Tag Archives: financial

Capital Investment– Fuel for Innovation, Engine for Growth, Fixes the Economy: More Investment Means More Prosperity

Share

Capital investment that companies make today in new product lines, new equipment and other assets… will determine the valuation of the companies in the future… This leads to a very fundamental objective within capital investment management, i.e., maximize value of the company through astute capital investment, which fuels innovation that propels the growth engine, which is good for the economy… According to Standard & Poor’s (S&P); despite a modest recovery in capital investment following the financial crisis– capital investment slowed again in 2012 and is expected to contract by 2% in real terms in 2013. Initial forecasts for 2014 are for capital investment to continue to slip, falling by 5% year-on-year. A modest post-crisis recovery appears to be stalling before it has really begun. This downward trend is especially prevalent in Western Europe, which has seen its share of global capital investment fall to just 24% in 2012, and its forecasted to remain steady in 2013 before inching up to 25.4% in 2014… According to S&P; the emerging markets also look fragile, especially Latin America where the region is expected to experience the weakest growth in business investment of all regions in 2013, in part because of its heavy reliance on the energy, materials and utility sectors… North America, however, is one region S&P expects to increase its share of global corporate capital investment from a low of 24%e in 2009, to 35.6% in 2013 and 36% in 2014… Many economists consider capital investment a vital part of the economy, which generally means that the overall mood of business has a considerable impact on the pace of capital investment and thus impacts the trend of economic growth… The prime objective of making capital investment in any business is to obtain satisfactory return on capital invested. Hence, the return on capital employed is used as the measure of success of a business in realizing this objective. Return on capital employed establishes the relationship between profit and capital employed. It indicates the percentage of return on capital employed in businesses and shows the overall profitability and efficiency of business… in addition, it becomes a key indicator for the health of the economy: When businesses are profitable, growing, innovating, investing… that’s a vital sign for the economy…

capital imagesCA00SC94

In the article Capital Management: A High-Wire Balancing Act by ATKearney writes: A tightrope walker daringly takes on a task that is magnified by the possibility of a great fall. A small misstep can have disastrous consequences. However, the performer has a secret: Focus on a few basic principles and follow them perfectly to reduce the chances of making a mistake. Managing multibillion-dollar capital investment is also a balancing act where it’s easy to lose sight of the basics. People often get distracted by the intricacies of the allocation process, the internal politics, or the complexity of the business case. This last distraction is almost always dealt with by quantifying every aspect of the business case, which may give the impression of managing all the details but in reality often results in at least three symptoms of poor capital management:

  • Failure to prioritize: When capital investments are not linked to corporate strategy and financial targets, it’s almost impossible to capture the required level of returns across the portfolio.
  • Loss of accountability: When accountability are not clearly defined, followed, or enforced, and reviews are not conducted (either while in progress or post-implementation), no one owns the outcome.
  • Poor visibility: Without a corporate-wide reporting structure there is limited visibility into spending and even less control of the investment portfolio. As cost overruns mount and projects slow-down, the economics of the original investment case are      often lost.

In the article Managing Capital by ey writes: Capital is the lifeblood of every fast-growth business. As you continue your journey to market leadership, a strong grasp of what we call the capital agenda should inform all of your important business decisions: Should you restructure your business? Is now the time to sell some of its assets? How can you seize the premium acquisition opportunities? The capital agenda model helps to address these type questions and is based on four key dimensions: Preserving, Optimizing, Raising, Investing:

  • Preserving capital: Fast-growth companies needs to preserve capital. So continuously evaluate your balance sheet, strategy and markets. Look for strengths and weaknesses. Seek opportunities, but identify risks and guard against value erosion. Your ability to access liquidity, manage and release cash, control costs and engage with key stakeholders is essential to preserving capital.
  • Optimizing capital: Capital is precious. Fast-growth companies need a tight grip on the drivers of efficient capital allocation. Greater operational efficiency can release excess cash and working capital. More companies are taking an active approach to business asset management. Such rigor can uncover poor capital deployment, leading to better capital preservation and allocation.
  • Raising capital: Fast-growth companies need to keep their capital needs under constant review. Even if your balance sheet appears strong, external shocks can delay your journey to market leadership. Review your business through the lens of the investment and lending communities. Whether you are refinancing debt or planning for an IPO, you can reduce your cost of capital if you understand the ratios and covenants they favor.
  • Investing capital: Use your capital wisely. Potential backers expect fast-growth companies to make investment decisions supported by in-depth and varied scenario      analyses. Show them you have considered the alternative uses of capital. Communicate a compelling value proposition and focus due diligence on the drivers that matter most.

capital 2013-04-15-chinavcmarket

In the article Investment Is Understated by Edward Conard writes: An increase in investment by one economy relative to another will likely affect their relative rates of discovery (innovation) and implementation. Successful risky investments in innovation will grow the economy faster than less risky investments and that enlarges the existing business capacities. Also, successfully commercializing good ideas is as important as discovering them and, generally, that requires similarly risky investments… Innovation expands the economy and benefits consumers by providing better value… As risk takers grow increasingly optimistic; asset values rise. This makes investors and consumers grow increasingly willing to take risks. As risk taking grows, the economy expands, increasing the amount of investment and the value of assets relative to the economy… A fast-growing company with higher profit margins that is pouring more money into investment than its competitors looks much more attractive to investors, and thus garners a higher valuation. Business investment is good for innovation; innovation is good for business investment…

U.S. companies will make capital investment totaling roughly $2 trillion in 2013, according to research by McKinsey. These capital investments are critically important to future of their companies and the economy; over 50% of corporate growth is directly attributable to capital investment. The companies that manage their capital investment well, significantly outperform their rivals… Booz Allen found that companies that employ best practices in capital investment management earn 25% higher profits than their peers. With respect to capital investment, today’s top performers are focused on the three key dimensions: Accountability, Visibility, Efficiency. Accountability has many dimensions… Yes, the numbers do have to be right. Having a clean electronic audit trail of all approval decisions and demonstrating that proper controls are in place to ensure compliance with corporate policies is critical… According to David Straden; real measure of performance in capital investment is ROI. It sounds obvious, yet most companies fail to track and report on actual ROI… If you don’t know how you did on the most important capital investment metric, than what are the chances of driving sustained improvement over time? The simple act of announcing that actual ROI will be tracked will often lead project management to be more realistic with their estimation of potential benefits… Formalizing the capital investment process and imposing rigorous methodology over project evaluation is a step in the right direction…

A second key capital investment management dimension is visibility: The only constant in today’s world is change. In a world where everything is moving faster and faster, the best companies use speed as a competitive advantage. Given the long lead times required for larger investment, it’s arguably even more critical to be flexible and responsive managing capital investment. New opportunities continually present themselves, whether from merger and acquisition activity, new product developments or competitor difficulties… New threats also unfortunately abound, whether it’s diminished liquidity, fluctuating exchange rates, market forces, competition, political upheaval… To move both quickly and intelligently decision makers must have real-time access to the necessary information… The best companies are proactive in establishing process to give themselves informational context and be prepared to adapt quickly to changing circumstances… An efficient capital investment approval process is the basic building block: The best companies focus on capital investment efficiency. Doing more with less is a key imperative and being lean means putting capital investment to the highest and best use… It’s not about being smarter it’s about having a better process; one that enhances productivity and leads to greater effectiveness… Start tracking actual ROI on capital investments, year over year.; that’s the ultimate key performance indicator (KPI) to assess progress in improving performance.. Improving efficiency is the ultimate weapon in a challenging world. Having less doesn’t have to mean achieving less. If you institutionalize accountability, increase visibility and enhance productivity, you can do more with less: More growth, higher profits, and better economy are worthy objectives…

Share

Zombie Companies– Barely Alive, Living Corpse, Walking Dead: Clinging-Financially Undead, Waiting For Creative Destruction.

