Many of us first encountered the word “covenant” in the Old Testament story of the bond forged between God and Abraham and his descendants. In the context of faith, “covenant” conveys a mutual commitment of the most intimate sort.
Later in life, we encounter “covenant” in its more secular context when we take out a mortgage to buy a home, establish a line of credit to launch or grow a business, or in other realms in which we accept the status of borrower or lender. In such relationships, the covenants have come to mean the formal terms of the relationship, the metrics to which parties are to be held accountable, the conditions to which both parties are bound, and the consequences for violating those terms.
Perhaps more important than these formal agreements have long been the informal covenants between lenders and borrowers, that is, the societal expectations that supersede those drawn up by legal compact.
Think about the word “bond” for a moment. We use it to describe a security now, but what is it really? When investors buy bonds, they really are loaning money to a country (United States Treasury), a company (General Electric), or municipality (Los Angeles Public Schools). They also might be loaning money to a pool of credit card holders, a pool of mortgage holders, a pool of churches, or other borrowers. This use of the term “bond” is no accident, for the security represents a literal binding between lender and borrower, the forging of a relationship of mutual trust, confidence, and respect that provides assurance to both parties.
Over time, social convention has defined that bond or relationship between borrowers and lenders: A lender will not change the terms of the loan outside of parameters agreed upon in advance; a borrower will repay the lender in a timely fashion as promised; the lender will receive the rights commensurate with the lender’s position in the capital structure (secured, unsecured, senior, junior, etc.); the borrower will conduct itself with due care and loyalty to the lender at least until the borrower has fulfilled is obligations. In this social framework, the lender-borrower relationship remains built on the premise that loans are bonds and that covenants are sacred. But is that framework still operating?
Modern securities markets are such that lenders and borrowers rarely know each other. In the vast majority of cases, the lender knows neither why the borrower wants or needs the money nor how the money will be used. Instead, many lenders rely on a credit rating, yield, and maturity to ascertain whether the borrower is worthy. Likewise, the borrower rarely knows the lender. A municipality raises funds from thousands of faceless lenders located across the municipality and many living outside of it. The corporation borrows money from lenders seeking yield and some level of safety but who may have no other investment in the success of the corporation.
This evolution of the borrower-lender relationship from a true bond to one that is largely detached from a sense of mutual obligation is causing some intriguing and troubling events. In Harrisburg, capital of Pennsylvania, Mayor Linda Thompson is faced with a choice of maintaining city services or paying the city’s lenders (aka bondholders). For her, the choice is clear: do not cut services. According to the Wall Street Journal (“Harrisburg Surrender,” 9/8/10), Ms. Thompson said, "To disrupt [services] because we can't make a bond payment would just be unconscionable. And as a leader I couldn't do it," To her credit, she also is concerned about scaring off bond investors, recognizing that to do so would impact a critical source of financing.
A similar tough choice is faced by Michael Thomas, a leader of the Pequot tribe in Connecticut, owners of one of the world’s largest casinos at Foxwoods: Pay dividends to tribal members from Foxwoods’ revenues versus pay bondholders who have lent money to build Foxwoods. (WSJ, “Tribe’s Roll of Dice Rattles Lenders,” 9/17/10) The Pequot and other Indian tribes are in a privileged position for now because as sovereign nations, they can’t be forced into bankruptcy, and even if they declared it, their lenders would not be allowed to operate casinos on reservations. That said, the casino business will suffer greatly if by stiffing current lenders, the pool of future lenders dries up.
Ms. Thompson and Mr. Thomas are not alone in this dilemma. Municipal borrowing (states and cities) has grown from $1 Trillion in 1990 to $2.4 Trillion in 2010, an increase of 140% over 20 years. Not evident in these numbers is the concurrent sharp increase in unfunded or underfunded pension and health care obligations municipalities have accepted. These commitments paired with a sharp decline in tax revenues have converged to confront municipalities with multi-horned dilemmas of epic proportions: Pay underfunded pensions versus support public education versus build infrastructure versus support unemployed citizens versus pay secured lenders versus maintain vital emergency services versus raise taxes versus encourage new business investment versus get reelected versus…
An early sign of the current economic crisis occurred when banks stopped lending to each other following BNP Paribas’s announcement that it could not adequately value the loans on its books. The overnight interbank lending rate spiked and the crisis of confidence began. Soon after, investment banks stopped supporting the auction rate market, another marketplace where lenders and borrowers met to support each other’s interests. The municipal bond market experienced its greatest shock since the 1860s. These events occurred in late 2007 and early 2008, well before the escalated fears of municipal defaults, declining tax revenues, and unfunded pension obligations, and before the failures or near failures of Bear Stearns, Washington Mutual, Lehman Brothers, AIG, Merrill Lynch, General Motors, Wachovia, Goldman Sachs…you get the idea.
So where are we today? We all operate with an investment marketplace driven by computer algorithms and high frequency trading, an investment industry populated with countless exchanges, traders, product engineers, and money managers, a regulatory framework with agencies possessing complex mandates without rationalizing guidance to address conflicts like those described above, and a global pool of millions of borrowers and lenders striving to make the most effective decisions for themselves every day.
Despite these complexities and technological innovations, at the end of the day, we have borrowers and lenders who desire confidence in the larger system and in their relationships with each other. For all of our wizardry, those who lend and borrow want to have the assurance that comes from relationships built on a shared commitment to each other.
America is at a crossroads in so many ways, and the most difficult of our collective economic decisions still lie ahead of us. Before we further diminish the sanctity of the relationship between borrower and lender, we need to recognize how doing so irrevocably impacts our culture. This is not a time to say that our social contracts do not matter because they force difficult choices; this is a time to make difficult choices precisely because our social contracts are what bind us.
Friday, September 24, 2010
Thursday, September 9, 2010
Beware the Financial-Industrial Complex
Three days before the end of his term as President, Dwight D. Eisenhower—Republican, architect of D-Day, and senior military officer for the United States in the closing years of WWII—gave the American people his parting thanks and a stern warning about the growing interdependence of the Federal government and what he described as the “military industrial complex.” He said in part:
“This conjunction of an immense military establishment and a large arms industry is new in the American experience. The total influence -- economic, political, even spiritual -- is felt in every city, every State house, every office of the Federal government. We recognize the imperative need for this development. Yet we must not fail to comprehend its grave implications. Our toil, resources and livelihood are all involved; so is the very structure of our society.
In the councils of government, we must guard against the acquisition of unwarranted influence, whether sought or unsought, by the military industrial complex. The potential for the disastrous rise of misplaced power exists and will persist.”
While we lack the bully pulpit and gravitas of a departing president, we would like to issue a similar warning about our society’s changing relationship with financial services. We ask you to reread Eisenhower’s passage above, substituting “financial” wherever you see a reference to “military.” It would start, “This conjunction of an immense financial establishment and a large finance industry is new in the American experience. The total influence—economic, political, even spiritual—is felt in every city, every State house, every office of the Federal government…” And so on.
Is this overstating matters? Consider that the financial services industry spent over $5 billion on campaign contributions and lobbyists in the decade leading up to the financial crisis, that by 2007, nearly 3,000 lobbyists represented the industry in Washington, and that the cost of bailout, stimulus, TARP and other recent programs stands at over $3 trillion. From 1998-2008, campaign contributions from the financial sector rose by 185% to $443 million while lobby expenditures grew by 117% to $455 million. Meanwhile, the Standard and Poor 500 fell by 13%.
It is important for all Americans to acknowledge that the political contributions and policy missteps (deliberate or well-intentioned) occurred under both Democratic and Republican leadership reflecting the near-even split in political contributions from banks, securities firms and insurance companies. (See: “Sold Out” http://www.wallstreetwatch.org/) This is not one party’s problem.
