Late Stage Capitalism

The Daily Escape:

A 20 feet x 9 feet sign placed in Times Square, NYC in Sept. 2013. Created by Steve Lambert.

In yesterday’s column about Bed Bath and Beyond’s (BBBY) bankruptcy, Wrongo used the term “Late Stage Capitalism” to describe some of the factors that led to the firm’s demise. Several readers asked what Wrongo meant.

First, some history. A German economist named Werner Sombart seems to have been the first to use the term “Late Capitalism” around the turn of the 20th century. A Marxist theorist named Ernest Mandel popularized it in the 1960s. For Mandel, “late capitalism” described the economic period that started with the end of World War II and ended in the early 1970s, a time that saw the rise of multinational corporations, mass communication, and international finance.

In America the terms “Late Capitalism” and “Late Stage Capitalism” are used interchangeably. Late-stage capitalism is characterized by greed, corruption, and a focus on profits over people.

The current crisis of capitalism’s legitimacy stems from business pursuing the aberrant form of capitalism known as shareholder capitalism, which began in the 1970s. It causes firms to seek maximizing shareholder value as reflected in the current share price, at the expense of all other stakeholders and society.

Some of the problems with late-stage capitalism include wealth inequality, environmental destruction, and financialization. Financialization refers to the increase in size and importance of a country’s financial sector relative to its overall economy. In the US, the size of the financial sector as a percentage of GDP grew from 2.8% in 1950 to 21% in 2019. The financial services industry, with its emphasis on short-term profits, has played a major role in the decline of manufacturing in the US. Financialization has created “unproductive” capitalism. According to economist Michael Roberts: (brackets by Wrongo)

“…financialization is now mainly used as a term to categorize a completely new stage in capitalism, in which profits mainly come not from…production, but from financial [engineering]

Today, capitalism is no longer the heart of a free market. Algorithms run the stock and foreign exchange markets. Large players in these markets operate freely with the expectation that they will eventually be caught. They then pay off the DOJ or SEC, chalking up the fines to the cost of doing business.

Lobbyists on Capitol Hill curry favor with politicians. Companies then receive substantial tax breaks and move their ever larger profits to offshore tax havens. The revolving door between Wall Street and the banking sector allows former Federal Reserve Chairs to charge speaking fees of $500,000 and earn seats on the boards of the algorithmic trading firms. The Pentagon continues to benefit from budgetary increases while the profits of Boeing, Lockheed Martin, and other defense contractors continue to swell.

Late stage capitalism helped create the current distortion of wealth. From the wealthy one percent living in multiple homes and flying private, to the plight of the working poor in America. In a 2020 survey by Edelman, a marketing and public relations firm, 57% of people worldwide said that:

“capitalism as it exists today does more harm than good in the world”

When you have money, capitalism is your wing man. It opens doors to business leaders and helps develop political influence, all with the goal of amassing more wealth and power.

Late stage capitalism has allowed oligopolies and the oligarchs that run them, to rig the system in their favor. They’ve won Supreme Court cases, such as Citizens United v. FEC (2010), that give corporations the same speech rights as people, allowing them to spend millions on political ads to elect compliant politicians.

In recent years, capitalism’s shortcomings have become more apparent: Prioritizing short-term profits has sometimes meant that the long-term well-being of society and the environment has lost out. Indeed, if you judge by measures such as inequality and environmental damage, as economists Michael Jacobs and Mariana Mazzucato wrote in their book “Rethinking Capitalism”:

“…the performance of Western capitalism in recent decades has been deeply problematic…”

There’s also no denying that this strain of capitalism has led to increased economic growth worldwide, while lifting a significant number of people out of poverty. At the same time, its tenets of lowering taxes and deregulating business has done little to support investment in public services, such as crumbling public infrastructure, improving education and mitigating health risks.

Watch Paul Tudor Jones, a successful hedge fund manager describe why we need to rethink capitalism:

He’s concerned about capitalism’s laser focus on profits. He says that it’s:

“….threatening the very underpinnings of society.”

More people are aware of the term “late, or late-stage capitalism,” due to the growing wealth gap. People now have access to information that exposes the defects of capitalism, and the effects of political and elitist interference in the monetary policy of a country. There is a popular Reddit community devoted to it.

