Milking It For All It’s Worth
Age of Wisdom, Age of Foolishness (26)
The economic rent seeking behaviour of CEO’s, rather than their commitment to take risk and invest for growth, was highlighted in Age of Wisdom, Age of Foolishness (25) “Pride and Extreme Prejudice”; with the example of the proposed takeover of Alstom by GE as a case study. The spiritual worship of the sacred cow of Fed liquidity has become a search for cash cows in the temporal world.
Siemens has now jumped on the bandwagon and sought to compete with GE, by proposing an asset swap with Alstom as an alternative. Siemens wishes to enjoy the lucrative economic rent in Europe exclusively, but is unwilling to compete directly with GE and Alstom by producing competitive alternative products[i].
In the pharmaceutical sector, further evidence of rent seeking was evinced in the Pfizer bid for Astra Zeneca[ii]. The Pfizer deal will be the biggest in UK history if it is consummated. Pfizer recently closed all of its R&D facilities in Britain; and has a track record of doing the same to the R&D operations at all the companies that it acquires[iii]. Since R&D is the essence of drug pipelines and growth for pharmaceutical companies, it is clear that Pfizer is not searching for growth; rather it is searching for revenues aka economic rent. Pfizer can’t move its own share price needle with internal drug pipeline growth, so it is creating the appearance of growth on its balance sheet through buying other companies revenue streams.
The alarming rise in drug prices is creating great scope for raising the economic rent in this sector[iv]. Bayer also has entered the fray, seeking economic rent in a “rival” Merck unit[v]. Glaxo and Novartis have taken a different route to rent seeking via an asset swap[vi]. Reckitt Benckiser Group is also evaluating potential asset purchases in the healthcare sector, having declined to do a deal with Merck[vii].
“Big Pharma” is a microcosm of the activity, currently underway in the C-Suites and corporate finance houses, searching for economic rental opportunities in all sectors of the global economy. Buoyed by their stock prices and jaded by their search for new economic rents, CEO’s are making more use of their corporate jets for R&R as the money saved from curtailed R&D accrues on the balance sheet[viii].
“Rent Seekers flying high”
The romantic view is that the companies doing the bidding are betting high stakes. The reality is far more mundane. The reason that companies spend such vast sums on acquisitions is that the risk parameters are in fact quite low; because the economic rent of the target is being present valued in the acquisition price. The larger the deal size, therefore the larger the present value of the economic rent.
The problem with the math however comes with the discount rate used to do the present valuing. At the “Zero Bound” of interest rates, especially when the hunt for yield has collapsed credit-risk spreads, net present values are by default much larger. This is why it is safer to pay for another’s inflated shares with one’s own inflated shares, rather than real money; since the low discount rate impacts the present value of both the share price of the acquirer and the acquired so that they net out.
Janet Yellen has been at pains to yield liquidity for the rent seekers, even if this means job losses through synergies, by going out of her way to emphasize that the discount rate used to present value economic rents will remain low for some time well after QE officially ends. One can see that the new bubble in equity valuations will be evinced by merger mania, until the last greedy CEO overpays in the largest deal of all time which signals the top.
Large American corporates can’t merge with each other, because the current oligopoly market structure in place would be in conflict with Federal and State anti-monopoly hurdles. Instead, they go shopping for pricing power across the Atlantic. If and when a free trade deal is struck between American and the EU, the merged entities will have a level playing field on which to raise margins in both locations.
Free trade is therefore becoming anti-competitive rather than the competitive panacea which policy makers say that it is. America Inc has already positioned itself for rent seeking disguised as free trade with Europe.
Its next objective is to position for free trade in Asia; with the Trans Pacific Partnership which President Obama is currently pedalling in the region. The IMF lost little time in bolstering Obama’s current Asian tour, with a new edict for Asian nations to embrace economic reform in order to mitigate the negative side effects of the “Taper”[ix].
The principle reform is of course the removal of trade barriers to American exports. It is however unlikely that American companies will be expanding production at home to export to Asia. Instead they will gain control of Asian production capacity through acquisition; and then go to work on margins and pricing power.
