institutional investors, which depresses stock prices and makes these companies “troubled” in the first place. It isn’t that they are not profitable, but rather than institutional investors don’t like them, and as a result they trade at dramatically lower P/E ratios. Indeed, it isn’t even clear that takeover targets do have weaker stock performance if you look at total returns, including dividends.
Once a company goes public, it is essentially subject to “disciplinary” takeovers if it fails to act in accordance with financial sector preferences. This is often phrased as “poorly performing managers,” but what does that really mean? That is really just about enforcing a certain conventional wisdom about what a company ought to do. But these preferences are socially problematic. Consider some of the things that seem to contribute to being a takeover target: slow growth, stable revenues, cash on hand rather than debt, generous employee compensation, conservatively-funded pension or insurance plans. (Again caveats abound. There is no simply model of predicting takeover targets.)
So, in a sense, Bain, and other buyout specialists, serve to enforce a particular type of corporate behavior that focus on expansion at the expense of predictability, risk acceptance in terms of contractual obligations to employees, and a ruthless focus on cost controls at the expense of employee loyalty and stability.
As a practical matter, it is not clear that this sort of approach is conducive to more rapid economic growth. Certainly the rise of this consensus and expansion of “disciplinary” takeovers since the 1980s has not resulted in any noticeable improvement in U.S. macroeconomic performance. And furthermore, the evidence on whether takeover targets overperform or underperform after being bought is mixed.
But what has happened is that as firms accept these practices, they become more dependent on the financial sector. They borrow more, become more active in raising money through equity sales, they run leaner by hedging through derivatives, and so on. In each case, they pay a cut to financial firms. The result has been that the financial sector’s share of corporate profits has risen dramatically since the 1980s.
Some of these companies will now be more successful, but many that move toward debt-fueled expansion will crash and burn. The financial sector wins either way. But it isn’t clear to me that corporate America in general win, and certainly workers whose pensions gets looted, and unions busted, and ride the boom and bust cycles of overtime and layoff do quite poorly.
The stock market is not an efficient market and the prices do not reflect all the information. Modern financial theory is house of cards built on extremely shaky foundations.
Gin & Tonic
It would be great to see this discussed more broadly, if the American electorate had an attention span greater than that of a fruit fly.
Dear me. A fantastic, thoughtful bit of writing.
I am so glad you are here.
: @Gin & Tonic: If a concerted effort is made to frame and repeat, this concept would be understood more broadly. Effort is the key.
I know you’re new here, and I comment seldom(ly????).
But I have to say this is one of the best posts I’ve read in a long time. It’s a point that rarely gets made and needs to be made. “Free Market” means a lot of things, but it’s come to mean making money for the sake of making money, with no weighing of social or material benefit for or against.
The emphasis on “shareholder returns” over all else reflects a poverty of values. Thanks for articulating this so well.
Not to mention that the relentless focus on paying employees the bare minimum necessary has doubtless (along with the destruction of unions) been a major contributor to that stagnation and decline of wages.
Which is the whole point of the exercise from the Bain/Romney point of view.
They’re not engaging in the creative destruction that makes capitalism so tough but so useful. They’re just destroying companies by extracting all the money and leaving the shell to be paid for by the public and the government.
That’s fair, but it won’t go over well with a segment of the commentariat here, i.e., those who Already Know All The Answers. For that group, you have shown yourself to be merely another useful idiot shilling for Them.
Educational post. Gracias!!
Put another way, that’s capitalism.
Villago Delenda Est
This explains why our financial sector, as it currently exists, needs to be annihilated.
Smith would be appalled at this. It would represent everything wrong with the “merchant class” to him. It’s short sighted, narrow greed categorically opposed to enhancing the wealth of the nation entire.
It’s sacrificing every other possible value in the name of avarice.
The cult of Mammon needs to be eradicated.
Obama is a guy who’s always looking at the big picture. While he’s not perfect, I think one of the reasons people get frustrated with him is that he often doesn’t chase their pet issue of the moment, when he actually has bigger things in mind, to be pursued over a longer term.
It seems to me that his vision for this election is not just to take down Mitt Romney, but to use this opportunity to push for a reconsideration of how we’ve structured the economy over the last 30 years–what kind of behavior is tolerated and rewarded; who wins and loses; where the spoils go. I didn’t think so during the Republican primaries, but now I think Republicans delivered him the very best opponent he could have hoped for–better than Newt, better than Santorum.
Romney is not an actual opponent. He is Exhibit A. The Obama people just said so in the “Firms” ad (“He’s not the solution. He’s the problem.”) And we’re going to see this theme developed in multicolored form all the way to November.
I believe this will be the best campaign any of us has ever seen, or will see. It’s artistry.
Villago Delenda Est
You, like Rmoney himself, are part of the problem, not part of the solution.
I would be fascinated to see a post/article based on a search of news articles in the past couple of years containing the phrases “since the 1980s,” “in the past thirty years,” etc. It seems to me that phrase has been popping up quite a lot more lately, and nearly always in the context of how economic changes that have been disastrous for most people. But it’s nearly always just a mention of the time period, with no discussion of why all of these ugly trends just happened to start with Reagan and the rise of the market-worshipers.
Once again, it is ends justifying the means. We have the holy trinity of rationalizing. First, the public policy straussians, who believe that lying to achieve the desired policy end is “sanctified” by reaching the particular desired outcome. You have it on the religious right on matters of “moral” public policy that because they are working for jesus, the means cannot be improper, by definition. Again, the end (doing god’s work) sanctifies the means, such as harassment at clinics, etc. Here, we have the free marketeers who justify destroying a company and its workers by citing the value of the “free market” or “capitalism.”
