What's Really Holding Businesses Back?

This comment, from an interview with Federal Reserve Bank of Dallas president Richard Fisher, caught my attention:

Questions about health care expenses ... have kept businesses from hiring new workers, said Fisher, because executives don't know how much it will cost them. Businesses also have concerns about other costs, such as whether a VAT [value-added tax] will be imposed.

"How do you cost a worker?" Fisher said. "Let's say you run a delivery-truck system. What's the price of a new delivery-truck driver? You don't [know]. So how, as the CFO, do you go to your CEO or the board and say, 'I need to budget a new workforce.' And they say: 'What's it going to cost us?' And you say, 'I can't tell you the answer.' "

He's right. And it raises the question: What's really holding businesses back? Is it risk, or is it uncertainty?

What Fisher's describing is full-blown uncertainty, not risk. These definitions are easy to debate, but as I see it:

  • Risk is the measurable outlook of foreseeable consequences. It's a world of calculable randomness.
  • Uncertainty is the inability to measure risk. It's a world of unknowns.

It's an important distinction to make for one reason: In general, severe uncertainty dies before long, whereas risk is everlasting. Uncertainty can be caused by people waiting for questions to be answered -- in Fisher's example, businesses waiting for clarification on health-care costs and tax policy. Once those questions are answered, for better or worse, people look toward the future with a more measured, predictable, risk-based approach.

One example of this is what happened to Citigroup (NYSE: C  ) and Bank of America (NYSE: BAC  ) in early 2009. At the time, investors feared both companies would be effectively nationalized, just as AIG (NYSE: AIG  ) was a few months before. Wondering whether nationalization would occur created rampant, pants-wetting uncertainty, and both stocks were just completely obliterated. The prevailing attitude was that measuring how risky these businesses were wasn't possible until questions regarding nationalization were answered.

And then they were. Once the bank stress tests and subsequent capital raises were completed in mid-2009, the fear of nationalization vanished. On cue, both stocks soared toward levels more consistent with their measured risk profiles.

Remove uncertainty by answering a few basic questions, and gloom can give way to a whole new world of optimism.

Scared stupid
Fisher's comments make me think something similar is brewing within corporate America. Consider that:

  • Corporate profitability is at an all-time high.
  • Real (inflation-adjusted) consumer spending just reached an all-time high.
  • CEO confidence is the highest it has been in five years.
  • Real gross domestic product will likely surpass its previous high later this year, according to St. Louis Fed president James Bullard.
  • Businesses are holding a record amount of cash, with $1.8 trillion lying around, waiting for something to do.

And yet! And yet unemployment is gruesome. Businesses are loath to hire and expand. Banks are hoarding cash. Markets are scared witless. Paul Krugman won't shut up about America revisiting the Stone Age. In so many realms, there's a wide gap between results and confidence.

Some, maybe most, of this is defensible. We have big, ugly problems, and nobody wants to deal with the ugliest ones. That's scary. But how many of these problems are caused by uncertainty -- businesses, consumers, and markets just waiting for simple answers -- rather than inherent risk? More than we might think.

Will businesses start hiring once health-care regulations and their costs are clarified? Probably, which echoes Fisher's point. And they certainly have enough cash, and likely have enough demand, to justify doing so. Likewise, banks will become more gung-ho about opening up their balance sheets and extending capital once financial reforms are set in stone.

Take JPMorgan Chase (NYSE: JPM  ) and Goldman Sachs (NYSE: GS  ) , which would get smacked if regulations on derivatives and propriety trading become law. If you ran these banks, would you be quick to extend yourself, not knowing whether pending rules may or may not gut part of your franchise? Probably not. And CEOs haven't. They're in wait-and-see mode. But this cautiousness isn't entirely about the risk of making new loans. It's about regulatory uncertainty.  

Blame Congress. Then rejoice.
In one sense, this uncertainty is frustrating because Congress is mostly to blame. And a lot of it has to do with pure partisan flame-throwing, not good, honest debate that happens to slow the legislative process. Shame on them -- that was Fisher's point.

But the deluge of uncertainty might also set the stage for a stronger recovery than some expect. The three big "questions" -- health-care reform costs, financial reform rules, and tax policy -- will all be answered and codified before long. Even if the answers to these questions make you want to cry (raising the cost of employment, higher taxes, etc.), the end of uncertainty will, in all probability, unleash a mind-set that's more productive than what we're stuck with now. After the stress test in mid-2009, Bank of America announced that it needed to raise a mountain of capital, diluting shareholders by a staggering amount. In itself, this was terrible news. But the market's response was to send shares surging severalfold in a matter of months. Even really bad news is preferable to wild uncertainty.

To that point, value investor Mohnish Pabrai gets the last word: "Wall Street sometimes gets confused between risk and uncertainty, and you can profit handsomely from that. The Street just hates uncertainty, and it demonstrates that hate by collapsing the quoted stock price of the underlying business."

Check back every Tuesday and Friday for Morgan Housel's columns on finance and economics.

Fool contributor Morgan Housel doesn't own shares in any of the companies mentioned in this article. The Fool has a disclosure policy.


Read/Post Comments (10) | Recommend This Article (29)

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On July 09, 2010, at 11:45 PM, ChrisBern wrote:

    Good article, but don't forget about the drag that real estate (residential and commercial) is having and will continue to have. Factoring that in tempers my enthusiasm for strong recovery anytime soon.

  • Report this Comment On July 10, 2010, at 8:32 AM, Shawnerz wrote:

    Could be re-titled as:

    "What's holding businesses back? Risk or uncertaintiy?"

