Those new stock-market records? Just another bubble—but this one might well finish us. ‘Great Deformation’ author David Stockman tells Daniel Gross where we went wrong, and who’s to blame.
Most 742-page jeremiads aren’t much fun to read. But The Great Deformation, David Stockman’s revisionist history of the past 100 years of capitalism American-style, is a spirited, occasionally gleeful skewering of many of our most widely held assumptions and most lionized figures. A former divinity student, Stockman chronicles what he views as the moral rot in the American financial system—one fueled by easy money, profligate debt, and needless government intervention. To a degree, this book is autobiographical. As a congressman, Reagan-era budget official, and private-equity executive, Stockman has lived through the booms and busts of the past half-century. He knows the world of which he writes from the inside out. And in The Great Deformation, few escape his opprobrium—current and past policymakers, Roosevelt and Reagan, Democrats and Republicans, leveraged buyout titans, and corporate CEOs. “Sundown now comes to America because sound money, free markets, and fiscal rectitude have no champion in the political arena,” Stockman writes.
David Stockman. (Louis Lanzano/AP)
He spoke with Daniel Gross about The Great Deformation.
Reading this book, it seems like your approach was less that of a historian than that of an archeologist.
Right. Economic archeology. I started reacting highly negatively to the bailouts in September 2008. The Federal Reserve was creating $600 million an hour in new money. That was a disconnect, a major leap into the unknown. And I thought the bailouts were a repudiation of everything that the Republican Party and conservatives stood for. I didn’t believe the rationalizations at the time. I started on Capitol Hill in 1970, as a young guy on the sidelines and then a congressman, then in the thick of it in the Reagan era, then on Wall Street. So this is an effort to make sense of all the experiences and encounters, of the evolution I personally witnessed. And the deeper I dug into it, the more I became convinced that the whole thing was an unnecessary panic. So I had to dig into the root causes. So I backed into the tenure of Alan Greenspan and Reagan, and all the way back to the founding of the Fed—basically a reconsideration of 20th-century economic, fiscal, and monetary policy.
You were a divinity school student. The title—The Great Deformation—and tale of the decline you describe has an Old Testament-prophet quality to it. Is this a morality tale? And is the U.S. like the Catholic Church circa 1518?
I wouldn’t carry the analogy too far. It’s not so much a comparison or wordplay on the Reformation. I do believe free markets are the only route to prosperity. But they have been so deformed and distorted and misused. This book is a polemic. It is an attempt to identify where we got off track and how one thing compounded another. It’s not meant to be any kind of a moral tract but a chronicle of where things went wrong in a practical sense. For decades now, mainstream opinion has held that the markets and capitalism are good, but they have inherent flaws and tend to wild swings in the business cycle. My argument is that we’ve so overloaded the state, including the central bank, with tasks that it is paralyzed and is caught in policies that are clearly not sustainable. In trying to solve the alleged problems of capitalism through an act of the state, we’ve ended up wrecking the state. I call it statewreck.
There’s something in here to disappoint everybody. Liberals excited at the way you take after Alan Greenspan will be chagrined at your critiques of the New Deal. And libertarians who like your critiques of the Obama stimulus probably won’t like your harsh take on Reagan.
This year’s tax increases were supposed to destroy the country and send Americans to the bread lines. That didn’t happen. In fact, the economy is pretty damn happy, writes Daniel Gross.
What if they threw a big tax hike, and nobody noticed?
On January 1, a new set of allegedly confidence-killing, consumption-destroying, investment-unfriendly taxes hit the economy. The payroll tax rose from 4.2 percent to 6.2 percent on the first $113,700 of income. The top marginal rate rose from 36 percent to 39.6 percent for families with adjusted gross income above $450,000. Taxes on capital gains and dividends for those same top earners rose from 15 percent to 20 percent. Meanwhile, the Affordable Care Act levied an additional 3.8 percent tax on investments, and an additional .9 percent Medicare payroll tax on families with adjusted gross income of more than $250,000.
The notion was that putting these taxes on the rich and middle-class, taxing income and investments, at a time when the economy was going at a painfully slow rate, would cause people to stop spending and investing, go Galt, and send the economy into a recession. To read the Wall Street Journal editorial page, you would have thought Hugo Chávez had been named to succeed Barack Obama.
But three months into this new experiment in extremely mild socialism, it seems like Americans are generally shrugging off the tax increases. A survey released this week by Bankrate.com found that “more than half of working Americans either haven’t noticed (48 percent) or have been unaffected by (7 percent) the January 1 expiration of the payroll tax cut.” Some 30 percent said they’ve reduced spending, while 11 percent are saving less as a result. Bankrate.com analyst Greg McBride noted that “the lowest-income households were the least likely to have cut back on spending and the most likely not to have noticed the change in the payroll tax.”
Of course, surveys measure feelings and intentions, not actual activity. But pretty much every consumer indicator has continued to tick up through the first few months of 2013—all in the face of higher taxes. Home sales and auto sales have risen smartly in the first two months of the year. Overall retail sales in January and February were up 4.3 percent from the first two months of 2012. The ICSC/Goldman Sachs index of chain-store sales has been chugging along.
Sure, Walmart has complained of poor sales. “Where are all the customers? And where is their money?” read a plaintive internal Walmart email that surfaced in February. But Walmart has been struggling for the last several years, before and after the tax cut, as its core consumers cope with low wages. And as Renee Dudley at Bloomberg reported Tuesday, another factor may be at work. Her article argues that the company has scrimped so much on labor and labor costs that its shelves aren’t sufficiently stocked. And that is pushing customers to take their money elsewhere.
If anything, the economy on the whole has been strengthening since January 1. The forecasting firm Macroeconomic Advisers now says the U.S. economy, which grew at an anemic pace in the fourth quarter, is expanding at a 3.2 percent rate in the first quarter—and that includes the initial effects of the sequester.
