How Corp America & Wall St Robbed the Mid Class & Sunk the Economy

We are witnessing the demise of the (US) middle and lower class based on two factors that are accelerating:

• 1) Wealth is becoming more concentrated among the wealthiest citizens and
• 2) Real wages for the middle and lower class are stagnating.

In the US, this trend is especially disturbing because GDP growth is dependent on consumer consumption. It is estimated 70% of all GDP is attributable to the consumer (as opposed to Government or Business spend). Without a growing middle and lower class, consumption slows and therefore, GDP stalls, which is exactly what we are seeing today.

The Fed and others have been very confused on why GDP is stalled given that the traditional economic indicators for growth are strong. That is low unemployment and low interest rates along with falling oil/ gas prices at the pump historically stimulates consumption.

The title of this essay refers to the wealthiest class getting wealthier in a systematic way that has robbed the other classes of fair opportunity to participate in wealth growth and in doing so has harmed the overall economy. It is ironic that as the wealthy class has concentrated their wealth at the expense of the other classes, they have inadvertently robbed the economy from future expansion. This is a similar parasitic scenario that faced the Financial Community in the 2000’s when they systematically increased risk to accelerate and build wealth while in the process jeopardizing the entire global banking system, thereby putting their own wealth at risk.

To explain how this happened, let’s start with why wealth has become more concentrated. And then it will be important to understand how the Fed is unwittingly accelerating the outcome.

 Wealthy investors are buying substantial positions in public companies. Sometimes these are individuals and sometimes they represent larger investing organizations. As American Corporations buy back significant blocks of stock, they are actually passing on a share of the company tax free to their largest stock holders. Warren Buffet explained this concept best in his Annual Letter to Shareholders in 2012, “When Berkshire buys stock in a company that is repurchasing shares, we hope for two events: First, we have the normal hope that earnings of the business will increase at a good clip for a long time to come; and second, we also hope that the stock underperforms in the market for a long time as well. Share repurchases may be likely but will only make sense if the shares remain cheap enough. In other words, nicely below per share intrinsic value. Repurchases that are executed above approximate per share intrinsic value is generally lower class use of capital. Since estimated per share value is best case an imprecise range, there should be a plain margin of safety. The discount to value should be obvious. Share count reduction needs to be accomplished in an economically sound manner. The logic is simple: If you are going to be a net buyer of stocks in the future, either directly with your own money or indirectly (through your ownership of a company that is repurchasing shares), you are hurt when stocks rise. You benefit when stocks swoon. Emotions, however, too often complicate the matter: Most people, including those who will be net buyers in the future, take comfort in seeing stock prices advance. These shareholders resemble a commuter who rejoices after the price of gas increases, simply because his tank contains a day’s supply.

 Charlie and I don’t expect to win many of you over to our way of thinking – we’ve observed enough human behavior to know the futility of that – but we do want you to be aware of our personal calculus. And here a confession is in order: In my early days I, too, rejoiced when the market rose. Then I read Chapter Eight of Ben Graham’s The Intelligent Investor, the chapter dealing with how investors should view fluctuations in stock prices. Immediately the scales fell from my eyes, and low prices became my friend. Picking up that book was one of the luckiest moments in my life.”

 An example to make this point clear. If Co A’s stock price were to average $200 during a given period Co A could buy back 250 million shares for $50 billion. If the stock instead sold for $300 on average during the five-year period, Co A would buyback only 167 million shares. Over the five years, Berkshire’s share of those earnings would be a full $100 million more at the lower stock price point. And in essence, the larger stake translates to a larger percentage ownership of the company. That transfer of wealth came at zero cost to Berkshire, although Co A spent $50B of money that could have gone into R&D, employee benefits & salaries, or investment in the business.

 It may not seem obvious to most people that the role of buybacks is to concentrate more wealth in a no cost fashion to the shareholder. Many market analysts have shrugged these efforts as part of a process to financially engineer corporate earnings by boosting EPS in order to get an expected stock price lift. This is important to understand that only the largest shareholders benefit from buybacks. The small individual shareholder does not see any material change in his wealth position.

 The reason the Fed is accelerating this outcome is because it has kept interest rates at historically low levels in order to stimulate the economy. This has resulted in cheap money, which corporations are using to fuel stock buybacks.

 The bigger societal problem with this scenario is that no real value (GDP) is created with buybacks. There is no innovation, job creation, or real consumption as a result. And the negative effect is that more wealth is concentrated with the wealthiest class without any tax consequence to them.

 It could be argued that these companies, that are beholden to the wealthiest shareholders, are using investment capital not to further their company’s future value or competitive position but rather to improve their largest shareholders stake in the company.

