[OPE-L:5363] Re: Re: Re: Re: Re: the bursting bubble and the U.S. working class

From: Steve Keen (s.keen@uws.edu.au)
Date: Thu Apr 19 2001 - 15:18:45 EDT


There have also been some real financial swifties pulled in the earnings 
department during this boom, which a number of people more expert than I in 
this area have documented (some of the best work here is done by Marshall 
Auerback, who works for the Prudent Bear Mutual Fund (check the archive 
below for stories):


Two key articles are:

November 21, 2000 - Stock Options: Be Prepared for a Sea Change
February 20, 2001-Stock Options Follow-Up: Hypothetical Costs Are Now 
Becoming Real

Stock options reduce the wage bill (as is well known), but also transfer 
tax liability to the employee--thus giving the firm a double earnings 
benefit. When options become worthless, wage costs will no longer be 
disguisable--though the final impact could be on employment more than the 
wages bill.

There have also been games with put and call options, which Marshall 
documents very well. Microsoft at one stage had booked over $3 billion 
profit from selling put options against itself. These options are now 
strongly "in the money", which means that at some stage their holders will 
make a motza exercising them--and Microsoft's profits from "financial 
engineering" will turn sour.

All in all, there will be lots of accountants and executives appearing 
before congressional hearing panels, and desperately trying to avoid gaol, 
when this whole thing finally unwinds.

At 07:58 PM 4/19/01 Thursday, you wrote:
>Steve writes:
>>A large part of the fall in the burden comes from the lower interest 
>>rates which prevail now, but there is no denying that the level of debt 
>>financing has risen dramatically over the past 6 years. Pardon me for 
>>burdening everyone's in-tray with a couple of files, but I think the 
>>following are instructive.
>>The data is taken from the Federal Reserve's web pages; I don't know how 
>>they define debt, but I'm prepared to accept their definition here. 
>>Notice that the debt to M1 ratio has risen from 11:1 tp 16:1 during the 
>>internet boom--a substantial rise in the extent to which economic 
>>activity is debt-financed, rather than cash-flow financed.
>>Also, the WSJ article you mention quotes interest costs to sales ratios; 
>>like a lot of "new economy" math, the numbers look persuasive until you 
>>ask what they mean. You don't repay interest costs out of sales--you 
>>repay them out of earnings. I expect that the interest/earnings ratios 
>>don't look so hot, and of course they will be the ones to collapse should 
>>a depression strike.
>Well it seems that earnings have been indeed been hot, largely due to 
>sinking interest costs (itself the effect as Fred has shown of the surge 
>in the intake of foreign capital, which I think will continue to be 
>strong). The point is that the maintainence of recent earnings growth on 
>this basis would only be possible if interest costs were going to drop to 
>nothing. And they may now be moving in the opposite direction. What will 
>feed earnings growth now? It seems that we are in the process of a massive 
>wave of labor cost cutting rationalization. Firms are also not risking the 
>costly build up of inventory; in fact they are writing them down and 
>effectively disaccumulating, which is what lead Greenspan to the surprise 
>rate reduction.
>>One key point not covered in these official stats, though, is the level 
>>of financial corporations debt, and off-balance sheet trades. The former 
>>may well be three times the debt/GDP ratio of private/non-financial debt; 
>>the latter is simply unknown, but a rough estimate is that US$30 trillion 
>>worth of interest rate swaps are extant. While the impact of that is 
>>slight when liquidity prevails--only the servicing costs, which are 
>>comparatively trivial, impact on the economy--things can get nasty if any 
>>of the parties to these swaps go bankrupt. Then you can have events of 
>>the magnitude of Long Term Capital Management, and a true liquidity 
>>crisis can eventuate.
>Surely seems possible.
>Yours, Rakesh

Dr. Steve Keen
Senior Lecturer
Economics & Finance
Campbelltown, Building 11 Room 30,
School of Economics and Finance
s.keen@uws.edu.au 61 2 4620-3016 Fax 61 2 4626-6683
Home 02 9558-8018 Mobile 0409 716 088
Home Page: http://bus.uws.edu.au/steve-keen/

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