And calling something “late” implies the potential for significant change or revolution, A “late” period always comes near the end of something. Calling it “Late capitalism” says:

“…This is a stage we’re going to come out of at some point…”

Perhaps we’re on the cusp of society dictating that capitalism provide us with a more equitable way of life. Or maybe the wealth gap will continue to grow, and the corporations will continue to seize more power.

Whenever late-stage capitalism eventually comes to an end, you can be sure of one thing – it won’t be a soft landing.

 

Sources and reading list:

https://wrongologist.com/2023/04/bed-bath-and-beyond-another-retailer-bites-the-dust/

https://en.wikipedia.org/wiki/Werner_Sombart

https://www.theatlantic.com/business/archive/2017/05/late-capitalism/524943/

https://www.investopedia.com/terms/f/financialization.asp

https://www.linkedin.com/in/prof-michael-r-roberts/

https://www.fec.gov/legal-resources/court-cases/citizens-united-v-fec/

https://www.wiley.com/en-gb/Rethinking+Capitalism%3A+Economics+and+Policy+for+Sustainable+and+Inclusive+Growth-p-9781119120957

https://www.bbc.com/future/article/20210525-why-the-next-stage-of-capitalism-is-coming

https://www.edelman.com/sites/g/files/aatuss191/files/2020-01/2020%20Edelman%20Trust%20Barometer%20Global%20Report.pdf

https://www.reddit.com/r/LateStageCapitalism/

Alternative Views:

https://tomdehnel.com/crushing-the-myth-of-late-stage-capitalism/

https://www.nytimes.com/2023/04/20/opinion/american-capitalism-good.html

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Bed Bath And Beyond: Another Retailer Bites The Dust

The Daily Escape:

Super bloom, Carrizo Plain NM, CA – April 2023 photo via Today’s California

Bed Bath and Beyond (BBBY) filed for Chapter 11 bankruptcy on April 23. It said it will liquidate its assets and close its remaining stores unless it can find a bidder for the 360 Bed Bath and Beyond stores and for the 120 buybuy BABY stores.

A little history: A year ago, the prices of their bonds began to collapse. By August 2022, suppliers halted shipments due to unpaid bills. When this became public, its 30-year bonds, issued in 2014, plunged to 16 cents on the dollar (last Friday, they were at about 5 cents on the dollar).

From Wolf Richter:

“While all this was going on, the company promoted its latest turnaround plan and closed hundreds of stores. But you can’t turn around a failing brick-and-mortar retailer. On January 5th this year, the company issued a “going concern” warning.”

There are at least three lessons to take away from the BBBY story: First, they are the latest victim of the move to online shopping. People trusted Bed Bath & Beyond, and they had a pretty good e-commerce business. They could have done very well with it if they had accepted 10 years ago that they needed to phase out of their brick-and-mortar stores.

But brick-and-mortar retailers have difficulty letting go of their brick-and-mortar storefronts. They just can’t explain to their investors that their huge, fixed investment in physical stores are doomed and need to be closed.

Wolf has two great charts comparing the rapid growth in e-commerce and the steep drop in sales by brick-and-mortar retail over the past 15 years:

These two charts show that e-commerce basically replaced $5-9 Billion in annual in-store sales for the retail industry. The top chart shows that e-commerce had reached about $115 billion by 2023. The lower chart shows that in-store sales fell from $17 billion per year in 2008 to a low of $8 billion in 2020 before recovering to nearly $12 billion in 2023.

The second issue was that rather than investing in their business, BBBY spent $11.6 billion on share buybacks from 2005 to 2021. Since 2010, BBBY basically burned $9.6 billion in cash on its share buybacks. Like other companies, BBBY used share buybacks to drive up its share price, as “demanded” by its large shareholders and Wall Street. In addition, by not using that money to transition to e-commerce, they began driving the company towards April’s Chapter 11 filing.

A third problem was that the activists that won control of the BBBY board created a self-imposed disaster. While BBBY had withstood competition from Amazon earlier, in 2019, activist investors in control of its board hired a CEO who implemented a private-label product strategy. This led to customers no longer finding the national branded goods they expected on BBBY’s shelves. Products like AllClad, Kitchen Aid, Rowenta, Miele, Corning, Wustof and Braun. So customers bought them elsewhere. That sent sales down even further, and left BBBY in a cash-poor position.