 There is another implication of shareholder wealth concentration that contributes to real wage stagnation. If you look at the billions of dollars that have been funneled into buybacks, it has come at the expense of the worker of those corporations. Real wages are a significant component of SG&A in most companies and can compose 50% or more of expenses. So, in order to drive profitability, corporations went after one of the biggest items on the Income Statement—the payroll. Reductions in payroll have taken the form of:

• Elimination of pay increases
• Reduction in medical benefits including larger employee out-of-pocket
• Elimination of pension
• Reduction in retirement benefits
• Reduction in wages
• Elongation of the work week

This systematic effort of compensation reduction has resulted in wage stagnation that has hit both middle and lower class.

 Time Sep 8/15, 2014, “The Answers Issues” provides some of the facts behind this crisis.

• 30% of US Households earn <$29K annual; Income growth =7% since 1975
• 26% of US Households earn $30-59K annual; Income growth=12% since 1975
• 22% of US Households earn $60-99K annual; Income growth=24% since 1975
• 17% of US Households earn $100-199K annual; Income growth=56% since 1975
• 5% of US Households earn $200+ annual; Income growth=80% since 1975

While the macro impact of the middle and lower class wage stagnation is sluggish consumption, there is more specific evidence at the point of consumption. Those retailers and consumer product companies that have traditionally relied on the lower income consumer for growth and have seen sales decline sending the values of their companies down. These corporations are blaming the “economy” for falling sales. Meanwhile, other fast food and retail catering to higher income have seen positive growth. This is the tip of the ice berg of the eroding consuming economy. There appears to be an intellectual disconnect between these distinct changes in consumption patterns and the connection to GDP.

 Wage stagnation has impacted the dynamics of wealth creation. In past generations there were abundant opportunities for workers to move up the corporate ladder, get promoted and increase their earning capacity over time. Also, these employees armed with retirement packages, could plan on leaving the work force at the healthy age of 55 or even 60 years old. This progression was critical to opening up the way for younger employees to move up the ladder and create wealth. Given the demographics of the population, the Baby Boomers retirement was expected to open up countless opportunities in corporations as they piled out of the workforce and the next generations moved up.

 However, with diminished compensation and reduced and/or eliminated retirement benefits, the average worker is now staying in the workforce longer. According to WSJ, Monday Oct 13, 2014, older faces are becoming more common in workplaces as seen in labor-force participation rates:

• Workers aged 65-69 had a participation rate of 20.6% in 1992, but in 2012, participation shot up to 32.1%
• Workers aged 70-74 had a participation rate of  11.1% in 1992, but in 2012, the rate of participation nearly doubled to 19.5%

Therefore, there is a greater participation of older workers in the work force today, and the bad news is this is expected to rise to 62% by 2022. More than 70% of surveyed Baby Boomers expect to work to age 65 or beyond; when asked at what age they expect to retire, surveyed Boomer said,

• Retire 66 or older = 39%
• Retire 65= 24%
• Retire 64 or younger= 27%
• Never Retire= 10%

This shift in retirement planning has had a direct impact on the working generations proceeding the Boomers and their ability to climb the corporate ladder and compete for higher paying work. The glut of older workers is also an impediment for the youngest workers entering the workforce seeking employment and professional development.

 There has been a focus in the last few years on aligning education with middle class opportunities for the youngest generations preparing to work. What is interesting is how academic alignment with employment opportunities has evolved and tightened over the last 60 years, namely as the competition has increased for fewer executive roles and corporate positions.

In the 1960’s and 1970’s college degrees in generally any major earned a graduate a beginning track for management development in Corporate America. The economy was expanding around the Boomers (the largest generation in 200 years) as companies added workers and management layers. The companies had an obligation to provide lifelong careers for the Baby Boomers, and develop and train them to be the future leaders of tomorrow.

By the 1980’s, many American companies had lost their competitive edge to more efficient global companies that could produce better products at a lower price. American consumers voted with their dollars and were buying well-made foreign goods. As the fat American company realized an overhaul was needed, they targeted the worker and management layers were slashed while lower level capabilities were pushed overseas to cheaper labor markets. Opportunities to advance up the ladder eroded which resulted in a more competitive labor market for those corporate positions. Specifically, in order to enter corporate and advance, the worker had to have more education and experience to be competitive. Herald in the era of the MBA.

In the 1990’s, Corporate America developed a tighter alignment with shareholder wealth creation as executive compensation became more dependent on the stock price valuation. Many pension plans were dissolved in the 1990’s as companies looked for ways to decrease costs and increase profits. Productivity investments in the 1990’s built on those of the 1980’s as companies designed leaner supply chains, invested in Enterprise Resource Planning tools, cut more layers in management, and got creative with corporate tax structures. The complex corporate tax structure took off as CFO’s found a hidden gem and unlocked another profit engine.

