Friday, April 4, 2014

Financialization of the real economlly

This post is about Guitar Center and how it has been forced into a restructuring, not because of bad management or the lack of buyers for musical instruments, but because it became a target for financial gain.  The writer begins:



I never paid too much attention to the musical instrument (MI)
business in my profession of strategic analysis; it simply does not
represent enough cash flow to have significance in national economies.
For example, the global MI industry is around $13 billion a year. I used
to do high-level analysis of the market for antipsychotic medication,
something most people know nothing about, which has the same annual
sales revenue in the US alone. My only interest in musical instruments
was for pleasure, so when I was suddenly elected The People’s Analyst of
the Industry, (current salary: $0) I had a lot of catching up to do. After much deliberation, I see the MI industry as a microcosm of
every other problem in the global economy. To borrow from the analysis
of Thomas Piketty in his brilliant “Capital in the 21st Century,”
the monied interests of society have expanded their reach such that
they can concentrate and dominate almost every area of human endeavor,
and the deleterious effects are now evident to all. In the end, this story isn’t about a big box music chain, but how a
small number of citizens can subvert every product made, every job
offered, and every purchase decision – and how we can regain control of
our lives, starting with the musical instrument industry......




When I recognized how much the financial markets have become like
2006, I finally figured out why some other financier could shell out $50
or $100 or $300 million for Guitar Center junk bonds.  For the customers of private equity, a few million isn’t that much money.
These investors actually need some higher-risk assets in their
portfolio, rather than let their money sit around in a zero-interest
rate environment. They might be like Warren Buffett and already have
huge stakes in sensible things like Too-Big-To-Fail banks, railroads or
Coca-Cola. This just rounds out their overall position. Make 6-9% with
the chance that the company could finally go tits-up? Why not! If it pays out, then great, and if it doesn’t – tax write off!



You know who else thought like that? The people who set the mortgage market on fire just a few years ago. They
made a fortune by structuring finance in such a way that investments
produced income irrespective of their true value. They could not have
cared less about whether the end result was old people thrown out of
their homes or eight million unemployed – that was someone else’s risk.
Their risk got hedged by the taxpayer who would bail out the industry so
long as the collapse was big enough, so building a decent, functional
economy was besides the point.





This is the logic at play with Guitar Center. Financial parasites
have taken over the host company and could not care less about the
industry itself. They install some CEO who used to be selling DVD
players. They swap private equity firms in and out. It doesn’t matter –
it’s just another place for loose capital to suck out a few extra
dollars or a tax break. After all, the entire value of the company is
less than what JPMorgan paid in fines last year without breaking a
sweat.




We need to figure out sensible regulation for financial transactions. 



See How to get beyond the parasite economy

8 comments:

  1. Again, a disturbing article on the greed of individuals in this country and around the world. I completely agree that there needs to be more pressure on financial institutions from the SEC and the government. For a stable economy to be in place in the U.S. and around the world, effective regulation will be the key. Fiscal and monetary policies exist to help an economy, however they will only be effective if financial institutions and transactions are regulated on a consistent basis.

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  2. What are some ideas for this regulation of financial institutions? I like the idea however, I want to know how regulation will come to pass.

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  3. I agree more regulation is needed. In my opinion, there are not enough policies to regulate opportunistic behavior. I think many of the recent scandals in the financial industry (e.g. the crisis itself, LIBOR, London Whale) have come about because the downside risk (i.e. fines, jail) are not proportional to the upside gains (i.e. millions of dollars). If a person or firm could make potentially billions of dollars by bending the rules slightly and risk paying a relatively small fine, would you not expect them to go for the billions? I think human nature can become a bit perverse when the numbers get so large.

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  4. I think that regulation is the key to success in terms of this financial predicament. I also am interested in the last sentence of Sanjay's response. I feel that the financial sector has lost sight of the people they are affecting and the stocks they buy are no longer connected to the companies they are affecting (i.e. Guitar Center). It seems we are looking at a similiar situation faced by enron traders who manipulated the system without understanding or considering the impact of their actions. The financial sector in my opinion should not be so disconnected from the business sector.

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  5. Does anyone know how policies that regulate financial transactions have evolved? what are some of the most controversial ones?

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  6. maybe the problem is not lack of regulations but the implementation of regulations. there seems to be a disconnect between markets and business operations and the trickle down effect on society and people (in reference to the enron scandal). can financial markets redeem the failed promise of capitalism?

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  7. Are Guitar Center junk bonds actually higher in risks? I am a bit confused reading the first half of the second paragraph.

    When people look out for their own interests, they can do "amazing" things, be it good or bad. If they can easily escape the consequences of their actions ("getting evicted is someone else's risk"), they are more likely to do business in unethical ways. The trick is how to hold these people accountable for what they do?

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  8. the issue that the author seems to be implying has to do with ethics within the market and the business environment. firms enter industries that are beneficial and profitable towards the growth of the business. the huge profit that the CEO's reap from this business venture directly enhances their socioeconomic status. as a result, a very small portion of the population seems to be reaping large salaries and bonuses whereas the majority is robbed of jobs or pensions that they are rightly entitled to, have earned or deserved. i think the financial regulations that the above commentators point towards seek to regulate the market system so that it can operate in a fair manner, where every participate is rewarded accordingly.

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