In
case you hadn’t noticed, GDP is at an all-time high, well above pre-recession levels, corporate
profits are at an all-time high and the stock market has come back to
near its high point in 2008. So is our Deficit.

In
the past, that would have been enough to move us toward acceptable employment
levels but this time, we have an enormous number
of unemployed, or functionally unemployed, about 15 million people. Check out
this graph:

We need to cut the rate of unemployment
about in half
to approach the country’s prior average levels of unemployment. And we need to
do this when profits are great, the stock market is good, and GDP is at an all time high.

So, where will the jobs come from?

Is this as good as we can expect? Are we
condemning a generation to residing in the lower economic class? Pew Research has just published
a study
about the growth in Americans who self-identify as members of the lower-middle
or lower class.

The headline is that the percentage who identify
as lower-middle or lower class has risen
from a quarter of the adult population to about a third in the past four years.
Pew surveyed 2,508 adults.

Pew
reports that not only has the lower class grown, but its demographic profile
also has shifted:

• A
  virtually identical share of blacks (33%) and whites (31%) now say they are in
  the lower class.

• The
  share of Hispanics who place themselves in the lower classes grew by a third.
  

• The percentage of blacks who say they are in the lower classes is unchanged from 4 years ago, while the percentage of whites grew by 35%.

As
those surveyed look to the future and that of their children, many in the lower
class see their prospects getting worse. From the report:

• About
  three-quarters (77%) say it’s harder now to get ahead than it was 10 years ago.
  

• Only
  half (51%) say that hard work brings success, a view expressed by overwhelming
  majorities of those in the middle (67%) and upper classes (71%).

While the
expectation that each new generation will surpass their parents is a central
tenet of the American Dream, those lower classes are significantly more likely
than middle or upper-class adults to believe their children will have a worse
standard of living than they do.

Downward mobility has political
consequences:
Although it is not clear whether any of Pew’s findings are based on perceptions
created at the political conventions, only
8% identified the Republican party as favoring the poor more than Democrats.This is even more surprising since the
survey shows that more Republicans and Conservatives say they are
in the lower class than said so in 2008. From the Survey:

• Nearly twice the proportion of Republicans now places themselves in the lower class than did so four years ago (23% vs. 13%).
  

• The share of political independents who say they are in the lower classes also increased to 37%, a 10 percentage point increase over 2008.

• About a third of all Democrats say they are lower class (33%), compared with 29% four years ago, a change that is not statistically significant.
  

Here’s the big problem: Based on current unemployment levels in what are otherwise
relatively good times, and based on the statistics presented here and here; and the in the Pew Survey above, the middle class is shrinking
in absolute terms while those who self-identify as lower class is growing
rapidly.  

Consumer spending is 70 percent of the
nation’s economic activity.
The way we add jobs is INCREASED CONSUMER DEMAND. That means getting more
American consumers spending again. Most
new spending comes from the middle class and those aspiring to join the
middle class. They are the true job creators. Adding to the lower class is not
helpful.

But, consumers can’t spend when they
are unemployed or working part time, when their wages are shrinking, their savings are
depleted, their homes are worth a fraction of what they were five years ago,
and they’re worried about keeping their jobs.

This is the heart of our economic
dilemma, 15 million people are having difficulty making ends meet because they
are not working, or they have less of a job than they want.

Neither
party, nor their presidential candidate has addressed the question. They prefer
arm waving about middle class jobs.

The question at the
core of the upcoming presidential election isn’t merely which candidate’s story
most voters believe, the debate should be:  What needs
to be done starting in January to add more jobs in this economy?  

Romney has the usual Republican
arguments: Cut taxes on corporations and the already rich, cut government
spending (mainly on the lower-middle class and the poor), and eliminate costly
government regulations.

But corporations won’t hire more
workers simply because their tax bill is lower and they could spend less on
regulatory compliance.
Most companies are simply sitting on the profits they’re already making. They
are waiting for DEMAND to
improve.

In Part II,
we will talk about what steps we might take that will lead to more jobs and
more demand.

South Tower falls:  9:59am September 11, 2001

The Memorial Site at Night:

9/11 Memorial Pool closeup:

“We
may have democracy in this country, or we may have wealth concentrated in the
hands of a few, but we cannot have both.” Louis Brandeis

What’s
Wrong Today:

Part I of The Coming Political Reset laid
out some of the facts about the gutting of the middle class over the past 30
years. Let’s review some of the points:

1) The majority of new
jobs are low paying: see also, the NELP report outlined in The Coming Political Reset, Part
I.

2) The middle class is eroding, with a few
leaving for the upper classes, but most are moving to being members of the
working poor.

The
Coming Political Reset:

Are we overseeing the creation of a permanent underclass? 

• We
  are destroying the middle class.

• This
  causes tax revenues to continue to fall as fewer people find good paying jobs.

• That
  means fewer public services.

• There
  will be increasing distrust of people in power by a growing number of the new
  hopeless, who see those in power as ignoring their plight.

• Talent
  is increasingly sidelined through churn-and-burn corporate policies and hiring
  practices (e.g. hiring contract employees without benefits and little job
  security for the lowest possible wage).

