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The GOP-CEO Lovefest Lives On

It’s all about taxes, friends. Taxes, and holding on to as much cash as possible, however possible, and whatever the consequences. Daniel Gross on the continuing insanity of the GOP-CEO lovefest.

Are the Republicans finally losing big business?

Not yet.

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Lloyd Blankfein has friends in Washington. (Photo Illustration by The Daily Beast)

On Wednesday, a group of Wall Street chief executive officers came to Washington to meet at the White House. At the end of the meeting, Goldman Sachs CEO Lloyd Blankfein obliquely took Republicans to task. “Individual members of our group represent every point on the political spectrum,” Blankfein said. “But the one thing they have in common is: You can litigate these policy issues, you can relitigate these policy issues in a public forum, but they shouldn’t use the threat of causing the U.S. to fail on its obligation to repay debt as a cudgel.”

Wall Street, which has generally been unruffled by the shutdown, is really freaked out about the prospect of a hint of a whiff of an inkling of a debt default. If U.S. government bonds fall sharply in value, institutions like Goldman Sachs would suffer greatly.

In the Washington Post this morning, Zachary Goldfarb wrote that corporate America may be souring on congressional Republicans’ constant brinkmanship and inability to conduct business as usual. In a world where government spending is about 22 percent of gross domestic product, a government shutdown is bad for all sorts of business. As Goldfarb noted, the Washington, D.C.–based U.S. Chamber of Commerce on Monday put out a letter decrying “a government shutdown that will be economically disruptive and create even more uncertainties for the U.S. economy.”  

The response of the Senate and House GOP to such urgings has essentially been: whatever, dudes. The mindless shutdown, the refusal to negotiate a budget, the obsession with Obamacare, and the willingness to storm into a debt crisis is making corporate CEOs annoyed, angered, and even anxious. But it’s nowhere near enough for them to come out and do what would be necessary to change the dynamic in Washington.

This has been going on for years. Big business—including the Chamber of Commerce and many major infrastructure companies—has been arguing for the need for more spending and private-public partnerships to improve America’s ailing infrastructure. The congressional GOP has responded with the sequester and budget cuts. Big business has been begging for comprehensive tax reform that will simplify their lives. The congressional GOP won’t countenance any such reform that involves raising net revenues. And so there hasn’t been any action. Big business desperately wants immigration reform, so it can have access to skilled workers (at the high end) and not have to worry about being busted for employing undocumented workers (at the low end). The House GOP says no. And so on. And so on. Most large corporations have either made their peace with—or actively lobbied for—greater protections and respect for the rights of gay Americans. The congressional GOP is anti. Business claims that uncertainty in fiscal policy hinders its ability to make plans and invest. For the past two years, since August 2011, the congressional GOP has actively and vocally embraced a strategy of hostage-taking and brinksmanship.

Wish You Were Here

The Day Tourism Died

Travel is a big business, and it just tanked. Daniel Gross on how the shutdown could wreak havoc on a key part of the U.S. economy. (In other news, this selfie stick is a thing.)

On the mall in Washington yesterday morning, World War II vets stormed the shuttered World War II monument. In New York, the Statue of Liberty was closed. The South Dakota state government is trying to keep Mount Rushmore open. Campers in glorious Yosemite have been given 48 hours to get out.

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Larry Downing/Reuters

The anecdotes from government-run parks and tourist states are symbolic, and make for good images of the real-world impact of a government shutdown. (There are certain upsides, of course. The Klan apparently canceled a rally it had planned at Gettysburg.) But they also speak to a larger truth. There’s a certain blitheness of spirit surrounding the impact of the shutdown. Most people at most companies simply showed up for their jobs as usual, and can easily conclude that it won’t matter much. But in some industries, including some really vital American industries, the impact of the government shutdown is immediate—and difficult. 

Travel is a very big business in the U.S. I could tell you precisely how large a business it is, but the Bureau of Economic Analysis’s website is closed today. And the section of the Commerce Department’s website that contained very detailed data on tourism is likewise shuttered temporarily. However, the U.S. Travel Organization put out an annual report that estimates the impact of travel generally in the U.S. The report suggests 14.4 million total jobs are supported by travel, or one in every eight in the private sector.  For 2013, it forecasts travel spending will be $889.1 billion, up 3.9 percent from $855.4 billion in 2012. New York City alone in 2011 welcomed (or didn’t welcome, as the case may be) 50.9 million tourists.

Of course, most tourists traveling in the U.S. visit sites run by the private sector—like Disney World, or Las Vegas. But federally-run sites are also among the largest attractions. Mount Rushmore gets three million visitors per year. That’s nearly four times the population of South Dakota. Without government entities, the 17.9 million tourists who visited Washington, D.C. in 2011 would have had little reason to go. An estimated 275 million people visit national parks each year. And without other government operations—the State Department, which processes and grants visas, the airports, customs officials—people wouldn’t be able to enter, exit, and move about the country.

At midnight on Tuesday, October 1, the government went dark, and different agencies announced that they were being shuttered.

While many of the jobs tourism supports may be low-paying, it is also a vital export industry. This is an important, little-understood point. When people from abroad come and spend money in the U.S., that’s considered an export. Every time you see a Brazilian at the National Gallery, Swedish backpackers in Yosemite, or Korean tour groups at Kennedy airport, you’re watching exports happen in front of your eyes. By contrast, when Americans spend money as they travel abroad, that’s considered an import. And in an era when the U.S. continually racks up large trade deficits (I’d link to the latest figures, but the site isn’t functioning today), and in which foreigners increasingly have the purchasing power to enjoy America, the ability to attract, process, and entertain tourists is of vital importance.

When they get money, foreigners like to come to America and see what it’s all about. By contrast, Americans are more insular. And so the U.S. runs a significant trade surplus each year. Indeed, the rapid growth in international tourism has been a key factor in bringing down the trade deficit in recent years. In 2011, some 62.3 million international visitors came to the U.S., up 5.6 percent from 2010. According to government figures, U.S. tourism exports have risen from $134.5 billion (a $31.2 billion trade surplus) in 2010, to $152.4 billion in 2011 and $168 billion in 2012. In 2012, the U.S. notched a record $50 billion trade surplus in tourism. For 2013, the U.S. Travel Association projects  the number of international visitors will rise to 69.6 million, up from 67 million in 2012.

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It’s Not Obama’s Debt

House Republicans seem to hold the president responsible for the entire national debt—forgetting it was racked up by Republicans and Democrats alike. Daniel Gross explains with a chart.