The Cyprus banking crisis is reminding us of a fundamental, much-neglected truth about finance, writes Daniel Gross: when you leave money in the bank, you’re the lender.
So Europe resolved—at least for now—the crisis in the Cyprus banking system. Needing a massive bailout, Cyprus on Monday opted for what’s known as a “bail-in.” In exchange for cash from the European Union, the European Central Bank and International Monetary Fund, Cyprus will raise several billion euros by assessing a levy on uninsured deposits of its large banks. CNBC has the details: accounts above 100,000 euros in the Popular Bank of Cyprus and the Bank of Cyprus will be assessed a levy (or tax, or confiscation) of 30 percent or more.
Specialist Joseph Mastrolia, left, and trader Gregory Rowe work on the floor of the New York Stock Exchange Monday, March 25, 2013. U.S. stock markets opened higher after Cyprus clinched a last-minute bailout that saved it from bankruptcy. (Richard Drew/AP)
The relief was short-lived, as stocks around the world fell in response to the news. Why? Well, as we should have learned from five years of crisis management, the financial problems in Europe are never contained—especially when the relevant authorities say they are. More broadly, the “bail-in” is causing people to change the way they think about banks and the money they leave there. Indeed, Cyprus has forced us to relearn a fundamental truth that gets lost in the world of brands, 24-hour ATMS, catchphrases and goofy ads as banks compete feverishly for wallet-share. When you leave money in the bank, hoping to get a small return of interest, you’re not investing. You’re lending money. When push comes to shove, you’re not a customer of the bank. You’re a creditor. And these loans, like every other type of loan, can go bad.
When financial entities fail in the business world, the people who have made commitments to them suffer losses. Stockholders get less than they paid for their shares, and may wind up with nothing. Other stakeholders—the landlord who rents space to a store, the supplier who extended credit, workers with underfunded pensions, bondholders—settle for less than they were legally entitled to by contract. These “haircuts” take place all the time in and out of bankruptcy courts.
Now, in the U.S., and in most other places in the 21st century, the overwhelming majority of us “lend” to banks without consequence, and without fear of loss. In the U.S., the Federal Deposit Insurance Corporation’s will insure up to $250,000 of “loans’ made by a single customer to a single bank.
When your bank fails, as hundreds have in the last several years, the FDIC fund, which now contains $33 billion, steps up. And in 2008 and 2009, when it seemed as if the insurer would be overwhelmed by a tsunami of failure, the Federal Reserve and Treasury offered further guarantees. That’s how the U.S. prevented the Great Panic of 2008 from turning into the second coming of the Great Depression of the 1930s.
Regulatory orthodoxy in the U.S. and Europe has generally held that banks can’t be allowed simply to collapse because they are too interconnected and too leveraged. Lenders, it turns out, are prodigious borrowers themselves—banks borrow from one another, from the capital markets in the form of bonds, from central banks, and from depositors. When they fail to make good on their commitments, it triggers a host of failures and a chain reaction that effectively freezes economic activity. See: Lehman Brothers, September 2008. The investment bank owed more than $600 billion to other parties. Its plunge into bankruptcy caused the entire global financial system to go into a deep freeze.
A sign in a shop window in Nicosia, Cyprus. March 25, 2013 (Milos Bicanski/Getty)
He walked away from his high-energy cable-news slot last summer and ventured into greener pastures: an ex-Marine’s organic farming enterprise aimed at employing his fellow veterans.
Dylan Ratigan resurfaced this week.
After nearly two decades of climbing the New York media ladder—Bloomberg wire-service reporter, anchor at Bloomberg TV and CNBC, a self-titled show on MSNBC—Ratigan walked away from his show last June. On Wednesday, he announced on his blog that he has moved to Southern California to help a former Marine build a network of hydroponic greenhouses aimed at employing fellow veterans.
(L-R) Carla Hall, journalist Dylan Ratigan, and Daphne Oz speak on “The Chew” on March 21, 2013. (Donna Svennevik/ABC via Getty)
Cue the snark from the Twitterverse and the blogosphere. Many of us occupy a world in which having your own hour on a cable channel is an all-consuming goal and the ne plus ultra. Ratigan, who lived the dream, now inhabits one in which people don’t know what a “hit” is, men typically don’t wear makeup, and few people know—or care—what TVNewser is. “I don’t miss it,” he told The Daily Beast on Thursday. “I teach a class at the school on the farm with the veterans, and somebody will occasionally raise their hand and say, ‘Aren’t you the guy who did the crazy rant on YouTube?’ “
The crazy rant came in August 2011, a Howard Beale moment from a journalist who understood the financial crisis from the inside out, and watched in disbelief and rage as banks and financiers got bailed out while veterans returned home to a poor jobs market. Ratigan fleshed out his frustrations in Greedy Bastards, a book about the intertwined and corrupt financial and political systems. The show and bestseller were simultaneous jeremiads about the search for solutions. Aside from just talking heads and journalists (disclosure: including me) tossing around left-right talking points, his show featured people who were trying to make a difference, discussions of sustainable agriculture, renewable energy, and jobs programs.
As a working journalist, Ratigan had long believed that “telling good stories and revealing not readily apparent truths have benefit—to the investment structure, or the culture, or the political construct,” he said. But by mid-2012, “I had lost any sense that that was true.” And so after the book launched, a frustrated and burned-out Ratigan walked away, seeking meaning and purpose in his life. “After 780 hours of political cable news, 6,000 hours of live financial television, 45 cities, two national jobs tours, 277,963 signatures to amend the Constitution, 245 pages of book, and a promotion tour for Greedy Bastards, I was exhausted,” he noted on his blog this week.
Many observers believed Ratigan’s next step (after a long vacation) might include a run for office, or a return to another platform—another program, another network. But Ratigan was spending more time with a couple he had met on his show, Colin and Karen Archipley. Colin is a Marine veteran of three combat tours in Iraq who had redefined his mission as building hydroponic greenhouses that can be run by veterans.