Peter Edelman, a law
professor at Georgetown University, writes in his recent book So Rich, So Poor: Why
It’s So Hard to End Poverty in America that the proliferation of low-wage jobs — not the lack of
jobs — is the single biggest cause of persistent poverty. He argued in a July New York Times op-ed:

“We’ve been drowning in a flood of
low-wage jobs for the last 40 years… Half the jobs in the nation pay less than
$34,000 a year…25% pay below the poverty line for a family of four, less than
$23,000 annually.”

Our stalemated political situation is driving our unstable economic environment.
Our current divided politics will
last only as long as the majority of working baby boomers, the silents and a
good chunk of the Xers continue to think they can hang on to some piece of the American
Dream and not start to concentrate on simply
envying those who have it better than them. 

Young people today are completely screwed. The youth unemployment
rate (ages 16-24) was 17.1 % in July 2012. The unemployment
rate for young men was 17.9 % and the rate for young women
was 16.2 %. The jobless rate for young whites was 14.9%,
compared with 28.6 % for young blacks, 14.4% for Asians,
and 18.% for Hispanics. 

Those with educations have astronomical student loans, many have
no job, or low wage jobs and they can’t afford to live independently
and can’t afford to start a family. 

Our political stalemate could begin to break down by 2020, which is
when the demographics start to turn: 

• Demographic
  projections of Census data by the Census Bureau show that at that point, the US
  will be older than ever: People over 64 will have grow by 7.2% to 28% of the
  population compared with 21% now.

• The
  white majority will decline to about 60% from 68% now.

• People
  of working ages (18-64) will decline by ~15% to 61.8% from 76.7%.

Unless
we deal with the middle class jobs problem before 2020, today’s young underemployed
and discouraged boomers could coalesce around a view that the system is rigged against them. Elderly voters (a
growing bloc) will have less economic
security and much less control over the political process. They may
join together to start a new political movement. It may not look like the
Occupy movement or the Tea Party movement, but it will be informed by both.

Remember,
2020 is only two presidential elections from today.

We should also remember that the places where
revolutions, peaceful and otherwise, are happening in the Middle East are
places where the majority of the
population is young and are unemployed.

In the
2012 election cycle, Republicans are calling for austerity.

Every time someone says that the middle
class and the working poor must settle for much less while the top 2% continue
to do very well, we all should die a little inside.

With the political system broken, the legal
system’s power is becoming more dominant. If justice isn’t available in the
courts, a descent towards violence may be inevitable.

Governments
recognize this. It is the reason that the US is militarizing
its police forces at all levels and coordinating operations under DHS, which
has become the first domestic security “ministry” in US history.

Our governments from city to federal levels
are also purchasing drone aircraft, establishing a
surveillance state, so any violent revolution in the US is unlikely to be
successful: In fact, the fast, violent and coordinated response to Occupy
movements throughout the country coupled with the suppression of the on-scene
media coverage, shows that the
government expects resistance to grow and it stands ready to suppress it.

In the
Sixties, millions of students and others actively demonstrated in the streets.
At that time, alternative newspapers and word of mouth were the only means of
communication/coordination that protesters had. 
Cell phones and the Internet have changed all that, so movements can
start from nowhere and grow virally. What we saw in the third world would be
much more effective here.

In the Sixties,
the young and the principled were mostly against the draft. Ordinary Americans,
in particular most of the middle class, politicians, governments and labor,
were opposed to the protests and sided with the government. Economic times were different, too.

Today,
with rising domestic economic pain, it would not be unusual for our youth to no
longer see any real future. Despite the Republican and Democratic presidential
nominees’ optimism and cheer leading, many ordinary people fear that their kids
will not be as well off on average as their parents.

The real questions are:

1.   How do we get the
financial health of the US middle class to be the top priority in US politics?

2.   If is not the top
priority, are we prepared for a revolution, whether violent or non-violent?

This then,
is the Coming Political Reset:
Millions of people in the street is not at all far-fetched. What the outcome of
that civil disobedience will be is unimaginable.  

Pay
attention, Democrats and Republicans, your time is short. This could turn ugly by 2020; that is just two presidential terms
from today.

President Obama said it at a
campaign event in New Hampshire:

“…This is the defining issue of our time. This is a
make or break moment for our middle class and folks who are aspiring to get
into the middle class. The next president and the next Congress will face a set
of decisions on the economy, on deficits, on taxes, that will have a profound
impact not only on the country we live in today, but the country that we pass
on to our kids.”

What’s
Wrong Today:

Both
parties are arguing about whether individuals are better off today than when
Obama took office.

It’s irrelevant: The debate needs to be about which
candidate can create more middle class jobs over the next four years.

So,
What’s Wrong?

The
reason that neither party has a workable jobs plan is that they both expect more of the same for the next decade: jobs growth will mostly be in low wage
service jobs. This kind of jobs growth will continue the evisceration of our middle class that has been going on
for 40 years.

Jeff
Faux, a progressive economist who founded the Economic Policy Institute in
1986, is the author of the new book, The Servant Economy:
Where America’s Elite Is Sending the Middle Class. He argues that by the mid-2020s, even with the most optimistic assumptions about economic growth,
current trends indicate that the average American’s wages will drop about 20
percent.