The enigma of the “Taper” should therefore be seen as a cover story for a free trade mystery, inside of which is wrapped the riddle of rent seeking behaviour. America will be exporting capital rather than goods, as it has always done. This time however the current account deficit will be balanced by a capital account surplus. American shareholders will also legally own the foreign assets, which advances the cause of American global hegemony euphemistically referred to as Democracy. By 2016, the GOP seems likely to be in office in order to enforce this order of things, “with boots on the ground”, when the legal rules of commerce break down.
This rent seeking behaviour has become affordable because the Fed’s QE policy has inflated the shares in the American companies, to levels at which CEO’s can use them as currency instead of having rights issues to fund acquisitions or paying with cash. Pfizer would like to pay for 70 per cent of the Astra Zeneca acquisition with its own shares. The negative externality of the “Taper”, on asset prices outside America, makes them cheaper for American companies to acquire. The stronger US Dollar, as a result of the “Taper”, is just the icing on the cake, which makes the non-American assets even cheaper to acquire with inflated American shares priced in US Dollars.
It should now be dawning on the Fed that it has created another monster, by inflating equity prices, which will ultimately lead to Stagflation. There is always a cost, often born by those who do not benefit from the income and capital gains involved the strategy, which must be paid; and this cost is Stagflation. The rent seeking American CEO is now only interested in acquiring competitors, cutting costs with the synergies that accrete and then applying the increased pricing power of the merged entities. There is no need to invest in capex or growth. There is also no need to create jobs; indeed jobs will be lost during the synergy phase that follows the acquisition.
Myopic central bankers will no doubt see the increased redundancies from global synergies as another signal to be more accommodative with monetary policy. Central bankers, like the man with a hammer, will only see the nails of job losses which they call deflation. The increased pricing power of the merged entities goes undetected. The central banks have enabled the conditions, which they will then try to mitigate with more of the same loose monetary policy.
“Main Street” and “Wall Street” have found a new partnership to game “20th Street and Constitution Ave”. This “Masters of the Universe” partnership has a limited liability status, because the Fed and the Taxpayer assume all the unlimited liability for its failure. Because “Wall Street” and “Main Street” have listed shares, the perception is that their shareholders take all the risk. In practice as was seen in 2008, this risk is larger than the share capital of the two partners, so it must be underwritten by the taxpayer and enabled by the Fed. Common and preferred equity has therefore become limited liability equity for those companies that are Too Big to Fail (TBTF). “TBTF Wall Street” and “TBTF Main Street” therefore become “ TBTF Wall Street LLC” and “TBTF Main Street LLC”; and they combine to form “TBTF LLP”. With the passing of Lehman and Bear Stearns, “TBTF Wall Street LLC” has become smaller in shareholders and even bigger in terms of systemic risk. “TBTF Main Street LLC” is in the process of shrinking in the number of shares outstanding and concentrating risk in the new wave of M&A. A classic example of the LLC status of “TBTF Main Street LLC” was recently highlighted by GM. The Treasury finally admitted to losing $11.2 Billion in its GM bailout[x].
The best example of “TBTF Wall Street LLC” is “GSE LLC” aka Freddie Mac and Fannie Mae. Confirmation of their LLC status came in a recent FHFA stress test report; which stated that they would need $190 Billion in bailouts in the event of another severe downturn[xi]. In effect, they become LLC’s in a financial crisis. What was most alarming, about the report, was not the size of the bailout suggested but the fact that this was assumed to be readily forthcoming should it be needed.
The bailout has been unofficially written into the articles and memoranda of association of “GSE LLC”, as it is also implied in the articles and memoranda of “TBTF LLP”. Perhaps “TBTF LLP” should just be called “Moral Hazard LLP” to simplify things. Freddie however may have started to hedge itself by providing loans for Trailer Park owners, where the casualties of its home-lending policies will end up in the next crisis[xii]!
