|
World
Needs Better "Face of American Capitalism" than
Private Equity, Goldman Sachs, Media "Freak Show"
by
Econotech
December 20, 2006
Dec 19 (Econotech
FHPN)
– Thanks very much and happy holidays to my readers this past year;
the web sites that have been extremely kind to post my articles;
Google for freely hosting http://econotech.blogspot.com/ ; and the
friends without whom I would have never started putting my articles on
the web. I also express my appreciation for mainstream journalists
whose reporting I heavily rely upon, in a non-mainstream way.
Private Equity New “Face of American
Capitalism”
Private Equity Is Unfair, Wastes Capital, Distorts Corporate Resource
Allocation
Da Boyz Simply Never Know When Enough is Enough
Why Are Management Buy-Outs Even Legal?
Private Equity Is a Bad Global Financial Model for Industrializing
Nations
Some Extraordinarily Good News for the Holidays …
… And Some Very Bad News
Weakening Dollar, Déjà Vu All Over Again, and Again, and Again
Private Equity New “Face of American
Capitalism”
I apologize for starting this article with far more quotes than usual,
they make some critical, almost self-evident, points from credible
sources.
“in the United States, private equity has grown enormously over the
last few years. In fact, today, I think, private equity is perhaps the
face of American capitalism. In the old days - 1950s, 1940s, 1930s -
large corporations that would trade on the New York Stock Exchange
might be seen as the face of American capitalism. Companies like US
Steel or IBM or General Motors. Those are still very good companies in
many cases, but I don’t think they are seen as the face of American
capitalism. Today I think the face of American capitalism is the large
private equity firms that are buying companies, improving them, adding
value for shareholders and returning very good returns for their
investors … I think China is probably the single most attractive
market over the next five to 10 years for private equity …
predictions. First, that there will be a $50bn buyout done within the
next year. Two: that there will be a $100bn buyout done within the
next two years.” (David Rubenstein, Co-Founder and Managing
Director, The Carlyle Group, one of the very largest private equity
firms, “View from the Top” interview, FT, Dec 7)
“there are at least two sets of rules -- one for the rich and
well-connected, another for the middle class, the Wall Street
proletariat … The upper class is now serviced by a vast and growing
industry, loosely called Private Equity. The job of the private-equity
investor is -- again, speaking loosely -- to exploit the idiocy of the
ordinary investor, and the corporate executives and mutual-fund
managers who purport to serve him … the relationship between the
upper class and the proles more explicitly parasitical than it usually
is … the smartest, best-connected money has separated itself from
the rest of the stock market, and has gone into the business of
trading against that market. It seeks to buy from the stock market
cheap, and sell to the stock market dear, and if you need evidence
that this is possible you need only look to the returns on private
equity, which have been running three times the returns of the public
stock market.” (Michael Lewis, Bloomberg, Dec 11, author of
“Liar’s Poker,” “The New New Thing”)
“A surfeit of liquidity in the financial markets is tempting bankers
to underwrite and finance deals that may come back to haunt them, a
top banker at Goldman Sachs said. Eugene Leouzon, the chief
underwriting officer for Europe and Asia who sits on the investment
bank's global credit committee, said the current conditions were
unparalleled in his experience of investment banking. Leouzon, who
approves new loans and debt deals to fund mergers and acquisitions.
"The things we are seeing being done, both on the investment
grade side and the non-investment grade side, are I would say
borderline stupid." "There is just too much capital going
after too little by way of deals." But Leouzon said the outlook
was for a strong level of new deals going forward, led by lending
money to fund leveraged buyouts and cash mergers and acquisitions …
Competition among bankers chasing big bonuses is also likely to keep
the pressure on doing deals.” (Reuters, Nov 16)
“Goldman Sachs reported earnings yesterday that left jaws agape on
Wall Street. Quarterly profits soared 93 percent. The bank earned
nearly as much per share in 2006 as it had in the last two years
combined, both of which were also record years … the bank is paying
roughly $623,418 for every employee [about 26,000]. Rainmakers in
investment banking can expect to see $20 million to $25 million each
while traders who booked big profits will take home up to $50 million
apiece. In 1997, investment banking and trading and principal
investments produced roughly the same revenue. In 2006, trading and
principal investments [essentially Goldman’s own hedge and private
equity funds] produced almost 70 percent of the total net revenue.”
(NYT, Dec 13)
“Goldman Sachs's William Dudley to head the [NY Fed] market's group.
