Generation Debt Bomb
“Civilization and profits go hand in hand.” – Calvin Coolidge
Somebody should make a movie about the life and times of David Wittig.
Just nine years after graduating from Kansas with a degree in economics, Wittig made the cover of Fortune magazine (November 24, 1986). He was the hero of an article entitled “Wall Street’s Overpaid Young Stars”. At only 31, Wittig was already making $500,000 a year at Kidder Peabody.
There Wittig sat, on the cover of Fortune, cigar in hand, making sure you and everyone else knew just how rich he was. I wonder if his mother was proud…or embarrassed.
But as with the market, so with market players: what goes up usually comes down.
After attaining “master of the universe” status as a junk bond trader at Kidder Peabody – a firm that imploded because of the ethical lapses of its top traders – Wittig moved on to Salomon Brothers. The questionable ethos of Saloman at the time was documented aptly by Michael Lewis’s book “Liar’s Poker”. I can summarize the theme for you – steal as much as you can from each of your clients and brag about it to all of your friends.
David Wittig: Western Resources
What was the encore to this fine Wall Street career?
In 1995, John Hayes, CEO of Western Resources (now Westar Energy), Kansas’s largest utility, wanted to juice things up and move his firm into the new “unregulated” field of power trading and services. He hired Wittig away from Salomon to be the head of corporate strategy.
Soon, Wittig had Western Resources embroiled in several high-profile, Wall Street-esqe takeover battles. One such skirmish was for Kansas City Power & Light; another was over ADT, a security firm being pursued by the acquisitive Tyco.
In the end, Tyco agreed to fork over $800 million for Western’s shares of ADT. And on the strength this one lucky deal, Wittig ascended into the corner office at Westar Energy.
As CEO, Wittig turned out to be a one-trick pony. He bought another security firm, Protection One – but this time there was no Tyco waiting in the wings. The acquisition has cost $2 billion in losses and prompted an SEC investigation. Meanwhile, Wittig was paid millions in salary and benefits. And it’s alleged he took a little more than the board was paying, too. Wittig was indicted on money laundering charges after he “falsely borrowed” $1.5 million. (N.B. To most of us, “falsely borrowing” means stealing.)
David Wittig: Embracing Bad Ideas
Wittig embraced all of the bad financial ideas of his generation – from junk bonds to highly leveraged takeovers. He found a way to make himself rich…but only at a steep price to his partners.
Wittig’s generation embraced a lot of bad ideas. I’d include drugs, disco, free love, affirmative action and conspicuous consumption for starters. But the worst ideas of this generation relate to financial management…or the lack of it. No other generation of Americans has ever been so in debt. No other generation of Americans has ever made so much…with so little to show for it.
The press calls this generation of Americans the “Baby Boomers”. I call this group, born largely in the 1950s, “Generation Debt”.
Private and corporate debts (owed mostly by Baby Boomers and the companies they now control) are the single largest threat to America’s prosperity, thanks to America’s companies’ buy-now-pay-later approach to life. As the boomers have come to power since the late 1970s, American corporations, in the aggregate, have suffered negative cash flows. Profits have not equaled capital expenditures in any year for the last 25 years. Even the very best American corporations have become addicted to debt. GE, for example, has been a net borrower since 1992.
Individually, meanwhile, Americans have leveraged their home mortgages to a degree unprecedented in our national experience. Lawrence Capital Management details the phenomena by noting that in the last 19 quarters, total mortgage debt increased by $3 trillion (+58%). To put this in perspective, prior to 1997, it took 13 years to add $3 trillion in mortgage debt. Or, said another way, before 1997, around $50 billion a quarter was being borrowed against homes. Today, the run rate is near $200 billion per quarter, or four times as much. Household borrowings now total $8.2 trillion in America, and they continue to grow at near double-digit rates.
Total non-financial debt (public and private) now stands at $20.3 trillion, nearly triple annual GDP. Interest on our debts alone now tallies 7% of GDP.