People could give in to cynicism, chuckle at the irony of financial reform being named after Barney Frank and Chris Dodd, stare in amazement at political candidates who claim to represent the “regular folks” yet are funded by those who exploit their ignorance of finance, shake their heads when government officials promote annuity sales as the basis for retirement planning, and marvel that so little has changed structurally in how investments are crafted, regulated and sold. But that would be a weak response, a concession not worthy of those who are aware of these problems and can potentially influence their successful resolution.
Eisenhower, too, could easily have succumbed to cynicism in his farewell message; however, his next paragraph admonished Americans to be more vigilant. He stated that,
“We must never let the weight of this combination endanger our liberties or democratic processes. We should take nothing for granted. Only an alert and knowledgeable citizenry can compel the proper meshing of the huge industrial and military machinery of defense with our peaceful methods and goals, so that security and liberty may prosper together.”
So let’s imagine for a moment that we share a similar goal with regards to the relationship between American society and financial services. What would it take for us to more effectively “compel the proper meshing of the huge (machinery of finance) with our peaceful methods and goals, so that security and liberty may prosper together?”
While the question deserves a more comprehensive review of cultural, regulatory, and operational changes, there are some low-hanging fruit that are ripe for the picking that do not necessarily require Washington’s acquiescence.
· Create much clearer and more restrictive policies regarding how past and present senior officers and directors of major banks, broker-dealers, and insurers can serve in positions of authority or influence at the Federal Reserve Bank, in the US Department of the Treasury, the OCC, FDIC, SEC, and other regulatory agencies or offices, state or federal. Obviously, these policies would need to flow both ways. The argument that their “talent” is invaluable has been sufficiently disproven by those who have crossed over previously and failed massively in their economic judgment if not their political adroitness. If enough voters express enough frustration when conflicted appointments are made, fewer will be made.
· Stem the consolidation of financial power in a few financial institutions that have become increasingly dependent on government largess to support their operations. Antitrust or banking regulators could carry this out; in the meantime, consumers decide where to conduct business.
· Support community banks and credit unions that are imbedded in the local community, are more likely to return profits to the community, support FDIC, and are of a more human scale.
· Eliminate the conflicted relationships between broker-dealers and money managers that materially increase costs to investors in a manner that lacks transparency. Rather than waiting for the SEC to take action, consumers can refuse to do business with conflicted professionals.
· Create a fiduciary standard for anyone involved in the manufacture, promotion, or distribution of financial products. That is, require that every financial professional in the supply chain of investment product creation and distribution demonstrates the highest ethical standards and always prioritizes the loyalty and care due to the end client, be it a retired couple, a pension plan, or a municipality. This does not mean that every investment must work perfectly, but that every investment product must be crafted and marketed with the intent of benefitting the end investor—even insurance products. We demand similar accountability in most other industries; finance is largely exempt.
· Reward politicians who refuse to accept money from financial corporations that do business in manner that is conflicted with the best interests of their customers.
Eisenhower’s words of warning resonated and surprised because he had tremendous credibility when it came to military matters. He was an insider. He had seen the evolution of the US military from 1941 to 1961 and—right or wrong—he did not like what he saw.
Financial Services lacks such a powerful figurehead. There is no one voice that can stand up in Washington DC with the credibility of an Eisenhower to warn against the corruption of finance and government. Because of that vacuum, it becomes all the more important that citizens, consumers, and voters of all persuasions express their sentiment in their actions to the best degree they can.
Pogo once said, “We have met the enemy and he is us.” What Pogo forgot to mention is that, “We have met our allies, and they are us, too.”
“This conjunction of an immense military establishment and a large arms industry is new in the American experience. The total influence -- economic, political, even spiritual -- is felt in every city, every State house, every office of the Federal government. We recognize the imperative need for this development. Yet we must not fail to comprehend its grave implications. Our toil, resources and livelihood are all involved; so is the very structure of our society.
In the councils of government, we must guard against the acquisition of unwarranted influence, whether sought or unsought, by the military industrial complex. The potential for the disastrous rise of misplaced power exists and will persist.”
While we lack the bully pulpit and gravitas of a departing president, we would like to issue a similar warning about our society’s changing relationship with financial services. We ask you to reread Eisenhower’s passage above, substituting “financial” wherever you see a reference to “military.” It would start, “This conjunction of an immense financial establishment and a large finance industry is new in the American experience. The total influence—economic, political, even spiritual—is felt in every city, every State house, every office of the Federal government…” And so on.
Is this overstating matters? Consider that the financial services industry spent over $5 billion on campaign contributions and lobbyists in the decade leading up to the financial crisis, that by 2007, nearly 3,000 lobbyists represented the industry in Washington, and that the cost of bailout, stimulus, TARP and other recent programs stands at over $3 trillion. From 1998-2008, campaign contributions from the financial sector rose by 185% to $443 million while lobby expenditures grew by 117% to $455 million. Meanwhile, the Standard and Poor 500 fell by 13%.
It is important for all Americans to acknowledge that the political contributions and policy missteps (deliberate or well-intentioned) occurred under both Democratic and Republican leadership reflecting the near-even split in political contributions from banks, securities firms and insurance companies. (See: “Sold Out” http://www.wallstreetwatch.org/) This is not one party’s problem.
People could give in to cynicism, chuckle at the irony of financial reform being named after Barney Frank and Chris Dodd, stare in amazement at political candidates who claim to represent the “regular folks” yet are funded by those who exploit their ignorance of finance, shake their heads when government officials promote annuity sales as the basis for retirement planning, and marvel that so little has changed structurally in how investments are crafted, regulated and sold. But that would be a weak response, a concession not worthy of those who are aware of these problems and can potentially influence their successful resolution.
Eisenhower, too, could easily have succumbed to cynicism in his farewell message; however, his next paragraph admonished Americans to be more vigilant. He stated that,
“We must never let the weight of this combination endanger our liberties or democratic processes. We should take nothing for granted. Only an alert and knowledgeable citizenry can compel the proper meshing of the huge industrial and military machinery of defense with our peaceful methods and goals, so that security and liberty may prosper together.”
So let’s imagine for a moment that we share a similar goal with regards to the relationship between American society and financial services. What would it take for us to more effectively “compel the proper meshing of the huge (machinery of finance) with our peaceful methods and goals, so that security and liberty may prosper together?”
While the question deserves a more comprehensive review of cultural, regulatory, and operational changes, there are some low-hanging fruit that are ripe for the picking that do not necessarily require Washington’s acquiescence.
· Create much clearer and more restrictive policies regarding how past and present senior officers and directors of major banks, broker-dealers, and insurers can serve in positions of authority or influence at the Federal Reserve Bank, in the US Department of the Treasury, the OCC, FDIC, SEC, and other regulatory agencies or offices, state or federal. Obviously, these policies would need to flow both ways. The argument that their “talent” is invaluable has been sufficiently disproven by those who have crossed over previously and failed massively in their economic judgment if not their political adroitness. If enough voters express enough frustration when conflicted appointments are made, fewer will be made.
· Stem the consolidation of financial power in a few financial institutions that have become increasingly dependent on government largess to support their operations. Antitrust or banking regulators could carry this out; in the meantime, consumers decide where to conduct business.
· Support community banks and credit unions that are imbedded in the local community, are more likely to return profits to the community, support FDIC, and are of a more human scale.
· Eliminate the conflicted relationships between broker-dealers and money managers that materially increase costs to investors in a manner that lacks transparency. Rather than waiting for the SEC to take action, consumers can refuse to do business with conflicted professionals.