In each case, otherwise wholly immoral conduct is justified by a desired policy outcome. Such is the relativism that all three rail against to demonize their critics who point to a more complex world that does not allow for such black and white moral pronouncements.
It is their aversion to moral complexity that allows them to stand in a coalition because they are all adept at creating alternate explanations for outcomes that service their desired objectives.
Villago Delenda Est
@Gin & Tonic:
Aye. The dearth of critical thinking skills (something actually thought of as a GOOD THING by the Texas Rethuglican pary) exacerbates the fruit fly meme.
@Gin & Tonic:
For political purpose, the best messaging remains. Vulture capitalist Romney. Job outsourcer Romney. Greed merchant Romney etc…. etc…. Let the other side try and talk themselves into a pretzel to try and explain the wonk, that causes voters to roll their eyes and vote for Obama.
“The financial sector wins either way” is the important point, IMO. The profits from ‘risk management’, leverage, hedging, and whatever have to come from someplace, and a moment’s thought shows that place has to be “Out of the hides of the financial sector’s customers.”
c u n d gulag
What I want to know is – what happened to Mr. Bain, of “Bain Capital,” who started the firm?
How did Mitt get total control?
Where’s Mr. Bain now?
Is he buried in the same grave, Mafia-style, above the one for Mr. Roebuck, at the Sears Cemetery?
This is great. I don’t often read things about the current political climate that have an angle to them that is completely new to me. Thank you.
Jeff(the other one)
And who, pray tell are they?
Excellent post! This goes to the bottom line with one of the problems with business in this country today.
Gin & Tonic
@Keith G: The conditions that Bernard describes have prevailed for nearly three decades. There is nothing new in his post at all. What makes you think any attempts to explain this will meet with success now?
Culture of Truth
Is there a parallel here to the Neocon mentality, itself an offshoot of the colonial, white man’s burden? Iraq was “troubled” and we went in and were going to “turn it around” burst the terror bubble and install a functioning capitalist democracy (after getting rid of the bad management at the top, of course).
Likewise, you could argue the real motive is the same, swoop in like vultures, loot, pillage, take what isn’t nailed down, declare victory and leave a bankrupt hollowed out shell.
@EconWatcher: Yeah, a lot of us have been longing for that fundamental transformation a la Reagan, but I don’t know that I share your confidence that it’s a-comin. Maybe if Romney gets thrashed in this election it will help speed things along, but first that has to happen, and then we’ll see. If Romney wins 48% of the popular vote I don’t think I’ll be ready to conclude that America is ready to turn away from his brand of pro-corporate sloganeering.
I agree. I was at a campaign rally on Saturday, and a significant amount of Obama’s stump speech is about building an economy that works for the middle class, that builds strength from the bottom up. It’s not sound-bite length, so it tends not to show up in news reports (especially teevee), but it’s always there.
Now, a certain amount of that is intended to tag Mitt (and congressional Republicans) with the “failed trickle-down” label, but there’s more to it than that.
Jeff(the other one)
It sounds like the only way to avoid being ripped to shreds by the sharks is to swim quietly, don’t get big enough to be noticed, and swim in schools if necessary-hardly a recipe for roaring success
The Invisible Hand smites; and, having smote,
@Culture of Truth: yes, that is the precise point of post upstream. they are of the same moral make-up. use the end to justify the mean and excuse the messy outcomes along the way
ETA: the neocons that got us into iraq were disciples of straus
It would be well worth someone’s time (not me cause I have no idea how to go about it) to look into the failed companies and see how much money it cost the government to bail out the pension funds. The graphic that could be constructed would be illuminating, i.e., a) is the amount of money Romney and his partners made and b) is the amount of money the government had to pay out to save the pensions in order to line Romney’s already bulging pockets.
@Villago Delenda Est:
Thank you for proving my point.
Gin & Tonic
@General Stuck: But it’s not just about making sure Romney loses. He’s just a symptom of a far larger problem. “Buy and hold” is so out of fashion (inexplicably so, since Warren Buffet, perhaps its greatest current practitioner, is well-known and gives good quote.) But less “financial engineering” means fewer 7-figure jobs for your Princeton frat brothers, which is no a Bad Thing.
Thanks for this post & I hope the points your raise get more discussion here and elsewhere. My local newspaper was modestly profitable and not in debt. It had it’s problems but wasn’t in debt and did at least semi-robust reporting.
But then it was taken over (w/ a leveraged takeover) and ultimately destroyed by cuts/layoffs/etc. All the cuts were prefaced by “we need to cut costs to make this paper profitable b/c it is in debt” and so forth. Never stated was the fact that the paper was only in major debt because of the way the takeover was financed. The powers just took advantage of the “newspapers are dying” meme to continue their slash & burn.
It would be interesting to do a thorough analysis of companies that have been taken over to see if there are significant differences between the ones that have done well and the ones that have failed. I can think of a lot of potentially significant features, so it would be interesting to see which ones were really important and which ones just seem like they ought to be important and aren’t.
@Jeff(the other one):
One of them has shown up.
Makes me wonder: is Newman’s Own publicly traded?
While Romney thinks that waiters and waitresses serving food at a posh Country Club are “middle class” how could he be so fucking clueless?
@Villago Delenda Est: Everyone who works in the financial sector should be forced to read “The Wealth of Nations” as well as “The Theory of Moral Sentiment.” They are complimentary works.