The debt-limit drama is heating up. By mid-October, the U.S. government will run out of the legal authority to issue new debt. That means it won’t really be able to operate. On cue, the House Republicans have now released their enormous, exorbitant, foolish list of demands in exchange for lifting the debt limit. Obama has refused to negotiate on the topic. House Republicans, by contrast, are begging for him to enter talks. Their theory seems to be that in exchange for giving President Obama something that he wants (but that they don’t want to give), he should give them a bunch of things they want (but that he doesn’t want to give).

It's John Boehner vs. President Obama in the fiscal face-off.

The House Republicans, and, unfortunately, many of my brothers and sisters in the media, misunderstand what is going on here. The debt-limit increase is not something that Congress “gives” President Obama. It’s something the Congress will give President Reagan, and President Bush (I and II), and President Clinton. It’s something they’ll give all the prior Congresses, including ones in which current House GOP leadership served in and ran. And above all, it’s something that Washington gives to the holders of the trillions of dollars of bonds this country has issued over the last 30 years—central banks, financial institutions, companies, and individuals who are legally entitled to interest and principal payments.

The government spends more than it takes in every year, and has done so for the last many decades, under every partisan arrangement imaginable—full Republican control, full Democratic control, Republican presidents with Democrats running Congress, Democratic presidents with Republicans running Congress, etc. (In the late 1990s, there was a brief moment where the government actually made a small profit.) In addition, we fund our biggest and most cherished entitlemen—Social Securit—by issuing bonds as IOUs to the Social Security Trust Funds. Simply by living and breathing, the government’s debt rises each year.

To fund current operations and pay off debt that has been accumulated in years past, the government sells bonds. Some roll over very quickly, but others endure for 10 years, 20 years, or 30 years. The government needs to increase the debt limit so it can raise cash to pay for next year’s operations. But it also needs to raise cash to pay for last year’s, and last decade’s, and last century’s operations. Bonds we issue today are paying for the stimulus package approved by Democrats in 2009. But they’re also paying for the Medicare Prescription drug benefit—an expensive entitlement without a funding mechanism that was rammed through a Republican Congress whose members included Speaker John Boehner and Rep. Paul Ryan, and signed into law by President George W. Bush.

Go check out the Bureau of the Public Debt, which has a wealth of information. On Feburary 18, 1986, in the middle of Ronald Reagan’s second term, the government sold 30-year bonds, at a yield of 9.25 percent (those were the days!). That issue, CUSIP # 912810DV7, is still trading today. On November 7, 1991, when George H.W. Bush was president, the government issued 30-year bonds at an 8 percent rate. We’ll be paying interest on those until 2021. On August 7, 1997, with President Clinton in the White House and Republicans controlling the House, the government issued $10.37 billion in 30-year bonds paying a 6.375 percent interest rate. In August 2006, with George W. Bush in the White House, the government auctioned $14 billion in 30-year bonds yielding 4.5 percent. In November 2011, the government raised $17.224 billion, selling 30-year bonds at a 3.125 percent interest rate. These bonds were issued to fund the operations of government and the payment of benefits in the 1980s and 1990s—to pay for satellites in the last years of the Cold War, to fund the Gulf War and the Iraq War and the bombing of Serbia, to support a generation of research at the National Institutes of Health, to pay for the medical care of our grandparents. The taxpayers are currently making payments on all those bonds, and the government needs to increase the debt limit so it can continue doing so.

In the corporate world, those who fail to make payments wind up losing ownership in bankruptcy. It’s not quite that way with government debt. When a public entity defaults, or even acts in a way that makes people suspect it might default, the market freaks out. The borrower loses credibility, respect, and the ability to participate in the market in the future. Which is why cities and states work so hard to avoid defaulting on bonds—they’ll gladly stiff suppliers, workers, and citizens long before they’ll stiff bondholders.

Yes, the debt has exploded in recent years, in large part because the government ran successive trillion-dollar deficits during the recession and the early years of the recovery. But as this chart from the Center for Budget and Policy Priorities shows, a great deal of today’s debt can be traced to policies enacted before President Obama arrived.

Tesla Model

All In on Electric

Tesla Motors may be wildly overvalued, but all the public adulation and attention is forcing bigger manufacturers to play catch-up. Daniel Gross on how cachet has a way of developing into a real business.

Cars can’t fly. But Tesla Motors, the electric sports car manufacturer, continues to defy gravity. Its stock has risen six-fold in the past year, giving it a market capitalization of $22 billion. That’s stunning, especially given that Tesla sells only about 2,000 cars per month and last quarter reported a $70 million profit.

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Justin Sullivan/Getty

By contrast, GM, which sold more than 275,000 cars in August and earned $1.2 billion in the most recent quarter, has a market capitalization $51.8 billion—about 2.5 times that of Tesla. And Ford, which sold 221,270 cars in August, more than 100 times Tesla’s total, and notched a $2.6 billion profit in the most recent quarter and is valued at $68 billion, about three times what Tesla is worth. Put another way, these companies have more in profits each quarter than Tesla has in revenues.

The astronomical valuation of Tesla could be a sign that investors are shrewdly predicting the future. The stock market, after all, is famously a futures market. Or it could be a sign of the sort of exuberance that frequently infects American investors. Hopped up on momentum and dreams, investors often bid up shares of companies beyond all reasonable valuation.

Tesla’s continuing rise is angering electric car haters, auto dealers (who have sought to keep Tesla’s direct-sales model out of several states), and investors who focus on fundamentals. A hedge fund manager I know hisses the word “Tesla” with the same mixture of fear and annoyance that Jerry Seinfeld used to deploy when he said, “Newman.” Indeed, it’s hard to escape Tesla and its founder, Elon Musk. While others are contracting in Europe’s poor car market, Tesla is expanding. It opened a plant in the Netherlands last month. In the first half of September, Tesla was the leading car seller in all of Norway, with 322 units sold. It’s building out its supercharging network in California. This spring Tesla repaid its loan from the Department of Energy several years early and raised $1 billion in private capital. Earlier this month, the media dutifully covered the news that Musk would drive his family cross-country in a Tesla.

But Tesla’s stock and its vehicles aren’t just driving people to distraction. Tesla, the stock and the phenomenon, is having an impact far beyond the 2,000 cars it sells. Rather, this tiny tail of the car industry is starting to wag the dog. Innovation happens when start-ups get huge—think of Google or Facebook or LinkedIn. But it also happens when giant incumbents decide they want to be part of something new. And that is happening, thanks to the success of Tesla. Larger auto companies, which generally have remained aloof from the electric car industry, are now actively seeking the, um, juice and earnings valuation that Tesla has. And they’re doing it by investing more seriously in electric cars, or in the electrification of gasoline-powered cars.