As the National Employment Law Project report showed the other day, the jobs that have been
created since the end of the Great Recession are at a disproportionately lower wage. This has serious implications
for our ability to maintain annual GDP growth at the 3%-4% levels we have
typically experienced. It also has serious societal implications as we create a
larger working poor class and a declining middle class. The report found that :

• Lower-wage
  occupations were 21% percent of recession losses, but accounted for 58% of recovery growth.

• Mid-wage
  occupations were 60% of recession losses, but only 22% of recovery growth.

• Higher-wage
  occupations were 19% of recession job losses and 20% of recovery growth.

What
this means in real terms is that many of the people who had a middle class job
in 2008 now have a working poor job. The report goes on to say:

“The lower-wage
occupations that grew the most during the recovery include retail salespersons,
food preparation workers, laborers and freight workers, waiters and waitresses,
personal and home care aides, and office clerks and customer representatives.”

This table from the
NELP report shows that the 2.8 million
Mid-wage jobs lost ranged between $14 and $21/hour. That is, an annual
salary of between $29,120 and $43,680 per year. In most cases, these are not
jobs that offer career upside to the job holders.  Asking
our economy to replace jobs like these should not be an insurmountable challenge. 

It gets worse: As reported by the
Economic Populist,
food stamp usage is actually up according to the latest data. As of May 2012,
46,496,788 people are on food stamps in the United States. That’s 14.8% or over
1 in 7. The United States population in May 2012 was 313,878,000 and this
figure includes everyone, including people overseas. Food stamp usage has increased 2.4% from May 2011 and 0.5% from April 2012. This
shows that the working poor have traded a mid-wage job for a low-wage job using
food stamps to supplement a declining household income.  

Since October 2007, food stamp usage has increased
72.2%. Population
has increased 3.7% during the same time period. That
is how badly America is hurting. There are over 6
million
whose only income is food stamps. That means they are living on the streets
with absolutely nothing else. Nutrition
assistance (the SNAP program) now accounts for 67% of the USDA’s budget, compared with 26% in
1980.  

The
real political economy question:

Is not: “Are you better off today than you
were 4 years ago?”

Is: “Which party will return the middle class
to the levels we saw before 2008 by 2016?”

We are not facing the
same catastrophe today that we faced in September 2008.

Ours is a new catastrophe wherein a young person (educated or
not) can’t get a job and a mid-career person can only find a low wage job. This
will not turn around by itself, we need a structural change:

• Away
  from Corporatists driving our tax, finance and trade regulations
• Toward
  a state commitment to jobs creation

A friend in Australia
who reads this blog reminded me of a meeting he once had, when he was head of
an Asian Merchant Banking operation, with the Financial Secretary of Hong
Kong.  He asked the Secretary how a small group of British civil
servants had such success in building a high employment economy.  In
essence what Sir John told him was:

1. We were desperate – millions of
refugees were coming across the border from China and we had no money in the
coffers to look after them

2. We had to develop a policy that
put many people to work

3. That policy had to be enforced

Their
approach was that every piece of
legislation that was put forward had to pass a simple test: does this bill
increase employment or reduce it if we put it into effect?

If
yes, then it went on its way to the next stage; if no then it was reconsidered
and forced to pass that economic bar.  Simple but brilliant, although I
doubt they had as many so-called “independent” groups that “score” ideas in
Hong Kong as we do in DC.

My
friend thinks Washington could never do this. The Wrongologist thinks that
Obama might actually think that is a good idea… Would Romney? 

A
Final Thought:

The one answer
Democrats should use when asked what is holding the recovery back is: “the Republican economic agenda”.
As Mitt Romney himself admitted, he has replaced middle class jobs
with ones that don’t pay the bills.

And he’s gotten wealthy
doing so.

Mitt Romney is the
poster child for why middle class job growth is unlikely to get better, because
Mitt’s entire experience and success has come from using the rules set in place
by the corporatists that went before
him, helping to accelerate a downward trend in the number of middle
class households
that we’ve seen since the 1970s.

Many people are not better off than
they were four years ago because people just like Mitt built a different world
in the past 30 years by:

• Attempting
  to roll back the social safety net both parties built on the foundations of
  FDR’s response to the great depression,

• Paying
  lower state taxes when companies play one state against another for tax relief,

• Making
  retention of the Bush tax cuts a litmus test for political campaign funding,

• Approving
  bailouts for their Wall Street partners while they complain about bailing out
  the Auto industry,

• Offshoring
  jobs while blaming the lack of a “competitive” tax and regulatory climate in
  the US,

• Packing
  the Supreme Court so that the Citizen’s
  United case could begin the process of institutionalizing the
  corporatist agenda,

• Using
  social wedge issues to take voters’ attention away from economic issues.  

To the extent people aren’t better off,
it’s for precisely the same reasons Mitt (and his ilk) are better off.

Based on the track
records and current policies of both parties, neither is likely to do much to improve
our chances of coming out of this existing low wage crisis.

Without GDP growth,
our economy is doomed to second class status. Without more middle class jobs,
there will be little increase in demand for goods and services beyond the rate
of inflation, that is, limited GDP growth.

 

Part II of the Coming Political Reset will
examine what happens if these trends continue for the next 10+ years, as they
seem likely to do.