Wrongo and Ms. Right occasionally shopped at our local BBBY stores, both here in CT and earlier in CA. We always thought it was a good value proposition, particularly for towels, sheets and pillows. Back then, the stores seemed well-stocked and the 20% off coupons didn’t hurt.

BBBY followed a classic path to failure: The retail founders preside over rapid growth. Then when Wall Street and the financers get involved, the founders step back. They then hire “professional” CEOs from their big retail rivals who apply whatever worked at their previous employer.

The new leadership skips the crucially important step of giving customers more of what they need than competitors do, focusing instead on sophisticated financial engineering.

All the while their aggressive rivals are going after their customers. This leads to a loss of market share, ultimately sending a once-proud retailing icon into bankruptcy. To BBBY’s credit, they outlasted far older, bigger and better financed competitors from Sears to Montgomery Ward to pretty much everyone else in their household-goods space.

Is late-stage Capitalism at fault in the BBBY story? You betcha.

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Will New House Prices Go Down?

The Daily Escape:

Mt. Hood viewed from Timberline Lodge – December 2022 photo by Mitch Schreiber Photography

We have all watched house prices go through the roof since the start of the pandemic. Of Wrongo and Ms. Right’s six kids, two do not currently own a home, and despite having good jobs, and wanting to buy, they’re priced out of their local markets. Houses near Wrongo’s daughter on Cape Cod, MA have nearly doubled in price since the start of the pandemic. The same is true for Wrongo’s son in Bergen County, NJ.

But house sales in US have been slowing down in the past few months as interest rates climb. Wolf Richter at Wolf Street says there are now too many new houses for sale:

“Inventory of new houses for sale…has ballooned to 470,000 houses, up by 21% from the already high levels a year ago, and the highest since March 2008….Which destroys the theory that home prices are high because the industry isn’t building enough houses…”

Wow, nearly a half-million unsold new houses! Much of this inventory of unsold new houses were built in locations that are far from the big suburbs and the cities. After the pandemic started, US businesses redefined the office to include working from home. That further moved to “live anywhere” remote work for some firms.

Now, firms are bringing people back to their physical offices. That makes selling houses at great distances from the office a tough proposition for new home builders. It means buying a lower price rural home based on a big remote salary is no longer in the cards for many workers.

According to Bloomberg, Lennar a major home builder, has been approaching the big corporate rental landlords with an inventory listing about 5,000 houses that it wants to offload:

“Lennar is circulating lists of properties to potential acquirers, according to people familiar with the matter….Many of the properties are located in the Southwest and Southeast…with the builder giving landlords the chance to acquire entire subdivisions in some cases.”

It’s an industry-wide problem. Home builders have pitched at least 40,000 new houses to rental operators in recent months. Bloomberg says that many of these houses had originally been sold to individual buyers who later canceled their purchase contract.

According to a survey by John Burns Real Estate Consulting, the purchase contract cancellation rate spiked to 26% in October, up from a rate of 8% a year ago, and up from 11% in October 2019. The cancellation rates were highest in the Southwest at 45%, up from 9% a year ago. In Texas, the cancellation rate spiked to 39%, up from 12% a year ago. That’s understandable since mortgage rates have been rising so quickly.

This tells us that a part of the “housing shortage” is both local and price-driven. We know that house prices are driven by building costs, which have spiked in the past two years. Prices are also driven by the quality of the schools in the area, or whether the location is near a tourist destination. Retirees can move anywhere, but they generally want to be close to doctors and medical centers and will pay a premium for location rather than pay a lower price to live in the middle of nowhere.

Entire subdivisions sold as a rental community is better from the viewpoint of an individual home buyer instead of a percentage of that development’s homes being sold into a rental pool. No one should buy into a development that is partially sold and partially rented. The big landlords will rarely improve them beyond the least amount possible. So the overall value of all the homes in that community will be diminished by the presence of a rental pool.

We saw that in California in the 2007-2009 real estate bubble, where a few houses in otherwise nice neighborhoods would have overgrown lawns and trash lying in the yard, a clear sign of vacancy. That didn’t help the property values of the individual homeowner neighbors.