We see it all the time. Innovation tends to come from the high-end and the fringes, not from the low end and the center of the market. The first cars Henry Ford built cost a fortune for early 19th century Americans. A decade ago, Toyota captured the imagination of the auto marketplace by selling a small number of expensive hybrids. After a while, other car companies rolled out their own versions. They did so not because they believed they could make money and sell lots of hybrids. Rather, these technology companies—and make no mistake, car companies are technology companies—didn’t want to be seen as being left behind. They wanted some of the cachet that came with making and selling hybrids. But cachet has a way of developing into a real business. Toyota still dominates the hybrid market. But Ford is coming on strong, there are dozens of models, and 53,000 hybrids were sold in the U.S. in August. What’s more, hybrid-lite technology is starting to become a standard offering in American-made trucks, SUVs, and cars, and that’s helping to boost the fleet’s mileage and performance. The pressure Toyota exerted forced other automakers to adapt—in a way that benefited consumers and the auto industry as a whole.

Something similar may be happening with Tesla and electric cars. Larger, established companies that want some of what Tesla has—the cool factor, the higher multiple, the public adulation and attention—respond by saying they’ll be part of this exciting new market.

New French Fries!

This Took Ten Years

After a decade of research on two continents, BK is rolling out new crinkle-cut fries. Was it all worth it? Daniel Gross tests the goods.

Last week, I was invited to the penthouse suite of the Morgan, a chi-chi boutique hotel in midtown Manhattan. The place was done up with flowers and bright colors, and a gaggle of staffers from Allison Brod Public Relations and style bloggers sat on mod couches. This wasn’t a launch for Tory Burch or BMW. We had been summoned to a product reveal for...Burger King?

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Noel Barnhurst

Eric Hirschhorn, chief marketing officer for Burger King, North America (sweater, glasses, New York digital media look), started a brief PowerPoint. A lot had changed since Burger King opened its first outlet nearly 60 years in Miami, he said, but the core business was still the same: burgers, fries, and drinks. And yet times are changing. Consumers want choices, including healthier options. They expect higher quality. The solution?

“Satisfries.”

“Satisfries?”

Yes. Burger King’s new offering, rolling out Tuesday, is crinkle-cut fries—slightly thicker than the usual fare. They’re made from the same potatoes, fried in the same oil, and processed on the same equipment as traditional Burger King fries. But get this: they’re much lighter. On a gram per gram comparison, Burger King says the “Satisfries” have 40 percent less fat and 30 percent fewer calories “than the leading French fries.” (Read: McDonald’s.) “Change in French fries over time has been about shape,” said Hirschhorn. “This is real innovation.”

Burger King has a bunch of challenges. The typical American consumer isn’t getting much of a raise, so the capacity of core consumers to eat out more isn’t rising. Competition is intense. And powerful figures in our society—from First Lady Michelle Obama to New York Mayor Michael Bloomberg—are effectively urging kids and adults to consume less fast food.

The solution Burger King has taken is not to retire existing products, or to branch out into super-healthy offering (quinoa burgers, anyone?), but to offer consumers a choice with incremental but significant improvements. Comparisons aren’t particularly easy. Burger King says that based on a 70-gram serving, the “Satisfries” would have 6.3 grams of fat and 150.5 calories. Here is the McDonald’s menu nutrition information. By my calculations, based on McDonald’s data, a 70-gram serving of McDonald’s fries would have 227 calories and 11.4 grams of fat. So the numbers do seem to add up.

No, Seriously

What Shutdown? Buy Bonds!

Washington is in an uproar over Friday’s House vote to defund Obamacare, threatening a default. So where should you put your money? In government bonds, of course. Daniel Gross explains why.

Washington is about to get insane again. Immense disruptions lurk. Only a few legislative days before government agencies run out of money. The new fiscal year is poised to start October 1, and there’s no mechanism for funding the government. Friday morning, the House GOP passed a law that continues to fund the government through the end of December—but only if the Senate and President Obama agree to defund implementation of the Affordable Care Act. Worse, in less than a month the Treasury Department will run out of authority to issue new debt. And House Republicans say they’ll only increase the debt limit if (wait for it!) Obama agrees to delay implementation of the Affordable Care Act.

Capitol in Washington

United States Capitol in Washington, D.C., September 19, 2013. (J. Scott Applewhite/AP)

So the U.S. government is about to run out of money and may announce its unwillingness to meet legal debt obligations. What should you do with your money in the face of such impending calamity? Why, buy U.S. government bonds, of course.

The U.S government bond market, $12 trillion deep, is the most liquid, safe, and vital of all global financial markets. Savers, central banks, companies, and institutions around the world stash short- and long-term savings in government bonds. In theory, playing havoc with the government’s finance and creditworthiness should be the equivalent of throwing toxic chemicals into the pool. Everybody would run for their lives.

But both the stock and bond markets have been—and remain—generally complacent. That’s in part because other Washington-based activity, like the Federal Reserve’s announcement this week that it would continue its aggressive bond-buying activity, matters much more to markets than anything Congress can do. Political nuttiness is just one of many factors that affects the trajectory of financial markets.

Indeed, investors have learned to ignore the lunacy and approach D.C. grandstanding with a certain amount of cynicism. “We’ve cried wolf with the debt-ceiling problem in August 2011 and the fiscal cliff back in January,” said Gregory Valliere, chief political strategist at Potomac Research Group. “These things always seem to get resolved, even though it’s messy.” The shutdown is a far less daunting threat than the debt ceiling, which is still several weeks away—i.e., several lifetimes in today’s Wall Street of high-frequency trading. “But even then, the idea that we’d default on the debt is still very unlikely,” Valliere added. The prospect of the U.S. not paying its bonds is so loony, so scary, and so unthinkable that markets are refusing to countenance its possibility.

Given this mentality, not only is it perfectly safe to keep buying government bonds, it may make financial sense. Government shutdowns, fiscal restraint, and manufactured crises are generally bad news for stocks and good news for bonds. Should the sequester continue, or if Obama agrees to more budget cuts as a condition for increasing the debt limit, the American economy would slow. U.S. companies that depend to various degrees on government contracts, subsidies, and indirect payments—defense contractors like Lockheed-Martin, technology firms like IBM and Cisco, contractors like Booz Allen Hamilton—would have to reduce their forecasts. That’s bad for a particular group of stocks.

