How the "Job Creators" REALLY Spend Their Money

Tuesday, May 29, 2012 by Common Dreams

by Paul Buchheit

 

In his "Gospel of Wealth," Andrew Carnegie argued that average Americans should welcome the concentration of wealth in the hands of a few, because the "superior wisdom, experience, and ability" of the rich would ensure benefits for all of us. More recently, Edward Conard, the author of "Unintended Consequences: Why Everything You've Been Told About the Economy Is Wrong, said: "As a society, we're not offering our talented few large enough rewards. We're underpaying our 'risk takers.'"

Does wealthy America have a point, that giving them all the money will ensure it's disbursed properly, and that it will create jobs and stimulate small business investment while ultimately benefiting society? Big business CEOs certainly think so, claiming in a letter to Treasury Secretary Timothy Geithner that an increase in the capital gains tax would reduce investment "when we need capital formation here in America to create jobs and expand our economy."

They don't cite evidence for their claims, because the evidence proves them wrong. Here are the facts:

The Very Rich Don't Like Making Risky Investments

Marketwatch estimates that over 90% of the assets owned by millionaires are held in a combination of low-risk investments (bonds and cash), the stock market, and real estate. According to economist Richard Wolff, about half of the assets of the richest 1% are held in unincorporated business equity (personal business accounts). The Wall Street Journal notes that over three-quarters of individuals worth over $20 million are invested in hedge funds.

Angel investing (capital provided by affluent individuals for business start-ups) accounted for less than 1% of the investable assets of high net worth individuals in North America in 2011.

The Mendelsohn Affluent Survey confirmed that the very rich spend less than two percent of their money on new business startups. The last thing most of them want, apparently, is the risky business of hiring people for new innovation.

The Very Rich Don't Like Taking On Risky Jobs

CEOs, upper management, and financial professionals made up about 60 percent of the richest 1% of Americans in 2005. Only 3 percent were entrepreneurs. A recent study found that less than 1 percent of all entrepreneurs came from very rich or very poor backgrounds.The biggest investment by corporations is overseas, where they keep 57 percent of their cash and fill their factories with low-wage workers. Commerce Department figures show that U.S. companies cut their work forces by 2.9 million from 2000 to 2009 while increasing overseas employment by 2.4 million.

In fact, the very rich may not care about U.S. jobs in any form. Surveys reveal that 60 percent of investors worth $25 million or more are investing up to a third of their total assets overseas. Back home, the extra wealth created by the Bush tax cuts led to "worst track record" for jobs in recorded history. The true American job creator, as venture capitalist Nick Hanauer would agree, is the middle-class consumer.

The Very Rich Corporations Don't Like Spending On America

How do corporations spend their money? To a good extent, they don't. According to Moody's, cash holdings for U.S. non-financial firms rose 3 percent to $1.24 trillion in 2011. The corporate cash-to-assets ratio nearly tripled between 1980 and 2010. It has been estimated that the corporate stash of cash reserves held in America could employ 3.5 million more people for five years at an annual salary of $40,000.

The top holders of cash, including Apple and Google and Intel and Coca Cola and Chevron, are spending their money on stock buybacks (which increase stock option prices), dividends to investors, and subsidiary acquisitions. According to Bloomberg, share repurchasing is at one of its highest levels in 25 years.

Apple claims to have added 500,000 jobs to the economy, but that includes app-building tech enthusiasts and Fedex drivers delivering iPhones. The company actually has 47,000 U.S. employees, about one-tenth of General Motors' workforce in the 1990s.

The biggest investment by corporations is overseas, where they keep 57 percent of their cash and fill their factories with low-wage workers. Commerce Department figures show that U.S. companies cut their work forces by 2.9 million from 2000 to 2009 while increasing overseas employment by 2.4 million. They also tap into a "brain drain" of foreign entrepreneurs, scientists, and medical professionals rather than supporting education in America.

One last way corporations see fit to spend their money: executive bonuses. Especially at the banks, where the extra stipends are often paid for with zero interest loans from the Federal Reserve.

The richest individuals and corporations are really good at building up fortunes. They're even better at building up their "job creator" myth.