Last fall, at a U.S. Marine Corps ball, Ratigan hung out with Archipley and members of Lima 3/1 Company—a group of guys who had been through hell in the Battle of Fallujah. “And they weren’t resentful, and they weren’t petty and self-absorbed,” Ratigan said. Impressed by their strength, their potential, and Archipley’s leadership, Ratigan had an epiphany. “I had all my hesitations about my own assets and my own life. I was just like, ‘Fuck it.’ Understanding what they had been through, all I had to do was move across the country.” Ratigan sold his Tribeca loft on North Moore Street, sold the Porsche Cayenne Turbo, and rented a 1933 furnished log cabin near Dana Point, California. “The only thing I own inside of it is my clothing,” he said.
The $614 million Steven A. Cohen’s SAC Capital paid to settle SEC insider-trading charges is worth celebrating for reducing our deficit—but Daniel Gross says our culture of settlement is deeply corrosive.
Late Friday afternoon, this year’s budget deficit instantly shrank by more than $600 million through an extraordinary tax levied on a few very rich people.
Mathew Martoma, former SAC Capital Advisors hedge-fund portfolio manager, exits Manhattan federal court with his attorney, Charles Skillman, left, on November 26, 2012, in New York. (Louis Lanzano/AP)
The payment will flow into Treasury’s coffers because SAC Capital, the huge hedge fund run by billionaire Steven A. Cohen, agreed to settle. Securities and Exchange Commission charges that SAC and its affiliates had profited by trading on insider information. The charges, outlined last November, were relatively simple. The government alleged that an SAC trader, Mathew Martoma, received inside information on trials of drugs made by two companies, Elan and Wyeth. A doctor who helped run the trials had admitted to passing on the information in exchange for cash. When the fund learned the trials wouldn’t be successful, the government alleged, the hedge fund sold its large position and then bet the stock would go down—saving it from huge losses and allowing it to reap big profits.
The $614 million settlement, the largest in the SEC’s long history, is worth celebrating for its contribution to deficit reduction. It also should bolster the confidence of millions of ordinary shareholders. The regulators showed an ability to detect misbehavior, to find and act legally against those who carried it out, and to recover large sums of money.
But we shouldn’t let the large figure cover up the deep cynicism at work here. Indeed, the culture of settlement that the SEC and Wall Street have constructed over the years is deeply corrosive. Here’s why.
Reviewing the complaint, it sure seemed as if the government had the goods on Mathew Martoma and, by extension, SAC. The doctor who provided the information had already agreed to cooperate. The timing of the trades appeared highly suspicious. But the SEC was happy to settle—at the right price. Why? An enforcement action is an enforcement action, and this is a volume business. A Wall Street Journal article on Monday noted that the number of SEC enforcement actions seems to be going down—at a time when the public is still thirsty for blood. Settlements don’t chew up the time and manpower that trials do. They allow regulators and prosecutors to escape the potential hazards of a trial, in which a mistake, a well-constructed defense, or simply a few stubborn jurors can mean a person suspected of wrongdoing gets off free. So the SEC settles. For the right price, the settling party enters a kind of existential limbo—it is allowed to deny guilt while also being prohibited from declaring its innocence. The SEC adds the case to the list, sends the money to the Treasury, and winks at the public. Sure, the party settling the case gets to say he didn’t do anything wrong. But really, if he hadn’t done anything wrong, why would he be paying this huge fine?
For the settling party, a different cynical calculus is at work. Wall Street is a world in which everything has a price—even the ability to walk around saying you didn’t do anything wrong. For SAC Capital in this instance, that price turned out to be $614 million. Far from being embarrassed, the company is officially glad. “We are happy to put the Elan and Dell matters with the SEC behind us,” spokesman Jonathan Gasthalter said in a statement to the press on Friday. “This settlement is a substantial step toward resolving all outstanding regulatory matters and allows the firm to move forward with confidence. We are committed to continuing to maintain a first-rate compliance effort woven into the fabric of the firm.”
Happy? People who run hedge funds are never happy about doing something that causes their net worth to decline by more than $600 million—or even by $6 million. These are people who live and die, and measure their status, self-worth, and manhood by the size of their bank accounts. Even for a billionaire like Cohen, who owns much of SAC and hence will foot much of the settlement bill, $614 million is a lot of money.
The latest retail numbers are up—a lot. Which means Washington insanity doesn’t crimp consumer spending, which means Americans still love to shop. Viva Costco, writes Daniel Gross.
If you visit public schools or public libraries, you’ll probably come across the Works Progress Administration–era social-realist murals that depict Americans—farmers, doctors, shopkeepers, laborers—going about their work with a sense of dignity. Aside from providing employment to idle painters, these Depression-era works were meant to show people calmly going about their useful social purposes in an unsettled era.
Today if I were to commission a mural highlighting the quiet heroes of our current economic era, it would look something like this: a teenager checking out at Abercrombie & Fitch; a 35-year-old mother with two kids filling the cart at Costco; a middle-aged man running into Cabela’s, stocking up on guns and ammo; a multigenerational family feasting at Olive Garden; and an office worker clicking the “buy” button on Rue La La when she should be working.
Why? Because at this stage of our expansion, which is heading toward its fourth birthday in June, shoppers are doing the heavy lifting.
The Census Bureau on Wednesday reported retail sales numbers for February. And they were impressive: up 1.1 percent from January to February and up 4.6 percent from February 2012. January’s gain was revised higher, too. To be sure, higher gas prices account for a decent chunk of the increase. But the report showed that consumers continued to spend despite of higher gas prices and all the other headwinds.
A second big number came out Wednesday. The Commerce Department reported that business inventories business inventories rose a solid 1 percent from December to January. In plain English, it meant that companies, anticipating that their sales might be higher in February and March, ordered more stuff to hold in inventory.
