[PEN-L:2735] 2 Questions

[Rob Parenteau <rwp@xxxxxxxxxxx>]

Michael -

I am not sure about the linkages in your first question on productivity
measurement during highly competitive periods. When competition is high,
product prices should be low, so the value of nominal sales may be low for
firms. But productivity is generally measured using real output per labor
hour or per real capital "unit". So I am missing the reason why measured
productivity would necessarily be low during highly competitive periods,
unless you are working with some kind of view that states the glut of
capacity forces most plants to work below their technologically optimal
level of production.

Regarding stock buybacks and financial fragility in your second question,
Andrew Smithers calculates as of Q3 1998 Fed Flow of Funds data, the
dividend payout ratio exceeded 140% for nonfinancial corporations if one
includes share repurchases as a form of dividend to shareholders. Firms must
find a way to finance these massive payouts.

Tobin's q by most measures is at unheard of levels. Some attribute the
historically high level of intangible capital (human capital, brand status)
in contemporary firms. Regardless, as you know, when Tobin's q is high, the
market value of financial claims on capital assets is high relative to the
historical cost of capital equipment and structures. A high Tobin's q
supposedly provides a very high incentive to produce new capital goods, and
a very low incentive to buy back expensive financial claims on productive
assets. Yet that is exactly what management is doing right now - buying back
stock. Since profit margins have been under pressure for nearly two years
now, the only way to fund stock repurchases has been a very sizeable build
up in corporate debt. Revenue per share growth is close to 0% for the S&P
400, yet nonfinancial corporate debt is expanding at something like a 9%
pace. Too bad Hy Minsky isn't around to see this one.

Turns out we have introduced a massive unrecognized moral hazard by allowing
management to load up on stock. Since stockholders are also benefitting from
the shrinking supply of stock, they aren't about to blow the whistle. And
judging by Greenspan's don't rock the boat speech two weeks ago, neither is
the Fed.

I am watching the Fed's survey of senior bank lending officer's willingness
to lend to tell me when corporate credit demand will clash with a less
aggressive bank sector. I am guessing the recent surge in bank lending has
to do with firms drawing on prearranged credit lines after the corporate
bond market got hit in the August/September 1998. At some point those lines
will be tapped out and subject to review, and bank lenders are likely to
take a more restrictive eye toward financing the share repurchase Ponzi
scheme. Interestingly, despite the rapid rebound in stock prices following
the Fed's panic easing last year, corporate bond spreads remain quite large,
suggesting corporate bond buyers now recognize they may be holding the short
end of the stick in this new game.

This is the bomb still ticking after Brazil, Russia, Asia, and all, and I am
constantly surprised at how little recognition there is of this ongoing
Ponzi scheme. I suppose if you recognize the dynamic underway, you are to
leave the cat in the bag and take advantage of it while the easy money is to
be made. But the external cost when this jig is up will probably be very
large since with the personal savings rate at 0%, it would appear many
households are living off their capital gains. If you thought the bond
vigilantes were a particularly vicious lot in the '80s, just wait until the
equity lynch mob comes riding into town!

I sent a note on this Ponzi scheme to the list back in August, and would
gladly resend it to you or anyone. There is an international dimension to
this as well given our rising external debt which is not unrelated to rising
internal corporate debt.