And great post. You spelled out exactly what is wrong. I’ve been thinking that the dictates of Wall Street is part of the main reason many newspaper companies are suddenly going under. They’re making a profit, but enough of a profit.
doesn’t hurt that the banking sector is being rocked by various mismanagement and rate-fixing scandals. good time to run as a wall st tycoon, eh?
true story: the only chain bookstore in my small Kansas town, called Carroll’s, closed down a few years ago. Chain management decided the store wasn’t making spectacular profits. Its earnings were steady but unremarkable. So away it went. And that leaves us with one small, not great, mom-and-pop store. While Carroll’s wasn’t brilliant, it was better than what we’re left with.
What good are ‘quiet’ companies anyhow? Why can’t everyone see that loading them up with massive debt, stripping them of all their assets and driving them into bankruptcy is such a more Wall Street thing to do. On that score, Romney rocks!
GOP: Government is in the way of business and the market.
The reality of Capitalism: without proper government regulation, the market and its businesses cannot function because disequilibrium in the form Bernard describes will more and more upset the society capitalism needs to function.
I’ll bet dollars to donuts the Obama people already have this data and are waiting to unleash it at the right moment. I agree that it could be devastating.
Yup. Romney’s business was entirely about maximizing leverage and figuring out a way to have zero downside exposure. I’d like to see Obama start comparing this to Donald Trump’s real estate business, in which, like Bain apparently, he’s a notorious bad actor and serial deadbeat.
It’s insane that people who master making money while leaving pensions and lower-tier investors holding the bag are lauded, while people who simply bought the house that they liked and that they’re banker & realtor told them they could afford are saddled with the blame for the financial crisis.
irony can’t take much more of this abuse.
Here comes another one
I hope you are right.
Great article, Bernard, but I think I need a little more background (fellow commenters, please jump in any time).
So explain it to me like I’m 5 (which, when it comes to financial matters, is pretty accurate).
A company can start and flourish as a private company, with no public shareholders. (Bain is private, right?)
Going public could potentially make money for people who buy shares in the stock market, and make money for the company if the perceived value of the company stays high. Going public can also bring in a shitload of instant money from the IPO (which is about all I got from the recent Facebook fiasco).
But going public also makes the company vulnerable to a hostile takeover. Is there any way they can protect themselves against this, except for limiting the number of public shares so that they can always retain control? If a company these days doesn’t go public, can it still do well? Is the insurge of money from an IPO worth the apparently real risk of being gutted by the likes of Bain (who make parasitic wasps look like saints)?
Once a company goes public, can it ever go private and survive?
And if more and more companies choose not to go public because of the risk, what happens to all the nice teachers and pensioners depending on their investments?
Basically, can we (non-Galtian masters of the universe) burn the whole fucking thing down and come out ahead?
@EconWatcher: I think the Obama campaign against Romney comes down to making Mitt the poster child of your misery. I think they are laying the groundwork now. There are plenty of people in this country (particularly in the rust-belt and the south) who either has lost their job through a buy-out, or know someone who has. It’s a powerful message if properly articulated, but I think it’s the ballgame.
Belafon (formerly anonevent)
I call this the “Why in the hell is Cartoon Network showing live action programming?” problem. You have to do something new because you can’t just make a profit, you have to make more of a profit than you did the last time.
@Gin & Tonic:
Timing is everything.
@Jeffro: My 2 sec google shows that they were privately held at his death. No idea now.
@MattF: Yes, and this gets to my point in my previous posts about finding way to win politically and also set up a longer-term agenda.
Bashing Bain and Romney is great politics. But from a policy perspective, there is some real traction to be gained by working on convincing corporate American that the financial sector is their enemy as well.
There is a real tension here that is worth developing as a long-term strategic approach.
This is the thing that people like Yglesias, who are pro-offshoring, never acknowledge. There is no particular reason you have to maximize profits by getting the cheapest possible labor… plenty of companies are perfectly successful by hiring “expensive” labor from their communities. That makes the decision to do the things that Bain does not “inevitable” acts of a functioning free market, but actions with moral consequences. So Obama’s position that these are “bad things to do” without simultaneously wanting to make takeovers and offshoring illegal is perfectly reasonable.
Gin & Tonic
@Jeffro: No. It’s privately held.
@Culture of Truth: Of course, Tom Friedman has basically made a career doing rhetorical mash-ups of b-school lingo and imperial hawkishness…
Well, aren’t you an asset to the blog! Thank you for that.
@Gin & Tonic:
Get rich quick rules the roost in our business world, from stem to stern. And quarterly reports the limit of long term business strategy. So I agree as far as the broader problem. It got that way over three decades of Laissez-faire economic policy, that the country embraced, long as they were given easy unlimited credit to buy their toys, with no need to ask deeper questions. It will likely take more than 8 years to turn that around, and exorcise those demons of unsound policy for the longer term in having healthy growth and viable middle class, firmly woven into our national fabric. And we have to do this fighting the lies and dubious intent of republicans every step of the way, that are drunk with hording wealth for a few.
We have to win elections to have a chance. Preferably all of them. And to do so in whatever way that works. Nothing else whatsoever, is more important, imho. This post was and is educational to me, it will take longer to educate the average voter. We have to win elections to be able to do that. But I already said that.
@J.W. Hamner: And one of Obama’s most commonly recurring bits, about community and brotherhood and such, is expressly a retort to the idea that the best conception of value resides in the bottom line.
@Bernard Finel: “gained by working on convincing corporate American that the financial sector is their enemy as well.”
I agree, but it will take a lot of convincing. GM would benefit from a national healthcare system, it would take over all those retiree health costs. But they oppose it tooth and nail because ( as I see it) they have been trained to be in lockstep with all the other businesses who have decided it is a bad thing.
