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Business, Finance, and Jobs

The economy looms large in this year’s Presidential race. Romney is portraying himself as a Harvard MBA businessman who can bring fiscal responsibility to the nation and restart the ecomony.

There are three concepts that most people don’t seem to understand. I’m hoping this will clarify them.


Business is the activity of developing a product, finding a market, and bringing that product to that market. If a business can sell the product for more than it costs to manufacture and deliver the product, the business makes a profit. If a business spends more than it can make on a product, it loses money and eventually goes bankrupt.


Finance is the activity of buying and selling money. Banks are financial institutions. Creating loans, packaging the loans into (ironically named) securities that can be bought and sold, and redirecting the flow of money are all finance activities.

Finance does not produce anything directly. Indeed, finance deals in a commodity product (cash). Financial firms are paid by facilitating the exchange of money between two other parties, and being paid as a percentage of the transaction.

After a financial transaction, money that was previous available to produce goods, employ workers, and create tangible products and services is no longer available to the businesses that do those thing. It’s been taken out of the system into the coffers of the financial firm in the form of transaction costs.

(And indeed, there are some actual costs associated with paying the salaries of the bankers who do due diligence, who structure the deals, and who fill out all the necessary paperwork. The percentage-of-transaction-based compensation provides them rewards proportional to the value others have created, not proportional to the work they’ve actually done.)

Business Doesn’t Create Jobs

The misconception everyone seems to have is that businesses create jobs. That’s true in the sense that business provides the mechanism for people to contribute to making goods and services. But businesses don’t create jobs.

A good businessperson tries to reduce costs and run as efficiently as possible. That’s why automation so revolutionized the world—we could do more work with far fewer people. That’s why businesses pursue productivity, so they can scale up their production faster than they need to scale up their headcount.

Any businessperson who is acting in the interest of the bottom line should be trying to slow job growth or actively shed jobs within their company.

Jobs are created when a business experiences so much demand that it has no choice except to hire more people to cope with the demand. The demand drives the business to create more jobs.

Someone with the business experience of presiding over a growing business does not know how to create jobs; they know how to create demand for their specific products and services. This is a great skill for growing an individual business.

Growing a business isn’t the same as growing an economy. As Apple grows demand for its products, it grows demand in no small part by taking business away from its competitors. Apple does well, but Microsoft does less well that it otherwise would. Getting one business to do better is not the same thing at all as growing an overall economy so everyone does better.

Finance Isn’t The Same as Business

Finance skills have to do with sales and deal structure, not with making the people, process, logistics, and marketing decisions that build a business capable of mass production of goods or services. In fact, since financial firms are rewarded as a percentage of other people’s value, the best-run firms from a business perspective can increase their profits by simply seeking out higher-value transaction that require the same amount of work to carry out as lower-value transactions.

The skills needed to put together a money-capturing financial transaction that buys and sells businesses simply have very little to do with the skills needed to build and run the businesses being bought and sold.

It’s possible that in a large-enough financial services firm, the managers must develop business skill with respect to managing the analysts and bankers who put together the transactions.

We Want Jobs!

What most Americans are worried about is job creation. They’re asking “will I be able to make a living and get paid a fair and decent wage?”

That depends on the ability to build the economy overall. To return to the Apple/Microsoft example, what’s needed is for both Apple and Microsoft to grow (along with gazillions of small entrepreneurial businesses, which is where most new jobs get added to the economy).

Stimulating an overall economy is an enormously complicated task. It involves establishing the rules and regulations of business to create a playing field for businesses to compete. Urban planning, architecture, public works projects, and so on, are the province of economic development.

Even if you have the right infrastructure and resources all lined up, you need to get consumers to demand products. Once they demand enough products, businesses will have to hire to meet demand, and the economy revs back up to life. You need both the infrastructure and the demand to get the economy moving.

There are different economic theories on how to kick start consumer demand. It’s way beyond the scope of this article to discuss them. Suffice to say that there are many factors that may be keeping people from spending money: too much personal debt, insecurity about the future, limited earning potential caused by lack of marketable skills, etc. As such, stimulating demand may require approaches that address all of these things.

Neither Candidate Knowns How to Create Jobs

Which candidate will be able to create conditions that create jobs? I have no idea.

What I can say is that neither candidate has experience that inspires confidence in me.

Romney? I’m Not Confident.

Romney earned his money in finance, not in business. He bought and sold businesses, using fancy borrowing techniques to get his money out while saddling the businesses with vast amounts of debt. That isn’t a recipe for job creation.