former Goldman executives control or influence the oversight of key
aspects of the US financial system and hold prominent positions
throughout the Bush White House. They include: Hank Paulson, the
Treasury secretary and former Goldman chief executive; Reuben Jeffrey,
a former Goldman managing partner who is the chief regulator of
commodity futures and options trading; Joshua Bolten, White House
chief of staff who served as a Goldman executive director; Robert
Steel, the former Goldman vice-chairman who advises Mr Paulson on
domestic finance; and Randall Fort, the ex-Goldman director of global
security who advises Condoleezza Rice. Bush's working group on
financial markets is composed of Mr Paulson, Mr Jeffrey, [Bernanke and
Cox] - would be Mr Bush's first port of call in the event of a
financial crisis. Mr Dudley would also play a crucial role in
stabilising the markets in the event of a meltdown … Goldman
represented the biggest single donor base to the Democratic party
ahead of this year's mid-term elections. Jon Corzine, the New Jersey
governor, and Robert Rubin, the former [Clinton] Treasury secretary,
are Goldman alumni.” (FT, Dec 4)
“yesterday deals worth nearly $90bn were announced around the world
… adding to the $3,500bn of takeovers agreed so far this year. This
has made 2006 the busiest year on record for M&A globally,
exceeding the volumes of the internet bubble of the late 1990s …
While most observers are expecting favourable conditions for
dealmaking to remain next year, there are concerns the market may be
overheating, as it did in 1999 and 2000. Worries centre on large
amounts of debt being piled on to companies by private equity groups,
with critics believing a string of bankruptcies is inevitable.” (FT,
Dec 19)
“Private equity funds are playing much the same role as Santa Claus
in the equity market rally. Yesterday brought another four huge
private equity buy-outs … Many in the market assume that there is an
effective "private equity put" - named after options that
allow you to sell at a fixed price. If things go badly, your company
becomes a target. If it catches on to a wave of the moment, buy-out
funds will pay more. Either way there is a "put" … Knowing
there is a private equity put reduces the perception of risk for
everyone.” (John Authers, FT, Dec 19)
“Heavy debt-raising has continued into the traditional winter
slowdown, making this December among the busiest in recent memory for
US capital markets. The unseasonable frenzy of deals stems from huge
investor appetite for credit-related exposure. It has also raised
concerns that debt levels could in some cases be dangerously high.”
(FT, Dec 18)
“Private-equity firms accounted for more than a third of all deals
involving U.S. targets in 2006.” (MarketWatch, Dec 18)
“That's not just a record in dollar terms but is more than twice the
amount of private equity deals for all of 2005 … "There's an
endless appetite for credit now, and that's kind of scary," said
one high-yield investment manager. "It's all liquidity-driven.”
(CNNMoney, Dec 18)
“Private equity firms accounted for 22 percent of global M&A
volume in the first nine months of the year, hitting a record $570.1
billion in deals. That's up from around 5 percent a few years ago.”
(Reuters, Dec 16)
“U.S. firms could raise $225 billion in private-equity funds this
year, soaring over 2000's $177.8 billion … Investments in
private-equity firms returned 22.5 percent during the 12 months ended
June 30, compared with a 6.6 percent return from the S&P 500. Over
the past 10 years, private-equity investments have returned 11.4
percent per year, compared with 6.6 percent per year by the S&P
500. Over the last 20 years, the comparison is 14.2 percent for
private equity vs. 9.8 percent for the S&P. ” (Dallas Morning
News, Dec 13)
“This year, the average gain for an IPO of company owned by buyout
firms is just 1%, compared to a healthy 30% return for all other U.S.
company IPOs … This year buyout-sponsored IPOs account for 42% of
the total dollars raised in the market for new stock offerings … In
the past, private-equity firms typically held onto an investment for
several years trying to make the business more efficient before
looking to cash out. But now private-equity firms are paying
themselves hefty dividends and looking to cash out just months after
taking over a company.” (thestreet.com, Nov 27)
“Billionaire investor Wilbur Ross last week said ``it's inevitable
that we will see higher default rates'' after announcing a plan to
help invest $685 million in bankrupt companies for a group formed by
New York-based Goldman.” (Bloomberg, Nov 14)
“A group of 12 securities industry associations … said they have
adequate procedures in place to guard against improper trading in the
unregulated market for credit derivatives and other markets including
loans that are privately negotiated between banks and investors. They
will ``educate'' and ``inform'' members about how to handle
information that hasn't been publicly disclosed that could influence
markets.” (Bloomberg, Dec 13)
“Greenspan [said] "I expect that the dollar will continue to
drift downwards until there will be a change in the U.S. balance of
payments." "There has been some evidence that OPEC nations
are beginning to switch their reserves out of dollars and into euro
and yen." ” (Reuters, Dec 11)
“The recent weakness in the U.S. dollar is sending tremors through a
popular practice in foreign-exchange trading, raising the potential
for further instability in global currency markets. known as the carry
trade: Investors borrow money in a country in which interest rates are
near zero, such as Japan, and invest it in a country like New Zealand,
where interest rates hover above 7%. The trade works best when
currencies involved remain relatively stable -- sharp currency moves
can wipe out gains from the difference in interest rates.” (WSJ, Dec
13)
“Bonuses for bankers who arrange structured credit rose 15 to 20
percent on average this year, beating increases of 10 to 15 percent
for credit-default swap traders.” (Bloomberg, Dec 12)
“The bonuses at Goldman and elsewhere on Wall Street are expected to
give the New York area’s economy a substantial boost, particularly
in sales of high-end residential real estate, luxury cars and other
pricey goods.” (NYT, Dec 13)
“unit labor costs in the nonfarm business sector rose at an
annualized rate of 2.3% in the third quarter [and] fell at a 2.4% rate
during the second quarter [both below the rate of inflation].” (WSJ,
Dec 6)
“[Bernanke] said labor costs ``have been rising more quickly of
late,'' and there is a ``worrisome possibility'' employers will pass
on costs to consumers, causing inflation to accelerate. Wages as a
share of value added in the private sector fell to 50.5 percent last
quarter, the lowest since World War II.” (Bloomberg, Dec 7)
“Executive-pay consultants, about to lose their anonymity as the
result of a new federal [SEC] rule, are asking the companies they
advise to shield them from lawsuits by shareholders angry over lavish
pay packages for corporate executives.” (Bloomberg, Nov 15)
“In 2000, the top 1 percent of the world's population -- some 37
million adults with a net worth of at least $515,000 -- accounted for
about 40 percent of the world's total net worth. The bottom half of
the population [over 3.2 billion people] owned merely 1.1 percent [in
total] of the globe's wealth. ” (NYT, Dec 6)
“The [media] Freak Show is new. Its incentives for divisiveness are
embedded deeply in political and media culture. These incentives—for
publicity, for influence, for money, for votes—favor more extreme
and uncompromising positions, provoking the ruthless tearing down of
adversaries … The Freak Show is the enemy of ideas. But ideas are
also the enemy of the Freak Show … The cumulative effect of these
incentives and the actions they inspire is a political system
constantly staggering toward the irrational … Its incentives breed
division even when the underlying issues are of minimal relevance. It
obscures legitimate debate behind clouds of accusation and spite.”