 

What’s Wrong Today:

Some final thoughts on yesterday’s column on Mr. Romney’s job creation record:

Igor Volsky @ Think Progress reported on July 17:

During an appearance on Fox News on Tuesday morning, Mitt Romney surrogate and former New Hampshire Gov. John Sununu (R) argued that President Obama did not have the requisite business experience to create jobs because he was “smoking something” in Hawaii.

OK, let’s compare and contrast the records of our two candidates:

1. Mr. Romney did 67 private-equity deals as CEO of Bain.
2. Mr. Obama has done just 2 private-equity deals, both in his role as president. They were bigger than the sum total of all the deals Mitt Romney did at Bain and they worked better. All of the benefit accrued to the stakeholders: employees, vendors, management, customers, communities, taxpayers and the national economy.  And no investment banking or management fees were collected. It IS true that he used your money to do it.
3. Particularly telling was the action taken by the president once his team realized that that both the management and boards of GM and Chrysler were incompetent and unworthy of investment. Mr. Obama, through car czar Steve Rattner, did what a truly great CEO (or private-equity guy) would do: He fired them and brought in new guys from outside Detroit. That was a huge risk, undertaken at lightning speed, which all of the traditionalists in the industry thought was crazy. In doing so, he fixed fifty years of Detroit incompetence at the highest levels.
4. Mr. Romney touts his business acumen and job-creation record as a key qualification for being the next U.S. president. You remember his Op-Ed against the Auto Bailout. Above is a graph of domestic auto sales and production: Note what happened to sales after the Romney Op-Ed.
5. So, let’s contrast Obama’s performance above with Bloomberg’s description of how Romney operated:

What’s clear from a review of the public record during his management of the private-equity firm Bain Capital from 1985 to 1999 is that Romney was fabulously successful in generating high returns for its investors. He did so, in large part, through heavy use of tax-deductible debt, usually to finance outsized dividends for the firm’s partners and investors. When some of the investments went bad, workers and creditors felt most of the pain. Romney privatized the gains and socialized the losses.

As the Wrongologist has reported,10 of roughly 67 major deals by Bain Capital during Romney’s tenure produced 70 percent of Bain’s profits. Four of those 10 deals, as well as some others, later wound up in bankruptcy.

So, it may be less than clear how his experience at Bain is relevant to the job of overseeing the U.S. economy, strengthening competitiveness and looking out for the welfare of the general public, especially the middle class.

Some final thoughts on Mr. Romney:

A. He says he is a true believer in protecting the job creators from paying taxes. He shows this by hiring Paul Ryan to be his VP.

(i) Under Paul Ryan’s budget plan, Mitt Romney would have paid an effective 0.82 percent tax rate on $21 million of currently taxable income, since Ryan’s plan eliminates all taxes on capital gains, interest, and dividends, while reducing the top marginal tax rate to 25%, and eliminating the Alternative Minimum Tax.

(ii) So, instead of paying roughly $3 million in taxes in 2010, Romney would have paid about $177,000 instead.

B. Let’s look at what Mr. Romney has been doing since he was governor of Massachusetts:

(i) He hasn’t worked. 

(ii) He hasn’t created any jobs outside of his political campaigns and the new house in La Jolla.

C. He says he is a true believer in the trickle-down theory.

(i) So, shouldn’t he be creating more jobs with all of his wealth?

(ii) Is there any reason to believe that he would have created even more jobs if he’d been allowed by Mr. Ryan’s plan to keep an extra $3 million dollars a year over the last five years?

As anyone who has been around the financial industry knows, there are very few private equity firms that primarily buy and hold.

Most are like Bain, looking to turn a fast buck by purchasing and then quickly selling their targets. That’s their modus operandi.

To anyone who can look beyond their politics, Romney’s use of Bain’s short holding strategy to drive investment returns is totally understandable.

Using it as a proof statement for “job creation” is simply laughable.  

What’s Wrong Today:

How many jobs did Mitt Romney create during his tenure at Bain Capital ?

By his count and that of his presidential campaign, the answer is more than 100,000. The calculation comes primarily from counting every position added from the point of the initial Bain investment until the present at four successful investments, including Staples Inc. and Sports Authority, Inc., by Bain Capital and Mr. Romney.

The number of jobs created by Bain during Romney’s tenure is a centerpiece of his campaign. The Republicans say that President Obama has not done enough to create jobs, despite the fact that the economy has created 4.5 million private sector jobs since the bottom in 2010.

Romney’s job creation record is used by the candidate and the Republicans to buttress the contention that Mr. Romney would be a better steward of the economy than President Barack Obama.

It also is a source of dispute between the campaigns as the Democrats assert that, far from creating U.S. jobs, Bain Capital under Mr. Romney was a leader in sending jobs abroad, which Bain and the Romney campaign reject.

So, What’s Wrong?

This is the most important debate we can have in the Presidential campaign. Without substantive job creation, we face a long-term low/no growth economy, which will be a significant challenge to our national security and our place in the world order.

This graph From the St. Louis Fed shows the US’s long-term unemployed currently at 5.2 million. Behind every data point on the line is a real live person, with ability, skills, promise, knowledge and capability who desperately needs someone to hire them.