The number of companies that have dropped out of the Chamber of Commerce for either its anti ACA lobbying, or its anti-global warming hysteria, is still quite small.
Focus is on the goal, not the means.
Seem to recall a parable about a golden goose.
Knock yourself out, boys. The barnacles and bottom-feeders will enjoy your fancy yacht in due time.
I do think Reagan gets mentioned a lot in connection with the “since the ’80s” thing, but maybe I have just become sensitized to it. Or it could be that voice in my head that yells “Reagan!” every time I read “since the ’80s.”
@General Stuck: “Get rich quick rules the roost in our business world, from stem to stern.”
Warren Buffett would like to have a word.
Way to hit the ground running, with a great post.
Was wall st ever about raising capital for businesses?
I think not.
Was wall st ever about making better companies out of the traded stocks?
I think not.
Was wall st always about making money on moving paper and never about making anything else?
We have a winner!
All that has happened in the last century is that we have faster trading(more money), hidden trading and information(more money), trading on trading(more money), a ruination of the middle class(who gives a shit, more money!) and a general idea that making/having money is better than making stuff and therefore making money is better and the overwhelming reason to get up in the morning, more than anything else. Better than art, better than sex, money is just better. So if I have more, I’m better, or if I have less I’m crap.
As it always has I predict that it will not end well. Eventually.
@Comrade Mary: I’m sure someone will come along shortly with a better explanation, but I’ll give it a quick shot.
When the company goes public, most of the shares aren’t bought by individual investors, but by hedge funds, brokerage firms, etc. You know, the people who are demanding the ever higher profits. Shareholders run the company, but usually rubber stamp whatever the management wants to do anyway. When the management doesn’t subscribe to the conventional wisdom, they’re replaced by people who do; the kind of people who bring in folks that wreck things in the name of “creative destruction.”
@Comrade Mary: It is all about access to capital. If you want to grow, you either have to bring in additional money by selling off part of your company (going public), or by borrowing. There are costs and benefits to each, of course. But the point is that unless you have very deep pockets, it is hard (not impossible, but very hard) to grow a company and expand operations purely out of cash flow.
But you raise a key point, and this is something we’re seeing already with a reduction in IPOs and something of a move toward taking more companies private — but if being subject to various financial sector shenanigans deters companies from either going public or borrowing then that is a net drag on economic performance.
It seems likely to me that fear of exposure to financial markets is a more severe drag on economic performance than any sort of mythical regulatory uncertainty. Or, in other words, my guess (and I have no solid evidence here) is that a more robust regulatory regime for the financial sector would actually be quite good for corporate America on the whole.
@Gin & Tonic: Well first and foremost, my optimistic view that rationalism can prevail over mythology with time and effort.
Also, ideological seasons are changing now. With each passing month of this bitter harvest it is easier to dull the effects of corporate boosterism. The “ever increasing pie” of yore is emphatically gone and greed at the top of the pyramid is more hateful and therefore actionable, than anytime in one hundred years if not forever, really. One didn’t have to like Andrew Carnegie to have some inkling that his industrial success was important to the growth of a successful America.
All that is gone and now the fields are fertile for new ideals to take hold. I hope our side gets busy planting the seeds.
Buffet is one of the few good guys in that world. He is greatly outnumbered, I fear.
Terrific post. Thank you. Keep ’em coming.
Gin & Tonic
@catclub: Precisely. I love his description of his investment strategy: “lethargy bordering on sloth.”
Romney is not a “Turnaround Specialist”. Turnaround guys are the ones who clean up Romney’s messes – they move into the now overleveraged cash poor companies and attempt to right ship, generally by shedding jobs, negotiating haircuts with creditors, sell “excess” assets, etc. Often with help of Chapter 11. [i.e. it’s the D.E.N.N.I.S. system where Romney is Dennis Reynolds, Mac is a turnaround guy]. It is probably no accident that a whole turnaround consulting industry has grown up in the wake of raiders like Romney. Some of these turnaround companies – Alix, Alvarez & Marsal, FTI – are now pretty significant professional service firms.
More money in the short run. In the long run the collapse of the middle class takes out demand and we all lose.
But the Bains and Romneys of this world are figuring they can extract all the money and run off with it. Run off where, I’m not sure.
This blog just went to eleven.
Awesome post, just fantastic! Keep ’em coming!
John of Indiana
@Zach: “…while people who simply bought the house that they liked and that they’re banker & realtor told them they could afford are saddled with the blame for the financial crisis.”
Time and again I asked “Are you sure I can do this? You have my whole financial body laid open in front of you, is this do-able?” and the answer was always “Yes.” “Don’t worry, you’ll have double your mortgage in equity in 2-3 years tops” “Man, the ‘as complete’ appraisal came back at $96,000.You’re only borrowing 62…”
Yeah, they got their commissions and bonuses off the top.
Now I rent, and I’ll *DIE* a renter. At least if I get tired of the locale I can make a phone call and be out by the end of the month, no long good-byes.
@Nutella: On that note, people should look more closely at what happened to KB Toys.
Joe Klein, quoted by Charlie Pierce.
If the jobs were “obsolete,” why were they transferred somewhere else, leaving the previously reasonably well-employed Americans in the lurch? And what’s creative about destruction when nothing but empty shells are left behind?
Agreed. We’ve gone so far into the no-regulations religion that we are hurting both employees and owners.
Just throwing in my statement to say thank you for this post. I hadn’t seen this sort of analysis before, although seeing how you linked to an Atlantic article that was written in 2009, the info has been out there. But somehow it hadn’t shown up for me in the times I’ve been reading and searching.
