The Breakdown - Why Are Execs of Bankrupt Companies Being Rewarded With Millions?

Episode Date: July 15, 2020

Today on the Brief: A followup on Tesla, corporate earnings and PayPal’s crypto ambitions New COVID-19 shutdowns in California  Small businesses on the brink  Our main conversation: Bloomberg has reported recently bankrupt companies including J.C. Penney and Hertz had provided executives with more than $131,000,000 in bonuses.  On this episode of The Breakdown, NLW examines: The logic behind these bonuses Why that logic is stupid  How this sort of reward for personal failure in the wake of 2008 led to the rise of populism on the right and left  Why we should allow companies to fail  Why people’s sense that the system is a crony system isn’t wrong

We have 39 states around the country who have an increase in the number of COVID cases. We're seeing a return to lockdown in such populous states as California. We're seeing the end of these additional unemployment benefits in just a couple of weeks. And at the same time, $131 million in bonuses for executives of companies that have failed. This is how you lose an entire generation. this is how you get an entire generation to start thinking that maybe somehow, this system that has undeniably pulled so many people out of mass poverty is worth rejecting because it doesn't work anymore.

And it has the stink of cronyism all over it. Welcome back to the breakdown, an everyday analysis breaking down the most important stories in Bitcoin, Crypto, and Beyond. This episode is sponsored by The Breakdown. bit stamp and crypto.com. The breakdown is produced and distributed by CoinDesk. And now here's your host, NLW. What's going on, guys? It is Tuesday, July 14th, and today we are talking about how bankrupt company executives have scored 131 million dollars in bonuses, even as their companies fail. Before we get into that, However, I want to thank you guys. Last week, I mentioned that it was really helpful to me when

you rate and review the show on iTunes or Spotify or wherever you listen. And I saw a bunch of new reviews come in that really, really, really helps. So thank you again. And if you haven't yet and you have the time, I super, super appreciate it. So thank you again. With that, let's turn to the brief. First up on the brief, a couple of follow-ups. Firstly, yesterday's story about Tesla was clearly interesting to you guys based on the response that I'm seeing and the downloads that I'm seeing. So I want to give voice to one perspective that I didn't get very deep into on the show. Dimitri Kofinas, who is the host of Hidden Forces, commented on the thread where I was asking people to describe Elon Musk's and Tesla's success in three words. And he wrote this.

As far as the darker case for Tesla is concerned, you were leaving out accusations of accounting fraud and stock price manipulation by the CEO. The macro forces you explore are absolutely important, but they don't explain why a stock that many successful value investors and well-regarded journalists describe openly and in private as a fraud is now the 10th biggest U.S. stock by market cap. The more this stock moons, the more attention it brings to the company, its accounting, its practices, and claims of stock price manipulation by insiders. Unless the government nationalizes it or Elon gets China to buy it, I imagine that we will eventually learn the truth.

At the risk of waiting too far into the Tesla-Tesla-Q debate, let me know if this is a subject that you'd like to see a guest speak to, someone who has much more experience and perspective than I do, either on the pro or the con or maybe both. So let me know, hit me up at NLW, and we can follow up from there. A second story building off of previous themes, Delta earnings. So I said yesterday that it was earnings week and it has not disappointed and the terror that we saw is in some places even worse. Delta earnings, they lost 91% of revenue year over year. And most importantly, and the thing that

has people really sitting up and taking notice is that the CEO is saying that demand isn't coming back because people are still scared of travel, right? They're still scared of COVID. They see this resurgence in COVID cases and they're not travel. I think this is incredibly important because our entire discussion around COVID-19 shutdowns has sort of avoided the fact of human agency and how people are going to change their habits regardless of what the government tells them to do. What's clear here is that demand destruction does not care whether the shutdown is mandated or voluntary.

And in the case of flights, what we're seeing very clearly show up in the numbers and the analysis is that people aren't willing to travel in that way. We'll come back to COVID-19 in our next topic on the brief, but first, another follow-up from even farther back in June. In June, Coin desk reported that PayPal was getting into crypto, and this was a big news. Now, there were some people who were skeptical and said, hey, it's just a story, it's reported, it's not confirmed.

