The social returns to financialisation?

Envision, one of the largest medical staffing companies, completed a restructuring of its roughly $7bn of debt this month as it moved to stave off bankruptcy. This comes less than 18 months after KKR — one of the oldest and largest US private equity firms with more than $200bn of assets — bought the Nashville-based company for nearly $10bn. The Envision deal highlights one of the stress points in a financial system that is creaking under the pressure of the coronavirus-induced recession.

To fund around two-thirds of the acquisition, KKR loaded the company’s balance sheet with junk-rated loans and bonds — a familiar private equity tactic. Those securities provided fuel for one of Wall Street’s least known but most important debt machines: collateralised loan obligations…..

…. In April, Envision began cutting the hours of emergency room doctors who have been one of the first lines of defence for Covid-19 patients. Bonuses have also been postponed and non-clinical staff were told they would be temporarily furloughed or see pay reductions.

“We are putting ourselves literally on the line, often without the protective equipment we need, to then be told our hours are cut, or that schedules are going to change,” says one emergency room doctor working for Envision in Florida. “It’s frustrating that this large company backed by a very large private equity group can’t find other ways around this that don’t hurt the doctors facing this disease head on.” Envision and KKR declined to comment. [Link]

A report from New York Times:

In July, a report from the Center for Popular Democracy, a progressive advocacy group in Brooklyn, said 10 of the 14 largest retail chain bankruptcies since 2012 involved companies that private equity firms had acquired….

… the collapse of Toys “R” Us in 2017 put a spotlight on how major buyouts by the firms could go sideways. The chain had been burdened with $5 billion in debt from a 2005 leveraged buyout by the private equity firms Bain Capital and Kohlberg Kravis Roberts and the real estate firm Vornado Realty Trust, and it did not have sufficient funds to invest in its stores and e-commerce business during a crucial period of growth for Amazon and Walmart.
It was eventually liquidated, and more than 30,000 workers were laid off. The workers were not paid severance — even as creditors, bankruptcy lawyers and consultants received payments — until they lobbied pension funds, which invest heavily in funds managed by private equity firms. The situation galvanised politicians and union activists and spurred public outrage. [Link]

Quite what the economy and the society gain from these transactions? What for?

The triumvirate of indexing

From John Authers:

LSE owns FTSE-Russell, one of the top three indexing groups (with MSCI and S&P Global) which have enjoyed enormous profits from the growth of passive investing. A new paper by Johannes Petry, Jan Fichtner and Eelke Heemskerk outlines how this Big Three has taken on enormous power over markets, with a role as the gatekeepers to equity capital now very similar to the role of ratings agencies in controlling access to credit. Chart below is from John Authers.

The paper that he links (see above) has this abstract:

Since the global financial crisis, there is a massive shift of assets towards index funds. Rather than picking stocks, index funds replicate stock indices such as the S&P 500. But where do these indices actually come from? This paper analyzes the politico-economic role of index providers, a small group of highly profitable firms including MSCI, S&P DJI, and FTSE Russell, and develops a research agenda from an IPE perspective. We argue that these index providers have become actors that exercise growing private authority as they steer investments through the indices they create and maintain.

While technical expertise is a precondition, their brand is the primary source of index provider authority, which is entrenched through network externalities. Rather than a purely technical exercise, constructing indices is inherently political. Which companies or countries are included into an index or excluded (i.e. receive investment in- or outflows) is based on criteria defined by index providers, thereby setting standards for corporate governance and investor access.

Hence, in this new age of passive asset management index providers are becoming gatekeepers that exert de facto regulatory power and thus may have important effects on corporate governance and the economic policies of countries. [Link]

We all know what has happened and is still happening with the ‘oligopoly’ in credit rating. This is one more. Oh, well….

Big Market and PE

I was in the Patalganga campus of teh National Institute for Securities Markets set up by the GoI last week to speak at their two-day conference on trends in capital markets. Shri. Ajay Tyagi, Chairperson of SEBI, inaugurated the conference. As part of my preparation for the speech, I had perused the blog post by Aswath Damodaran on the delusions of the big market that infects many start-ups.

Investors buy into that, pushing valuations into stratospheric zones and eventually reality sinks in. It hapened to Wework, Uber and Slack, according to Prof. Damodaran.

