In case you haven’t heard, former Merrill CEO John Thain resigned today, presumably because of this scandal (HT2 Gene Callahan for the video):
UPDATE: This video was messing up my precious Google ads, so I took it down. You can click the link above to watch it.
On his show today Rush made the great point that people should be congratulating Thain for creating jobs. Rush was kidding of course, but really, it works: If Thain hadn’t spent that money, Merrill / Bank of America would just be sitting on it. So the politicians are simultaneously yelling at the banks:
(A) “What are you doing, playing it safe with your loans? We gave you those billions so you would get it out into the community, putting people to work on infrastructure.”
(B) “What are you doing, taking money that we gave you and wasting it on fixing up your office building?! Be careful with those taxpayer funds!”
It is unclear if he is asserting copyright to it.
Available here. (Note: Don’t let the .mp3 ending fool you; the hyperlink takes you to a page where you can play the podcast from your browser.)
A colleague asked me about “enterprise value” and passed along this discussion:
Enterprise value (EV) represents a company’s economic value — the minimum amount someone would have to pay to buy it outright. It’s an important number to consider when you’re valuing a stock.
You may remember that market capitalization (the current stock price multiplied by the number of shares outstanding) also serves as a company’s price tag. But market cap ignores debt, and with some companies, debt is substantial enough to change the picture significantly. Enterprise value, on the other hand, is a modification of market cap that incorporates debt.
To better understand the concept of enterprise value, imagine that you’re looking at two companies with equal market caps. One has no debt on its balance sheet, while the other one is rather debt-heavy. If you owned the latter company, you’d be stuck making lots of interest payments over the years, so you probably wouldn’t pay the same price for each company.
At the risk of saying something foolish that I will later have to retract…the above strikes me as ridiculous. It’s like asking if a pound of feathers is lighter than a pound of lead. Investors presumably understand how debt works, and so if they are valuing a debt-heavy company at $50 billion and a debt-free company at $50 billion, the first company must be superior in other respects.
Just look again at the last sentence in the quote above: The writer is saying “You would pay more for the first $50 billion company than for the second $50 billion company.” Huh?
If you still don’t see it, try this one:
Suppose you have one million-dollar-property in a low-tax region, and a different million-dollar-property in a high-tax region. Because you would have to make lower tax payments, you would be willing to pay more for the first property than for the second.
Let me kick this thing one more time, just to make sure you realize how crazy it is. Let’s go with the guy in his example. Because of the huge popularity of Free Advice, millions of people read the Motley Fool analysis, slap their foreheads, and say, “Holy cow! It never occurred to me to look at a company’s debt before buying its stock. Let me go investigate this new angle.”
The two companies originally had a market cap of $50 billion a piece. Now, because of the Motley Fool revelation, investors pay more for the shares of the debt-free corporation and less for the shares of the debt-heavy company. The debt-free market cap rises to $51 billion, while the debt-heavy market cap sinks to $49 billion.
The same process happens with every corporation on the exchange. Investors suddenly take debt into account when bidding on stocks.
Now, after the dust settles, we once again look for two companies of equal market cap, but with vastly different debt loads.
Can we once again use the Motley Fool article to prove that these companies are obviously mispriced?
Jason brings to my attention this documentary project. I think these guys are nuts–meaning, I can’t believe they are screwing with cops like this. What they do is set up a room designed to look like a marijuana growing operation, but they don’t actually do anything illegal. And then they install hidden cameras to catch the police when they (allegedly) come in without a warrant etc.
The main idea here is that they claim the police routinely get a bogus witness to say there is illegal stuff going on at the private residence, and then the judge signs a warrant. So for real drug dealers, obviously they can’t prove that the police just invented the “evidence” to get the warrant.
But if the cameras have been rolling the whole time, and the whole thing is a reverse sting, then it’s obvious the cops must have lied when they said they had an informant saying he’d bought drugs at the house.
Anyway, an interesting project, but like I said I don’t mess with cops. When I get pulled over, it is hands-on-the-steering-wheel, and “Yes officer.” And I don’t try to catch them breaking the law on tape.
Per Bylund passed along this video interview with Krugman. He blamed the present mess on 30 years of rigid free market ideology, and then clarified that the regulatory apparatus failed to keep up with the changing financial system. In case you’re curious, the reason he has to say it that way is that there was no smoking gun of “deregulation” that the critics can point to. The only possible candidate is the 1999 relaxation of Glass-Steagal. Obviously I can’t prove that this is untrue, but if you study what that change did, I find it highly implausible that it sparked a housing boom that didn’t really kick into full gear until a few years later, and also coaxed banks to make trillions in bad loans.
The other gem of the interview is Krugman saying this is the worst financial shock since 1931/1932, but that (paraphrasing) “hopefully our policy responses will be different this time, so we won’t get another Great Depression.”
I agree, Professor Krugman. In 1931 and 1932,* the policy response was to run an unprecedented peacetime budget deficit, to urge businesses not to lay off workers or cut wages, to engage in massive public works spending, and to bring the discount rate really low to help the financial sector.
Good thing we’re not making the mistakes of the past.
* I would have to double check the timelines, but my description might more accurately apply to 1930/1931. By 1932 the government and Fed started to realize that their Krugmanian medicine (not their term) wasn’t working and they started changing course, like jacking up taxes (to try to close the deficit) and raising the discount rate (to stem the outflow of gold). But clearly they tried Krugman’s policies for two full years after the stock market Crash and got the worst depression in history.
Yet another sneak peek at my upcoming book. The standard mythology of the Depression holds that one of the main causes was (price) deflation: Falling prices make consumers reluctant to spend, but this just feeds on itself, blah blah blah.
So you probably think that the most severe deflation in U.S. history occurred in the early 1930s, right?
Nope, it actually occurred during the 1920-1921 depression. From June 1920 – June 1921, CPI fell 15.8%. In contrast, starting at November 1929 and going forward in 12 month increments, the greatest deflation was 10.4% from November 1930 – November 1931.
You know, the 1920-1921 depression, the one caused by laissez-faire reactionaries in the White House that you spent a week in history class discussing? Boy, I don’t know about you, but I got so sick of how much class time we wasted going over the causes of the 1920-1921 depression. They didn’t even have an SEC or Social Security back then. No wonder it was so awful!
I know, I know, I’m just beating up on the guy all the time because I have impossibly high standards for my libertarian economists. I suppose the following is actually a responsible plea to limit Big Government:
Here is my guest post on bank nationalization. I could have stressed further that bank nationalization works best in small countries with a small number of banks. The more banks a country has, the greater the danger that nationalizing a few of them will make the rest much harder to recapitalize, thereby leading to a kind of contagious need for nationalization.