Well, it came out today that PayPal had actually confirmed in a letter to the European Commission from March 20th that it had taken, quote, unilateral and tangible steps in the crypto space. So it does seem that we are going to see some amount of PayPal getting involved in crypto and Bitcoin. BitStamp is the original global cryptocurrency exchange. Since 2011, BitStamp has been the preferred exchange for serious traders and investors, trusted by over 4 million customers, including top financial institutions. BitStamp is built on professional gray trading technology.

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as they've just waived the 3.5% credit card fee for all crypto purchases. What's more? With crypto.com's MCO Visa card, you can get up to 10% back on things like food and grocery shopping. When you buy gift cards with the crypto.com app, you can get up to 20% back. Download the crypto.com app today and enjoy these offers until the end of September. I said that those were follow-up stories, but frankly, my next one could actually seem like another follow-up story as well. So second on the brief today is COVID lockdowns returning. Gavin Newsom, the governor of California on Monday, ordered that every county in the state had to close bars,

indoor operations of businesses like restaurants, movie theaters, and museums. In addition to that, he's also closing indoor operations for fitness centers, worship services, personal care services, malls, offices, hair salons, and barbershops for 30 counties that are on California's monitoring list, which together represent 80% of the state's population. So effectively, we are back in a lockdown situation in California. With the only difference being that there are a small number of counties representing 20% of the population where there are some of those basic services that are still available, and additionally, some of these businesses are going to be allowed to operate outdoors.

California was held up early as one of the models for COVID containment. The San Francisco Bay Area in particular went into lockdown much before even New York did, and because of that, they didn't see the sort of spikes that New York saw. Since then, however, it has been a different story. And as the numbers climb, you're seeing basically, again, I've called it the Groundhog Day economy before, and here we are. Business shutdowns mandated by the government. We keep talking about a second wave in these theoretical terms,

or at least we were talking about a second wave in theoretical terms for weeks and weeks and weeks, when all along what we should have been doing is focusing on the first wave that never finished, and thinking about how to avoid a second wave of shutdowns and layoffs, which is where we are now. Which brings us to our third point on the brief, our third topic, small business shutdowns. This is from a feature story in the New York Times and is just another reminder of the economic devastation happening. Small business is 44% of all U.S. economic activity, so this is not a small sector despite the name. According to Yelp, 66,000 businesses have

closed their doors since March 1st, and more concerning, because we knew that it was bad in March and April. But more concerning is that between June 15th and June 29th, permanent closings are happening at a higher rate than the previous three months. Permanent closures increased 3% overall, which represents 14% of the total closures since March. So basically the point is that these numbers are climbing. What's more, a Harvard research study suggests that the numbers are actually closer to 110K. And of course, again, we're now living in a situation where 39 states have a growing number of cases of COVID. And the reason that I wanted to bring up the Delta earnings piece and the comments of the CEO

is that I feel like a broken record, but we have this conversation as though it's somehow political and you can just put economic outcomes on the one side and health outcomes on the other, and you simply can't. When people are scared of this disease, and for as much as people have tried to say it's nothing, we still don't know anything about this thing. We're still learning what it actually does in terms of long-term impairment and damage to lungs. And what's very clear is that it's nasty and you don't want to get it. And when you have that situation, it doesn't matter if everything were open in the world.

People are going to change their habits and it's going to have a negative impact on businesses no matter what. This is not an advocacy for very overarching shutdowns or anything like that. It's just a reminder that we don't get positive economic outcomes really until we deal with health systems as well. But with that, let's shift to our main conversation and something which is just sure to enrage so many of you, and I think rightly so. Let's talk about bankrupt company executives and their bonuses. This conversation is nominally about a specific set of bonuses that have happened during the COVID-19 crisis and the ensuing economic crisis. However, it's much more about a larger narrative battle around the notion of the notion of the crisis.

capitalism itself, and that's really the stakes of the conversation that I'm interested in and why I think this is such an important conversation to have. There is a major rejection of the notion of capitalism happening, and many people, I think, would argue that the capitalism that people are rejecting is not really the type of capitalism that has achieved such incredible amounts of human progress, but that's sort of the point. The rejection of capitalism that's starting to happen in American society comes from a sense of people being convinced that not only is the system not designed to help them, but that it's actively stacked against them. There is fundamentally something different between I don't like equal opportunity for all,

and there is no equal opportunity for all. This is clearly stacked against me because I am not part of an elite economic class. Since the great financial crisis, these moments of economic turmoil have, I believe, validated people's concerns that the system is rigged against them rather than appeased them, rather than alleviated them. It started with seeing no one punished for what happened in the housing crisis, despite how many people it absolutely destroyed, right? And it has continued when corporations are given basically a limitless backstop by the Fed and by the government immediately deployed very simply and quickly when they got in trouble, but weeks are spent squabbling on the details of the payout for regular citizens.