“TBTF Wall Street LLC” has already conned the Fed into believing that it can’t multiply the Trillions of Reserves (which the Fed created), unless the Fed buys up the “Weapons of Mass Destruction” that will get securitised in order to facilitate this lending. And just for good measure, it would be even better if the Fed loosened capital adequacy rules so that “Wall Street” can take on more credit risk (which it will then pass to the Fed). If “TBTF Main Street LLC” can pull a similar stunt, by convincing the Congress that it won’t invest in growth unless there is a fiscal stimulus catalyst, then the economic rent being sought by the partnership can be maximised.
Any fiscal stimulus will do, as long as it provides the liquidity in the real economy that enables profit margins to be expanded through rising prices. As the old saying goes “Greed is good, Greed works”.
“Blue Horseshoe loves the FOMC and TBTF LLC’s”
It was recently reported that M&A activity is now at its strongest for seven years, in the region of $1 Trillion, signalling that the Master (of the Universe) LLP between “TBTF Main Street LLC” and “TBTF Wall Street LLC” is very prosperous for both[xiii]. The Equity market has now begun to discount the economic rent seeking style of investing, into equity risk premiums. This will manifest itself as an expansion in the Price/Earnings multiples.
Recent analysis by JP Morgan[xiv] shows just how significant the margin component of earnings has become. As CEO’s move into Stagflation mode, clearly the sales component will be less significant than the cost cutting and the pricing power.
The most egregious example of rent seeking behaviour in America today is to be found in the housing market itself. There is something ironic in the fact, that the sector which provided the classic scenario of boom and bust is now the place where the Masters (of the Universe) LLP has found fertile ground for economic rent and the rolling back of regulations. Homeownership declined as the crisis unfolded, however it has continued to decline even as house prices have risen in the economic recovery. This means that homeowners, with negative equity, have been foreclosed on and are now renting.
It also means that homeowners, who have made it back into positive equity, are either being foreclosed on or are hitting the bid and getting out of unaffordable mortgages. The continued decline in homeownership, during a period in which the Fed has manipulated and then held mortgage interest rates down, should be a major cause for concern at the Fed. Homeowners have been replaced with investors, who then seek economic rent through renting. Investment in housing is therefore not the investment in new homes that can be sold or rented, since the homebuilders are managing supply in order to maintain their own margins and the bankers are managing their foreclosed inventories to do the same.
The majority of the investment in housing is therefore in existing buildings. Low interest rates have driven investment flows into rental housing looking for returns; which has then driven up house prices to levels that are unaffordable for real buyers. Investors hope to drive rents higher, in order to justify the elevated level of house prices. The US Housing market is therefore another financial asset class, rather than a capital asset class as it is supposed to be, in the same way that equities are a financial asset class rather than a source of financial capital. Renters are now cutting consumption in order to pay rising rents. In more alarming circumstances, renters are running into debt in order to pay the rent. “TBTF Main Street LLC” however does not wish to pay higher salaries to sustain the rising rents which “TBTF Wall Street LLC” demands. The Renter must therefore run into debt, until he or she can no longer pay the rent and is evicted. Tenant evictions will replace foreclosures as the new danger signal.
Faced with this next bursting bubble “TBTF Wall Street LLC” is now pushing for a fiscal stimulus to provide renters with enough money to pay rising rents. It is notable that “TBTF Wall Street LLC” is not pushing for a fiscal stimulus that raises the supply of houses and reduces both house prices and rents. What appears to be forming is a compromise; in which the One Per Cent who control “TBTF Wall Street LLC” will accept some of their wealth being transferred via the tax code to the Ninety Nine Per cent who are the rent payers. The One Per Cent will thus continue to drive economic rents higher by funding them through the tax code. What the One Per Cent lose in taxes, they gain in rental income. Every time the Renters pass Go each tax year, they collect $200 from the Banker (tax code). The Renters however own no properties on the board, which means they get fleeced as they go around again.
MBA Purchase Applications
Released On 4/30/2014 7:00:00 AM For wk4/25, 2014
Economic Events and Analysis
The most recent Mortgage Bankers Association data suggests that the tipping point has been reached, at which the borrowers and refinancers have given up. The Composite Index is at its lowest level since December 2000. This will have a negative impact on house prices; and the homeownership rate should take another quantum move lower. Presumably they will become renters; and presumably their ability to pay rent is poor which should have a negative impact on rents also. Let’s see how the rapacious rent seekers make out with this latest wave of distressed renters.