(“The Way to Win, Taking the White House in 2008,” new book by
Mark Halperin, political director ABC News, John F. Harris, national
political editor “Washington Post”)
Private Equity Is Unfair, Wastes
Capital, Distorts Corporate Resource Allocation
In addition to the inequitable nature of private equity deals
highlighted by the Lewis’ quote above, my main criticism of private
equity and the rest of the global hyper-speculators, such as hedge
funds and investment banks like Goldman Sachs (mainly a very large
hedge and private equity fund), is the economically unproductive ways
in which they “earn” their extraordinarily high returns on
leveraged legal looting (ROLLL) (see the section with that title along
with several others in my 18-section Oct 27 article, “Global
Strategic Bargain: Positive Reality Therapy for America’s Critical
“States of Denial,” link)
In the case of private equity buy-outs, this done is by leveraging and
cosmetically re-packaging companies to then sell them back to the
public markets, adding very little real value, especially in the form
of innovative new products and services.
Leveraged buy-outs were rationalized back in the 1980s as necessary to
shake-up an admittedly then sclerotic and complacent corporate
America.
But since that time, supposedly “efficient” and “free” capital
markets have supposedly incentivized CEOs, via exorbitant stock
options, to “enhance shareholder value,” via layoffs, outsourcing,
pension and benefits cuts, wage suppression, working condition
changes, etc. As a result, corporate profit margins are at all-time
highs, while the percent of employee compensation is at an all-time
low.
If all this shareholder value enhancing was supposedly done by CEOs
already, then after two decades of it, what could possibly be the role
of private equity in now supposedly greatly providing even more of the
same?
However, if public companies haven’t enhanced shareholder value by
such draconian actions and now need to be wholesale replaced by
private equity, then the whole system of “free capital markets”
and corporate governance that the ex-Goldman Sachs U.S. officials
mentioned above are trying to persuade China and the rest of the world
to adopt was a legalized fraud perpetrated for the benefit of the very
few who have become unfathomably rich.
Even if the day of reckoning of the current immense wave of private
equity deals were continued to be postponed another year or two, this
unproductive use of capital already has greatly distorted global
capital market flows, corporate incentives, and thus corporate
allocation of scarce and critical resources, especially all-important
human talent.
“all the wheeling and dealing stems from lots of money sloshing
around the global markets, as interest rates remain low … That
suggests many deals are financial bets, not strategic business moves,
perhaps reducing their chance for success.” (WSJ, Nov 22)
In reality, private equity buy-outs have become essentially what I
have called return on leveraged legal looting (ROLLL). It is not
unique in that, but simply one manifestation of many types of global
hyper-speculation with the same purpose, to greatly enrich the very
few by ROLLLing the rest of the world’s population.
In that, the global hyper-speculators, which would include their
corporate CEO collaborators, have already exceeded beyond their
wildest dreams. For them, it is a very happy holiday, every day of the
year.
“When it comes to wealth, one in every 325 [American] households had
a net worth of $10 million or more in 2004, more than four times as
many as in 1989 … the winners include numerous partners in recently
formed hedge funds and private equity firms … Seventy-five percent
of the chief executives in a sample had a net worth in 2004 of more
than $25 million mainly from stock and options. That was up from 31
percent for the same sample in 1989, adjusted for inflation.” (NYT,
Nov 27)
The massive unproductive use of debt in the current private equity
buy-out boom is similar to but larger than the unproductive use of
equity by another form of private equity, venture capital, in the huge
TMT equity bubble of the late 1990s, which eventually resulted in an
$8 trillion loss in equity value.
In both cases, private equity depends, as Lewis says, on the
“idiocy” of the mutual and pension funds (and also hedge funds,
whose returns are much lower than private equity, with a far smaller
dispersion of results between best and worst, both indicating much
more competition among hedge funds in the public market than exists
among the small, exclusive private equity “deal clubs”).