And when you see the PPP program and things like it benefit people who are closest to government and have the biggest budget to go get it and the most privileged relationships with the banks through which it was distributed rather than the small businesses who need it most. But this sense that something is fundamentally off and stacked against regular people is also confirmed when the people at the top of companies not only aren't punished for their failures, but are actively rewarded and given bonuses as companies go into bankruptcy. Here's what happened. This comes from a story in Bloomberg today. And the first couple lines say it all. Before the bankruptcies came the bonuses. 10 million at JCPenney & Co. 25 million at Chesapeake Energy

Corporation. 1.5 million at Hertz Global Holdings. That's how much was promised to executives only weeks or in some cases days before bankruptcy. Of the 100 or so major companies that have filed since the coronavirus shutdown began, 19 of them have committed to paying a total of 131 million in retention and performance bonuses, both before and after filing, a number that's poised to climb as a record number of Americans are jobless and the pandemic spreads. So you may be wondering, what is the logic? How can this be possible when it seems like such an obvious thing not to do? Well, the stated logic has to do with consistency and stability in transition, right? These companies, they argue, are trying to preserve knowledge and to have budget for experts

from within the company and consultants to help as they go through a bankruptcy process to get restructured. The problem with this logic, however, is this. It presumes almost that bankruptcy was just a thing. that happened rather than the result of a specific set of decisions that led to bankruptcy. Instead of kicking Nero out, you're paying him to stick around and keep fiddling. There is another logic as well that wasn't necessarily the case in these bankruptcies but is worth noting, and which Matt Lovine has written about in the context of Deutsche Bank,

which is that if you're trying to recruit top talent to write a sinking ship, giving these sort of parachutes might make sense. He sums it up like this. He says, one, working in troubled businesses is less fun and rewarding than working in good businesses, so they have to pay more. But two, the troubled businesses are the ones that can least afford to pay more. My issue here, again, is just the fundamental logic underlying it. If a company is so far beyond redemption that you need to give these incredible golden

parachutes for an executive to come in for a year or 18 months only to fail spectacularly, that means that you are going to fail anyways and just let the thing die. So here's an alternative take. Sure, there are exogenous factors and black swan events that have shaken markets, but ultimately every company has leaders who should be accountable for the strategies that they implemented. If those strategies made the company so brittle and unresilient that they couldn't withstand this, why would you reward them and effectively bribe them to stick around? Why, even if you were a shareholder in those companies, would you want the same talent, quote unquote, that caused the problem to pretend to be there to fix it? It's just not going to work. It's the literal opposite of what should happen.

And people see this, and of course they're losing their minds. Thousands of jobs gone and the CEO has paid $4.5 million to stick around. Many times people sense of unfairly. in the economy can be manipulated and unfairly inflamed. This happens all the time in the media, happens all the time with politicians. It's part of why, again, capitalism is having such a hard time. But in this case, I think that the frustration is understood. You would have thought that after 2008, the failures of which led to the Tea Party and then Donald Trump, Occupy Wall Street, and then Bernie Sanders, that we would have learned that you can't have no accountability for people at the top, whether it's the top of companies or the top of governments. But we haven't. We haven't learned that.

And this is the result. And people are just going to get angrier and more likely to reject capitalism as an idea because why wouldn't they when they see these things that aren't supposed to happen? Companies are supposed to be able to fail. And failure doesn't mean rewarding the people who help that failure come about. Of course, there is a more compelling counterpoint to me, which is that at least these companies are going into bankruptcy. There's a larger issue right now that has even bigger implications in my mind, which is that companies are not being allowed to die. Part of the very notable thing about the Fed and the government's response to this crisis

is that it wasn't even a debate about whether government was going to come in to backstop every industry. It was just assumed. And the manifestation of that in this case has been things like the special purpose vehicle, through which the bed has been able to actually get involved in markets in a much more direct way and buy up everything, including junk bonds. The ability for corporations who don't have good credit ratings to sell their bonds and their debt to the government is a price-warping feature of the markets. It means that companies that should go under are not going under. Now, I am hardly the first person or the only person talking about this.

let's listen to Chimoth Palahapatia, the social capital investor who dropped this absolute bomb earlier in this year when he was talking about airline barrelouts on the cable news. Are you arguing to let airlines, for example, fail? Yes. Why? I mean, how does that make sense in the broader scheme of the economy? Because it's not, because when you look at what it means, this is why I'm saying, like, this is a lie that's been purported by Wall Street.