Share

Zombie companies… it’s inevitable and necessary to allow the failure of some non-competitive companies, so as to release the capital and labor for more promising companies ~Winnie Wu

Zombie companies are neither dead or alive… they have so much debt that any cash generated is used to pay off the interest on the debt… there is no spare cash or capacity for the company to invest or grow…  Zombie company is a media term for a company that needs constant bailouts in order to operate, or indebted company that is able to repay the interest on its debts but not reduce its debts… The term can be traced to Edward Kane and his analysis of the insolvency of U.S. ‘savings and loans’ in 1980s, and Japanese banks in early 1990s. Zombie firms are loss-making and have little hope of improvement in near future. Therefore, they depend on banks-other investors to grant them continuous loans to survive, effectively putting them on never-ending life support… According to R3; there are 146,000 zombie businesses teetering on the edge of solvency… they are only able to pay the interest on their debts but not tackle payments around the debt itself… R3 identifies three defining features of a zombie company; having to negotiate payment terms with suppliers; struggling to pay debts; facing the probability that if interest rates rise, they will be unable to service debts at all... According to Richael O’Brien; while allowing businesses to fail may not be a popular choice, it is becoming increasingly evident that it’s vital for overall economic growth. It can be easy to think in short-term when faced with the economic problems, but allowing progressively weaker business models to stack up will ultimately stall economic growth in the longer term. There is a lot to be learned from the Japanese and other similar experiences over zombie companies… As long as economic capital is tied up in struggling companies, the playing field is not level for emerging businesses… According to Hugh Pym; the rise of so-called zombie companies is, to some extent, a consequence of the current record low-interest rates… And, according to some experts around a third of UK companies– approaching 50,000– could be doomed to failure if interest rates go up. According to Christine Elliott; urgent attention is needed to avoid multiple failures and tens of thousands of job losses. According to Jon Moulton; more companies should be allowed to fail to overcome the economic downturn… Zombie companies is not a phrase that bankers and regulators like to use. Most shy away from the idea-prefer to talk in the usual jargon, like ‘forbearance’ and ‘provisions’. But there is no doubt that the dead hand of the zombie is casting a shadow over the economy…

In the article The Rise of the Zombie Companies by financialtimes writes: Europe is in midst of a zombie company revolution, where thousands of firms that should have folded due to colossal debts, are clinging on to solvency… Zombie companies are being blamed for Europe’s weak recovery, triggering fear that it may echo Japan in 1990s, where low-interest rates, loose government policy, big banks reluctance to foreclose unprofitable companies, caused decades of weak growth. According to Alan Bloom; the basic tenet of capitalism is that some bad companies need to fail to make way for new and better ones, is being rewritten. Many European companies are just declining slowly and have an urgent need for new management, revised capital structure, or at worst allowed to fail. According to Bank of England; some companies were able to remain in operation during recession [as result of government and central bank action], and might have hindered reallocation of capital towards more productive sectors. In U.S., ‘creative destruction’ is more in play; there are increases in insolvency rates since the crisis. But far less in Europe, where policy makers are focused on protecting jobs than on boosting efficiency. Europe is like a forest floor that is being clogged with weeds, choking off nutrients-light to saplings with a chance of becoming trees. What Europe needs is fire to clear undergrowth.

In the article Zombie Companies by Ian Stewart writes: Some commentators suggest that the UK economy is being held back by so-called zombie companies. These are weak companies that only survive thanks to low-interest rates and more tolerant attitude to corporate borrowers on part of banks-investors. The argument runs– that if zombie companies are allowed to fail, then more productive businesses would fill the gap, leading to more efficient allocation of resources. To advocates this sort of ‘creative destruction’ makes way for stronger businesses of the future… However, it’s impossible to prove weaker companies are holding back recovery. But some data are consistent with this theory. For example, despite a deep downturn– corporate insolvency have remained remarkably low in recent years. Roughly a third of UK companies is now making loss, and at higher rate than economy experienced in the 1990s recession. UK productivity growth has also been weak, something which might in part, be explained by the poor performance of zombie companies. The idea of zombie companies is not new: Economists of ‘Austrian School’ champion the notion that recessions clear out unproductive capacity and create space for more efficient companies. Joseph Schumpeter’s coined the phrase ‘creative destruction’ to describe this process… The failure of Japanese banks to foreclose on highly indebted and  unprofitable firms in late 1980s recession is seen by some as contributing to two decades of weak growth. The central problem with the zombie company’s argument is the difficult to distinguish between unviable businesses and those that, if nursed through a downturn, would have a bright future. The main weapon to counter the financial crisis and recession has been low-interest rates… it may be that one result of current ultra low levels of interest rates, in fact, is that some unviable companies are able to survive for a longer period. Yet this does not prove that low-interest rates or forbearance on the part of banks is an inappropriate response to the crisis. According to Spencer Dale; the whole point of monetary loosing is to keep companies that have a viable long-term future in business while demand is temporarily weak… The willingness of banks to nurse companies through tough times is predicated on a view that business has a long-term future. More generally, all economic policies that aim to bolster demand have unavoidable-unwanted side effects: For example; low-interest, ‘quantitative easing’ rates hit savers… Increasing government spending adds to the debt burden faced by future generations… Killing off zombie companies by raising interest rates could have huge, unwanted side effects, e.g., raising debt servicing costs for consumers-business, hitting confidence-depressing demand. Some experts predict that one percentage rise in interest rates could depress GDP up to 0.35%. This as a potential medicinal cure can risk killing the patient. The aim of the current macro-economic policy is to sustain business through this difficult period. The hope is, in time, many of zombie companies will be able to ‘rise from the dead’

In the article How to Spot Zombie Company by Sydney Finkelstein writes: Nearly every company studied in our ‘failure’ research was glorified as ‘number one’ in some category and made this status part of their self-image. Almost all of them trumpeted their front-runner status in company slogans, displays, PR… For example; Enron had a sign inside its corporate entrance that read: The world’s best energy company. Later, this sign was changed to read: The world’s best company. Nice. The problem is that when a company makes being ‘number one’ part of its self-image, the behavior that made the company ‘number one’ starts to change. The consequences of this inward maintenance of status can be seen almost immediately in the way employees of the company begin to treat others from outside the company. They are polite but condescending; since they believe they don’t have to listen to others, because they already know better. Many executives of failed companies were not only arrogant, but they were proud of it… Another sign of a zombie company is when it has unwavering vision of what it’s doing and this vision takes on a momentum of its own… then, after a while, the company will tend to do things not because they make any business sense, but because they carry out the vision. The extreme form of this irrational sense of mission is the strategy that could be called; ‘if-we-build-it-they-will-come’. The single worst aspect of this excessive loyalty is that it prevents companies from hearing what their customers are trying to tell them; they don’t just claim; we know what our customers want. They go further, claiming in effect; we know what our customers want better than they do, because we know what’s best for them, and eventually they’ll see it too… Now, astute readers may ask, doesn’t Apple do this too? Well, if you want to create a successful strategy, following Apple’s strategy, in the Steve Jobs era, is like professional basketball teams selecting Ivy League players, at the top of the draft, because of Jeremy Lin. Wild exceptions do not make the rule folks…

