In the days when corporate downsizing was all the rage, Wall Street took a lot of flak for judging companies too harshly and setting the bar for corporate performance so high that executives felt their only option was to slash payrolls. Or, alternatively, Wall Street was praised for its relentless focus on the bottom line and its insistence that corporations become more productive and more profitable. Either way, the point was that investors were taskmasters, Marine drill sergeants whipping corporate America into shape. Now this was never as true as Wall Street's critics or its supporters wanted it to be, but in any case, it is somewhat beside the point now. A quick glance at the Street today makes one thing clear: Boot camp is over.
Take Planet Hollywood. This is a company that: 1) has been a consistent money loser for almost its entire existence; 2) has constructed an entire business around the highly questionable proposition that people will overpay for mediocre food in order to sit next to the motorcycle that Bruce Willis rode in Pulp Fiction; and 3) is spending large sums of money to pay an executive to live in Hollywood and build relationships with up-and-coming stars. This is a company, in other words, that should not exist, with "should" implying nothing about the morality of the burger/movie star alliance and everything about its business prospects.
Though it has seen its stock price hit hard--justifiably--by its most recent woes, Planet Hollywood is forging ahead with plans to build a giant hotel in Times Square that will feature 564 "Hollywood-themed" rooms and suites. ("You can sleep in a bed just like Linda Blair's in The Exorcist!") In order to build this hotel, Planet Hollywood announced last week that it will raise $250 million by selling seven-year bonds. And Bear, Stearns, which is handling the deal, is confident it will be able to sell them. One analyst told the Wall Street Journal, "I think it's going to go all right. After all, it's only $250 million."
Ah, yes. What's a couple of hundred million dollars among friends?
Or take Pan Am. This isn't the Pan Am whose old carry-on bags are all the rage with urban hipsters. This is the tiny Florida airline that owns the Pan Am trademark now, which went bankrupt last month but now looks as if it's going to be taken over by a soccer team owner from the former Yugoslavia. Pan Am has never--never, that is--turned a profit, and when it filed for Chapter 11 it had $50 million in assets, including the value of the name, and $147 million in liabilities. If Pan Am were a dog, it would be put to sleep. But the odds are that it will be resurrected and chew up some more capital.
You can tell hundreds of similar stories about the real estate market, where a huge construction boom in suburban office space continues, even though no one seems to know how the space will be filled in an economy growing as moderately as ours is. And still more about the market for initial public offerings, which, after a mild slump last fall, is booming again. We seem to have reached the point where any company that wants to go public can, even if it has never reported anything remotely resembling earnings. And if it's an Internet company going public, fuhgeddaboutit. Go ahead and buy the Ferrari.
As Slate's Michael Lewis has pointed out, Silicon Valley now offers the curious spectacle of capitalism with too much capital. But the same spectacle seems to be on display throughout the country. Certainly since the Asian economies collapsed, enormous amounts of foreign capital have poured into the United States, even as domestic capital has been more likely to stay at home. Americans are not saving significantly more. But the flood of money into mutual funds--where all the money is turned into investment capital, as opposed to savings accounts that require a percentage to be held in bank reserves--has given fund managers more money than they know what to do with. With the market on a seemingly unstoppable rise, fund managers feel the need to stay fully invested, which means that eventually, even struggling companies will come back into favor. There's just too much money out there for them not to.
There are, though, a couple of problems with this picture. First, the concept of "too much capital" is a kind of macroeconomic impossibility. If the supply of capital truly exceeds demand, the rate of return will drop until the supply shrinks. Second, the idea that too much capital can be a bad thing makes little sense in a world where investment is the key to economic growth. So the image of lovelorn investors chasing standoffish borrowers can't really be right, at least not for the economy as a whole. And, in fact, there is no shortage of would-be borrowers. Consumer debt is nearing all-time highs. The junk bond market is booming, with companies issuing $109 billion in junk bonds last year. In the subprime loan market, people pay interest rates of more than 20 percent and risk their houses to get access to capital. And although government bond rates have dropped over the past two years, the real interest rate is still high today relative to the 1970s. There is a demand, then, to match the supply. The only problem is that this may not be such a good thing.
What an economy really wants, after all, is not more investment per se but better investment. It wants capital to flow to companies that will create value--not in the form of a rising stock price but in the form of more goods for less cost, more jobs, and rising wages--by enhancing productivity. In the absence of an omniscient central planner, though, the way to get better investment is to get more investment. The Planet Hollywoods are the price we pay for the Intels and Gillettes.
In the short term, though, it's possible to get too many Planet Hollywoods and not enough Intels. This is why Japanese banks continued to pump money into overbuilt Southeast Asian real estate and Korean "chaebols," and why a third of all the junk bonds issued in the late 1980s ended up defaulting. Markets get caught in self-perpetuating cycles of undue optimism and hysterical panic. The consequences are never pretty, which is what's so troubling about the ever rising stock market, the booming junk-bond market, and the real estate boom.
This is an economy, after all, that is doing well but not great, that is still growing slowly in historical terms, and that has still not shown significant evidence of a real boom in productivity (with the notable exception of the manufacturing sector). Yet investors are acting not simply as if there were only sunny skies ahead but also as if every company, every investment, were going to enjoy the warmth of the sun. And this means that capital is not playing its necessary disciplining role. You can't fuel real economic growth with indiscriminate credit. You can only fuel it with well-allocated, long-term investment. Unfortunately, that's a principle that doesn't seem to be at work in a capital market that just can't say no.