Friday, October 16, 2009

Common Sense

Why has the market surged; why did the Dow cross 10,000? The answers are complex, but they do not augur well for longer term comparable growth. First, the plunging economy actually got rid of large numbers of under and non-performing companies; anyone on the edge went over. Second, the recession gave many companies the ability to renegotiate union agreements, lay-off tons of employees that “over-staffed” the companies for years. They simply got efficient. Think of businesses you know that, in a moment of irrational demand, hired lots of people who were needed for that momentary bulge, but who were not really needed in the average level of expected business activity. Lock-step promotions and raises followed; the costs were just passed on to the consumer. Not anymore.

In many businesses – but particularly in government – power and status may be measured not as much in how much you make, but in how many other employees work under you. Powerful government bureaucrats enjoy the thought of masses of people under their supervision, and compensation is not a measure of success (there are caps and civil service limits). Hiring more people made you more important and powerful. And unlike businesses, governments have been unable to renegotiate unrealistic defined benefits retirement plans and healthcare that is viewed as luxurious by many. This too shall pass.

Further, as the dollar tumbled against world currencies, as rumor spread that Middle Eastern oil-producing nations were seriously considering opting out of a dollar-valued standard for the price of oil – the massive U.S. debt with little in the way of a clear path for repayment placed the dollar on an “inflation-perception” track of instability – investors needed to put their money anywhere but into dollar currency reserve. Presumably, a stock represents a value in a company (hard assets, inventory and hopefully international sales) that should adjust for inflation.

To many, in the initial phases of this meltdown, the market simply over-reacted in tanking share values (although there are some pretty smart voices suggesting that it did not react enough, and that the worse is yet to come with a second, more intense crash); the re-buying of stock was simply a vote in support of that theory. Others bought stock, because everyone else was buying stock… hoping that they were not sheep being led out to slaughter.

Flash trading – micro-second, computer determined trend analysis-driven stock trading, often with a further benefit to high profile financial entities of a second advance notice from an exchange and a closer location to the trading floor to save a few milliseconds – put the big institutions (Goldman, JP Morgan, etc.) literally in charge of the stock trends. Their ability to react in less time than any other entity or person on earth – combined with their willingness to trade on their own accounts in unbelievable numbers – gave them the edge. The numbers, their performance in the market, speak for themselves. While some of these abuses have been curtailed, it is equally clear that the stock market is this golden fountain and most certainly not the place where an ordinary “civilian” retirement plan stands much of a chance.

But growth requires great liquidity in the debt markets, particularly for the smaller businesses who are not listed on those national stock exchanges, and debt is really hard to come by these days. With the unemployment rates likely to stay in the 10% range (17% if you add in part-time employees looking for full-time jobs and those who have just given up looking), reductions in take home pay for those who still have jobs, consumer demand wavering (at best) – consumer activity represents 70% of our economy – and home prices at stagnantly low levels, it may be nothing more than wishful thinking to believe that the markets are truly headed, in any near-term analysis, back to 2007 levels.

And then there is the salt in the American economic wound – the folks with the unfair advantages (see my flash trade comment above), who have prospered in a buying frenzy of distress properties (read: other people’s misery), who created this financial mess in the first place with excessive borrowings (and creating “lending traps” to encourage consumers to take on stupid debt levels so that these companies could make even more money)… are making a mint without the slightest hint that government can make them stop or even slow down, despite rhetoric to the contrary.

The October 15th New York Times after Goldman Sachs reported $3.03 billion of earnings (and massive bonuses to its senior employees - $5.35 in compensation paid from July to September): “While many ordinary Americans are still waiting for an economic recovery, Goldman and its employees are enjoying one of the richest periods in the bank’s 140-year history.” I guess we live in the United States of Goldman. “Sachs” appears to be an ex officio cabinet-level appointment for Democrats and Republicans alike.

Try this analysis from the October 15th “On average, banks spend about 50% of their revenue on employee pay. There are standout cases, such as Morgan Stanley (NYSE:MS), whose compensation as a percentage of revenue is expected by the Journal to shoot up to 70% in 2009. According to The Deal's calculations, it stood at 50% in 2008 and 59% in 2007… The argument, voiced by J.P. Morgan Chase & Co. … CEO Jamie Dimon as well as Morgan Stanley CEO John Mack, who is stepping down at the end of the year, is that banks have to shell out to attract and maintain the best talent. But putting 70% of revenue toward compensation is, let's be honest, nothing less than insane. It is creating a bubble that at some point must burst.”

And the opposite of this insanity? Common sense… perhaps the most uncommon sense of all.

I’m Peter Dekom, and I am wondering why our leadership seems to be unable to contain this madness.

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