To the extent that he has direct business experience, he hired and managed people at Bain Capital. But growing a single business isn’t the same as creating conditions for businesses across the board to do better. And if once considers the collateral damage of the debt Bain Capital imposed on the companies it bought and sold, it’s not at all clear that the company is successful from a societal point of view (which is the point of view a President needs to take).

Furthermore, the statements he’s made about reducing taxes, raising military spending, etc., simply don’t add up math-wise.

Romney’s time as Governor in Massachusetts may provide clues to his ability to stimulate an economy, except (a) it’s unclear that a Governor actually does much to influence a State’s economy, and (b) under Romney, Massachusetts did reasonably well in absolute terms, but quite poorly relative to the rest of the country. (In other words, the overall economy seemed to be improving, but Massachusetts improved less than other states. If we do decide that a Governor makes a difference, Romney significantly underperformed other Governors.)

Obama? I’m Not Confident.

Obama’s experience has been in community organizing, not economic development. He is a smart man, and may have a grasp of economic principles that doesn’t come through when he is speaking to a national audience. I’ve been singularly unimpressed with his choice of advisors and equally unimpressed with his reaction to the 2008 crash, which has been to change nothing structurally to insure that it doesn’t happen again.

Congress Won’t Do it

Even if the President has a wonderful plan, remember that it’s Congress that has to adopt the plan. Given the current state of the legislature, it’s hard to imagine enough bipartisan sentiment to pass even the most perfect economic recovery plan.

In summary:

  • Business, finance, and economic development are different. Expertise in one doesn’t translate to the others.
  • Romney’s experience is in finance. Obama’s is in community organizing and law. Neither has much experience in business, and even if they did, it’s not clear business experience is relevant to overall job creation.
  • Romney’s economic track record in Massachusetts was underwhelming, but since Governors have little effect on a state’s economy, that may mean nothing.
  • The economy has improved under Obama by many measures, though I don’t get the impression he really has much of a theory as to how to really get things moving again.

Creative deal structure–could it solve the housing crisis?

One of the most essential negotiating skills is the ability to divide up the risk, reward, blame, and credit properly among the parties in a negotiation. One of the reasons many people are so outraged at the financial collapse brought about by the real estate bubble is that they (correctly) notice that the risk, rewards, blame, and credit were largely divided up in ways that people found unfair.

Many of the proposed solutions also leave a bad taste in people’s mouths. There is the sense that any solution should divide up both the pain and the responsibility for getting real estate back on its feet.

I recently met a remarkable woman, Kelle Sparta, of http://www.spartasuccess.com, who has been a real estate expert for years. She wrote an open letter to President Obama in which she laid out a plan for solving the housing crisis that, indeed, divides up the risks and rewards among all the players who made bad decisions in the first place.

Here is a copy of her letter. It isn’t a quick and easy read. Understanding her solution takes some concentration. It’s well worth it, however. Not only as a specific proposal to solve the housing crisis, but more importantly for our purposes, as an example of how deftly she has structured the solution so everyone involved—the banks, the homeowners, and the government—shares some of the costs and participates in the rewards.

– Stever

Dear President Obama,

I recently received an email as part of a mailing to the leadership in the real estate industry asking us to consider how to solve the problems of the current housing crisis.

How To Solve The Current Housing Crisis

I spent several weeks chewing on the thought. What would I say to you if you were to ask me how to solve this current crisis? I had mixed feelings on it. What it came down to for me is this: it’s not about saving the banks from bad investments, and it’s not about digging borrowers out of holes that they got themselves into. As a benevolent parent, the governments’ job is to stave off the catastrophic results the housing downturn is having on the economy as a whole and bring it down to just enough pain that we don’t do something this stupid again. At the same time, the government has to remember that not everyone is in the same situation and you have to be responsible to those who were not caught up in this buying frenzy as well. So, with that in mind, here is my thought.

Buy The Land Under The Houses

In most markets, we have fee simple land ownership that conveys with the house. On every street card, there is a value placed on the land and one on the building. If we’re going to bail people out and make things more affordable, then let’s do it by reducing the principle owed on the property without asking the bank to take a hard hit and without the owners losing their houses. The deal works like this:

  • The banks would have to forgive all late fees and rewrite the loans at no cost (after all, they are getting the benefit of not having to foreclose on a bad loan). They also have to agree to continue to collect the taxes on the land from the homeowner and pay them with the taxes on the home.

  • The government issues bonds to investors to raise the capital and then buys the land at current appraised market value.

  • The homeowner gets a deeded option to repurchase the land at a later date at the original price paid by the government or current market value – whichever is greater.