But the repeated fiscal clashes also have been bad news for stocks generally. For the last couple of years, the U.S. government has been a source of immense fiscal restraint, removing cash and consuming power from the economy through higher taxes and lower spending. The more it continues, the more it weighs on the ability of companies to hire and consumers to spend. That’s bad news for stocks, for the economies of foreign countries whose factories feed the American consumer (hello, China!), and for commodities. All things considered, lower levels of U.S. economic activity tend to lead to lower demand for grains, steel, and oil. And what do investors do when the economy is slowing? They buy government bonds.

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You Can’t Make CEOs Care

The SEC has issued a rule that forces companies to reveal how much their CEOs make compared to their employees. That’ll be fun to see, writes Daniel Gross, but it won’t change anything.

Who says class warfare is dead? Or that the Obama administration consistently sells out the left?

CORRECTION Walmart Shareholders Meeting

Gareth Patterson/AP

On Wednesday, the Securities and Exchange Commission announced a new rule that had long been sought by labor activists, do-gooders, and progressives. Publicly traded companies are already required to disclose, in exquisite detail, the compensation of their CEOs and other top executives in annual reports and proxy statements. Now, however, they’ll be forced to disclose more information about the compensation of rank-and-file employees—and then express the relationship between the two as a mathematical ratio. The rule, “required under the Dodd-Frank Act” and passed by a partisan 3-2 majority, “would require public companies to disclose the ratio of the compensation of its chief executive officer (CEO) to the median compensation of its employees.” 

The insane, obscene, yawning difference between the pay of workers and bosses has long been used as a cudgel by labor groups. Shareholder activists have proposed initiatives at companies such as Walmart (where the ratio is 1,034:1) to force them to disclose the ratio. Bloomberg did its own calculation this spring, and determined the ratio at companies in the Standard & Poor’s 500 is about 240:1.

The theory behind this seems to be that CEOs will have a sense of shame, or self-consciousness, about the disclosures, that the sunlight shining on the complicated web of executive compensation will force CEOs to either cut their own pay or raise the pay of employees. That somehow forcing companies to publish a benchmark will yoke public pressure and competitive instincts to bring the ratio down, thus reducing inequality, boosting the consumption power of workers, and putting a dent in global emissions to boot.

As a journalist, and an advocate of higher wages, I’m generally in favor of this. It’ll be great fun. It’s a great rhetorical gesture, like when President Obama calls for an increase in the minimum wage or rails half-heartedly against fat cats. But it won’t do much good or change anything. In fact, it seems like the rule’s boosters really misunderstand CEO and one percent psychology.

They’re not ashamed. Everybody knows that CEOs make way more than workers. That’s the point of being a CEO. And in general, they simply don’t care. If they did care about the disparities between top earners and their workers, they’d do something about it—like raise wages. But they haven’t. Any way you look at it, corporate America has been very stingy. The Census Bureau reported this week that median household family income was $51,017 in 2012, down from 2011—and, adjusted for inflation, below what the typical household made in 1999. A McDonald’s employee earning $8.25 an hour would have to work one million hours to earn what the company’s CEO makes in a year. Since 2009, the top one percent of earners have taken home 95 percent of the nation’s income gains.

These facts extremely well-known; they’re discussed in prominent media outlets. The data can be complicated at times. But it’s unclear to me that simplifying the stark divergence of fortune between the rich and everybody else in a simple ratio disclosed in SEC filings will change much.

Bonds

Bernanke Warns the Right

Chairman Ben Bernanke announced Wednesday that the Fed will continue buying bonds and mortgage-backed securities, effectively warning Republicans that their insistence on austerity is keeping him from backing off.

On Wednesday afternoon, Ben Bernanke channeled Miley Cyrus. When it comes to having the central bank conjure up cash out of thin air to buy bonds and mortgage-backed securities in an effort to boost the economy, he effectively said:  “And we can’t stop. And we won’t stop.”

New York Stock Exchange

Federal Reserve chairman Ben Bernanke, speaking at a news conference, is seen on a television screen on the floor of the New York Stock Exchange on September 18, 2013, in New York City. (Spencer Platt/Getty)

In response, stock traders began twerking en masse. Quantitative easing, the program of buying bonds and mortgage-backed securities, has been a boon to stocks. Why? It’s keeping interest rates down and pushing people into higher-yielding instruments like stocks. The prospect of any tapering, or reduction, in the rate of purchases would push interest rates up and make stocks less appealing. Bernanke said he’d provide the fuel for the party for at least a few more months. Stocks jumped by about 1 percent after the announcement.

While not a change in policy, this marked a change in posture. In June, Bernanke and the Fed had implied they would start to reduce the pace of bond purchases in the fall and set the Fed on a path to phasing out the purchases altogether over the course of a year. But the Fed said at the time that it would depend “on the evolution of the economic outlook.” It had to see evidence that inflation would be rising and jobs would continue to be added.

But that hadn’t happened. Here’s the Fed’s the statement. While things have continued to muddle along, the Fed had not yet seen enough improvement, especially in the labor market, to start tapering. (“The economic data do not yet provide sufficient confirmation of its baseline outlook to warrant such reduction.”) Earlier this month, the Bureau of Labor Statistics reported that the economy produced only 169,000 jobs in August, and revised down the total jobs created in June and July by 74,000.

Not everybody is thrilled by the Fed’s actions. Corporations have gorged on cheap debt, but many CEOs say they’d like to see the Fed remove its artificial support. On CNBC Wednesday morning, Goldman Sachs CEO Lloyd Blankfein called for the Fed to start tapering. And hard money types—libertarians, gold bugs, inflationphobes, many Republicans—have wanted the Fed to stop doing what it’s doing. Bernanke had words for these folks, too, though they were characteristically indirect. Essentially, he said, “You’re part of the problem.”

Buying bonds is one form of stimulus, but it’s a really ineffective one, especially when interest rates are low. Higher wages—employing more people for more hours for more pay—are an incredibly powerful form of stimulus. Americans, particularly those at the bottom and the middle rungs of the income ladder, tend to spend almost everything they make every two weeks. More money flowing into payroll systems translates pretty quickly into more money flowing into the economy. But that’s not happening, or it’s not happening fast enough. Between August 2012 and August 2013, average weekly earnings of private-sector employees rose just 1.7 percent—even though companies have epic amounts of cash on their books and have been making very significant profits. There were 3.7 million job openings in the U.S. at the end of July, but companies are in no rush to fill them. In June, Bernanke had said that the tapering could start only once gains in the labor market seemed persistent and safe. On Wednesday he said that he hadn’t seen enough improvement. If CEOs want him to stop stimulating the economy, Bernanke suggested, they’d have to start stimulating the economy themselves.