Why the Rich Love High Unemployment

Tuesday 24 May 2011by: Mark Provost, Truthout

In the last installment of this three-part series, Mark Provost again examines the myths perpetuated by the ruling class to frame massive transfers of wealth to the rich as well-intentioned economic "recovery" policies. Parts 1 and 2 appeared on Truthout in December 2010 and January 2011. - TO

Christina Romer, former member of President Obama's Council of Economic Advisors, accuses the administration of "shamefully ignoring" the unemployed. Paul Krugman echoes her concerns, observing that Washington has lost interest in "the forgotten millions." 

America's unemployed have been ignored and forgotten, but they are far from superfluous. Over the last two years, out-of-work Americans have played a critical role in helping the richest one percent recover trillions in financial wealth.

Obama's advisers often congratulate themselves for avoiding another Great Depression - an assertion not amenable to serious analysis or debate. A better way to evaluate their claims is to compare the US economy to other rich countries over the last few years.

On the basis of sustaining economic growth, the United States is doing better than nearly all advanced economies. From the first quarter of 2008 to the end of 2010, US gross domestic product (GDP) growth outperformed every G-7 country except Canada.

But when it comes to jobs, US policymakers fall short of their rosy self-evaluations. Despite the second-highest economic growth, Paul Wiseman of the Associated Press (AP) reports: "the U.S. job market remains the group's weakest. There are still 5.4 percent fewer American jobs than in December 2007. That's a much sharper drop than in any other G-7 country." According to an important study by Andrew Sum and Joseph McLaughlin, the US boasted one of the lowest unemployment rates in the rich world before the housing crash - now, it's the highest.[1]

The gap between economic growth and job creation reflects three separate but mutually reinforcing factors: US corporate governance, Obama's economic policies and the deregulation of US labor markets.

Old economic models assume that companies merely react to external changes in demand - lacking independent agency or power. While executives must adapt to falling demand, they retain a fair amount of discretion in how they will respond and who will bear the brunt of the pain. Corporate culture and organization vary from country to country.

In the boardrooms of corporate America, profits aren't everything - they are the only thing. A JPMorgan research report concludes that the current corporate profit recovery is more dependent on falling unit-labor costs than during any previous expansion. At some level, corporate executives are aware that they are lowering workers' living standards, but their decisions are neither coordinated nor intentionally harmful. Call it the "paradox of profitability." Executives are acting in their own and their shareholders' best interest: maximizing profit margins in the face of weak demand by extensive layoffs and pay cuts. But what has been good for every company's income statement has been a disaster for working families and their communities.

Obama's lopsided recovery also reflects lopsided government intervention. Apart from all the talk about jobs, the Obama administration never supported a concrete employment plan. The stimulus provided relief, but it was too small and did not focus on job creation.

The administration's problem is not a question of economics, but a matter of values and priorities. In the first Great Depression, President Roosevelt created an alphabet soup of institutions - the Works Progress Administration (WPA), the Tennessee Valley Authority (TVA) and the Civilian Conservation Corps (CCC) - to directly relieve the unemployment problem, a crisis the private sector was unable and unwilling to solve. In the current crisis, banks were handed bottomless bowls of alphabet soup - the Troubled Asset Relief Program (TARP), the Public-Private Investment Program (PPIP) and the Term Asset-Backed Securities Loan Facility (TALF) - while politicians dithered over extending inadequate unemployment benefits.

The unemployment crisis has its origins in the housing crash, but the prior deregulation of the labor market made the fallout more severe. Like other changes to economic policy in recent decades, the deregulation of the labor market tilts the balance of power in favor of business and against workers. Unlike financial system reform, the deregulation of the labor market is not on President Obama's agenda and has escaped much commentary.

Labor-market deregulation boils down to three things: weak unions, weak worker protection laws and weak overall employment. In addition to protecting wages and benefits, unions also protect jobs. Union contracts prevent management from indiscriminately firing workers and shifting the burden onto remaining employees. After decades of imposed decline, the United States currently has the fourth-lowest private sector union membership in the Organization for Economic Cooperation and Development (OECD).

America's low rate of union membership partly explains why unemployment rose so fast and, - thanks to hectic productivity growth - hiring has been so slow.

Proponents of labor-market flexibility argue that it's easier for the private sector to create jobs when the transactional costs associated with hiring and firing are reduced. Perhaps fortunately, legal protections for American workers cannot get any lower: US labor laws make it the easiest place in the word to fire or replace employees, according to the OECD.