· Create a fiduciary standard for anyone involved in the manufacture, promotion, or distribution of financial products. That is, require that every financial professional in the supply chain of investment product creation and distribution demonstrates the highest ethical standards and always prioritizes the loyalty and care due to the end client, be it a retired couple, a pension plan, or a municipality. This does not mean that every investment must work perfectly, but that every investment product must be crafted and marketed with the intent of benefitting the end investor—even insurance products. We demand similar accountability in most other industries; finance is largely exempt.
· Reward politicians who refuse to accept money from financial corporations that do business in manner that is conflicted with the best interests of their customers.
Eisenhower’s words of warning resonated and surprised because he had tremendous credibility when it came to military matters. He was an insider. He had seen the evolution of the US military from 1941 to 1961 and—right or wrong—he did not like what he saw.
Financial Services lacks such a powerful figurehead. There is no one voice that can stand up in Washington DC with the credibility of an Eisenhower to warn against the corruption of finance and government. Because of that vacuum, it becomes all the more important that citizens, consumers, and voters of all persuasions express their sentiment in their actions to the best degree they can.
Pogo once said, “We have met the enemy and he is us.” What Pogo forgot to mention is that, “We have met our allies, and they are us, too.”
Thursday, September 2, 2010
My Kingdom for a Treasurer!
In a literary reference often overlooked by high school English teachers, Shakespeare’s King Richard called out “A Treasurer! A Treasurer! My Kingdom for a Treasurer!” just moments before he lost his horse. Alas, he had neither reliable Treasurer nor brave horse and thus lost his kingdom. Let’s hope we do better.
In the coming months, voters around the country will select governors, senators, and congressmen. We will vote on controversial amendments and propositions. Further “down ballot” most of us will find elections for school boards, judges, university regents, attorneys general, and the little known and even lesser understood office of municipal treasurer.
Treasurers of municipal districts (states, cities, counties, etc.) are an underappreciated lot. Given their intense responsibilities, they also are under-scrutinized by voters and the media, and in too many cases under-qualified or under-resourced. Cynics might argue that the Treasurer’s office is nothing more than a political stepping stone to the greater glories of mayoralty or governorship or a chance to pocket some spare change from vendors of various stripes.
However, we believe that electing someone to serve as caretaker of the community’s purse is one of the most vital decisions voters can make and one worthy of the most thoughtful consideration. Syntrinsic has crafted a generic job posting for Municipal Treasurer in an effort to capture a sense of the arduous and often thankless task faced by the keepers of the purse strings.
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For Immediate Posting: Municipal Treasurer
The Municipality of [Insert locale here] seeks a Treasurer who possesses the judgment of King Solomon, the courage of King Arthur, the compassion of Mother Theresa, and the communication skills and media savvy of Oprah Winfrey.
Responsibilities
The following responsibilities are to be completed in full, without exception, every day, even during election cycles, with limited staff, without undue influence caused by partisanship, media hype, special interest pressure, kickbacks, traveling salesmen, or CNBC:
· Renegotiate unrealistic pension obligations made by previous administrations. Do so without causing taxpayer revolt, regional strikes, or municipal bankruptcy. Honor the sanctity of contracts while modifying them.
· Unwind illiquid derivative contracts with obscure counterparties without negatively impacting the balance sheet or attracting the attention of credit rating agencies, the press, voters, regulators, or former municipal employees whose jobs were cut to pay for the failed investments.
· Vet the fiscal health and ethical business practices of all financial institutions with whom the municipality does business, including custodians, bond issuers, credit providers, money fund issuers, bond traders, investment banks, broker-dealers, consultants, insurance underwriters, banks Pension Plan platforms, money managers, research providers, technology vendors, and other assorted financial partners.
· Assist in evaluating how the municipality can take on greater regulatory oversight for financial institutions and finance professionals within your jurisdiction, given changes in the national regulatory landscape.
· Improve education by cutting education spending. Stimulate the economy by raising taxes on businesses. Encourage employment by increasing the cost of hiring new employees. Identify other contradictions and address them with grace and composure.
· Predict the future.
Skills
Eligible candidates should be able to demonstrate the following skills and traits:
· Fearlessness
· A wonkish delight in policy balanced by a disdain for wonkishness
· Healthy skepticism
· Hope and faith
· The ability to make impossible choices
· The ability to make sure that no one blames you for the impossible choices you have made so that you can stay in office and make more of them
· The ability to travel to distant regions, meet new people, and persuade them to entrust you with their money
· Offend and inconvenience no one
· Persuade most everyone to share the burden and feel good about it
· Stay out of the press, but keep citizens informed
· Be transparent, but don’t cause a panic
· Make wise long-term decisions without the next election distracting you
· Raise money. (For yourself. It costs a lot to be a Treasurer these days.)
Final Consideration
For those uncertain if they might be suitable candidates, we have found that effective municipal Treasurers often have backgrounds as alchemists, nuclear weapons inspectors, HazMat crew chiefs, and Supreme Court justices. Mortals need not apply.
Please forward cover letter, resume, and glitzy promotional video to the address below. We will review your materials as soon as we can afford to rehire our elections staff. They were laid-off after one of our structured notes failed to protect the municipality’s principal. The lawyers tell us that the prospectus had said that might happen but…well, you know.
Attention: Candidates for Treasurer, State of Distress, One Long Road, Capital City, USA
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Friday, August 27, 2010
Giving Credit Where Credit Is Due
In 1985, a visitor to China strolling about Beijing or Shanghai could expect to see in a day perhaps 10-20 cars struggling to make their way through a phalanx of bicycles and streaming rivers of pedestrians. Now Beijing struggles with almost perpetual traffic jams involving tens of thousands of vehicles that may be stranded on the highway for days—even weeks.
Situations like this make statisticians salivate. How intriguing, they think, to understand these jams. Are they random? Are there causal factors that can be identified and even managed? In short, what is happening? We can’t help but ask similar questions, not about cars in China, but about leverage in America.
1. Why can’t we return to the stock market growth rates of the 1980s, 1990’s, and into 2007?
While we would like to think that stock market growth during those nearly 30 years was primarily due to productivity gains, technological innovation, and good ol’ American know-how, we think that much of that stock market growth was due to the massive increase in our country’s leverage at the exact same time. Heresy? Perhaps. But if we are correct, then investors need to rethink expectations for stocks going forward.
Chart I below compares the growth of the S&P 500 (large US company stocks) to the growth of Public Debt (Federal), Consumer Credit, and Mortgage Debt from January 1976 to June 2010. Syntrinsic has added a “Smoothed S&P 500” line that mitigates the volatility of the S&P from 1994 to the present, so we can better see the general S&P 500 trend excluding extreme market noise.
Source: Treasury Direct, Federal Reserve, Bureau of Economic Analysis
The Debt is almost perfectly correlated to the Smoothed S&P 500, with correlation between them of 0.99. It could be coincidence, but we think such a strong relationship indicates something more important. While there has been a lot of noise over the past 35 years (fall of USSR, emergence of internet, rise of China, rise and stagnation of Japan, NASDAQ bubble, 9/11, Iraq, Afghanistan, housing crisis, etc.), leverage is a prime suspect in driving stock market growth during this period.
Just to emphasize how much our country was increasing its use of borrowed money, during this period leverage grew at a rate of 4.8 times the concurrent rate of inflation.
Based on the relative growth of Debt and the S&P 500 during this period, the Debt could be responsible for 50 - 60% of the stock market’s increase. If we were to factor in growth in municipal and corporate debt, the role of leverage would be dramatically higher.