The example of the housing market can be easily transferred to the equity market, where “TBTF Main Street LLC” owns all the squares that consumers land on when they must purchase something. The problem occurs when a capital asset becomes a financial asset, by nature of the fact that central bank liquidity is pouring into the capital markets rather than into the real economy. The link between this reservoir of liquidity and the real economy is the price level in both markets. The capital markets liquidity is a source of inflation in the real economy, when the rent seekers from the capital markets raise prices in the real economy as they seek higher economic rents. Neo-Classical economic theory, assumes that liquidity from the capital markets creates new investment and goods and services in the real economy. The fact is that liquidity in capital markets creates rent seeking behaviour and hence inflation in the real economy. This rent seeking is enabled by consumers going into debt to fund consumption. When the consumer no longer can service this debt, the system collapses in what the Neo-Classical economists call creative destruction.
As the equivalent of raising the economic rent, “TBTF Main Street LLC” is now raising the price for its goods and services. Consumers, representing the Renters, therefore find what they collect each year buys less and less, as more and more of their income gets paid out in renting their homes; and also paying for other goods and services which rise with the increasing price level. The problem for the real economy is that the general price level rises with these economic rents, so that inflation gets baked in simultaneously as real growth stagnates. This version of Monopoly is called Capitalism. The objective of the game is to own as many properties and shares in companies as possible, to maximise the economic rental income earned. When all the money has been taken from the Renters, by the winner and the bubble asset bursts, the Fed and the Treasury provide the game’s Banker with more liquidity, by nature of the rules applicable when the LLC status of winners is triggered by their insolvency as the end of the current liquidity of the losers simultaneously occurs.
The FOMC has struggled with its wording in recent times, so the statement at the latest meeting was its shortest to date. Brevity is hoped to prevent the kind of misinterpretation which then calls for remedial action from Yellen and the “Plunge Protection Team”. In effect the Fed has failed in its guidance with words, so it has stopped trying to guide. We have now gone from “Quantitative Guidance”, through “Qualitative Guidance” to “No Guidance” at all. Reading between the few lines communicated, the “Taper” is still in place and the stimulus will end by the end of 2014. Markets must now speculate on what happens after then; although they have been given the big hint that interest rates won’t be rising for some time, so in theory they should be constructive. Since the meeting coincided with month end, the window dressers did the “Plunge Protection Team’s” work and closed the Dow out at an all-time high. This was not confirmed by any of the other major averages however; confirming that equity investors remain defensive and have an increased tendency to become rent seekers. Asset managers are also becoming economic rent seekers; seeking to live off the management fee rather than the performance fee. Switching into sectors that provide this economic rent has also become the main flow in portfolios. For those who like to take some risk, there is the overweight bet on Europe. Europe however is in rent seeking mode itself.
Age of Wisdom, Age of Foolishness (24) “The Short Good Friday” and Age of Wisdom, Age of Foolishness (25) “Pride and Extreme Prejudice” observed how the Catholic and Anglican faiths signalled their expectations for unfolding global-macro events. The week leading up to May Day began with the Catholic Church sending further signals. Pope Francis beatified Pope John XXIII and Pope John Paul II for being what he termed “men of courage”[xv]. The double beatification was said to be something very special; so one must assume that the Vatican wishes to set a very special precedent by doing something so unprecedented. Pope John XXIII courageously apologised to Judaism, on behalf of Catholicism, after the Second World War. Pope John Paul II courageously defeated the Soviet Union in Poland; and signalled the total defeat of the Soviet Union in the Cold War. Having observed the collapse of the double statehood negotiations[xvi], between Israel and the Palestinians recently after the latter made peace with Hamas[xvii], the beatification of John XXIII suggests that the Vatican sees trouble ahead in the Holy Land and wishes to occupy the moral high ground on Calvary. Having also observed the situation in Ukraine, one can conclude that similar moral high ground is being occupied there, by the beatification of the Pope who defeated the Soviet Union. It was interesting to see Mahmoud Abbas swiftly following the Vatican’s lead on its view of the Holocaust, in order to try and occupy whatever moral high ground that was lost by embracing Hamas[xviii].
