How social media became authoritarian

Justin Kownacki is one of those guys whose writing appears infrequently, but is always worth the wait. Today, he published a piece that is maybe in the top five most important things I have read this year. Doing some soul searching about the state of technology, he concludes that we have squandered the potential for social media to change society because we were so hungry for validation from authority figures. This is from his piece, “How Social Media Destroyed Itself.”

Those of us who were busy pioneering the digital formats we now all take for granted believed then that our newly “democratized” means of media production would change media as we know it. We presumed that audience tastes would change with the new formats, and that traditional media channels (TV, film, radio, publishing) would need to adapt to our way of life.

Why? Because we were ahead of the curve. We saw the potential of new forms, and we thought we’d be able to harness them faster than the “dinosaur” media conglomerates we derided.

We were right about our own speed, but that’s because most of us were young and childless then, so we had nothing but time to tinker with these new toys. We could afford to spend days and weeks and years perfecting our videoblogs and podcasts and other labors of love because we still felt like the underdogs who had something to prove to the dinosaurs we were outfoxing.

We claimed we wanted to plant our flag in their territory… but we were only being half honest.

Problem is, we also courted those same dinosaurs, because we wanted them to play in our sandbox. We wanted the validation of their attention and their money. We wanted them to acknowledge that we were right, and to reward us with seats at their table. We just thought we’d be the ones who’d be able to set the new rules, just because we were there first.

Boy, were we wrong.

staring-at-phonesI see this phenomenon everywhere these days. People have more capacity for freedom, self-government and justice than ever before. These technologies do, in fact, have the potential to rewire how society governs itself. This is also why dictators have been so motivated to co-opt these forms of media, and at the first sign of trouble, shut them down.

But in truth, their fears are overblown. Most people today desire authority figures to live above them, even when they are comically unable to play the part with any competence. Dull-witted, venal legislators, corrupt banking syndicates, absurd Supreme Court justices, plus lazy, shallow journalists to bleat press release quotations from their positions of unearned credibility: We live under a regime of some of the least-talented authoritarians in history.

Yet rather than challenge them in a meaningful way, by ignoring their supposed authority and organizing society based around our own communities, we outsource our civic life to powerful interests. The status quo is preserved, and we can go back to our sportsball.

It wouldn’t matter how many Internets you put in front of people who neither understand nor desire the rights and obligations of free citizens in a Republic.

On a final, happier note, that freedom remains right in front of us all. It is just a question of whether we pick it up and do something with it.

Cancellation of Transition Economics

Greetings all,

First, the news: Ticket sales and discussions with sponsors are insufficient to continue with with Transition Economics 2014. All registration is hereby closed, and I am contacting the existing ticket holders personally to offer a full refund.

Second, some analysis: In my initial research into the market demand and urgency around such an event, I misinterpreted both, particularly and ironically here in St. Louis. While I continue to believe that structural factors will push talent and capital here in the near- to mid-future, largely because of the economic contradictions found in major neoliberal cities, that does not, unfortunately, assure the viability of an intellectual event such as the one I have proposed.

Finally, a word on urgency: In Washington, DC I was the managing director of a consultancy called Competitive Futures. The firm provided trend analysis, forecasting and scenario planning services for C-level executives at Global 1000 corporations and government agencies around the globe. Our work in the 2000s had us examine the implications of climate change, surveillance technologies, talent management and more, but the one issue that loomed menacingly on the horizon was the extraordinary contradictions in the financial sector due to unprecedented mutations of the housing market. Over time, those contradictions gave way to clear evidence of widespread fraud and an impending collapse. While we worked for consumer products companies, defense contractors, heavy industry and government ministries, we took every opportunity to shift the conversation to a financial crash we saw as inevitable in the latter half of 2008. Once we discovered how many financial products had been sold around underlying assets that were grossly overvalued, it seemed all but decided that the swing in the interest of adjustable rate mortgages in late 2007 would soon give way to a breakdown in the US banking industry. Our prediction was to see one bank fail in early 2008, and a historic collapse in late 2008. [Continue reading]