  • The money paid by the government would go to the bank to pay down the principal balance of the loan, allowing the bank to convert an impaired asset into a performing asset which boosts the bank’s asset rate and lessens reserve requirements, strengthening its balance sheet. This makes the bank more stable, reduces the stress on government resources, and ultimately increases the availability of funds for consumer loans.

  • The homeowners would then get a new loan issued by the bank for the lower principal amount and have to pay a reasonable monthly lease (1% per year) on the land. The homeowner would also still be responsible for paying the taxes on both the land and the home.

  • The bonds issued by the government for the purchase of the land would be backed by the land with dividends provided by the lease payments.

Here’s how it would work in an example case: Harry Homeowner has a house that he is behind on his payments on. He is in danger of foreclosure. The bank has charged him hundreds of dollars in late fees and there is no way he’s going to get on top of things again. What he needs is a fresh start.

Harry’s loan is for $300,000, but the property is only valued at $225,000 in the current market and he can’t sell it. The government offers to buy the land under Harry’s house. The land is valued at $85,000. Harry sells the land to the government and pays down his loan to the bank, leaving a balance of $215,000. The bank agrees to forgive the late fees and rewrite the note. It issues a new loan to Harry on the house only in the amount of $215,000 at a lower interest rate taking Harry’s principle and interest payment from his previous payment of $1871.61 at 6.375% down to a new payment amount of $1073.46 at 4.375%. Harry pays an additional $70.84 per month (1% per year of the purchase price of the land) in addition to his mortgage to cover the lease costs on the land. This makes Harry’s total monthly payment (not including taxes and insurance) $1143.51, saving him $728.81 per month. This savings allows Harry to keep his home and the bank to avoid foreclosure.

Ten years pass and Harry wants to sell his home. He puts the house on the market and finds a buyer who agrees to pay $350,000. Harry then exercises his option to repurchase the land from the government. Current appraised value for the land is $110,000. Harry’s attorney does a simultaneous closing on the property, with Harry purchasing the land back from the government for $110,000 and conveying the house and the land to the new owner for $350,000. The bank gets its loan of $215,000 paid off, the government gets the $110,000 and Harry Homeowner gets the balance of $25,000 (less closing costs).

The Results

Win: The bank didn’t foreclose and got the full amount of its loan repaid.

Win: Harry didn’t lose his house to foreclosure, saved his credit and came out the other end with a little money in his pocket.

Win: As an investment for the taxpayers and bond holders, the $85,000 has matured into $110,000, for a $25,000 increase. In addition, the government has also received interest in the form of lease payments on the land in the amount of 1% or $850 per year. Over ten years, this totals an additional return of $8500 for a total profit of $33,500, an ROI of 3.38% per year which is a better return than the 10 year Treasury Bond rate which was 2.77 as of close of business Friday last week. (Obviously, this is a little more complicated than this, but you get the idea.)

What Happens If Harry Homeowner Still Forecloses? In many areas, affordable housing is a big issue. It’s all local towns and municipalities can do to get developers to include affordable units in their developments. Those towns could change their local regulations to state that the affordable housing unit doesn’t have to be in the development itself – it can be provided in the same town but in a different location within that town. This would make developers tremendously motivated to buy any of the properties served under this plan that go to foreclosure since they would cost the homeowner up to a third less than the local area prices. Even if the builder had to take a loss on the purchase and resale of the home to get the monthly payments into the “affordable” level, it will likely be less than the gain of an extra new unit selling for full price. It’s a good trade.

The Sparta Plan Has Several Benefits

  • It will reduce the principle of the loans for the current homeowners allowing them a payment level they can afford to sustain.

  • Banks only have to eat the cost of refinancing the loans at a lower interest rate and forgiving the late fees, not the cost of foreclosing and reselling.

  • The payments from the land purchases to the banks would allow them to convert impaired assets into performing assets. This boosts the banks’ asset rates and lessens their reserve requirements, strengthening their balance sheets. This makes the banks more stable, reduces the stress on government resources, and ultimately increases the availability of funds for consumer loans. Freeing up additional funds for new loans and opening up credit lines for new spending would be a boon for the economy overall.

  • Property values won’t suffer as a result of the plan since any subsequent purchase of the property would be made including the land when the current seller exercises his/her option to purchase the land back prior to conveying it with the property.

  • It’s a purchase backed by real estate, which means it’s not going to contribute to the deflation of the dollar.

  • It provides a stable investment for older investors who need some way to hedge their bets in this uncertain economy.

  • For the purchases that don’t get paid for by bonds, the tax payers will see a return on their investment as the economy recovers and property values improve. At the very least, we are guaranteed to get our money back with the land lease payments as interest. At the best, the appreciation and the land lease costs will provide a tidy profit for the use of taxpayer monies.