How far will housing prices fall? Nobody knows. Here is a chart showing average housing prices since 2019:

Comparing 2019 to 2022, average house prices have risen by 39%. Your area’s average may be even higher, particularly if you live in or near a large city.

It’s clear that the US housing market needs a price correction. Wrongo would like to say that people shouldn’t be offering anything higher on the house they want than it would have sold for in 2019. But, we may not get back to that price level anytime soon.

A price correction alone won’t solve America’s housing crisis, but a 20% correction sure would be a nice start.

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Monday Wake Up Call – September 26, 2022

The Daily Escape:

Arches NP, UT – September 2022 photo by Nathan Smith

It can now take longer than 10 years for a typical first-time US home buyer to afford the down payment on a modest house, so says S&P Global in a July report (registration required). From the report:

“By fourth-quarter 2022, it will take 11.3 years for a first-time homebuyer with median income to save for a 10% down payment. It will take this homeowner 22.6 years to save for a 20% down payment. Both are over twice their pre-pandemic rates of five and 10.6 years, respectively.”

S&P estimates that with house prices rising so quickly, down payments are now twice the amount that they were before the pandemic. They also estimate that 60% of households could be priced out of the housing market by Q4 2025.

The NYT also is looking at the US housing market. They say that the US has a deepening housing crisis, including an acute shortage of:

“small, no-frills homes that would give a family new to the country or a young couple with student debt a foothold to build equity…”

Factors include land costs, costs of construction materials and government fees. The typical new home has grown in median size over the past 60 years, while the average number of people living in each home has declined:

These long-term trends were accelerated by the pandemic, which drove up demand for homes and house prices as people scattered, worked from home, and snapped up second residences.

Local policies are also driving this new reality. The Times reports that communities nationwide:

“…are far more prescriptive today than decades ago….Some ban vinyl siding. Others require two-car garages. Nearly all make it difficult to build the kind of home that could sell for $200,000 today,”

So, high prices due to high demand. High mortgage rates due to the FED clamping down on inflation. And cities and towns making it more difficult to build low-end homes. On top of that, investors bought about a quarter of all single family houses sold last year.

Wrongo grew up when homes were affordable for a one-salary family. His 1,400 sq.ft. “starter home” in a tidy NJ suburb (walk to take the NYC train to Wall Street) cost $28,000 in 1970. We sold it for $38,000 in 1976. Zillow estimates that it would sell today for $647,000, 23 times what it did in 1969! It’s unbelievable how high home values in that neighborhood have risen.

Also, home buyer expectations are higher today. If a home doesn’t have an open floor plan, three bathrooms and granite countertops, most young buyers think they are settling for much less than they want.

Owning a home has been a part of the American Dream, but it’s one of the three legs of that dream that are currently being killed: (1) High housing costs (2) Stagnant wages and (3) High health-care costs. When you add college debt to the mix, you have the makings of a revolution against the 21st century’s form of capitalism.

Part of the American dream is for your kids to succeed. That starts with a good education in a school district that aligns with that goal. That can rule out most public schools in our larger cities. If young families can afford the costs of private schools in cities, they must be very well off.

The only way that most people can choose that kind of school is to look in the suburbs. Suburban school districts pay for their good schools with taxes on expensive homes. That means parents, and the local government all have a stake in keeping local property values as high as possible, thus the difficult zoning regulations that make houses larger.

But smaller homes are also desired by many retirees. People who are living out their golden years often want to “downsize” into an affordable small home, condo, or townhouse. Many of these developments are being built throughout America. They can be beautiful inside, but they are often attached or semi-attached boxes crammed together on land that was never supposed to be developed.

Time to wake up America! Today in most parts of the country there is hardly anything on the market for under $300,000. Not much that resembles the tidy starter home Wrongo purchased 52 years ago.

Affordable housing prices aren’t coming back without government intervention. America needs to look carefully at its housing policies along with how we have let financialization take over the housing market.

Financialization of housing refers to the increasing presence of corporations and organizations that are creating or using real estate management, mortgage processes, and financial instruments to profit-seek against individual homeowners.