These numbers were surprising and caused analysts to ratchet up their projections for growth. Macroeconomic Advisers fed the data into its model and upped its fourth-quarter figure to 0.8 percent, and to 2.7 percent for the first quarter of 2013. Deutsche Bank’s economic-research team, led by economist Joseph LaVorgna, was even more optimistic. It jacked up its first-quarter GDP growth forecast from 1.5 percent to 3 percent, in part because “February retail sales surprised significantly to the upside, and there were upward revisions.”
The increase in sales is particularly important, because some of the other forces that propelled growth in the early stages of this expansion are petering out. Exports, which soared in 2010 and 2011, are showing signs of plateauing as the global economy slows. The government, which did a lot to stimulate the economy in 2009, has become a rolling force for austerity.
Bridgewater Associates is the $145 billion hedge fund elite college grads are clamoring to work for. Daniel Gross on the oddball firm’s special sauce.
In the Northeast, spring is in the air, and at Ivy League schools, kids are planning their postgraduate futures. But this year, many of the smart young finance things who used to flood to positions at name-brand banks in lower Manhattan are casting their sights elsewhere. It’s not a bank. It’s not in New York. And it’s not a century-old global institution with a patrician name.
It’s Bridgewater Associates. Based in Westport, Connecticut, and founded and led by a person who is equal parts investing savant and shaman, Bridgewater might best be described as an alternative alternative asset-management company. It’s the creation of Ray Dalio, who was memorably described in a great New Yorker profile by John Cassidy thusly: “He looked a bit like an aging member of a British progressive-rock group.” Big shots like Stephen Schwarzman of Blackstone and Steven Cohen of SAC Capital may garner the headlines. But in recent years Dalio and Bridgewater have ridden new investment flows and superior performance to become America’s largest hedge fund, with about $145 billion in assets.
Bridgewater, which has 1,300 employees, isn’t for ex-jocks or day traders. Rather, it tends to attract—and look for—self-styled intellectuals and deep thinkers who like constructing arguments as much as they enjoy constructing portfolios. It’s “the thinking Yalie’s destination,” as one recent Yale graduate put it. Undergrads at Harvard report that the scandal-free firm is more desirable than Goldman Sachs, previously the ne plus ultra for young grads on the make. “Bridgewater is very popular because it is one of the few hedge funds that will accept people right out of college,” says a Harvard undergraduate who interviewed with the firm. “Also, the hours tend to be better. In investment banking you’re working 100 hours a week, and at hedge funds it is more like 70.” (This student may be overestimating the amount of time employees of both investment banks and hedge funds spend working).
Economist Joseph Schumpeter, who invented the phrase “creative destruction,” analogized the upper strata of society as a hotel in which the guests are always checking in and out. That has been the case on Wall Street for the last many years. The list of blue-chip recruiters in 2006 would have included Lehman Brothers (bankrupt), Bear Stearns (essentially failed and merged into JPMorgan Chase), and Merrill Lynch (now a unit of Bank of America). The survivors—Goldman Sachs, JPMorgan Chase—are all shedding workers and bringing in smaller classes. Meanwhile, other companies have come up in the world. BlackRock, the bond giant, boasts more than $1 trillion in assets. Private-equity firms like the Blackstone Group and KKR, which weathered the storm, are continuing to transform from small partnerships into large institutions. They’re hiring.
Then there’s Bridgewater, whose workplace more closely resembles The Master than Wall Street; the trading day is like a long encounter session in which people learn about themselves, and then trade their way to prosperity.
The edge at most hedge funds is getting an informational edge, or using holdings to push for changes in management. Bridgewater, which manages money on behalf of public-employee pension funds like the Pennsylvania Public School Employees’ Retirement System, foreign sovereign wealth funds, and other institutions, has a different approach. Bridgewater is a macroinvestor, meaning it analyzes big-picture economic trends, data, and market behavior to come up with ideas about how to profit off the movement of stocks, bonds, and currencies all over the world. The strategy appears to be working: Bridgewater’s main fund has returned 14 percent annually since 1991, with only one losing year—an astonishing record. As The Economist noted, over the last several years, the hedge-fund industry at large has underperformed the S&P 500 index.
To keep its machine finely tuned, Bridgewater searches out young intellectuals in addition to hiring experienced workers. No surprise they recruit from the Ivy League. The company “recruited incredibly aggressively at Yale,” noted one recent Yale graduate. “They offered students who did not apply for their summer internship program $100 gift cards to sit in a focus group and explain why.” Students say they received several emails from the company—personally addressed to them from friends or associates who were at Bridgewater.
The interviews themselves have become legendary. “Really weird” and “very confrontational” were two phrases used by students to describe the on-campus interview. A candidate is likely to be put in a room with about seven people. Instead of being grilled about stock trades or economic issues, students will be asked to debate controversial topics like Roe v. Wade or gun control for an hour. “They wanted you to compete with each other,” said a Harvard undergraduate. “Unsurprisingly, quite a few members of the Yale debate team end up working there,” says the recent Yale graduate.
Time Warner’s founding division, which was spun off Wednesday, still makes money. But while most media companies would be happy with the magazine unit’s performance, Time Warner isn’t a sentimental place, says Daniel Gross.
Time Warner announced Wednesday that it is spinning off Time Inc., its magazine unit, to existing shareholders as a separate company. Effectively, the parent company is cutting ties with the original founding division of the company. Time Inc.’s stock will trade separately, with its own management.
Oprah Winfrey and Time Inc. CEO Laura Lang attend Time’s screening of “Lincoln” in October in New York. Lang has stated that she will step down from Time Inc. (Neilson Barnard/Getty)
Until Wednesday, the presumption had been that Time Warner would effectively sell most of its magazines, including big moneymakers People and InStyle, to Iowa-based Meredith Corp. But Meredith, which specializes in women’s and consumer magazines, wasn’t interested in taking on harder-news Time, Fortune, Money, and Sports Illustrated. Rather than hold on to those prestigious titles as a small rump unit, Time Warner CEO Jeff Bewkes decided to spin off all the magazines to the public as a group.