The bigger story of how private equity corrupts

yves-smith-naked-capitalismThe other day I was talking with a friend of mine who does intelligence for large corporations. We were discussing my latest on Guitar Center’s subprime bond hustle and she said, “You should talk with Yves Smith from Naked Capitalism – her work on private equity suckering pension funds like CalPERS is a lot like what you are uncovering.” Six hours later, I got an unsolicited email from Ms. Smith, with whom I was not acquainted, asking if she could cross-post my “How to get beyond the parasite economy” in its entirety.

The piece is now up on her blog, one of the top economics sites in the English-speaking world, with some nice additions. I liked her intro:

Reader Lance N pointed me to an article on private equity by Eric Garland, a trend maven. I must confess that I’m skeptical of that breed (too many of them rely on devising clever buzz phrases to describe leading edge conventional wisdom), but even people who knew the transactions Garland discusses in his post were impressed with his grasp.

Garland uses the story of how the tender ministrations of Bain Capital pushed the music big box retailer Guitar Center into the bankruptcy-equivalent of a restructuring as a window into, as he puts it:

“…how a small number of citizens can subvert every product made, every job offered, and every purchase decision – and how we can regain control of our lives, starting with the musical instrument industry.”

We’ve been focusing on the investor side of private equity in our recent posts because its influence and its ability to maintain unheard-of levels of secrecy depends on the belief that long-term investors like pension funds can’t afford not to invest as much as they possibly can, after allowing for liquidity and diversification needs, in PE, because it is widely believed to deliver superior returns. But life insurers who also have long-term investment horizons, are for the most part not large investors in this strategy, because the rating agencies regard it as too risky for them to tie up all that much capital in it (as in they need more liquidity). So if the ratings agencies discourage investment in PE, and life insurers manage to do without it, pray tell why is it perceived to be necessary? The answer, of course, lies in pricing, or more precisely, the aggressive return assumptions that are widely used in defined benefit plans.*

And while we continue digging into the details that the private equity industry has worked so hard to shroud in secrecy, it’s important not to lose sight of the real economy consequences of this well-orchestrated wealth transfer scheme.

First, I’m especially pleased that Ms. Smith is skeptical of my ilk. God help me if it still said “futurist.” But in my mind, the work had better transcend the titles, and I’m glad if they think it did.

As to the wealth transfer scheme: It looks less well-orchestrated every day.

On Indio Radio talking about building wealth the right way

It’s not every day that I walk into a radio interview and walk out an unabashed fan of the hosts and the program. My colleague Dan Reus from Openly Disruptive hooked me up with The John & Kane Show on Indio Radio here in St. Louis which does two things extremely well: play cool tunes and have surprisingly deep discussions about local economics. They do what radio is supposed to do, but doesn’t, so they do it, and it’s cool. Make sense?

My part starts at minute 26, but I recommend the whole program because, no kidding, they have great music and interviews.

I have a great time talking about going pantsless at work, why Occupy Wall Street never protested at Steve Jobs’ house, how much a quadrillion dollars of derivatives really is, and why economic development will happen from the grass roots, up.

Have a listen, and I hope you become as big a fan as I have.

How to get beyond the parasite economy

It is the middle of the night between Friday and Saturday, and I am thinking about Guitar Center.

parasite economyIf the above sentence appears strange to you, we are in the same boat. I do not know how bizarre and random your life appears to you, but mine is definitely some sort of mysterious fractal. About four months ago, I was elected by the Internet to the position of United Nations Ambassador to Guitar Center. I made a simple, off hand comment about how I was surprised that the company was doing poorly despite all of the gear I bought there, and then the two separate streams of my life – music and business analysis – slammed together. Thousands of people began conflating my life as a somewhat decent bassist with my expertise in strategic forecasting. Now, with every development in the musical instrument industry, I have a flurry of emails and phonecalls from all levels of the business. It is surprising, fun, and as I now discover, significant of a much larger story.