Another consequence of labor-market flexibility has been the shift from full-time jobs to temporary positions. In 2010, 26 percent of all news jobs were temporary - compared with less than 11 percent in the early 1990's recovery and just 7.1 percent in the early 2000's.

The American model of high productivity and low pay has friends in high places. Former Obama adviser and General Motors (GM) car czar Steven Rattner argues that America's unemployment crisis is a sign of strength:

Perversely, the nagging high jobless rate reflects two of the most promising attributes of the American economy: its flexibility and its productivity. Eliminating jobs - with all the wrenching human costs - raises productivity and, thereby, competitiveness.

Unusually, US productivity grew right through the recession; normally, companies can't reduce costs fast enough to keep productivity from falling.

That kind of efficiency is perhaps our most precious economic asset. However tempting it may be, we need to resist tinkering with the labor market. Policy proposals aimed too directly at raising employment may well collaterally end up dragging on productivity.

Rattner comes dangerously close to articulating a full-unemployment policy. He suggests unemployed workers don't merit the same massive government intervention that served GM and the banks so well. When Wall Street was on the ropes, both administrations sensibly argued, "doing nothing is not an option." For the long-term unemployed, doing nothing appears to be Washington's preferred policy.

The unemployment crisis has been a godsend for America's superrich, who own the vast majority of financial assets - stocks, bonds, currency and commodities.

Persistent unemployment and weak unions have changed the American workforce into a buyers' market - job seekers and workers are now "price takers" rather than "price makers." Obama's recovery shares with Reagan's early years the distinction of being the only two post-war expansions where wage concessions have been the rule rather than the exception. The year 2009 marked the slowest wage growth on record, followed by the second slowest in 2010.[2]

America's labor market depression propels asset price appreciation. In the last two years, US corporate profits and share prices rose at the fastest pace in history - and the fastest in the G-7. Considering the source of profits, the soaring stock market appears less a beacon of prosperity than a reliable proxy for America's new misery index. Mark Whitehouse of The Wall Street Journal describes Obama's hamster wheel recovery:

From mid-2009 through the end of 2010, output per hour at U.S. nonfarm businesses rose 5.2% as companies found ways to squeeze more from their existing workers. But the lion's share of that gain went to shareholders in the form of record profits, rather than to workers in the form of raises. Hourly wages, adjusted for inflation, rose only 0.3%, according to the Labor Department. In other words, companies shared only 6% of productivity gains with their workers. That compares to 58% since records began in 1947.

Workers' wages and salaries represent roughly two-thirds of production costs and drive inflation. High inflation is a bondholders' worst enemy because bonds are fixed-income securities. For example, if a bond yields a fixed five percent and inflation is running at four percent, the bond's real return is reduced to one percent. High unemployment constrains labor costs and, thus, also functions as an anchor on inflation and inflation expectations - protecting bondholders' real return and principal. Thanks to the absence of real wage growth and inflation over the last two years, bond funds have attracted record inflows and investors have profited immensely.

The Federal Reserve has played the leading role in sustaining the recovery, but monetary policies work indirectly and disproportionately favor the wealthy. Low interest rates have helped banks recapitalize, allowed businesses and households to refinance debt and provided Wall Street with a tsunami of liquidity - but its impact on employment and wage growth has been negligible.

CNBC's Jim Cramer provides insight into the counterintuitive link between a rotten economy and soaring asset prices:

"We are and have been in the longest 'bad news is good news' moment that I have ever come across in my 31 years of trading. That means the bad news keeps producing the low interest rates that make stocks, particularly stocks with decent dividend protection, more attractive than their fixed income alternatives." 

In other words, the longer Ben Bernanke's policies fail to lower unemployment, the longer Wall Street enjoys a free ride.

Out-of-work Americans deserve more than unemployment checks - they deserve dividends. The rich would never have recovered without them.

1. The Massive Shedding of Jobs in America. Andrew Sum and Joseph McLaughlin. Challenge, 2010, vol. 53, issue 6, pages 62-76.

2. David Wessel, Wall Street Journal, January 30, 2010. "Wage and Benefit Growth Hits Historic Low"; Chris Farrell, Bloomberg Businessweek, February 5, 2010.

