…It also requires an institutional structure in which the government can quickly expand its normally remote position to one that temporarily, but flexibly, reduces the amount of risk borne by private capital so that funds continue to flow to qualified borrowers during a financial-market disruption or economic downturn. And that institutional structure needs to greatly minimize the chances of government bailouts, so that private participants do not have an incentive to take excessive risks.”, Jason Furman and James Stock. (Mr. Furman is Chairman of the White House Council of Economic Advisors, of which Mr. Stock is a member.)
“I am not sure that the government should cause mortgage funds to flow like normal in a housing downturn? FHA has touted its role during the housing and mortgage crisis of late 2007-2011, as a major provider of housing credit (when private mortgage markets disappeared almost overnight). I know why it made sense for Realtors, home builders, and mortgage lenders to be able sell and finance homes during this period of time, but did it really make sense for the government to encourage consumers to buy homes utilizing huge leverage (an FHA mortgage with as little as 3% down) when housing prices were still falling, unemployment rates were rising, and the economy was in The Great Recession? Sophisticated institutional investors waited, prudently raised funds, and didn’t step into the residential housing market until about 2012, when it was clearer that housing price declines had slowed significantly and/or housing prices were rising, and job formation and the economy had improved.”, Mike Perry, former Chairman and CEO, IndyMac Bank
We can end the Fannie and Freddie duopoly and bring more private capital to finance mortgages.
By
JASON FURMAN And
JAMES STOCK
April 24, 2014 7:29 p.m. ET
In his State of the Union address President Obama called for Congress to send him legislation that would provide a solid foundation for housing finance in the future. Such legislation would protect homeowners, communities and taxpayers from another housing crisis. It would also enhance access to home loans for creditworthy borrowers and ensure the availability of consumer-friendly mortgages like the 30-year fixed-rate mortgage.In the run-up to the Great Recession, Fannie Mae and Freddie Mac took on large amounts of risky mortgage debt that resulted in large losses when housing prices collapsed and defaults rose. To stem the spillovers that their failure would have on the economy, the Treasury ultimately put nearly $190 billion into these two government-sponsored enterprises to keep them afloat. They are now in a conservatorship overseen by their regulator, the Federal Housing Finance Agency.Although these efforts helped foster a housing recovery, further progress will best be advanced by moving beyond what is, in effect, a government-supported duopoly. Today, Fannie and Freddie, supported by U.S. taxpayers, guarantee payments to investors in mortgage-backed securities covering approximately 60% of mortgages. The size of these two giants, and their uncertain future, deter private firms from making the large, long-term investments needed to promote a vibrant, competitive market.
The dominance of Fannie and Freddie in the secondary mortgage market also stifles innovation and puts homeowners, communities and taxpayers at risk for future housing downturns, and is not making transparent sustained contributions to affordable housing. Although there are indications of pent-up demand for homes, uncertainty, including regulatory uncertainty, is placing unnecessary restraints on lending by banks and other mortgage originators. Creditworthy borrowers are being limited in their ability to buy homes, thereby creating fewer jobs and slowing economic growth. To support the recovery and set a firm foundation for the future, now is the time for reform.
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Public discussion has highlighted a number of critical goals. The reformed housing-finance system should enable the dreams of middle-class and aspiring middle-class Americans to own homes by supporting consumer-friendly mortgage products such as the 30-year fixed-rate mortgage. It should provide help, through narrow and focused programs, to creditworthy first-time borrowers who might otherwise have trouble qualifying for a mortgage; and it should stimulate broad access to mortgages for historically underserved communities.
A reformed housing-finance system should support rental housing, which is vital to many Americans, especially younger and lower-income households. It should stimulate competition and innovation, for example in mortgage products and service delivery, while building in consumer protections to make sure that the innovations benefit the broad American public. And it should protect the taxpayer by placing substantial private capital in front of any government guarantee—and ensure that the taxpayer be properly compensated for that guarantee.
Less discussed, but also important for the future: Housing-finance reform presents an opportunity to enhance macroeconomic stability by making the housing sector more cyclically resilient. Housing has long been one of the most volatile sectors of the economy, and that volatility spills over into other sectors—with all Americans, but especially the most vulnerable and disadvantaged, bearing the brunt of housing-related or magnified recessions.
The basic idea of cyclical resilience is straightforward: Even if the economy is in a downturn, and even if there are disruptions to financial markets, reasonably priced mortgages should remain available to creditworthy borrowers. Financial-market failures can reduce liquidity in the mortgage market. This reduced liquidity was particularly evident during and after the most recent financial crisis, when even creditworthy borrowers had—and still have—difficulty getting a mortgage.
Fostering cyclical resilience means ensuring that the key securitization infrastructure on which the secondary mortgage market relies is not exposed to financial risk resulting from swings in housing prices or the economy. It also requires an institutional structure in which the government can quickly expand its normally remote position to one that temporarily, but flexibly, reduces the amount of risk borne by private capital so that funds continue to flow to qualified borrowers during a financial-market disruption or economic downturn. And that institutional structure needs to greatly minimize the chances of government bailouts, so that private participants do not have an incentive to take excessive risks.
Housing-finance reform is a key unfinished piece of business from the financial crisis, and putting all the parts together is a complex undertaking. But the current period of relative economic calm is exactly the right time to do so. The Senate Banking Committee is making promising bipartisan progress on this crucial task, and the administration looks forward to continuing to work with Congress to forge a new private housing-finance system that better serves current and future generations of Americans.
Mr. Furman is the chairman of the White House Council of Economic Advisers, of which Mr. Stock is a member.
…In perhaps the most revealing line of the book, the 42-year-old Piketty writes that since the age of 25, he has not left Paris, “except for a few brief trips.” Maybe it is that lack of exposure to conditions and politics elsewhere that allows Piketty to write the following words with a straight face: “Before we can learn to efficiently organize public financing equivalent to two-thirds to three-quarters of national income” — which would be the practical effect of his tax plan — “it would be good to improve the organization and operation of the existing public sector.” It would indeed. But Piketty makes such a massive reform project sound like a mere engineering problem, comparable to setting up a public register of vaccinated children or expanding the dog catcher’s office.”, Tyler Cowan, “Capital Punishment”, Foreign Affairs, May/June 2014
“France has been losing talented citizens to other countries for decades, but the current exodus of entrepreneurs and young people is happening at a moment when France can ill afford it. The nation has had low-to-stagnant economic growth for the last five years and a generally climbing unemployment rate — now about 11 percent — and analysts warn that it risks sliding into economic sclerosis….“It is a French cultural characteristic that goes back to almost the revolution and Robespierre, where there’s a deep-rooted feeling that you don’t show that you make money,” Ms. Segalen, the recruiter, said. “There is this sense that ‘liberté, égalité, fraternité’ means that what’s yours should be mine. It’s more like, if someone has something I can’t have, I’d rather deprive this person from having it than trying to work hard to get it myself. That’s a very French state of mind. But it’s a race to the bottom.””, “Au Revoir, Entrepreneurs”,New York Times, March 22, 2014
Guillaume Santacruz is among many French entrepreneurs now using London as their base. He said of his native France, “The economy is not going well, and if you want to get ahead or run your own business, the environment is not good.”CreditAndrew Testa for The New York Times
Guillaume Santacruz, an aspiring French entrepreneur, brushed the rain from his black sweater and skinny jeans and headed down to a cavernous basement inside Campus London, a seven-story hive run by Google in the city’s East End.
It was late on a September morning, and the space was crowded with people hunched over laptops at wooden cafe tables or sprawled on low blue couches, working on plans to create the next Facebook or LinkedIn. The hiss of a milk steamer broke through the low buzz of conversation as a man in a red flannel shirt brewed cappuccino at a food bar.
A year earlier, Mr. Santacruz, who has two degrees in finance, was living in Paris near the Place de la Madeleine, working in a boutique finance firm. He had taken that job after his attempt to start a business in Marseille foundered under a pile of government regulations and a seemingly endless parade of taxes. The episode left him wary of starting any new projects inFrance. Yet he still hungered to be his own boss.