It seems to make sense, that the financial sector has created a sort of predatory capitalism that just serves to funnel the money into themselves. There’s a cultural climate that emphasizes profits and shareholder returns and de-emphasizes having productive enterprises that don’t just pull in enormous profits or somehow result in windfalls for stockholders and especially those stockholders with the time and resources to manage their holdings, but enterprises that produce wealth in the products they make and the wages they pay to their labor.
That’s one of the reasons why wages for the lower and middle classes have stagnated. We don’t have a financial and business climate that properly values labor, the value of labor gets lost in trying to amass profit and enriching shareholder portfolios. That sort of valuation of enterprise is almost certainly going to tip in the favor of those with the money.
Fuck. I don’t know or think that Obama can even come close to fixing it all in another 4 years. But I’m damn sure that were Romney to be elected, he wouldn’t do a damn fucking thing except make it even worse. He’d probably be selling off parts of the American government to whatever companies want to buy them and he’d walk out of his Presidency having set the table for him to double his fortune in the next 10 years.
Exceptional post Mr. Finel.
Gin & Tonic
@Bernard Finel: It’s also partly about number of shareholders. That was part of what pushed Facebook into its IPO – once you get above 500 (I think) shareholders you pretty much have no choice. The key to staying private is to remain closely held, a la Koch Industries (the US’s 2-nd or 3-rd largest private company by revenue, based on who’s counting.)
Villago Delenda Est
@Belafon (formerly anonevent):
This is always the problem with these assholes.
Just employing some people, providing a desired service, and making a profit is not enough. If someone thinks you’re not making enough profit (by cutting costs by paying slave wages with as few benefits as you can get away with, by fucking over customers repeatedly) for the CURRENT FISCAL QUARTER, you’re a wuss, and most likely, a socia1ist.
Money is the only thing they love, and money has become so detached from actual concrete physical value that it its real world meaning has been lost.
Smith constantly warned of one of the problems of the invisible hand…that some people get a glimpse of it, and they use that glimpse to gain an advantage over others that can distort the market, and ultimately destroy it. He pointed out that some things, such as say a trust fund for widows and orphans, set up for on the surface purely altruistic and beneficial purposes, can be manipulated by insiders to distort the market, and thus should be viewed with great wariness.
You post passages of The Wealth of Nations on glibertarian comment sections, and you’re immediately savaged as some sort of commie. That’s how detached from their roots the free marketeers are.
This is a point I would love to see developed vis-à-vis Germany, which seems to have highly paid workers, a robust social safety net and a strong economy. Why is it, exactly, that we can’t have that here?
Villago Delenda Est
The Caymans, Switzerland, Bermuda, etc.
SEAL Teams can always find these terrorists, though. Then deal with them with alacrity.
What’s the definition of institutional investor being used here? I usually think of them as mutual funds, pension funds, non-profit foundation endowments, etc. That is, ironically enough, they are often the investment vehicles of the middle class. As the middle class chases returns to ensure personal financial stability, the middle class also undermines the very conditions of its financial stability. Quite the dialectic.
I work for a middle(?) sized (1b+ in revenue) Telecom company that is privately held.
There have many many times that I have been thankful it is privately held and this post is exactly one of the reasons.
We would not have survived the telecom bubble had we gone public.
Villago Delenda Est
In Germany, representatives from the labor unions sit on corporate boards.
You’ll never see that in this country in a bazillion years. It’s fucking communism, I tells ya.
Culture of Truth
If Romney is indeed a turnaround specialist may I suggest he prove it to us all with his own campaign?
Culture of Truth
The Germans cheat by making high quality products.
One thing to keep in mind with Germany that they live off their exports. Their exports are cheap (relatively) because of the Euro.
Not saying it would not work here, but I doubt we could completely replicate their success because of their unique situation.
Culture of Truth
also the Germans have an advantage since they could start from scratch in 1945
I don’t know what you know about B Corporations Bernard, but this is a real alternative to the corporate model described in your excellent post. B Corps have stakeholders instead of stockholders which include employees and the community, and a few states have adopted the legislation to allow companies an alternative to the incessant short term bottom line pressure on directors to maximize profit for the shareholders.
I have a deep interest in this…my company just thwarted a hostile takeover bid from a vulture capitalist firm that had garnered 5% of our stock.
The goal was to sell the company off to a much larger entity to “increase shareholder value.” But, they wanted to flip it and take short term profits for the shareholders at the expense of a solid company that they felt had “so much more potential.” Bullshit. They didn’t care about the company.
We thwarted it with a poison pill, and the fact that the other investors had no interest in this company’s strategy to basically sell us off in pieces. It would have, literally, destroyed a good, solidly performing company.
This crap is destroying good companies. Mine just ended up not being one of them.
Thank you. Beautifully clear, and absolutely right.
As a side note, I went to law school at University of Chicago in the 80s, when the idea that the management of a publicly-traded company’s fiduciary duty was to increase shareholder value, and that increasing shareholder value by definition meant that such a company’s true, core product was its traded shares rather than the goods and services it produced for the market was being established as an article of almost religious faith. And trying to make people understand that this conception of a business’s core mission distorted priorities throughout the system, to the detriment of actual wealth production (as opposed to the reapportionment of existing wealth) was damned nearly impossible.
So it’s a particular pleasure to see it laid out so clearly. Obviously, this is a desperately important issue, something people need to understand if the country is ever going to even start on the difficult work of trying to put the system right.
@John of Indiana:
Yup. I have never made a major non-cash purchase. I have NO idea how much house/car/etc I can afford. I’d like to think I can go to a loan officer and trust that they’ve got a lot of incentive not to give me a loan I’m unlikely to pay back… that their downside is at least equivalent to the consequences of personal bankruptcy. This was so obviously not the case in the 2006-vintage era of zero-percent, 2-year car loans, etc.