2. But wasn’t our strong stock market of 1981-2007 due more to robust domestic growth than to leverage?
We wish that it were so; however, we think that domestic growth had a less significant impact than the increase in leverage. Chart II below compares the growth of the S&P 500 to the growth of America’s Gross Domestic Product (“GDP”). GDP is an imperfect measure of the economy, but it is the most comprehensive imperfect measure we have. Importantly, it includes much of the growth due to the increase in real estate values.
As with leverage, the smoothed stock market grew as GDP grew with a correlation of 0.99, (remember, perfect correlation is 1.00). However, the stock market grew 3.7 times faster than GDP grew during that period. Accepting that the correlation metric means something, then it would seem GDP is responsible for about 25% of the stock market’s growth. When we factor in the erosive effect of inflation, then the GDP growth rate falls to about 2.5% per year and GDP’s role in stock market growth drops below 10%.
The information below summarizes the annualized returns of these measures. Note that the sum of the annualized growth of Real GDP (Nominal GDP less CPI) and Public, Consumer, Mortgage Debt is quite close to the annualized growth of the S&P 500 (11.41% v. 10.66% per year); unfortunately, Debt represents over 78% of that sum.
Annualized Growth (Jan 1976 – June 2010)
S&P 500 = 10.66%
Public, Consumer, Mortgage Debt = 8.91%
Nominal GDP Growth = 6.55%
Inflation (CPI) = 4.05%
3. But aren’t we in a Great Deleveraging?
Nearly two years ago we wrote that we were in the midst of a Great Deleveraging, that it was time to rise up and spend down our lavish ways, unwind our collective exposure, and get back to basics—or something like that. Indeed, consumers have stopped increasing our leverage. Since the end of 2007, consumer credit has been stalled out at around $2.5 Trillion and Mortgage Debt has been stuck at about $14.5Trillion.
However, since December 2007 we have grown our country’s Public Debt from $9.2 to $13.2 Trillion, thus increasing the sum of our Public, Consumer and Mortgage debt from $26.3 Trillion at the end of 2007 to just shy of $30 Trillion as of June 2010. In short, we are not in a Great Deleveraging.
4. But if we are continuing to increase our leverage, then why is the stock market still about 25% below where it was in October 2007?
There are many reasons, but let’s consider investor sentiment and the how our leverage has been growing. Assume that 2008 was a shock to most investors and that people generally become more wary of the role of leverage. Certainly, there emerged for many an appreciation for the critical role that consumer credit and mortgage credit had played in America’s historically robust growth during this period.
But that is not the kind of debt we have been increasing; we have only been increasing our public debt. Increasing public debt at such massive levels has been sparking worry and fear, not consumer or investor confidence. Whether you embrace Keynes or Hayek, and whether or not you think the investing public is intelligent, investors are signaling their generalized anxiety about the potential affect of borrowing and printing more money. Thus, unless something enables consumer or mortgage borrowing to reengage, it is hard to see what would cause the market to rise materially.
Soon after news of Beijing’s traffic jam hit the international press, China’s state controlled media reported that the massive gridlock had mysteriously disappeared. Headline changed—problem (apparently) solved. Ah, that it would be so easy to solve an intractable transportation problem or to address our economic challenges. But just as the Chinese must at some point face up to a legacy of poor urban planning, corrupt officials, and a dishonest media, we in America must at some point look at our economy with more realistic eyes and not fool ourselves into believing in past economic glories or some sort of perpetual economic superiority.
It’s difficult to realize that what we had thought was a golden age economically was perhaps just a period of decent growth consistent with historic norms but juiced by leverage. But that realization should serve us better going forward than pretending otherwise.
Situations like this make statisticians salivate. How intriguing, they think, to understand these jams. Are they random? Are there causal factors that can be identified and even managed? In short, what is happening? We can’t help but ask similar questions, not about cars in China, but about leverage in America.
1. Why can’t we return to the stock market growth rates of the 1980s, 1990’s, and into 2007?
While we would like to think that stock market growth during those nearly 30 years was primarily due to productivity gains, technological innovation, and good ol’ American know-how, we think that much of that stock market growth was due to the massive increase in our country’s leverage at the exact same time. Heresy? Perhaps. But if we are correct, then investors need to rethink expectations for stocks going forward.
Chart I below compares the growth of the S&P 500 (large US company stocks) to the growth of Public Debt (Federal), Consumer Credit, and Mortgage Debt from January 1976 to June 2010. Syntrinsic has added a “Smoothed S&P 500” line that mitigates the volatility of the S&P from 1994 to the present, so we can better see the general S&P 500 trend excluding extreme market noise.
Source: Treasury Direct, Federal Reserve, Bureau of Economic Analysis
The Debt is almost perfectly correlated to the Smoothed S&P 500, with correlation between them of 0.99. It could be coincidence, but we think such a strong relationship indicates something more important. While there has been a lot of noise over the past 35 years (fall of USSR, emergence of internet, rise of China, rise and stagnation of Japan, NASDAQ bubble, 9/11, Iraq, Afghanistan, housing crisis, etc.), leverage is a prime suspect in driving stock market growth during this period.
Just to emphasize how much our country was increasing its use of borrowed money, during this period leverage grew at a rate of 4.8 times the concurrent rate of inflation.
Based on the relative growth of Debt and the S&P 500 during this period, the Debt could be responsible for 50 - 60% of the stock market’s increase. If we were to factor in growth in municipal and corporate debt, the role of leverage would be dramatically higher.
2. But wasn’t our strong stock market of 1981-2007 due more to robust domestic growth than to leverage?
We wish that it were so; however, we think that domestic growth had a less significant impact than the increase in leverage. Chart II below compares the growth of the S&P 500 to the growth of America’s Gross Domestic Product (“GDP”). GDP is an imperfect measure of the economy, but it is the most comprehensive imperfect measure we have. Importantly, it includes much of the growth due to the increase in real estate values.
As with leverage, the smoothed stock market grew as GDP grew with a correlation of 0.99, (remember, perfect correlation is 1.00). However, the stock market grew 3.7 times faster than GDP grew during that period. Accepting that the correlation metric means something, then it would seem GDP is responsible for about 25% of the stock market’s growth. When we factor in the erosive effect of inflation, then the GDP growth rate falls to about 2.5% per year and GDP’s role in stock market growth drops below 10%.
The information below summarizes the annualized returns of these measures. Note that the sum of the annualized growth of Real GDP (Nominal GDP less CPI) and Public, Consumer, Mortgage Debt is quite close to the annualized growth of the S&P 500 (11.41% v. 10.66% per year); unfortunately, Debt represents over 78% of that sum.
Annualized Growth (Jan 1976 – June 2010)
S&P 500 = 10.66%
Public, Consumer, Mortgage Debt = 8.91%
Nominal GDP Growth = 6.55%
Inflation (CPI) = 4.05%
3. But aren’t we in a Great Deleveraging?
Nearly two years ago we wrote that we were in the midst of a Great Deleveraging, that it was time to rise up and spend down our lavish ways, unwind our collective exposure, and get back to basics—or something like that. Indeed, consumers have stopped increasing our leverage. Since the end of 2007, consumer credit has been stalled out at around $2.5 Trillion and Mortgage Debt has been stuck at about $14.5Trillion.
However, since December 2007 we have grown our country’s Public Debt from $9.2 to $13.2 Trillion, thus increasing the sum of our Public, Consumer and Mortgage debt from $26.3 Trillion at the end of 2007 to just shy of $30 Trillion as of June 2010. In short, we are not in a Great Deleveraging.
4. But if we are continuing to increase our leverage, then why is the stock market still about 25% below where it was in October 2007?
There are many reasons, but let’s consider investor sentiment and the how our leverage has been growing. Assume that 2008 was a shock to most investors and that people generally become more wary of the role of leverage. Certainly, there emerged for many an appreciation for the critical role that consumer credit and mortgage credit had played in America’s historically robust growth during this period.