“What is worrying institutional investors is that [private equity]
funds are coming back to them too quickly for money … The value of
private equity-backed buyouts this year doubled to $602.4 billion from
last year, on 1,912 deals. At the same time, the value of their exits
is down 23 percent to $176.8 billion. The number of exits, which
include selling to other buyers or public offerings, is down 24
percent to 698 … buyout firms used to take four to five years to
spend their funds. institutional investors had money going out and
money coming in. Right now, the money is mainly going out. Indeed, so
many big funds are spending money so fast that it’s sucking demand
from investors.” (Reuters, Dec 16)
It was much easier for the public to eventually, albeit far too late,
see the unproductive use of capital in the TMT equity bubble, when in
retrospect after the bubble collapsed all those previously highly
praised “business models” were finally recognized for what they
really were, essentially legalized fraud, though virtually no
hyper-speculative perpetrators did time for them, unlike some
corporate essentially co-conspirators. Corporate America politically
paid for the sins of Wall Street with Sarbanes-Oxley, which then
further drove corporate CEOs into the arms of the private equity
buyout firms.
However, it is virtually impossible for all but the financial and
corporate elite to see a similar unproductive use of capital at work
in the deliberately less transparent current buy-out debt bubble, and
in the deliberately even more opaque derivatives/structured finance
markets, so non-transparent and over-extended that even the
regulators, usually compliant yes-men for Wall Street and the City of
London, have increasingly expressed their concern.
Da Boyz Simply Never Know When Enough
is Enough
Like the current version of Britney Spears, all sorts of
hyper-speculation which started out as once relatively harmless,
perhaps sometime even good, ideas have been pushed way too far, as is
usually the case, simply due to that age-old malady of the elite that
is unfortunately hard-wired into parts of the human brain, obsession
with greed, power, status (and Freud would add sex).
In the case of derivatives and structured finance, their legitimate
role in risk management, often extolled by Greenspan, has been turned
into a veritable orgy of paper speculation on a scale many times the
global economy that is hard to grasp by anyone, including the
regulators.
“The use of derivatives grew at the fastest pace in eight years
during the first half of 2006, boosting earnings at securities firms.
The face value of derivatives jumped 24 percent to $370 trillion,
according to the BIS. It was the biggest percentage rise since the
bank began keeping records in 1998.” (Bloomberg, Nov 17)
In both types of private equity, buy-outs and venture capital, the
original intent was perhaps actually somewhat justified. Especially
with venture capital, the tech equity bubble story was very easy to
sell the public, because it was initially true.
Venture capital did play an indispensable role in financing
risk-taking innovation making America and the world more productive
and creating great new products and services, often tied to the
Internet (though the key role of government in its initial development
was usually omitted in the telling by the later commercializers).
The private equity buy-out story has a lot less sex appeal, hence the
public has been kept largely unaware of it. How can you put a positive
economic spin on these stories?
“Clayton Dubilier & Rice, Carlyle Group and Merrill Lynch put up
$2.3 billion of the $15 billion they paid for Hertz in December
[2005]. The owners have received a dividend of $1 billion and plan to
get another payout of about $420 million. Coupled with the group's
remaining 72 percent stake valued at $3.46 billion, the owners more
than doubled their investment. shaved cash and cash equivalents almost
in half. net income slumped 77 percent. Total debt increased 32
percent to $14 billion. Interest expense almost doubled to $672.6
million.” (Bloomberg, Nov 16)
“After Weetabix Ltd., the maker of Britain's best-selling breakfast
cereal, fired 7 percent of its workers and canceled the employee bus
service to free up cash for debt from a leveraged buyout, the company
borrowed 130 million pounds ($249 million) so it could enrich owner
Lion Capital.” (Bloomberg, Nov 1)
“Kohlberg Kravis Roberts and Carlyle Group, the manager of the
biggest U.S. buyout fund, are among 13 private equity firms accused in
a class-action lawsuit of rigging the market to take companies
private. `Investors in the target company are deprived of the full
economic value of their holdings and `squeezed out' at artificially
low valuations,’ the suit says. The U.S. Justice Department launched
an informal antitrust investigation into allegations that
private-equity firms collaborated on leveraged buyouts, according to a
person familiar with the matter.” (Bloomberg, Nov 15)
In the case of both the venture capital equity bubble and now the
buy-out debt one, the first and most obvious deals are usually the
best, and often provide huge real economic value. E.g., with venture
capital, Yahoo, Amazon, eBay and Google have greatly helped change the
world.
But as with all the ridiculous IPO's that were funded in addition to
the healthy ones, with the "plausible denial" excuse that
one couldn't tell the difference, the current buy-out mavens simply
don’t know when to stop, or rather they know, but simply can’t
help themselves, like all obsessive-compulsive addicts.
I maintained at the time and since that every "professional"
involved probably knew, on some level, that the huge number of stupid
business plans going public in 1999 were essentially legalized frauds,
but that didn’t stop the vc’s and investment banks from shoveling
out, to their enormous self-benefit, many hundreds of them that year
to the public, nor Lewis’s “idiot” funds from buying them, much
to their investors’ later loss, anger and chagrin.
The same thing is happening today. So if investment bankers at Goldman
Sachs admit that these deals are “borderline stupid,” from a quote
in the lead section, then why are they still being done in record
number and size?
