August 16, 2019 / 10:31 AM / 5 months ago

Breakingviews - Cox: Let’s just get on with the recession already

NEW YORK (Reuters Breakingviews) - In the nine years since WeWork was born, everything has gone its way. The firm, which values itself at nearly $50 billion as it goes public, has only known a growing global economy where jobs are plentiful, creditors fall all over themselves to lend money and venture capital flows like the free beer in the shared offices its founder Adam Neumann operates around the world.

WeWork is far from the only hot new thing to have never experienced anything but a milk-and-honey environment. Last month marked the 121st consecutive month of U.S. economic expansion, the longest unbroken rebound since before the Civil War. The expansion came after the worst financial crisis since the Great Depression, so people are understandably extra-jittery about what comes after the possible end to what may rightly be called the Longest Recovery.

But with few exceptions (G’day Australia), recessions are normal. They should be expected, and perhaps even encouraged, in a free-market system. As the late economist Allan Meltzer famously declared, “capitalism without failure is like religion without sin. It doesn’t work.” Though they are painful, economic resets can usefully curb unhealthy excesses and course-correct bad policies that store up potentially bigger problems.

This is not an exhortation for things to go wrong. Nor is it a political argument like the one made by some opponents of U.S. President Donald Trump - an economic rout might harm his chances of re-election in November 2020. Make no mistake: Downturns suck. Jobs are lost, skills can atrophy, people get hurt. The worst-hit tend to be the most vulnerable – the poor who lack resources to pay their bills for medical care, education or even the basics they need to live on.

Yet, economic winters are required for healthy springs. More than a decade without a frost risks creating a generation unable to resist the cold – incapable of handling hardship. Without picking too much on WeWork, though its change of name to The We Company alone merits doing so, the New York-based firm really does look like the emblematic creature of the Longest Recovery.

As my colleague Rob Cyran detailed this week [nL2N25A0H2], the company exhibits all the worst corporate excesses of the past decade. Like every contemporary Silicon Valley upstart, it has multiple classes of stock designed to entrench its founder (whose wife even has a say in his replacement as chief executive). The We Company also has an organizational structure so convoluted it would make Blackstone (BX.N) boss Steve Schwarzman blush. There are also conflicts of interest, related-party transactions and, naturally, margin loans from underwriters in the mix. Oh, and it loses lots of money.

Neumann wraps the whole package into a hippy-dippy wheatgrass-sippy bow, with a stated mission “to elevate the world’s consciousness.” A business like this could not exist without an extraordinary misallocation of capital. Cue SoftBank (9984.T), whose Vision Fund and other affiliates have pumped more than $10 billion of cash, including money from the hardworking subjects of the Kingdom of Saudi Arabia, into Neumann’s creation.

Now, WeWork is not necessarily doomed if a slowing economy leads to declining demand for all those workstations and shared-office memberships, which history suggests it will do. But investors may regret handing over so many of their rights when the business model – blindly hoping that shorter term assets (memberships) will generate enough money to cover long-term liabilities (leases on office buildings) – is tested by a good old-fashioned recession.

It’s worth noting that WeWork’s prospectus came out alongside three data points suggesting the recovery will soon come to an end, sending investors into a tizzy. The yield on the U.S. Treasury’s benchmark 10-year note dipped below the yield of its two-year note, the first time that relationship has inverted since 2007. Germany’s economic output declined by 0.1% in the second quarter from the first. And China’s industrial output expanded by 4.8% in July, the slowest rate of growth in 17 years.

None of this guarantees the U.S. economy is heading into negative numbers, or that the rest of the world will follow. But there’ve been something like 18 recessions over the past century, lasting from as few as eight months to the Great Depression’s nearly four years. In nearly every case, a few things happened that helped the country, including its companies, industry and people to become stronger and smarter, though with differing degrees of intensity and success.

When economies contract, second-rate firms or those with too much debt, suffer most swiftly. For recent examples, think Lehman Brothers, which was both, in 2008, or many dotcoms at the start of the 21st century. Their businesses were too immature to weather what was one of the milder resets in recent memory (unemployment peaked at 6.3%).

The demise of the weak makes way for new and more efficient businesses to take their place. Capital that was allocated poorly gets transferred to more effective uses. While raised around $82 million in a hyped IPO in February of 2000 and went bust by November, Google (GOOGL.O) had quietly raised just $25 million, and went public after the U.S. had passed through the early-2000’s recession.

Something similar happens in the labor market. Again, while layoffs are painful, especially in the absence of a proper social safety net, workers can use them to improve their skills or to find new career paths. If Mike Bloomberg hadn’t been fired from Salomon Brothers during the 1981-1982 recession, though perhaps for other reasons, would he be New York’s richest man? When growth returns, job creation always follows, and labor is arguably reallocated to better uses.

Moreover, as the rule named after University of Chicago economist Victor Zarnowitz suggests, when downturns are short and sharp, recoveries are usually healthier. If anything, the problem is that no recession is ever short enough for a politician seeking re-election, and no market dip brief enough for the financier focused on this year’s bonus to let it run its course. But it’s inarguably time for a pause, to take capitalism forward, and maybe even “elevate the world’s consciousness.”


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