So, You Thought BP Was An OIL Company?

In fact, there isn’t that much of a difference between BP and Lehman Brothers – both have been among the major players in the unregulated $615 trillion OTC derivative market. If BP is forced to file for bankruptcy, it will probably have an even greater negative impact on the financial markets than the Lehman failure caused.

“Major BP risk lay in the $615T OTC Market that only the major international banks have any visibility to…. and they are not talking!”

Gordon T. Long

The potential contagion of the BP disaster may eventually show that Lehman Bros. andBear Stearns were simply early warning signals of the devastation lurking and continuing to grow unchecked in the $615T OTC Derivatives market. What is yet unknowable is what the reality is of BP’s off-balance sheet obligations and leverage positions. How many Special Purpose Entities (SPEs) is it actually operating?

Well, this it what we know so far:

Remember, during the Enron debacle Andrew Fastow, the Enron CFO, asserted in testimony nearly 10 years ago that General Electric (GE) had 2500 such entities in existence.

BP has even more physical assets than both Enron and GE.

Furthermore, no one knows the true size of BP’s OTC derivative contracts such as Interest Rate Swaps and Currency Swaps.

Only the major international banks have visibility to what the collateral obligations associated with these instruments are, their potential credit event triggers and who the counter parties are.

They are obviously not talking, but as Gordon T. Long explains in a recent article, they are aggressively repositioning trillions of dollars in global currency, swaps, derivatives, options, debt and equity portfolios.

The Murky World Of Off-balance Products

“Once again – as we saw with Lehman Brothers and Bear Stearns – we have no visibility to the murky world of off balance sheet, off shore and unregulated OTC contracts, where BP’s financial risk is presently being determined,” Long writes.

“At a time when understanding a corporation’s risk position is critically important investors are in the dark. When markets are uncertain, bad things are certain to follow. The new financial regulations under the Dodd-Frank legislation does absolutely nothing to address this. This was the central issue in truly understanding and corralling TBTF risk. It has not been addressed and the markets will likely make the tax payer pay for this regulatory failure once again,” he adds.

Mr. Long is a former senior executive with IBM and Motorola, a principal in a high tech public start-up and founder of a private venture capital fund. He is presently involved in private equityplacements internationally along with proprietary trading involving development and application of Chaos Theory and Mandelbrot Generator algorithms.

“Major BP risk lay in the $615T OTC Market that only the major international banks have any visibility to…. and they are not talking!” he writes in the article called “Sultans of Swaps”

Enron Times Ten

This is what Jim Sinclair at jasmineset.com says:

“People are seriously underestimating how much liquidity in the global financial world is depending on on a solvent BP. BP extends credit – through trading and finance. They extend the amounts, quality and duration of credit a bank could only dream of. You should this financial muscle behind a company with 100+ year of proven oil and gas reserves. Think about that in comparison to a bank with few tangible assets. Then think about what happens if BP goes under. This is no bank. With proven reserves and wells in the ground, equity in fields all over the planet, in terms of credit quality and credit provision – nothing can match an oil major. God only knows how many assets around the planet are dependent on credit and finance extended from BP. It is likely to dwarf any banking entity in multiples…. The price tag and resultant knock-on effects of a BP failure could easily be equal to that of a Lehman, if not more. It is surely, at the very least, Enron x10.”

Sound Familiar?

As long as an energy giant can manage its cash flows throughout the volatility of price fluctuations, it becomes a money and credit generating machine.

It can borrow with AAA yield any where on the curve and lend to less credit worthy entities at attractive spreads.

These lending differentials help fuel the $430 trillion Interest Rate Swap OTC market.

BP has been able to spin off $20B of earnings for the last 5 years and $15B in cash last year.

All of this suddenly comes to an end if its credit rating is significantly impaired.

But what could possibly cause this to happen?

It would take a black swan event. An outlier. A fat tail.

Sound familiar? Heard this discussion before?

“The Gulf Oil Disaster may be the fat tail to end all fat tails and show the exposure behind the entire risk models of the vast majority of derivative algorithm models. To suggest that BP would need to take impairments north of $20 billion would have seemed out of the realm of possibilities less than 90 days ago. Now, if it is contained to only $20B, it would be considered a blessing. Fitch dropped BP’s credit rating an unprecedented 6 notches on June 15 from AA to BBB which followed June 3rd’s AA+ to AA cut. This is what happens when a fat tail occurs and it has only just begun,” Gordon Long writes.