But that is not the kind of debt we have been increasing; we have only been increasing our public debt. Increasing public debt at such massive levels has been sparking worry and fear, not consumer or investor confidence. Whether you embrace Keynes or Hayek, and whether or not you think the investing public is intelligent, investors are signaling their generalized anxiety about the potential affect of borrowing and printing more money. Thus, unless something enables consumer or mortgage borrowing to reengage, it is hard to see what would cause the market to rise materially.
Soon after news of Beijing’s traffic jam hit the international press, China’s state controlled media reported that the massive gridlock had mysteriously disappeared. Headline changed—problem (apparently) solved. Ah, that it would be so easy to solve an intractable transportation problem or to address our economic challenges. But just as the Chinese must at some point face up to a legacy of poor urban planning, corrupt officials, and a dishonest media, we in America must at some point look at our economy with more realistic eyes and not fool ourselves into believing in past economic glories or some sort of perpetual economic superiority.
It’s difficult to realize that what we had thought was a golden age economically was perhaps just a period of decent growth consistent with historic norms but juiced by leverage. But that realization should serve us better going forward than pretending otherwise.
Sunday, August 22, 2010
Creating Something Better
A few weeks ago, political commentator and former Reagan speechwriter, Peggy Noonan, joined the chorus of those questioning whether the current generation leading America will leave America’s children something better. In her August 7, 2010 Wall Street Journal column, Noonan writes,
“The biggest political change in my lifetime is that Americans no longer assume that their children will have it better than they did. This is a huge break with the past, with assumptions and traditions that shaped us…The country I was born into was a country that had existed steadily, for almost two centuries, as a nation in which everyone thought—wherever they were from, whatever their circumstances—that their children would have better lives than they did. That was what kept people pulling their boots on in the morning after the first weary pause: My kids will have it better. They'll be richer or more educated, they'll have a better job or a better house, they'll take a step up in terms of rank, class or status…Parents now fear something has stopped…they look around, follow the political stories and debates, and deep down they think their children will live in a more limited country, that jobs won't be made at a great enough pace, that taxes—too many people in the cart, not enough pulling it—will dishearten them, that the effects of 30 years of a low, sad culture will leave the whole country messed up.”
But we have to ask, “Is it true? Has every American generation been confident that they were creating something better for their children? Is America a country that, as Noonan says, has existed steadily? One in which everyone thought their children would have better lives than they did?”
Consider a few major inflection points in American life and whether this intergenerational ethic was as clear and present to those who experienced them as they may appear in our historical mythology.
The American Revolution
America’s very founding revealed a country divided. Roughly one-third of the colonists were Tory supporters of England, one-third were what modern pollsters call “undecided,” and just one-third earned the title of rebel, whether given as compliment or pejorative. There was no consensus that one generation was leaving a better world for the next. That uncertainty was exacerbated—not settled—by Britain’s surrender.
The Civil War
Imagine yourself in the 1850s as the country spiraled ever closer to succession and war over the expansion of slavery. Regardless of one’s politics or geography, it is hard to imagine that either unionists or secessionists were certain they were leading their children down a path to a better country. And during the War itself, people’s confidence in America was shaken by the sheer scale of loss of life, disease and injury, destruction of whole cities, hunger, and fear that America and its ideals were disintegrating.
The Long Depression
The post Civil War Depression of the 1870’s was the worst America had seen in length and depth. Throughout the US and Europe, people were still reeling from devastating wars and economic collapse marked my deflation and bank failures. There were no formal safety nets, no pension plans, and only modest social and civil protections. By the panic of 1873, Americans had been living with a good 20 years of fear, uncertainty, war, and social turmoil. Little was certain, not least the future.
World War I
America’s “doughboys” were fighting a war that few felt would create a better world? The War was largely one of attrition marked more by new technologies of unprecedented brutality than by any sense of social or political accomplishment. The doughboys returned to a country that was not prepared to employ them, help them heal, or otherwise honor their service. Not America’s finest moment, and hardly a time of inspiring confidence in the future for the veterans or their children.
The Great Depression
The generation leading America through the 1930s faced much greater economic, social, and political turmoil than we do today and with far fewer resources for addressing those challenges. Were they confident that their children would be better off? Was America for them “steady?” If we think we are “disheartened” today, imagine how they must have felt.
World War II
Americans confronted global totalitarianism, the physical destruction of Europe, death camps, mass famine, casualties counted in the tens of millions. Our home front was divided far more than our selective and romantic memories recall. The outcome of the War was highly uncertain when America entered, our military was woefully underprepared. Parents sent their children into battle unclear whether the world would be better for it—hoping perhaps, but far from certain. They became what some call “The Greatest Generation” but no one knew that at the time.
This list is not comprehensive, nor does it come close to fully conveying the tremendous uncertainty with which Americans have lived since before this country was founded. But it serves as a good reminder, a grounding, a context for examining our current economic, political, and social challenges in a more realistic manner. We are not as bad off as the persistent social buzz might indicate.
For what has bound America over the years is not the constant assurance that one generation is creating a better world for the next generation; rather, it is the constant aspiration to create a better world. The distinction may seem subtle, but it is everything. We can never KNOW that our children will have it better, but heaven help us if we give up wanting it that way.
America has been about moving forward despite adverse conditions to raise loving families, start important businesses, build new friendships and communities, develop new technologies, build houses of worship, and expand the definition of freedom and human rights. America has never been constant or steady in the challenges it has faced. It has however, found over and over its core, its center, its commitment to persisting anyways in the desire to create a better world.
As always, the elements that have made America great are under tremendous pressure. When things are difficult as they so often are, it is natural that some would cry for more government regulation and control, and some for closed borders. At times like this, people look for scapegoats in immigrants, political opponents, and those from other cultures and religions. It is to be expected that some will lose hope and think that we as a country are lost—such despair is also a constant in American life.
However, we have more tools at our disposal than previous generations, far greater resources, better social support networks, more innovative technology, more accurate information, and most importantly, the wisdom gained from the experience of previous generations. America has not lost or forgotten something; we are simply struggling to recall what we already know and put it to action.
On this anniversary of the founding of our company, we move forward with great anticipation. Our lives have been greatly blessed by the generations before us who sacrificed, worked, thought, risked, persisted, and created. We expect our children—and theirs—to be able to say the same.
“The biggest political change in my lifetime is that Americans no longer assume that their children will have it better than they did. This is a huge break with the past, with assumptions and traditions that shaped us…The country I was born into was a country that had existed steadily, for almost two centuries, as a nation in which everyone thought—wherever they were from, whatever their circumstances—that their children would have better lives than they did. That was what kept people pulling their boots on in the morning after the first weary pause: My kids will have it better. They'll be richer or more educated, they'll have a better job or a better house, they'll take a step up in terms of rank, class or status…Parents now fear something has stopped…they look around, follow the political stories and debates, and deep down they think their children will live in a more limited country, that jobs won't be made at a great enough pace, that taxes—too many people in the cart, not enough pulling it—will dishearten them, that the effects of 30 years of a low, sad culture will leave the whole country messed up.”
But we have to ask, “Is it true? Has every American generation been confident that they were creating something better for their children? Is America a country that, as Noonan says, has existed steadily? One in which everyone thought their children would have better lives than they did?”
Consider a few major inflection points in American life and whether this intergenerational ethic was as clear and present to those who experienced them as they may appear in our historical mythology.
