The rate at which corporations reinvest profits back into their businesses has stayed stagnant, or even partially declined, for many years now. Source: Federal Reserve/Haver Analytics
Americans are overly bullish in that the general successes of the recent and ongoing economic recovery from the 2008 financial crisis will continue uninterrupted into the future, thereby disregarding risk and making ill-advised decisions. This illusion is called short-termism, and is also known as the hot hand fallacy—In basketball, it is the idea that after a player has made many consecutive free-throws the next one is almost a guarantee. This misconception has infiltrated American financial and government systems and has caused many to believe during long runs of economic growth that there is only one way to go: up. People thus begin to make decisions that are illogical and based on emotion rather than fact, a byproduct, this author believes, of the laws on America’s financial markets that have caused great distress in recent times. The current laws push companies to develop short-term, profit-driven results instead of long-term strategy, growth, and sustainability. It is each generation’s duty to leave the world in a better position than it found it, but current rules disastrously discourage such actions.
The 2008 financial crisis is a perfect example of the effect of short-termism on financial institutions. When all was said and done, $5 trillion evaporated from the market, 12.5 million people lost their jobs, and 46.2 million people were left in poverty. Many Americans lost their homes and were left wondering, “what next?” It wasn’t war or an economic dispute with foreign countries that caused this disaster, but rather our own ignorance and irrational decision making. Just like sports fans believe that Golden State Warriors’ star Stephen Curry may never miss a 3-pointer again after he has made a few in a row, bankers and government officials arrogantly felt that the economy may never come back down.
Both the Dow Jones and S&P 500 were at all-time highs, and banks were flourishing with newfound revenues from mortgage-backed securities. Louis Ranieri, a former bond trader at Solomon Brothers, is credited with introducing this new tool to America’s financial markets. His concept was to bundle together a collection of assets, primarily mortgages, to increase return rates while decreasing risk. The preconceived notion was, “who wouldn’t pay their mortgage, it’s a mortgage.”
2008 proved this to be tremendously false. Mortgage brokers began signing loans with clients who were by no means qualified. Scott Stern, CEO of Lenders One, admitted in a testimony before the Senate Banking committee that there was a “growing practice of pushing high risk loans on borrowers who had no reasonable expectation of being able to repay the mortgage.”
Another important tool bankers used is called a CDO: collateralized debt obligation. A CDO is made up of a series of “tranches”–a French word meaning a portion of something–varying in risk and bond rating. These CDO’s began to be filled with riskier and risker subprime mortgages that the ratings agency reclassified as a triple-A, the safest rating possible, thereby accelerating the purchase of these vulnerable assets. This process was rationalized by the booming housing market, wage growth, and profits made by financial institutions.
Lenders, borrowers, bankers, and government officials all believed that the stock market would never fail, but this just demonstrates the illogical decision making that short-termism produces.
The primary point of criticism for many business and financial leaders is the laws surrounding quarterly earnings reporting. Per the code of federal regulations, all publicly traded companies must report their income statement, balance sheet, and cash flow statement on a quarterly basis for shareholders to view, with the goal of making shareholders more aware and, the Securities and Exchange Commission (SEC) states, to prevent companies from hiding indecent business practices from their investors.
Many business leaders have spoken out against these laws. Warren Buffet wrote that “short-term-oriented capital markets have discouraged companies with a longer-term view from going public at all, depriving the economy of innovation and opportunity.” Elon Musk, CEO of Tesla Inc., also criticized the rise of short-termism in the economy by saying, “I fundamentally believe that we are at our best when everyone is focused on executing, when we can remain focused on our long-term mission, and when there are not perverse incentives for people to try to harm what we’re all trying to achieve.” The lack of “long-term mission” in the American economy is precisely the problem with the current laws and regulations on the books.
Many publicly traded companies like Tesla are reviewing the idea of going private, and some, such as Dell Inc., already have. Michael Dell took his company private with the help of the private equity firm Silver Lake Partners for roughly $24.4 billion when it was unable to keep up with the quarterly reporting system and saw its stock fall nearly 70% in the 10 years preceding their buyout. By going private, Dell was able to invest in long-term projects, freed of any regulatory pressure to release information. Dell has invested heavily in expanding its software and services for data centers, paying a record $67 billion for storage hardware giant EMC. The move from the NASDAQ to privately owned and operated allowed Dell to not only invest in new projects but rebrand themselves as forward-thinking and innovative. Dell now describes itself as “a strategically aligned family of businesses” and has even considered going public once again.
The attempted hostile takeover of San Diego-based Qualcomm Inc. by Broadcom Inc. was yet another decision made for short-term gains. Hok Tan, CEO of Broadcom, offered $105 billion to acquire Qualcomm in November 2017. Tan was originally CEO of Singapore-based Avago, but acquired Irvine-based Broadcom last year for $17 billion in cash. He layed off 1,900 employees globally with this acquisition and another 300 employees in the acquisition of San Jose-based Brocade Communications. Tan has gained the reputation by many as an executive with little concern for the employees of his newly acquired companies. Qualcomm was concerned that he treat their employees similarly to those of Broadcom and Brocade Communications, so they created a full severance package for employees if the deal was approved. Qualcomm and Broadcom had very different business models, but, “Qualcomm approaches their value creation through a much longer-term lens,” Patrick Moorehead from Forbes writes, “This is an unpopular approach on Wall Street, but one that is critical to the innovation ecosystem.”
President Trump jokes with Broadcom CEO Hock Tan as he announces his plans to redomicile Broadcom to the United States. Photo: Nicholas Kamm/Getty Images
Much of Qualcomm’s cash allocation is in research and development where a return on investment won’t surface for seven to ten years, but Broadcom would have slowed, possibly even ended, Qualcomm’s research into smart cities, artificial intelligence, autonomous vehicles, and 5G projects, thus depriving our society of a host of potential benefits.
President Trump in mid-August ordered the SEC to look at the idea of altering the quarterly reporting system to a bi-annual system. In an August 17th tweet, President Trump said:
“In speaking with some of the world’s top business leaders I asked what it is that would make business (jobs) even better in the U.S. “Stop quarterly reporting & go to a six month system,” said one. That would allow greater flexibility & save money. I have asked the SEC to study!”
His reasoning is that companies could invest more long-term and increase innovation, thus unleashing untapped economic growth. President Trump, along with many other financial experts, are looking for outlets to continue the great economic run that the United States’ financial markets are currently on. Their thought is that by allowing corporations to invest in growth and visionary projects, economic growth and domestic investment will continue. There is also a large cost–financial and opportunity–that companies sacrifice to comply with the quarterly system. Instead of innovating, they are working with legal teams to prepare their financial data for the markets and short-term investors.
I wholeheartedly agree with this proposal by President Trump and his economic advisors. American corporations are being constrained by laws that push them to make short-term decisions, which in turn inhibit economic growth. By adjusting the quarterly reporting system to a biannual system, new wealth and capital will be released through innovative projects and long-term investment in American corporations, and alleviate at least some of the psychological pressures that threw America into the short-term mentality that pushed America into the 2008 Crisis. We are currently faced with a critical question for America’s economic future: how will we continue the economic growth of the last 10 years? It is of my opinion that the surest way to do this is to abandon the quarterly reports and transition from a short-term mentality to a long-term one.