The Lame Blame on Short-Termism

There is a very silly notion being brought to you by the Aspen Institute Business & Society Program’s Corporate Values Strategy Group and what is admittedly a rather impressive list of names joining it. It is a call to end “Short-Termism” in the financial markets.  Imagine a long-term financial utopia where investors did not have to trouble themselves with the day in and day out wranglings of the stock market or the economy.

Imagine if quarterly earnings, monthly same-store-sales, quarterly or annual guidance, key turns in the demand cycle, interruptions or obsolescence of a business model and other issues were just able to be smoothed over.  Now imagine investing in this sort of a climate.  This idea sounds great on paper and probably looks great on economic models and charts that are the basis for the notion because it goes along with the current theme of thinking for the long-haul and doing what is best for everyone else.  The problem is that this is the most silly and perhaps dangerous notion for the public to embrace.  This is a path for investors large and small to get drummed, slapped, duped, discouraged and a few other things we decided not to print.

There are a lot of very impressive individuals who endorsed this idea.  It is also easy to see why these individuals would want tp shy away from “short-termism”…. John Bogle of Vanguard, who has been against ETF products taking away some of the longer-term community investing gains from mutual funds, is not surprisingly in his support.  Warren Buffett, who keeps maintaining that America’s brightest days are ahead and that things will all work out in time and who tries to maintain a time frame outlook of FOREVER, is for this.  As we continue to de-leverage and as we enter a jobless recovery that may take years; and as countries like Russia, China, India, Brazil, and a few others see leaps and bounds in their standard of living, ask yourself if America’s brightest days are really ahead… These countries are now experiencing what America saw from the 1950’s to the 1990’s.  America will still be the top of the pyramid, but that base is growing much larger than the peak.

The statement called “Overcoming Short-termism: A Call for a More Responsible Approach to Investment and Business Management” actually flies directly in the face of eliminating short-termism if you consider their points…. This has three leverage points to encourage “a renewed focus on long-term value creation and for addressing one part of market short-termism, shareholder short-termism.” The first idea is market incentives to encourage more patient capital through tax policy.  The second notion is alignment, to better align the interests of financial intermediaries and their ultimate investors.  The third is transparency, to strengthen investor disclosures.

The first notion of tax is a simple one to have lower taxes on longer-term investing.  Frankly, nothing is wrong with that on the surface.  That might not punish the short-termism and the idea that short-term capital gains are taxed as income rather than at a lower rate.  Frankly, whether that is fair is irrelevant because that already exits today.

Aligning interests of financial intermediaries and investors is also fine on the surface.  And ditto for transparency.  But there is a very silly notion in all of this.  The more transparent you make the market and the more companies have to disclose and the more all of our interests are aligned with each other only INCREASES short-termism.  If you are an investor that knows the economy is rolling over or that a new development may hit your investments by 40%, are you going to wait blindly for that to smooth out in a few years or are you going to sell and buy back in later?

There are a few key instances, albeit extreme ones, here that make the argument silly.  Despite the fact that these were fraudulent, there probably will always be some fraud in the market regardless of the penalty and regardless of the regulation.  Some are just too bent on cheating or are too hellbent on mischief.  The elimination of short-termism in these instances led to investors and employees of these companies being duped and left holding nothing but air.  In many cases it destroyed them.

• Billions of dollars were lost by investors in Bear Stearns and in Lehman, and many employees not tied to any of the problems saw their retirement wiped out entirely.
• Enron’s head liars told employees and the investment community that all was well and that they should buy more as the price dropped.
• Ditto at Worldcom.
• Tyco never recovered from its late-1990’s shenanigans, yet everyone wanted to believe.
• And Cendant…
• What about the great mismanagement of Adelphia as cable was still growing wildly.
• How is Sunbeam doing these days?

And now today, we have some very small financial stocks that are actually huge companies by the name of AIG, and two government sponsored entities called Fannie Mae and Freddie Mac.  Don’t worry, this all will smooth out through time.  Won’t it?  The good news is we are all supposed to be protected from this.  We have independent ratings agencies with great-sounding names like Standard & Poor’s and Moody’s.  Despite the notion that they managed to miscalculate the full house of cards, eliminating short-termism would be fine through time.  Right?  That is what this new “elimination of short-termism” would lead the minions of believers to think.  Those issues to need to be realigned, but it has nothing to do with short-termism or long-termism.

Jim Rogers, chairman, president and CEO of Duke Energy, said, “…it is vital that long-term vision rather than short-term gain guides economic decision-making in the decades to come…  We cannot afford to repeat the mistakes that led us to the economic damage currently surrounding us.  We hope the proposals here will help to focus the attention of business and investors on long-term performance.” It is probably easy for a CEO of an electric utility to tell investors that they should only worry about the long-term prospects of their customer base.   Go pull up a long-term chart on Duke and see how long-termism is working out.

Bill George, former CEO of Medtronic (and author of 7 Lessons for Leading in Crisis) said, “Short-termism is the root cause of the financial meltdown of the past year. To rebuild the US economy, we must restructure incentives around long-term sustainable performance.” Hang on a second…. THE ROOT CAUSE???? Hopefully, his book sold a lot of copies, but that is not sane.  If short-termism is the root cause then short-termism just got redefined to a system without regulation on lending requirements AND one with no borrowing limits, followed by a repackaging into creative financial instruments whose ratings and regulatory oversight were both on vacation, followed by a steady decade of buying homes (or multiple homes) and endlessly borrowing against them… Anyhow, this is a silly notion as this being the root cause.

There is one notion to consider here that does go more along with what these respected people are putting up.  As long as you can be certain that a company can withstand the long-haul woes and as long as you everything will be O.K. through time, then when things do get ridiculously cheap maybe you should buy and forget about for a long time.  And of course management needs to be aligned with investors.  Bad management should of course be replaced and poor practices should still be fixed.

For fairness, there are some notions here that do need to be adhered to that this group wants to address.  Systematic risk still exists in a dozen or so large institutions today.  Limits need to be placed on these firms so that one cannot drag down all, which technically does not yet seem to be the case.  It is a safe bet that lawyers and doctors probably don’t need to be day trading all day long, but they should also not have to lose endless amounts of money when they get nervous because of endorsing a sole aspect of “long-termism.”  And the goals of intermediaries and investors do need to be more aligned.  But that effectively has nothing to do with short-termism.

There is another notion here in short-termism’s elimination that might become a serious issue.  If everyone stopped looking at the stock market and at prices each day or several times a day, many more people would use that new found time to add to their hobby of watching sports and joining more fantasy sports leagues.  Do we dare ask how much casino attendance might rise?

JON C. OGG
SEPTEMBER 9, 2009