When the Money Goes on Strike – July 20, 2010

(Note – This is a post from last summer that did not get uploaded in sequence)

US corporations are sitting on $2 trillion in cash.  Banks can fund themselves for next to nothing and lend it to virtually anyone at virtually any rate and get a satisfactory return.  But it’s not happening.  The banks are not lending, as any overview of the economy will tell you.  And the corporations are not disbursing their cash hoards to hire or to invest.  What’s going on?

It’s called a capital strike. 

It’s not that there is some conspiracy going on to undermine the Obama Administration and get the Republicans elected.  Banks exist to lend; if they don’t, they are not earning a return on their funding that justifies their cost structures.  And corporate America will ultimately find that sitting on piles of cash earning next to zero interest will not please their shareholders.  These companies have it in their DNA to put money to work. The reason they don’t is simple: they are scared.  Scared of this government.
And they have plenty of reason to be wary.  This is a government that has shown few qualms about demonizing any private company that stands in the way of their policy objectives.  Thus insurance companies were vilified during the health care debate as “abusive,” evil entities that pad their profits by denying care to the suffering.  Thus banks and finance houses were tarred with one broad brush – “fat cat” institutions that got greedy and sent the economy into a tailspin.  Thus BP is threatened with lawsuits and subject to a shakedown before the President even met with its CEO to work out a response to what is, at the end of the day, a common problem for both the company and the country.  Boards of directors are told to fire CEO’s; bondholders are told to take a hike.  This government’s first instinct is to protect the “little guy” at the expense of the “corporate behemoth.”  And the politics and the PR of the times is such that, if you have the misfortune of being labeled a miscreant by the White House, you don’t even get your day in court – your best bet is to apologize meekly, settle generously, and hope the glare quickly passes to some other company.
And even when you think you have a deal, this government will renege.  Health insurers found that out to their cost, when they agreed to end the kinds of practices that helped keep them solvent and profitable, like denying coverage to people who subvert the actuarial cost structure by signing up for insurance when they are already sick.  The quid pro quo for this concession was that there would be a large new pool of healthy people who will be forced to buy insurance.  Then came the double-cross: the government pocketed the concessions, thank you, but that large new pool won’t have to buy their insurance until 2014, and even then the penalties in the early years are so light that millions of people will pay them and skip the insurance.  Too bad, insurers – your claims expenses just went up astronomically but the extra revenue is not coming in.
Nor is this government shy about knocking about the rule of law when it suits them.  The most egregious example of this was the treatment meted out to the holders of Chrysler bonds, whose documents clearly said in black and white that they have a superior claim over all others to the assets of the firm in the case where the company can’t pay its bills.  But when the White House decided to “save” Chrysler, they stomped all over those legal claims and gave the majority of the company to the union pension plans.  Save the worker, let the “fat cats” go hang.  Never mind that those “cats” were in fact investors trying to earn a decent return for, in many cases, the pension funds of other workers.  To hell with legal claims, says the White House.  The restructuring necessitates other measures.  Odd, since the President is the one who places his hand on the Bible and solemnly swears to enforce the laws of the country.
On top of this, of course, businesses know their costs are going up.  They see the impact of Obamacare, and despite the administration’s promises, nobody believes that medical costs are going to come down.  And they know their taxes are going up.  Not only are the Bush tax cuts set to expire, and they see the health care taxes that are going up to pay for that bill, but there are also all the other taxes that are going to be raised to pay for the gusher of government spending that has been taking place for the last couple of years.
And there’s the cost of regulation, too.  Tons of it.  Obamacare alone is full of them.  For instance, Obamacare requires that companies with as few as ten employees will have to prepare a Form 1099 every year for every vendor with whom they do as little as $500 worth of business.  That’s every business relationship you have when you’re a moderately successful small firm.  That means keeping a paper trail for every little item that crosses the checkbook and generating and sending out new tax forms on top of everything else.  On top of that, the government is now talking about forcing all companies to make an automatic IRA account available for every employee.   Makes you hesitate to hire that 11th employee, doesn’t it?  Every rule, no matter how well-meaning, ends up raising the businessperson’s costs.  Higher costs, without extra revenue, just make it harder for the entrepreneur to grow the business.  And a growing business is one that hires people and invests in the future.
But the greatest deterrent in the current environment is the uncertainty of how much more is coming down the pike.  This is what is really holding businesspeople back.  It is characteristic of major legislation that Congress sets the outlines and lets the bureaucracy set the actual rules.  So Obamacare, in 2,000 pages, really just sets the boundaries of what later rulemakers will clarify, on issues as varied as who qualifies for what benefits, what coverage will be acceptable and avoid government fines, and so forth.  Then there’s the recently passed financial markets “reform,” which has been estimated will result in between 250 and 500 new regulations covering everything from global banks’ derivatives operations to the local builder offering payment terms.  And of course, beyond that, we have the upcoming energy bill – assuming Obama can muster the support to force that through a one-armed Congressional approval process – and who knows how many new regulations will flow from that one.
It’s been called the Uncertainty Principle.  Business is hard enough to plan for when the legal, tax and regulatory circumstances are stable.  You don’t know whether the market will favor your product or service.  You don’t know what the competition will do, or what competitor will spring from nowhere to pose an unforeseen challenge (like Apple did to Motorola and Nokia, just to name one example).  You don’t know what new technological development will burst on the scene to completely undermine your business model (think travel agents).  You don’t know how the business cycle will play out, and whether it will be robust enough to repay the investment you’re contemplating.  You don’t know how well the new hire you’re considering will work out.  All of these uncertainties and more must be thought through and their risks estimated before the businessperson can make the important decisions.
These are what Donald Rumsfeld, in another context, called the “known unknowns.”  You don’t know the answers, but at least you can identify the important questions.  Now, our own government ladles on the “unknown knowns” and the “unknown unknowns” – things like future taxes, cost of health care, regulations, rules, and requirements the shape of which is only vaguely discernible amid a fog of uncertainty.  And these are hugely consequential – a change in the tax environment can chop your net income in half for making the same return on your investment.  The regulations and all that will add no benefit whatsoever to your business but will add – who knows how much? – extra cost to burden the same revenue, again reducing the net income.  So even if you knew the answers to the “known unknowns” you still don’t know how much money you stand to make from taking the plunge and investing your life savings in that new bakery.
The White House doesn’t see it, but while they are casting about to find ways to “stimulate” the economy and get businesses to shake loose the cobwebs, their very agenda is weighing on entrepreneurs like a pair of concrete boots.  They are simply trying to do too much, and the slow speed (quite necessary, I might add) at which all this legislation is turned into practice is working a greater harm on the economy than all the government spending they could possibly muster will do for the good.
Rahm Emmanuel famously said “you never want a serious crisis to go to waste.”  But he’s wrong – when the economy is as shaken as this one is, and still trying to find traction in the quicksand, an ambitious agenda is the last thing you should attempt.  Americans are in no mood for big changes.  They want the gyroscope to stop spinning for a while so they can regain their footing and get back to work.
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