Duh?! Academic fairy tales of “efficient” and “free” capital
markets to justify this supposedly “rational” behavior are spun
for the very same reason that it exists in the first place, excessive
greed.
It really doesn’t take an economics ph.d., in fact it helps not to
have one, to see that private equity and all the other global
hyper-speculators are obsessively driven by their “need” for yet
another mega-home, another yacht, another private jet, another luxury
car, another private school, another vacation, another facelift,
another plaything, another “experience,” another trophy wife,
another mistress, another another.
To constantly grasp for more of everything, the global
hyper-speculators just keep “pushing the envelope,” with each deal
becoming more unjustifiable and ridiculous than the next.
With the paper dollar adrift from real value since 1971 and absolutely
no financial “adult supervision” in the credit and
derivative/structured finance markets and central banks reining in
those out-of-control adolescent emotions, these waves of deal-making
and speculation play out until economies, nations and their ordinary
citizens eventually really do get unjustifiably hurt, one way or
another.
In the process, the well-educated and perhaps even once well-meaning
(especially in the case of venture capital) perpetrators have lost all
sense of perspective and culpability (see the section titled
"Self-Described 'Schmucks' of the Financial World" in my Oct
27 article, "Global Strategic Bargain," link).
Why Are Management Buy-Outs Even
Legal?
With corporate profit margins already at all-time highs, and the share
of employee compensation at all-time lows, the last thing corporate
America probably needs is even more incentives, either to avoid or
participate in buy-outs, to do even more of the same.
Are the private equity owners going to actually spend out of their own
pockets on development of great new products and services, capital
investment, employment, etc.?
Again, duh?! Of course not, they wouldn’t know how (they’re not
actually as smart and capable as they claim), even if they wanted to,
which they don’t.
They are simply going to leverage with even more debt, loot the
companies they buy, pay themselves a huge cash dividend, then flip the
sucked-out leveraged company back to the public.
As I mentioned earlier, the impact on corporate decision-making to
avoid this fate is one of the biggest negatives of private equity.
Since this was well expressed in the following quote, I’m repeating
it from the section titled "Return on Leveraged Legal Looting (ROLLL)"
from my Oct 27 article, “Global Strategic Bargain” link:
"Cheap credit is everywhere … the most avid consumers of
leveraged loans have been private equity groups. Many corporate
executives sniff at what they see as financial engineering, especially
when private equity groups quickly sell their investment or lock in
their returns by floating a portfolio company on the stock market. It
is even harder for a CFO to announce that he is planning to trash his
employer’s credit rating just for the sake of returning capital to
investors. The current situation has created an arbitrage that is
being exploited by private equity groups at the expense of public
shareholders. Either defaults begin to rise and corporate credit
conditions tighten again, limiting the scope for buy-outs, or
companies will inevitably conclude that they should be more aggressive
in their borrowing." (Peter Thal Larsen, FT, Sep 26)
The very largest private equity funds and investment banks belong to
an oligopolistic "deal club" dominated by a very small
handful of firms that make far higher returns than others in their
hyper-speculative “industry,” including hedge funds.
Unlike corporate investment, which generates innovative new products
and services and jobs, these hyper-speculative entities do very little
economically and socially useful.
Unlike another form of private equity, venture capital, there is not
even the pretense of buyout funds investing for progress. It is simply
legal looting for the sake of a very small group.
Thus, it is not unreasonable to ask why is this looting activity even
legal. Ben Stein asked that question, specifically with respect to
management buy-outs, I’ll repeat the quote again from the ROLLL
section from my previous article, “Global Strategic Bargain” link.
"[management buyouts] should simply not be allowed at all as a
matter of law … they buy the assets on the cheap and sell them off
for their own management benefit, or they manage the company
differently for the benefit of themselves and their buyout partners
… breaching that fiduciary duty … management is seeking to pay the
least it can get away with for the assets of the public holders, while
the public holders want the most they can get. irreconcilable conflict
of interest … lack of full disclosure … [buyout] memos are not
disclosed to the stockholders or to the market generally … insider
trading. what is a management buyout other than trading on inside
knowledge?" (Ben Stein, NYT, Sep 3)
This is now a global issue:
“Management buy-outs are fraught with conflicts of interest
anywhere. In Japan, MBOs take these risks to even higher levels - as
shareholders are learning to their cost. The actions of some Japanese
management teams, and the private-equity funds bankrolling them, are
notable … Minorities [shareholders] are effectively being bought
cheaply. Worse, from investors' perspective, their options when faced
with an inferior offer are severely constrained.” (Lex, FT, Dec 4)
One powerful group is trying to protect itself.
“Bondholders worldwide are suffering a double whammy this year
because more than 80 companies controlled by LBO firms have borrowed
at the expense of workers and debt investors just so they can pay
themselves dividends … The payments have helped the [buyout] firms
recoup 86 percent of their investments within two years.”