Bernanke also had a message for Congress: stop being such jerks and fund the budget, get rid of the sequester, and raise the debt limit. He didn’t put it quite so simply. But it is easy to read between the lines. The modern Fed has always seen its job as counteracting the contractionary activities taking place in the economy. If companies are cutting jobs, the Fed cuts interest rates. On Wednesday, Bernanke said the Fed would have to continue its bond-buying activities because the economy faced headwinds. Among the headwinds Bernanke cited were “tighter financial conditions,” i.e., higher interest and mortgage rates. That one is partially on the Fed chief. Interest rates on the 10-year bond started spiking this spring and summer after the Fed said it might curtail its bond purchases.

Skin Tight

Melt That Double Chin

An obscure product made by a company with an obscure name has markets excited. Daniel Gross on the injectable compound that gets rid of your unwanted fat.

We’ve been down on American business recently and its ability—or lack thereof—to come up with great new ideas. Last year’s brilliant Doritos Locos Taco gave way to this year’s derivative Fiery Doritos Locos Taco and the dreaded Burger King French Fry Burger. Large technology companies, which used to put money at risk to create brilliant new products, services, and economic ecosystems, can’t really think of anything to do with their cash. On Tuesday morning Microsoft announced that it would spend $40 billion to buy back its own shares and increase its dividend—two clear signs that it is out of ideas. Not surprisingly, the stock market shrugged at this reaction. Investors would rather hear what new profitable products and services Microsoft will create with its huge cash pile.

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Image Source/Getty

And yet. And yet. America still is a land of dreamers, risk takers, and idea generators. Microsoft’s stock was dead in the water Tuesday morning. But the stock of Kythera, a biopharmaceutical company, was soaring. In early trading it was up 27 percent, boosting its stock market valuation by $175 million. A nine-figure sum has just been conjured out of thin air. The reason for the rise was the favorable performance in trials of one of Kythera’s new proprietary products, which is aimed at combating a growing and pernicious human woe.

Now this company possesses the rare combination of an inscrutable corporate name (Kythera), an inscrutable product name (ATX-101), and an inscrutable active ingredient (“a proprietary formulation of a purified synthetic version of deoxycholic acid”) that treats an inscrutable medical condition (“the reduction of submental fat”) that the market seems to love.

But it’s actually quite simple. And once you translate the Latin and Greek, the whole situation might make you slightly less optimistic about America and the types of ideas it is generating.

First, the name. Kythera, as the company notes, is the Greek island in the Ionian Sea from whence hails Aphrodite, the Greek goddess of love and beauty. The company, founded in 2005, is based in Calabasas, California, which is squarely in the San Fernando Valley. By now, you may be able to guess where this is going.

Rather than focus on cures for cancer or diabetes, this biopharmaceutical company focuses on aesthetic applications for proprietary compounds. “Our objective is to develop first-in-class, prescription products using an approach that relies on the scientific rigor of biotechnology to address unmet needs in the rapidly-growing market for aesthetic medicine,” the company notes on its homepage. “Our initial focus is on the facial aesthetics market, which comprises the majority of the aesthetic medicine market.” In other words, Kythera is aiming to build a suite of products like those made by Allergan, a wildly successful biopharmaceutical company based in Southern California, that allow people to fight the ravages of time and human behavior without invasive plastic surgery. ATX-101, the company’s main product, could be the “first-in-class submental contouring injectable drug.”

To put it in layman’s terms: Kythera makes some stuff you can inject into your jowls to make your double chin melt away.

No, Really!

Banks Really Are Different

Still think our dysfunctional financial system hasn’t changed a bit since the day of the cataclysm five years ago? On debt, consolidation, and consumers, Daniel Gross explains why you’re wrong.

Five years ago Monday, I sprinted through Midtown to Bank of America’s headquarters adjacent to Bryant Park to watch Bank of America CEO Kenneth Lewis and Merrill Lynch CEO John Thain announce their hastily arranged merger. Lewis was enormously pleased with himself, basking in the attention from the New York media. I chased a tight-lipped Thain as he scurried through the lobby to get back to his headquarters. I then spent the remainder of the week working on the slightly infamous King Henry cover story on Treasury Secretary Paulson for Newsweek.

lehman

Protestors hold signs behind Richard Fuld, chairman and chief executive of Lehman Brothers Holdings, as he takes his seat to testify at a House Oversight and Government Reform Committee hearing on the causes and effects of the Lehman Brothers bankruptcy, on Capitol Hill in Washington, in this October 6, 2008 file photo. (Jonathan Ernst/Reuters)

Sixty months after the failure of Lehman Brothers, many of the characters have changed. Henry Paulson is a wistful memoirist, and Tim Geithner, then the New York Fed president at the heart of the Lehman non-rescue, is working on his own book. Lewis is retired, and Thain has reinvented himself as CEO of the reinvented lender CIT Group. A lot of people have moved on. And so, too, has the U.S. economy—to a surprising degree.

The conventional wisdom holds that nothing—or at the very least, not nearly enough—has changed in the dysfunctional financial system or in the credit-addled U.S. economy. But many of the people making that argument either weren’t paying much attention to what was going on in the economy at the time or haven’t been paying much attention since. I’ll grant that the banks remain arrogant, highly leveraged, largely unrepentant, and prone to violating regulations with the same frequency and ease with which you and I have a glass of wine. But by and large, the financiers, the financial system, and American consumers all think differently about debt now.

To wit: debt in the financial sector has come down significantly. Five years ago, Lehman Brothers, an unregulated financial institution that didn’t have a base of deposits and funded itself with overnight borrowings, had about $30 of debt for every dollar of cash it had on hand. So did Bear Stearns. Giant banks like Citigroup had balance sheets that weren’t much more solid. Such species don’t exist anymore. They all got taken out in 2008. Lehman failed. Bear got eaten by JPMorgan Chase. Morgan Stanley and Goldman Sachs morphed into commercial banks and swiftly dialed down their debt levels. Merrill Lynch merged with Bank of America. And Citigroup, after taking a huge bailout, raised cash and shed assets in one of the great garage sales in Wall Street’s history. According to the Federal Reserve (see chart D. 1), financial sector debt has shrunk for each of the last four years. In the fourth quarter of 2008, the financial sector had $17.1 trillion in debt. In the first quarter of 2013, that figure stood at $13.9 trillion, off 19 percent. We may still hate the banking system. But the reality is that it is much better capitalized than it has been in years. Fewer banks are failing each year, and fewer banks are in danger of failing each quarter.