To help you wake up listen to Buddy Guy perform “Gunsmoke Blues” along with Jason Isbell. The tune is highly relevant, and very powerful. It’s from Guy’s album ,“The Blues Don’t Lie” due out on September 30th:

Lyrics:

Trouble down at the high school
Somebody got the gunsmoke blues
Trouble down at the high school
Somebody got the gunsmoke blues
Read it in the morning paper
Watch it on the evening news

Some folks blame the shooter
Other folks blame the gun
But that don’t stop the bullets
And more bloodshed to come
A million thoughts and prayers
Won’t bring back anyone

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The New Housing Bubble

The Daily Escape:

Shakers Creek flowing into the Mohawk River, Colonie NY – April 2021 photo by M’ke Helbing.

We’re hearing about bidding wars for single family homes, often with winning bids that are substantially above already high asking prices. In fact, house prices have risen by 11.2% from a year ago, the largest increase since housing bubble #1 in 2006, according to the National Case-Shiller Home Price Index for January.

The Home Price Index measures “house-price inflation” by comparing the sales price of a house in the current month to the price of the same house when it sold previously. It’s tracking the dollars it takes to buy the same house over time.

But house price inflation isn’t part of the Consumer Price Index (CPI). While about one-third of CPI is based on housing costs, it only tracks rents, not home prices. So, you can see what’s going on: Everybody knows that the costs of home ownership are surging, but only a portion are included in our inflation measures, so inflation is being understated.

Let’s look at the NY metro area. It covers NYC and numerous counties in the states of New York, New Jersey, and Connecticut. Here’s the spike in prices over the past six months:

House prices rose 11.2% for the year. There were big differences between price tiers, with low-end house prices surging by 14.9%, while condo prices remained in a tight range for the past three years, and the NYT reports that Manhattan condo developers are selling units at big discounts.

There’s another factor driving prices. The WSJ reports that: (brackets by Wrongo)

“From…individuals [with]a few thousand dollars to pensions and private-equity firms with billions, yield-chasing investors are snapping up single-family houses to rent out or flip. They are competing for houses with ordinary Americans, who are armed with the cheapest mortgage financing ever, and driving up home prices.”

The WSJ quotes John Burns, a real estate consultant: (emphasis by Wrongo)

“You now have permanent capital competing with a young couple trying to buy a house.” Burns estimates that in many of the nation’s top markets, roughly one in every five houses sold is bought by someone who never moves in.”

Houston is a favorite location, with investors accounting for 24% of home purchases. More from Burns: (emphasis by Wrongo)

“Limited housing supply, low rates, a global reach for yield, and what we’re calling the institutionalization of real-estate investors has set the stage for another speculative investor-driven home price bubble…”

This is the second try by institutional investors to play in the single-family home market. Starting in 2011, they bought foreclosed homes at steep discounts, accounting for about a third of sales in some markets and setting a floor for then-falling home prices.

It turned out that renting suburban homes proved very profitable. The pandemic has brought a new race for suburban housing. And the big new-home builders like DR Horton and Lennar Corp, are working directly with institutional investors. They’re building blocks of homes, and selling them to the investors, who rent them out.

Horton built 124 houses in Conroe, Texas, rented them out and then put the whole community up for sale. It was purchased by an online property-investing platform, Fundrise LLC, which manages more than $1 billion on behalf of about 150,000 individuals.

Lennar just announced a rental venture with investment firms including Allianz and Centerbridge Partners to which it will sell more than $4 billion of new houses.

This is late-stage capitalism at work. Young working couples are increasingly shut out of buying homes, and that’s both depressing and disturbing.  America has failed them. It would be helpful for families to buy homes instead of renting, and pricing families out of home ownership carries risks to a cohesive society.

And the Right wonders why young people are turning to socialism. Freezing young people out of the housing market could have disastrous social consequences.

We should have tax policies that disincentivize ownership of multiple single-family homes, especially by investment funds. The way to remedy this is to steer investors to other assets that don’t directly impact individual welfare to the same degree as housing.

Back in the 2006-2009 housing bubble, we had plenty of speculators and an excess of housing inventory. It was so bad that Wrongo’s barber owned nine rental houses in three states before the bust.