The American Revolution
America’s very founding revealed a country divided. Roughly one-third of the colonists were Tory supporters of England, one-third were what modern pollsters call “undecided,” and just one-third earned the title of rebel, whether given as compliment or pejorative. There was no consensus that one generation was leaving a better world for the next. That uncertainty was exacerbated—not settled—by Britain’s surrender.
The Civil War
Imagine yourself in the 1850s as the country spiraled ever closer to succession and war over the expansion of slavery. Regardless of one’s politics or geography, it is hard to imagine that either unionists or secessionists were certain they were leading their children down a path to a better country. And during the War itself, people’s confidence in America was shaken by the sheer scale of loss of life, disease and injury, destruction of whole cities, hunger, and fear that America and its ideals were disintegrating.
The Long Depression
The post Civil War Depression of the 1870’s was the worst America had seen in length and depth. Throughout the US and Europe, people were still reeling from devastating wars and economic collapse marked my deflation and bank failures. There were no formal safety nets, no pension plans, and only modest social and civil protections. By the panic of 1873, Americans had been living with a good 20 years of fear, uncertainty, war, and social turmoil. Little was certain, not least the future.
World War I
America’s “doughboys” were fighting a war that few felt would create a better world? The War was largely one of attrition marked more by new technologies of unprecedented brutality than by any sense of social or political accomplishment. The doughboys returned to a country that was not prepared to employ them, help them heal, or otherwise honor their service. Not America’s finest moment, and hardly a time of inspiring confidence in the future for the veterans or their children.
The Great Depression
The generation leading America through the 1930s faced much greater economic, social, and political turmoil than we do today and with far fewer resources for addressing those challenges. Were they confident that their children would be better off? Was America for them “steady?” If we think we are “disheartened” today, imagine how they must have felt.
World War II
Americans confronted global totalitarianism, the physical destruction of Europe, death camps, mass famine, casualties counted in the tens of millions. Our home front was divided far more than our selective and romantic memories recall. The outcome of the War was highly uncertain when America entered, our military was woefully underprepared. Parents sent their children into battle unclear whether the world would be better for it—hoping perhaps, but far from certain. They became what some call “The Greatest Generation” but no one knew that at the time.
This list is not comprehensive, nor does it come close to fully conveying the tremendous uncertainty with which Americans have lived since before this country was founded. But it serves as a good reminder, a grounding, a context for examining our current economic, political, and social challenges in a more realistic manner. We are not as bad off as the persistent social buzz might indicate.
For what has bound America over the years is not the constant assurance that one generation is creating a better world for the next generation; rather, it is the constant aspiration to create a better world. The distinction may seem subtle, but it is everything. We can never KNOW that our children will have it better, but heaven help us if we give up wanting it that way.
America has been about moving forward despite adverse conditions to raise loving families, start important businesses, build new friendships and communities, develop new technologies, build houses of worship, and expand the definition of freedom and human rights. America has never been constant or steady in the challenges it has faced. It has however, found over and over its core, its center, its commitment to persisting anyways in the desire to create a better world.
As always, the elements that have made America great are under tremendous pressure. When things are difficult as they so often are, it is natural that some would cry for more government regulation and control, and some for closed borders. At times like this, people look for scapegoats in immigrants, political opponents, and those from other cultures and religions. It is to be expected that some will lose hope and think that we as a country are lost—such despair is also a constant in American life.
However, we have more tools at our disposal than previous generations, far greater resources, better social support networks, more innovative technology, more accurate information, and most importantly, the wisdom gained from the experience of previous generations. America has not lost or forgotten something; we are simply struggling to recall what we already know and put it to action.
On this anniversary of the founding of our company, we move forward with great anticipation. Our lives have been greatly blessed by the generations before us who sacrificed, worked, thought, risked, persisted, and created. We expect our children—and theirs—to be able to say the same.
Thursday, August 5, 2010
Our Modern Age of Exploration
In 1914, toward the end of the Age of Exploration, former US President, Colonel Theodore Roosevelt and famed Brazilian scientist and explorer, Colonel Candido Rondon, led a team of naturalists and camaradas (workers) on an expedition to be the first to map and explore the Rio da Duvida, the Amazon’s River of Doubt.
Their team had no idea of what they might encounter on their adventure. Almost all were capable and almost all had investigated other parts of the Amazon; none had explored this particular river. They had no way to know its course, speed or the nature of the hazards that they might encounter. It may be hard to imagine in our world of GPS that in 1914 (just 96 years ago!) a thousand-mile long river did not exist on any map and was essentially unknown to all except the small number of native clans that lived along its shore, people who had had no contact with the outside world.
Consider some uncertainties they faced:
· What type of boat(s) does one take down an unexplored river? Shallow draft or deep? Heavy or light? Wood, canvas, or metal? What is the ideal length? How should they be powered? How many such boats should be brought?
· What food does one bring and how much on a journey that could last two months, six months or more? Can one rely on hunting or fishing along the way? Since any food must be carried and stored and potentially cooked, and knowing that starvation had claimed the lives of many explorers, how does one prepare accordingly?
· What kinds of people should be included in the team? What traits and skills are needed? What if your one doctor falls ill? Your one naturalist? When do you decide that team member is unfit for the journey? Who decides and what is done about it?
The Commission consisted of a band of smart, courageous adventurers who already had proven their mettle in difficult circumstances around the globe. They knew that they were embarking on a journey of great uncertainty and were hoping that their experience, skill, and will power would enable them to make it through safely and successfully.
But the most powerful character in the adventure and the greatest variable of all was the course and behavior of the river itself. It was completely unknown. Every bend meant a new possibility, each whirlpool or eddy could mean intense danger or nothing at all. Each rapid had the ability to shoot the explorers forward or dash their boats and hopes to pieces. The river—inspiration for such a grand undertaking—could easily have brought about the death of those so inspired.
In Candice Millard’s book, Theodore Roosevelt’s Darkest Journey: The River of Doubt, the author describes various characters gradually accepting or at least being challenged to consider that their past experiences, common sense, and abilities were not necessarily enough to see them through, that they might not complete this journey, that for all their planning and thoughtfulness, they may not succeed and may in fact die on what had started as a rather straight-forward adventure.
The river represented the great unknown. One could wonder whether we more modern Westerners are comfortable with the notion that there are places as yet unmapped. With our quick and easy access to information of both superficial and in-depth nature, and with a rather glib confidence in and reliance upon our technology and analytic skills, perhaps we have grown accustomed to imagining that we can place ourselves at any point in time and place and understand what to do next.
Maybe that is why the political airwaves in this decisive year are filled with soaring—and often patronizing—rhetoric about the economy and other matters. Politicians, analysts, economists, and other commentators have been impassioned in their claims that they know exactly what to do about just about everything, from health care and financial reform to containing Iran and North Korea (not to mention China and Russia), from energy policy to immigration policy to stimulating economic growth.
Col. Rondon knew and demonstrated as he led the Commission down the River of Doubt that a lack of humility about our knowledge is frightening, that blind certainty represents a person’s or a society’s greatest potential weakness. He was as confident and brave as anyone in his position could be in part because he was willing to admit that there were risks he did not understand and was thus not willing to take or ask others to take.
Productive doubt is good. It causes us to give pause, to think more deeply, more carefully, to see things with less ego clouding our judgment so that we can better perceive the variables on the periphery that might be terribly important and yet easily overlooked by decision-makers who think they already know all that there is to be known. Doubt that leads to paralysis is not helpful, but doubt that leads to more deliberate planning can be a welcome friend.