Yesterday a comment provided a lightbulb moment for me.
Bush’s eight-year reign was a bustout of the United States.
Buy it with investor money (campaign contributions).
Load it with debt: Seniors Drug Benefit, 2 wars off the books.
Repay your investors: Tax cuts. Crony capitalism to eclipse Andrew Jackson’s. Subvertion of most regulatory agencies.
Raid pension funds: Social Security privatization almost there.
Crash it and cash out: Almost 50% of the amassed wealth of the 99% has been lost. Not so much with the 1%.
Our problem has been that since the 1980’s only one side has been supplying the generals.
@Comrade Mary: In addition to what Bernie said, there are endless ways to structure the “going public” process. Some founders keep a majority of stock (at least initially) so that they can call most of the shots. I believe Zuckerberg did that. Martha Stewart or Steve Jobs among others did not. I think that for a while the Murdock family held a controlling interest in News Corp, but later expansions lead to larger issues of stock and now they own less than 51 %.
Companies can buy back stock an go private. It is easier to do if the business is having a hard go and the price drops. And big, strong brands can stay private, as in the Levi Strauss Co.
I am not sure who you are including in corporate America, but both GE and GM have their paws in the financial sector, with GE capital and GM financial.
ETA: The problem is much deeper than you have elucidated, the tentacles of the financial sector are everywhere even in the so called non-financial companies.
People who run businesses that provide real goods and services need to shake off their country-club solidarity and recognize that the financial sector is their enemy. (As is the health insurance mafia.)
I wonder whether there’d be a simple solution to this in the form of some high-class debtors prison. Something like the largest shareholder of a bankrupt corporation owing debts to American entities must spend some small amount of time in jail or in house arrest or something. Given how selfish most of these people are and how much they value their time, a very small individual penalty could offset a much larger amount of collective financial gimmickry.
Yes, companies can go private and survive.
Going private is usually not synonymous with, say, sole ownership by an individual or family. Speaking broadly, it means the company is de-listed from the trading markets and is no longer subject to some regulations and some regulatory authority.
The sheer cost in cash involved in buying back the stock of a publicly-held company (almost always at a premium price when privatization is the goal) means that private-equity firms commonly handle the bulk of the transaction, as they have access to borrowing the dough and use leveraging (very simply put, financing via the debt of borrowing the cash and expecting to pay off the interest and costs from income) as opposed to buying back the stock by means of the company’s equity (again, simply put, using cash and assets on hand).
For an example, IIRC, Burger King has gone from private to public, back to private and then back to public again.
I’m not anywhere even close to being an economist, so hope anyone with better info can correct or refine what was just said.
They’ve been on the euro only, what, 10 years? I think a lot of their affluence predates that. But, yes, it helps.
What I was thinking was that there were conscious decisions made–or maybe cultural biases at work–not to offshore/outsource, not to prize ever increasing short-term profit over all else, not to denigrate labor as just another expense dragging on the bottom line, etc.
I would love to read an explanation of where the obviously different economic/social philosophy came from.
We couldn’t become Germany but we could, if we wanted to, move along this path to get a lot of the benefits of that kind of economy. Ezra Klein recently pointed out that Romney could have been the ideal person to push the idea that the creative destruction of capitalism combined with a decent safety net leads to strong economies by combining his capitalist and RomneyCare histories.
That can never happen in today’s Republican party, of course. It also would depend on some personal integrity from Romney and we’ll never see that, either.
Where’s a good place to find which companies pay their workers better, contribute more to charity, etc? I’ve heard that it is better to shop at Costco than Sam’s Club for this, but what else?
Companies do go private from time to time. I think a number of them went private in the previous decade at least in part in response to Sarbanes-Oxley, but it also makes sense if they want to stick to a long-range growth plan.
Some examples include Burlington Coat Factory, Univision, CDW and Sports Authority.
The Murdoch family holds only 12% of the stock but they hold 51% of the voting stock.
well done, newbie. keep at it.
@jwb: What’s the definition of institutional investor being used here? I usually think of them as mutual funds, pension funds, non-profit foundation endowments, etc. That is, ironically enough, they are often the investment vehicles of the middle class. As the middle class chases returns to ensure personal financial stability, the middle class also undermines the very conditions of its financial stability. Quite the dialectic
And labor union funds. Yes, a very good point. At one time these funds did not chase 30% returns. They invested in community bonds and helped build their cities and states. And what has happend to the bond market, huh?
Today the source of those funds is going south. Public sector retirement funds will soon be gone, too, if states keep electing Republican governors.
Judas Escargot, Acerbic Prophet of the Mighty Potato God
Saw some of Ezra;s tweets on the subject, also, too. Much the same.
I’ve decided to just entertain myself by watching him shift inexorably rightward as he slowly climbs the income ladder.
If it helps to decide between those two (choose Costco), Sam’s Club is owned and operated by Wal-Mart.
Thanks, this is a great post. I linked to a bunch of stuff (including that Atlantic article) here, but lacked your perspective and that key policy + messaging insight. Some of the other stuff I had at that post:
Former Fed Chair Paul Volcker said a few years ago, “I wish someone would give me one shred of neutral evidence that financial innovation has led to economic growth — one shred of evidence”, before concluding that the only worthwhile financial innovation of the past twenty years was the ATM.
