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On Capital Traps   (DC, April 15, 2008)

Nice bit of work today on housing as a capital trap. (Real Estate: A Capital Trap for National Savings April 9, 2008)

It left me confused and picayune as to a couple of points though:

While I understand your point about how residential real estate has turned into an illiquid sinkhole of dough, I don't understand your point about the capital trapped at financial institutions. Isn't it the same capital (a least as embodied in the original, non-derivative securities)? And if the capital was enabling the investment in real-estate, in what sense was it trapped (one supposes it could have gone anywhere)? Of course, it may be more trapped now, but the point remains that it seems to be the SAME dough that's trapped in OSB sheathing and half-built clubhouses... I guess I need some more clarification of this point.

I also disagree that no jobs were created as a consequence of the building. Though you allow that jobs were created in the construction, you seem to dismiss their significance. But a lot of those jobs paid quite well, and there were a lot of them (whether or not they persist). Finally, the retail build-out didn't leave behind exactly nothing - it left a lot of retail and service jobs (crappy jobs, to be sure, but still a lot of them).

As to why corporate and other collective capital doesn't/didn't go elsewhere, that's an interesting question. The motivation behind corporate buybacks, though, is pretty straightforward: in addition to propping up share prices through the purchasing activity itself (which I would suggest is statistically invisible), reducing shares increases EPS, which increases share price more tangibly, and so increases the value of management's ultimate perk, the stock option. (It also conveniently offsets the *increase* in shares respresented by the option grants. Though I'm not sure what the actual numbers are, given that buybacks are usually denominated in billions and options in the (obscene) millions, I'd guess it works out to a net decrease in shares outstanding).

Are there no better uses for the money? I've often thought that one answer might just be that the hurdle rate of return is set too high and/or has increased over time within companies. Though there are rational calculations involved in determining what a cash return needs to be to cover costs in an enterprise, often the number is just made up, I'm thinking at least in part just to show how manly the company or manager involved is. If the CEO says any new project has to show an 18% return to obtain company capital, that's what has to be built into the projections, and it seems to me that demands of that scale are both hard to meet and probably higher than they were 30 years ago. I mean, 18% is a lot. Call it 20% and it's even more. (Seems to have work though - look at the money they make.) But I wonder if this sort of expectation is "natural" or realistic, in some way. Would a farmer expect this? Of course, I have no idea if this is actually true.

The other branch of this thinking is that maybe there aren't the number of high-value investments available that we'd like to think there are. To be sure there are lots of *public* undertakings that could absorb a lot of dough, but that's a different question. But one significant possibility is that much of the *manufacturing* capacity that the world needs can be satisfied by a relatively small proportion of the population and available capital. Though it's a gross simplifiication, we might be able to agree that the manufacturing capacity of China + the US + Europe, + 5 years for growth and consolidation, could, in gross terms, be enough to provide everyone in the world with all the stuff they use at roughly the same levels of consumption as now. That this is a managable conceptual simplification suggests to me that we recognize that manufacturing (which is the classic "good-job" activity) has become and will continue to be very efficient, and it might be misplaced to suppose that there's a crying need (vs. desire) for more of it everywhere.

At the same time as there is an evident lack of good-job-producing investment, there is tons of cash running around looking for someplace to land. Large amounts of it goes into big dumb sterile activity like buybacks and takeovers, but there's also lots looking for big scores in venture capital. The abundance of that money led to the dot-com boom, and may soon lead to another bubble in alternative energy. In this case, there's no shortage of available investments, but they are constrained by their small size (of both capital and payroll) and the probablilties of failure. The scale of available capital doesn't coincide with the scale of decent, new, investments.

There is one last point: to the extent that coporate managements can't or won't find more productive (re)investments for all the loot they make overcharging us to make their 20% hurdle rates, there's no excuse to be hoarding the resultant cash. Though the argument is weakened owing to the skewed distribution of stock in the population, one obvious form of relief is for corporations to start paying out significant parts of the cash in dividends, putting it back into consumptive circulation and kicking up demand for more stuff and services. Other than having the cash on hand to do buybacks for the reasons outlined above, it escapes me as to why companies choose to ignore the basic premise of paying its stockholders this way.

I'm not sure, then, that the final issue comes down to a lack of capital or willingness to invest productively. To be sure, a lot of capital is being destroyed in the housing disaster, but there is trillions left looking for places to go. What might be significant about this particular capital is that its regular-folks' capital being destroyed instead of the corporate capital that gets destroyed all the time but is noted only as writedowns of goodwill and restructuring charges in dull financial news.

Perhaps the bigger issues are the consequences of *concentrated* capital in huge enterprises and the ultimate productive efficiencies of the global economy. If 5 companies in each industry could satisfy demand for everything *necessary* to comfortable existence using a tenth of the world's population working in 10 large economies, what would the rest of us be doing? Holding their stock and collecting dividends? Maybe.. (or maybe I'm just full of shit).

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