He decided that he would try again. Just not in his own country.
“A lot of people are like, ‘Why would you ever leave France?’ ” Mr. Santacruz said. “I’ll tell you. France has a lot of problems. There’s a feeling of gloom that seems to be growing deeper. The economy is not going well, and if you want to get ahead or run your own business, the environment is not good.”
In the Campus London basement, Mr. Santacruz, who is 29, squeezed into one of the few remaining seats. Within hours, he was to meet with an entrepreneur he identified only as Knut, to discuss an investment in the company that Mr. Santacruz was trying to build. He called it Zipcube, and was pitching it as a sort of Airbnb for renting office space online.
From 80 to 90 percent of all start-ups fail, “but that’s O.K.,” said Eze Vidra, the head of Google for Entrepreneurs Europe and of Campus London, a free work space in the city’s booming technology hub. In Britain and the United States, “it’s not considered bad if you have failed,” Mr. Vidra said. “You learn from failure in order to maximize success.”
That is the kind of thinking that drew Mr. Santacruz to London. “Things are different in France,” he said. “There is a fear of failure. If you fail, it’s like the ultimate shame. In London, there’s this can-do attitude, and a sense that anything’s possible. If you make an error, you can get up again.”
Mr. Santacruz had a hard time explaining to his parents his decision to leave France. “They think I’m crazy, maybe sick, taking all those risks,” he said. “But I don’t want to wait until I’m 60 to live my life.”
France has been losing talented citizens to other countries for decades, but the current exodus of entrepreneurs and young people is happening at a moment when France can ill afford it. The nation has had low-to-stagnant economic growth for the last five years and a generally climbing unemployment rate — now about 11 percent — and analysts warn that it risks sliding into economic sclerosis.
Some wealthy businesspeople have also been packing their bags. While entrepreneurs fret about the difficulties of getting a business off the ground, those who have succeeded in doing so say that society stigmatizes financial success. The election of President François Hollande, a member of the Socialist Party who once declared, “I don’t like the rich,” did little to contradict that impression.
After denying that there was a problem, Mr. Hollande is suddenly shifting gears. Since the beginning of the year, he has taken to the podium under the gilded eaves of the Élysée Palace several times with significant proposals to make France more alluring for entrepreneurs and business, while seeking to preserve the nation’s model of social protection.
His deputy finance minister for business innovation, Fleur Pellerin, a dynamic 40-year-old credited with schooling Mr. Hollande on the importance of the digital economy, has been busy pushing initiatives to turn Paris into a “tech capital” to rival the world’s most active start-up hubs.
Those initiatives, however, have not yet closed the spigot on the flow of French citizens to other countries. Hand-wringing articles in French newspapers — including a three-page spread in Le Monde, have examined the implications of “les exilés.” This month, the Chamber of Commerce and Industry of Paris, which represents 800,000 businesses, published a reportsaying that French executives were more worried than ever that “unemployment and moroseness are pushing young people to leave” the country, bleeding France of energetic workers. As the Pew Research Center put it last year, “no European country is becoming more dispirited and disillusioned faster than France.”
Next month, the National Assembly will convene a panel to examine the issue.
Today, around 1.6 million of France’s 63 million citizens live outside the country. That is not a huge share, but it is up 60 percent from 2000, according to the Ministry of Foreign Affairs. Thousands are heading to Hong Kong, Mexico City, New York, Shanghai and other cities. About 50,000 French nationals live in Silicon Valley alone.
But for the most part, they have fled across the English Channel, just a two-hour Eurostar ride from Paris. Around 350,000 French nationals are now rooted in Britain, about the same population as Nice, France’s fifth-largest city. So many French citizens are in London that locals have taken to calling it “Paris on the Thames.”
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Axelle Lemaire, a lawmaker, says France should enhance competitiveness but not compromise its social model.CreditAndrew Testa for The New York Times
In the past, most of these people would have gone back to France after some adventure and experience. That may still be true of some in the French diaspora, but nearly 40 percent of French people abroad now say they plan to stay there for at least 10 years, according to the report by the Chamber of Commerce and Industry. Many are quietly saying that they may not return.
Taxes, Frustration, More Taxes
Mr. Santacruz grew up in his parents’ small, tidy home in a suburb of Aix-en-Provence in the south of France. During one of his summer breaks from college in Bordeaux, he visited a cousin who had become rich working in finance and lived in a sprawling residence in the Luberon Valley. When Mr. Santacruz drove up to the entrance, electronic gates opened to a vast garden.
“It was crazy,” he said. “I drove five minutes just to reach the house. That’s when I thought, ‘I want to make it like him.’ ”
“Making it” is almost never easy, but Mr. Santacruz found the French bureaucracy to be an unbridgeable moat around his ambitions. Having received his master’s in finance at the University of Nottingham in England, he returned to France to work with a friend’s father to open dental clinics in Marseille. “But the French administration turned it into a herculean effort,” he said.
A one-month wait for a license turned into three months, then six. They tried simplifying the corporate structure but were stymied by regulatory hurdles. Hiring was delayed, partly because of social taxes that companies pay on salaries. In France, the share of nonwage costs for employers to fund unemployment benefits, education, health care and pensions is more than 33 percent. In Britain, it is around 20 percent.
“Every week, more tax letters would come,” Mr. Santacruz recalled.
The government has since simplified procedures and reduced the social costs for start-ups. But those changes came too late for Mr. Santacruz, whose venture folded before it could get off the ground.
His parents were relieved when he took a job in Paris at the boutique firm NFinance. But he knew that it was a way station. He quickly turned to drawing up blueprints for a new venture.
“I asked myself, ‘Where will I have the bigger opportunity in Europe?’ ” he said. “London was the obvious choice. It’s more dynamic and international, business funding is easier to get, and it’s a better base if you want to expand.”
Diane Segalen, an executive recruiter for many of France’s biggest companies who recently moved most of her practice, Segalen & Associés, to London from Paris, says the competitiveness gap is easy to see just by reading the newspapers. “In Britain, you read about all the deals going on here,” Ms. Segalen said. “In the French papers, you read about taxes, more taxes, economic problems and the state’s involvement in everything.”
French officials have sought to play down such stories. Their takeaway is that migration — which has grown 4 percent a year since 2000 — is hardly new, so the outflow is nothing to lose sleep over. Bernard Emié, France’s ambassador to Britain, even argued that it was something to celebrate.
“The French are expatriating themselves more and more, but this is encouraging,” Mr. Emié told me. “We are not worried about it. They get experience, create wealth, and then they will bring that back to France.”
Photo
President François Hollande of France with Fleur Pellerin, second from right in foreground, his deputy finance minister for business innovation, visiting San Francisco last month.CreditAlain Jocard/Agence France-Presse — Getty Images
Mr. Hollande’s government is now trying to re-brand itself as business-friendly, especially for start-ups. Ms. Pellerin recently cut the ribbon on a large-scale technology incubator in Paris. She unveiled initiatives to free up venture capital and encourage digital entrepreneurship, including a “second chance” program intended to remove the cultural stigma attached to failure.
Defeat is seen as so ignominious that France’s central bank alerts lenders to entrepreneurs who have filed for bankruptcy, effectively preventing them from obtaining money for new projects — a practice that Ms. Pellerin would halt.
A pledge that Mr. Hollande made in January included a “responsibility pact” — a promise to relieve businesses of some of the burden to finance France’s welfare state. In February, he announced additional measures to lure investors back to France, unveiling plans to stabilize corporate tax rules, simplify customs procedures for imports and exports and introduce a tax break for foreign start-ups.
These changes were welcomed by business, but the more than 20 French expatriates I interviewed said their country was marked by a deeper antipathy toward the wealthy than could be addressed with a few new policies.
“Generally, if you are self-made man and earn money, you are looked at with suspicion,” said Erick Rinner, a French executive at Milestone Capital Partners, a British-French private equity firm, who has lived in London for 20 years.