This time around, we have very low inventory, the lowest rates ever, and big money chasing yield. Once pension funds are investing in an appreciating asset class, you know the bubble is about to burst

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Monday Wake Up Call – April 6, 2020

The Daily Escape:

Texas bluebonnets, Round Rock, TX – 2018 photo by dried_fruit

Here are the latest national numbers (which will be out of date by the time you read them). From The COVID Tracking Project: (as of 4/4)

  • Number of daily cases: 305,755, up 33,767 or +12.4% vs. April 3
  • Rate of case increase: 12.4% vs. 13.75% on 4/3 and 15% average for the past week
  • Number of deaths: Total 8,314, up 1,352 vs. April 3
  • Rate of deaths increase 4/4 vs 4/3: 19.4% % vs. 20.4% on 4/3
  • Daily number of tests 4/4 vs. 4/3: 1,623,807, up 226,945 over 4/3
  • Rate of increase in tests: +16.2% vs. previous day

The rates of growth in cases and deaths have begun to slow. In the past week, they are in a decelerating trend, declining by about 1%/day. Testing is growing, which is a very good thing.

Just when you think you can’t get any more cynical about America’s response to the pandemic, we tumble to the fact that about a third of hospital emergency rooms are now staffed by doctors on the payrolls of two physician staffing companies, TeamHealth and Envision Health. They are owned by two Wall Street private equity firms. Envision Healthcare employs 69,000 healthcare workers nationwide while TeamHealth employs 20,000. Private equity firm Blackstone Group owns TeamHealth; Kravis Kohlberg Roberts (KKR) owns Envision. Private equity is the term for a large unregulated pool of money run by financiers who use that money to invest in, lend to, and/or buy companies and restructure them.

Wrongo began hearing that despite the urgent pleas from hospitals on the front lines of the COVOID-19 outbreak, nurses and doctors were being taken off schedules in nearby places once “elective” procedures were suspended, as they are at many hospitals and clinics. That means the associated revenues were lost, or at the very least, postponed.

Here’s a report from Yahoo Finance:

“KKR & Co.-backed Envision, which carries over $7 billion of debt amassed through one of the biggest leveraged buyouts in recent years, reported steep drops at its care facilities. In just two weeks, it suffered declines of 65% to 75% in business at its 168 open ambulatory surgical centers, compared to the same period last year, the company said in a private report to investors. About 90 centers are closed.”

Private equity has taken over more and more of hospital staffing, including emergency departments. The legal fig leaf that allows private equity firms like Blackstone and KKR to play doctor is that their deals are structured so that an individual MD or group of MDs is the nominal owner of the specialty practice, even though the business is stripped of its assets. The practices’ operating contracts are widely believed to strip the MDs of any say in management.

Care of the sick is not the mission of these companies; their mission is to make profits for the private equity firms and its investors. In 2018, Paladin Healthcare, an entity owned by private equity baron Joel Freedman, bought Philadelphia’s Hahnemann University Hospital. This hospital served the poor, and Freedman closed it down so he could use the land to build luxury apartments.

When the city recently asked to use the empty hospital as part of its solution for the Coronavirus pandemic, Freedman demanded $1M/month in rent. Overcharging patients and insurance companies for providing urgent and desperately needed emergency medical care is bad enough. But holding a city hostage?

In another example, STAT reports on another private equity firm: (emphasis by Wrongo)

“Alteon Health, which employs about 1,700 emergency medicine doctors and other physicians who staff hospital emergency rooms across the country, announced it would suspend paid time off, matching contributions to employees’ 401(K) retirement accounts, and discretionary bonuses in response to the pandemic…The company also said it would reduce some clinicians’ hours to the minimum required to maintain health insurance coverage, and that it would convert some salaried employees to hourly status for “maximum staffing flexibility.”

NY’s Governor Cuomo and others are pleading to have doctors come out of retirement, and here we have skilled doctors who have the training and are being asked to work fewer hours? All of the Republican talk about “choice” and “markets” in healthcare is just self-serving BS that benefits their buddies.

Time to wake up America!

Why do private equity firms continue to benefit from the “carried interest” tax loophole? Shouldn’t they shoulder their part of the financial grief the pandemic is causing to our country?

To help you wake up, here is John Lennon’s 1970 song, “Isolation”. It appeared on John Lennon/Plastic Ono Band. It has a whole new meaning in today’s context:

Sample Lyric:

We’re afraid of everyone,

Afraid of the sun.