Of course, one of the undesired outcomes of the last several years has been consolidation. A few large banks now control a disproportionate share of deposits. It’s hardly surprising. We had an epic lending bubble. And consolidation is what happens in the aftermath of bubbles. The banking system pre-2008 was more diffuse and more competitive than it is today, in part because there were many more banks running around making insane loans. Check out the data (PDF) from the Federal Deposit Insurance Corporation. At the end of 2007, there were 8,534 banks in the U.S. That figure has fallen for six straight years, thanks to hundreds of failures and hundreds of mergers, as weak and struggling banks died off or fell into the arms of saviors. Today there are 6,940, down about 20 percent from the peak. Banking has a smaller cultural, retail, and employment footprint than it did several years ago. That’s different.

There’s been a fundamental change in the way consumers regard and use debt. As noted, the financial sector has reduced its use of debt. And in many important ways, so, too, has the household sector. In 2006 and 2007, the U.S. in many ways had a false economy. Hundreds of thousands of homes were bought with mortgages on which no payments were ever made, loads of clothes bought with credit cards on which payments were never made. I’ve noted this repeatedly—this is the age of the heroic American consumer. Americans are relying less on debt to consume, and they’re doing a much better job keeping up with debt. The credit card delinquency rate is at its lowest level since 1990. Credit card balances are back where they were in 2006, even though retail sales are much higher. In 2009, according to Cardhub.com, American credit card companies wrote off $83 billion in bad debt. This year, the total is likely to be about one third of that. The New York Federal Reserve’s quarterly report on household debt and credit shows that since peaking at $12.675 trillion in the third quarter of 2008, American consumers’ debt load has fallen to $11.153 trillion, a decline of $1.52 trillion, or 12 percent. That’s debt paid down, written off, or refinanced. Consumers, who account for about 70 percent of economic activity, are driving economic growth while steadily chipping away at their mountain of debt. It wasn’t like that in 2008. The relationship between debt and consumption has changed—not enough for many people’s liking, perhaps, but it has changed.

Yes, there’s much more work to do. And the bankers, like the poor, will always be with us. The large banks should be forced to hold much more capital than they do today. If they want to get bigger, they should be forced to hold even more capital. Imbalances continue to build up—especially in emerging markets and the student loan markets. And it’s quite likely we will have another financial crisis this year or next. But it won’t start in America’s housing, investment banking, and consumer debt complex, and spread throughout the world. Rather, the risk we face today is that a debt crisis in Brazil, India, or China will infect our financial system, that we’ll import a problem rather than export a problem. That’s another difference from 2008.

He’s Out

The Summers Whodunit

Who killed Larry Summers’s shot at running the Fed? Daniel Gross narrows down the list of suspects, from Elizabeth Warren and Wall Street to the brilliant economist himself.

On Sunday night, Larry Summers—brilliant economist, former Harvard president, former Treasury secretary—withdrew his name from consideration for the post that would top off one of the Western world’s great résumés: chairman of the Federal Reserve Board.

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Superficially, it’s obvious who—or what—killed the Summers nomination: the candidate himself took his name out of consideration. But at second blush, this situation is a little like an Agatha Christie mystery. There’s a victim (the dead nomination) and a host of suspects.

First, there’s President Obama. Of course, all the inside reporting tells us that Obama really wanted Summers in the post. They worked together in the crucible of the first years; they’re both Harvard men. But the president has a strange way of showing his favor. Decisive as a campaigner, Obama has been oddly indecisive and passive when it comes to emphatically naming nominees and then pushing aggressively and relentlessly for their approval. From the beginning, he has been slow to name judges and push for their confirmation, slow to name Federal Reserve governors and push for their confirmation, and slow to name nominees for Treasury and other departments. And rather than come out and declare that Summers was the man to replace Bernanke, that he should be confirmed quickly, and that he would brook no dissent, Obama simply sent out smoke signals about his preference.

Second, there are the congressional Democrats. In the Senate, Republicans can be counted on to filibuster everything, including lunch. So in order for a nominee to get approved, the 53 Democrats and the two independents who generally caucus with them have to stick together and then persuade five Republicans to let a vote proceed. Then they have to ensure that the 53 Democrats will actually vote for approval. But as time went on, and as President Obama dithered, opposition to Summers began to bubble up from within the Democratic Party. It started in the House, as the Democrats who form the party’s left wing began to agitate against Summers, citing his Wall Street ties, his support for deregulation, and the fact that he would be displacing Janet Yellen, who, if nominated, would be poised to be the first woman to head the Fed. Then last week, three Democratic senators signaled their opposition: John Tester of Montana, Sherrod Brown of Ohio, and Jeff Merkley of Oregon. Elizabeth Warren, an icon for the left wing of the Democratic Party and a former colleague of Summers at Harvard, was also said to be reluctant. Such opposition from within the Democratic caucus made Summers’s position untenable.

Third, there are congressional Republicans. If left-wing Democrats were suspicious of Summers for being too centrist and too close to Wall Street, right-wing Senate Republicans were suspicious of Summers for being too much of a socialist. After all, he was in the White House when the stimulus and Obamacare were conceived. So Texas Sen. John Cornyn said preemptively that he wouldn’t support a Summers nomination. And given that a few Democratic senators on the Senate Banking Committee had said they’d oppose Summers, he was going to need at least a couple Republican votes to get out of committee. But as of the first week of September, as The Wall Street Journal reported, “No Republican has publicly expressed support so far for any potential White House nominee for Fed chief.”

Fourth, there was Wall Street. Five years may have passed since the Lehman Brothers debacle, but that’s not enough time for the nation to forget the pathologies of the finance industry that did so much damage to the U.S. economy. And Summers, far more than Yellen, is identified with modern Wall Street. He was in the Clinton administration in the 1990s and was an advocate for deregulation. He worked for a hedge fund, D.E. Shaw, where he made a ton of money. He’s consulted for big Wall Street banks and has gotten paid to give speeches to banks. And he has been essentially unrepentant about it. Even without a Wall Streeter in charge, the Federal Reserve is always going to be overly solicitous of the financial sector’s needs. And so putting someone in charge who is a part of the system was always going to be a problematic proposition.

One more thing. To a degree, Summers has been punished for the shortcomings of President Obama and Wall Street. But he’s also been punished by his own shortcomings. Let’s be clear. Larry Summers has all the academic, professional, government, and intellectual credentials and skills necessary to run the Fed. Had he been appointed and confirmed chairman, he would doubtlessly have been an excellent one. But the job is a multifaceted one. It’s not enough simply to be the smartest economist around. You have to be a consensus builder, you have to demonstrate a capacity for empathy, to take the feelings, sensitivities, fears, of all sorts of actors into consideration.

