Businomics Blog

General Motors and Private Investment: Don't Partner with the Federal Government

The General Motors debt for equity deal reveals a genuine danger to private investors.  If you are considering investing in some other turnaround, be very careful if Uncle Sam might get involved.  An editorial in today's Wall Street Journal presents some estimates of how much different creditors to GM will receive.  I've charted these estimates (and they are not hard figures, just estimates):

From an investor's viewpoint, this is very scary.

From a public policy viewpoint, the GM results will scare off potential investors, leaving even more trouble for the federal government to try to clean up.

From a business strategy viewpoint, be cautious about your business relationships (either as customers or vendors) with entities that may soon be run by the federal government.

Strategic Planning in the Recession: Guidelines for Corporate Executives

It's an awful time to do strategic planning, but the planning MUST go forward.  The time is awful because of the uncertainty.  Here are some suggestions for planning processes that begin in mid-2009:

• Make your scenarios fairly far apart.  I was just reviewing the three economic forecasts (baseline, optimistic and pessimistic) developed by a major forecasting firm.  I was in a good discussion about the outlook, which included people I respect but don't always agree with.  My conclusion: the optimistic alternative was not sufficiently optimistic, and the pessimistic alternative was not as pessimistic as it should be. 

• I'd go with an optimistic view that turns around right now, gets GDP growth up to two percent very quickly, then ramps up to four percent over the next four quarters.
• I'd like a pessimistic scenario to be "L-shaped:"  no further declines in GDP, but no improvement for six or eight quarters.  Ouch!

• Don't just outline the scenarios and run them through the routine planning process.  Look for common action steps under all scenarios.  If you are going to replace the customer database in all three scenarios, that tells you something:  get going with the project.

• For critical decisions which depend on the scenario, develop a set of economic indicators to monitor so that you learn which of your scenarios is in play as soon as possible.

• Look for items that you will NOT do in any of the scenarios.  Take them off the table and stop talking about them.  (That sounds so obvious as I write it, but I've seen many, many organizations continue to argue about things they will never do.)

Call me if your company would like more help.

Housing Vacancies Still High

Too many empty units, not just single family homes, but rental apartments too.  Calculated Risk did a good job of examining the numbers and showing charts, so I'm referring you to his commentary.

The outlook for housing depends on an important lesson: that we cannot look at the single-family home market in isolation.  Every politician, journalist, and blogger who is trying to promote a clever solution misses the point: if you make the owner-occupied market better, you do so at the expense of the rental market.  And then rental houses go up for sale, rental condos go up for sale, traditional apartment buildings get converted to condos, and the newly-finished condos do not get rented out but instead are offered for sale.  The only solution is population growth, which will take some time.

Long-Run Investment Returnes

Capital Spectator has the latest long run investment returns and risk measures here.  But don't be in a hurry: when you're calculating averages from 1825 or even 1926, another day or two won't make a big difference.

Business Planning for a Flu Pandemic

A couple of years ago I developed a set of materials regarding business contingency planning for a flu pandemic.  The concern back then was Avian Flu (called H5N1 by the in crowd).  Today's swine flu (A/H1N1) is a different bug with similar implications.  Here are a few highlights:

• The riskiest bugs hit young healthy people worst, rather than children and the elderly.  This has huge workforce implications.
• The macroeconomic effects would be like a severe recession, along the lines of 1980-82.  The flu's impacts in the midst of a recession would be lessened, but still additive to the pre-existing recession.
• Businesses should not over-react, but there are a set of reasonably easy steps that can be taken now that will be tremendously useful if the epidemic worsens significantly.

Call me if you'd like a presentation on this subject.

Two Recoveries: The Economic Forecast Has Two Distinct Phases

Two observations about the present situation:

1. There is excess capacity virtually all across our economy.
2. Some of that excess capacity will not come back into service.

The first claim is pretty obvious from the aggregate data, but here's a chart for those of you who like charts:

The second statement derives from the previous housing boom.  We built up the capacity to construct two and a quarter million units per year, when we only need three-fourths of that amount.  By the time we are once more ready to build over two million new housing units in a year, the backhoes, nail guns and pickup trucks will have rusted out.  In an economic sense, that capacity is gone today, just as a buggy-whip factory wouldn't add much to our economically-viable total capacity.

The first stage of the recovery will be to fully utilize the capacity outside the old boom sector.  That's most everything outside housing construction and its supply chain (lumber, doors, windows, carpet, etc.) and outside of closely related industries (title insurance, mortgage brokerage, etc.).