Isolation

The sun will never disappear,

But the world may not have many years.

Isolation.

Those who read the Wrongologist in email can view the video here. 

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Here Comes the Retail Apocalypse

The Daily Escape:

The Oberlausitzische Library of Science, Gorlitz Germany

There is a growing concern that the mall as we know it is in big trouble. RadioShack, The Limited, Payless, and Toys“R”Us were among 19 retail bankruptcies this year. From Dave Dayden: (brackets by the Wrongologist)

This story is at odds with the broader narrative about business in America: The economy is growing, unemployment is low, and consumer confidence is at a decade-long high. This would typically signal a retail boom, yet the [retail store] pain rivals the height of the Great Recession.

Many point to Amazon and other online retailers as taking away market share, but e-commerce sales in the second quarter of 2017 were 8.9% of total sales. There are three reasons for so many sick retailers.

First, while online sales are “only” 8.9% of total retail sales, these businesses have very high fixed costs and low net profit margins. The Stern School at NYU tracks net profit margins on thousands of businesses across many sectors, including retail. The margins for Specialty retail for the year ending January 2017 was 3.17%. It was 1.89% for Grocery and 2.60% for General retailers. If a high fixed cost business loses 9% of sales, it can easily wipe out the bottom line.

Second, many retail companies carry high debt levels. Bloomberg explains that private equity firms (PE’s) have purchased numerous retail chains over the past decade via leveraged buyouts, where debt is the primary source of the money used to buy the business. There are billions in borrowings on the balance sheets of troubled retailers, and sustaining that load is only going to become harder if interest rates rise.

Third, there are just too many stores in our cities and suburbs to sustain sales in a world where online shopping is growing rapidly.

Worse, billions of dollars of that PE-arranged debt come due in the next few years. More from Bloomberg:

If today is considered a retail apocalypse…then what’s coming next could truly be scary.

This chart shows what percentage of retail real estate loans are delinquent by area:

Source: Trepp

There are large areas of America where more than 20% of the loans are past due. More from Bloomberg: (emphasis by the Wrongologist)

Through the third quarter of this year, 6,752 locations were scheduled to shutter in the US, excluding grocery stores and restaurants, according to the International Council of Shopping Centers. That’s more than double the 2016 total and is close to surpassing the all-time high of 6,900 in 2008…Apparel chains have by far taken the biggest hit, with 2,500 locations closing. Department stores were hammered, too, with Macy’s Inc., Sears Holdings Corp. and J.C. Penney Co. downsizing. In all, about 550 department stores closed, equating to 43 million square feet, or about half the total.

This threatens the retail sales staff and cashiers who make up 6% of the entire US workforce, a total of 8 million jobs. These workers are not located in any one region; the entire country will share in the pain.

These American retail workers could see their careers evaporate, largely due to the PE’s financial scheme. The PE’s, however, will likely walk away enriched, and policymakers will share the blame since they enabled the carnage.

Our tax code makes corporate interest payments tax-deductible. So the PE kingpins load up these companies with debt and when they walk away, they get tax credits for any write-offs, incentivizing them to borrow and play the game again. The PE firm might lose some or all of its equity, but in most cases, it already drew cash out via special dividends and fees, so it has made its money.

The lenders, employees, state development authorities are the ones left holding the bag.

The GOP’s new tax plan proposes a cap on the deductibility of interest payments over 30% of a company’s earnings. But, the GOP left a loophole: Real estate companies are exempt from the cap.

Surprisingly, this benefits Donald Trump’s businesses! It also helps PE firms that split the operating side of the businesses they buy from the property side, as most do. They put the borrowing onto the property side, and continue to deduct the interest.

So financialization businesses like PE will continue to strip the value out of companies with hard assets.

Billions in asset-stripping and thousands of operations sent overseas. Labor participation rate is stagnant, yet we are assured that if we pass big corporate tax cuts, the US economy will grow fast enough to more than compensate for the losses.

What’s wrong with this picture?

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Retail Stores Are Closing Fast

The Daily Escape:

Cougar with Radio Collar – Griffith Park, Los Angeles, via Nature Photography

Retailers are closing thousands of stores and going bankrupt at a rate not seen since the Great Recession, and tens of thousands of people are losing their jobs as a result. Although thanks to insolvency experts like Bankruptcy Calgary operated by Hudson & Company, solutions are available to help individuals struggling with debt, the atmosphere for retailers seems far more bleak.

