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alstry (35.13)

Economy: A BIG PONZI SCHEME??? Is the crash about to begin?

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July 09, 2008 – Comments (6)

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.

 

6 Comments – Post Your Own

#1) On July 09, 2008 at 5:10 AM, alstry (35.13) wrote:

It just keeps spreading...........

In another development, the U-M student newspaper - The Michigan Daily - is no longer accepting advertising from Steve & Barry's because the store owes $20,326 for advertisements taken out during the 2006-07 school year, when it was the paper's single largest advertiser.

Elaina Bugli, an incoming U-M senior who is the newspaper's business manager, said the retailer is by far the newspaper's biggest debtor. Its debt also is far larger than the approximately $16,000 the paper has set aside to cover unpaid debts for the year. "Obviously, that isn't even enough to cover this one account," she said.

http://blog.mlive.com/annarbornews/2008/07/steve_barrys_loses_license_to.html

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#2) On July 09, 2008 at 6:06 AM, hansthered0 (< 20) wrote:

Thats funny. I went to a Steve and Barrys once. Everything there was so cheap I asked "How come you guys dont advertise, I didnt even know you existed?"

The store clerk told me they dont advertise because it saves money and its all about word of mouth.

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#3) On July 09, 2008 at 6:32 AM, DemonDoug (80.36) wrote:

How do we pay back tens of trillions of accumlated debt with only a few trillion in the bank.

The official stance of the US government on this one is clear.  It isn't by cutting spending.  It isn't by cutting taxes.  Survey says....

Inflation.  Devalue the dollar, every dollar is worth less, but that means all the debt from before are worth less and are easier to pay off.

Steve and Barry's is not an isolated event, I think we've seen enough evidence of that.  They may be one of the biggest and worst examples though.

Incidentally the GE capital thing is a main reason I've not seriously considered investing in GE.  Their finance division - who knows how littered it is with these types of things.  It could be 5 or even 10 years before they get it sorted out.  Such a shame because their infrastructure business is world-class and definitely worth investing in.

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#4) On July 09, 2008 at 8:59 AM, alstry (35.13) wrote:

Demon,

I am not talking about the US Government with regard to debt or spending.  My focus is on individuals, businesses and local and state governments.  I have little doubt the US Government is fine. Over 2/3 of our economy is non federal spending and most of the federal revenues comes from non federal sources.

The direct debt of the US government is only about $10 trillion(not including medicare or social security).  The debt I am focusing on is the over $50 trillion of non federal debt.

You and I both agree the Federal Gov can print there way out of anything.....but the individuals, businesses, and non Fed Governments don't have such privelege.

Again, the question now is what percentage of the economy was created by debt and how far will this go.  In addition, I am not contemplating the shutting down of America completely....just the bankruptcy and legal reorganiztion of many of its citizens, businesses and local governments.

In the meantime, one day you have retailer of the year, the next day it could be bankruptcy.  The same with an airline, or a homebuilder, or a manufacturer, or a municipality as the slowdown goes on and on.....

LONDON (MarketWatch) -- Beauty salon operator Regis Corp.  said Wednesday that it plans to close up to 160 under-performing company-owned salons in fiscal 2009. The group, which owns 8,500 salons in total, said the pretax charge for closing the stores will be around $20 million to $25 million. The charge includes around $4.5 million of fixed-asset write-downs which will be recognized in its results for the fourth quarter of fiscal 2008, which will be announced on Aug. 20. "Closing these salons prior to their lease expiration dates eliminates a significant time drain on supervisory and corporate personnel and will be accretive to our bottom line profitability," the group said.

OR

NEW YORK (MarketWatch) -- The country's largest airline, American Airlines, will be dismissing employees at airports in Washington, Florida and Texas as it wrestles to pay an exorbitant fuel bill, according to various media reports. The Fort Worth, Texas-based carrier will cut about 13% of its workforce at Sea-Tac Airport in Seattle, and around 209 employees at airports in Texas. It may also dismiss up to 221 employees at its Florida destinations.

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#5) On July 09, 2008 at 3:34 PM, friscojonesp (< 20) wrote:

I have personally known  both Steve and Barry for years.  They were in business over 23 years. They were both hard working young men that worked night and day to build their empire.  They grew from one store to 276 stores. They always made a profit, although it was always  a small percentage of their sales. They believed in making high quality clothing available to families that otherwise might not have been able to afford it. They attracted similar thinking philanthropist celebrities like Sarah Jessica Parker, Venus Williams, Armanda Bynes, Stephen Marbury, Lard Hamilton and Bubba Watson. They allowed poor and middle class families to dress in "affordable style". While it is true that they always made a profit running the business, their true desire was to do good for their fellow men.

The landlords helped them sell cheap clothing by giving them low rents. They also helped them finance the stores. This helped the landlords put new life into decaying malls. It helped rejuvenate decaying neighborhoods. It made jobs for over 20,000 people, and many suppliers over the years made a good living helping Steve and Barrys grow.The government collected big taxes on their earnings, and the banks made good interest helping them expand.

I know for a fact that Jan-May sales were up around 70% and same store sales were up about 15%, and their gross profit on sales was decent.  . This is an incredible performance for a retailer in a decaying economy.

 What went wrong?  The economy was getting bad, so profit margins were thin.  The company continued to expand as this was necessary to utilize its recently expanded warehouse and foreign buying setup  inorder to lower its cost as a percentage of the expanded sales,

 GE Capital, like all banks, decided to reduce their exposure to retail stores.  They tightened their credit line that Steve and Barrys had relied on to fulfill its commited expansion program.  The truth of the matter is GE  panicked and over reacted to the slow down in the economy.  The proof of this will be public in the coming days when we will all learn that GE will not lose a penny on their loans to Steve and Barrys. In fact they will have made millions of dollars on these loans.

 Unfortunately they did not realize that it would have been cheaper for GE to take a chance with Steve and Barrys.  The downfall of this giant retailer will adversely effect countless malls which are financed by GE. GE will lose 100 times what they had at risk if they did not reduce Steve and Barry's credit line.  But as with all big companies, different people handle different departments, and like the US government, they do not talk to each other.

Let's hope someone like Sears sees the value and growth in Steve and Barrys and helps avoid a potential financial disaster to the US economy that all these mall vacancies can cause in an economy like ours where there is no one to lease this potentially vacated space.

 Had the Wall Street Journal not leaked the problems, I believe that even in this economy lenders and or investors would have stepped forward and saved this great company.  However, the Wall Street Journal caused a "run on the bank" which would have  made much more money necessary to save this company than if the article hadn't be run. 

Asi es la vida

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#6) On July 09, 2008 at 4:06 PM, alstry (35.13) wrote:

I agree with much of what you say.  If S&B is worth saving....there is no doubt it will be saved.  If it is not......the problems are much deeper than S&B.

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