The move highlights the dizzying pace of change in the media business. Time Inc. CEO Laura Lang arrived at the company in January 2012. She replaced the prior CEO, Jack Griffin, who had lasted just six months. Lang didn’t come up in the publishing world. A Wharton M.B.A., she was the former CEO of the digital advertising agency Digitas, and she quickly set about revamping the unit. Lang reshuffled executives and promised more innovation in digital ads, brought in Bain & Co. to consult, ordered up a round of cost cutting, and in late 2012 was energetically pushing new plans to higher-ups on how Time Inc. could prosper in a digital world.
But Lang returned from the New Year’s break deflated, according to company executives. Time Warner reviewed her plans and essentially said thanks but no thanks. It pocketed the staff reductions—layoffs of about 500 were announced in late January—and almost immediately set about figuring out a way to divorce the slimmed-down company. Time Warner started discussions with Meredith in mid-February.
It’s no secret that magazine publishing is a very tough business. But Time Inc. still makes money. In 2012 it reported revenue of $3.436 billion and operating income of $420 million. The overwhelming majority of media companies would be pleased with such a performance. But Time Warner, which is justifiably proud of its magazine properties and their fantastic history, is not a sentimental place. Ultimately businesses rise and fall within the company based on their ability to generate higher profits and growth. If a troubled unit is seen as a drag on the corporate bottom line, as AOL was, it can get spun off. If a successful unit is viewed as having greater potential as an independent entity, as Time Warner Cable was, it can get spun off too.
Time Inc. more likely falls in the former bucket. While still profitable, it has lost its ability to contribute to growth. The move, Bewkes said in his memo, enables Time Warner “to focus entirely on our television networks and film and TV production businesses, and improves our growth profile.” (My italics.) In 2002 Time Inc. had $5.4 billion in revenue and $881 million in operating income. In 2007 the unit had revenues of $4.955 billion, but still managed to make $907 million. But in the ensuing five years, as noted, revenues fell 30 percent while profits fell by an even greater margin—54 percent.
People walk by the Time Warner building in New York in 2007. (Diane Bondareff/AP)
A ‘giant’ way to save movies.
Americans are losing the taste for going to the movies. According to the Motion Picture Association of America, movie admissions in the U.S. and Canada dropped 18 percent between 2002 and 2011. Domestic admissions per capita were 3.9 in 2011, down from 5.2 in 2002.
An audience wearing 3D glasses at the London BFI IMAX cinema. (David Levene/eyevine, via Redux)
Flat is the new up. But not at IMAX, which builds giant-screen movie systems and remasters films to be shown in those venues. Just before the Oscars, IMAX reported that its 2012 revenues had increased a smart 20 percent to $284.3 million, and that it had installed 125 new theater systems last year. “The network has grown around 25 percent for the last four years, compounded,” says Richard Gelfond, a former lawyer and Drexel Burnham banker who has been running the firm since 1996. IMAX’s stock has quadrupled in the past five years, giving it a value of $1.7 billion.
Why? IMAX is playing a different game than some of its struggling counterparts. It is essentially a technology company. IMAX doesn’t produce its own films, nor does it build or operate multiplexes. Rather, it markets a film-going experience—a huge screen, dramatic pictures, fantastic sound, and expensive tickets. Add in 3-D, and IMAX turns a trip to the movies into an immersive, tactile, enveloping event that can’t easily be replicated on smaller devices outside the theater. And while Regal Entertainment and AMC, the two largest U.S.-based theater owners, have no operations outside America, IMAX has successfully persuaded the burgeoning ranks of foreign theater developers to include it in their spanking-new multiplexes.
That ability to get into the foreign market matters—a lot. Middle-class Americans may be falling out of love with movies. But middle-class Chinese, Indians, and Russians are just starting to pick up the habit. Today about two thirds of Hollywood’s box office comes from overseas. The number of screens in China has risen fivefold over the past several years.
Boston Consulting Group refers to the discretionary spending of emerging-market middle-class consumers as the “$10 trillion prize.” “We had a minimal international presence seven years ago,” says Gelfond, a youthful 58, with wavy, brown hair and a residual Long Island accent. “But right now about half of our box office is international.” In 2009 Avatar aired in 13 IMAX theaters. In 2012, by contrast, The Hobbit opened in about 100 IMAX theaters in mainland China. “And I have that many [more] signed up being constructed,” he adds. In Russia, IMAX has 30 screens open and another 10 in backlog. Overall, by the end of last year, the company had 276 theaters in the process of being built, many of them outside the U.S., and Gelfond expects that to continue to grow: “There are something like 30 cities in China with over 1 million people that don’t have a movie theater, let alone an IMAX.”
As traditional high-end multiplexes proliferate around the globe, they are likely to include an IMAX, which, like Tiffany, Apple, and Starbucks, is an aspirational brand. “If you want to impress your date, you take her to the IMAX,” says Gelfond. In China, the average ticket price at an IMAX theater is $15. In Moscow, where well-heeled businesspeople are known to buy out 400-seat IMAX theaters to watch films with their pals, the 80-seat IMAX Sapphire at the Russia Mall charges $80 per ticket.
The globalization of movie attendance is changing the business in all sorts of ways. “Films aren’t really greenlit these days in Hollywood without taking into account how they will perform in various foreign markets,” says Gelfond. And the company is helping to create local content for local audiences. In 2012 it converted five Chinese films into the IMAX format, while in Russia they’re converting a movie called Stalingrad. (A lighthearted rom-com it’s not.)