Golden Era

There Goes the Deficit

A funny thing happened on the way to the debt-ceiling battle: a big chunk of our annual budget quietly melted away. Daniel Gross on the good news you didn’t see coming.

Here we go again. The debt ceiling is approaching, and Washington is in the grips of another round of mania. Will the Republicans in the House engineer a default, or a near-default, on America’s sovereign obligations? Will President Obama agree to delay the implementation of the Affordable Care Act in exchange for a debt-ceiling increase? Will Obama and House Majority Leader John Boehner finally be able to engineer a grand bargain on taxes, spending, and deficit reduction? (The New York Times reports this morning that Boehner is appealing to Democratic White House leaders and the White House for help.)

The Capitol Dome

The Capitol Dome is seen reflected in water pooled on panels of glass on the visitors center on Capitol Hill in Washington, on Sept 12, 2013, as the Republican controlled House and the Democrat controlled Senate will have to work together to to avoid a government shutdown after the 2013 budget year ends Sept. 30. (Carolyn Kaster/AP)

The answer? Maybe, no, and no.

There’s a great irony afoot. This week, there was plenty of new evidence that Washington is set to prove, yet again, its dysfunctionality on dealing with the basics of taxing and spending. But there was also fresh evidence that there has been enormous progress in the effort to cut the annual budget deficit.

In fact, we’ve long argued that we live in a Golden Age of Deficit Reduction. The August Treasury Monthly statement, released Thursday, and a Congressional Budget Office report released earlier this week, show just how far we’ve come in the space of a year.

In August, revenues were $185 billion, up 3.4 percent from $178.9 billion in August 2012. Spending was $333 billion, down 9.7 percent from $369 billion. The result: the deficit for the month of August was $147 billion, down 22 percent from $190 billion in August 2012. Some of the decline in spending is due to timing issues – benefits paid on the 31st of the month one year that aren’t paid until the 1st of a different month the following year. But the broader trend is intact: more people are working at higher wages, and wages are being taxed at a higher rate. Through the first 11 months of fiscal 2013, which ends at the end of this month, revenues are up 13 percent and spending is down 3.6 percent. The deficit for the first 11 months, at $755 billion, is off $409 billion, or 35 percent, from $1.164 trillion in the first 11 months of fiscal 2012. The picture is likely to get better, because in September, the government typically runs as a surplus as companies and individuals pay quarterly taxes due. Last year, the surplus for September was $75 billion. Should the September 2013 surplus come in at the same amount, the full year deficit would come in at $680 billion. That would represent a decrease of $409 billion, or 37 percent from last year. All in the absence of a grand bargain.

Many professional deficit hawks have argued that this year’s deficit reduction has come in the worst way possible. There hasn’t been any rational grand bargain or tax reform, and the sequester has functioned as an indiscriminate meat cleaver. But that’s not entirely true. A lot of the deficit reduction has come in the best way possible – from taxing those who can most afford to pay, from economic growth, from cutting spending on defense, and from falling spending on recession-era entitlements like unemployment benefits. According to the CBO, some $24 billion of the reduction comes from a decline in spending on unemployment benefits, because the number of people filing claims and receiving benefits has plummeted as the labor market improves. Because companies are earning more profits, they’re paying more income taxes—$216 billion through the first 11 months of fiscal 2013, up 16 percent from the first 11 months of fiscal 2012. That accounts for another $30 billion in deficit reduction. Individual income taxes are up $160 billion so far this year, because people are earning more and because the very rich are now paying higher taxes. And social insurance receipts (basically the Social Security and Medicare payroll taxes) are up by $101 billion so far this year, in part because the two-year cut on the Social Security payroll tax expired on January 1, in part because of the Obamacare excess payroll tax on Medicare, and in part because two million more people are on payrolls today than last year. The cuts attributed to the sequester, about $75 billion this fiscal year, account for only a small portion of the deficit reduction we’ve experienced this year.

And so as Washington continues to dither about the debt ceiling, funding the government, and a grand bargain, the annual deficit quietly melts away.

Stock Plunge

Lululemon Goes Sour

The international yoga apparel retailer is a hot company with a ton of stores and great sales. But now Wall Street thinks it has grown too fast and saturated the market, says Daniel Gross.

Breaking: trends are trendy.

Case in point: Lululemon Athletica. The high-end yoga apparel retailer has enjoyed astronomic growth as the craze for stretching, striking poses, and uttering Hindi phrases has gone national. It’s hard to negotiate the streets of New York these days without being knocked in the head by a yoga mat strapped onto a backpack.

Its shares, as shown by the chart below, soared from the single digits in 2009 to a peak of $82 in June.

But trends can get taken too far. Companies get overconfident. Consumers are fickle. In fashion, as Heidi Klum says on Project Runway, “One day you’re in, the next day you’re out.” LuluLemon isn’t quite out. But it’s not quite as in as it used to be. The company has had a rough 2013, as Erin Cunningham documented in these pages last month. There were the see-through pants that had to be recalled, the resignation of its chief executive officer, and accusations that the company discriminated against plus-sized women because it doesn’t make clothing larger than size 12.

Thursday morning, Lululemon suffered another blow: disappointing third-quarter earnings that led the stock to fall more than six percent in early trading. Since June, the company has lost about 21 percent of its market capitalization. Its shares have assumed the dreaded “downward stock” pose.

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The revelations in the earnings report are likely to be more damaging to Lululemon’s brand than the revealing pants or the executive turmoil. Fashion bloggers don’t pick up much on things like same-store sales and gross margins, but the numbers help explain why Lululemon has fallen out of fashion, at least as an investment.

Here are the fiscal 2013 second quarter. At first blush, the numbers look pretty good. Net revenue was up 22 percent year over year, and same-store sales (the preferred metric for retail analysts) were up a healthy eight percent. “Direct to consumer” revenue (online sales?) rose 39 percent from the year before, and now account for 14.3 percent of revenues. Income from operations were up 12.5 percent from the year before to $79 million. So, a profitable company with rising sales.

iFail

This is Not a Cheap iPhone

Apple’s new ‘low-cost’ iPhone is still pretty expensive, which is bad news for profits in an economy where wages are stagnant and truly cheap options are plentiful. Daniel Gross on the stock market’s punishing response—and the bleak outlook in Asia and Africa.

