by Carl Hegelman
The economy is terrible right now. Almost everybody seems to agree. The business community, as represented by the US Chamber of Commerce, the Business Roundtable and most Republicans, has some ideas as to how to fix it: cut taxes; reduce the deficit (!); rein in Big Government spending (except defense); stop over-regulating business so they can get on with business. The Democrats have their own idea: more stimulus, in the form of, for example, extending unemployment benefits. Who’s right? If anybody?
As a corporate bond analyst, I get some perspective on this. My job is to analyze companies and try to figure out whether they can service their debt (pay interest and return the principal when it comes due), or, perhaps more often, how much of a loss their creditors (banks, bondholders, vendors, pensioners, etc) are going to take in the bankruptcy, and what the company is going to look like when it has screwed them all (except the lawyers and financiers) and emerges in a relatively debt-free state from Chapter 11. I spend a lot of time gazing at spreadsheets (in between ruminating over Solitaire, Hearts, Tetris and Bridge), corporate slide-shows and SEC filings. I listen to a lot of “earnings calls” (the conference calls given by management when their quarterly earnings numbers are released). I read the Financial Times every day. (Gave up the Journal a long time ago, fed up, finally, with the one-sidedness of its editorials).
There’s a thread that runs through most of the calls I listen to: Demand is weak; we are responding by cutting the fat and becoming leaner and meaner; when demand picks up, we’ll be in good shape.
Most of the companies I follow have a line in their income statements: Restructuring charges. When they close a plant and lay people off (“headcount reductions”), they have to pay severance and, for instance, break leases. And that’s what restructuring charges are all about. Granted, I don’t follow upper-class companies like Exxon or IBM or Microsoft; but pretty much every US company I do follow has this line in its income statement. And even most of the blue-chips have probably taken these restructuring charges at some point in the past two or three years. Yes, even Microsoft ($290 million in the March quarter of 2009).
Just as an aside here, there’s a reason for them breaking it out like that as a separate line-item in their expenses: that way, they can present it as a “one-time charge”. Analysts like me are supposed to discount it in looking at their “real” underlying cash flow and in forecasting their financial futures. It’s a one-time charge. Trouble is, it almost never is a one-time charge. That line, Restructuring Charges, appears, for most of my companies, every single quarter. Sometimes you begin to wonder what’s left to restructure.
Most CEOs and CFOs on earnings calls are not taking the big-picture view. They’re focused on the details of their own particular business. Still, I often ask myself if they see the connection that’s staring you right in the face: when is “the consumer” going to start spending again? Well, maybe when you stop firing him.
This really seems to be the root of the problem here in the US, and these earnings calls are like a microcosm of the whole US economy. You’ve probably read a hundred times that consumers are responsible for about two-thirds of GDP. (In the last four quarters up to 3/31/2010 it was close to 71%). So if they don’t have any spendable money because they’ve been fired (or are afraid they’re going to be fired), demand will be weak.
In other words: If I fire everybody, then who is going to buy the stuff I make? You can see how this turns into a vicious circle.
A corollary of this whole phenomenon, incidentally, is this: Private enterprise “surplus” as a percentage of GDP has stayed at a pretty high level-about 25% over the 12 months to 3/31/10. That’s well above the trough in the last really big recession in 1980, when it ran about 20%. At the same time, perhaps not surprisingly, corporate cash is at $1.8 trillion, according to the Federal Reserve, which at 7% of assets is as high as it’s been since the 1960s. There’s probably another reason for that other than all the money they’ve saved by their “reductions in force”: they’re haunted by the ghost of the credit crunch, when cash was very hard to come by and you couldn’t be sure your bank would survive. Still, there’s obviously a connection.
You probably think this is all leading up to a big rant against the evil corporations. Not so. I mean, there’s plenty to rant about, including the extraordinarily high salaries of the corporate managers and, particularly, the egregious parasitism of “financial services” companies whose contribution to our economy is minuscule in comparison to their cost; but staying “lean and mean” is just facing reality: keeping employees hired just for the good of US-kind is a short-term fix with bad long-term consequences.
The stock answer to this quandary is that we must invent new industries and re-train workers in the skills required to drive them; but, frankly, that’s bullshit and I think we secretly all know it. The truth is, there is no good answer to this quandary.
One thing does seem clear, though. The US Chamber of Commerce, Business Roundtable and Republicans generally have the wrong answer. The reason businesses are not hiring is not that their taxes are too high or that they’re over-regulated or that their healthcare costs are too high or that they don’t have enough cash or that they can’t borrow. The reason is that there’s fewer and fewer people left to buy their stuff (except the Chinese, but that’s another story). It’s not even clear, really, that’s there’s anything government can do. But if we have to pick between the Republican solution and the Democrat one, well, the Democrats win by default.
Carl Hegelman (a pen name) is a corporate bond analyst and a connoisseur of leisure.