The Vatican has therefore joined William Cohen[xix] (“The Short Good Friday”) and Tony Bliar[xx] (“Pride and Extreme Prejudice”) as a further confirmation that the crisis in Ukraine is linked directly to the crisis in Syria, which was first suggested in Age of Wisdom, Age of Foolishness (18) “Beyond the Pale”[xxi]. In effect, the double beatification is the direct link. Suddenly the linkage between the two crises does not seem so absurd after all. To add further context, Iran’s last President had strongly divergent views on the Holocaust from the Vatican. Iran is also the principal supporter of the Assad regime; and may soon provide the financial support for the Palestinians which Israel has just pulled.
“Team Obama” has come out swinging after the recent criticism levelled at it for appeasement of global bad guys[xxii]. President Obama spelled out his doctrinal approach to Ukraine, Syria and Iran for the confused observer. His strategy is to win incremental battles, rather than a total war. In his own words[xxiii]:
"That may not always be sexy. That may not always attract a lot of attention, and it doesn’t make for good argument on Sunday morning shows. But it avoids errors. You hit singles, you hit doubles; every once in a while we may be able to hit a home run. But we steadily advance the interests of the American people and our partnership with folks around the world."
The errors that are supposed to have been avoided are manifest in the current total deterioration of all of these geopolitical situations. “Team Obama” has struck out.
“I did not use the A-word. Never use it.”
Secretary Kerry’s zeal has been his downfall however. His recent miss, using the allegory of Israel and Apartheid South Africa did not go down well[xxiv]. His allegory, made in confidence, was leaked to erode his political capital. He has since tried a diplomatic retreat, about the use of the A-word just as absurd as Jeremy Clarkson’s apology for using the N-word, but his credibility and influence in the Middle East has been undermined; which will no doubt spill-over into his credibility and influence in the Ukraine.
Notwithstanding these failures, “Team Obama” can still manipulate the behaviour of the Ukrainian leadership. So it was therefore, that on the day that Obama was having “unsexy” dialogue with Angela Merkel[xxv] and the EU was having “unsexy” energy security dialogue with Russia[xxvi], the Ukrainian leadership launched a “sexy” offensive to retake the eastern city of Slavyansk[xxvii]. Just as Mrs Merkel was “un-sexily” explaining why she couldn’t get tougher with sanctions and the EU negotiators were reassuring their Russian counterparts of the same, all hell was breaking loose in Eastern Ukraine; and European Equities were starting to reflect this new threat. Risk managers and portfolio managers will now be spending the weekend trying to put a potential financial number, on the potential carnage, for their CEO’s. The “Plunge Protection Team” will be studying its technical chart points, for maximum results from economy of force.
The EU has more at stake than just energy security. As the CFR recently pointed out, European banks, particularly the French, have got significant exposure to Russia. Given Italy’s volatile political landscape and its financial exposure to Russia, which increased whilst other scaled back, it is hard to see any interest in tough sanctions from there either. It is hard to imagine the EU triggering the next debt crisis to save Ukraine, which is not even an EU member. President Putin ran his numbers very well, which is why the current credit downgrades and financial crisis in Russia actually applies directly to the EU, despite the propaganda and omissions from the western credit rating agencies. “Team Europe” therefore has little interest in sanctions that bite. “Team Obama” must therefore apply leverage, via the Ukrainian leadership, which now understands that “Team Europe” is about to sell it out for energy and financial security.
“Team Obama” however must also be aware that its own banks are significantly at risk. It would seem that Russia is “TBTF” in both financial and energy terms. The only Achilles Heel for Russia is the fact that a significant component of its Military Industrial Complex supply chain is based in Eastern Ukraine[xxviii]. The production of Russian attack helicopters and intercontinental ballistic missiles is very dependent upon Eastern Ukraine. Currently 40 per cent of Ukraine’s machinery exports are to the Russian military. Since Russia under Putin has embarked on a strategic rearmament programme, valued at $646 Billion which will last for more than a decade, the loss of Ukraine would be a massive strategic problem. It would also be a loss in hard currency earnings to Russia’s booming arms export industry. This is presumably what is really worth fighting for; and why Russia threatens to intervene militarily. It is presumably why Crimea and its Black Sea port were annexed also. It is presumably why Russian speakers were resident in these places in the first place. The inevitability of this Russian rational strategic reaction seems to have been timed closely with the US Presidential Cycle; and the return of the “warmongers” who Jimmy Carter warned of[xxix] in Age of Wisdom, Age of Foolishness (24) “The Short Good Friday”.