David Wittig: Small-Town Wittigs
These numbers mean little in the abstract. But consider the typical member of generation debt – your neighborhood’s own small-town David Wittig. Your neighbor, corrupted by the same zeitgeist, spends more than half his income on debt service and taxes. His total savings – on average – tally around $40,000, including savings earmarked for retirement. When something goes wrong – say your neighborhood’s version of Enron or Long Term Capital Management – your neighborhood generation debtor doesn’t have any financial safety net. Over 400,000 Americans went bankrupt in the third quarter last year, the most ever for one quarterly period.
In their teenage years, members of Generation Debt brought us “flower power” and Woodstock. As they grew older, their ideas of sexual freedom and promiscuity led to the AIDS epidemic we face today. In the 1970s, they embraced drugs and disco. In the 1980s, they discovered money and began a consumption binge like none ever seen before. In the 1990s, this generation elected the Clintons to the White House…
But the worst damage wrought by the Baby Boomers comes from their work in the boardroom and their ideas about business. These people believe that profits are bad.
Last month, I was searching for a stock to recommend to the readers of my newsletter. I almost couldn’t find one. There are lots of good companies – even in the tech sector – but almost none of them are run with the goal of producing a real profit for shareholders.
Consider Adobe Systems, a leading software firm. Sales are rebounding. Earnings are up. But profits available to shareholders have all but disappeared. In the last five years, net income has grown from $105.1 million to over $191 million. Sounds great, doesn’t it? And it would be, except stock-based compensation in the same period grew from $50 million year to over $184 million a year. Taking into account options expenses, net income shrank from $54 million to only $6 million. Adobe, a firm valued by Wall Street at $7 billion, can only produce $6 million in genuine net income. Bruce Chizen, Adobe’s CEO, was born in 1956. Generation Debt.
David Wittig: Yahoo!
Steve Jobs – the picture-child of baby boomers – is another example. Apple Computer, the company he founded and still runs, lost $25 million in 2001. It paid out $371 million in stock-based compensation that year. In 2002, results were better: the company made $65 million. But results for shareholders were just as bad, as Apple spent $229 million on stock-based compensation. Fittingly, Al Gore is now on the board of directors at Apple. Jobs gave him 30,000 shares. And why not? He invented the Internet, so he must know a lot about the computer business…right?
The worst options accounting abuse, however, goes on at Yahoo! It’s a shame, because this company has a great brand and the potential to become the first important media company of the Internet. Last year Yahoo! had a net income of $42 million. But it spent more than ten times that amount on stock-based compensation: $482 million. The year before, $890 million was given to employees at shareholders’ expense. And the year before that, $1.3 billion in stock was doled out. Since 1998, Yahoo! has lost over $3 billion on operations – when you include stock- based compensation. Officially, the company reports earning $55 million in the period.
There are many other examples I could cite…but the all point to the same conclusion: the best businesses of an entire generation aren’t producing long-term wealth. Instead, they’re merely producing compensation and consumption.
Baby Boomers are approaching retirement with nothing in their saving accounts. Their equity portfolios have been demolished, and their pension funds are wiped out. But the most dangerous sign of all is that even now, the companies headed by their contemporaries can’t produce real profits or real dividends for shareholders.
Without a revolution in the boardroom, the baby boomers will never retire. There simply aren’t any profits where there should be in the companies created by this generation in the 1980s and 1990s. Meanwhile, old-line blue-chip firms with good earnings and sensible accounting policies are crippled by the pension obligations they currently owe to an older generation.
The baby boomers are heading into retirement with no savings and no productive companies to support them in old age. Generation debt is a ticking time bomb…with about ten years left on the clock.
for the Daily Reckoning
April 14, 2003
“Where’s the dividend?”
The Washington Post wonders what we wonder. The war went as planned…it was so quick and easy, another one is almost inevitable.
But so far, the stock market has failed to throw confetti or splash champagne. Mr. Market, supposedly looking ahead, does not seem particularly overjoyed. What does he see?