What struck me as interesting was his advice to policymakers:

3. Governments and Market Regulators In the aftermath of every correction, there are many who look back at the bubble as an example of irrational exuberance. A few have gone further and argued that such episodes are bad for markets, and suggested fixes, some disclosure-related and some putting restrictions on investors and companies. In fact, in the aftermath of every bursting bubble, you hear talk of how more disclosure and regulations will prevent the next bubble. After three centuries of futility, where the regulations passed in response to one bubble often are at the heart of the next one, you would think that we would learn, but we don’t. In fact, over confidence will overwhelm almost every regulatory and disclosure barrier that you can throw up. We also believe that these critics are missing the point. Not only are bubbles part and parcel of markets, they are not necessarily a negative. The dot com bubble changed the way we live, altering not only how we shop but how we travel, plan and communicate with each other. What is more, some of the best performing companies of the last two decades emerged from the debris., a poster child for dot com excess, survived the collapse and has become a company with a trillion-dollar market capitalization.  Our policy advice to politicians, regulators and investors then is to stop trying to make bubbles go away. In our view, requiring more disclosure, regulating trading and legislating moderation are never going to stop human beings from overreaching. The enthusiasm for big markets may lead to added price volatility, but it is also a spur for innovation, and the benefits of that innovation, in our view, outweigh the costs of the volatility. We would choose the chaos of bubbles, and the change that they create, over a world run by actuaries, where we would still be living in caves, weighing the probabilities of whether fire is a good invention or not. [Link]

One can have a day-long seminar debating the pros and cons of his advice. To a degree, I can understand what he is trying to say. Authorities must carefully weigh the pros and cons of interfering and also must weigh the pros and cons over a relevant time horizon. What is that horizon? No one knows.

I would like to leave two points for consideration:

Authorities may not want to actively intervene to prick bubbles and deflate them but the question remains as to whether they actually fan it.

Two, what are the social costs of allowing bubbles (that boost asset prices) to grow and expand? Especially every subsequent bubble creates more debt on top of the previously accumualted debt (that fanned the previous bubble) and hence, weakens the system and its capacity to grow in future.

The article by Joe Nocera on the PE investment in a grocery chain in New York makes for sad reading. So, Professor Damodaran might want to revisit his (facile) advice to policymakers, especially to central bankers and their monetary policy decisions, instruments, etc.

Tax cut, the stimulus effect and other links

The Financial Times had the following header, “Sugar rush from India’s tax cut starts to wear off” in an article yesterday. The contents were less negative. Stock market euphoria might or might not fade. But, the medium-term positive impact on corporate cashflows and hence on investments will be there. It might take some time.

Abhijit Banerjee, one of the winners of the Swedish Riksbank Prize for Economics, had wanted India to roll back the corporate tax cut. He has argued that the sure way to boost economic growth is to put money in the hands of the people and that the resulting higher demand would boost investments. Fair enough.

But, whether tax cuts for big businesses are an unfair advantage conferred on big businesses are entirely a matter of context. In the Indian context, the tax cut offered seems par for the course. The best response to the point put forward by Abhijit Banerjee came from R. Jagannathan, Editor of Swarajya, through his regular column (‘Arthanomics’) for Mint. He had explained beautifully as to why, in the Indian context, the corporate tax cut was not wrong and that higher taxes would not be welfare-enhancing. It is an important read.

Now, back to the context of this blog. I came across this review of the recent book by Piketty (ht: Ramagopal). The review was somewhat short and ended abruptly but it had an important statistic:

Per capita income growth was 2.2% a year in the U.S. between 1950 and 1990. But when the number of billionaires exploded in the 1990s and 2000s — growing from about 100 in 1990 to around 600 today — per capita income growth fell to 1.1%. [Link]

Piketty has a point about extreme inequality. But, I am not sure if forced redistribution would work simply because political economy forces would not allow the redistribution to happen. There is a moral hazard. Nations can cheat and allow tax arbitrage even if they agree on harmonisation of tax policies and rates.

OECD’s proposal for taxing the income of multinationals would be an important step forward, if it came about. In fact, this could be one of the most far-reaching tax reform to be proposed in recent years. Without that, redistribution of surplus between labour and capital would be a non-starter. However, it is chastening to note that OECD has been at it at least for six years if one went just by the first page hits when one searched for ‘OECD TAX PROPOSAL’

This F&D article (somewhat long) has a very useful overview and a wealth of links to pursue. It links tax-havens and tax-evasion to ‘Too much finance’. In other words, the jurisdictions that are willing to act as tax havens end up suffering from the ‘Finance’ curse.

One wonders if the post-Brexit Britain wants to or can double down on its role as a financial/tax haven?

The Rise of Finance

The article is an extract from a forthcoming book. It is thoughtful and thought-provoking.

Some paragraphs are exactly in line with the sentiments expressed in ‘The Rise of Finance: Causes, Consequences and Cures’ and those were the sentiments that motivated our book:

Jensen and his co-author, William Meckling, proposed a series of measures to correct then-prevailing ideas about corporate governance. They argued that the owners of stocks and bonds should push corporate management to attend very closely to the price of their company’s shares and less closely, if at all, to the needs of society.

It’s always tempting to think about the way things turned out as having been inevitable—as the only possible response to vast, irresistible forces—but history is always contingent.

But there was a problem. The shareholder revolution and the rise of finance made the kind of social vision that Berle, Drucker and others were promoting for post-World War II America impossible to sustain.