Mr. Hollande’s election, and especially his proposal — since ruled unconstitutional — to impose a 75 percent tax on the portion of income above one million euros (about $1.4 million) a year, have only reinforced that perception.
“It is a French cultural characteristic that goes back to almost the revolution and Robespierre, where there’s a deep-rooted feeling that you don’t show that you make money,” Ms. Segalen, the recruiter, said. “There is this sense that ‘liberté, égalité, fraternité’ means that what’s yours should be mine. It’s more like, if someone has something I can’t have, I’d rather deprive this person from having it than trying to work hard to get it myself. That’s a very French state of mind. But it’s a race to the bottom.”
Sharing Space, Waiting Tables
Mr. Santacruz’s efforts to get Zipcube off the ground were full of fits and starts. While London had opportunities, living there was tougher than he had imagined. His apartment in Paris had been spacious, with tasteful modern furniture and French windows overlooking the gold statues atop the Paris Opera. After work, he would go to places like the Hôtel Costes or Le Forum, a bar on the Right Bank, to talk and to sip cocktails.
In London, he had none of that. Without a steady income, he was renting a room in a leaky group house with three roommates. He had also taken a night job as a waiter at Momo, a Moroccan restaurant near Oxford Circus, earning 6.50 pounds (about $10.80) an hour to make ends meet. He would come to Campus London every day to work on Zipcube, but by 4:30 he had to leave to be on time for his shift at Momo, which ended at 2 a.m.
“Sometimes I do ask myself if I’m making the right choice,” he acknowledged. “But if you don’t take risks, there will be no reward.”
Another French entrepreneur I met in the Campus London basement, Emilie Bellet, 30, had a more inspiring story. In less than a year, she had raised a half-million pounds to finance her venture, SeedRecruit, which finds talent for other start-ups. With two partners, she hired four more people.
Photo
Diane Segalen moved most of her executive recruiting practice to London from Paris. In France, she says, “there is this sense that ‘liberté, égalité, fraternité’ means that what’s yours should be mine.”CreditAndrew Testa for The New York Times
“In London, every day is a fight,” she said. “But then you get rewarded. I don’t think this would have been possible in France.”
Such convictions are a challenge for officials like Axelle Lemaire, a lawmaker who represents the French population in Britain and Northern Europe in the National Assembly of France.
The growing number of French people settling in London is a sign that France needs to enhance competitiveness, Ms. Lemaire told me one afternoon in her office near Camden Market. But Anglo-Saxon-style capitalism was not the solution if it would compromise France’s social model, which she sees as protecting citizens from the ravages of the free market.
In Britain, “it has been surprising to see the level of deprivation of some of my fellow citizens,” she said. “When things fail here, they can wind up without a penny in their pockets, living on the street. That’s the part of the story you don’t hear.”
At the same time, she said, France’s generous safety net could not continue unchanged without risking further economic malaise. “Socialist politicians all agree on that now,” Ms. Lemaire said.
Back in France, Mr. Santacruz’s parents were still trying to grasp their son’s decision. Having spent her career at the state telecom company, his mother, like many others in her generation, assumed that her children’s main aspiration would also be lifelong job security.
“It’s 35 hours a week, good vacation, a pension and protections,” she told me. “O.K., it’s not very interesting, and I don’t get paid much. But it’s stable. I thought that’s a dream that our young people would want, too.”
His father saw Mr. Santacruz’s move as courageous but felt vexed to have invested in his son’s degrees, only to see him leave his country in a state of disillusionment.
The elder Mr. Santacruz had grown up poor, but eventually got a job as a government customs official.
“France gave me an opportunity to make a life,” he said. “The French Republic formed me, and it also formed Guillaume. When I hear young people disparage the country as they leave, I don’t like that. The children of France should not forget that the state has given them a lot.”
France? Maybe for Retirement
Guillaume Santacruz was grateful for the benefits that his country gave him. But he wanted something else — to innovate. By September, his project was not where he wanted it to be. Yet he maintained that he was better off pursuing it outside France.
He had incorporated Zipcube and had bites of interest from an executive at Booking.com, a website for booking hotel rooms. But Knut, the investor, was not willing to invest after all, and Mr. Santacruz was again seeking financing.
Even if Zipcube fell apart, he told me one chilly weekend at his Kensington flat, where paint was peeling off the walls, “I would not change my mind and head back to France; I see only cons to doing that, no pros.” He was skeptical that the government’s recent offensive to spur France’s entrepreneurial environment would quickly bear fruit.
Several of his French friends in London felt the same way. “I asked them, if things don’t work out, will they go back? Not one of them would,” Mr. Santacruz said. “Maybe for retirement. But not for work — we’d rather go to the United States or Asia before returning.” France seemed to have lost another citizen in the prime of his productive working years.
By February, though, Mr. Santacruz’s foray to England was finally paying off. He had a new programmer and a partner who was handling marketing and sales. Zipcube was selected by Sirius, a British start-up accelerator program, for a grant of £36,000, and he had recently started to reel in some clients. Though he still needed to build the business, he felt he was on the right track.
And while the bar to succeed was high, “I’m confident I’m going to make it,” he declared.
Correction: March 30, 2014
An article last Sunday about entrepreneurs who have left their native France referred incorrectly to Milestone Capital Partners, the firm that employs Erick Rinner, a French executive who has lived in London for 20 years. Milestone is a British-French private equity firm, not a British-based investment bank.
“It’s essentially crony capitalism (which abhors free and fair market competition and change), which unfortunately has also taken root in the United States.….look no further than our Too Big To Fail Banks and dysfunctional civil legal system in the U.S. (not dissimilar to how Italy’s is described) and those in the private sector seeking protection (from their governments) from Uber and AirBnB’s innovative and consumer-friendly business models. Ultimately, as you can see from Greece and European countries like Italy; crony capitalism stifles innovation, risk-taking, and effort and always leads to economic stagnation and loss of liberty. And once its imbedded in a country and culture, it takes years to change.”, Mike Perry, former Chairman and CEO, IndyMac Bank
Can Italy Find Its Way? Resistance to Change Means Slow Recovery
Hardened Habits, Accumulated Over Decades, Prove Difficult to Overcome; ‘We Change or We Go Nowhere’
By
MARCUS WALKER and
DEBORAH BALL
April 29, 2014 11:00 p.m. ET
FLORENCE— Bernardo Caprotti was a 45-year-old entrepreneur when he agreed to buy a suburban plot of land for a new supermarket.
Building permits recently came through. He’s now 88. His Milan-based retail chain, Esselunga SpA, had grappled since 1971 with local bureaucrats who raised shifting concerns about traffic volumes, architectural suitability and proximity to a medieval monastery.
“It has become so difficult and complicated to do business in Italy,” Mr. Caprotti said in an interview. “Italy can’t go on like this. Either we change or we go nowhere.”
Mr. Caprotti’s wait to open a store is a small symbol of a persistent problem for Italy. Like some other European countries, it has struggled to change and grow its economy fast enough to shake off a long debt crisis.
Entrenched interests and hardened habits have accumulated in Europe over decades, slowing once-dynamic economies to a crawl, and are now proving difficult to overcome. From bureaucrats to businesses, unions to pensioners, interest groups vigorously defend the status quo, even when it leaves no one satisfied.
Italy, like the 18-country euro zone, is slowly recovering from a six-year slump, leading some to believe Europe’s crisis is receding. But the difficulty of economic renewal, say economists and business leaders, means the crisis hasn’t been solved—it has merely mutated from an acute condition to a chronic one.
A tepid recovery after a long fall, towering debts and high unemployment have put Europe in danger of suffering a lost decade—one in which its economies have to limp forward while some other world regions march on. The economy of the euro zone is still 2.7% smaller than it was in early 2008.
Many Europeans blame years of austerity policies that have sapped demand and prolonged the post-2008 downturn.
But the deeper malaise, say some economists and policy makers, is a long-term decline of Europe’s economic growth rate. In societies whose populations aren’t growing, sustainable growth comes from improving productivity, or the efficiency of the economy’s supply side. And that requires constant change: Europe’s Achilles’ heel.