The term zombie company is metaphor to describe companies that are merely treading water until a trigger, such as an increase in interest rates, pushes them into insolvency. It can be argued that this stagnation ties up capital that could be used for other healthier businesses and indeed these zombie businesses risk dragging healthy companies into decline… According to Ernst & Young; financial crisis had created an environment where it’s ‘too difficult to fail’, with businesses being kept afloat to detriment of the broader economy… According to Alan Bloom; everything is becoming complicated and making insolvency difficult option…. It means that businesses which probably should fail, don’t fail. In a capitalist economy you get winners and losers… According to Sarah O’Connor and Brian Groom; companies with broken business models should be allowed to fail, so that their resources and workers can then ‘flow’ into new-expanding companies that are better able to drive economic growth. However, according to Richard Barwell; real world is messier than the world of macro-economic models. Workers do not always ‘flow’ effortlessly into new and more productive jobs, especially when the economy is weak. However, in the long run we do probably need capital, and more importantly human capital, to be released from inefficient firms to more efficient ones… According to Lauren Lyster; in the life cycle of capitalistic boom-and-bust there is failure, as well as success… One must acknowledge– failure, then re-price, liquidate, and move on… According to Joseph Schumpeter; capitalism is like– forest floor– life, death, regeneration… Here you’re looking at stagnation without death-regeneration… zombie imagesCA2DYW2M

 

Share

Hoarding Cash– Corporations Stashing Billions: Accumulating Massive Amounts of Cash Reserves– Caution, Fear, Greed…

Share

Hoarding cash: Billions-Trillions in cash that are socked away are a good measure of what global business thinks about our times: It isn’t pretty… despite what some suggest it doesn’t appear to be guided by greed or complacency… John Bussy

Hoarding cash is the practice of companies holding large amount of cash (‘cash reserves’)… cash held in anticipation of facilitating company initiatives, for example; acquisitions, expansions, investments… Analysts often speculate about the purpose of corporations’ large cash reserves, i.e., act of accumulating assets, especially cash… over and above that is needed for immediate use… According to ‘Federal Reserve’, as of third quarter of 2012, non-financial corporations in U. S. held $1.7 trillion of liquid assets; cash, securities… One explanation for higher cash holdings is uncertainty of the economic environment… or, they may also face greater difficulty in getting credit on short notice, and need to hold more cash as precaution. A 2011 study by ‘International Monetary Fund’ suggests; higher cash holdings by corporations are simply a sign that they plan new investments in the near future. It says, this is a ‘good omen’ that indicates investments can increase significantly over the next year or two. However, the dominant explanation for increased liquidity of non-financial corporations appears to be the growing role of multinational corporations and profits of foreign operations. According to Kevin Warsh, ‘Federal Reserve Board’; higher corporate cash holdings are dominated by those with foreign operations… the ‘ratio of cash to assets’ at domestic-only businesses increased 20%, while it increased 50% among multinational businesses. While this may indicate multinational corporations expect better growth potential among foreign subsidiaries, and planning for additional offshore investments; however, some believe a more likely explanation is tax-based… That is, under U.S. tax law corporate profits generated offshore are taxable with tax credit for taxes paid in foreign jurisdictions. But, U.S. taxes don’t apply unless and until such profits are repatriated. A study in ‘Journal of Financial Economics’ found; among multinational corporations, those facing higher repatriation taxes tended to hold more cash abroad than those facing lower tax burdens. Moreover, cash holdings tend to be higher in countries with lower taxes than those with high taxes. Further more, tax sensitivity appears to be greater in technology-based companies… According to Michael Mandel; lagging business investment is one of the chief problems slowing down  the recovery. Companies are letting money sit idle, accruing minimal interest, rather than spending it on new equipment, investments… and that’s not even touching research and development (R&D), new employees… So how can corporations be coaxed to invest more? Some suggest enforcing tax penalties on companies that hold excessive cash reserves… In the meantime, companies are going to keep stuffing cash into their mattresses until the economy calms down…

In the article Hoarding Cash Is Nothing New by Tom Lindmark writes: So why have firms opted to accumulate cash over the past two decades. Here are a couple of ideas. According to Timothy Taylor; broadly speaking, there are two reasons for firms to hold more cash; ‘precautionary motives and repatriation taxes’. ‘Precautionary motives’ refers to notions that firms operate in situations of uncertainty, for example; uncertainty about what stresses-opportunities might arise, and whether they can get a loan, on favorable terms, when they want it: Cash offers flexibility. ‘Repatriation taxes’ refers to taxes that are due to the U.S. government from corporations operating abroad… such taxation only takes place when earnings are repatriated… Typically, business decision-makers react to uncertain market conditions with the most natural, intelligent, and rational human response imaginable: Caution. Failure to invest under conditions of economic malaise, recession, or disruption is not cowardly, stupid, irrational… it’s often just plain common sense. Furthermore, executives and directors of corporations owe a fiduciary duty to their stakeholders to make rational and prudent decisions. If prudence dictates caution, who will gainsay CEO’s or board’s decision to defer that new manufacturing line, acquisition… until conditions become clearer? So what do we know: Well, there’s nothing new about U.S. companies accumulating cash, they’ve been doing it for a long time. U.S. tax policy most likely contributes to the practice of parking excess cash overseas, and may also stymie the distribution of profits to shareholders… and technology firms seem to lead the hoarding pack. I suppose this last fact has something to do with knowledge that any given technology firm is just one invention or innovation away from extinction. That does tend to focus one’s attention and perhaps lead to an abundance of caution…

In the article Cash Hoarding Stunts Europe by Stephen Fidler writes: Across Europe corporations are sitting on a mountain of cash. The trouble is they aren’t spending much of it. It’s not only in Europe that companies are hoarding piles of cash. According to ‘Institute of International Finance’; corporations in U.S., euro zone, U.K., and Japan hold some $7.75 trillion in cash or near equivalents, an unprecedented sum. In Europe, the problem is particularly acute. According to Simon Tilford; the ‘ratio of investment’ to ‘gross domestic product’ in Europe is at 60-year low even as companies pile on cash. Corporate cash holdings are now €2 trillion ($2.64 trillion) across the euro zone and extraordinary £750 billion ($1.19 trillion) in the U.K.  Companies are piling up cash for combination of reasons; one is reaction to financial crisis. Companies that built excessive debts before the crisis are paying them down. Firms also are hoarding cash because of a broken banking system: Banks have retreated from lending and companies are building cash buffers to compensate. For continental Europe, where companies still draw a majority of their finance from banks rather than from the capital markets, the retreat of bank lenders is significant. Mr. Tilford argues; another reason is government policies. Excessive fiscal austerity, he says, has snuffed-out Europe‘s tentative economic recovery and threatens a swath of the euro zone with a slump… another factor helping to build corporate cash piles is distorted incentives for senior executives… Firms are being run for cash rather than growth, with damaging implications for economic activity…

In the article Previous Corporate Hoarding Of Cash by Sy Harding writes: For a number of years politicians and analysts have bemoaned the fact that U.S. corporations were hoarding cash to an unprecedented degree, refusing to invest it for future growth that might have helped the economy recover from the back-to-back recessions of 2001 and 2008. Lagging business investment has continuously been tagged as one of the major factors stifling the economy. Depending on whose numbers you believe, corporations are sitting on a record $2 trillion to $4 trillion in idle cash, earning only today’s minimal interest. It’s my expectation that the economy and stock market face one more setback at some point, which will be created by the next step in returning to normal; the belt-tightening austerity measures that will have to be imposed on the country to tackle the major remaining problem– bringing down the record government debt level… However, the next set-back is not likely to be anywhere near as severe, and the hoard of corporate cash is one reason for that expectation: Corporations are planning ahead…

In the article Myth of Corporate Cash Hoarding by Alan Reynolds writes: U.S. non-financial corporations were sitting-on $1.93 trillion in liquid assets at the end of last year’s third quarter, according to the ‘Federal Reserve Board’. This has become one of the most frequently echoed statistics, viewed as indisputable evidence that U.S. business leaders are unduly timid or evil. More recently, ‘Washington Post’ columnist Harold Meyerson opined that; U.S. corporations can’t sit on their nearly $2 trillion in cash reserves forever, but that doesn’t mean they’re going to invest their stash in job-creating enterprises within the U.S. The chorus of media outrage about supposedly excessive corporate cash reveals nothing about the financial health of any U.S. business. It simply reveals ignorance of elementary accounting… In fact, U.S. corporations are increasing investments in plant and equipment at same time they are increasing investments in so-called ‘liquid’ assets (e.g., bonds, time deposits, mutual funds…). The widely repeated notion that prudent corporate investments in liquid assets have somehow reduced real investments is nonsense…