  • It’s not a free ride for anyone. The banks lose out on the refinance and late fees as well as taking only a slightly more than break-even interest rate. The homeowners lose out on the appreciation of their land and have to pay conveyance taxes and closing costs on the land multiple times. In short – those who made bad decisions get a chance to pay for those bad decisions without being destroyed by them.

So, that’s the crux of the idea, Mr. President. It seems to me that it would work. I’d welcome the opportunity to discuss it with you. I also have some ideas on how to make it easier to be self-employed if you’re interested.


Kelle Sparta
Author of The Consultative Real Estate Agent 
National Speaker, Trainer and Coach for the Real Estate Industry

Income Distribution and the Ultra-Rich

A friend wrote to a group I’m part of:

Some folks I know who are at pre-IPO companies are really opposed to Warren Buffett’s support of raising taxes on the ultra-rich, saying that Buffett is helping keep a glass ceiling in place between them and being super rich.

They say we shouldn’t discuss politics in public, because then people won’t like us and we’ll die alone in a gutter. So after much deliberation, I decided to risk ending up in the gutter and posted my response to my friend’s post:

My Response

And thus we find the problem: the vanishingly small percentage of people who stand to benefit from low tax rates on the rich are vocally opposed to changes.

I’m surprised at how vehement and negative my reaction is to your friends’ outrage.

First of all, it’s stupid to complain about taxes and ignore the rest of the costs of their equity.

Tell your friends if they are concerned about increasing their take, they should lobby for the investment banking fees that get withheld from their IPO proceeds to get capped at some rational number. The banking fees are financial rape, but since they’re “standard,” no one bothers to protest. And they should read the prospectus carefully to see how badly their stock and options got diluted by sweetheart deals in the footnotes.

Speaking of which, do they track outstanding shares on a weekly basis and calculate their ongoing dilution? Or market fluctuations? If not, why not? Those effects can have far more effect than the tax rate differences. Did they quiz the founders on the dilution that last round of funding brought, and whether the return to your friends was negatively affected? Was that last round really necessary? Did those capital improvements really need to be made pre-IPO? Etc. Most people cry foul when the government wants a share, but ignore all the others who take a bite. They don’t ask whether those others are providing value for their money.

I’ve been through 4 IPOs and they’ve all been feeding frenzies. Of all the parties who lifted significant sums (sometimes many millions) out of the transaction, at least the government provides something in return:

  • A stable system of contracts, which makes IPO-able business possible in the first place.
  • A public infrastructure that gives them electricity, water, food, etc. so they can spend their time building their business instead of worrying about the logistics of running a server farm when power is spotty and only available for part of the day.
  • Financial markets that, no matter how corrupt individual players may be, at least provides liquidity for those IPO-bound friends.
  • A justice system that enforces the contracts allowing business to rely on them.
  • Etc.

Perhaps your friends should learn something called gratitude for having the privilege of living in one of the very few times in human history where we had an infrastructure that afforded them any chance at an IPO, combined with the incredible luck to be at a company that can viably go public (which only ~.02% of companies do).

On the other hand, I’ve been through 4 IPOs—all when the tax rate was a lot higher than it is now—and still have to work for a living. Maybe I’m just bitter and begrudge your friends a lifetime’s worth of free money without them having to contribute to the upkeep of the system that made it all possible.

How rich is an ultra-rich person?

Most people have no idea how truly ultra one must be to be one of the ultra-rich. Let’s tie the numbers to something real:

A million dollars is 25 years’ income for an American median family (median income is about $40K)

Ten million dollars is 250 years’ income.
100 million dollars is 2,500 years’ income.
A billion is 22,500 years’ income.
Ten billion is 225,000 years’ income.

John Chambers stashed four of those overseas to avoid taxes. Bill Gates has four of those in his bank account. In other words, enough money for a family of four to live at an American median standard of living for a million years, ten times as long as our species has existed.

Explain to me the value system in which there is any way to justify that concentration of wealth.

Yes, the mechanism of the system allows that to be accumulated by one person. But to argue that somehow we should be concerned about his tax rate seems bizarre. Honestly, a 100% marginal tax rate seems perfectly reasonable to me. He has enough to survive for a million years. No matter how hard he works, or what he contributes, he doesn’t need a single cent more.

(Nor do I believe his contribution to the human race approaches the contribution a family of four would make over a million year timespan, no matter how much one may like Windows.)

Tell your friends to use their after-tax proceeds to start another company that’s more successful, only they can do it in another country with a more favorable tax structure. I suggest Haiti. Port-a-Prince is looking for commerce.

