No Value for the Money

A few weeks ago, I watched Bill Clinton on the Daily Show discuss the current economic meltdown.  His insight into this whole mess was that the demand for the mortgage-backed securities was so high that the sellers of these began underwriting more and more risky mortgages in order to fill the demand.  Because no one really understood how these worked, and because the risks of these bad mortgages were now borne by many investors instead of just a few, these securities continued to be created and sold to meet the demand.  This insight got me thinking about the current state of investing these days, and I’ve concluded that there are no good places to put your money.
 
First, let’s look at bonds. US Treasuries used to be a good investment, but these days due to our big deficit , bonds no longer have much value. Both the value of bonds themselves is declining due to the amount of government spending and the interest they get is pretty paltry.  When I last looked, the interest rate was less than most certificates of deposit.  Bonds for municipalities may be returning higher rates, but some of these are considered to be junk due to looming fiscal crises. Who really wants to invest retirement or college savings in junk bonds?  

Then there are stocks. Looking at the Dow Jones Industrial Average, stocks had steady growth in the 80’s and 90’s. If you invested after the .com bubble burst in 2000 or 2001, your money didn’t do much until 2007. Now with the latest crash, stocks are trading at about the same price as 1996. Much of my bonus and options were in Pfizer stock, granted at prices between 32 and 47, which is now trading at 15. I also thought buying Fannie Mae preferred stock was a relatively conservative investment.  A friend of mine had her retirement portfolio from Amex in Lehman Brothers stock.  Even GE, once the epitome of a ‘solid’ investment is struggling to reward shareholders.

This leads us to real estate, the last bastion of investing. Not getting solid returns from either bonds or stocks,  people turned to the “safest” of assets – real estate. Investing in real estate these days, though, is more than buying property. You can buy all sorts of securitized mortgages and REITs. The only problem is that there just wasn’t enough of the mortgage assets to satisfy the needs of the market. This led to more risky lending practices and more people buying real estate. With the risks spread to multitudes in the form of securities, it seemed as if no one would actually have to pay for bad debt, so why stop?  As housing prices rose, more people entered the market, feeding the frenzy and the bubble. Many of these people were pure speculators who thought they could get rich by flipping houses without having enough money down for a traditional mortgage. The whole real estate market turned out to be a giant pyramid scheme, not unlike the .com bubble of a decade ago. You think we would have learned from that, but obviously we didn’t. 

Now, John McCain was mercilessly raked over the coals by saying our economic fundamentals were good. However, there is something very amiss with our fundamentals.  Actually, there is one fundamental that most worries me – the American economy no longer creates value.  There is one basic exception – the high tech industry – but mostly, our government, our large corporations, and our real estate investors engage in schemes. It’s all about timing the market these days, not about creating value.  The most important criterion for a good investment is to ensure you have someone else to sell it to.

Let’s look at our government.  For the past eight years, government spending has increased and the government has become bigger. But where is the money going? Obviously, to the two wars we are waging and increased security.  What’s suffered in those years are basic services and infrastructure. Literally, our bridges and roads are falling apart and welfare, unemployment, and social services have been cut. As an investor, I like to put my money where it can do some good and get returns.  I have a fund for my kids’ education, because I think that it will ultimately result in better job opportunities for them. I think investing in people in the form of education, health care, poverty relief have a better chance of generating positive returns than security and war fare.  Hopefully, this way more people could contribute to our society through taxes, jobs, and even volunteering.  I recognize that protection from terrorism is a fundamental  need for a society to function, but we should be careful that we still have a society worth protecting.  Wary of excessive defense spending, Eisenhower once said, “We will bankrupt ourselves in the vain search for absolute security.”

Secondly, our businesses are not creating much value.  Although I applaud the slate of entrepreneurs and high-tech startups for their innovations, much of main stream corporations just engage in number crunching. The mandate of business management is to meet the quarterly profit projections no matter what. Having books that look good has taken the place of creating value for consumers.  Whenever revenues don’t meet projections, the easiest lever to pull to meet earnings is to cut costs. The easiest costs to cut are long-term investments, especially in R&D.  Yet, companies can’t cost-cut themselves to growth, so unable to grow organically, they seek new revenue streams through mergers and acquisitions. Although intended as a growth mechanism, M&As are notorious value-destroyers. Fully two-thirds of M&As turn out to be unsuccessful.  Typically, the financial justification for a merger or acquisition consists of synergy targets that can be achieved by combining operations and getting rid of redundant assets, especially people assets. Ironically, usually the most highly paid and most experienced employees are targeted for lay-offs, hence ensuring that years of knowledge and wisdom are effectively purged. Oddly enough, my experience with layoffs is that the Finance and Legal departments usually escape unscathed because they are needed to further justify the success of the effort and to structure future deals.   Thus, most corporations are in the business of structuring deals and justifying them through cost-cutting – not an environment conducive to developing innovations and creating value.

Lastly, look at the real estate bubble. Typically, when a family buys a home and lives in it for a while, they add value to it, either by upgrading the interior, putting up an addition, or improving the exterior. They may also improve the neighborhood in which they live by contributing to the police or fire dept or joining the  PTA.  Many people who have a limited budget buy “fixer-uppers” and pour sweat equity into home improvements.  In all these ways, people add value to their homes or to their communities, making the investment actually worth more. However, during  bubbles, people flip houses, just waiting for the prices to go up in order to sell, adding no value to the home or neighborhood. Worse yet, convinced to purchase homes they can’t readily afford,  owners have no cash to spend on improvements or anything else. Everything goes toward paying the mortgage.

My argument is that there just can’t be any good investments in assets that don’t create value. An economy cannot exist on market timing; yet this is what we have been doing for the past decade, if not longer. Our government barely supplies basic needs when compared to governments elsewhere that subsidize healthcare, education, and even child care. Our companies are obsessed with meeting short-term projections and making the books look good. Our real estate markets depend on the availability of people  willing to pay too much for homes.  Nowhere is that old-fashioned philosophy of investing to  make life better for everyone. 

As a final point, I’d like to point out who our most highly paid professionals are.  During this financial crisis, many people have been railing against the high compensation of Wall Street executives.  Although these are some of the highest paid people in the country, we should also look at other classes of excessive compensation – movie stars and professional athletic stars.  What do these stars and the Wall Streeters have in common? None of these professions contribute real value to our society. Wall Street execs try to make money for themselves and sometimes for others, while movie stars and athletes keep us entertained. What about the people who teach our children, protect our streets, create new medicines, build our infrastructure, keep us healthy or tend to us when we are ill? Salaries for teachers, cops, scientists, engineers, nurses are pitiful in comparison. Even doctors don’t make much anymore, except for plastic surgeons.  How can a society justify investing hundreds of millions of dollars in a comic-book action movie while it skimps on orphan drug research and space exploration?

This is the fundamental problem of our economy. We no longer create enduring value.  We no longer value value.