We’ve already saved the billions of dollars the sequester is meant to save. So why are we about to jump off the cliff, asks an astonished Daniel Gross.
The sequester is rapidly approaching. If no one stops it, we’ll experience automatic and devastating spending cuts of $84 billion between now and this fall.
Pipefitters, Glenn Browne (left) and Mike Turner who were recently hired by Cool-Breeze Air Conditioning work on installing an air conditioner in a hotel on January 6, 2012 in Miami Beach, Florida. (Joe Raedle/Getty)
There are many insane things about this, but one in particular strikes me as ludicrous beyond comprehension: the deficit has already shrunk by $84 billion so far this fiscal year.
Get it? The whole point of the sequester was to cut the deficit—meaning the difference between what the government makes in taxes and what it spends. Yet through natural forces, the deficit has already been cut by essentially the same amount the sequester would cut.
Why everyone—the president, Congress, the commentariat—is ignoring this blinding truth is beyond me. What I do know, is how we got to this place. And it’s important to understanding the lie behind the sequester, and the actual economic forces at work.
When the sequester was set in motion in the summer of 2011, the government was about to complete its second straight fiscal year with a $1.3 trillion deficit.
But our budget situation isn’t static. It’s cyclical. When the economy slumps, tax revenues from payroll, income, and corporate taxes fall. At the same time, spending on unemployment benefits rises and the political system provides stimulus through tax cuts or higher spending. That’s what happened in the 2009-2011 period. So the deficit quickly grows by big leaps and chunks.
This also works in the other direction. When the economy improves, and more people go back to work, receipts from corporate, payroll, and income taxes rise at the same time that money spent on unemployment benefits decline. And so the deficit can decline quickly. What’s more, in January 2013, taxes rose significantly. The Social Security payroll tax rose from 4.2 percent of income up to $113,700 to 6.2 percent (that’s an increase of almost 48 percent), while taxes on very high earners rose a few basis points.
Republicans cheering for the sequester to kick in this week may find that their big-government states will suffer the most. Daniel Gross on the budget's poetic justice.
The sequester, which is poised to hit at the end of this week, is dumb, dangerous, and bad policy to boot. And yet I can’t help but welcome its arrival. Why? It will lay bare an obvious fact that too many on the political right (and many in the political center) have been ignoring for the last few years. The federal government plays a very important role in the economy, in employment, in supporting consumption and investment, and in building and running the infrastructure that enables commerce.
U.S. Speaker of the House Rep. John Boehner (R-OH) (6th L) speaks as House Majority Whip Rep. Kevin McCarthy (R-CA) (L), Republican Conference Chair Cathy McMorris Rodgers (R-WA), House Majority Leader Rep. Eric Cantor (R-VA) (3rd R) and other Republican House members listen during a media availability February 25, 2013 on Capitol Hill in Washington, DC. (Alex Wong/Getty)
Washington Republicans remain rather blasé about the impact of the upcoming sequester. But state Republican officials are already starting to freak out. Virginia Governor Robert McDonnell, a onetime Tea Party favorite, is worried the sequester will affect the large military and government operations in his state. That’s to be expected. Economically speaking, the Commonwealth of Virginia is rapidly becoming an exurb of the District of Columbia. But Washington pols may soon be hearing about the negative impact of the sequester from some distant Republican redoubts – like Utah.
Utah, where I spent the past week, might seem like an unlikely source of pleadings to maintain government spending at current levels. The state’s mythology and history speak to a sense of self-reliance, anti-government sentiment, and entrepreneurship. Mitt Romney, a quasi-native son by virtue of his Mormon faith, advocated balancing the federal budget through spending cuts alone. He carried the state last November by a stunning 73-25 margin. "I’m for sequestration," Sen. Orrin Hatch, the veteran Utah senator said last week, according to the Salt Lake Tribune. “We’ve got to face the music now, or it will be much tougher later."
And yet, the sequester is going to make the music really discordant in Hatch’s home state, which is disproportionately dependent on the federal government.
The federal government is the biggest employer in the state, employing 34,000 people in Utah. The list of the largest state employers is topped by Hill Air Force Base, a mammoth, 6,650-acre installation that specializes in aircraft maintenance. A city unto itself, Hill features residences, “a modern shopping complex,” plus “a bowling center, fitness center, clinics, chapel, museum, recreation center, officer and enlisted clubs, dining facilities and a child development center.” It has 1,475 buildings and 228 miles of roads. According to Natalie Gochnour, chief economist of the Salt Lake Chamber of Commerce, Hill directly employs 9,300 military personnel and 16,300 civilians, with a combined annual payroll of $1.2 billion. In addition, the base purchases $832 million in goods and services locally each year.
But wait, there’s more. A large regional IRS processing facility in Ogden (here’s a street view) employs between 4,000 and 5,000 state residents.
Oh, and because two-thirds of the state is federal land, the Bureau of Land Management and other federal agencies are major economic forces. Many small towns are home to BLM offices with several employees – biologists, firefighters, sanitation workers. “Typically in rural Utah, the biggest employer is the school district and right after that is the federal government,” Gochnour said.
An Indian CEO sits atop a cutthroat world.
Outsourcing is a loaded word in politics. But in business, it’s a vital activity, a huge source of profits. Nobody knows that better than S.D. Shibulal, cofounder and current CEO of Infosys Limited. Started in 1981 with 7 employees and a mere $250, Infosys now has $7.23 billion in annual revenue, a market value of $30 billion, and 155,000 employees in dozens of countries. Infosys has come a long way from call centers and help desks to being the outside IT and e-commerce consultant for the world’s major corporations. “The dimensions of value are much more complex today,” Shibulal tells me in a quiet room at the World Economic Forum meeting last month in Davos, Switzerland.