The only Democrat feeling secure currently is Hillary Clinton. Fairleigh Dickinson University's new PublicMind poll shows her trouncing all the predicted potential GOP candidates in 2016. Jeb Bush comes off the worst; so assuming that he is still up for it he has got his work cut out. His “love” for the Hispanic and Asian immigrant (legal and illegal) is thus very important and needs to grow manifestly in magnitude and amplitude.
Mario Draghi actually said something different last week. Even more interestingly, what he said actually reversed his traditional and timely vocal support for the European markets. It should be noted that he was speaking for a German audience however, so his assurances that he would not be imminently doing any bond buying[xxx] must be put into Teutonic monetary context. Draghi should be called Zelig; due to his uncanny habit of assuming the appearance and demeanour of whatever audience he speaks to. One day, he will have to dance as well as sing all characters simultaneously though, which will be an interesting performance to watch.
European countries are also milking their Central Bank, in a similar way to American CEO’s. Rather than restructure their economies, European countries are happy to fire workers and cut output in order to meet fiscal austerity targets. European CEO’s have also followed their political leaders and hunkered down for no growth. This hunkering down obliges them to seek economic rent from their business portfolios; and to raise prices in order to defend this rental franchise. It is this behaviour that acquisitive American CEO’s find so attractive.
In Age of Wisdom, Age of Foolishness (25) “Pride and Extreme Prejudice” the subtle assassination of Prime Minister Abe by BOJ Governor Kuroda was observed, as the central banker distanced himself from the inflationary consequences of “Abenomics”[xxxi]. Last week, Kuroda twisted the fatal arrows a little deeper into the wounds, when he failed to ratchet up the monetary stimulus and opined that he saw the economy weathering the recent Sales Tax increase. He also said that he saw inflation rising going forward, in a vague manner which failed to say that the inflation was being driven by the Sales Tax hike and BOJ monetary easing. By some miracle, the Japanese consumer is supposed to withstand the rising prices and flat salaries. The auto sector is the first casualty of the Sales Tax hike, with deliveries falling to the lowest level since December 2012 post tax hike[xxxii]. The April Manufacturing PMI decline illustrates the damage that the Sales Tax hike has done[xxxiii]. Japan Inc (and its equity market) received another “Abenomic’s” gift, in the form of a cut in corporate taxes[xxxiv]. Japan Inc has been gifted pricing power and now the opportunity to pay less tax on this pricing power. An average Japan Inc CEO therefore has every incentive to raise prices; and no incentive to invest or hire. “Abenomics” has therefore redistributed wealth from Japanese consumers to Japanese companies. It has shot itself in the foot by reducing aggregate demand through inflation and a Sales Tax increase. This shot is not however fatal for its equity market just yet, until companies have raised their prices to levels at which the consumer retrenches further.
Kuroda however is not invincible to the Three Arrows of “Abenomics”. It would seem that Abe has his own Ninjas, hidden on the board the BOJ, who are dissenting of Kuroda’s view on rising inflation. These three Ninjas recently attacked and fatally wounded Kuroda with three arrows of their own[xxxv]. According to Kuroda, there is “a high possibility” of the inflation rate reaching the bank’s target of 2% “around the middle” of its price forecast period between April this year and March 2017. Ninjas Sato and Kiuchi refused to endorse the use of “a high possibility” and asked for it to be removed. Ninja Shirai separately demanded that “around the middle” be replaced with “toward the latter half”. Mr Kuroda’s own position is now under threat.
God bless the inspiration for Age of Wisdom, Age of Foolishness (24) “The Short Good Friday”
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