Good morning, dear readers. Please enjoy Part 2 of Wednesday's article. Keep in mind when reading this that the administration recently reported that a good part (more than half) of the recent GDP growth was attributable to the "Cash for Clunkers" program and other initiatives funded exclusively by the government (when I or anyone else says "funded by the government," at all times read "funded by the tax payers"). For some reason we are supposed to consider this cause for celebration.
While the performance of major indices were universally dreary, it quickly became clear how Bank of America shareholders felt about the merger of what had been a stalwart pillar of American finance to a leper like Merrill Lynch. Below, again, is a comparison of BAC stock to the DJIA.
This brings us back to the question of value. By no means was Merrill Lynch a complete waste of talent and resources. Lewis was quoted as saying that Merrill Lynch’s Global Wealth Management division was the true goal, the “crown jewel” of the merger. Again, this was the most profitable sector of Merrill Lynch and to Lewis this was where the value was. Bank of America had to take the entire bank, however, liabilities and all. Value, a misplaced value, was dictated to them by the government. Had Merrill Lynch filed for bankruptcy protection, the bank could have been split up along acceptable lines. Bank of America could have paid far less than they did for the only division they really needed, and the rest of the bank could have been sold at appropriate prices. This opportunity never arose due to government intervention.
It has been said in movies that everyone can be bought. We can adjust this and apply it to economics by saying that everything can be sold. That is to say, value can be attached to everything, even if it must be broken down to its basest components. In a world where that value takes the form of pricing; and pricing is a function of supply and demand; and demand is a function of utility, both suppliers and consumers determine the value of a good. The production of that good takes place only because the value the consumer attaches to its utility exceeds the value that consumer attaches to the utility of the amount of money making up the price the seller asks. If no consumer exists who will buy that good, it is because for all potential consumers the utility of the amount of money it would take to acquire the good exceeds the utility of the good itself. The price must be lowered to a point at which the utility of the good exceeds the utility of the money. To sustain production of that good, the supplier must have reasonable expectations of new buyers continuing to purchase those goods at prices that exceed the utility, or value, the supplier attaches to all the inputs of that good. This is basic, basic, basic economics, but government stimulus creates an artificial demand level (which in turn sets a price) that it can’t hope to sustain. The United States has an enormous budget, but the spending power of the market will always dwarf the spending power of any government. It is for this reason, therefore, that real economic growth will not occur until businesses are able to use their own criteria of value to guide purchase decisions, and customers are not able to look to government to show them where to spend.
The stimulus efforts that have come out of Washington in the last year, many of which have been emulated overseas, are certainly well-intentioned, but they have created a reverse-Pavlovian stimulus-response system for the American business and the American consumer. With so much showing that policymakers will create programs or use monetary policy to trigger spending, it becomes unwise for the individual business to liquidate assets or liabilities without such an action.
When Pavlov was doing his experiments he wanted his dogs to associate the expectation of a need being met with an audible sound, and was able to get his dogs to associate the ringing of a bell with the availability of food. What Washington has done is conditioned the American business and consumer to associate the ABSENSE of the expectation of a need being met with the ABSENSE of a signal. The assets that businesses want to buy from competitors have value. Consumer goods have value. They have utility for every person who could want to acquire them, but logic based on recent history dictates that if one spends without the government showing where to do business and offering an incentive for the transactions, one will have either wasted money or missed opportunities for capital.
This would not necessarily be a problem if the government were funding transactions that would have taken place anyway but that were hampered due to lack of capital. Had Ken Lewis followed protocol and done appropriate due diligence before signing off on what was at the time a $55 billion deal, he would have been able to approach it with a much clearer picture of Merrill Lynch’s problems and could have come up with an appropriate price closer to the relative value of Merrill Lynch to Bank of America. That price would have been lower than what was spent, but the deal, had it been done with full disclosure all around, would not have been followed by shareholders’ anger (shown in the falling of the share price and the ousting of Lewis as Chairman of the Board).
With the lure of Washington funding to grease the wheels of the transaction, Lewis entered into a deal where sufficient value for Bank of America was not present, and shareholders retaliated. When consumers buy cars with assistance from the government, when they buy houses based on savings of $8,500, they could very well be spending money they had not intended for those purchases, and so their value priorities are being subordinated to those of policymakers. They can’t be blamed for taking advantage of such generous programs, but this is unsustainable. Instead of spending increasing based on unassisted value judgments, spending is increasing based on dictated value judgments. All the good intentions in the world can’t direct those accurately, and the end result often is what happened to Bank of America. A good bank dragged down by a hastily assembled and badly priced acquisition.
Washington can’t spend forever. There will be an end to the stimulus money, and there will be an increase in consumers moving under their own power, buying based on what they need for themselves, not on what policymakers say they need. Prices will yield to consumer demand, no longer being propped up by the artificial demand created by spending power that should not be there. The danger is that with the lure of government stimulus to come, there is no reason to spend without it. It will therefore be some time before people begin to prioritize their own estimations of value and the consumer side of the recession will be far longer than it would have without stimulus.
As always, thank you for reading.
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