Living well is the best revenge

Buttonwood

Nov 15th 2005
From The Economist Global Agenda

Your columnist signs off, with some thoughts for the coming months on private equity, interest rates—and happiness

DO THEY really still call those things Dixie cups? The news that Georgia-Pacific, which makes them, has agreed to be acquired by Koch, a diversified private company, brings back to Buttonwood memories of dubiously diluted punch at high-school dances. But clearly the paper-products firm has more to offer than little disposable cups for the $13.2 billion-plus that Koch is prepared to pay. If the deal goes through, it will create America’s largest privately-held company, and contribute to the exodus of firms from public listing and scrutiny.

Looking back over the year—for this is the current Buttonwood’s last column before she moves elsewhere on the paper—four things stand out as having clearly dominated the financial landscape. The first is the private-equity phenomenon, of which the Dixie-cup deal is a sort of kissing cousin. The second is the extraordinary importance of American interest-rate policy. Oil prices and China will live to be discussed another time; but where are the first two heading?

Private-equity deals have been on the increase since interest rates were slashed in 2001, stockmarkets began recovering in 2002 and companies began stockpiling cash in 2003. Private-equity investors have spent about $130 billion buying firms in America this year and have another $100 billion or so in the kitty. In Europe, too, private equity is booming. This is largely, but not entirely, good news.

The classic private-equity investor, or consortium, buys a public company that is mismanaged or undervalued, takes it private, loads it with debt, restructures it, cuts costs, “turns it around” and floats it on the stockmarket again, paying shareholders a healthy profit. Household names such as Toys R Us, Hertz and Debenhams have all gone private. And the rewards, for some, have been spectacular: Kohlberg Kravis Roberts, for example, quadrupled its investment in less than a year by “flipping” PanAmSat. Others are not so happy. Thomas H. Lee has had to write off about half of the roughly $500m it channelled into Refco last year, and is now suing three executives of that bust futures broker for faulty accounting.

Mergers and acquisitions in general, and the private-equity transactions that have generated much of the business, have supported share prices during a year in which uncertainty over economic fundamentals might otherwise have pushed them right down. They seem bound to carry merrily on, with takeover targets in Europe increasingly in view and emerging markets not far behind. There is much to be said for the discipline and scope for creative destruction that private-equity takeovers provide. Vanishing from public sight allows a company to focus on long-term investment strategies rather than quarter-to-quarter pay-outs to demanding public shareholders, as Georgia-Pacific’s boss has pointed out.

But there are costs. One is that a large chunk of the economy is removed from full public scrutiny. Another is that private-equity deals frequently disadvantage bondholders, who are left with a reduced claim against the company’s assets while shareholders make out like bandits. Though it is not yet clear how the Dixie-cup deal will be financed, the cost of insuring against the possibility that Georgia-Pacific won’t be able to pay its debts more than doubled on news of the takeover, as bondholders prepared for loss. The firm’s share price, meanwhile, went through the roof, as investors contemplated the near-40% premium that Koch was offering.

A third cost is that share prices will become overheated as the private-equity mania sweeps the market. Standard & Poor’s says that in big deals worth more than $1 billion, acquirers are now paying eight times cashflow, up from six-and-a-half times a few years ago. Finally, because these deals typically teeter on a pyramid of debt, they are vulnerable to interest-rate increases. They will come unglued at a rate of knots if interest rates rise sharply, pushing down the stockmarket.

And further rate hikes there will certainly be, the futures market tells us. The price of money for future delivery assumes three more increases, of 25 basis points each—two before Alan Greenspan hands over the controls at the end of January and one more under his successor at the Fed, Ben Bernanke. Twelve such rises since June 2004 have taken the federal funds rate from 1% to 4% (not far below annual headline consumer-price inflation, which is on the rise).

Long-term bond yields broadly failed to follow suit for most of that time (Mr Greenspan’s famous “conundrum”). They have edged up recently, however, from about 4% to just over 4.6%, as uncertainty about the direction of inflation has grown. Just as historically low interest rates helped to inflate asset-price bubbles in housing and, it could be argued, in bonds, so higher ones are perhaps beginning to let the air out. Whether the bubbles are burst or are gradually let down will depend in large measure on whether Mr Bernanke and his team at the Fed get their interest-rate policy right.

On Tuesday November 15th, senators were grilling Mr Bernanke about his views on inflation, and about how he sees the trade-off (if any) between keeping inflation down and employment up. But more is at stake even than the health and wealth of the world’s economic powerhouse.
Capital markets—especially fixed-income markets—are becoming one around the globe.

Because interest rates in America have been higher than in almost any other developed country, foreign investors have been happy to hold American assets, the dollar has stayed stronger than it had any right to do, and the United States has been able painlessly to finance its large and growing current-account deficit. All that may now be up for grabs, especially if a dovish Mr Bernanke stops raising rates just as Europe and Japan begin to increase their own.

Against this background, Buttonwood cannot help feeling that financial markets are entering tougher territory. Slowing corporate-profits growth, rising inflation, rising interest rates, high levels of household debt, high energy prices—it doesn’t add up to a trouble-free saunter. Yet many are bullish. Merrill Lynch’s monthly survey of 290 fund managers with $945 billion of assets under management, out on Tuesday, shows them to be a sanguine lot. For the first time in a year, more money managers want companies to go for growth, investing more in productive capacity, than want them to return cash to shareholders. This suggests that they are banking on the continued resilience of America’s economy, as well as improved prospects in the euro area and Japan, rather than worrying about the things that preoccupy your columnist.

Don’t profit, be happy

So let us turn from financial gloom and doom, and consider briefly the point of it all. Does striving to make money make you happy? No, maintains James Montier, a strategist at Dresdner Kleinwort Wasserstein. A year ago he proposed a notion that shocked some financial folk: that money and happiness are not positively correlated. Now, in a fascinating note, he expands that idea, citing a host of academic studies on the point.

Those who value “materialistic” goals (wealth, fame, image) are less happy than those who value more “intrinsic” goals (personal growth, relationships, community). Happiness is achieved by progressing towards these intrinsic goals, not by attaining materialistic ones. And too great an emphasis on money can predispose you to various nasty psychological conditions, including attention-deficit disorder. Which, it must be said, makes Buttonwood view her hyperactive teenaged daughters in a new light—as budding capitalists rather than potential school drop-outs.

So for those who missed the dotcom boom in the 1990s, the housing boom in the 2000s and the hedge-fund and private-equity booms throughout, perhaps it doesn’t really matter: living well is the best revenge on those who made a fortune. On this note, and in the hope that several far-flung heads will prove better than one London-based one, your columnist now hands over this space to a team who will be weighing in from financial centres around the world, beginning next week. Good night and good luck—and I will miss your letters.

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