Monday, December 28, 2009

ROI, IRR, EPS vs The Level Playing Field

For several months, MONEYTHOUGHTS has discussed the concept of the Level Playing Field as it relates to Monetary Policy and Investment Securities Regulation in the United States. Because of the way Monetary Policy is implemented by the Federal Reserve Bank, along with the deficits and borrowing that is done by the Federal Government, Monetary Policy in the United States is decidedly for the benefit of corporate America. The bottom line is, that over a period of 20, 30 or 40 years, loss of purchasing power due to inflation is an economic fact of life in the United States.

You have a choice: 1.) you can put your savings in a bank and earn interest; or, 2.) you can invest your money in the capital markets and try to hedge yourself against inflation and the loss of purchasing power of your money. We all know that we have long term responsibilities to ourselves and our families. Whether it is investing for our own retirement or a child's college education, we recognize that over an extended period of time, our money will not be worth what it was when we placed it in a savings account 20, 30 or 40 years ago.

I do not believe that Monetary Policy in the United States will change with regards to its second duty - put enough money into the economy to further economic growth. In my opinion, the Fed's first duty of protecting the integrity of the dollar is in reality a distant second. As such, investing, not saving, for retirement is really the only way to get from point A to point B.

I have asked this question before. For whose benefit is Monetary Policy in the United States directed? My answer is economic growth. There is nothing wrong with that answer as we need our economy to grow if we are going to survive as a nation.

That brings me to the role securities regulations play in our quest to meet our financial responsibilities to ourselves and our families. Securities regulations and the credit rating agencies are the weak links in the system.

Corporations exist to make money. Profits is the name of the game. Without profits a corporation has no purpose to exist. Publicly traded corporations produce a lot of financial information for their shareholders like Earnings Per Share (EPS). But it is the Return On Investment (ROI) that moves EPS. Corporations look at many ideas before they decide to invest in a new project. The project they decide on is usually determined by something they call the Internal Rate of Return (IRR). The Modified Internal Rate of Return (MIRR) takes into account the cost of capital. Borrowing money is leverage for a corporation and can propel its earning per share. Earning Per Share is what many CEOs have their salary and bonus based upon. As a result, EPS are very important to them and their Board of Directors. The ability to borrow in the capital markets at low interest rates gives the corporation the ability to have a higher Return On Investment (ROI).

The Federal Reserve Bank serves business first and the family second. I challenge any economist to prove me wrong. If, the Fed is going to place the interest of the corporation before the interests of the individual and his/her family, then does it not make sense that the regulation of the capital markets should be sincere and if tilted at all, should be tilted in favor of the investor, be they individual or institutional?

Stay tuned.


LceeL said...

It seems to me, that Corporations exist for more than "Profits". Or should. If I was the President of a Corporation, and we made 'whatchamacallits', then to me, my focus should be on making sure we make the best 'whatchamacallits' in the world - because if we do, people will buy them, the Corporation will make money, people will have jobs, and their jobs will contribute to hte health of the overall economy.

moneythoughts said...

Everything you said is true Lou. But, you don't need a corporation to do that. You can have a company with a single owner do all those things.

The reason why I am saying a publicly traded corporation, is because it is the lax regulations of the securities laws and the poor SEC enforcement that has brought us to where we are today. Weakened securities laws as well is a big part of the problem.

I threw a lot out there today to make a point. Monetary Policy is not going to change because we need to continue to grow our economy and create more jobs. But, on the other side, we need better regulations of the capital markets and the investment products that are sold to the individuals and institutional investors.

This is the point I am trying to make.

Jientje said...

You threw a lot in there, and you made a very good point fred. Very well written post.

moneythoughts said...

Thank you Jientje for your comments.

Europe is a head of us in moving towards stricter financial regulations. And, Monetary Policy is much more conservative in Europe too. Germany knows only too well what inflation can do to a currency.

I am trying to give people a perspective in which to view these competing concepts: Economic growth, but not at the expense of inflating the currency, along with securities regulation and enforcement to ensure that those that choose to invest will not be cheated out of their hard earned money.

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