Mr. Romney says that he is the better job creator. The debate over his job creation record while at Bain Capital is relevant and it should turn on how many jobs were created while he was there. The estimates range from 100,000+ claimed by the Romney campaign, to 1,500, under a more radical counting method, so the Wall Street Journal’s Mark Maremont reports.

Assigning job creation numbers to private-equity firms is an uncommon exercise among researchers.  As a result, there is no widely accepted accounting measure. The Romney campaign’s 100,000+ jobs claim is flawed, because:

• It gives Romney all the credit for jobs the firms created, even long after he left Bain.

• It gives Bain ALL the credit for all the jobs, even though other investors also played a role in each of the four key companies, not to mention management.

Take Sports Authority for example: The venture capital syndicate was led not by Bain, but by William Blair Venture Partners. The group included First Chicago Venture Partners, Phillips-Smith Venture Partners, Marquette Venture Partners, and Bessemer Securities along with Bain Capital.

Staples is often cited as Romney’s and Bain’s biggest success. It is a giant firm with more than 89,000 employees. Again, Bain was not the first investor or the lead investor in the company; Bain’s initial investment was $650,000. The other initial investors were Fred Adler of Adler & Co., Bessemer Venture Partners, and Hambro Ventures. Romney sat on the company’s board of directors, as did a representative from each of the other investors.

Unnoticed amid the debate is that the four companies at the core of Mr. Romney’s 100,000+ jobs claim were relatively insignificant in dollar terms in the context of Bain’s portfolio investments during his 15-year Bain career.

The total invested in the four he claims credit for as a job creator was about $25 million, or about 2% of the money Bain invested during Mr. Romney’s tenure.

The other two companies, in addition to Staples and Sports Authority, are Bright Horizons Family Solutions LLC, a day-care provider, with about 19,000 employees, and Steel Dynamics Inc, a steel producer, with about 6,500 workers.

The WSJ chart above compares three ways of “counting” Romney’s success as a job creator. The first column gives him credit for ALL of the jobs created from the time of Bain’s investment to the present, long after his exit from Bain.

The second column gives Romney credit for the 100% of the jobs created, but ends with his reported “exit” from the firm in 1999.

The third column bases Romney and Bain’s credit as proportional to the scale of Bain’s investment to the total amount invested in the 4 firms.

The three different answers from the three different methods of counting underscore why many experts say it is futile to try to pin a number on Romney’s success as a job creator.

What’s wrong here is that any jobs creation claim by the RNC and the Romney campaign is fact-free and safe from scrutiny.

How would you grade Romney and Bain as job creators? The Wrongologist calls it a Gentleman’s “C”.

Remember that creating jobs isn’t the primary goal of venture capital or private equity capital firms. They measure success by returns produced for investors. Job creation is at best, a secondary measure of success.

And consider this:

• A group of investors ponied up $2.7 million to buy restaurants from Richard and Maurice McDonald.
• Banker Ken Langone led a group of 40 investors to raise $2 million to start Home Depot.
• Mike Markkula gave Apple Computers the $250,000 it needed when it incorporated in 1977.

Do we credit the jobs created by McDonald’s, Home Depot, and Apple to the money men? No, but, unlike Mr. Romney, those money men were not running for President.

Instead, we credit them to Ray Kroc, Bernard Marcus and Arthur Blank, Steve Jobs and Steve Wozniak. Because they had the ideas, ran the operations, and assumed most of the risk.

It’s unclear why we should treat Romney’s role at Bain any differently.

Let’s also remember that the VAST majority of the jobs created at Staples, Sports Authority and Bright Horizons are low-value service worker positions. That’s righteous work, but we can’t win if the only jobs available to the long-term unemployed pay the minimum wage.

And the skills of an investor aren’t those we should think of first when contemplating the presidency… If they were, Warren Buffett would be squaring off against George Soros every four years. And considering our last column, it’s doubtful that Mitt Romney’s investment record would get him to the finals with those guys.

Why not have Romney and Obama REALLY debate unemployment?

Maybe they could discuss innovative ways to get people back to work:

• How about incubators to start up businesses, complete with grants, tax incentives and investment, but require that the incubator and start-up incentive be run by some of the long term unemployed?
• How about requiring a percentage of private business new hires to come from the long term unemployed?

There are great companies out there, with innovative ideas and new services to be developed, new products to be launched.

And we have millions of long term unemployed capable of helping to create those services and products.

Would that be socialism? Would it end freedom in America? Would it be Wrong?

What’s Mitt’s better idea?

What’s
Wrong Today:

If there
is one thing everyone seems to agree on, it’s that Bain Capital under Mitt
Romney was one of the most amazingly profitable and successful investment
companies in history. He was “coolly brilliant,” agreed his biographers,
Kranish and Helman. How brilliant?  Published reports cite fantastic
performance figures:

• Some
  media reports say the firm earned “50%
  to 80% a year” for investors over fifteen years.
• The Real Romney cites reports that
  put the figure at 88% a year.
• The
  American Enterprise Institute went even further than that. In a glowing
  profile
  of Mitt Romney published in 2006 in its magazine, The American, they claimed:
  “During the 14 years Romney headed Bain Capital, the firm’s average annual
  internal rate of return on realized investments was a amazing 113 %. The magazine added:

“At that growth
rate, a hypothetical $1,000 investment would grow to $39.6 million before fees.
Few, if any, VC firms have ever matched Bain Capital’s performance under Mitt Romney.”