Daniel Foster at the National Review(!) links to this 2009 paper, which he describes as follows: “investment banking was basically easy, and boring, in the heavily regulated period between 1930 and 1980; that subsequent deregulation and the rise of exotic financial products created great demand for high-skilled workers … the paper concludes that as much as 30-50 percent of financial compensation is pure rent.”
This Kauffman Foundation study concluded that “the industry’s growing size potentially suppressed entrepreneurship as financial services and young companies compete for many of the same employees”.
From Man-Sized Target, a quote from fund manager Jeremy Grantham: “… Let us say that by 1965 – the middle of one of the best decades in U.S. history – we had perfectly adequate financial services. Of course, adequate tools are vital. That is not the issue here. We’re debating the razzmatazz of the last 10 to 15 years. Finance was 3% of GDP in 1965; now it is 7.5%. This is an extra 4.5% load that the real economy carries. The financial system is overfeeding on and slowing down the real economy. It is like running with a large, heavy, and growing bloodsucker on your back. It slows you down.”
Outstanding post, and (by and large) excellent comment thread. A real treat all around.
The biggest flaw with our current system, one merely illustrated by Romney’s exploits at Bain Capital, is that our current ethos of governance for publicly traded companies in any industry doesn’t just make it somewhere between difficult and impossible for even creative companies to survive long-term (which the odds are against in any business regardless of governance). In fact, that ethos, in many cases, is functionally indistinguishable from putting a loaded gun to your head and pulling the trigger. People call it “vulture capitalism,” but that’s an insult to vultures, which typically neither attack healthy animals nor redefine “healthy” to justify their predatory scavenging.
@schrodinger’s cat: GE is a financial firm that makes stuff to finance. GM became the same thing before it went bankrupt, but in the process forgot it had to make good products. GMAC Mortgage and subsidiary Dietech were big cash cows during the bubble
Thanks for a great post.
I think the following sentence is a key issue:
” As a practical matter, it is not clear that this sort of approach is conducive to more rapid economic growth. ”
More precisely, does the rapid growth in stock market valuation enforced by Bain and other leveraged buy out firms have anything to do with maintenance and growth in human welfare in the real economy (that is, regular people producing and consuming food, clothing, shelter, medical care, etc.)?
Especially when that growth rate in stock market valuation is gained at the expense of profitable stable companies?
The answer is, no one really knows. There is certainly no coherent and empirically verifiable economic theory that says so.
One of the big points of econophysics is that the kind of growth rate process enforced by US style stock market is inconsistent with any stable equilibrium of anything at all. Joseph McCauley has made this point most directly. Not saying the econophysics can produce a theory better than current economics, but they can churn through the math just as well as economists can (or maybe better), and give their two cents on whether it makes sense. Most of them say it doesn’t.
(I’m playing hooky from a conference call RIGHT NOW, but I want to thank everyone who answered my rambling bag o’ questions comment above. Truly appreciated!)
Herbal Infusion Bagger
You can also leverage the firm.
To a first approximation, you can’t add value to a firm by leveraging it: you’re trading return for risk (this is one of the few firm theories in finance: the Modiglani-Miller theorem).
However, there’s one caveat. As the firm can expense debt against , but not dividends or capital gains on shares, using debt in this case acts as a “tax shield”, and does increase the value of the firm’s shares somewhat. Of course, you’re still taking on more risk.
Leveraging probably was one of the ways (as well as using differences between valuation of preferred and common stock) that Rmoney was able to load his IRA with stock that later grew radically.
And I can’t help but notice that we got this wonderful President (best in my lifetime, and arguably even better than that) because of those DFH the Republicans hate; the Flower People.
The changes they helped agitate for allowed President Obama’s parents to have a relationship without one of them getting lynched; to get this promising young man into fine schools; to actually develop the family and friends and expertise to fuel his career and support him as he rose; and to turn around and school the nation on what has happened to us, and how to fix it.
I think a best-seller couldn’t have been plotted better.
Sorry, but this post still doesn’t get to the heart of the PE business as it began to be practiced within a very short time after it started with this brilliant idea of reaping the reward of the PE firm’s brilliant management expertise by just buying the company, fixing it, and then reselling it.
PE has one, and only one, objective: make money for the partners of the PE firm with no risk to them. Lots and lots of money. Doing so requires the PE firm to also make more money for its investors than they could make just playing the market, but that’s just an annoying bug they can’t seem to figure out a way around.
To do this, they look for a company that can’t get an even break in an IPO or, if public, whose stock price has been beaten down.
When they find one, they look at it hard and try to find ways to shake money out of it and into their own pockets, and into those of their annoying yet indispensable, investors. Sometimes it means selling off chucks of it’s assets, putting the money in their pockets, bleeding out what’s left in “management fees” and then passing it on to some greater fool. Sometimes it means loading the company up with debt, looting the borrowed money from the company’s treasury in the form of “dividends” and “management fees” and then releasing it back into the wild in its weakened condition to starve or recover.
Sometimes It just means pumping up the balance sheet by slashing “unnecessary” expenses like R&D and reducing costs by replacing salaried and benefitted employees with temps and offshoring, sucking out all the “management fees” possible and then either taking it public again, if the damage isn’t too visable, or selling it to some other “greater fool” PE firm that will repeat the process until the company is a dried out husk.
Whatever it takes. It’s like being a capo–your business is to make money anyway you can. The Don’s not going to care how as long as he gets his piece, just as the investors won’t.
Sometimes the companies come out of PE and thrive, sometimes, they struggle along, and sometimes they just die. But, in every case, they come out weaker than they would have been if they’d just hired some management consultants at a reasonable rate rather than bleeding off “management fees” at rates set by the people being paid the fees.