The European Union’s executive arm, the European Commission, warned in January that the euro zone’s long-term productivity growth has been slowing since the mid-1990s, and that the crisis years have done further damage to the region’s ability to grow.
The pressure of the debt crisis has forced some euro members, such as Spain and Greece, to enact overhauls of labor rules and highly-regulated business sectors, among other measures. But the reforms are widely seen as partial at best, and momentum has faded since the peak of the financial-market panic.
Italy has emerged as a Technicolor example of the problems. Its growth has been stuttering for 20 years. Since 2008, its economy has shrunk by 9%, and this year it is struggling to expand by even 1%.
Without faster growth, Italy will struggle to tame its public debt of over €2 trillion (US$2.77 trillion), or 133% of gross domestic product. If its debt mountain keeps rising, fears for Italy’s solvency could return, reigniting the capital flight that nearly tore the euro apart in 2011-12.
Italy’s new Prime Minister Matteo Renzi, a kinetic 39-year-old with big plans to cut taxes and stem regulation, shot to power with widespread support from a public yearning for someone to break the country’s impasse. Yet even many sympathizers doubt he can reinvigorate Italy’s growth.
The roots of the problem, say many Italians, lie in how vested interests in the private and public sectors gum up the economy, preventing change that replaces old practices with new, more efficient ones, and repeatedly frustrating political attempts to shake up the country.
It adds up to “deep-seated cultural obstacles to growth,” says Tito Boeri, a professor at Milan’s Bocconi University who is one of Italy’s top economists. “In Italy you define your identity in terms of your membership of some specific interest group,” he says, making it hard to rally support for any notion of the common good.
Roberto Zuccato, president of Ares Line Carlo Furgeri Gilbert for the Wall Street Journal
Outside perceptions of Italy’s enviable lifestyle mask a stubborn resistance to change. Smaller family companies led by aging owners rebuff outside investors even when they lack the money or vision to compete. Regulated professions such as lawyers and pharmacists consistently beat back efforts to break their cartels. Powerful bureaucrats bog down the implementation of new laws for years. And Rome’s political class is so quarrelsome that governments last little more than a year on average.
It used to matter less. Italy’s economy grew rapidly in the postwar era despite a stonewalling bureaucracy, legions of tiny companies and a fragmented, often corrupt political system. But growing was easier then: Relatively poor Southern European countries mainly had to copy technology from more-developed economies such as the U.S., and use it to churn out goods cheaply.
Making the wheels turn in an advanced economy requires the efficient rule of law, reliable public administration and more capital and expertise than many mom-and-pop businesses can muster, says Fabiano Schivardi, an economist at Rome’s Luiss University who has studied the stagnation of swaths of Italy’s business sector.
“Our institutions were good enough for an economy that was catching up, but they’re not good enough any more,” he says.
Some of Italy’s best-known companies, such as Prada SpA, Ferrero SpA and Luxottica Group SpA, have flourished globally, showcasing the country’s prowess at fashion and food. Yet according to the Bank of Italy, 98% of Italian companies employ fewer than 15 people.
Many family business owners prefer to stay small, sticking to the staff and customers they already know and trust, says Matteo Bugamelli, senior analyst at the Bank of Italy. “Often, all of the family wealth is in the firm, and there isn’t the risk appetite that you need to invest and grow,” he says.
Roberto Zuccato, an entrepreneur from Vicenza in Italy’s affluent northeast, wanted to break out of his niche and build a business with more international heft.
His company, Ares Line, makes furniture for offices and public venues such as theaters, employs about 90 people, and has annual sales of €20 million ($27 million). The market leader, Steelcase Inc. of the U.S., has annual sales of $2.9 billion.
In 2005, Mr. Zuccato teamed up with a Milanese private-equity firm and sought to merge with local Italian rivals under a holding company with sales of €100 million. With fresh capital and economies of scale, they planned to invest in building a global brand that played to Italy’s reputation for elegant design.
But only struggling companies wanted to partner up. Others chose to stay alone, even if they weren’t growing, Mr. Zuccato says.
“The culture here is be the padrone in your own house,” he says, using the Italian for “boss.” Many family entrepreneurs “don’t trust outsiders and prefer to bring in their own son, even if he’s not well qualified,” he says.
In 2009, after fruitless talks with around 20 companies, the private-equity fund sold its investment in Ares Line back to Mr. Zuccato.
Red tape is one factor that deters businesses from growing. Esselunga, the supermarket chain, says it has scaled back plans for new stores after several frustrating experiences involving building permits and other permissions—although it will finally open its long-awaited Florence store this fall.
What maddens locals can baffle foreign investors. In 2012 British Gas PLC threw in the towel on a €500 million gas import terminal in southern Italy after struggling for over a decade to get the necessary permits.
It is a problem familiar to Mr. Caprotti. “If we start something today, it could take 15 years to finish,” he says. “Then you’re lost because you find that the size or the location doesn’t work anymore.”
Italy’s court system also spooks businesses: Routine contract disputes take more than three years on average to resolve in court—and much longer if there are appeals. Italy’s lawyers, who outnumber their French brethren fourfold, have resisted efforts to streamline a judicial system that offers rich opportunities for lengthy proceedings. At the end of 2012, there was a backlog of 9.7 million cases, according to the International Monetary Fund.
Italian unions have also often dug in their heels to resist change. For years, union battles held up efforts to save the national airline, Alitalia, which struggled to get its labor costs down. Last fall, as the carrier faced imminent bankruptcy, unions agreed to pay cuts and more-flexible working terms.
Fear often lies behind unions’ defense of the status quo. Redundant blue-collar workers might never find jobs again in Italy’s sclerotic jobs market.
There are some signs of change. Natuzzi SpA, one of Italy’s leading sofa makers, also grappled with union issues to stay afloat. The company had strained against lower-cost foreign competition once the euro was introduced. For years, it did too little to address high costs—even as losses mounted. But in 2013 it reached a deal with unions to cut labor costs and buy out hundreds of staff, in order to keep production in Italy.
“We can’t hide the fact that there are difficulties,” says founder Pasquale Natuzzi. “But there is greater awareness on the part of both unions and business” that change is needed to defend manufacturing in Italy, he says.
Companies’ demands to cut labor costs grate with workers whose take-home pay has already suffered from the long downturn and tax hikes. Italian households’ disposable incomes have fallen by 13%, or about €2,400 per worker since 2007, one of the biggest declines in the euro zone, according to the state statistical agency.
Mr. Renzi has made cutting payroll taxes among his highest priorities, with a pledge to trim €10 billion in payroll taxes this year.
Taxes on labor are particularly high. One reason is that taxes that would normally help spread the burden—including on the incomes of small businesses and the self-employed—are widely dodged.
Italian entrepreneurs evade over 50% of the income taxes they owe, while people living off investment income skip over 80%, the country’s central bank estimates. The heavy taxes on payrolls deter companies from hiring and weaken consumers’ spending power, economists say.
Even when leaders pass reforms into law, change doesn’t necessarily follow. Bureaucrats who must implement laws by issuing administrative decrees often stall, dilute them or render them incomprehensible, say reform-minded officials. When the government of Enrico Letta fell in February, about 500 laws had been passed but not implemented. Among them: a measure to reduce the number of permits required for companies to do business and a law to digitize certain processes to simplify dealing with the government.
“There is a great deal of difficulty in moving the bureaucracy and the whole machinery of the state,” said Graziano Delrio, undersecretary to the prime minister, in an interview. “There has been this approach of making modest changes, but we need to make a leap in how it all works.”
Former Premier Mario Monti tried to inject more free-market competition in service sectors where regulation protects incumbents’ profits. Striking taxi and truck drivers, railway workers, pharmacists, lawyers and gas-station owners protested his overhaul attempts and lobbied parliament to water them down. Even the weakened measures that passed into law have often made little difference, because the public administration hasn’t acted on them, Mr. Monti says.