These are
amazing numbers. Alas,
they are Wrong.

So,
What’s Wrong?

Bain/Romney did not return 113%
per year. In fact, their investment performance, according to their own data,
was borderline unremarkable.

Thanks to two Wall Street Journal
reporters, the full
Romney/Bain investment record is available. Patrick O’Connor and Mark Maremont
of the Journal completed a comprehensive assessment of Bain Capital,
including all 77 businesses Bain invested in while Mr. Romney led the firm from its 1984 start until early 1999,
when he says he left the firm. On August 5, Brett Arends released the eBook, The Romney Files, which includes extensive reviews of
Bain Capital.

The Journal sourced
its data from a private placement document Deutsche Bank AG used to raise capital
for a new Bain fund in 2000; 77 Bain investments covering 1984 through 1998 are
included in that placement memorandum. Deutsche Bank cites Bain as a source for
the deal history; these deals accounted for about 90% of the money Bain
invested during that period. (The Journal obtained updated information from a
similar 2004 prospectus). This
is  the main source relied on by the Wall Street Journal, the Los
Angeles Times, the Boston Globe, and other publications. It’s the one cited by the Romney campaign itself when discussing his
record.

Among the key
findings in the WSJ article:

• $.9
billion invested generated $2.4 billion in gains for its investors
over 16 years.
• 22% of the companies either filed for bankruptcy reorganization or closed
their doors.
• An additional 8% ran into so much trouble that Bain lost 100% of client money
invested in each deal.
• Ten Bain/Romney deals produced more than 70% of the total dollar gains; 4 of
these businesses later ended up in bankruptcy court.
• Several of Bain’s largest successes were retail firms: Staples, Domino’s
Pizza Inc. and Sports Authority, creators
of many low-paying jobs.

But if you
invested $900 million in steady amounts over fifteen years and earned “80%” a
year, you would have about $900
billion.

If you
earned “113%” a year, you would end up
with about $9 trillion – or nearly three quarters of the U.S. annual
GDP. Bain Capital is a successful company, but if Bain now owns three quarters of the nation’s annual economic
output, I’m sure we would know.

Such are
the miracles of compound interest and the ways that Private Equity firms count
investment gains when they are talking about their investment prowess.

Take this example:
In 1996, Bain Capital bought Experian for about $80 million and then sold it for
about $250 million.

To you and
me, this would count as a 212% gain: Bain Capital made 3x its original
investment. But, according to the Deutsche Bank prospectus, the Experian deal
has an “implied annualized internal
rate of return” of 6,636%.

Why? They flipped the company in seven weeks.

On an
annualized basis, it’s an awesome return. But it’s only relevant to investors if Bain Capital were able to come up with
a string of identical deals for a full year. That’s what “annualized
return” means.

So, it’s
in the context of a 7 week investment and using that computational methodology that
Bain/Romney claims these outsized returns.

Yet, any investor could
have achieved net returns of ~20% per year during that same period, 1984-1998, just
by buying the S&P 500 index and holding it while reinvesting the dividends.
Any investor using leverage the way Bain did could have returned more than 30%.

As Mitt
Romney would later admit (according to The Real Romney), “I was in the
investment business during the most robust years in the history of
investments.” Stock prices soared. The Dow Jones Industrial Average rose more than sevenfold. When you
include dividends, the market rose twelve-fold.

So Bain’s clients
could have just picked stocks out of the newspaper, gone fishing, and earned
about 20% a year. No Harvard MBAs. No Mitt Romney. A broker, a dart board, a copy of the
stock prices page of the Wall Street Journal and a fishing rod. No fees to
Bain, just a steady 20% a year.

But that’s
not all. As everyone in finance knows, what really matters isn’t just your absolute
level of return, but your returns when
adjusted for the risk you took.

Bain
Capital didn’t just buy stocks, the way your mutual fund does. It bought its
companies with debt, ­lots of it. Leverage, as Mitt Romney has said, was
absolutely key to the business model. LBO firms like Bain Capital bought
companies with a few dollars down and huge loans.

In some cases the leverage used was very large. Bain Capital made
spectacular “internal rates of return” of 1,100% on one of its earliest deals
under Mitt Romney, Accuride, which it bought in 1986 and sold a few years
later. How do you earn returns like that? According to newspaper reports at the
time, Bain Capital put down just 3% of
the purchase price. Most of the remaining $200 million it borrowed.

The
Experian deal described above, involved just 10% down. Bain Capital’s use
of leverage was perfectly legitimate. It was a gamble that paid off. But it
matters a lot when it comes to measuring the investment returns.  

Stock
prices boomed during the eighties and nineties. Meanwhile the cost of debt,
like the cost of mortgages for the real estate investor, plummeted. Prime
lending rates fell from 12% to about 8%, according to the Federal Reserve. The
interest rate on corporate bonds halved.

So for
fifteen years, it got cheaper and cheaper to borrow money to buy stocks that
just went up and up and up. There was,
in short, never a better moment in human history to borrow money and use it to
buy U.S. companies. Good timing, Mr. Romney.What
have we learned?