When a company fails, it does not fire their employees. It goes through a packaged bankruptcy, right? If anything, what happens is the people who have the pensions inside those companies, the employees of these companies end up owning more of the company. The people that get wiped out are the speculators that own the unsecured tranches of debt for the folks that own the equity. And by the way, those are the rules of the game. That's right, because these are the people that purport to be the most sophisticated investors in the world.

They deserve to get wiped out. Here's another clip from earlier this year with Mark Yusko from Morgan Creek Capital talking about zombie companies that can't even afford to service their debt, much less pay it back. We've kept the stock market elevated by doing, I think, ill-advised things with interest rates. I think, you know, cutting interest rates as quickly as we did back in 2015, 16, 17, was ill-advised. I think we should have been, you know, raising rates and people's, oh, but we would have caused a recession. What's wrong with recessions? Resessions are actually good. They cleanse the system. We get rid of the weak companies. That's how capitalism is supposed to work, right? We're

supposed to allow the weak to go away. We're supposed to encourage the strong to survive. We're supposed to give the tools for all companies to compete and build markets. Instead, what we've got is cronyism today, whereas if you're well connected to the president or the administration, you're going to get a handout and you're going to continue to exist. And the stat I keep going to is zombie companies. 38% of the S&P 1500s, so the biggest 1,500 companies, 38% can't service their debt with their current EBITDA. Forget paying back their debt. They could never do that. they can't even service their debt. So interest rates have to stay low. They have to be zero.

And they're going to be zero for a long time because of what I talked to about is the killer D's. Demographics, bad demographics, too many 65 to 85 year old people who don't spend a lot. They like bonds, not equities. Then you have too much debt. And when you have too much debt, you can't afford to service it. So you've got to have low interest rates. And then we have deflation. And deflation comes from, you know, basically competition is one, but also just an abundance of caution and hoarding. And again, that's why I think the response to the crisis is going to cause a more deflationary environment because people are going to hoard and not spend. The point here is that this isn't capitalism. People are calling bullshit because it's a calcified

system that prevents only the pain at the top. Darius Dale from Hedgeye Research, a stalwart of this economy, says, why does everyone hate socialism when the income support is for poor people struggling to provide for their families? When it's for rich Wall Street guys and corporate execs, it's heralded as brilliant and necessary to stave off a crisis. A crisis in what? Missing yacht payments?

You know something has shifted when this is the rhetoric from the mainstream financial world as well. But we still have an issue of politics. will and an unwillingness to upend the apple cart and let companies fail. Companies have to be able to fail. Bloomberg Economics published a piece this morning called Creative Destruction, a risky idea. Nobody wants to try. Sahel Bloom, an investor from California, wrote, Bankruptcy is a feature, not a bug of capitalism. It encourages creative destruction and the efficient allocation of capital. Central banks are crushing this critical feature by zomifying companies.

and stalling out the natural regeneration process of the economy. What's more, this is happening right as people's benefits end. So let's talk about what's really happening right now. We have 39 states around the country who have an increase in the number of COVID cases. We're seeing a return to lockdown in such populous states as California. We're seeing the end of these additional unemployment benefits in just a couple of weeks. And at the same time, $131 million in bonuses for executives of companies that have failed. This is how you lose an entire generation.

This is how you get an entire generation to start thinking that maybe somehow, this system that has undeniably pulled so many people out of mass poverty is worth rejecting because it doesn't work anymore. And it has the stink of cronyism all over it. If it sounds like I think the stakes are high, it's because I do. I believe this is one of the biggest narrative battles, and it shouldn't be happening just in politics. It should be a discussion that we're all having, that we're all contributing to, and that

we're actively shifting the way that we respond in this crisis right now. A little more intense this one, guys, but I think it's important, and I'm glad you stuck around to listen to it. So until tomorrow, be safe and take care of each other. Peace.