I never paid too much attention to the musical instrument (MI) business in my profession of strategic analysis; it simply does not represent enough cash flow to have significance in national economies. For example, the global MI industry is around $13 billion a year. I used to do high-level analysis of the market for antipsychotic medication, something most people know nothing about, which has the same annual sales revenue in the US alone. My only interest in musical instruments was for pleasure, so when I was suddenly elected The People’s Analyst of the Industry, (current salary: $0) I had a lot of catching up to do.

After much deliberation, I see the MI industry as a microcosm of every other problem in the global economy. To borrow from the analysis of Thomas Piketty in his brilliant “Capital in the 21st Century,” the monied interests of society have expanded their reach such that they can concentrate and dominate almost every area of human endeavor, and the deleterious effects are now evident to all.

In the end, this story isn’t about a big box music chain, but how a small number of citizens can subvert every product made, every job offered, and every purchase decision – and how we can regain control of our lives, starting with the musical instrument industry.

News on Guitar Center’s finances – and what it means

If you are a regular reader you know that I have been keeping close tabs on the finances of the Westlake, CA-based retail behemoth. Had their executives never made visits to my Facebook page, I never would have thought that it was worth any research, but my experience is that if you see unusually emotional behavior from technocrats, a bigger story lurks. Confirming my instincts, a perfunctory analysis of the company’s finances showed gargantuan debt structure and a liquidity crisis (also known as being broke.) Because the company is/was owned by a holding company created by private equity firm Bain Capital, it was impossible for me to deduce exactly the structure of their ownership and debt covenants. To summarize the story for those who don’t have a taste for corporate finance, just imagine you had $65,000 in credit card debt financed at a crappy rate, and that you made around $80,000 a year. Things on the horizon would look bleak, and you would be forced to either change your lifestyle or declare bankruptcy and get a fresh start. As such, irrespective of the contradictions inherent in the big box model and the general draining of wealth from their supposed middle class customers, I figured that these guys would be lucky to make it a few more months.

The other shoe dropped a few weeks back when the main holder of Guitar Center’s debt, Ares Capital Management, stepped up to take ownership in place of future bond payments. The business media reports this arrangement as an alternative to bankruptcy, which sounds about right. I expected as much, because this model is in a slow death spiral, and the only way to extract the millions of dollars owed will be to run the Bain playbook, only harder and faster. As such, my forecast is for the $500 – 600 million of inventory to be sold at cheap prices while employees and vendors get squeezed for every nickel. This is no different than the past six years of company management, according to my sources, it’s just that this time, there is a time-sensitive goal – to get the most money out before the whole thing collapses.

The latest update: More details about the Bain-Ares handoff came out around 48 hours ago. They revolve, unsurprisingly, around a restructuring of senior PIK (payment in kind) notes that offered money up front with huge balloon payments on the back end. Under the current deals, GC would owe over $950 million in 2017 alone, an amount that would be impossible to pay off. I was skeptical about any form of refinancing, since the ratings agencies have compared their debt to scratchers tickets. But Ares is charging ahead and is preparing a bond offering to the market despite all the hullaboo:

Westlake Village, Calif.-based Guitar Center is further revamping its capital structure by launching an offering of $940 million in senior notes that will be used to repay debt connected to its buyout.

The proposed offering will include $615 million in senior secured first-lien notes, which Taylor said she expects will price around 6%, as well as $325 million in senior unsecured notes, which Taylor expects will price around 8%.

Moody’s rated the proposed secured notes at B3 and proposed unsecured notes at Caa1 in a March 25 report.