Barron’s takes a guess. Bubble II seems to be forming in tech stocks, says this week’s paper, with our old friend the river-of-no-returns stock, Amazon.com, trading at 80 times earnings. Of course, 80 times earnings is an improvement over the Bubble I years…in which Amazon had no earnings. eBay, meanwhile, has a P/E of 65…and Yahoo trades at 69.
The S&P 500 sports a P/E of 30 times reported earnings. Based on core earnings – which are closer to the truth – these stocks sell at nearly 40 times earnings.
Stock buyers may be bullish on America…and bullish on its military…but not necessarily bullish on its currency or its stocks.
The number of equity funds fell in February for the first time since Bubble I began in ’96. In ’97 there were 3000 stock funds. Today, there are 4750, and falling. In the last major bear market, the number of funds fell for a period of 9 years…so that there were fewer in ’81 than there had been in ’70.
We are in the 4th year of a bear market. Stocks are lower today than they were when the year began. Even with the war behind us…Mr. Market seems to see little reason to change course…
Eric, who is closer to Mr. Market, has more details…
Eric Fry, reporting from Wall Street…
– Mr. Market is AWOL! For weeks, he had been bravely charging ahead, shoulder-to-shoulder with the advancing coalition forces. But last week, as coalition troops stormed the Iraqi capital, Mr. Market turned tail and ran. The Dow Industrials retreated 73 points for the week to 8,203, and the Nasdaq pulled back 1.8% to 1,358. Evidently, Mr. Market encountered a far more terrifying foe than the Republican Guard: a toothless American economy…Dodging rocket-propelled grenades is nothing compared to ducking a weekly barrage of initial jobless claims.
– “For weeks, perhaps even months, the market has been hostage to the war – first in fearful anticipation, then with its actual onset and breathtakingly swift resolution, pure elation,” remarks Barron’s Alan Abelson. “But no sooner was it manifestly clear that the good guys had emerged victorious and Saddam Hussein was history than the celebration came to an abrupt end and the war, together with its attendant triumphs and looming consequences, was no longer front and center in investor consciousness.”
– The Iraqi V-Day inspired no euphoric stock market response. Perhaps that’s because when the stock market “Johnny” comes marching home again, he will not find his sweetheart economy awaiting him with open arms. Instead, he will find her conducting a ménage-à-trois with rising unemployment and falling corporate profits.
– “In the past two months, employment has dropped by 465,000, in the past two years by nearly 2.5 million,” Abelson observes. “And the stubborn refusal of weekly new claims for unemployment insurance to slip below 400,000 betokens an extension of this doleful trend this month and gosh knows for how months to come.”
– Making matters worse, says Dan Denning, the “Europeanization” of the U.S. labor market will inhibit job growth for years to come. “Healthcare and pension contributions, in particular, are making it more expensive for the average American business to hire additional workers,” says Denning. “The American labor market is increasingly European, both in generalities and in particulars. Generally, political pressure to provide better healthcare and benefits is raising real employment costs, making it harder for business to expand.”
– And so, they are not expanding; they are cutting – both workers and workspaces. The U.S. office vacancy rate jumped to 16.2% in the first quarter – the ninth straight quarter of rising vacancies and declining rents. “One worrisome sign,” says the Journal, “was the return of so-called negative absorption – a drop in demand for office space. In previous real-estate cycles, demand always grew at least slightly, even if vacancy rates soared because of overbuilding. Tenant demand slipped 1.2% in the quarter in the nation’s top 50 markets, according to Reis Inc., a New York real-estate research firm.”
– The economy’s other intimate companion, falling corporate profits, just keeps hanging around. The S&P 500 is trading for about 16 times forecast 2003 operating earnings. 16 times earnings, while not an obscene valuation, is not exactly cheap either, especially when one considers that energy stocks account for ALL of the S&P’s anticipated earnings growth.