S.D. Shibulal, CEO of infosys. (Adeel Halim/Bloomberg, via Getty)
Outsourcing began when U.S. companies hired people abroad to do mind-numbing support work for much lower wages. That work still accounts for 60 percent of Infosys’s business. But the company would prefer to be thought of as a high-end consultant like McKinsey, not a cheap substitute for the IT department. A third of revenue comes from “consulting and system innovation,” says Shibulal, a notably soft-spoken man. Another 6 percent comes from “products and platform”—e.g., a new mobile point-of-sale system for Nordstrom. In 2012 Infosys paid $350 million to acquire Lodestone, a European management consultant.
Born just eight years after India’s independence, Shibulal has ridden Infosys’s fortunes to become the 77th-wealthiest Indian, according to Forbes (net worth: $770 million). The fortunes of India’s global rich share headlines with grim news on political corruption, social problems, and deep-seated poverty. “All emerging countries are countries of contradictions. India is no different,” he says, and then rattles off statistics that would make Tom Friedman drool. “India produces 1 million English-speaking engineers, but we have 14 million children who are not in school. We have 70 percent of our health care in cities, but 70 percent of our people live in rural areas.”
Shibulal resides in Boston and Bangalore, but lives “on a plane” and has the weary eyes to prove it. He’s predictably bullish on India’s future. “When I was growing up, we had 30 million middle-class people. Today that number is 350 million,” he says. India has proven itself adept at “frugal innovations” that afford access to goods developed countries take for granted, but at much lower prices. Shibulal cites the Tata Nano, a microcar that sells for $3,000, and a machine that can take EKG measurements for a dollar. American companies, he notes, can’t thrive in India simply by producing a cheaper, smaller fridge. “The power still won’t support it,” he says. “It is about creating a new refrigerator that can remain cool even if the power goes out for two hours.”
When I ask what Infosys does to ensure it can operate at global standards inside India, Shibulal’s eyes light up. “You asked the question. So I can’t resist.” He pulls out a tablet and offered a guided aerial tour of a 400-acre campus in Mysore, 90 miles southwest of Bangalore. It’s the size of a university: a million square feet of classrooms, a software development center that can house 10,000 people, and residence buildings that hold up to 14,000 employees and spell out INFOSYS when viewed from above. “Want to see our rainwater harvesting facility?” he asks, zeroing in on a huge reservoir. “It’s a zero-discharge site. Every drop of water we get we pump back into the environment.” The campus has a food court, a restaurant, a movie theater, a cricket ground.
It could be Silicon Valley, or suburban Cincinnati. In fact, the Indian outsourcer is now hiring in America—400 positions in the most recent quarter. “The U.S. is the largest spender in our space, and we work with many large corporations in America. And so we recruit in the local markets,” he says. Yet Shibulal, who has a master’s degree from Boston University and spent five years with Sun Microsystems, laments the shortage of engineers and tech workers in the U.S. “In our industry in the U.S., unemployment is 3.5 percent,” he says. “So while we are recruiting people in the U.S. in large numbers, we find it hard to find people, even with the unemployment.”
An outraged hedge funder bites into Apple.
When Apple CEO Tim Cook took the stage at San Francisco’s Palace Hotel to speak at an investment conference on February 11, the first questions weren’t about the next iteration of the iPhone. Instead, analysts asked the CEO about a lawsuit that had just been filed by New York-based investor David Einhorn.
David Einhorn, President of Greenlight Capital. (Brendan McDermid/Reuters, via Landov)
The 44-year-old proprietor of the hedge fund Greenlight Capital believes Apple “has a cash problem,” as he told CNBC. It has too much of it. Einhorn has compared Apple to his “Grandma Roz,” who lived through the Depression and was so focused on pinching pennies that she wouldn’t leave him messages on his answering machine. Einhorn has sued Apple over a proposed governance change that would limit the company’s ability to sell new preferred stock—the mechanism he has proposed Apple use to funnel some of its $137 billion cash pile back to shareholders.
Einhorn, who parlayed $500,000 in 1996 to an $8.8 billion fund today (cumulative return: 1,829 percent), has a history of tilting at very large windmills. A Midwesterner with a low-key mien—“very mild-mannered, but almost passive-aggressive,” according to a financial-industry veteran—he possesses some very large scalps.
His modus operandi is to take deep dives into corporate balance sheets and make lengthy, sustained public cases about the merits (or faults) of stocks. For six years, he pursued a small financial company in which he held a short position, Allied Capital, compiling presentations on what he viewed as the company’s suspect accounting methods. Then he wrote a 2008 book about it: Fooling Some of the People All of the Time. In October 2011 he used an hourlong, 110-slide presentation to argue that Green Mountain Coffee, the high-flying manufacturer of coffee pods, was overvalued.
Einhorn’s fame—and a good chunk of his fortune, which Forbes pegs at $1.2 billion—stems in large measure from his 2007 decision to short Lehman Brothers. As the financial crisis mounted, Einhorn relentlessly delved into the giant company’s balance sheet and queried executives and the ratings agencies over their assessment of Leh—man’s health. When Lehman went bust in September 2008, it was a huge vindication—and a boost to his fund’s bottom line.
Einhorn knows how to use the financial media; his wife, Cheryl, worked at Barron’s for several years. But he’s more self-contained than many of the preening hedge funders who have taken to holding reality TV–style clashes over stocks on CNBC. He lives in the suburbs, in Westchester County, New York, not on Fifth Avenue. He looked into buying a stake in the New York Mets in 2011 but backed out. When Einhorn finished third in the 2012 Big One for One Drop poker tournament in Las Vegas, he donated his $4.35 million in winnings to the nonprofit group City Year.
Not all of Einhorn’s bets have worked out so well. A loss in the last few months of 2012 caused Greenlight Capital to post a market-lagging 7.9 percent return for the year. “The disappointing fourth quarter result reduced our year from good to pedestrian,” Greenlight noted to investors in a January letter that was filled with puns and references to stocks—i.e., “our coffee was too hot, our apple was bruised.” That last bit was a reference to the decline in the shares of Apple—one of Greenlight’s largest positions.