Guitar Center would use the proceeds from the notes offering to repay a $675 million term loan that backed its Bain buyout. The term loan, which is priced at Libor plus 600 basis points and matures on April 9, 2017, had $617.5 million outstanding at Sept. 30, according to a regulatory filing.

Guitar Center would also repay a portion of its $375 million in 11.5% senior unsecured notes due Oct. 15, 2017.

So Moody’s is still calling GC’s debt “subprime,” for those of you who remember that term from a little financial crisis a few years back – but that doesn’t mean that it won’t find a buyer. In fact today I saw news of GC’s bond issuance tucked in between some other deals from an online publication that follows the corporate bond market for traders:

Guitar Center’s two tranches followed suit. The 6.5% secured notes due 2019 and 9.625% unsecured notes due 2020 were both pegged at 98.5/99 this morning, from 98.9 at offer apiece, according to sources. Bank of America led the bookrunner quartet, with issuance under Rule 144A for life. As reported, the deal is part of a broad recapitalization effort whereby vintage-2007 buyout loans and some bonds held by Ares Management are repaid in full, a portion of cash-pay opco bonds are swapped into equity, and all holdco PIK notes are swapped into holdco equity.

Then, it hit me. I think I threw my head back and laughed. Chances are, Ares Capital Management will find buyers for Guitar Center debt at 6 – 9% interest, because for financiers today, higher risk just means higher returns, not actual risk -  just like back in the mid-2000s. Because of wealth concentrated in the financial sector, the dynamic is almost identical to what destroyed the mortgage market: Complexity obfuscated the true risk of financial instruments, which was being fobbed off onto other parties until the whole thing blew up.

Complexity: the financial structure of this operation seems absurdly complex given their business of selling guitar amps. To truly understand the structure of the Guitar Center business, I have had to consult professionals with a much deeper expertise – CEOs, CFOs, people with masters degrees in finance. Almost every one has looked at various details of the company and said, “That’s a pink zebra right there,” or, “Wow, I’ve maybe heard of that kind of thing one other time.” To understand some of their SEC filings, I had to drag up papers from the finance department of the Wharton School of Business. When you look up the corporate structure from which Bain Capital invested in Guitar Center, you find it (as of 2009) located as 3.34% of a billion-dollar investment corporation based offshore in the Cayman Islands, wedged into a financial partnership structure with a dozen other corporations.

In my experience, complexity of this sort is meant to keep casual analysts, regulators and journalists guessing – not unlike what we saw with the mortgage market eight years ago. And just so I had a good active comparator, I pulled the annual report for ExxonMobil, a company with a $290 billion market cap. Compared to GC, its filings are a relative oasis of simplicity and clarity, with the whole business laid out and finances making basic sense without enormous leaps of logic. Then again, it’s easier when you’re profitable.

Risk: None of the guys behind this deal have what Nassim Nicholas Taleb calls “skin in the game.” Nobody making decisions will lose their family fortune if it goes badly, and everybody in management stands to make substantial fees, bonuses and salaries. You see, Guitar Center used to be a musical instrument company, but now it is just one more imperial outpost for the spare financial capital of the top 0.1% of the population. For the people now supplying GC with liquidity, risk is a tool for cash flow, not a concern for survival.

When I recognized how much the financial markets have become like 2006, I finally figured out why some other financier could shell out $50 or $100 or $300 million for Guitar Center junk bonds.  For the customers of private equity, a few million isn’t that much money. These investors actually need some higher-risk assets in their portfolio, rather than let their money sit around in a zero-interest rate environment. They might be like Warren Buffett and already have huge stakes in sensible things like Too-Big-To-Fail banks, railroads or Coca-Cola. This just rounds out their overall position. Make 6-9% with the chance that the company could finally go tits-up? Why not! If it pays out, then great, and if it doesn’t – tax write off!