There is no reason or advantage for companies to hoard cash (i.e., excessive cash reserves)… companies that do not invest their cash in income-producing assets do not grow: It’s that simple. While a stagnant company can survive for a while by sitting on a stash-of-cash might seem safe; it’s a false sense of security. Companies that hoard cash– don’t invest or don’t plan to invest on business growth initiatives are doomed to fail… investing in business growth is an imperative… According to ‘Fortuna Advisors LLC’; companies that hoard cash beyond a certain limit actually deliver lower returns to shareholders… In an article in CFO magazine writes: Investors are growing restless, and in some cases furious, about what they see as ‘inefficient balance sheets’ that are building large cash balances. They often demand fat share repurchases to disgorge cash cushions that they claim erode management’s accountability to the capital markets and reduce the company’s ‘return on capital’. Cash balances are, to be sure, clearly on the rise. Analysts  examined the largest non-financial U.S.-domiciled companies, eliminating those without adequate accounting and share-price data for the last 10 years. At the end of 2010 those 885 companies held almost $750 billion in cash and equivalents– nearly four times the level of 10 years earlier. This represents a doubling of the ‘ratio of cash to assets’ from 3.7% to 7.3%, over that period. Although most of the companies now hold less than 15% of their assets in cash, some hold as much as 40% or more. Do such large cash balances have a negative impact on ‘expected share price’ performance as investors claim? To answer this, a group of companies were defined as ‘cash hoarders’ that had over 15% of their ‘total assets’ in cash and cash equivalents on average over the last 10 years. Research of the period from 2001 to 2010 shows that the cash hoarders deliver median ‘total shareholder return’ (TSR) about 4.6% lower per year in comparison with the companies that hold less cash. Holding cash doesn’t seem to affect TSR as much until it exceeds 10% of assets, but then it seems to have fairly strong negative effect once cash is above 15% of assets. Excessive cash hoarding is destructive to business… Companies unable to deliver a higher rate of return by deploying excess cash– must return cash to shareholders and not squander it.

Share

Changing Face of Money and Money-Like Instruments: How Money Is Created-Valued-Devalued… Future of Money

Share

Anyone can create money, the problem is getting someone else to accept it ~Hyman Minsky

As important as money is to most people, most take it for granted without giving thought to what it really is, where it comes from, or how it works. We earn it, we spend it, we save it, and some may complain they don’t have enough of it, but few really know much about it. For most people, money, finances, monetary policy… are pretty confusing…  Many assume the paper bills stuffed in their wallet is money. But, is it? Throughout history, money has taken on many forms and there hasn’t been much agreement on what ‘object’ money is: It really is nothing more than a symbol that represents the value of something: Practically speaking, the value of money represents what it will buy – or its purchasing power. Whatever form it takes, it’s used as an intermediary for trade – or medium of exchange, in order to avoid inefficiencies of barter systems. Money is generally considered to have the following four characteristics: medium, measure, standard, store. That is, money functions as– medium of exchange, unit of account, standard of payment, and store of value. Money is a vague term and, technically, anything can serve as money. Historically, many things have served as money, but modern forms of money have evolved to become more complex and institutionalized. In this regard, it’s best to think of money as being the social tool with which we primarily exchange goods and services. In the modern monetary system– fiat money (or paper money) is the form of money we utilize on a daily basis. In strict sense, this paper money is largely a creature of law, e.g., in U.S. paper money takes form of U.S. dollars… But, what gives these pieces of paper value? It’s helpful to break the demand for fiat money down into two components: First is acceptance value and second is quantity value. Acceptance value represents the public’s willingness to accept something as the nation’s unit of account and medium of exchange. Quantity value describes the medium of exchange’s value in terms of purchasing power, inflation, exchange rates, production value… While acceptance value is generally stable and enforceable by law, quantity value can be quite unstable and result in currency collapse in a worst case scenario… According to John Keynes; money is the measure of value, but to regard it as having value itself is a relic of the view that the value of money is regulated by the value of the substance of which it is made, and is like– confusing a theatre ticket with the performance…

Money Is Not Wealth– Money is simply a tool that allows citizens to exchange and transact in the underlying goods and services. If  government spends money in excess of a nation’s underlying productive capacity it will devalue their money and generate destructive inflation. This would result in too much money chasing too few goods and a potential decline in real living standards. So, the key for government is to balance the amount of money in the system in order to keep the temperature just right– not too hot and not too cold. For example, visualize the economic system is a machine. Metaphor of a car is useful to understand how all the pieces fit together. Monetary policy is akin to the brake and accelerator pads. When the central bank raises the ‘Federal Funds Rate’ it does so, typically, to suppress inflationary pressures and, in effect, slows or braking economic activity. Vice versa when the Fed lowers the ‘Federal Funds Rate’, typically, to counteract a swelling in number of underemployed, this decreases borrowing costs across the spectrum of credit products (e.g., loans made on shorter-term basis), thus accelerating economic activity. Monetary policy is mainly about manipulating short-term interest rates though there are other factors… Modern monetary theory distinguishes among different ways to measure the money supply, reflected in different types of monetary aggregates, using a categorization system that focuses on liquidity of the financial instrument used as money. Most commonly used monetary aggregates (or types of money) are conventionally designated– M1, M2, M3. These are successively larger aggregate categories: M1 is currency (coins and bills) plus demand deposits (such as checking accounts); M2 is M1 plus savings accounts and time deposits under $100,000; and M3 is M2 plus larger time deposits and similar institutional accounts. M1 includes only most liquid financial instruments, and M3 relatively illiquid instruments… Market liquidity describes how easily an item can be traded for another item, or into the common currency within an economy. Money is most liquid asset because it’s universally recognized and accepted as common currency. Thus, money gives consumers the freedom to trade goods and services easily without having to barter. Fiat money or fiat currency is money whose value is not derived from any intrinsic value or guarantee that it can be converted into a valuable commodity (e.g., gold). Instead, it has value only by government order (fiat). Usually, the government declares the fiat currency (e.g., central bank…) to be legal tender, making it unlawful to not accept the fiat currency as a means of repayment for all debts, public and private…

In the article How Money Is Created… And How It Dies by Tyler Durden writes:  The concept of money used to be simple; items of recognized value– initially in form of shells, livestock… then precious metals. At some point, someone decided to print paper currency, but it was widely understood that it had to be backed by something of real value, e.g., gold, silver… This is oversimplified, but it illustrates the central truth: Money that is created at will, rather than– grown in field, mined from earth, or otherwise subject to supply limits, can be easily degraded. What, then, determines value of money? For some, the worldview and ethics of those in charge of printing presses are obvious answers that are often overlooked. Another is confidence of the people who hold and trade money or claims that are denominated in money… Fast forward to the modern era– featuring central banks, which allow commercial banks to create money by making loans while keeping other reserves on hand… However, as money market funds, bank CDs… like instruments were created– and became a sizeable portion of the global financial system– then, things got even more complicated. Also, add modern derivatives, which entered the scene in significant way only some 30 years ago, and the picture becomes even murkier. Money has gotten complex in the modern banking and derivatives era, and old model of money (i.e., mainly product of bank reserves, loans…) is woefully inadequate… More global leaders must know-understand– value of sound economic policy, necessity of sound money, difference between government actions that enable growth and economic stability and those that risk abject ruin. Unfortunately, it appears that few leaders do, currently…