BP’s Derivative World

Here’s what rating agencies, analysts, bloggers and journalist have managed to dig up, so far.

The CSO’s (Credit Synthetic Obligations):

A study by Moody’s outlines that a BP bankruptcy would impair 117 Collateralized Synthetic Obligations (CSOs) which would lead to pervasive losses by a broad range of holders.

The 117 effected is a startling 18% of the total CSOs outstanding, which is an indication of the scope and impact of BP financing globally.

For those that remembthe 2008 financial debacle, you will recall its epicenter was the collapse of Collateralized Debt Obligations (CDO) associated with mortgages and Credit Default Swaps (CDS) of financial companies impacted.

CSOs are even more leveraged and more toxic.

This is what Moody’s writes:

The CDS’s (Credit-default Swaps):

On June 25th BP’s Credit Default Swaps shot up 44 to 580 on the 5 years CDS. This meant it costs $580,000 per year to ensure $10 million in BP bonds over a 5 year contract period.

Anything approaching 300 is considered serious risk. For counterparties willing to pay this amount means their dynamic hedging models are working overtime, and a near panic scramble is taking place.

On June 16 the blog Zero Hedge reported:

The Bond Inversion:

With Credit-default Swap consern we would expect this to be reflected in BP’s yield curve spread.

What is interesting is that the curve is inverted as BP’s CDS curve. Usually short term yields are less than longer yields because of inherent risk over a longer period of time.

This suggest that the market is pricing in a credit event.

A credit event would have a profound impact on OTC contracts, to which we have no visibility.

What we do know, however, is that BP has between $2 and $2,5 billion in one year commercial paper to rollover that is required for trading operations and working capital.

This is going to make it both more expensive and harder to secure, and will be a liquidity drain for BP.

The Liquidity Requirements:

To the commercial paper roll-over ($2-$2.5B in one year), ongoing new and rollover debt issuance, we need to add the $20B it has agreed with the White House to put in place, though we know of no detailed agreement actually being signed.

The Short Interests:

The Financial Times Alphaville via Data Explorers reported the short interest through June 4th.

By stripping out the spike related to the last dividend payment, the underlying level of stock outstanding on loan (SOOL) has barely budged since the Gulf spill.

So, short sellers can’t be blamed for the plunge in the share price; the selling must be coming from somewhere else, such as long-only funds.

Roumors circulated on June 10 that the Norwegian Government Pension Fund, who is the fourth largest shareholder in BP, was looking to offload 330 million  shares.

Brokers said the total transatlantic volume of stock traded in BP on June 9 had a value of $8 billion.

To put that figure into some perspective, the total volume traded on the entire EuroStoxx index on the same day amounted to $15 billion.

Moreover, since the Deepwater Horizon rig exploded on April 21th, 70% of BP’s market cap has turned over, most of it the US.

Trading volumes in BP American Depository Reciepts (ADRs) are usually 19% lower than the ordinary shares in London.

Since the spill, that position has been reversed and the ADRs have traded 3,5 times the ordinaries, all of which suggests BP’s largest US investors base have been dumping stocks.

The Option Activity:

The Wall Street Pit wrote on June 19 that “Option volume on beleaguered oil company, BP Plc, is fast approaching 750,000 contracts, fueling a more than 79,7% upward shift in the stock’s overall reading of options implied volatility to a 5-year high of 120,96%. Options activity on the stock can easily be described as frenzied as volume continues to grow in both call and put options across multiple expires.”

The cost of capital is skyrocketing for BP which as fundamentally an energy financing corporation can be terminal.

Way Too Big To Fail

According to Gordon T. Long, the most likely scenario is that the US operations of BP will voluntarily attempt Chapter 11 bankruptcy proceedings.

“This the worst possible scenario for claimants. The problem here is that this triggers a credit event which has daunting repercussions to the highly leveraged global financial markets. Like AIG before, the government does not want to tamper with the ramifications and fall out of a CDS event. Lehman was one too many.”