By the 2000’s, the stock market had made the necessary correction and witnessed an economic recession. By 2003, the stock market and the economy were showing signs of growth. Corporate leadership would have even tighter alignment with stock market performance and would usher in the Stockholder Era. Not just any shareholder, but the biggest wealthiest shareholder. Over time, some of these large shareholders would dub themselves “activists” as if they had meaningful objectives to benefit the interests of a larger class of citizens. But in reality, these wolf in sheep clothing were pressuring corporations to buyback (more) stock. This provided the largest free transfer of wealth in history.

As companies pushed more money to the bottom line to impress Wall Street and fund buybacks, they would reach deeper into their cost structure to reduce one of the biggest line items on the income statement—salaries & benefits.

These conscious efforts by Corporate America to redirect wealth to the largest shareholders has inadvertently decimated middle and lower class by restricting:

• Current and future wage growth (those funds are fueling buybacks)
• Medical and retirement benefits (more money for buybacks)
• Upward mobility (stagnation in the corporate ladder)

This has increased competition in the labor market for fewer corporate advancement opportunities. This in turn has raised the educational bar for candidates which has put more financial burden on the middle and lower class.

Time Sep 8/15, 2014, “The Answers Issues” provides insights of how education parallels economic opportunity:

• 30% of US Households earn <$29K annual; 20% have a Bachelor degree or higher
• 26% of US Households earn $30-59K annual; 35% have a Bachelor degree or higher
• 22% of US Households earn $60-99K annual; 56% have a Bachelor degree or higher
• 17% of US Households earn $100-199K annual; 74% have a Bachelor degree or higher
• 5% of US Households earn $200+ annual; 83% have a Bachelor degree or higher

It has been argued that the current generation graduating school is one of the most educated the workforce has ever seen, yet they are one of the most unemployable segments of the population. They struggle with unemployment rates in the double digit range. WSJ, Oct 4-5, 2014, reported on the unevenness of the job recovery citing the 16-24 year olds faced 13.7% unemployment; during the 2009-10 recession this group saw nearly 20% unemployment levels. While 13.7% shows progress it is still well above healthy levels and the long term impact of a generation that faces such harsh economic realities has yet to be seen. Are we sowing the seeds of a shrinking economy? Will this young generation be forever pessimistic about the economic possibilities? Much like the generation that came out of the Great Depression that saved for what they believed would be future bad economic conditions.

In conclusion, I hope that I have been able to make the connection between corporate wealth, wage stagnation, the erosion of the middle and lower class, and the impact on sluggish consumption. To reverse the course we are on will take heavy lifting from the Fed, IRS, and Congress. But in the meantime, and more importantly, it will take middle class and lower class workers to recognize that Corporate America is destroying the economy. We saw this at the turn of the last century when the Industrial Age produced the wealthiest barons, who exploited the American worker to their financial benefit. The government intervened and workers organized to demand better treatment.

I think I understand why Keynes' belief that interest rate cuts when the rate is near zero has little effect on consumer consumption and why the Fed's current monetary policy is failing to jump start consumer consumption. If working class individuals feel poor because their compensation is stagnating and future career prospects are dim while big parts of their wallet spend are going up (like rents and education), then the difference between interest rates at 3.75% vs 3.6% has little impact on working class disposable income. Net impact is a stalled consumer recovery. Keynes pushed instead for Fiscal Policy with tax cuts. In this case, I could see that a material change in the tax rate for the working class with a result in increased net disposable income, could in the near term impact individual consumption.

Wages are a critical component of the consumption model and in the current environment, explain why the recovery is stalling and government stimulus is not working. However, government can use Fiscal policy to make a near term impact and stimulate consumer demand. But longer term, companies will have to be compelled to raise total compensation and provide healthy career prospects for a growing economy. This is where the individual comes in to play a critical role in that shift.

As we are in the swing of the Digital Age, we need to think about workers organizing for fair pay and benefits that contribute to their wealth, the future of American companies, and the expansion of the economy. Companies that do a terrible job of providing their workers with opportunities to share in the expanding wealth of the organization, need to be called out by society for poor behavior. Perhaps their goods and services are boycotted. Perhaps their leadership is recognized much like Yelp reviews individual businesses. Social media and sites like Glassdoor offer marketplaces for ranking companies, CEO’s, and brands. And on the other side, positive public recognition should be given to companies with leadership that recognize the delicate balance of running a well-run organization with the need to provide fair opportunities for growth for their employees.