In some respects the Age of Exploration is over. And yet in other ways it is never over, for the world has never been here before, never before experienced this convergence of political, social, technological, economic and environmental conditions. Our path forward is just as uncertain and unknown as the River of Doubt was to Roosevelt, Rondon and their men; thus, our path forward requires that we ask questions they faced as well. How will we move down our river? What supplies do we need along the way? And what types of people are required to make the journey successful? Whether we like it or not, we are on a grand adventure together, one fraught with danger and with great potential to learn about our world and make better sense of it. With good care, it could be quite a journey.
Their team had no idea of what they might encounter on their adventure. Almost all were capable and almost all had investigated other parts of the Amazon; none had explored this particular river. They had no way to know its course, speed or the nature of the hazards that they might encounter. It may be hard to imagine in our world of GPS that in 1914 (just 96 years ago!) a thousand-mile long river did not exist on any map and was essentially unknown to all except the small number of native clans that lived along its shore, people who had had no contact with the outside world.
Consider some uncertainties they faced:
· What type of boat(s) does one take down an unexplored river? Shallow draft or deep? Heavy or light? Wood, canvas, or metal? What is the ideal length? How should they be powered? How many such boats should be brought?
· What food does one bring and how much on a journey that could last two months, six months or more? Can one rely on hunting or fishing along the way? Since any food must be carried and stored and potentially cooked, and knowing that starvation had claimed the lives of many explorers, how does one prepare accordingly?
· What kinds of people should be included in the team? What traits and skills are needed? What if your one doctor falls ill? Your one naturalist? When do you decide that team member is unfit for the journey? Who decides and what is done about it?
The Commission consisted of a band of smart, courageous adventurers who already had proven their mettle in difficult circumstances around the globe. They knew that they were embarking on a journey of great uncertainty and were hoping that their experience, skill, and will power would enable them to make it through safely and successfully.
But the most powerful character in the adventure and the greatest variable of all was the course and behavior of the river itself. It was completely unknown. Every bend meant a new possibility, each whirlpool or eddy could mean intense danger or nothing at all. Each rapid had the ability to shoot the explorers forward or dash their boats and hopes to pieces. The river—inspiration for such a grand undertaking—could easily have brought about the death of those so inspired.
In Candice Millard’s book, Theodore Roosevelt’s Darkest Journey: The River of Doubt, the author describes various characters gradually accepting or at least being challenged to consider that their past experiences, common sense, and abilities were not necessarily enough to see them through, that they might not complete this journey, that for all their planning and thoughtfulness, they may not succeed and may in fact die on what had started as a rather straight-forward adventure.
The river represented the great unknown. One could wonder whether we more modern Westerners are comfortable with the notion that there are places as yet unmapped. With our quick and easy access to information of both superficial and in-depth nature, and with a rather glib confidence in and reliance upon our technology and analytic skills, perhaps we have grown accustomed to imagining that we can place ourselves at any point in time and place and understand what to do next.
Maybe that is why the political airwaves in this decisive year are filled with soaring—and often patronizing—rhetoric about the economy and other matters. Politicians, analysts, economists, and other commentators have been impassioned in their claims that they know exactly what to do about just about everything, from health care and financial reform to containing Iran and North Korea (not to mention China and Russia), from energy policy to immigration policy to stimulating economic growth.
Col. Rondon knew and demonstrated as he led the Commission down the River of Doubt that a lack of humility about our knowledge is frightening, that blind certainty represents a person’s or a society’s greatest potential weakness. He was as confident and brave as anyone in his position could be in part because he was willing to admit that there were risks he did not understand and was thus not willing to take or ask others to take.
Productive doubt is good. It causes us to give pause, to think more deeply, more carefully, to see things with less ego clouding our judgment so that we can better perceive the variables on the periphery that might be terribly important and yet easily overlooked by decision-makers who think they already know all that there is to be known. Doubt that leads to paralysis is not helpful, but doubt that leads to more deliberate planning can be a welcome friend.
In some respects the Age of Exploration is over. And yet in other ways it is never over, for the world has never been here before, never before experienced this convergence of political, social, technological, economic and environmental conditions. Our path forward is just as uncertain and unknown as the River of Doubt was to Roosevelt, Rondon and their men; thus, our path forward requires that we ask questions they faced as well. How will we move down our river? What supplies do we need along the way? And what types of people are required to make the journey successful? Whether we like it or not, we are on a grand adventure together, one fraught with danger and with great potential to learn about our world and make better sense of it. With good care, it could be quite a journey.
Thursday, July 29, 2010
No Nonprofit is an Island
While Catholic theologian, Thomas Merton, long argued that “no man is an island,” many of us retreat into a relatively solitary world when life becomes most difficult. For some, the isolation is a way of dealing with insecurity or shame, for others it reflects a fear that no one else cares or can understand, while still others figure that they can best rely upon themselves to solve their problems. And of course, when facing tremendous obstacles, sometimes we simply cannot see outside of ourselves very well to seek the help we need or to identify the help that might already be waiting.
Organizations are no different. Small businesses and large corporations alike can become strikingly insular under pressure. The times when they most need to look outside for guidance, financing, or other support can easily become the times when barricades go up, trust disappears, and people turn on each other instead of to each other.
Given their community orientation, collective spirit, and life affirming missions, it may seem ironic that nonprofit organizations face similar challenges. Layoffs, budget cuts, uncertain and declining revenues, and higher demand for services make the equation particularly challenging for nonprofit boards and staffs. Whether leading human service organizations, health care facilities, houses of worship, educational institutions, environmental organizations, museums, or other mission-driven organizations, nonprofit officers and executives often feel much like they are stranded on an island when the storms of economic crisis are looming.
Recognizing that many nonprofit organizations face business challenges on a scale and frequency they have never before experienced, and realizing that it can be difficult to access perspectives from peers in different industries or geographic regions, we thought it might be helpful to identify patterns we have witnessed across nonprofit organizations throughout the nation across size and sectors.
1. Executive turnover is higher than in the past.
We have seen more nonprofit executive (CEO, CFO, Executive Director) turnover in the past nine months than in the previous 10 years combined. The causes are as varied as the people and the organizations. Some executives have completed their main objectives at one organization and simply are ready for new challenges. Others have left organizations going through internal structural realignment designed to increase margins, efficiency, profitability, effectiveness, skill sets, etc. We have seen organizations change leaders as a result of clarifying their missions and others change leaders because they are not sure of their mission. Some leaders have moved on simply because the work is terribly demanding and they need a break. And of course, we have witnessed leaders move on because they lacked the aptitude or value system required. Whatever the reason, there’s change amongst executives is occurring on a massive scale throughout the country.
2. Revenues are more uncertain and for different reasons than in the past.
Many organizations that rely primarily on private donations and/or corporate sponsorships are facing the reality that their private and corporate donors live in a highly uncertain world, one buffeted by questions about tax policy (e.g. Estate tax? Charitable deductions?) as well as radically reduced donor liquidity and net worth. Organizations that rely on federal, state or local reimbursements are in a tremendous quandary as they deliver (and pay for) services for which they may not be reimbursed in a timely manner or in the amount committed by the associated municipality. And many faith based organizations—a final safety net in many communities—cannot rely on the revenues contributed previously. When someone who tithed 10% of their income (and yes, there are many who do so), becomes one of many congregants who needs financial support while looking for a job, then the financial model in many faith-based communities falters. There are numerous churches facing bankruptcy; that is not normal.
3. Mission matters more than it did before.
A nonprofit that is not sure about its mission or cannot clearly articulate its mission likely will not endure this period in history. Some organizations are reinventing themselves despite successful work over the past 20, 50, or even more years. They have to. The landscape has changed, the way that society identifies and addresses problems has changed, the way that people communicate has changed. Meanwhile, other organizations are getting back to their roots, honing in on their core competencies and cutting back on non-core initiatives that seemed logical when times were more flush and the competition for dollars less intense. Whether missions are newly revised or thoughtfully reaffirmed, organizations that can express their relevance have a much better chance of achieving sustainability.