(Bloomberg, Nov 1)
“The world's biggest bondholders are determined to make an example
of Henry Kravis. Pacific Investment Management Co. and Advantus
Capital Management, frustrated by the sudden losses caused by
leveraged buyouts, are forcing companies to guarantee immediate
payment of principal whenever the borrower is acquired by Kohlberg
Kravis Roberts, Blackstone Group or any of the dozens of LBO firms
that have ravaged the corporate bond market.” (Bloomberg, Nov 7)
Private Equity Is a Bad Global
Financial Model for Industrializing Nations
I have a final criticism of private equity. The combination of its
capital market distortions and inequity has made private equity a
terrible “business model” and “brand image” of the current
version of Wall Street-City of London hyper-speculative financial
capitalism for those regions of the world that might learn from a
better model, most especially China, India and the Middle East.
“the aims of foreign policy go far beyond the misnamed ‘war on
terror’ … Equally important are maintenance of a prosperous world
economy, management of the rise of new great powers, economic
development, not least in the Islamic world, and management of the
global commons … The victories over communism were not secured
through force of arms, but through the attractions of the west’s
prosperity, freedom and democracy … The right way ahead … should
go via the power of US example rather than its military power and via
its ability to give a lead rather than unilateral dictation. The great
US policymakers of the 20th century understood that well.” (Martin
Wolf, FT, Nov 28)
Wolf is the well-regarded chief economic writer of the FT. Without
minimizing the importance of the use of military power when justified
in legitimate self-defense, I fully agree with his emphasis on the
critical role of economic development and America’s example. Btw,
the division in academic international relations theory between
"high" (national security) and "low" (economics)
politics has always been silly since the real-world of course makes no
such distinctions.
If the 20th was “America’s century” and the 21st may eventually
become China’s, how China develops should be of major importance to
Americans, yet they are being very badly misled on the China issue, by
the “Freak Show” media and both Republicans and Democrats (such as
Pelosi, Schumer, etc).
China and Asia had devastating first-hand experience in the so-called
Asian financial crisis of 1997-98 and fully understand that the
current American-Anglo version of so-called “free market”
capitalism is designed solely for the benefit of the global
hyper-speculators, and they will only play along with it so long as
doing so is perceived to be to in their self-interests.
This major, permanent shift in Asian perceptions, both elite and
popular, of Wall Street-City of London hyper-speculative "free
market" global capitalism was totally lost on most Americans,
with the exception of a few such as Nobel economist Stiglitz, then at
the World Bank, due to the “Freak Show” media pre-occupation with
Clinton’s sex life in 1998 (ex-Goldman chief Rubin was Clinton's
Treasury Secretary at the time, economist Summers his key aide).
China is in the midst of a multi-year effort to try to reform its
financial system. The U.S., led by ex-Goldman chief Treasury Secretary
Paulson, is strongly trying to influence it in the direction of the
American-Anglo “free market” model, rather than perhaps the more
traditional Asian one of state dominated banking systems that produced
remarkable results in the industrial rise first of Japan then later S.
Korea, both under authoritarian regimes. (For more on this, see the
section titled "Whither China?" in my Oct 27 article,
"Global Strategic Bargain," link.)
China going from the huge problems of its own state-dominated banking
system to the Wall St-City of London hyper-speculative “free capital
markets” model would be somewhat like jumping from the frying pan
into the fire, but that limited choice is the way the issue is always
framed.
“Some bankers have expressed dismay at bureaucratic hurdles and
funding requirements, which analysts have said are designed to soften
the impact of foreign competition on inefficient and often largely
insolvent local [China] banks. Some [global] banks have protested
local incorporation will complicate global operations. But Beijing has
insisted it is necessary for consistent oversight and in line with
global practice.” (FT, Nov 15)
“Reform of China's banking sector has only just begun. Despite
pouring more than $18 billion into minority stakes in Chinese banks
over the last few years, foreigners haven't made much headway in
changing their partners' outdated lending practices … it's in the
[Communist] Party's interest that banks like Citi succeed.”
(editorial, WSJ, Nov 22)
I would make a similar argument with respect to the Middle East. The
very real problems caused by millennia-old feuds over religious
identities are not going to be solved until more practical issues are
also addressed, such as the lack of good jobs and education for
unemployed youth, and clean water.
But rather than trying to address such issues, burgeoning massive Arab
oil wealth is currently trying to build up its own version of Wall
Street-City of London hedge and private equity funds and financial
centers. This is simply not going to help the solve the ethnic,
religious and sectarian violence in that region.
To help solve the many often seemingly intractable global issues,
including global warming, the world needs to see a better “face of
American capitalism,” a more progressive, technology-based
industrial renaissance, seriously addressing the needs of global urban
and rural development, clean sustainable energy, universal quality
health care and education, etc., etc.
Right now, the distorted U.S. financial system and economy is so far
away from addressing these needs, due to its free ride of massive
credit creation on the basis of the paper dollar, and the prospects of
that changing look so remote, that ultimately China, India (new U.S.
nuclear deal notwithstanding) and the rest of Asia, with or without
U.S. ally Japan, along with Russia and other countries, will simply
keep moving further away from the U.S. into their own economic
development bloc.
Some Extraordinarily Good News for the
Holidays …
This being the holiday season and my not wanting to completely appear
to be Ebenezer Scrooge, I want to very briefly counter-balance this
“bah humbug” tale of Wall Street greed with some very good news.