Well that was an expensive product launch. On Tuesday, Apple unveiled two new iPhones, the “cheaper” 5C and the whiz-bang 5S, or as my colleague Winston Ross dubbed them, the “cheap” and the “fancy.”

Apple

Several versions of the new iPhone 5C are displayed in Cupertino, California, on September 10, 2013. (Stephen Lam/Reuters)

Tech fanboys and fangirls marveled at some of the new features—new colors for the shell! Thumbprint security! But investors were less impressed. The company’s stock, which was trading at $505 in the middle of the day, closed at $494.64. On Wednesday morning, after investors slept on it, they decided to dump the shares like a cheap BlackBerry. By noon, the stock was off another $29, at $465.55. That decline—from $505 to $465.55—is a fall of 7.8 percent in about 24 hours, and a reduction of $35 billion in Apple’s market value.

What accounts for the fall? It could be that this was another case of investors buying the rumor and selling the news. Apple’s stock had run up sharply in the last few weeks as anticipation built surrounding the big reveal.

But I’d suggest something else is at work. It could be that investors are coming to grips with the problem facing the present—and the future—of the iPhone. It’s a rather expensive device. In the wealthy, developed economies where Apple has the strongest market positions, incomes of typical consumers aren’t rising. In the huge developing markets where Apple has a minimal presence, incomes of typical consumers are rising—but they’re nowhere near sufficient to enable them to afford Apple products. And Apple isn’t (yet) willing to meet customers where they are.

Let’s review. In the U.S., the new iPhone 5C costs $99 with a contract, while the new iPhone 5S costs $199 with a contract. That sounds cheap. But don’t be fooled. Those prices are only available when you sign up for a lengthy voice and data contract. At Verizon, such plans can cost $100 per month and up. Apple sells the device to the phone company, which recoups the cost of the device by marking up the cost of its voice and data service. The cost of the device, in other words, is embedded in the contract. In order to get the $99 iPhone, a customer must commit to spending $1,000 or more with a service provider over the course of a year.

The actual retail cost of the phone is much higher. According to Ian Sherr and Greg Bensinger of The Wall Street Journal, an iPhone 5C sold without a carrier subsidy will cost $549 in the U.S. That’s a lot of money when you consider that the typical American worker makes $829 per week. Worse, as I’ve written many times, the failure of American companies to raise wages for typical workers over the last several years has rendered workers increasingly unable or unwilling to afford the products and services that American companies make, market, and sell. Well-off Americans can buy a lot of iPhones and iPads. But if you want to be a mass business, and you want to keep growing off a very large base, it’s very hard to post impressive numbers if underlying incomes aren’t rising. Especially when you make a discretionary product. Everybody may need a mobile phone in America, and many people may need a smartphone. But very few people really need an iPhone. The pricing of these new products doesn’t do much to alter this equation.

Apple also faces a much worse problem in larger and more rapidly growing markets overseas. For the first time, yesterday, Apple formally held a product launch in Beijing. This was a recognition by Apple that the world’s largest country (by population) and second-largest country (by size of its economy) is a vital market. But Apple is poorly equipped to compete in China—and in other developing economies where lots of potential consumers live.

Goodbye, Makers

Meet the Servicey New Dow

In its biggest shakeup in nearly a decade, the elite Dow Jones industrial average booted manufacturers and welcomed companies that specialize in services and assembly. Daniel Gross on how the move reflects the new economy.

On Tuesday, three big changes were made to the Dow Jones Industrial Average. Out went Bank of America, Hewlett-Packard, and Alcoa. In came Goldman Sachs, Visa, and Nike.

Wall Street

Traders work on the floor of the New York Stock Exchange on August 27, 2013. (Richard Drew/AP)

The news was of more interest to students of finance history rather than to practitioners of finance. Yes, the 30-member club gets pride of place among indices when market summaries are reported. But investment firms design products to mimic the performance of broader, more diversified indices like the Standard & Poor’s 500 and the NASDAQ 100.

Symbolic as it may be, the Dow, which dates back more than a century, is supposed to hold up a mirror to the U.S. economy. It assembles an exclusive group of 30 of America’s largest and most valuable companies, with representatives of every major sector. The Dow, like all valuation-based indices, is an imperfect tool, in large part because markets themselves are imperfect. At times, they boost the value of one sector or company irrationally (hello, Tesla!), and at other times they irrationally knock down the value of others (Apple’s stock was worth only a few billion dollars 10 years ago). Indices like the Dow tend to bring in companies after they’ve had a large, prolonged run-up, and tend to drop them only after they’ve suffered a significant, prolonged decline.

Still, the roster of guests checking in and out of the Dow Hotel tells us something about who is up and who is down, what sectors are thriving, and what has changed about the U.S. economy. At first blush, there wouldn’t seem to be much change happening today. One huge bank in, one huge bank out; one California-based technology firm out, another California-based technology firm in; one global manufacturer out, another global manufacturer in. But there are some significant differences between those exiting and those entering. And these moves say a lot about how the economy has changed: fewer makers and more takers, less manufacturing and more services, less building and more assembling.

Let’s take them in order.

Bank of America may seem like just another gigantic bank. But it’s got an interesting backstory. A.P. Giannini, the son of Italian immigrants, in 1904 founded the Bank of Italy in San Francisco to provide banking services to the “little fellows.” Not part of the East Coast establishment, Bank of America thrived far from Wall Street. It took deposits and lent them out so people could buy and build stuff. Its postwar growth surge was made possible by one of the first sustained efforts to provide consumer credit to middle-class borrowers. In the modern era, Bank of America strayed from commercial and consumer banking into investment banking, and merged its way into gigantism—and into trouble. It acquired Merrill Lynch in 2008 as part of the empire-building efforts of former CEO Kenneth Lewis. His successor, Brian Moynihan, has shrunk the bank’s footprint as it continues to dig out of the financial muck.

Goldman Sachs has always been a different creature. It’s an investment bank, not a commercial bank. Based on Wall Street, not in California, it has always served other institutions and high net-worth individuals, not middle-class investors and borrowers. Goldman makes money in a lot of different ways. But many of them involve taking a piece of transactions. Underwrite a stock offering or a bond offering, take a 7 percent commission. Advise on a deal, get paid a commission. Manage money, and take a percentage of total assets as the fee. Do a transaction, and take a couple of basis points as a commission. Yes, Goldman often puts its own capital to work. But to a large degree, investment banking is a service business whose success rests on taking a little piece of every transaction that comes its way.

About the Author

Author headshot

Daniel Gross

Daniel Gross is a columnist and global business editor at The Daily Beast.

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