The second stage of the recovery reconfigures our capacity to meet the new demands.  If housing construction is to be a smaller proportion of total GDP, something else will be a larger proportion.  We will need to build up capacity in those "something else" sectors.  (More on that topic in a later post.)

(Note for econo-geeks:  the estimates of Potential GDP that are used in the Taylor Rule should be reduced to account for the loss of economic capacity.

Another note for econo-geeks: we should thank our friends from the Austrian School for reminding us that composition of demand and production is important.)

Business Strategy Implications:  Plan on a recovery that is not a strong as past recoveries.  We will rebound, we will get back up to normal growth rates, but we will not have the excellent growth needed to get back to where we would have been absent the recession. 

Business Challenges After the Recession

When the recession is over, business challenges will be different, not gone.  Companies wrestling with the downturn need to consider what new problems they’ll face in the recovery.

 

You may have cut back on your staffing level to survive the recession.  When sales recover, you’ll start hiring—but whom?  Many of the folks you laid off will not be available.  Some of the people you hire may not have worked in your industry before.  You will have a training challenge greater than you had before the recession. 

 

The employees who stayed with you through the recession will be different.  They may have felt guilty when they survived layoffs.  Then they worked hard without bonuses, pay raises or much chance of promotion (because the company was not expanding, and few higher-ups were quitting or retiring).  After working hard through the recession, their attitudes will be different than had been a few years earlier.

 

Consumers are cutting back on their spending, but the day will come when they buy cars and furniture again.  How will the recession change their attitudes?  Will they buy the same products, the same styles, at the same price points as they did in 2005?  Probably not.  What mix of products will fill the consumer’s need to celebrate the return to normalcy, without falling into the same old bad habits?

 

When it’s time to ramp up production, will your vendors be ready?  If you had to cut back your orders during the recession, your vendors will be hurting.  They may have laid off key personnel, and they may not have the financing in place to buy raw materials to provide you with products.  Their problems will become your problems if you rely on them for critical supplies.

 

Speaking of finance, what about your own situation?  The financial crisis has changed the world of credit in ways that won’t quickly be reversed.  Securitization will continue, but at a much slower pace, with far simpler deals.  This is a problem even for companies that never floated complex deals on Wall Street.  Virtually all forms of business credit have been securitized:  bank loans, lease receivables, commercial mortgages, credit card debt.  Many business borrowers didn’t even know that the money for their loans came through these channels.  The closure of secondary markets, though, makes business credit harder to obtain.

 

Business recoveries are stressful to balance sheets.  Chief financial officers who have felt stressed by declining sales volumes will feel a different kind of stress next year.  Increasing orders will require spending on inventories and personnel, much of which has to take place before payments are received from customers.  This need for working capital will increase before credit markets fully adjust to the financial crisis.

 

How does a business leader prepare for these new challenges?  The first step is to keep the company going, which means dealing with today’s challenges.  At the same time, take a few hours and sketch out the challenges you expect when the recovery comes.  Bring in a few colleagues and brainstorm.  Then look at the issues that need current action.  Some problems can wait until they arise, but others can be nipped in the bud with a little forethought.  The companies that thrive in the recovery will be those that not only survived the recession, but also planned for better times.

Core Inflation: How It Forecasts the Future

A year ago many of our beloved readers were casting flack at Dr. Businomics for his use of "core inflation," which is inflation excluding food and energy.  Back in 2007 I made the point that core is a better indicator of where future total inflation will be than total inflation is.  This morning's consumer price index report closes out the story:

Over the last 12 months the CPI has declined by a small amount.  When total inflation was galloping away at a four percent rate, which was only a year ago, who would have thought that the outlook was for lower inflation?

Here's the takeaway:  If you want to know what happened to the total cost of living in the past, use the total CPI.  If you want an idea of whether we face an inflation problem in the future, look at the core inflation rate.

Retail Sales: Bouncing Along the Bottom

Today's headlines sound gloomier than the data--once again.  The Wall Street Journal says, "U.S. Retail Sales Show New Weakness."  Yahoo Finance says, "Stocks slip as retail sales data disappoint."  So how bad is the new data?

Looks to me like we're bouncing along a new bottom.  True, total sales declined last month, but the change was small.  I'm happy having relatively small changes for a few months--sure beats the sharp decline of late last year.  This pattern is consistent with my view that we are in the neighborhood of the bottom for this cycle.  But only time will tell.

Surviving Bad Economic Policy: Why I Am Not Gloomy

My commentary for Cascade Policy Institute was published by the Statesman-Journal newspaper.