Sign in using…

I just went to ScreenR to try out this download-less screencasting site. It requires me to log in using my Google, Twitter, LinkedIn, etc. account. Creating a separate account on ScreenR.com isn’t possible.

Am I the only one who is vaguely disturbed by this? This puts Google, Yahoo, etc. in the position of having an accumulated list of all the sites I use and the login credentials I use to access them. I simply don’t know if I want every site I use, every email I receive, and every person I contact conveniently located in a single database. While I’m not particularly worried about Google or Yahoo, history is full of cases of databases being hacked, stolen, or subpoena’d by people and groups that have political or social agendas.

For those who think such things just don’t happen in America, as recently as 2004 administration, congressional aides hacked into the opposing party’s computer files and leaked them to the press. Never mind the “outing” of CIA agent Valerie Plame as a political maneuver designed to put pressure on her husband.

So I’m cautious. We’re putting more and more of our personal, private information into the hands of fewer and fewer companies. Do I want to log in using my Google account? No. I want to log in using credentials that connect only to that web site. Sadly, that’s becoming a rarer option.

Tax cut obsession is absurd; vote for tax increases!

Tax cut obsession is absurd; vote for tax increases!

The paper was full of Democrats promising middle-class tax cuts yesterday. I really don’t understand why the national obsession with tax cuts. People seem to think about taxes as if the government is stealing from them. As much as I believe the government does steal on occasion(1), mostly, the money is going to needed common goods and services.

We’d love to believe that cutting taxes makes the government efficient. Nonsense. If a simple lack of money could make an organization efficient, then increasing taxes would make all our families more efficient because we’d have less money. It doesn’t. It just means we feel more pain, can do less, save less, and live our lives at poorer quality.

Do we want an efficient government? If so, we need to train people how to be more efficient! Government employees have neither the training nor the incentive to streamline their operations. In fact, exactly the opposite: when running on less money this year means you get less next year (often the case in government), “lean and mean” becomes a recipe for waste. But money cuts without adequate training and reorganizing won’t do much except kill the quality of the services that remain.

Of course, it would sure help if those cutting the budget demonstrated some money-savvy themselves. They don’t. The Bush Administration granted Halliburton several billion dollars worth of contracts in a no-bid decision. Halliburton promptly spent an extra $61 million on gas, either through incompetence (paying a supplier twice the market rate) or through willfull overcharging. Either way, the message to the rest of the government employees is clear:cost-cutting and efficiency aren’t the measures that matter in doing a job.

And by the way, people, cutting your income taxes won’t even make a big dent in your tax bill. If you make less than about $200,000, your social security (FICA) taxes make up as much or more of your tax burden than your income taxes. And while your employer pays half of your FICA, it’s still taxes being paid that could have been money in your pocket instead if your employer didn’t have to pay Uncle Sam.

Your overall tax bill is probably higher after the tax cuts. Do you own your own home? The federal tax cut meant Massachusetts got less federal aid. The state promptly raised property taxes to help close the gap. My property taxes went up more than I saved on federal taxes, and we still laid off teachers and cut services like graffitti cleanup. And oh, yes, subway prices took a 25% hike as well. Nice. I’m now paying more in taxes overall and receiving fewer services.
(If you rent, don’t gloat too much. Your landlord will be passing through that tax increase momentarily.)

I’ve had fun with all this, of course. We’ve seen an unusually large number of teenagers begging for money for their sports teams, uniforms, etc. this year. I educate them. Their parents got a $300 tax refund. That’s the money that would have paid for their school programs. If their parents chose to blow the $300 on something else, rather than saving it to make up for the services their kids lost, then it’s kind of silly for me to show more care, love, and financial commitment to these kids than their parents showed. It’s a cold, cruel world out there. And taxes are how we join together as a community to make it a warmer, friendlier, and happier world for humans.

Let’s have clean streets. Let’s have decent schools that prepare our kids to succeed(2). Let’s have food inspection that can afford to use “healthy for you” as a standard! That all takes money, and that’s where our taxes go. Instead of blindly voting for tax cuts, think for a few minutes about which services you benefit from. Street cleaning, perhaps? Sewer systems? Water treatment? Toxic waste cleanup? Because when services get cut, the military and terror budgets stay steady and it’s the quality-of-life budgets that get decimated.

(1) See http://www.nytimes.com/reuters/news/news-iraq-halliburton.html?ex=1075349072&ei=1&en=763f8032abf2c364

(2) Except for graduates of 4-year colleges, the U.S. ranked near list in the world in terms of literacy. See the National Institute for Literacy resources: http://www.nifl.gov/nifl/facts/reference.html#sum2002