For example, despite the tech equity bubble, not because of it, the
Internet already really is one of the greatest communication and
social innovations, ever, in terms of sheer global scale and scope,
spurring unfathomable amounts of world-class creative collaboration
that is changing the world greatly for the better. Bioscience really
is in the middle of one of the most potentially awe-inspiring and
beneficial scientific and technological revolutions, ever.
While most Americans would agree with this, they don’t share my view
that the “peaceful development” of China, India, Russia and some
other major countries really is one of, and potentially, the most
unprecedented, positive economic and social transformations, ever,
again especially in terms of sheer scale and scope.
Failure to understand these profound changes in the global economy is
one of the main reasons economic, political and social critics and
doomsayers and investment bears (often concerned with avoiding the
very real “this time is different” trap) have tended to get things
wrong so far in the 21st century.
Those who have tended to make this mistake also often intensely
dislike Greenspan, an authority figure, who far better than most more
clearly understood, starting in 1996, the positive impact on
controlling inflation of two successive massive global positive
“supply shocks,” first of the Internet in the latter half of the
1990s and then China’s unprecedented growth in global manufacturing
following its WTO accession in 2001. Nonetheless, Greenspan of course
did get monetary/credit policy wrong, for which eventually a price
will be paid.
… And Some Very Bad News
All of human history has shown over the long run not to bet against
human creativity and progress. But all of human history has also shown
that it is just as unwise to bet against the negative aspects of
excessive human greed and power. Human progress is not pre-ordained,
nor does it go in a straight line.
Establishment supporters and apologists and investment bulls and
cheerleaders tend to make this mistake. They tend to conflate and
confuse the extremely positive trends in the real economy, such as
those mentioned above, with another extremely negative trend, the
complete hijacking by private equity and hedge funds, investment banks
and all the rest of the hyper-speculators of the global financial
system, solely for their own selfish benefit.
The hyper-speculator practitioners and their apologists would have you
believe that they represent “free capital markets” and are one of
the prime causes of global peace and prosperity and the extremely
positive real economy trends that I mentioned above.
Whereas the exact opposite is actually true. These so-called “free
capital markets” are actually oligopolistic control of the world’s
financial system by a handful of extremely powerful firms, whose
domination of a virtually unlimited supply of global credit, supported
by compliant supposedly “independent” central banks, enables them
to earn inordinately excessive returns on leverage legal looting (ROLLL)
and thus expropriate the real wealth of the real economy for a very
select few.
The true innovators in the Internet felt that the financial
shenanigans of Wall Street were the sideshow. Google’s founders
clearly felt that way during its own IPO after the bubble collapsed.
But to Wall Street, the Internet and all other real wealth-producing
innovations is the sideshow. Wall Street could care less about the
actual, real-world benefits of the Internet, or of bioscience, or
China's stunning development for that matter, viewing each as simply
the next “new, new thing” to exploit solely to line its own
pockets.
Wall Street readily moved on without skipping a beat from the Internet
bubble as soon as it collapsed to the real estate bubble, leaving the
investors and denizens of the previous hot arena to pick up the
pieces. Btw, venture capital private equity has modestly picked up the
pace to a little over $30 billion this year (dwarfed by buy-out
deals). Unfortunately, one area of focus is Web 2.0 ad-based
narcissistic social networking, not what the world needs more of.
The stakes are so high in real estate and in China that Wall Street
and the Fed will first try to do everything it can to take to prevent
a true crash in the former and to heavily penetrate the financial
system in the latter. But make no mistake about where Wall Street’s
ultimate loyalty will always solely lie, its own pocketbook, it has no
national loyalty.
Weakening Dollar, Déjà Vu All Over
Again, and Again, and Again
The first quote in the beginning of this article about private equity
being the new “face of American capitalism” from the co-founder of
the Carlyle Group (which, btw, Bush Sr. has been associated with)
shows the same level of hubris as Bush/Cheney, and although it is far
more “reality based,” such arrogance may eventually suffer a
similar setback.
But for the moment, while Bush/Cheney are under pressure, private
equity has been very safely flying under the radar screen of the vast
majority of Americans, who barely know it exits, let alone what it is
doing and the effects it is having.
One of the main points in Lewis’s article quoted in the first
section is that the American middle-class seems so surprisingly
complacent about being fleeced by private equity. He writes:
“One of the miracles of Wall Street is its ability to create a class
system without class resentment … There is, you might think, a war
waiting to happen between the Haves and the Have-Mores. And yet no one
much complains … from time to time … the proles take to the
streets with their pitchforks and torches. But they don't seem to be
disturbed by the inequality inherent in the financial markets in good
times … the investment lower class is surprisingly docile ... But
it's going to be hard to keep them distracted … Trust me. The
ordinary investor is now and forever cast in the role of the peasant
at the king's banquet. He's so happy to have any food at all that he
fails to notice that bone between his teeth isn't the meal. It's the
scraps.” (Michael Lewis, Bloomberg, Dec 11)
I’ve mentioned in the past the many “déjà vu” similarities
between the current global economic/political situation and the one in
the early 1970s (Middle East wars, rising oil prices, and increasing
terrorism being a few of them).