Retailers blame Amazon and other online vendors for the lack of physical sales nowadays. This could be true as more and more people do seem to find it easier to order online than physically enter a store to purchase a product. With e-commerce sales booming, more businesses seem to be offering online products. These e-commerce sites can use recurring billing, if they please, to increase their sales. This works by turning customers who would only purchase something once into customers who are regularly making a payment. However, one reason that many businesses seem to succeed is due to software, like samcart, offering their customers a hassle-free checkout. This means that the whole process of ordering online is becoming so much easier for the consumer that it’s not surprising that retail stores are beginning to feel the effects.

While some brick-and-mortar retailers are doing well, many are losing money. The Atlantic reports that:

Overall retail employment has fallen every month this year. Department stores, including Macy’s and JC Penney, have shed nearly 100,000 jobs since October-more than the total number of coal miners or steel workers currently employed in the US.

Wolf Richter has the following chart showing the nature of the problem for retail stores:

But the e-commerce industry won’t rescue out-of-work retail employees. Most warehouses are regional, and located far from residential areas, which means they might not be within a reasonable commuting distance for displaced workers. By contrast, retail stores are typically located near residential centers. E-commerce warehouses also employ fewer people than retail stores, since the warehouses are increasingly automated, and no longer need to buy roll cages from PHS Teacrate or other companies due to not needing stock delivered to smaller stores.

Yves Smith offers this idea: (parenthesis by the Wrongologist)

One of the reason so many real world retailers are hitting the wall so hard is that private equity leverage and asset stripping made them particularly vulnerable. While the losses to online retailers would have forced some downsizing regardless, the fact that so many are making desperate moves in parallel is in large measure due to the fact that…their private equity (PE) overlords have made them fragile.

That’s a new angle for evaluating Amazon’s performance: it’s not that retailers are closing because Amazon is expanding, but Amazon is expanding because retailers are closing. Jeff Bezos should be thanking the PE firms for looting the retail industry.

The Federal Reserve’s low interest rates also made it easier for Private Equity funds to load these retailers up with debt. Management could borrow more money than necessary, pay themselves cash bonuses, and claim “interest rates are low; making payments will be easy“.

They would even show you the math. Of course, that math assumed that store sales would continue climbing in the future. If sales fell, high debt payments could quickly become an outsized burden.

The Private Equity all-stars often follow a particular deal model. After purchasing the retail company, the PE firm sells the real estate owned by the retail company to another entity (owned by the PE fund). Then the retail company makes lease payments to its new landlord. This splitting of the assets into an operating company and a property company allows the PE fund manager to make a cash distribution to its investors early on, producing a quick return on the deal. Later, the property company will be sold.

The problem with this approach is that businesses that choose to own their real estate are typically seasonal businesses, as all retailers are. Or they are low margin businesses particularly vulnerable to the business cycle, like restaurants. Owning their property reduced their fixed costs, making them better able to ride out bad times.

To make this picture worse, the PE firms often “sell” the real estate to itself at an inflated price, which justifies saddling the operating business with high lease payments, making the financial risk in the operating company even higher. Of course, those high rents make the property company look more valuable to prospective investors, who may fail to look close enough at the retailer who is paying the rents.

Companies with little debt generally can survive lower sales. They can engage in cost-cutting, maybe encourage some employees to retire early, etc. It’s easier to survive if they own their own property. But when you’ve got a lot of debt, and servicing that debt requires that sales continue to rise quarter after quarter without fail, then things become a LOT more fragile.

Trump claims he’s created 500,000 new jobs in his first 100 days. Notice that he doesn’t say what these jobs are, or where they were created. Certainly they weren’t in Retail. Or Coal. Or Steel. Those jobs aren’t coming back.

Here is Jonathan Richman with his 1990 song “Corner Store” which laments what towns have lost to the malls:

Those who read the Wrongologist in email can view the video here.

Takeaway Lyric:

Well, I walked past just yesterday
And I couldn’t bear that new mall no more
I can’t expect you all to see it my way
But you may not know what was there before
And I want them to put back my old corner store.

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