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March 28th, 2013

The Fed Is To Liquidity As Pez Dispenser Is To…

The Fed is to Liquidity as Pez Dispenser is to Candy. This analogy appeared on the 2012 SAT verbal test. It is intriguing to watch our credit crisis of 2008-2009 be “solved” by pushing the price of credit near zero. Financing markets have reached the almost comic point where debt re-pricings are announced the same week as the fundings of the original issue. Debt multiples of EBITDA now equal or exceed the legendary levels of 2007. Our guardrail-to-guardrail credit climate is a large contributor to the financial cycles we witness every few years. Cheap credit serves as opium to the PE masses. Rather than focus on what is a sensible debt level for a company or an industry the prevailing attitude of accepting credit is Edmund Hillaryesque in philosophy. Much of the internal rate of return created in the 2003-2007 period was due to the kindness of credit not to improving companies. The post-2008 decline in performance was heavily influenced by the absence of credit as strong enterprises could not abide their substantial debt loads, nor could they buy time through additional credit. Post depression era children learned how to prepare for a “rainy day.” Decades of reliable easy credit have obviated that lesson.

In December 2012, all forms of media or politicians screeched like Chicken Little for the dire need to avoid crossing the “fiscal cliff”, a trumped-up metaphor meant to describe the confluence of increasing payroll and income taxes with mandatory spending cuts. Despite the gnashing of teeth about the consequences of the fiscal cliff it is useful to examine the actual consequences to help us better gauge how many sodium chloride grains to apply the next time an official in D.C. announces a crisis. In late December, income and payroll taxes were raised; mandatory spending cuts were deferred two months and then were enforced. The fiscal cliff was driven over, but no skid marks were seen. No apocalypse ensued. The media failed to even report the cliff as crossed. Politicians did not acknowledge it. The sun still came up the next day.

No matter where one falls on the political spectrum with respect to taxing or spending it is widely agreed that the collection of taxes on earned income is both necessary and reasonable to sustain government, yet federal policy paradoxically emphasizes excluding taxpayers from participation for reasons ranging from policy incentives to simply doing the bidding of campaign contributors.

Problem solvers ranging from Teddy Roosevelt to Willie Sutton have recognized one gets the maximum effect by addressing the largest players that have the money. Yet our Federal approach has been the opposite. General Motors, one of our largest enterprises, earned $5.6 billion last year, but paid no federal income tax because the law was “suspended” when they were bailed out, enabling them to retain billions of net operating losses, losses a legal bankruptcy would have eliminated, and use those losses to avoid paying income taxes. Kinder- Morgan, a large oil and gas company and many of its peers are established as master limited partnerships meaning neither they, nor any company they acquire, pay any federal income tax. Kinder- Morgan earned $2.24 billion in 2012 of net income and paid no income tax. Each of these companies are fully in compliance with laws that have been written to either benefit the company or the industry to the detriment of the system. It is perhaps politically fulfilling to spout shibboleths about “loopholes that need to be closed” etc., but here are sources of “real money” (See Everett Dirksen) that are making no contributions to the system. The same leaders attacking loopholes created sinkholes for these companies. A market infusion of common sense into the process of solving the fiscal issues would be a great substitute for the mud wrestling we are currently watching. For private equity, stability and clarity of tax rules would be a windward anchor for investing as capital planning and hiring at portfolio companies would be subject to less caprice.

I’m Rob Morris and I approved this blog.

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