In the article Monetary Policies for a Modern World by Gene Chan writes: There is a lot of misinformation that simply does not reflect the current state of monetary world and misinformation is correspondingly causing a gigantic misallocation of private capital to non-productive uses, and overblown distrust in government’s monetary policies. The best framework for describing system of fiat currencies is ‘modern monetary theory’ (MMT). The theory itself is actually not very modern– the first iteration was formed in 1920s and called Chartalism– and it’s currently experiencing a revival since it more accurately explains and predicts what is actually being observed in many modern economies… The euro-zone (EU) is an exception– they don’t have a fiscal union at the ‘federal’ level: In other words, the arm of government that spends most of the money (e.g., EU’s national governments– Ireland, Greece…) doesn’t have power to print money (euros). These countries cannot monetize their euro-denominated debt, which arbitrarily forces them into constraints that regular households and private enterprises experience everyday– need to balance budget and fund expenditures with income. However, in  the current ‘modern monetary system’ (e.g., U.S., Canada, Japan, UK, Switzerland…), the government has no obligation to balance revenue and expense. In fact, it can spend-on deficits forever, with the only ceiling being the economy’s ability to produce-inflation. In these economies, the government never actually ‘owes’ money in the traditional sense, since they can just print more money… Essentially, the following assumptions hold true for all major developed economies outside the euro-zone:

a) Money is not physically backed by any commodity or pegged to any foreign currencies.

b) Government is sole issuer of money.

c) Government has power to maintain the legal tender status of money (through taxation and court system).

d) Fiscal and monetary arms of the government effectively work as a single unit.

Money has gone from– seashells to gold to paper bills to digits in a computer. Now money is about to evolve again as ‘mobile Internet’ unlocks new consumer behaviors, business opportunities and new concepts of value that are redefining the future of money. Within next decade, smart mobile devices will gain mainstream acceptance as a method of payment and could largely replace cash and credit cards for most online and in-store purchases. In survey by Elon University and Pew Research; security, convenience, and other benefits of ‘mobile wallet’ systems will lead to widespread adoption of technology for everyday purchases by 2020. But, other experts– expect this process to unfold much slower due to a combination of– privacy fears, desire for anonymous payments, demographic inertia, lack of infrastructure to support widespread adoption, resistance from those with financial stake in existing payment structure… According to Jerry L. Jordan; just as fiat money replaced specie-backed paper currencies, electronically initiated debits and credits will become the dominant payment modes, creating the potential for private money to compete with government-issued currenciesAccording to James A. Dorn; there is certain inertia in the current fiat money regime: even though persistent inflation has eroded the value of the money over the past 50 years, e.g., 1947 U.S. dollar is now worth only 14 cents… In the future, however, government fiat money may be placed on the endangered species list as people shift from paper currency to electronic money. Stored-value cards may become a customary circulating medium along with privately supplied digital money stored in computer devices and used over the Internet to facilitate electronic commerce. The transition from a paper-based monetary system to an electronic payments system– reduces transactions costs, expand markets, empowers people… The speed of that transition and expected benefits, however, will depend on creating an effective legal and secure  infrastructure… The rules that govern the new monetary universe must be– more transparent, equally applied, consistent with individual freedom… if people are to have trust and confidence in cyber-money…

Share

All the Angst about- Fiscal Cliff- is Creation of Media– Lots of Bull: Actually Its More Like– Fiscal Slope or Austerity Gridlock

Share

Fiscal cliff has nothing to do with a cliff or slope or butte or any other kind of geological formation… more like ‘fiscal folly’ or ‘taxmageddon’ or ‘debt reckoning’ or ‘fiscal deadline’

Fiscal cliff is deeply misleading term and actually it’s more like a fiscal slope, or better yet austerity gridlock. According to Edward Krudy; the fiscal cliff sounds like a scary place with headlines about taxmageddon are flashing on TV screens, next to clocks ticking down to January 1. The Dow Jones Industrial Average has skidded over the last month, largely due to concerns about the standoff in Congress over– how to stop a barrage of tax hikes and spending cuts. But some major investors say the doomsayers are getting too much attention and cliff watchers should relax a bit. These investors argue that the U.S. economy does not face immediate disaster even if lawmakers can’t reach a deal by the end of year. There is time for lawmakers to come up with a deal before major damage starts to be done, in early 2013. According to Warren Buffett; the fact that [lawmakers] can’t get along for a month or so is not going to torpedo the economy. In short, what has been dubbed ‘cliff’ is more like a fiscal ‘slope’ that gets steeper as time goes on: How far the U.S. economy slides down the slope depends on how quickly lawmakers take to do a deal. The problem is that if no agreement is reached, current law will slash deficits by sharply raising taxes and gutting spending…

In the article How Important is the Fiscal Cliff? Hint: Not Very by Barry Ritholtz writes: The fiscal cliff paranoia continues unabated. Just search the Internet with the term ‘fiscal cliff ‘ and the term’s appearance simply goes ballistic. But, what does the fiscal cliff mean? Let’s start with a definition: The term refers to the deal that Congress made in late 2011 to temporarily resolve the debt ceiling debate. The sequestration, as it’s known, calls for three elements: tax increases, spending cuts, and an increase in payroll tax (FICA). The Washington Post’s Wonkblog has run the numbers and finds: $180 billion from income tax hikes, $120 billion in revenue from the payroll tax, $110 billion from the automatic spending cuts and $160 billion from expiring tax breaks and other programs. That is a not-insignificant amount of money, but it is hardly end of the world. To put this into context, it’s little less than the TARP bailout for Wall Street in 2009 and somewhat less than the American Recovery and Reinvestment Act (stimulus package). An educated guess puts this at about $600 billion to $700 billion out of $15 trillion (size of U.S. economy). I’d ballpark that at about 4% of GDP or 0.50% of forecasted GDP growth of 2% for calendar 2013. The term fiscal cliff is really misnomer, as several analysts have correctly observed, and the effects of sequestration are not a Jan. 1, 2013, event. The impact of the spending cuts and tax hikes would be phased in over time. Additionally, as students of history have learned, single-variable analysis for complex financial issues is invariably wrong…

In the article Big Business of the Fiscal Cliff by Anna Palmer and Kate Brannen write: The fiscal cliff is big business in Washington, DC: Lobbyists, grassroots firms, accountants, lawyers… are raking in cash as Congress and the White House argue about how to avoid a fiscal calamity at the end of the year– threatening spending cuts, tax hikes and changes to entitlement programs. It’s a classic Washington, DC phenomenon: Ahead of major deals, corporate clients and other groups pay a premium to Washington influence machinery to make sure their interests are protected. Republican and Democratic consultants say the recent surge in newly inked contracts is particularly good news, since the presidential election had meant a slow six months in town. Now, it’s springtime in Washington, DC in January, said Rich Gold, head Holland & Knight’s public policy practice. Everybody has their nose under the tent surrounding the fiscal cliff…

In the article How Far Over the Fiscal Cliff Could They Go? by Connie Cass writes: The dealmakers who warn that a year-end plunge off the fiscal cliff would be disastrous don’t seem to be rushing to stop it. Why aren’t they panicking? For one thing, Dec. 31 deadline is more flexible than it sounds. Like all skilled procrastinators– from kids putting off home work to taxpayers who file late– Washington, DC negotiators know they can finagle more time if they need it. That doesn’t mean delay would be cost-free– stock markets might tank if 2013 dawns without a deal; however, pushing deadlines too far is a risky strategy… The Congressional Budget Office (CBO) predicts that fiscal cliff policies, if left unchecked, would spark a recession later in 2013 and send the unemployment rate above 9% by fall. How long could negotiators balk and bicker before putting U.S. economy in jeopardy? The calendar becomes less and less forgiving as the weeks pass. Here is a procrastinator’s guide to pushing the deadline:

  • DECEMBER: Democrats and Republicans say it’s critical to reach a deal this month. Yet both sides appear dug-in over taxes. A good chunk of the fiscal cliff–the automatic spending cuts known as the sequester is an artificial deadline created by Congress in hopes of forcing itself to come up with a deficit-cutting plan.
  • JANUARY: If there’s no deal in December, the economy won’t fall off a cliff on New Year’s Day. But it probably will begin a bumpy downhill ride. The new Congress that convenes Jan. 3 won’t look much different, divided between Republican-controlled House and Democratic-dominated Senate. However, lawmakers will feel more heat… According to Mark Zandi, chief economist at Moody’s Analytics; thinks the economy could weather a few more weeks of uncertainty as long as negotiators appeared to be working toward an agreement.
  • FEBRUARY: What might finally get procrastinators moving if nothing else does is the ‘fear’ of U. S. defaulting on debts for first time ever. Unless Congress acts, government is expected to hit its legal borrowing limit of $16.39 trillion by the end of December. In the last debt limit showdown, the government came within a whisker of default, in August 2011, before a compromise was reached. At that time, Standard & Poor’s down-graded the nation’s credit rating. Like wise, if again we come to edge of default, then that would probably send the stock market plummeting, and for sure finally shake-up the lawmakers…

In the article What If the Fiscal Cliff Is the Wrong Cliff? by Robert Wright writes: One premise of the people who instigated the fiscal cliff, in effect; committed Congress to either make big inroads on the deficit or have big inroads made automatically– meat-cleaver style. But is government debt the central economic problems. What if, they’re wrong? What if, public debt isn’t the main problem? What if, the public debt is such a small part of the overall problem that we’re setting ourselves up for disappointment? What if, we make lots of budget cuts only to find that the long-term benefits, while real, are dinky in the scheme of things, and there’s a much bigger problem that’s been left unaddressed? That’s the view of some analysts whose voices aren’t getting much airtime amid all the freaking out about the fiscal cliff. They say, private debt, e.g., mortgages, credit card bills, business loans… is much bigger problem than public debt… and, we’re going to have to confront it before we truly recover from the recession. According to report by Steve Clemons and Richard Vague; private debt is higher as a share of America’s GDP than anywhere in Europe. So what do you do when your economy is burdened by a huge debt overhang? How about we just forgive the debt? That may sound simplistic, but, actually, there tends to be an element of out-and-out debt forgiveness, for example; debt restructuring’ or debt relief. People are starting to talk about doing this sort of thing on large-scale, for example; Martin Wolf, chief economist at the Financial Times, agrees with Vague and Clemons that– the private debt problem dwarfs the public debt problem, and something must be done about it in form of debt relief. Obviously, debt forgiveness is more popular among debtors than among creditors. An According to Martin Wolf and Richard Vague; we’ve got to help people get out from under the mountain of debt that looms, barely seen, beyond the fiscal cliff…

In an article by Sarah Michael and Chris Paine writes; fiscal cliff sounds like a banjo player from a long-forgotten bluegrass band. But, the global economy’s term du jour is serious business. At the simplest level, there are a lot of spending cuts and tax hikes that will come into effect– at midnight December 31, or January, or February, or some time soon… Many people are worried that if they all take place at once U.S. economy will slide into recession. It boils down to this; U.S. is in lot of debt: It makes about $US2.3 trillion/year, but spends about $US3.6 trillion. So, somehow, it has to slash $1.3 trillion. But if all the scheduled changes happen together, the Congressional Budget Office predicts the GDP will drop by 0.5% next year, plunging the U.S. into recession, which means unemployment rate may rise to 9.1%. That’s loss of about two million jobs– not good. So, what are Democrats and Republicans planning to do about all this? Well, there is a lot of arguing: Republicans want to slash spending but avoid raising taxes. Democrats are looking to raise taxes and avoid too many spending cuts. What happens now? According to some experts, there are three main options:

  • They [lawmakers] can let all the planned changes come into effect.
  • They [lawmakers] can cancel some or all of the tax hikes and spending cuts.
  •  They [lawmakers] can agree on a middle ground.

The latest news– talks over a compromise are frozen… Yikes. That’s not good…

Share

Dodd-Frank– ‘Monster or Slayer’ in the World of Financial Business Reform: It’s So Complex, No One Knows…

Share

Two years after the sweeping Dodd-Frank Act was signed into law, banks are paring operations and ramping up compliance, regulators are drafting mountains of new rules, and observers still doubt the financial system is any safer than it was after the 2008 financial crisis. ~Dennis Kelleher

The Dodd-Frank ‘Wall Street Reform and Consumer Protection Act’ (Dodd-Frank) is U.S. federal law that places regulation for the financial industry in the hands of government. One main goal of Dodd-Frank is to reduce federal dependence on banks by subjecting them to a myriad of regulations, and breaking-up of any companies that are ‘too big to fail’. The act created the ‘Financial Stability Oversight Council’ to address persistent issues affecting the financial industry and prevent another recession. By keeping the banking system under a closer watch, the act seeks to eliminate the need for future taxpayer-funded bailouts. According to Robert Kulak; the problem with Dodd-Frank is that it’s so long and ponderous that anyone can say anything about it and be right. Consider the fact that the Act is 2,319 pages long. Republicans have attacked Dodd-Frank, in part accurately and in part from a partisan perspective. Democrats have defended Dodd-Frank, in part accurately and in part from a partisan perspective. That’s a pretty good debate for an act that neither side understands completely. A particularly contentious issue between banks and the Dodd-Frank is the ‘Volcker Rule’, which prohibit banks from risking depositors’ money on risky investments. From 1933 to 1999, depositors were protected by ‘Glass-Steagall Act’ (formally, ‘Banking Act’ of 1933). In 2009, ‘Paul Volcker’ described how the ‘Volcker Rule’ should work, in the current economic environment, in a three-page memo. After Dodd-Frank became law, federal banking regulators expanded Volcker’s three-page memo to 298 pages covering 400 topics with 1,300 questions. Then, to provide further clarification, Sullivan & Cromwell, an 800 lawyer law firm, produced a 41 page synopsis (by contrast, the original ‘Glass-Steagall Act’ was 37 pages long, double spaced).  In fact, in their introduction, Sullivan & Cromwell said ‘… the Volcker Rule affects; larger U.S. banking organizations, non-U.S. banking organizations, other financial organizations with trading operations, asset management business or other operations’. Did they say non-U.S.? Did they say other financial organizations? Yes, they did… Also, Dodd-Frank identifies a new acronym– SIFI (systemically important financial institution). Thus, it appears that Dodd-Frank also sets the stage for not only bailing out banks that are deemed– too big to fail, but also any other SIFI, e.g., insurance companies, real estate companies, Fannie Mae and Freddie Mac, and non-U.S. financial institutions– all would be regulated by Federal Reserve. According to ‘Richard Fisher’ at Dallas Federal Reserve Bank, said; If you are ‘too big to fail’, then ‘you’re too big’. It’s not that we don’t need to better regulate financial industry, we do. But Dodd-Frank, not with standing any positive aspects, is not the way…

In the article Two Years Later, Dodd-Frank Law Largely Stalled  by Bobby Caina Calvan writes: Nearly two years after the signing of the landmark Dodd-Frank legislation, many of the rules meant to restore public trust in the country’s financial institutions have yet to be enacted. Squads of lobbyists, lawyers, and accountants have overwhelmed the rule-making process, in minutia, with blizzards of paper, and hundreds of meetings. As a result, regulators have missed more than half the rule-making deadlines, with just 120 of the 398 regulations enumerated by law; according to a tally by Wall Street law firm ‘Davis Polk’. Key provisions are still months away, most notably the so-called ‘Volcker Rule’ meant to rein in banks’ appetite for risky investments and prevent repeat of 2008 meltdown that led to the public bailout of some of the country’s largest financial institutions. To complicate the matte, at least two lawsuits are pending, challenging various aspects of the law’s rule-making process: One filed by Texas community bank and another by several financial industry associations. The Dodd-Frank was a major victory for Democrats, in 2010: an offensive against what they viewed as free-wheeling culture of Wall Street. Supporters envisioned stronger protections for consumers against predatory lenders, stricter rules for protecting bank deposits from being used for high-risk investments, and transformation of Wall Street into more accountable and responsible public citizen. But, ‘even when finished, we still won’t have resources or people to implement it’, said ‘Gary Gensler’, commission chairman. He likened the challenges to a football game without enough referees. According to ‘Cornelius Hurley’; ‘to the extent that the purpose of this entire exercise is to restore confidence in the financial system, then that objective is far off… a deeply flawed statute is being implemented haltingly under very difficult circumstances’.