You know who else thought like that? The people who set the mortgage market on fire just a few years ago. They made a fortune by structuring finance in such a way that investments produced income irrespective of their true value. They could not have cared less about whether the end result was old people thrown out of their homes or eight million unemployed – that was someone else’s risk. Their risk got hedged by the taxpayer who would bail out the industry so long as the collapse was big enough, so building a decent, functional economy was besides the point.

This is the logic at play with Guitar Center. Financial parasites have taken over the host company and could not care less about the industry itself. They install some CEO who used to be selling DVD players. They swap private equity firms in and out. It doesn’t matter – it’s just another place for loose capital to suck out a few extra dollars or a tax break. After all, the entire value of the company is less than what JPMorgan paid in fines last year without breaking a sweat.

In the final analysis, this is less about business sense and more about business domination. There are dozens of industries that have been locked up by a few players in this way: mortgages, cars, pharmaceuticals, retail, you name it. Since the chances of antitrust suits under “leaders” like George W Bush and Barack Obama are so low, the tiny tranche of society with all the money can run a time-worn playbook – consolidate companies, squeeze vendors, push manufacturing overseas, lower wages, wash, rinse, repeat, discard. The numbers of the business – which suck in GC’s case – do not matter as much as control of yet another industry. As long as you have dominance over an industry, your positions are hedged for risk automatically because there is no other game in town – or at least people believe that. In the meantime, you get management fees, income from bonds, the occasional IPO payout.

And if not, you move on to the next group of suckers.

Time to return the musical instrument business to its human roots

All of this cold-blooded nonsense stands in stark contrast to the amazing people I have met in every other corner of the industry, including the actual long-time employees of Guitar Center who have reached out to me. I have had the tremendous honor to speak with inventors, entrepreneurs, retailers and fellow musicians about current events and I have been astonished by their intelligence, kindness, creativity and overall sense of humanity. All of this is diminished by the presence of these rapacious colonialists and it is time for them to take their leave of our economy, starting with the musical instrument industry.

Music, you see, is about about way more than just money – it is about a crazy, primal, uncontrollable passion. Most people who have dedicated their lives to music realize that it is an irrational thing – a little unhealthy but strangely fulfilling. The “industry” is actually a culture built by men and women who obsess over the rich sound of analog synthesizers; the warm thud of Leo Fender’s Precision bass; the sublime beauty of the sunburst on a vintage Les Paul; the roar of a Marshall amplifier; the silky vocals behind Neumann tube microphones. Note the prevalence of family names in these company names – the real industry was built on the artistic endeavors of individual geniuses who acted out of pure inspiration, not banks. Financial return represents but a small fraction of the motivation behind the involvement of the vast majority of people in the musical instrument business.

Yet for Bain Capital and Ares Capital, it is 100% of the reason for their involvement – and that is not good enough for the rest of civilization. As the weeks have worn on, I find myself resolute in what should be done. It is time to convince the financial parasites to leave us alone. Massive changes to the tax code need to make labor and entrepreneurship more valuable than financial trickery, but in the meantime, you can help as an individual. I recommend that you refuse to buy as much as a guitar pick from any company currently owned by a private equity firm, or any financial entity that does not come from the music industry itself. Your purchasing decisions will decide whether these financiers will continue to dominate this industry, because if they cannot achieve a return on these bonds, they will move on. The revenue that has been consolidated through complex debt structures will return to the rest of the industry. It will mean new businesses and new jobs. In just one small way, life will get better.

This is not about size; there are big companies that are great to work with. It isn’t about corporations; that is just a legal structure. And while it is great to work with local retailers, there are online vendors run by real people with something special to offer who simply choose not to pay rent every month to a physical space. This is simply a movement against parasites. It is about taking the tiny fraction of society with the spare capital to ruin people’s lives in exchange for a few bucks and telling them that enough is enough.

It will require considerable effort to reform critical sectors of the economy such as financial services, manufacturing, and healthcare. The musical instrument industry is small enough that we can return it to health and use it as an example of the authentic economies that we can create in the future. What happens next is up to you.