“Across the board, the last ring in the chain of implementation is often not there,” says Mr. Monti, looking back on his reform efforts. Prime minister for only 17 months, he says he would have needed more time to take on Italy’s uncooperative mandarins. Urgent fiscal measures, he says, were needed against Italy’s debt crisis. “I couldn’t afford a revolt of the bureaucrats.”
Some foreign entrepreneurs are discovering just how tough it remains to penetrate the Italian market.
Uber, the app-based car service that launched in Italy last year, says traditional taxi drivers have verbally abused its drivers, who respond to customers’ orders sent by smartphone. The taxi union denies any aggression, and says its members have paid a fortune for their taxi licenses, which now trade at about €170,000, and offer a public service that needs to be protected.
“During a period of change, there are some whose jobs are under threat and a sense of protectionism sets in,” says Benedetta Arese Lucini, general manager of Uber in Italy. “Unfortunately, Italy is afraid of changing.”
Carmaker said its move to Plano, Texas, from Torrance had nothing to do with cost-cutting but is an effort to foster efficiency and collaboration.
By Jerry Hirsch
7:53 PM PDT, April 28, 2014
Toyota Motor Corp.’s move to Texas will mean the transfer of 3,000 marketing and finance jobs from its sprawling Torrance campus to a new North American headquarters.
The shift, announced Monday, is part of a strategy to consolidate corporate management on one campus near the company’s Southern manufacturing hubs. It marks the second high-profile move of a major automaker from Southern California. Nissan moved its U.S. headquarters from Gardena to a Nashville suburb in 2006.
Some observers and California officials seized on the announcement to criticize what they said is California’s business climate for high taxes and onerous regulations. But Toyota officials said the move to a Dallas suburb had nothing to do with cost-cutting and everything to do with fostering efficiency and collaboration.
“This is the most significant change we’ve made to our North American operations in the past 50 years,” said Jim Lentz, chief executive of Toyota’s North America region.
Toyota’s announcement Monday surprised its workers.
“There’s a lot of shock,” said one employee, who declined to give his name. “They did a good job of keeping it secret…. My boss, a national manager, didn’t even know.”
A Southern California native and 23-year Toyota veteran, he was unsure whether he would move to Texas.
“People aren’t angry,” he said. “It’s just a lot of sadness.”
California officials were similarly taken off guard.
Toyota executives waited until Friday to tell Gov. Jerry Brown’s administration of the planned exit, said Brook Taylor, deputy director of the governor’s Office of Business and Economic Development. He declined to answer further questions on Toyota’s departure.
Don Knabe, the Los Angeles County supervisor from the 4th District, which includes Torrance, said he first learned that Toyota might move over the weekend from rumors circulating on Facebook and Twitter. He emailed contacts at Toyota but said no one responded.
“I am very shocked,” Knabe said. “Toyota is such a great corporate citizen.”
He said state and local officials should conduct an “exit interview” with Toyota, to ask how California can better avoid “being a target for every other state.”
The move will take place in phases over the next three years as the new headquarters is built at an office park in Plano, a Dallas suburb. All of Toyota’s employees can transfer to the new office at their same salary and benefits. Toyota will pay for workers to visit Plano before they decide and will cover their relocation expenses.
The move affects about 4,000 employees nationally, including 2,000 at Toyota’s sales and marketing arm and an additional 1,000 in its financial services operations, both in Torrance. Toyota will also close its engineering and manufacturing office in Erlanger, Ky., near the Cincinnati-area airport, and those workers will be offered jobs in Plano and other sites.
The car company will keep about 2,300 workers in California at its design studio in Newport Beach, a motor-racing division in Costa Mesa, a parts factory in Long Beach and at other facilities. But no Toyota workers will remain at the company’s 2-million-square-foot office complex in Torrance. The company said it has not yet determined what it will do with the property.
The loss of thousands of well-paying jobs will be a big blow to Los Angeles County, which is still struggling to recover about 76,000 jobs lost during the recession, said Gary Toebben, chief executive of the Los Angeles Area Chamber of Commerce
“It’s a very negative step back for the Los Angeles County economy,” Toebben said. “If we lose another 3,000 jobs, that means 3,000 more jobs we have to recover.”
The Toyota move will have a ripple effect on the Southern California economy as workers either hunt for other jobs or move out of California altogether, he said.
“My only hope is that this is a wake-up call for the state of California,” he added. “We had this wake-up call when Nissan left, but I think everybody forgot.”
The move of a big corporate headquarters feeds into the perception that California is unfriendly to businesses, said Esmael Adibi, a Chapman University economist.
“This has a very negative impact on the stigma that already exists about California,” he said, “not just in terms of taxes but also regulations and labor laws.”
Toyota’s Lentz, however, told workers Monday that the move was driven by a desire to create an efficient management structure in a centralized headquarters.
In meetings with employees, Lentz described the move as a critical step in erasing divisions among Toyota’s separate engineering, manufacturing, sales and financial operations. He said putting all those businesses on a single, state-of-the-art campus will improve communication and collaboration.
Toyota chose Plano because of its Central Time Zone location, proximity to airports serving all parts the U.S. and Japan, its cost of living, educational opportunities and cultural offerings, Lentz said.
Despite Toyota’s pending departure, the auto industry remains well represented in California and an important source of jobs. Honda, which has its U.S. sales and marketing office, and 2,500 employees, in a complex not far from Toyota in Torrance, said it doesn’t plan a move.
South Korean auto company Hyundai just moved into a new, $200-million North American headquarters in Fountain Valley and has about 2,200 Southern California employees. Kia, its sister company, and Japanese automaker Mazda have their U.S. headquarters in Irvine.
Other automakers including Volkswagen, Ford, General Motors, Tesla Motors and BMW have smaller footprints that include design studios, testing facilities and R&D centers in Southern California.
Toyota’s move is an example of how big global corporations make location decisions, said James Rubenstein, an auto industry analyst and geography professor at Miami University in Oxford, Ohio. Companies that do business by the tens of billions of dollars annually make these type of moves for strategic reasons rather than tax incentives dangled by one state or another, he said.
“The world’s largest corporations don’t bend with the wind to the short-term political situation in any locality,” he said.
Toyota did, however, collect on some of those incentives from Texas. The new headquarters will be a $300-million project, and the state will provide Toyota with $40 million in incentives, according to Gov. Rick Perry’s office. Plano also is offering the automaker an incentive package that is likely to include property tax abatement, cash and waivers on building and construction fees. The details will be released next month.
Plano started talking with Toyota about three months ago, after Perry and other state officials started to court the automaker, said Mayor Harry LaRosiliere, the city’s mayor.
The automaker doesn’t plan layoffs, although it knows that not every worker will make the move. Only 42% of Nissan’s Southern California employees moved when it relocated its U.S. headquarters to Tennessee in 2006.
A small contingent of Toyota workers will move to Plano this year, followed by hundreds next year. Most employees will go when the campus is completed in late 2016 or early 2017.
Those who make the move will be given a “retention” bonus. Those who decide not to move, but who stay with the company until the move is completed, will also receive a bonus.
The move will cement what Rubenstein called a “Southern strategy” for Toyota. It builds the Camry and Avalon in Kentucky, the Corolla in Mississippi and the Tundra and Tacoma pickup trucks in Texas. It also has a big engine plant in Alabama.
Although the company is successful at selling passenger cars in the U.S., it has never gained the traction in the truck market it has hoped for, Rubenstein said. Toyota’s sales are also too heavily weighted to women, he added.
“Texas is the most male, macho state in the country,” Rubenstein said. “Texas is where they think they can learn more about what big-truck buyers want in their vehicles…. They already have California in its back pocket. Priuses are next to godliness in California.”
“…David Winters of Wintergreen Advisers, who led the charge against the Coke equity plan….told me that if Buffett had announced a month before the Coke annual meeting that he was going to abstain, it might well have been a factor. “If people had known that Buffett had agreed with us that the plan was excessive, the outcome of the vote might have been significantly different,” he said. As it was, 83 percent of the shares voted favored the plan, a number Coke has been trumpeting….”, Joe Nocera, New York Times
The first Saturday in May is always a great day for Warren Buffett. That’s the day his conglomerate, Berkshire Hathaway, holds its annual meeting in Omaha.