In the article Five Myths about Dodd-Frank by Christopher Dodd (co-author of the bill) writes:  Even though the Dodd-Frank is only beginning to take effect, critics are launching false attacks against the law in an effort to undermine it. Whether they are intentionally misleading or misguided; they are wrong about the law’s purpose and impact. Now, to debunk five of the myths:

  • Dodd-Frank is deepening the economic slowdown: Even though only 10% of Dodd-Frank’s provisions are implemented, so far, critics claim that the law perpetuates ‘job-killing’. In fact, it was the uncertainty inherent in a non-transparent and reckless financial system that made Dodd-Frank necessary in the first place.
  • Dodd-Frank hurts small businesses and community banks: The law is squarely aimed at better regulating the largest and complex Wall Street firms– ones that were most responsible for the crisis and still present the most risk.
  • Dodd-Frank failed to truly reform Wall Street: Dodd-Frank fundamentally transforms the financial system. Requires banks to keep more capital on hand as buffer against bad loans. Establishes process for unwinding firms, if they fail and prohibits Federal Reserve from bailing them out. Brings more transparency and accountability to derivatives market. Shuts down ineffective regulators and insists remaining ones share information to expose next financial trouble spots. Establishes single agency whose mission is to protect consumers.
  • Congress didn’t fix Fannie Mae and Freddie Mac: The issues  with the housing market– as well as, the debate over the future roles of Fannie and Freddie– remain complex and contentious, but they have hardly been ignored.
  • It’s time to repeal Dodd-Frank: In short, repealing Dodd-Frank would invite disaster, putting working families, U.S. businesses and the global economy at risk of an even worse meltdown.

In the article Morning Bell: Dodd-Frank Financial Regulations Strangling Economy by Amy Payne writes: There’s a reason the financial regulation law has been called ‘Dodd-Frankenstein’. This monstrous creation will swell the ranks of regulators by 2,849 new positions, according to ‘Government Accountability Office’ (GAO). It created yet another new bureaucracy called ‘Consumer Financial Protection Bureau’ (CFPB) that has truly unparalleled powers. This bureau is supposed to regulate; credit and debit cards, mortgages, student loans, savings and checking accounts, and most consumer financial product and service: It’s not even subject to congressional oversight. Frighteningly, the CFPB’s regulatory authority is just as vague as it’s vast. More than half of regulatory provisions in Dodd–Frank state that agencies ‘may’ issue rules or ‘shall’ issue rules as they ‘determine are necessary and appropriate’. Congress avoided making real law with Dodd-Frank, and passed the responsibility for ‘fixing’ the financial sector to these newly minted bureaucrats… which hasn’t been going well. As Heritage’s ‘Diane Katz’ explains in a two-year checkup of the law: As of July 2012, implementation of Dodd-Frank is behind schedule with 63% of target deadlines missed, which has intensified the cloud of uncertainty surrounding the finance sector and the economy, since passage of the law. Thousands of businesses do not know what the law demands– that they do differently or when they must do it. The results of this haphazard regulation are dire; Katz says, ‘consumers will have tighter credit, higher fees, and fewer service innovations. Job creation will suffer… financial firms of all sizes are shelling out hundreds of millions of dollars for regulatory compliance officers, accountants, and attorneys rather than making loans for new homes and businesses’. In effect, the law that was supposed to fix the financial sector is hurting consumers rather than ‘protecting’ them…

Scope and structure of Dodd-Frank are fundamentally different than those of its precursor laws, notes ‘Jonathan Macey’, at Yale Law School: “Laws classically provide people with rules. Dodd-Frank is not directed at people… It’s a ‘law outline’ directed at bureaucrats, and it instructs them to make still more regulations and to create more bureaucracies.” According to ‘Ron Ashkenas’, HBR blog network; Dodd-Frank passed in the wake of the financial crisis, has the potential to be classic example of ‘controls’ imposed to ‘fix’ a problem, and the ‘fix’ becomes so complex that it create other problems. This leads to increasing bureaucratic cycles of more breakdowns, more complex fixes, and more breakdowns. This law’s various sections deals with– bank bailouts, derivatives and swaps markets, mortgage reform, consumer protection, and other issues. According to ‘Daniel Horowitz’; Dodd-Frank regulations are so complex that most of them have not been formally drafted; causing thousands of businesses to halt expansion and new hiring until the government provides them with some clarity. It’s nothing short of wholesale takeover of financial services and the banking industries; much like Obamacare to healthcare industry. One of the law’s most vocal critics is ‘Jamie Dimon’, CEO JPMorgan Chase; who cites not only the cost of compliance, but also difficulty of actually making the regulations work effectively. Another critic ‘Karen Petrou’, says; ‘Dodd-Frank’s implementation is creating ‘complexity risk’ for the financial system. If we don’t understand cross-cutting effects and inherent contradictions in all of the stringent standards now being written into final form, we risk doing real damage.’ Responding to criticisms, ‘Treasury Secretary Geithner’ argues; ‘Wall Street is suffering from amnesia about the recent financial crisis… if banks and other financial institutions don’t follow regulations, we’ll have another meltdown’… In fact, we do need effective controls to close gaps that allowed financial systems to fall apart. However, if regulations are unreasonably complex, they will not only create unnecessary costs, but are likely to be unenforceable and eventually ineffective. What’s clearly needed is something in the middle– simple and practical controls that banks can understand and regulators can enforce. Getting there– requires dialogue, compromise and coordination. Wall Street institutions, government regulators, and other parties need to get together in constructive forums and create realistic and workable practices that fulfill the spirit and intent of Dodd-Frank guidelines. Leaders on both sides should convene key parties, map out, and streamline the regulatory process…

Share

Companies-’Too Big to Fail’ or ‘Too Big to Exist’: Dilemma– Morton’s Fork, Hobson’s Choice, Darwin’s Rule…

Share

Once you lose your freedom to fail, you also lose your freedom to succeed and you cease to be a free society. ~Jeb Hensarling

Too big to fail (TBTF) is a phrase used in regulatory economics and public policy and describes certain enterprises and institutions that are so large and so interconnected that their failure will be disastrous to the economy. Therefore, the federal government has a responsibility to support them when they face difficulty, so goes the logic. Proponents of the theory believe that the importance of some institutions means they should become recipients of favorable financial and economic policies from governments or central banks. Some economists, such as, Nobel Laureate Paul Krugman hold that economy of scale in banks and in other businesses are worth preserving, so long as, they are well-regulated in proportion to their economic clout; therefore, the too big to fail status can be acceptable. In addition, the global economic system must also deal with sovereign states (countries) that are too big to fail. Critics see the policy as flawed and large banks or other institutions should be left to fail, if their risk management is not effective. Critics, such as, Alan Greenspan, believe that such large organizations should be deliberately broken up: If they’re too big to fail, they’re too big.

