Round Up, and Returns
I’ve been off line for a few days, so I ought to catch up with the news.
Which, it turns out, isn’t really news at all. The economy is right where we left it. Chugging along at an unspectacular pace, adding jobs at a modest rate, growing, but too quickly, and exposed to the exact same risks that beset it before. Our banks are still way too large relative to our economy, Europe still is dithering about in self-inflicted recession, and the Middle East is simmering back to one of its regular boils thus threatening oil supplies.
The more things change, the more they stay the same. Or something like that.
Stateside, things are going reasonably well for an economy hobbled by awful policy leadership and gluttonous banks. Sales of homes are showing signs of life, which by itself is a relief, but is probably more important as an indicator the households are growing in confidence. Both new homes and existing homes are selling at rates above their crisis bottom dwelling levels. But neither are bubbling along at unsustainable rates either. I have mentioned before, but here I go again, that construction has now fallen behind long term demand. We have a growing housing shortage in some areas. Especially multi-unit housing. I suspect that sometime in the next year or so we will see a small blip – and I hope it is only a small blip – in construction as this shortfall is erased.
The long slow debt reduction process has evidently had an impact on household expectations: purchases of big ticket items has picked up. Unfortunately wages are lagging still – they have for decades – so any acceleration in these kinds of products will inevitably involve a run up in debt as well. The key will be reaching a sustainable level of debt and avoiding the excesses of the Bush era bubble.
Which brings me to the banks.
They remain a dagger pointed directly at the heart of our economy. They have failed us mightily for a very long time. During the past two decades they have misdirected capital throughout the economy with spectacular abandon. The dot-com and housing bubbles stand in permanent testimony the the ineptitude of our banker’s ability to spot a good investment opportunity. The one thing we know bankers are good at is generating, on paper at least, profits that justify big bonuses. They are less adept at ensuring a reliable and stable flow of capital into the real – non-financial – economy where the economy would benefit from long lasting increases in its productive capacity. And they are certainly not very good at credit analysis.
This latter point is being hammered home heavily at the moment by the squirming over sovereign debt. The steady right-offs of sovereign debt by our large banks is horrific to watch. Even worse is the craven attempt to get taxpayers to offset such losses in one way or another. Bankers are supposed to be skilled at risk management. Apart from managing our payments systems that’s what they are paid to do. Yet they seem all to want to be relieved of that duty every time they make a mistake. Making mistakes is an essential part of the training of every good risk manager. They are supposed to learn and get more capable as they go along. Ours just want to be bailed out so they can get back to making a quick buck. Where, oh where, are our regulators?
Which bring up the scuffle going on over the Volcker Rule.
This, as you all know, is a rule that iS supposed to be appended to the infamous – and frankly incredibly dense and not at all good – Dodd Frank reform of banking. You would have thought that within a document of over 800 pages someone would have find room to write in a rule to deal with proprietary trading. This is the kind of trading that banks do for themselves and not on behalf of a client. It is the locus of the most egregious casino mindset that sent us careening off the cliff, and is the least useful of all the things banks do. I have nothing against proprietary trading along as taxpayers are not deployed to clean up the losses. If traders want to have fun gambling, sop be it. Not on our dime. Not at all. The Volcker rule is supposed to force banks to carve out proprietary harding and thus eliminate taxpayer support for gambling. The banks are aghast. They are crying and pouting because it looks like their toys are being taken away. Which they are. Justifiably so. You don’t give fireworks to children. You don’t allow traders to trade on the taxpayer’s dime. Things get blown up otherwise. Nonetheless they banks are marshaling a formidable array of lobbyists to attack Congress in order to keep the subsidy they rely on to boost their margins. Keeping the Volcker rule off the books is one way to avoid having to be good at banking – playing with free money is so easy any juvenile can succeed. Look around the yahoos on Wall Street to see just how stupid one can be and still make a fortune if you are playing with someone else’s money.
This brings me to the inimicable effects of returns. Particularly the return on equity in whose name all sorts of evils are wrought on a daily basis. ROE is the driver of modern business. Everyone tries to ‘maximize’ ROE. As if maximization is possible in an uncertain world – just how do you determine what a maximum is in the face of uncertainty? No one knows, but all sorts of experts opine about maximization as if it is possible. It isn’t. So business leaders use a proxy: they seek to attain the ROE the ‘market expects’. This is a measure admittedly plucked from thin air. Or, more precisely, the air between the ears of sundry Wall Street analysts who opine constantly about the required return on equity in various industries. It is very subject to whim and rises and falls rather like skirt lengths on Parisian fashion runways. The problem recently has been that everyone is reaching for ever higher levels of ROE. Hence the urge to cut costs, deploy more capital at the expense of labor, off-shore production, otherwise outsource, and – this is the killer – to take more risk.
Just last week Proctor and Gamble announced a slew of lay-offs in order to ‘align’ its ROE with market expectations. P&G’s problem is that too much of its business is here in the US where ROE is hard to squeeze – the underlying sluggish growth of the economy is a major block to higher ROE, growth is much more attainable in emerging economies where consumption is still a novelty. Thus P&G needs to downscale its operations in the US – hence the layoffs – while boosting its operations abroad. This, by the way, is the same company that has abandoned much of its marketing to the US middle class on the basis that said class no longer has sufficient purchasing power to justify the expense. P&G’s shareholders, no doubt, will be happy to hear about the move to boost ROE. American workers probably less so.
Likewise, much of the banking objection to reform is that it will limit ROE. Poor dears, perhaps this means less of a bonus. Here’s my response: tough. Banking is not supposed to be a high ROE business. And if your bank is so large that it is a good cross section of the US economy – which all the big banks are – then your ROE will mimic, or track closely to, the economy’s overall performance. Trying to squeeze an abnormal rate of return from a mature economy is likely to drive you to do reckless things. And we know where that leads. Safe banking is low ROE banking. Get used to it. The lunatics on Wall Street who constantly demand higher rates of return than are sustainable should be silenced or ignored. If they really want those rates of return they ought to invest in boutique style banks that have portfolios small enough and select enough not to be samples of the entire economy. Size matters in banking. Just don’t tell those traders. They’re juvenile enough as it is.
So. There we are. There’s lots going on, but not a lot of change. Which is probably a good thing in an election year fraught with awful candidates and practically no sharp criticism. But that’s another story.
Oh, and one last thing: does anyone really care anymore about the Oscars? If there’s one totem to the past it is an awards ceremony in an era of instant review. Social networking, downloading, streaming and all the other properties of an internet economy have made the movie industry look increasingly out of touch. It still knows how to lull an audience in order to make a living, but its business model is looking extraordinarily musty. The Oscars belong in the 1950’s. It’s time to move on.