If someone can name more than a dozen companies that came out of PE ownership stronger than they would have been they’d just hired some management consultants at a reasonable rate, I’d be stunned.
PE is to venture capital as a parasite is to a commensal.
Look at Cargill and Archer Daniels Midland as examples of Koch-style private companies.
So, essentially, the more the company takes care of its employees and gives fair value to their customers, the more they handle themselves ethically and sensibly and responsibly… the more Wall Street devalues them and makes them a target to be destroyed
Thanks. It explains a LOT.
If it is a good company with capital, profits and not the lowest costs, they will be back. They will come from a different angle or with more money but they will be back at some point. Vultures are all about finding whatever they can and cleaning it down to the bones. They’d eat those too if they could find the slightest value. They are never about creating, only carting off everything they can eat.
What a great post. Have just Tweeted this far & wide, Mr. Finel. Cole, you picked a winner.
Bernard – Thanks for pulling back and offering a broader perspective. We should be questioning the value on offer in some financial sector practices, and we do need to acknowledge the biases of that sector.
@NCSteve: This certainly seems to be the case. There’s something perverse about buying a company on a debt-financed basis and then rolling that debt onto the purchased company while walking away after you’ve made your money (which was probably debt-financed by the company too!).
This is why TARP had to be done. You can’t explain this to people. They want Geithner to be in jail.
@PeakVT: Separating the financial sector from corporate America is an exercise in futility. They are not two separate entities but two faces of the same coin.
This paper by Greta Krippner goes into the details.
@Maude: True, we would be in a recession that would have rivaled the Great Depression.
@WereBear: Not entirely. There are mutual funds that make a point of investing in ethical companies. Overall though, you’re right. It’s all about the profits.
That seems about right.
I take back my remark where I even tried to compare Bain to parasitic wasps. That was totally unfair to the wasps. (Video, if you dare.)
@Nutella: Bing Bing Bing, we have a winner. They look for companies with equity and loot that equity. They’re pirates.
Bain goes in to a company, uses that company’s borrowing capacity to take a loan, pay themselves a dividend, and leave the company with a loan to be repaid.
If I can sell my widget at 75% of your widgets cost and still make as much money as you, you will soon be going out of business.
The auto industry is an example of what happens, when competitors put in better production practices and automation, to reduce overheads and you do nothing.
In a global market place, you can’t just sit back and assume no one is going to try and do things better than you, i.e. better or comparable quality at a lower cost.
Greed Is God
I have to say that this is one of the best posts and comment threads I have read on BJ.
-From an MBA in Corporate Finance: UC Berkeley, Class of 1986.
PS Look up my Commencement Speaker
In reality, to make it even simpler, it comes down to this….
Modern finance has made short term gain versus long term stability more profitable (much, much more profitable). There is no risk in setting up a business transaction to fail in the future as long as you can raid it now. The markets have made lack of ST success (even at the expense of LT success) extremely risky for current shareholder return.
So these practices are practices that all emphasize the ST versus the LT. And now we are seeing the LT effects.
And it does show the stark difference between public and private entities (and why I think Facebook going public will be it’s downfall – as an example).
Of course the whole ST versus LT thing is everywhere and part of the human pysche and hard to combat. But I work in the extractive industries and an example there is if production looks like it will be down for the quarter we ramp up production to pump through ounces / tons to meet the quarters production / revenue expectations (public company) so the stock doesnt get hammered. Of course by doing so we have robbed Peter (the next quarters production) to pay Paul (this quarters production). So you end up in the vicious cycle where you are always having to bend over backwards and hurt LT stability to meet ST public sector expectations.
Seconded. This is why I was so enthusiastic about Bernard Finel signing on as a front-pager.
Contra the claims of schrodinger’s cat and pattonbt, the issue isn’t just the alleged inefficiency of a non-perfect market, nor mere emphasis of short-term profits over long-term profits. Financializing a company drastically changes the behavior of the company.
To put it extremely bluntly, when a company gets sufficiently financialized, it turned into a scam machine rather than a purveyor of useful products. This can lead to outright criminal control fraud, as in Enron, or simple predation, as in the sociopath Jack Welch’s decision to turn GE into a predatory lending loanshark operation.
Many people don’t realize that when Jack Welch set up GE Capital, a subsidiary within the company, GE Capital wound up making 70% of GE’s profits. But how did it make those profits? By setting up a chain of payday loan and title loan legalized loanshark operations to prey on the poorest people in society.
That’s pathological, and it’s not just an issue of “short term very long term” profit. It’s about destroying a community to make your money. It’s about gouging money at 300% (yes, three hundred percent, you read that correctly — that’s the annualized interest rate of payday loan and title loan operations, which astoundingly is now legal to charge after the Reagan-era repeal of usury laws) from the poorest people in the community.
@Greed Is God: Okay, I looked it up, and the name meant nothing to me. Care to elaborate for the rest of us?
@WaterGirl: Assuming I found the right name, here is the probable relevance (Wikipedia):
Further down in that Wikipedia article:
I remember the name, and a lot of noise in the news, though I have no direct recollection of details. Looks like he was father of a modern trend.
@sharl: That’s the name I found, too. It occurred to me after I posted that I could have googled the name, and I wondered if it would come up in connection with Bain. Not so, I guess, except in spirit.
I travelled from IL to NC for my niece’s graduation from law school a few years ago, and McCain was the commencement speaker. Ugh. He is really a terrible speaker. Just terrible.
In a long ago time and not so far away place, corporate charters were granted by the State, subject to revocation in the event that the corporation’s operations proved to be pernicious in practice to the greater interests of the people of the State.
A fish rots from the head.