One of the most obvious is that back then, while the antiwar left and
liberals were pre-occupied with the Vietnam War and Nixon’s
impeachment, virtually no one outside a very small circle of financial
insiders really understood the profound ramifications when the post
World War II “Bretton Woods” monetary/financial system was changed
by a stroke of a pen on August 15, 1971 during the severe, protracted
dollar crisis of that era.
That change led to the current financial/economic system and its
problems that the world is currently facing. It was no accident that
from the very next year, 1972, the strong post WW II rise in average
weekly real (inflation-adjusted) earnings of American workers stopped
dead in its tracks, and have declined -17% since then, a profound
break with the previous three hundred-plus years of American history,
while income and wealth inequality have reached an all-time high.
A similar thing is happening today, this time with Iraq replacing
Vietnam. While public debate in the “Freak Show” media and opinion
polls are completely dominated by and divided over that issue,
virtually nothing is being said about the profound transformations in
the global financial system, changes which may eventually lead to
various crises, as was experienced in the 1970s.
E.g., the potential of a dollar crisis somewhere down the road is very
slowly ebbing into the news once again, driven by the continued
explosive growth in non-productive debt for their benefit by the
global hyper-speculators.
“Rubin, Treasury secretary under Clinton, and former Fed Chairman
Volcker said foreign investors probably won't keep increasing dollar
holdings, raising the risk of a slump in the currency. ``It seems
almost inconceivable that this will continue indefinitely,'' Rubin,
who now chairs Citigroup's executive committee, said. ``It's
incredible people have gone on so long holding dollars,'' Volcker
said.” (Bloomberg, Nov 15)
“Fed Dallas President Fisher clashed with United Arab Emirates
Central Bank Governor Sultan al-Suwaidi, who said the euro will
overtake the dollar by 2015'' (Bloomberg, Nov 17)
“comments from Wu Xiaoling, deputy governor of the People’s Bank
of China, indicating her unease at the rapid build-up of $1,000bn of
reserves in China. She said Asian foreign exchange reserves were at
risk from the dollar’s fall.” (FT, Nov 24)
There is always the possibility, as is analyzed by many on the web
sites that post my articles, that the financial system itself may
either implode (deflate) or explode (inflate) under the weight of
increasingly unproductive debt creation by the global
hyper-speculators.
Even if that day of reckoning continues to be postponed, then at
minimum the tremendous increase in global inequality, both between and
within nations, will tend to continue to produce more social and
political tension.
Because of America’s historical social/political “exceptionalism,”
greatly aided by the benefit of incurring its unprecedented debts in
its own currency, significant political, economic and social reform,
e.g. to the education and health care systems, probably will not
happen in the U.S. But that simply means that these rising tensions
will keep getting pushed abroad.
Very unfortunately, the “Freak Show” of both old and new media
continually exploits the fact that the world’s population has always
been divided, currently to the immense benefit of a globalized elite,
by overly zealous nationalism, religious fanaticism, racial and ethnic
hatred, and other modern if anachronistic manifestations of ancient
clan/tribal identities deeply hard-wired into the human brain.
This makes it much easier for U.S. workers, and Democratic party
leaders, to get angry at China than at the CEO of the global
corporation that moved the factory there in response to the incentives
of the global hyper-speculators (whose predecessor moved it to the
American south from the north many decades before that for essentially
the same reasons, in that era to exploit regional divisions in the
national population).
“Democrats are returning to power on Capitol Hill just as two
powerful wings of the party, labor and Wall Street, are colliding over
economic issues. The dispute over trade and budget policies prompted a
high- level private meeting earlier this month between AFL-CIO
President John Sweeney and former Treasury Secretary Robert Rubin, who
is now chairman of the executive committee at New York-based Citigroup.”
(Bloomberg, Nov 22)
Contrary to popular opinion, Wall Street has always been a “powerful
wing” of the Democratic party. But Rubin is not FDR, his
"Hamilton Project" notwithstanding; Sweeney is not a labor
leader of the 1930s; Pelosi gets her wealth from her real-estate
developer husband; and it’s no accident that Hillary Clinton moved
to become one of the Democratic senators from Wall Street, the other
being Schumer, the most important Democratic fund-raiser in the
mid-term election (along with Bill Clinton's Democratic Leadership
Council protege Rep. Rahm Emanuel).
For more on “Any Hope for the Dismal State of Politics in
America,” see the final section with that title in my Oct 27
article, “Global Strategic Bargain” link.
Until some political party, and as I said in that section I honestly
don’t care which it is, eventually comes up with the 21st century
version of a “New Deal” for globalization, the “Freak Show”
will dominate American politics and hence the world will remain at
great risk of being drawn into yet more wars in the coming year, with
the Democrats being just as, if not more, inclined to do so as
Bush/Cheney, especially in parts of the Middle East.
Once again, thanks very much to all those who have read my often
overly long articles this year and best of luck in 2007.
© 2006 Econotech
Editorial
Archive | Econotech
Blogspot
This
article is intended solely for information purposes. The opinions are
those of the author only. Please conduct further research and consult
your financial advisor before making any investment/trading decision. No
responsibility can be accepted for losses that may result as a
consequence of trading on the basis of this analysis.
CONTACT
INFORMATION
Econotech
USA
Email l Website
The
opinions of FSU contributors do not necessarily reflect those of
Financial Sense.
|
