Tuesday, November 06, 2007

A Discredit to Credit

The problems with credit in the U.S. may be pervasive. In the securities markets they are broader than had been anticipated just a few months ago and beyond that the questions are being asked. These credit problems are creating imbalances that lead to a weaker dollar today, tomorrow will lead to higher interest rates beyond the shortest term, and after that will lead to inflation. There is nothing intrinsically wrong with credit, or borrowing and lending money, if it's productively invested. That is, finance theory proven I think, unequivocally a good thing---but that's where the problem rests today.

To that point the following is a quote from the octogenarian portfolio manager, Marvin Whitman, of the Third Avenue Value Fund to its shareholders:
"Of itself, increasing indebtedness is not a huge problem, provided the use of funds created by the borrowing is used productively, i.e., to create wealth. Insofar as the use of proceeds do not result in wealth creation, or it creates only modest increase in wealth, i.e., there exist a negative multiplier, or a modest multiplier, the borrowing entity, sooner or later, has to face diminished credit worthiness."
"The U.S. is incurring massive debts. By and large, the use of proceeds from incurring this debt seems to be only modestly productive or even counter productive. These uses of proceeds seem to have been non-positive, or even negative, multipliers. Non productive uses of proceeds include the following:
...By the U.S. government: massive expenditures in Iraq.
...By Consumers: massive expenditures for consumer goods that depreciate rapidly
...By Corporate America: leveraged buy outs where most of the proceeds from debt incurred are used to make cash payments to stockholders, rather than to use the cash to build or acquire productive assets."

Speaking to each of Mr. Whitman's comments:
----The U.S. government borrows, and state govts as well, but they have not made the infrastructure investments that should be made. The comparison is striking. That's not a comparison with the obvious wealth and optimism being displayed in Dubai, Shanghai, or in a few other unique situations, that's a comparison with most of the G-7 world. Look at parts of continental Europe, cities across Germany and France, Scandanavia, even parts of Eastern Europe, and public works projects are apparent in urban life and activity continues. To those Americans accustomed to the status quo, apart from new shopping malls, it is in fact startling to see. Not much is happening to suggest that this government should be a net borrower. Then there's the health systems, educational systems, penal systems, environmental foresight for energy and water resouces, the investments have been maintenance style at best in most cases. Like any small business knows, no investment leads to no payback or worse.
---As to consumer, a large portion of the subprime loans now at issue were bought by or sold to consumers in decent financial shape to finance lifesytle improvement, or more likely staying at a lifestyle that was already not sustainable. This is not a good state of affairs. This comment is not aimed to solely the market segment in question. Many Americans of all stripes represent a spending mindset which propels our economy, but is not always based sound long term thinking.
---The LBO business has reached a crescendo in its rapaciousness in recent years with its payout schemes. What goes on now might even repulse Milken. The former rational purpose for LBO's, enhanced productivity and free cash flow, has been perverted into a notion of gamesmanship involving legal, tax and negotiating skills, and the accumulation of wealth measured competitively as in some major league sports standings.

It's true.


Anonymous kf said...

You focus on the government when you comment on infrastructure investment but what about corporates. To the extent they investment in plants and equipment much of it is now in other countries. When they want and need to invest here there can be such restrictions that they choose not to as in the fact that it's been almost 30 years since an oil refinery has been built in this country and that is one of the reasons gasoline prices as so high. Corporates don't invest in their people the way they used to. They want short term performance and low costs and have cut back on the kind of intangible investment in things that help employee morale and commitment, except at a unique place like Google. This issue of lagging u.s. investment is a corporte issue too.

9:01 PM  

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