• Mitt
  Romney’s investment returns were nowhere near as high as some of the fantastic
  numbers you’ve read.
  
• And
  the lion’s share of those returns came from playing in a great bull market: The
  returns came from leverage and market growth, not from “vulture capitalism” or
  from “brilliance”.
  
• They
  were not the result of finding underperforming companies and making their
  operations better, nor ruthlessly stripping assets and laying people off.
  
• They
  came from betting on U.S. firms with borrowed money.

Good for
him. But PLEASE, call it what it is.

And
there’s one more thing. His reported investment
figures are gross, that is, before Bain’s fees.

Nobody see’s
investment returns before fees as indicative of their returns. After all, all
mutual funds quote their figures net. So does every hedge fund. It’s when you are campaigning that you want
to make the returns seem as large as possible.

Bain
Capital charged investors between 1.5% to 2% of their money each year just for
managing it. They also took another
20% of any profits. Simple math tells us that over the course of
fifteen years, based on the information we have regarding the size of Bain’s investment
funds, Bain Capital must have pocketed
at least $500 million in fees and quite possibly, more.

Once you
deduct these fees, you realize that during a fifteen year period Mitt Romney’s
investors put in about $900 million and got back about $2.4 billion. In other
words, Bain Capital under Romney made a dollar-over-dollar gain of about 170%.
Not annualized: In total.

If their
average dollar was invested for five to seven years, it means that Romney’s
investors earned, net, between 17% and 25% a year. You could have too.  

Brett
Arends, author of the book The Romney Files,
asked Vanguard, the low-cost
mutual fund company, how much investors would have made if they had just
dollar-cost averaged $900 million into a basic U.S. stock index fund over the
same period, 1984 to 1998.

Vanguard’s
response? The investor would have made
more than $3.5 billion in gains.

$3.5 billion with
Vanguard vs. $2.4 billion with Bain.

 

Brilliant record? Adequate record? You
decide…

The Wrongologist has been away, looking at the sea in Maine and thus providing zero blogging.  Although not publishing, your intrepid columnist has been thinking, aided by his wife, Ms. Oh So Right.   

Here is the view from the house we occupied on Cundy’s Point:

Each morning we would discuss the current state of politics and economics over strong coffee prior to moving on to alcohol to drown our sorrows.

The discussion group included an ethicist, an international taxation lawyer and two college professors.  We solved no problems, but I gained plenty of ideas to share with you.

The next two columns will present the facts regarding Mitt Romney’s claims to fame in the private sector: His success as an investor and his success in creating private sector jobs.

OK, back to work.

What’s
Wrong Today:

Being a woman is no longer a pre-existing
condition since eight preventive services concerning women’s health mandated by
the Affordable Care Act, including contraception coverage, went into effect on
August 1st. This means that insurance companies have to provide birth
control, mammograms and other well-woman and preventative tests and procedures
without co-pay.

Under the policy,
employees of some religiously affiliated institutions, such as Catholic
hospitals and schools, may receive birth control directly from their insurance
company, still without requiring a co-pay.

Churches and houses of
worship are exempt.

The new policy covers
a range of other preventive healthcare services apart from birth control,
including STD screenings and counseling for women who are breastfeeding or are
victims of domestic violence. The
new policy does not cover women without insurance.

So, What’s Wrong?

House Republicans called the ACA’s mandate
“religious bigotry” and compared it to the attacks on Pearl Harbor
and on Sept. 11, 2001. A few GOP freshman House members held a press conference
to draw attention to the start of the program. According to The Hill’s Elise Viebeck, some of
them may have gotten a little carried away. This is what
freshman Rep. Mike Kelly (R-PA) had to say:

“I
know in your mind you can think of the times America was attacked… One is
December 7 — that is Pearl Harbor Day.

Another was September 11 — that was the
day of the terrorist attack…

I
want you to remember August 1, 2012 — the attack on our religious freedom. That
is a date that will live in infamy, along with those other dates.”

Actually,
it IS an anniversary of sorts. August 1st is the 69th anniversary of
the raid on Ploesti, (an oil refinery in
Romania) in 1943, in which the Army Air Forces tried to knock out Hitler’s oil
supply. In all, 54 planes (30% of the wing) were
lost. Five officers received the Medal of Honor for bravery on this mission.

But this was back in the days when
Americans could get together to do something worthwhile and even Republicans
served.

But,
generations from now, will we remember August 1st, 2012, as the first day of
the “Zygote Holocaust”?  

Maybe the
Republican freshman can follow up by declaring a “Chic-Fil-A-Infamy Day”.

In all
seriousness, this battle of insanity has become horribly tiring. Preventative
care saves millions of dollars in addition to women’s lives.  Who
are these Republican legislators that take the crazy train to every press
conference?

The
Wrongologist has news for them: we passed crazy a few exits back. These guys (apparently
not all men, considering Ms. Bachmann is right there with them) have refined
their gift for bringing hysteria, hyperbole and umbrage taking to the
microphone. They should try for a little perspective:

These benefits are
a choice for the individual to use or not to use.

If using this
portion of your benefits does not line up with your religious beliefs than you
are not obligated to use them.