American Airlines and US Airways are getting hitched—meaning one more aviation conglomerate bent on flying fewer Americans on fewer flights and in more crowded cabins.
Another airline merger?!
An American Airlines plane in the new livery (left), rests on the ramp beside a US Airways plane at Dallas/Fort Worth International Airport in this February 14 American Airlines handout photo. (Handout/Reuters, via Landov)
On Thursday, American Airlines, the nation’s third-largest airline, agreed to merge with US Airways, the fourth-largest, to create the biggest carrier in the U.S. “This is good for consumers, because we can take these two networks and put them together,” American Airlines CEO Doug Parker, who will eventually oversee the combined behemoth, told CNBC. Of the 900 routes the two airlines fly, Park said, “there’s only overlap on 12.”
For now, the two companies will continue to operate as independent entities, with different frequent-flier mile and reservation systems. Their respective CEOs promised the two frequent-flier programs will eventually be combined, with the value of miles being preserved.
The move is certainly good news for those with a financial stake in American, which filed for bankruptcy in late 2011, and in US Airways as well. But for consumers? Not so much. In the short term, it is sure to mean less, not more, competition. Fewer, not more, flights. And higher, not lower, prices.
The sky-high love match is just the latest step in a wave of consolidations that began during the Great Recession of 2008 and 2009. When the economy cratered, it was evident that too many airlines were competing for too few fliers. While upstart independents like JetBlue and Southwest continued to expand, the airline industry as a whole has been shrinking since. So Delta snapped up Northwest in 2008, and Continental merged with United in 2010. Rather than continue to discount one another into bankruptcy, the big airlines have decided to join forces and rationalize.
The result has been a decline in capacity. Since 2007, according to the U.S. Department of Transportation, the number of domestic flights in the U.S. has fallen every year, from 9.8 million in 2007 to 8.643 million in 2011—off nearly 12 percent. Accordingly, the number of passengers flying domestic flights fell from a peak of 679.1 million in 2007 to 618 million in 2009 before rising to 637.5 million in 2011. Through the first 10 months of 2012, the number of flights was down another 2.3 percent compared with the first 10 months of 2011, while the number of passengers was up .8 percent from the corresponding period.
Airlines have become more rational, reducing unprofitable flights and routes. And they’ve also become more rational by using data, software, and information technology to maximize sales and traffic on their flights. A plane seat is a perishable good. Once the cabin doors close, an empty seat becomes worthless. For years, airlines were generally content to throw out a large chunk of their inventory. A decade ago, the industry’s domestic load factor—the percentage of seats actually occupied—stood in the low 70s. But it has risen steadily from 75.5 percent in 2005 to 82.1 percent in 2010. Through the first 10 months of 2012, the load factor for domestic flights was 83.6 percent. In October 2012, the domestic load factor was at a record 84.1 percent.
The president pivoted from deficit reduction to increasing demand—with a surprising call for a higher minimum wage.
What does it take for a Democratic president to start talking like a Democrat about economic issues? Two big presidential election wins, apparently. For when it comes to economics, President Obama delivered a center-left speech for a center-left economic country.
Vice President Joe Biden applauds as President Barack Obama gives his State of the Union address during a joint session of Congress on Capitol Hill in Washington, Tuesday Feb. 12, 2013. (Charles Dharapak/AP)
When Obama delivered his State of the Union in previous years, the economy was in deep recession (2009), starting to dig out (2010), and muddling along in very low gear (2011 and 2012). Finally, however, he was able to lead with some justified boasting about the strong run the economy has enjoyed over the past year—in spite of Washington, not because of it.
Housing is back, he declared. The stock markets, energy production, and car sales are all at high levels. “After years of grueling recession, our businesses have created more than six million jobs,” he said. (He might have added that the Treasury Department today reported that the government actually reported a surplus in January.)
The best thing the government can do to help the economy keep growing at this pace is to get out of the way a little bit—to stop with the brinksmanship and threats over the debt ceiling. “The greatest nation on Earth cannot keep conducting its business by drifting from one manufactured crisis to the next,” he said. Obama offered his preferred solution of a balanced replacement to the impending sequester, composed of some budget cuts and new revenue through the closing of tax loopholes.
So far, so centrist. But he then made a slight turn to the left. To promote growth, he ran through his longstanding laundry list of encouraging manufacturing and clean energy. And then he made a sharper turn. Obama has received his share of grief from the left (and increasingly from the center) for focusing too much on the deficit and not enough on promoting demand. Obama seemed to take some cues from Paul Krugman. Departing from the official bipartisan Washington consensus, he proclaimed that “deficit reduction alone is not an economic plan.”
Then he pivoted to a largely neglected subject in the past four years: wages. “Corporate profits have skyrocketed to all time heights, but for more than a decade wages and income have barely budged,” he noted. Then Obama launched into perhaps the most surprising section of the speech—one that was not rolled out to reporters in the pre-speech phone calls. And to me, it was one of the best parts.
Today, he noted, someone working full time at the minimum wage makes just $14,500 a year. Even with extra tax breaks and credit, “a family with two kids that earns the minimum wage still lives below the poverty line. That’s wrong.” He continued: “Tonight, let’s declare that in the wealthiest nation on Earth, no one who works full time should have to live in poverty, and raise the federal minimum wage to nine dollars an hour.” Doing so would promote economic justice, to be sure. “It could mean the difference between groceries or the food bank.”
After a University of Massachusetts student found significant errors in a study beloved by budget cutters world over by Harvard economists Kenneth Rogoff and Carmen Reinhart, Stephen Colbert does what he does best -- leaves them in the dust.
From America’s manufacturing prince to adulterated generic drugs, The Daily Beast brings you the best in business and finance journalism from the week of May 18, 2013.