Editorials

Bruce Glensky | More obtuse jobless oratory

The silly season of politics is defined by the period between the conclusion of the primary season and the first debates. A close observer will argue that it began early this time; both candidates have been guilty of distorting the others statements before the conclusion of the 24-hour spin-cycle. The focus of the fall debate will be the economy and joblessness. Neither candidate will directly confront the causes of why this economic recovery has been one of the weakest on record; their commentary will be intentionally obtuse.

The oratory will be consistent with the traditional party brands and unfortunately be heavily weighted to taxation. The Democrats will invoke class warfare and argue that the Romney economic plan gives tax cuts to millionaires and the Republicans will berate President Obama’s run-away spending and the disincentives of higher tax rates on small business. But make no mistake, the Democratic Party is no longer the party of the middle class and the Republican Party is no longer the party of small business. Both of our political parties provide advantage to large business and large finance.

The key to job creation is investment. The invisible hand of capitalism, through the pricing mechanism, directs producers to create capacity for goods and services that people want. But now and then the invisible hand gets burned; we create sizable capacity in areas that yield negligible return. This is termed mal-investment. We have had two significant areas of mal-investment: housing and leveraged buy-outs. We have failed to deal with the remnants of the former, and of the latter, we have yet to recognize that the mal-investment even exists.

Michael Milken, the Drexel Burnham investment banker that developed the high yield bond market, was prescient when through the Milken Institute he forewarned that we were investing too much in residential real estate and not enough in our children’s education. Housing may make us more comfortable but it does not raise the productivity of future generations. Nor does it make us more competitive in global markets.

The weakness of the current economic recovery was pre-ordained irrespective of leadership in the White House. Simply, you can’t have a housing bubble that destroys $16 trillion of housing wealth and expect the traditional policy tools to paper over it. Liberals are dissatisfied with the Obama administration’s failure to direct policy to solve the housing problem. Wall Street was bailed out with access to $225 billion of direct capital and the credit default swap obligations of American International Group to investment banks were made whole. Yet the middle class received no relief even while the government sponsored mortgage guarantors Fannie Mae and Freddie Mac remain in government receivership. Liberals want mortgage contract modifications. Absent government activism it will take more time to digest the housing mal-investment.

The politics of leveraged buy-outs have been a high priority since the beginning of Mitt Romney’s candidacy but the economics of buy-outs have been neglected. A leveraged buy-out is created when a sponsor uses funds from our pension plans and high yield bond portfolios to recapitalize an existing corporation. There is no new capacity to deliver goods and services; there is no improvement to the productivity of future generations. Flipping corporations is no different than flipping houses. It is sterile investment from a long-run societal viewpoint. Public policy has encouraged buy-outs through the ability to deduct interest expense on speculative investments and the treatment of sponsor fees as capital gains rather than ordinary income.

High yield bonds are the special sauce that makes the LBO work. The market that Michael Milken created to provide access to capital for growth companies like Turner Broadcasting and MCI Communications in the 1970s and early 1980s has been abused. That abuse has been extended for 25 years and the negative societal ramifications of the mal-investment in buy-outs are beginning to bite. Capitalism would have dealt with this mal-investment absent the monetary policy of an activist Federal Reserve. Holding short-term interest rates at low levels has subsidized leveraged buy-outs and encouraged investors to chase higher yielding assets.

The mojo of free market democracy has always been the investment of capital to expand productive capacity to provide goods and services that people want and to improve the productivity of future generations. America wants its mojo back. Americans want their capital markets to be free. They want their savings channeled to investment that will raise their standard of living. Productive investment creates jobs; it does not destroy them. We will get our mojo back when buy-out lending is displaced by small business lending.

Should you believe this piece is an attack on Mitt Romney, you are incorrect. The sponsors of leveraged buy-outs include prior secretaries of Treasury and Commerce from both political parties. Both political parties have foregone opportunities to redirect our savings to productive investment and away from speculation. Both parties have relied heavily on the guidance and advice of investment bankers within their cabinets and neither party has acted to restore our mojo.

Contact Glensky, a former Wall Street financial manager who now lives in North Myrtle Beach, at bwglensky@sccoast.net.

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