4. Financial stewardship is a higher priority and more creative than in the past.
Most nonprofit organizations are accustomed to doing more with less, running lean, and relying on the generosity not just of donors, but also of staff willing to earn less than they might in for profit ventures. Thus, some behavior we have witnessed recently is simply prudent budget management. But we also are seeing more intense integration of financial planning into the broader strategic vision of many nonprofit organizations. Five year planning is receiving more serious consideration than in the past, with more conservative revenue estimates and more realistic cost estimates. Spending models for endowments and supporting foundations are using more conservative spending assumptions, reduced return assumptions, and making allowances for potential emergency draws. Organizations are analyzing their illiquid assets such as buildings and land to evaluate if they can provide liquidity to support operations and special projects. And like the rest of the world, many nonprofits are doing whatever they can to deleverage, that is to pay down their debt and reduce or eliminate their current debt service.
5. Board leadership is essential.
It surprises us how many excellent nonprofit organizations with strong track records of effective service have relatively weak or at least inconsistent Board leadership. In a decent economy, an organization can limp along without good governance; in an economy like the current one, a lack of effective leadership signals the beginning of the end. Look back over this list—every item on it requires courageous, attentive and skillful Board-level guidance. This item can be a hard one to admit, but believe us, many organizations are trying to figure out this challenge without letting the world know that their Boards are not all they can be.
Nothing mentioned herein is radical. Yet for each nonprofit organization, these may well be life or death challenges; at the very least, they compel a level of soul searching that many officers and directors have not previously faced. And as our nonprofit organizations examine themselves, they echo the self-reflection going on throughout America and around much of the world. Yet because many of these organizations serve as a mainstay of our civil society, because they represent a key ingredient in making capitalism more compassionate, democracy more participatory, and society more sustainable, it is vital that on the whole they are successful in addressing these challenges.
We know our audience, and many if not most of our readers are actively engaged in addressing these concerns as professionals and volunteers. But there is a great deal of leadership needed throughout our communities to address these concerns and there are people who are isolated now who have tremendous gifts to offer and service to provide. Even Merton, who practiced the relatively solitary life of a Trappist Monk, created ways to reach out and connect with others in an effort to effect social change. Let’s find those whom are not yet connected to community and invite them to join us. There’s work to be done.
Organizations are no different. Small businesses and large corporations alike can become strikingly insular under pressure. The times when they most need to look outside for guidance, financing, or other support can easily become the times when barricades go up, trust disappears, and people turn on each other instead of to each other.
Given their community orientation, collective spirit, and life affirming missions, it may seem ironic that nonprofit organizations face similar challenges. Layoffs, budget cuts, uncertain and declining revenues, and higher demand for services make the equation particularly challenging for nonprofit boards and staffs. Whether leading human service organizations, health care facilities, houses of worship, educational institutions, environmental organizations, museums, or other mission-driven organizations, nonprofit officers and executives often feel much like they are stranded on an island when the storms of economic crisis are looming.
Recognizing that many nonprofit organizations face business challenges on a scale and frequency they have never before experienced, and realizing that it can be difficult to access perspectives from peers in different industries or geographic regions, we thought it might be helpful to identify patterns we have witnessed across nonprofit organizations throughout the nation across size and sectors.
1. Executive turnover is higher than in the past.
We have seen more nonprofit executive (CEO, CFO, Executive Director) turnover in the past nine months than in the previous 10 years combined. The causes are as varied as the people and the organizations. Some executives have completed their main objectives at one organization and simply are ready for new challenges. Others have left organizations going through internal structural realignment designed to increase margins, efficiency, profitability, effectiveness, skill sets, etc. We have seen organizations change leaders as a result of clarifying their missions and others change leaders because they are not sure of their mission. Some leaders have moved on simply because the work is terribly demanding and they need a break. And of course, we have witnessed leaders move on because they lacked the aptitude or value system required. Whatever the reason, there’s change amongst executives is occurring on a massive scale throughout the country.
2. Revenues are more uncertain and for different reasons than in the past.
Many organizations that rely primarily on private donations and/or corporate sponsorships are facing the reality that their private and corporate donors live in a highly uncertain world, one buffeted by questions about tax policy (e.g. Estate tax? Charitable deductions?) as well as radically reduced donor liquidity and net worth. Organizations that rely on federal, state or local reimbursements are in a tremendous quandary as they deliver (and pay for) services for which they may not be reimbursed in a timely manner or in the amount committed by the associated municipality. And many faith based organizations—a final safety net in many communities—cannot rely on the revenues contributed previously. When someone who tithed 10% of their income (and yes, there are many who do so), becomes one of many congregants who needs financial support while looking for a job, then the financial model in many faith-based communities falters. There are numerous churches facing bankruptcy; that is not normal.
3. Mission matters more than it did before.
A nonprofit that is not sure about its mission or cannot clearly articulate its mission likely will not endure this period in history. Some organizations are reinventing themselves despite successful work over the past 20, 50, or even more years. They have to. The landscape has changed, the way that society identifies and addresses problems has changed, the way that people communicate has changed. Meanwhile, other organizations are getting back to their roots, honing in on their core competencies and cutting back on non-core initiatives that seemed logical when times were more flush and the competition for dollars less intense. Whether missions are newly revised or thoughtfully reaffirmed, organizations that can express their relevance have a much better chance of achieving sustainability.
4. Financial stewardship is a higher priority and more creative than in the past.
Most nonprofit organizations are accustomed to doing more with less, running lean, and relying on the generosity not just of donors, but also of staff willing to earn less than they might in for profit ventures. Thus, some behavior we have witnessed recently is simply prudent budget management. But we also are seeing more intense integration of financial planning into the broader strategic vision of many nonprofit organizations. Five year planning is receiving more serious consideration than in the past, with more conservative revenue estimates and more realistic cost estimates. Spending models for endowments and supporting foundations are using more conservative spending assumptions, reduced return assumptions, and making allowances for potential emergency draws. Organizations are analyzing their illiquid assets such as buildings and land to evaluate if they can provide liquidity to support operations and special projects. And like the rest of the world, many nonprofits are doing whatever they can to deleverage, that is to pay down their debt and reduce or eliminate their current debt service.
5. Board leadership is essential.
It surprises us how many excellent nonprofit organizations with strong track records of effective service have relatively weak or at least inconsistent Board leadership. In a decent economy, an organization can limp along without good governance; in an economy like the current one, a lack of effective leadership signals the beginning of the end. Look back over this list—every item on it requires courageous, attentive and skillful Board-level guidance. This item can be a hard one to admit, but believe us, many organizations are trying to figure out this challenge without letting the world know that their Boards are not all they can be.
Nothing mentioned herein is radical. Yet for each nonprofit organization, these may well be life or death challenges; at the very least, they compel a level of soul searching that many officers and directors have not previously faced. And as our nonprofit organizations examine themselves, they echo the self-reflection going on throughout America and around much of the world. Yet because many of these organizations serve as a mainstay of our civil society, because they represent a key ingredient in making capitalism more compassionate, democracy more participatory, and society more sustainable, it is vital that on the whole they are successful in addressing these challenges.
We know our audience, and many if not most of our readers are actively engaged in addressing these concerns as professionals and volunteers. But there is a great deal of leadership needed throughout our communities to address these concerns and there are people who are isolated now who have tremendous gifts to offer and service to provide. Even Merton, who practiced the relatively solitary life of a Trappist Monk, created ways to reach out and connect with others in an effort to effect social change. Let’s find those whom are not yet connected to community and invite them to join us. There’s work to be done.
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