– “Earnings for the energy companies in the Standard and Poor’s 500-stock index are expected to nearly triple for the first quarter, far higher than the aggregate 7.2% rise expected for companies in the broad index,” observes the Wall Street Journal’s Ken Brown. “Without [the contribution from energy stocks], earnings for the index would be down 7.1% for the first quarter.”
– Surprisingly, as we have pointed out previously in this column, most energy stocks have been trailing behind the S&P 500. Clearly, incredulity is priced into the energy markets. Based on the uninspiring price trend of most energy stocks, investors expect energy prices to fall…a lot! Who knows, a little faith in rising energy prices may be a rewarding bet.
Bill Bonner, back in Rome…
*** “The Pension Chasm” is how the Washington Post describes it. It is the deep crevice between what the retirement people hope to have in retirement and what they can actually afford.
“Within the next few weeks, many thousands of Britons are going to receive the shocking news – in their annual pension forecast – that the amount they can look forward to when they retire will be up to 75 per cent less than they expected,” reports my old friend Martin Spring, from England.
But what is true in the old country may be even truer in the new one. Martin continues:
“In America, the pension, healthcare and insurance expenses of former employees who have already retired account for almost $900 of the cost of every vehicle sold by General Motors. The $70 billion deficit in its employee benefit funds threatens to swallow up its entire cash flow surplus over the next few years, leaving nothing for shareholders.”
*** We keep saying…but now cannot remember why…that the glory days of American capitalism are over. The system no longer rewards the capitalists – it is the proletariat, their lawyers…their politicians…and the lumpen-voters that benefit.
*** Looking out from our balcony this morning, in the bright sun of an Italian spring, we count at least 16 churches. And there, off to the left, is a huge monument to Victor Emmanuel II. Nobody seems to know what happened to Victor Emmanuel I, for there is scarcely any mention of him in the history books and not even a small monument. Behind the grandiose edifice for the second Victor Emmanuel are the ruins of the Forum…and the Coliseum up the hill.
*** On Saturday, we went to visit Hadrian’s villa at Tivoli. The place, of course, is in ruins. Edward, enjoying the open air, jumped over 2000-year-old walls…explored subterranean passages…ran around in what used to be communal baths…
In his exuberance, he ran into a Doric column. And for a moment, we feared Edward had done what the Goths and Alamani and other barbarian tribes had done before him – left the place in even greater ruin than he found it. But the column held…
We are here wallowing in Roman history, bumping into columns, tripping over statues, knocking against the bones of an empire that once controlled almost all of Europe and the Mediterranean basin…and after which almost all Western governments have been fashioned. Senates, parliaments, constitutions…lobbyists…demagogues…if Rome did not invent them, she made them famous. And even the monuments you find along the Potomac or the Thames are little more than recreations of those here in Rome. Down the hill from our apartment is a pillar commemorating Trajan’s victory over the Dacians. Except for the detailed history in bas-relief on the column itself, the pile looks almost exactly like the monument to George Washington erected in front of our office in Baltimore at the end of the 18th century. We would have to study the face more carefully to be sure it’s not the same person.
*** Yesterday was Palm Sunday, recalling Jesus’ triumphal entry into Jerusalem. He was greeted with hosannas, say the gospels, and with the ancient world’s equivalent of red carpet; the crowd spread palm leaves on the ground for him to walk on. We marked the occasion with a mass at the Chiesa del Gesu, a spectacular church built for St. Ignatius Loyola. We arrived early, fearing that the huge house of worship would be mobbed by Catholics on one of their most holy days. Instead, there were almost as many priests as worshippers.
The church is stunning. Somehow it seems to have escaped the impulse of the ’70s and ’80s that led Catholics to strip their churches of adornments. Hardly a square inch of the interior is free from gold leaf…statues…paintings. There is even a statue of St. Ignatius Loyola so extravagantly decorated in azure stone and polished silver that it is worthy of Louis XIV. The ceiling is painted in the marvelously voluptuous Italian fashion – with angels and archangels and enough rosy flesh to give you a crick in your neck by the end of the service.