Thousands of shareholders descend on the city — there were more than 30,000 last year — where they eat ice cream at Dairy Queen (one of Berkshire Hathaway’s holdings), shop at Borsheims (the Omaha jewelry store Berkshire has long owned) and dine at Gorat’s and Piccolo’s (Buffett’s favorite restaurants). This year, according to his annual letter, the festivities will also include a newspaper-tossing contest, and a blindfolded chess player and an American table-tennis champion who will take on all comers.
Mostly, though, investors come to hear Buffett and his longtime partner, Charlie Munger, answer questions, which they’ll do for six hours on Saturday. Some of the questions will be about Berkshire Hathaway. Others will give Buffett a chance to talk about the buy-and-hold stock strategy that has made him, at 83, the second-wealthiest American behind Bill Gates. Buffett has long called his annual meeting “Woodstock for capitalists.” But it’s really more like a revival meeting.
I wonder, though, if anyone attending this year’s meeting is going to ask him about his decision to abstain from voting Berkshire Hathaway’s 400 million shares against Coca-Cola’s equity compensation plan, even though Buffett felt the plan was, in his own words, “excessive.”
I am returning to this subject because, on Monday, following widespread criticism of his decision, Buffett gave a remarkable interview to Fortune magazine’s Stephen Gandel, an interview that was strikingly different in tone from his remarks of last week. When he first acknowledged to Becky Quick of CNBC that he had declined to vote against the compensation plan, he seemed flustered and mildly embarrassed. His reason, he said, was that he loved Coke and its management and he didn’t want to do anything that might be viewed as disparaging them. Given Buffett’s previous statements about the importance of institutional investors speaking out against excessive executive compensation, I thought he had been both cowardly and hypocritical. So did a lot of other people.
But having had a few days to lick his wounds, Buffett went on the offensive with Fortune. In abstaining, he told Gandel, he was taking a stand. “That’s a very loud voice coming from Berkshire,” he said. “It obviously means we don’t approve of the plan.” He added that the Coke board was simply acting the way all boards do: “The other guys are doing it so we will do the same thing. The idea of fundamentally re-examining the whole thing doesn’t occur to these companies.” Nor was Buffett willing to try to bring about such a re-examination, even though he was in the perfect position to do so in this case.
In fact, Buffett had it right when he spoke to Quick: He should be embarrassed. It’s actually worse than I had realized. My original assumption was that Buffett didn’t want to offend his fellow board members, especially those on the compensation committee, who had vouched for the equity plan. But Buffett left the board in 2006. (His son Howard joined the Coke board four years later.) As the company’s largest shareholder, he should have felt duty-bound to vote against the plan — or at least to let it be known beforehand how he was going to vote.
Indeed, when I asked David Winters of Wintergreen Advisers, who had led the charge against the Coke equity plan, what he thought about Buffett’s latest statement, he told me that if Buffett had announced a month before the Coke annual meeting that he was going to abstain, it might well have been a factor. “If people had known that Buffett had agreed with us that the plan was excessive, the outcome of the vote might have been significantly different,” he said. As it was, 83 percent of the shares voted favored the plan, a number Coke has been trumpeting ever since the annual meeting.
(Coke added in a statement: “The Coca-Cola Company Board respects Mr. Buffett’s philosophical stance on equity-based compensation. As our largest shareholder, Mr. Buffett is an avid supporter of the Company and its management team, and has been a wonderful counselor through the years.” In other words, no harm, no foul.)
In his annual letter to shareholders this year, Buffett gives a lovely dissertation on buy-and-hold “value” investing. He explains to readers that they shouldn’t be distracted by the white noise of the market, and that while he and Munger may make stock-picking mistakes, they won’t be the kind of disasters “that occur, for example, when a long-rising market induces purchases that are based on anticipated price behavior and a desire to be where the action is.”
When it comes to buying stocks, everybody should follow Warren Buffett’s example. But, on the subject of executive compensation, do what he says, not what he does.
….Today, easy credit from federal loan programs provides little incentive for campuses to keep tuition low, and many students and parents gladly borrow to pay these increasing costs, only to run into financial trouble when the loans come due. Delinquency rates on student loans reached 12% in 2013, higher than the roughly 10% delinquency rate on mortgages at the height of the housing crisis in 2008-09.”Miguel Palacios and Andrew P. Kelly, “A Better Way to Finance a College Degree”; April 13, 2014, Wall Street Journal
“By now, it should be clear to everyone that with $1+ trillion in U.S. student loan debt and too many of these students out of school and unable to pay, that we have another huge consumer debt crisis on our hands. This reminds me a lot of the recent mortgage and banking crisis in U.S.. How so? They both involved massive market distortion/intervention by the government (albeit well-intended) that encouraged both lenders to lend more and borrowers to borrow more (and prices for homes and college to rise rapidly; well above inflation rates). Today, both the U.S. student loan and U.S. mortgage markets have essentially been nationalized.”, Mike Perry, former Chairman and CEO, IndyMac Bank
SOMETIMES it seems as if our lives are dominated by financial crises and failed reforms. But how much do Americans even understand about finance? Few of us can do basic accounting and fewer still know what a balance sheet is. If we are going to get to the point where we can have a serious debate about financial accountability, we first need to learn some essentials.
The German economic thinker Max Weber believed that for capitalism to work, average people needed to know how to do double-entry bookkeeping. This is not simply because this type of accounting makes it possible to calculate profit and capital by balancing debits and credits in parallel columns; it is also because good books are “balanced” in a moral sense. They are the very source of accountability, a word that in fact derives its origin from the word “accounting.”
In Renaissance Italy, merchants and property owners used accounting not only for their businesses but to make a moral reckoning with God, their cities, their countries and their families. The famous Italian merchant Francesco Datini wrote “In the Name of God and Profit” in his ledger books. Merchants like Datini (and later Benjamin Franklin) kept moral account books, too, tallying their sins and good acts the way they tallied income and expenditure.
One of the less sexy and thus forgotten facts about the Italian Renaissance is that it depended highly on a population fluent in accounting. At any given time in the 1400s, 4,000 to 5,000 of Florence’s 120,000 inhabitants attended accounting schools, and there is ample archival evidence of even lowly workers keeping accounts.
This was the world in which Cosimo de’ Medici and other Italians came to dominate European banking. It was understood that all landowners and professionals would know and practice basic accounting. Cosimo de’ Medici himself did yearly audits of the books of all his bank branches; he also personally kept the accounts for his household. This was typical in a world where everyone from farmers and apothecaries to merchants — even Niccolò Machiavelli — knew double-entry accounting. It was also useful in political office in republican Florence, where government required a certain amount of transparency.
If we want to know how to make our own country and companies more accountable, we would do well to study the Dutch. In 1602, they invented modern capitalism with the foundation of the first publicly traded company — the Dutch East India Company — and the first official stock market in Amsterdam. But it was through an older and well-maintained culture of accountability that they kept these institutions stable for a century. The spread of double-entry accounting to the Netherlands during the early 1500s made the country the center of accounting education, world trade and early capitalism. Well-accounted-for provincial tax returns allowed the Dutch to float bonds at dependable 4 percent interest rates. The Dutch trusted their managers to know how to keep good books and make regular interest payments, while paying off state debt.
Every level of Dutch society practiced double-entry accounting — from prostitutes to scholars, merchants and even the Stadholder, Maurice of Nassau, Prince of Orange. Painters regularly depicted merchants keeping their books; Quentin Metsys’ “The Money Changers” (circa 1549) showed that even skilled accountants could be fraudulent. In other words, the advantages and pitfalls of accounting were at the fore of public consciousness.
Not only did the Dutch have basic financial management skills, they were also acutely aware of the concept of balanced books, audits and reckonings. They had to be. If local water board administrators kept bad books, the Dutch dyke and canal system would not be well maintained, and the country risked catastrophic flooding.