And this is not
about the government misusing tax receipts. People pay for things every day
(indirectly through their taxes) that go against their conscience and for some,
against their religious beliefs.

War for one. Dick
Cheney’s pension and heart transplants, for another.

And
finally, the mandate was about as stealthy an “attack” as the Macy’s
Thanksgiving Day parade.

Other than
all that, of course, it’s a perfect
analogy, just like every other issue under the sun for our
friends on the Crazy Train.

What’s
Wrong Today:

At the risk of boring all readers of this blog, the Wrongologist wants to
make a few more points on the regulators of our banking system. Today, we place
the Securities
and Exchange Commission’s  (SEC) in our
sights.

Although
the SEC has stepped up its investigations of Wall Street in the last decade, it
has repeatedly granted exemptions to
laws and regulations that act as a deterrent to securities fraud.

Who benefited? JPMorgan Chase, Goldman
Sachs and Bank of America continued to receive advantages reserved for the most
dependable companies, making it easier for them to raise money from investors
and to avoid liability from lawsuits if their financial forecasts turn out to
be wrong.

An
analysis by New
York Times of S.E.C. investigations over the last decade found 350
instances where the agency has given big Wall Street institutions and other
financial companies a pass on those or other sanctions. Those instances also
include waivers permitting firms to underwrite certain stock and bond sales and
manage mutual fund portfolios.

•              JPMorgan
  Chase has settled six fraud cases in
  the last 13 years, including one with a $228 million settlement last
  summer, but it has obtained at least 22 waivers, in part by arguing that it has
  “a strong record of compliance with
  securities laws.”

•              Bank
  of America and Merrill Lynch, which merged in 2009, have settled 15 fraud cases and received at least 39 waivers. Bank
  of America settled by agreeing to a $150 million payment. The S.E.C.,
  however, did not to charge the bank with fraud, which could have endangered the
  bank’s special status.

• Citigroup
  is one of the rare Wall Street giants that lost significant privileges
  recently. In October 2010, the
  bank paid $75 million to settle charges that it misled investors in 2007
  about the size of its holdings of assets backed by subprime mortgages. The company told investors that it had
  about $13 billion of those risky investments on its balance sheet, when it
  really had more than $50 billion, according to the S.E.C.

The Times analysis found 11 instances
where non-financial companies that had settled fraud cases had actually lost
the special privilege for fast-track stock or bond offerings, versus 49 times
that the S.E.C. granted waivers from the punishment to Wall Street firms since
2005. Overall, the analysis counted 91 waivers since 2000 granting immunity
from lawsuits, and 204 waivers related to raising money for small companies and
managing mutual funds.

Only
about a dozen companies, Dell, General Electric and United Rentals among them, have
felt the full force of the law after issuing misleading information about their
businesses.

By
granting those waivers, the S.E.C. allowed Wall Street firms to have powerful
advantages, securities experts and former regulators say. The institutions
remained protected under the Private Securities Litigation Reform Act of 1995,
which makes it easier to avoid class-action shareholder lawsuits.

S.E.C. officials say
that they grant the waivers to keep stock and bond markets open to companies
with legitimate capital-raising needs. Ensuring such access is as important to
its mission as protecting investors, regulators said.

Others however, argue
that this may be a pattern in which the
government is too soft on Wall Street, as it has become a much larger
part of the economy in recent decades.

So, What’s Wrong?

Of
course there is a pattern here.
It looks like the SEC is in the business of “Selling Indulgences” to
the Wall Street financial crowd. Selling Indulgences for sins committed was one
of the symptoms of an ossified, corrupt Church. It was one reason for Martin
Luther nailing his tract on a church door at the beginning of the Protestant
Reformation.

So it is in
Washington, which could certainly use a Reformation. Now.

Fining these firms is a
tax on all of us (depositors, shareholders, citizens) by other means. The
fines, although they seem large, are not large enough to have corrected the
behavior of Wall Street, as the record shows.

The SEC and the rest of the
financial regulatory apparatus are failing in their mission. There is no power in government
that feels strong enough to face down the rampant illegal conduct in the
banking, insurance and securities industries.

 

The
reason for this is, of course, money and jobs. Government regulators and legislators move at will between jobs in
the private sector as lobbyists, lawyers and employees of the regulated.

 

Here
is what we need to do:

•         
  End
  the revolving door by instituting a three-year window between working in a
  regulated industry by former “public” officials.
  

• Institute public financing of elections.

A final thought:

There
may finally be some evidence of backbones among the regulators.

According
to Reuters, (published last night) U.S. prosecutors and European regulators
are close to arresting individual traders and charging them with colluding to
manipulate global benchmark interest rates, according to people familiar with
the investigation into the Libor rate rigging scandal.

Reuters reports that Federal prosecutors in
Washington, D.C., have recently contacted lawyers representing some of the
suspects to notify them that criminal charges and arrests could be imminent.  

Defense lawyers, some of whom represent suspects, said
prosecutors have indicated they plan to begin making arrests and filing
criminal charges in the next few weeks. In long-running financial
investigations it is not uncommon for prosecutors to contact defense lawyers
before filing charges to offer suspects a chance to cooperate or take a plea,
these lawyers said.