“If a US voluntary bankruptcy is stopped by the US and there is a BP corporate bankruptcy, then there is a strong possibility that the British Government will be forced to step in and bailout BP. In the end, the tax payers will pay as the ongoing game of Regulatory Arbitrage is playing masterfully once again.”

“Deleveraging associated with BP may be the event that triggers the $5 trillion quantitative easing spike we have been warning about for some time now. It will be needed to complete the final process of manufacturing of a Minsky Melt-up to avoid the looming pension, entitlement and US state financial crisis.”

“The ability of the government to achieve this is anything but certain. However, we need to expect the unexpected and watch out for fat tails to trip over,” Mr. Long concludes.

Next bubble: Corporate bonds...and stocks

by Jonathan Stempel
NEW YORK | Jun 9, 2010

(Reuters) - Tulip bulbs. Florida real estate. The Nifty Fifty. Gold. Japanese real estate. The Internet. Housing.

History is littered with asset bubbles where investors piled into the next hot thing, only to lose much or all of their investments once the bubble bursts.

One leading strategist said the next bubble could be in something more mundane -- high-quality corporate bonds -- as investors burned after U.S. stocks fell by half from late 2007 to early 2009 flock to perceived safety.

And then, perhaps down the road, it could be the turn of some equities to become overheated again.

"Retail investors buying bonds today, at a time when the supply of corporate bonds is shrinking ... they're chasing a bubble," Tom Lee, chief  U.S. equity strategist at JPMorgan Chase & Co, said Wednesday at the Reuters Investment Outlook summit in New York.

"We had a credit bubble, a mortgage and housing bubble, and that caused equities to collapse," Lee said. "I wouldn't rule out equities as the next area where bubbles could emerge, but I don't think it's going to start in 2010."

Many speakers at the Reuters Investment Summit have said individual investors remain cautious on stocks, despite a 13-month run-up that ended in April, saying net U.S. domestic stock fund inflows have been roughly nil.

In contrast, bonds are attracting bushels of cash. The intermediate-term bond fund Pimco Total Return, the world's largest mutual fund, has some $227.9 billion of assets, according to Morningstar Inc. And the average high-quality corporate bond yields 4.5 percent, a level last seen in 2004.

The love for bonds might not last, Lee said.

"Have Americans ever been satisfied with earning a steady rate of return?" he said. "What we have in American history, I think in capitalism, is rolling bubbles, whether it's real estate, commodities, land speculation, emerging markets, time shares.... Basically, savers chase the next bubble, and then when that bubble shifts, they will move to the next one."

"NO BRAINER" FOR STOCKS

Lee said prices on 10-year Treasuries and high-grade corporate bonds appear rich relative to the price-earnings ratio of companies in the Standard & Poor's 500 .SPX.

Treasuries trade at about a 33 multiple, or the number of years it takes to earn $1 from $1 of principal, while corporate bonds trade around a 20 multiple, he said. But more than half the S&P 500 stocks trade below a 10 multiple, he said.

"Corporate balance sheets are pristine today, so the bond multiples are justified," he said. "But the equity multiples are ridiculously low."

Lee said the average yield on corporate bonds is just 2 percentage points higher than the S&P 500 dividend yield, the smallest differential since 1967.

"Corporate bonds are already (trading) at 108" cents on the dollar, he said. "If they were at 130, what would you do if you were General Mills (Inc)? Buy back all your bonds, and issue new bonds at 3 percent. And then what does it mean for your stock? All of a sudden, maybe you de-equitize by 30 percent, because your cost of capital can justify it."

General Mills bonds have risen in price. Its 5.65 percent notes maturing in 2019, sold in January 2009 at 99.91 cents on the dollar, traded Wednesday at 111.76 cents, yielding 4.03 percent, according to the bond pricing service Trace.

Kirstie Foster, a spokeswoman for the cereal maker, declined to comment, citing a "quiet period" before General Mills reports quarterly results.

Lee said improved corporate credit quality historically heralds increasing stock prices and could do so again.

He expects the S&P 500 index to rise roughly 20 percent by year end to about 1,300, saying it could easily support a price-earnings multiple above 14, compared with about 12 now.

"I think you get the no-brainer to buy stocks for the next decade, unless you just thought we were going to have the world economy shrink," he said, "or if we're Japan."