This desire for accountability was what pushed the Dutch to reform their financial system when it began to collapse under the weight of fraud. The first shareholder revolt happened in 1622, among Dutch East India Company investors who complained that the company account books had been “smeared with bacon” so that they might be “eaten by dogs.” The investors demanded a “reeckeninge,” a proper financial audit.
While the state did not allow the Dutch East India Company’s books to be audited in public, Prince Maurice did do a serious internal audit, and Dutch burghers were satisfied with both company and state accountability. A cultural ideal was set. For the next century, it became common practice for public administrators to have portraits of themselves painted with their account books — sometimes with real calculations in them — open, for all to see.
These historical examples point the way toward achievable solutions to our own crises. Over the past half century, people have stopped learning double-entry bookkeeping — so much so that few know what it means — leaving it instead to specialists and computerized banking. If we want stable, sustainable capitalism, a good place to start would be to make double-entry accounting and basic finance part of the curriculum in high school, as they were in Renaissance Florence and Amsterdam.
A population well-versed in double-entry accounting will not immediately solve our complex financial problems, but it would allow average citizens to understand the nuts and bolts of finance: balance sheets, mortgage interest, depreciation and long-term risk. It would also give them a clearer sense of what financial accountability really means and of how to ask for and assess audits. The explosion of data-driven journalism should also include a subset of reporters with training in accounting so that they can do a better job of explaining its central role in our economy and financial crises.
Without a society trained in accountability, one thing is certain: There will be more reckonings to come.
Jacob Soll, a professor of history and accounting at the University of Southern California, is the author, most recently, of “The Reckoning: Financial Accountability and the Rise and Fall of Nations.”
“…. to spend now — but the economy is so crummy that few know quite how to do that. A report from Standard & Poor’s released this month found that 1,700 big, nonfinancial companies were holding on to about $1.53 trillion in cash and short-term securities at the end of 2013. Pension funds, endowments, high-net-worth individuals and the like are also trying to figure out how to invest all their money — and along with places like the Bakken and a few emerging markets, Palo Alto seems awfully appealing. A few million in seed funding might turn to billions in an acquisition in just a few years, after all. “Valuations are at extreme levels because you cannot get a decent return on your money doing anything else,” Fred Wilson of Union Square Ventures…”, New York Times Magazine, April 22, 2014
“Can it be clearer that this is current tech bubble is caused by the Fed’s easy money policies? Just like the stock, bond, and housing market bubbles of just a few years ago….and now asset bubbles seems to be brewing again. How many asset bubbles and busts are we going to allow the Fed to create?”, Mike Perry, former Chairman and CEO, IndyMac Bank
This year, Facebook purchased the mobile-messaging application WhatsApp for $19 billion, or about $350 million per employee and $40 per user, only some of whom even pay the $1 annual fee for the advertisement-free platform. But what was perhaps most remarkable about Facebook’s acquisition of WhatsApp was that the start-up was making any money in the first place. In recent years, Facebook has shelled out 10-figure sums for Instagram and the virtual-reality headset maker Oculus V.R., both of which had scant or no revenue. Ditto for the safe-sexting-enabler Snapchat, which reportedly turned down a $3 billion offer from Mark Zuckerberg.
Those numbers seem as bubbly as a hot bath or cold Champagne, a sure sign that Silicon Valley valuations have soared far higher than Silicon Valley balance sheets can support. A recent downturn in tech stock prices is perhaps indicative of this uncertainty. But if tech really is a bubble, would the rest of the country be harmed if it burst?
There are hundreds more examples of big companies spending eye-watering sums for acquisitions, firms going public at fat valuations, tech stocks reaching high highs and venture-capital firms tossing money at start-ups. That’s not to mention the cultural afterbirth of all that cash, from the medieval-themed weddings to the office ball pits. (If HBO sees fit to satirize your corner of the economy, things have probably gone a bit weird.) Meanwhile, the rest of the country slouches along, unemployment high, wages stagnant, credit tight. But Silicon Valley feels like a foam party.
It turns out that one might have more to do with the other than you would think. The Federal Reserve is currently keeping interest rates very, very low. They’ve been keeping them very, very low for a long, long time. The idea is to spur investors to spend now — but the economy is so crummy that few know quite how to do that. A report from Standard & Poor’s released this month found that 1,700 big, nonfinancial companies were holding on to about $1.53 trillion in cash and short-term securities at the end of 2013. That is enough liquidity to purchase Google, Apple, General Electric, McDonald’s, General Motors and Walmart outright, with a few billion to spare.
Pension funds, endowments, high-net-worth individuals and the like are also trying to figure out how to invest all their money — and along with places like the Bakken and a few emerging markets, Palo Alto seems awfully appealing. A few million in seed funding might turn to billions in an acquisition in just a few years, after all. “Valuations are at extreme levels because you cannot get a decent return on your money doing anything else,” Fred Wilson of Union Square Ventures wrote on his blog. “It’s been a good time to be in the V.C. and start-up business, and I think it will continue to be as long as the global economy is weak and rates are low.” In other words, the perks-laden, savior-and-ninja-saturated, TED-talking beast that has seemingly taken over Northern California in recent years might be a byproduct of high corporate profits and Fed policy as much as anything else.
But what happens if and when the normal patterns of the economy reassert themselves? What happens when the easy money gets a bit harder to come by, and firms suddenly need the companies they invest in to turn a profit? I put that question to half a dozen academics and businesspeople, and the general response was a shrug.
If it is a bubble, one thing that sets it apart is its relative dearth of retail investors. The dot-com bubble of the late 1990s and the economic collapse of 2008 still loom large, for investors and executives alike. “In the 1990s, as time went on, skeptics started to see Porsches in their neighbors’ driveways,” said Lise Buyer of the Class V Group, a consultancy for firms looking to go public. “Time beat back the skepticism.” It resulted in a disaster on the Nasdaq and the end of the Clinton boom. But now, she said, there is fresh memory of how badly things can go, and how quickly. For evidence, she pointed to the fact that 10 of the 19 technology companies that went public this year are trading below their offering price. “That isn’t the kind of performance that drives most folks to bet the mortgage money on the next hot wonder company,” she said. “Sanity prevails.”
What about those start-ups raising mountains of cash from investors? The queasy truth is that many of those investors could afford to lose it all. Technology giants — Apple, Facebook and Google, among many others — are raking in cash. They might be overpaying for acquisitions, but there is no reason to think that should damn their bottom lines in the long term. The same goes for the rich individuals funneling money to young companies through venture-capital firms and other vehicles.
“Where’s the bulk of the ownership of these companies?” said Josh Lerner, a professor at Harvard Business School. “They’re mostly in the hands of a small number of venture funds.”
But the American public has bought into the tech boom, at least a bit, in a more concealed way. Big institutional investors, like pension funds, do put some of their money into private-equity and venture-capital firms. A drop in tech stocks or a flotilla of start-ups going belly up could sting Uncle Joe and Aunt Nancy that way.
And that downturn might already be taking hold. Recently, Bloomberg asked investors, analysts and traders if Internet and social-media stock valuations were unsustainable. Only 14 percent did not see a bubble. Even some tech companies themselves have argued that expectations have drifted too high. For instance, Netflix’s chief executive, Reed Hastings, recently said he sensed some “euphoria” driving the firm’s stock price. “We have a sense of momentum, investors driving the stock price more than we might normally,” Hastings said. “There’s not a lot we can do about it.”
But relatively few tech companies have actually gone public during this boom, which wasn’t the case in the late ’90s: With so much corporate cash sloshing around, there is less need to head to the public markets in order to raise capital. And investors seem to be more wary. This spring, many market participants ditched high-growth but volatile biotech, social-networking and cloud companies stocks, noted Kathleen Smith of Renaissance Capital, an I.P.O. investment-advisory firm. “This was a necessary correction that many had been looking for after such a strong sustained rally,” she said. It’s a sign of investor discipline. And although the sell-off has sent prices sliding, the damage has been contained. Far fewer Americans are mortgaging their homes to day trade, as they were back in the days of Pets.com.
