Your father has confused leverage with how the market works. There is no reason for banks to call in debt, if the businesses are profitable. De-leveraging is only forced on businesses making losses. Leverage increases the volatility of the return on equity and its value is discounted by the market in poor economic environments. Dividends are largely irrelevant.

Markets have recently rallied because they believe dreadful earnings have already been priced in (as in the chart), but actual results have not been as bad as feared. This is a favorite Wall Street game: lower expectations to engineer short-term rallies. When the reporting season is all over, they sudden realize PE is at unsustainable levels…

http://www.chartoftheday.com/20090724.htm?T

I forwarded the chart to my father who replied thus:

“You guys [my brother and I] are the ones with the finance and commercial degrees so I am interested in your take on this. – Here is my layman’s view:-

Until 2 yeas ago, if an enterprise was yielding, say, 15% on its capital (assume capital of $100 Mill.), it had earnings of $15Mill. If it then borrowed $200Mill. @10%, this could then boost earnings to $25Mill. (5% profit on 200M) This was good business. (Bear with me … read on please)

Now… last year this enterprise decided to deleverage as fast as it could. (assume it’s bank was in trouble and it indicated an unpreparedness to renew the $200Mill loan). The enterprise repaid $100Mill (which it had liquid but the other $100Mill was tied up (stock, plant and machinery etc…)

Now it takes all its earnings at the end of this financial year (say this is back to $15Mill) and repays that off of the 100Mill. outstanding, this leaves it $85Mill in debt.

It pays it’s shareholders no dividend this year,…. but…..it is still in a very strong position. If it can reliably roll over its debt of $85 Mill. (banks are now more robust that last year), it is in fact bigger and stronger than 2 years ago when it had Capital of $100Mill. ….However…. its share price will take a bath because it will pay no dividend this year as all earnings have gone to debt redemption.

However, the market will look beyond this event and will price into the share, responsible management (because it chose to recover debt so promptly at this time) and the share price will find a floor of, maybe, 20 – 50% of its previous highs. We have seen the market do just this over the last year. As soon as the capital squeeze is over, responsible management will allow some earnings to flow through and consequently a return to (but diminished) dividend and the share price will start to climb. (as we are seeing at the moment)

This, of course, is the situation in the American market. Our local market is much healthier.

So…. low or even negative earnings do not necessarily spell zero value.

Publication of this kind of chart in isolation has, to my mind, limited use as it provides a limited and narrow focus on one aspect only.

Now, I could be way off beam. What do you two think?

Dad”

to expose the delusion of the

“canberra treasury archipeligo”

our neo classical interlectuals get sent to or seconded to our version of siberia,

canberra, to walk the hallowed halls of the treasury building

Spot on. Interesting story, and I suspect very few people who are advantaged by financial & industrial capitalism really see how flawed the system really is. After all, such people don’t want to understand when their incomes depend on them not understanding.

Business as an institutional system of power requires constant delusions and self-deception to continually perpetuate itself – otherwise people may begin to look outside the cocoon and realize that there may be better ways to run the institutions in our society.

The task of the ideological managers within economic university departments and government is to recite the gospels and sing praises of the wonders of state capitalism. It is essentially no different in the Soviet and Easter Bloc communist countries. Over there, they had Marxism as the religion and communism as the economic form of organization. Over here, we have neoclassicism as the religion and capitalism as the form of economic organization.

There is one amusing difference, though. If an intellectual under the communist system was to denounce it, they could be sent to the gulag. When intellectuals in our free society regurgitate the required incantations and engage in state and corporate worship, it is cowardice and/or indoctrination.

Regarding what you said about the nonsense that resides in the heads of intellectuals, one of the best quotes I’ve come across is this:

“The dominant economic discourse has, since the early 1980s, reinforced its hold in academic and research institutions throughout the world: critical analysis is strongly discouraged, social and economic reality is to be seen through a single set of fictitious economic relations which serve the purpose of concealing the workings of the global economic system. Mainstream economic scholarship produces theory without facts (“pure theory”) and facts without theory (“applied economics”). The dominant economic dogma admits neither dissent from nor discussion of its main theoretical paradigm: the universities’ main function is to product a generation of loyal and dependable economists who are incapable of unveiling the social foundations of the global market economy. Similarly, Third World intellectuals are increasingly enlisted in support of the neoliberal paradigm; the internationalisation of economic “science” unreservedly supports the process of global economic restructuring.” (p. 42)

Chossudovsky, Michel. 1998. The Globalisation of Poverty: Impacts of IMF and World Bank Reforms (Sydney, Australia: Pluto Press)

On your comment about making a contribution to society, I think that many people have lots of interesting suggestions for improvement – if they could be encouraged to come forth and speak about them. Some do, some don’t. I hope to make mine when I do my PhD later on (researching a new model to eliminate IPR for pharmaceutical drugs).

Probably a half of job offers for “senior” software engineers in Sydney come from the financial industry:
http://mycareer.com.au/jobseeker/search/results.aspx?s=102&q=senior&d=7&l=1&c=3.174
There is also one offer looking like from a patent trolling company.

So what do you expect me to do? I have very limited assets as a migrant from Eastern Europe, I just need to feed my family (my wife also has to work full time). Should I go to a company which offers me 20% less and may not survive the next year?

What should Steve do? Teach for free future bank executives who are going to earn 20 million a year?

The sad truth is that the “broad” financial industry will always survive and these people who really do something productive for the society are first to go broke.

This article is interesting in the context of job offers mentioned above:
http://opinionator.blogs.nytimes.com/2009/07/24/weekend-opinionator-is-wall-street-picking-our-pockets/

Yes I know there might be some minor inaccuracies in the article but…

In a previous thread, I compared the scientific achievement of the moon landing with the global financial crisis 40 years later. You commented correctly: “a gradual flight from the arts and sciences into business and finance over the last couple of decades”.

You also suggested correctly that was because “students seeing education not as an end in itself but rather a means to get richer”. When I left rocket science for economics and financial engineering more than two decades ago, it was not so much “to get richer”, though it did happen, it was due to a lack of job opportunities from: winding down of NASA, relentless funding cuts by governments in research everywhere etc. I swapped scientific research for unscientific research, with increased pay. I moved from one financial sector to another witnessing greed and incompetence, but I was gagged by money. Eventually, I decided something must be done, even before the global financial crisis, which was no surprise to me and hence had no impact on my wealth (so far).

But change is not easy, because there is so much nonsense inside the heads of academics, government officials and regulators that they have great difficulties in understanding what really happens inside commercial financial institutions. They had fallen asleep, assuming efficient markets and have deregulated for too long to have any idea of the growth and consequences of “financial innovations”. Government policies have allowed the real economy to be cannibalized by the financial economy, which steals a disproportionate share of earnings from honest labor and savings. Some people have been saying this for a long time and may only be beginning to be heard. Here is one example:

http://johncbogle.com/wordpress/wp-content/uploads/2007/05/Georgetown_2007.pdf

It would be bad taste (and illegal) for me to give Steve financial advice, as only he really knows what’s “enough” for him. One thing seems obvious to me: none of us is participating in this blog for the money. Sometimes, the satisfaction of making a contribution for the improvement of society is “enough”. Philip, I guess we are of a like-mind on this.