Just as political systems a century ago had to adjust in response to the social dislocations produced by industrial capitalism, today they are adjusting to the social consequences of the financial revolution of the late 20th century.  

This became the theoretical accompaniment to a great remaking of the relationship between corporations and finance, which put finance in a much more empowered position.

We are at an inflection point in the world. The Conservative movement in the UK is in disarray. The Labour Party has radical (but unviable) ideas. In the USA, the Democratic Party’s balance of power has shifted decisively to the Left.

To a large extent, the rise of finance and the corporate greed that rose along with it are to be blamed for this.

Postscript: it appears that Binyamin Applebaum’s book also mentions ‘financial liberalisation’ as one of the bad ideas to have emerged from ‘free market’ economists. I have not read the book but here is a review of the book (ht: Rajeev Mantri).

Sovereign dollar bonds

Many of you might have noticed that the Indian government announced a plan to borrow in dollars in international capital markets. It will be India’s first foreign currency sovereign borrowing from capital markets.

In one short sentence, it is ill-advised. If you thought that the issue of ‘Masala’ bonds (rupee bonds issued for foreigners to subscribe) were safer, that is wrong too. Happy to elucidate. Have done so here.

I wrote about it in my column on the budget published the day after the budget was presented:

One headline that grabbed attention pertains to the government announcing its intention of issuing sovereign debt in foreign currencies. Apparently, India thought of it in 2013 but did not go ahead as the macro fundamentals were deemed dodgy then. But, probably the best time to borrow would be when the domestic currency is undervalued. The Indian rupee in the second half of 2013 was close to being undervalued. Right now, India’s macro fundamentals are not weak, although big question marks remain over the economy’s growth rate, its sustainability and vulnerability to a global stock market correction. In other words, the risk is tilted towards further weakness of the Indian rupee. In 2013, it was tilted towards its strengthening after a hefty correction.

On the other hand, the timing is opportune in another sense because global central banks are back to considering further crazy monetary easing moves. To that extent, raising foreign currency borrowing now is a case of good timing. Another upside is that the government would not be crowding out domestic savings, which have declined in recent years and show no signs of reviving. That is a good thing. [Link]

The above two paragraphs only focused on the micro issue of timing the bond issuance in foreign currency. But, the argument in favour of issuing foreign currency denominated bonds in terms of it not crowding out domestic borrowers is not entirely correct, I admit, because Dr. Y.V. Reddy had pointed out lucidly as to why it is no help to domestic non-sovereign (private sector borrowers).

The argument is this: if India’s safe current account deficit is 2% of GDP and if Government of India borrows from foreigners (it is part financing of the CAD), then the amount available for other domestic borrowers in foreign currency is going to be reduced by that amount. The ‘ceiling’ is unofficially set by the ‘safe’ current account deficit for the country.

Then, on July 9, I wrote more extensively for MINT on the dangers of the Indian government borrowing in foreign currency. [Link]. It might open the door, together with other measures announced in the budget, for greater financialisation of the economy at a time, when its macro-economic health and performance are brittle.

Besides Dr. Y.V. Reddy’s piece, one of the best comments on this subject came from Sanjaya Baru. It is well worth a read.

In this piece, Shankkar Aiyar suggests alternatives to raising dollar resources through sale of sovereign bonds:

Yes, India must raise additional resources and in dollars to finance the aspiration for high growth. Why not raise dollar resources by listing LIC? Why not aggregate surplus land with government into a land bank and call for bids? Why not transfer government ownership of public sector banks and enterprises into an exchange-traded sovereign fund?

The broken world of finance or Does Capitalism need enemies?

I was startled to read these two stories and contrast them with the picture below.

This image file came via courtesy of this website.

This article in Bloomberg gamely tries but fails to make sense of the craze for negative yielding bonds.

Wework floated a debt before filing for IPO! It has been losing money ever since it was founded and it is valued at USD47.0bn!

In contrast,

Regus owner IWG , founded in 1989, has a similar business. It booked revenue nearly twice as high as WeWork did last year yet it has an enterprise value a bit above $4 billion. [Link]

Wework co-founder has reportedly cashed out US$700 million from the company through stock sale and borrowings against shares of Wework. JP Morgan advised him on his sales and it is also advising the company on its debt offering. His shares hold 10 times the voting rights of standard shares. He has properties that are leased back to Wework and he collects millions in rent from Wework! Source: Link

Evidently, he could cash out so much because the company had the chutzpah to issue USD4.0 billion of debt

What a model of ethical capitalism!

It is into this loss-making company with co-founder cashing out such a large sum before IPO that Softbank decided to invest USD 16.0 billion including USD 6.0 billion of new money! The amount was eventually scaled back after partners opposed it.

Blame central banks and their policies for money losing its value and investors losing their heads and eventually, their shirts and trousers.