Perhaps the most immediate effect of a tech bust — and one I imagine would be accompanied by a certain amount of delicious schadenfreude outside Silicon Valley — would be on the local economy. Suddenly broke, start-up guys would stop buying plug-in cars and condos and expensive green juices. Housing values might tumble; fancy boutiques and car dealerships might close; yachts and vacation homes in Hawaii might go into foreclosure. But the effect would probably be fairly localized to areas of Northern California, New York, Boston and the like.
The truth is that most Americans have little interaction with the big-money, small-jobs technology boom, so they might be sheltered from the worst of the technology bust, at least as it looks today, if not years from now. But that might be cold comfort: It is a sad state of affairs if one of the most vibrant, explosive and creative parts of the economy — and one of the few that is minting millionaires — seems more like a walled garden than a public park.
Annie Lowrey is an economics reporter for The Times.
A version of this article appears in print on April 27, 2014, on page MM14 of the Sunday Magazine with the headline: If a Bubble Bursts in Palo Alto, Does It Make a Sound?.
“In my opinion, and with the benefit of hindsight, the odds of the 2008 financial crisis occurring were so improbable, that no banker could have taken actions just prior to it occurring (say in 2007 or early 2008) that would have made a material difference, without looking like a wild speculator to their customers, employees, shareholders, and regulators. In point of fact, it was only a handful of unregulated, high risk speculators who got it (mostly) right and placed the appropriate bets to prosper when the unprecedented collapse occurred. And it is only because firms like Goldman Sachs were sought out by these speculators to help structure and create these bets (and importantly, they were not regulated banks at that time) that they were able to study these speculators information and arguments (essentially utilizing their inside information as market makers) and reduce risk themselves.” Mike Perry, former Chairman and CEO, IndyMac Bank
A year ago, I found out that my son, Isaac, won $300,000 playing online poker the previous day. His mother, Francie, was pleased to hear about this on her way out the door for work. The next day, I learned that he won another $62,000.
A few weeks later, I discovered that Isaac had lost $800,000, probably the largest loss for anyone in the world that day, and his losses for several weeks looked similarly catastrophic. For Isaac, these results fall squarely within the kind of variance he expects. He had been playing poker online for 10 years and before his losing streak was up $1.6 million for that year alone.
Francie and I like to avoid risk as much as we can, and Isaac’s detachment from our sense of money makes us queasy. But 28 years ago, three days after he was born, we risked as much as we could imagine. The pediatrician sent Isaac directly from a routine checkup to the neonatal intensive care unit of Albert Einstein Medical College, in the Bronx. From work, I sped to the hospital in tears.
Isaac’s skin was the sickly yellow of an old bruise, and the toxicity of his blood rose steadily toward the level where, experts told us, permanent brain damage would set in. Every time one of the nurses jabbed his heel for another blood test, he began to cry, and Francie wept.
The bilirubin in his blood soon rose to the level that indicated a need for a total exchange transfusion, which meant removing all of Isaac’s blood through an umbilical catheter and replacing it with blood products from the hospital. But the blood products frightened us as much as the bilirubin. In 1985, the Bronx was a hot spot for the AIDS epidemic, then at its height, and we had doubts about the reliability of the new screening test.
The doctors in the I.C.U. insisted that we do the total exchange to avoid the crippling effects of the toxin in Isaac’s brain. My helplessness felt something like a trance. These doctors were excellent at their job, but I trusted Francie’s judgment more. She had been a nursing teacher and was now a third-year medical student.
Brooks Haxton Credit Frances Haxton
She was insisting, although no one mentioned this alternative, that we exchange half of Isaac’s blood for an equal volume of saline to dilute the bilirubin. Blood is, after all, mostly salt water. The partial exchange would remove some of the toxin and lower what remained in proportion to the overall volume of blood, giving Isaac a chance to make more good blood for himself. If this failed, Francie told me, we could still consider a transfusion with blood products. The terrible likelihood was that the source of the problem, which no one understood, would keep causing it. No one knew how many transfusions would be necessary.
Heated disagreement ensued. We were trying, as Isaac does now at the poker table, to calculate with incomplete information the probability of various outcomes. We knew that any action would have to be predicated on our understanding of probabilities.
The doctors described the risks. Francie nodded steadily, as if the physical act of nodding generated empathy and understanding on both sides. But she refused the permission necessary, and I stood behind her, while the doctors shot wild looks my way, in hopes that I might reason with her or take charge. Finally, they agreed to Francie’s plan, and it bought us time until the problem seemed to dissipate as inexplicably as it began.
We played the cards as they were dealt. Francie happened to have the presence of mind and the expertise to play them with great skill, and we got lucky.
I am not arguing that medical science is a game of chance. To think of the world primarily as a game is appalling. Einstein said that “the Old One,” his name for the ultimate cosmic power, “does not throw dice.” The logical crux of this statement for an agnostic like Einstein might have involved some gamesmanship. But Einstein’s refusal to accept a way of thinking that devalues the idea of consequence and choice has always struck me as admirable.
In Isaac’s case, the mathematical ability he uses to play poker, like his transient hyperbilirubinemia, must come from an improbable combination of genes. His mind-set under pressure, I believe, is inherited largely from his mother, who has never taken an interest in games. For reasons Einstein would approve, Isaac does not throw dice. He uses the cards.
Brooks Haxton teaches writing at Syracuse University. His memoir, “Fading Hearts on the River: A Life in High-Stakes Poker,” will be published next month.
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A version of this article appears in print on April 27, 2014, on page MM54 of the Sunday Magazine with the headline: Playing the Cards.
Fed’s low-interest-rate policies cost savers $758 billion, study says
By Jim Puzzanghera
This post has been corrected. See the note below for details.
8:35 AM PDT, April 22, 2014
The Federal Reserve’s low interest rate policies, designed to stimulate the economy, have cost savers about $758 billion since the end of the Great Recession, according to a study released Tuesday.
Inflation and low returns on deposits have led bank customers to lose more than $100 billion in purchasing power in each of the last five years, said MoneyRates.com, which provides consumers with information about bank rates, investing and personal finance.
The Fed’s benchmark short-term rate has been near zero since late 2008 as central bank policymakers tried to battle the financial crisis and Great Recession. The goal was to make money cheap so that consumers and companies would spend rather than save, stimulating economic growth.
The Fed’s policies helped push mortgage rates to historic lows and made other types of loans cheaper, saving consumers money in some ways, said Richard Barrington, a senior financial analyst for the company.
Fed officials have pointed to those savings, as well as the broader benefits of an improving economy, in justifying the low interest rates.
Central bank policymakers are reducing another stimulus program, its monthly bond-buying effort, and have indicated they could start raising interest rates slowly next year if the economy continues to improve.
But Fed Chairwoman Janet L. Yellen has emphasized that rates probably would remain very low for some time because of still sluggish economic conditions.
So far, the low rates have shifted money from savers to borrowers and have provided an ongoing “stealth bailout” to banks, Barrington said.
“Low-interest-rate policies have helped bail out banks, the stock market and real estate, but the Fed has not publicly acknowledged the cost of those policies,” Barrington said.
“Our estimate of the hidden losses due to low interest rates is an attempt to shine a light on that cost,” he said.
The study said that average money market rates have ranged from 0.08% to 0.1% over the last year, well below the 1.5% inflation rate.
By adjusting the $9.43 trillion in U.S. bank deposits up for interest earnings and then down for inflation, the study calculated that savers lost $122.5 billion during that time. Added to losses over the prior four years, the Fed’s low-interest-rate policies have cost savers $757.9 billion, the study said.
Still, Gallup poll results released Monday found that Americans, by a 62%-to-34% margin, prefer saving money to spending it. The so-called saving-spending gap is much greater than it was before the Great Recession as Americans have tried to reduce their debt.
[For The Record, 9:55 a.m. PDT April 22: An earlier version of this post stated that savers had lost $758 million because of the Fed’s low-interest-rate policies and more than $100 million in each of the last five years. The losses are $758 billion and more than $100 billion in each of the last five years.]
Not Too Big To Fail 