In the article “Too Big to Fail” by Kimberly Amadeo writes:  The phrase too big to fail arose during the financial crisis to describe why the government needed to bailout some companies. Big banks, insurers…  improved their profitability by creating, then selling, complicated derivatives… When the economy was booming, they derived an unfair competitive advantage, took over smaller firms, and became even bigger. When their investments started going south, they knew the taxpayers would be forced to bail them out– or risk global economic collapse. An example is AIG, one of the world’s largest insurers. AIG was too big to fail because, if they went bankrupt it could trigger the bankruptcy of many other financial institutions… Lehman Brothers, investment bank, was also too big to fail but the government refused bailout and it filed for bankruptcy, triggering a deep-drop in the stock market… The mortgage giants, Fannie Mae and Freddie Mac, were also too big to fail because they guaranteed 90% of all home mortgages. The government guaranteed $100 million in their mortgages, in effect, returning them to government ownership. If Fannie and Freddie had gone bankrupt the housing market decline would have been much worse, since banks were not lending without their guarantees…

Enter the Dodd-Frank Wall Street Reform Act, which is the most comprehensive financial reform since the Glass-Steagall Act. It sought to regulate the financial markets and make another economic crisis less likely. It set-up the ‘Financial Stability Oversight Council’ to prevent any more banks from becoming too big to fail. How? It looks out for risks that affect the entire financial industry. It also oversees non-bank financial firms like hedge funds. If any of these companies get too big, it can recommend they be regulated by the Federal Reserve, which can ask it to increase its reserve requirement. The Volcker Rule, another part of Dodd-Frank, also helps end too big to fail. It limits the amount of risk large banks can take. It prohibits them from trading in stocks, commodities or derivatives for their own profit, however, they can do so only on behalf of their customers, or to offset business risk.

In the article “Big Banks: Now Even Too Bigger to Fail” by David J. Lynch writes:  Two years after the Obama administration vowed to eliminate the danger to the economy from financial institutions that are too big to fail; those same institutions, the nation’s largest banks are bigger than they were before the financial meltdown. Five banks: JP Morgan Chase, Bank of America, Citigroup, Wells Fargo, and Goldman Sachs– held more than $8.5 trillion in assets at the end of 2011, equal to 56% of the U.S. economy, according to the Federal Reserve, and that’s up from 43% five years earlier. These banks, today, are about twice as large as they were a decade ago relative to the economy, meaning trouble at a major bank would leave the government with the same Hobson’s choice it faced earlier: let a big bank collapse and perhaps wreck the entire economy or inflame public ire with a costly bailout. ‘Many believe that nothing has changed, that too big to fail is fully intact, says Gary Stern. Giant institutions sheltered under an invisible government umbrella pose ‘a clear and present danger to the U.S. economy’. This isn’t what the president had in mind two years ago when he vowed to prevent the further consolidation of the banking industry. The sprawling Dodd-Frank financial regulation bill that he signed in July 2010 was designed to avoid a repeat of the government’s frantic rescue of failing banks. Yet credit-rating companies Standard & Poor’s and Moody’s aren’t convinced that the too big to fail threat has been vanquished. According to Richard Spillenkothen, former Fed’s director. ‘Probably the only way you can be 100% sure you’ve solved too big to fail,’ he says, ‘is by doing away with banks that are too big.

In the article “Too Big to Fail – Too Big to Govern – Too Big to Manage.” by John W Rodat writes: The recent news that JP Morgan Chase had incurred a $2 billion trading loss reminds us again of the risks, to the rest of us, of organizations that are not only too big to fail, but too big and complex to be effectively managed. Professor Simon Johnson, economist, puts it in simple terms:  The lessons from JP Morgan’s losses are simple. Such banks have become too large and complex for management to control. The breakdown in governance is profound. Conventional regulation will not protect either the economy or society because regulators have even less information and what information they do have is even more delayed than in the organizations they presume to regulate. The only effective solution is to reduce the size and perhaps the complexity of organizations that are so interlinked with the economy and society that the economy and society cannot afford to let them fail. According to Johnson; while information processing capabilities have grown to an extraordinary degree over recent decades, they have still not kept up with the growth in the size and complexity of large financial institutions. When too big to manage meets too big to fail; disaster – or another bailout – is inevitable.

In the article “If It’s Too Big to Fail – Is It Too Big to Exist?” by Eric Dash writes: Nearly a
century ago, the jurist Louis Brandeis railed against what he called the ‘curse of bigness’. He warned that banks, railroads and steel companies had grown so huge that they were lording-it over the nation’s economic and political life. ‘Size, we are told, is not a crime,’ Brandeis wrote. ‘But size may, at least, become noxious by reason of the means through which it is attained, or the uses to which it is put.’ Brandeis worried that the corporate giants of his day would imperil democracy through concentrated economic power. His essays, published in 1914 under the title, ‘Other People’s Money and How the Bankers Use It’, helped drum up support for the creation of the Federal Reserve System, antitrust laws, and trust busting.  Devotees of economic Darwinism insist that corporate size, and its accompanying economies of scale, brings progress and benefit to consumers. But how big is too big to fail? And how would you measure it anyway? In the case of big organizations, policy makers argue that the interconnection of modern finance, as much as the size of the players, is the real issue. Frederic S. Mishkin, former Fed director, said; ‘there could be no turning back on too big to fail. You can’t put that genie in the bottle again. We are going to have to deal with it’.

In the article “Too Big to Fail or Too Big to Change” by Chad Johnson, Bernstein Litowitz Berger & Grossmann LLP write:  Pundits have criticized the Securities and Exchange Commission (SEC) and the Department of Justice (DOJ) as capitulating to the interests of big finance; citing the characterizations of SEC settlements as mere slaps on the wrist and the DOJ’s failure to convict a single executive responsible for creating the great recession despite significant evidence of misconduct.  While the SEC has reached several settlements in connection with misconduct related to the financial meltdown, those settlements have been characterized as cheap, hollow, bloodless, and merely cosmetic, as noted by John C. Coffee, law professor. The relative lack of prosecutions stemming from this financial meltdown stands in sharp contrast to the government’s response to past corporate malfeasance. The criminal cases arising from the ‘Savings and Loan’ scandals of the 1980s and 1990s, where some of the biggest kingpins– including Charles Keating of ‘Lincoln Savings & Loan’ and roughly 3,800 other bankers– were thrown behind bars, as well as, the Enron and WorldCom accounting debacles in the early 2000s where Jeffrey Skilling, Kenneth Lay and Bernard Ebbers were jailed, demonstrated that executives would be held accountable for their crimes. As David Einhorn, hedge fund manager, told The New York Times; ‘since there have been almost no big prosecutions, there’s very little evidence that the government has stopped bad actors from behaving badly.’ Simply put, without forcing executives to answer for their misconduct, no amount of financial reform will restore public trust in government or the markets…

Too big to fail (TBTF) has no clear guidelines and thus any large organization can claim; it’s vital to the health of the economy, because its failure would have a domino effect on suppliers. For example, large oil companies going out of business would have a terrible impact on supplies of gasoline and heating fuel… Big pharma that produce antibiotics and vaccines… which are essential and an interruption in their supply could have catastrophic consequences, from a public health point of view… According to Michael Heberling; TBTF
is problematic, because it indirectly influences how companies are managed. If there is a real, or implied, government safety-net, management might be inclined to take on more risk for greater profit. ‘Expecting a government bailout if things go wrong creates an incentive for a company to take on risk and enjoy the associated increase in return’, said
Gregory Mankiw. According to Thomas Sowell, ‘the hybrid public-and-private nature of these activities amounts to privatizing profit and socializing risk since taxpayers get stuck with the tab when high-risk finances don’t work out.’ In other words, it is a travesty to say or imply that current crisis stems from market failure. The most troubling aspect of ever-increasing number of government bailouts is the subtle change overtaking the entire country. The mindset of companies and individuals today is shifting away from self-responsibility. We blame everyone else for our mistakes and look to others (the taxpayer) to come to the rescue. When it comes to handouts and bailouts the government is no longer simply on the slippery slope– it’s in free-fall. Every bailout makes it harder to say no when the next TBTF request comes forward…

If you put all your eggs into one basket, you better watch that basket. ~Mark Twain

Share