Economy: A BIG PONZI SCHEME??? Is the crash about to begin?
For the past few weeks I have been a bit fixated on the Steve and Barry's saga. The focus is not because the retailer was fast growing and absorbing about 20 million square feet of retail space in a relatively short period of time. Not the fact that it had accumulated around 17,000 employees. Not even the fact that mall owners paid Steve and Barry's hundreds of millions of dollars to move into their spaces, a private equity form fronted it over $300 million in 2006 or that GE Capital provided a line of credit for $200 million as late as March.
The focus on Steve and Barry's comes from the fact one could argue its growth was simply predicated on companies and investment firms throwing capital at it and not from its fundemental business model. It apprears most of its earnings came from the hundreds of millions of up front landlord payments and not from selling clothes. Then one thinks to themselves, WOW, this company sucked in probably over $1 billion dollars, hired 17,000 workers, and occupied around 20,000,000 square feet of retail space because it grew in a period where easy money was easy pickings and just about anything can grow in that environment by borrowing from one hand to pay the other.
Borrowing or taking money from one group to pay others in an ever widening circle, with little expectation that the business will ever generate cash, could be viewed as a Ponzi scheme.
THE QUESTION IS HOW MUCH OF AMERICA'S, AND THE WORLD'S ECONOMY, OVER THE PAST FEW YEARS WAS SIMPLY DEPENDANT ON CHEAP AND EASY MONEY FOR ITS SUCCESS AND NOT THE UNDERLYING BUSINESS.
For example, in the above, GE recently fronted Steve and Barry's a $200 million LOC and generated reported profits from the transaction. The mall owners reported profits and positive cash flow from the rents. The employees received paychecks and paid taxes. The government received millions in payroll, income, and sales taxes.
In the Steve and Barry's example, lots of people made lots of money simply by advancing hundreds of millions of dollars regardless of whether the business model was sound. As long as people kept throwing money, the merry go round kept spinning......until the spigot was shut off. Now GE stands to lose hundreds of millions, so does the private equity firm, thousands of employees will likely get fired, landlords will have millions of empty square feet with no rent coming and millions in charges ahead, and government will lose millions per year of previously paid taxes.
THE FALLOUT IS HUGE JUST FROM ONE COMPANY.
The question now is whether it is just one company or was this the culture of our entire economy over the past seven years or so. Did the entire home building business expand on foundation of cheap and easy money and not on people's ability to pay for the home. Same with the expansion of big box retailers. And growth in our banking industry. And growth of airlines. And government growth. As one thinks about it, it becomes clearer the growth of much of our economy was simply built on money being thrown around and not on sound business fundementals.
It could easily be argued over 50% of the S&P's earnings came directly or indirectly from financing activities. We are talking about Trillions in earnings and even more Trllions of accumulated debt. Now that the spigot is being shut off, we are seeing businesses failing or gettng in trouble just like Steve and Barry's.
The debt wants to be paid back and there is not the revenues to service it. Its getting harder and harder to access credit to keep payments current. Incomes are evaporating as sales slow creating an ever growing spiral of contraction. Individuals, Businesses, and Governments are suffocating from slowing revenues....just like Steve and Barry's. The rate of failures is increasing.
It appears Steve and Barry's is not simply an isolated tumor but a symptom of a much larger cancer that has spread throughout our entire economy. Every time we think we have cut it out we later learn it has spread more and more.
How do we pay back tens of trillions of accumlated debt with only a few trillion in the bank. The debt went into overbuilding homes, shopping centers, schools, office and condo developments, granite countertops, SUVs, vacations, shopping sprees, and hiring millions and millions of new workers.
This debt is the core of the assets in our pension funds, insurance companies, retirement accounts, and banks balance sheets. If the debt fails, so does our entire financial system. Then you get into the problem of moral hazard....why pay your obligations when few others are able or willing to make theirs. If people stop paying, then debt fails even faster and few will be willing to extend credit in that environment.
As you can see, it was one hell of a party at Steve and Barry's and one hell of a party for our economy. It always is when you can get money for nothing and interest rates are practically free. The environment persisted much longer and grew much bigger than ever before because SWAPS gave investors the perception that they were hedged even if the debt failed. No one cared about the lasting effects of overleveraging the economy because BIG money was being made now.
Now that we are waking up, the hangover gets more painful by the minute. Is Steve and Barry's a visible symptom of a much BIGGER problem or an isolated case by itself. Our bankers understand the problem and are scrambling right now. The head of the New York Fed likens the issue to unscrambling an egg. The more you scramble, the harder to unscramble.
Without the cash flowing in, millions of wokers are getting fired, thousands of retailers are shutting down, vacancies are skyrocketing in commercial spaces, governments are cutting off services, homes are getting foreclosed ect.........
There is no joy about writing about this, it is simply a diagnosis of the problem and we better understand the issue in order to solve it. Rising food and fuel prices only make a bad situation worse.
We keep hearing the credit crisis is contained only to learn it is getting bigger. Now the question is how BIG will this get? Now do you see why our politicans are soooooo silent.