    How about neither. How about a lack of sales?

  • Report this Comment On July 10, 2010, at 10:35 AM, basil409 wrote:

    This article matches a perception that I have had about jobs. Earnings in a lot of sectors have been rising, revenues are moving up again and positive cash flows have bounced back. Normally, after some waiting and seeing, companies begin to expand their workforces. The uncertainty comment concerning health care is a major reason, plus the fact that technology and external staffing/outsourcing allow companies to wait a very long time. Let someone else take the risk...namely temp services and contract production/logistics companies. Plus, you don't have to give anyone insurance. In a larger sense, this is the new normal.

  • Report this Comment On July 10, 2010, at 7:03 PM, mtracy9 wrote:

    This is just more claptrap from those who do not

    want to see health-care reform or bank reform.

  • Report this Comment On July 10, 2010, at 8:06 PM, only1ferret wrote:

    Many of the tech. jobs were moved to china, India and Vietnam. Companys like IBM and Cisco have no intention of building their US workforce. If the jobs don't go to overseas they are filled here with H1Bs first.

  • Report this Comment On July 11, 2010, at 10:18 AM, FutureMonkey wrote:

    One businesses uncertainty is another businesses opportunity. For businesses willing to take risks in this environment the opportunities are enormous and there are multilayered incentives and safety nets to protect developing new business. Friend of mine just started a novel agricultural venture underwritten by loan guarantees, ridiculously low interest, and fantastic tax deferrals for new agriculture. My veterinary business is expanding at a break neck pace, I've doubled my workforce in the last year and am only limited by my ability to work longer hours or to be in more than one location at a time. Now is time for bold new ventures and grabbing market share while everybody else is hanging back, sucking their thumbs. Cost of health care, tax policy uncertainty is just an excuse for fear and cowardice. Never let fear of short-term loss prevent you from aggressive pursuit of long term gains.

    But to your point, clarity and certainty about employment costs and tax policy would unleash the giants; I just hope they wait long enough for the small caps to take advantage of their hesitation.

  • Report this Comment On July 11, 2010, at 12:13 PM, putnid wrote:

    If consumer spending is at "an all-time high" then why are sales tax receipts/revenues significantly down in state after state from coast-to-coast? Something doesn't compute.

  • Report this Comment On July 11, 2010, at 2:37 PM, plange01 wrote:

    once obama is finally removed from office and replaced with someone who will do something about the horrible unemployment in the US then we will see a improvement in business.the faster obama can be removed the better!!!

  • Report this Comment On July 12, 2010, at 9:45 AM, Zade wrote:

    One aspect that isn't addressed is our whole political system. Everything planned can be overturned in 2-4 years with a change in administration. Nothing is planned for the long haul so companies don't know whether certain taxes (costs) will remain or not. Our tax code is ridiculous! Every administration alters it to such a degree that no business can truly plan for the future because their costs will change with the next election. Scrapping it for some type of flat tax makes sense for this reason alone.

  • Report this Comment On July 12, 2010, at 10:46 AM, FutureMonkey wrote:

    Plange01

    Blaming Obama for the unemployment and stalled business in the US is nonsensical. Obama's actions abruptly arrested the devestating destruction of jobs more rapidly than any of us had a right to expect. The recession was not one of his making, but his policies reversed the recession and the rate of job loss. Take a look at the parabolic reversal of jobloss since Obama took office and decide again if he is to blame. Conversely it is the GOP's do-nothing obstructionism that creates the uncertainty delaying full recovery.

    Goverment influences monetary policy (interest rates), availability/liquidity of a stable credit market lending to grow business. When that didn't work, rapid implementation of direct spending/tax policy was introduced to stimulate the economic engine. So aggressive government stimulus spending and deeper targeted tax credits were necessary. But the government spending cannot create jobs - that is the private sectors responsibility; Hounsels article hypothesizes that private business is on the fence due to uncertainty of the future and fears of margin squeeze from healthcare expenses and change in tax policy.

    Obama is a very smart man and has surrounded himself with policy advisors from all sides in order to craft the best response to a bad situation. None of the policy solutions are fun, just necessary. At least those in charge are willing to make hard and painful decisions, even if they are not popular. If the "replacement" you desire has ideas that will work better, I wish she or he would voice them instead of just complaining, critizing, and obstructing. It is easy to say what you wouldn't have done, and automatically oppose any idea from the administration, but that is not the same as saying what you would have done or are going to do. Doing nothing or executing half measures is not a rational response to a threat of this magnitude.

    Ideally, I'd like to see TARP rolled-up and put away now that only $400B of the $700+B was needed and most of the money has been repaid with interest (people always forget that part); I'd like to see the stimulus slowly unwound with transition from direct funding towards permenant or at least long windowed tax incentives on private spending (get some of that 1.8 Trillion private sector dollars off the sideline and into the game), and for the Obama administration to clearly state that there will be a no tax policy changes that increase business or individuals until 2016 and then only if the economy acheives certain growth targets. One thing I'd like to see is reduction of payroll taxes paid by businesses that would reduce cost of employment to both small and large businesses. I'd also like to see a 10 year extension of the Bush tax cuts, and maintenance of current taxation on capital gains and dividends (encourage continued investing), and Obama needs to get rid of this "soak the rich" nonsense that puts downward pressure on spending/investing by the top 2-10% of American citizens. Yes, we do need a progressive tax schedule that shifts pressure off the middle class, but can't make those changes all at once When the sun starts shining again we can start getting back on track with the deficit, unwinding the stimulus, and building a rainy day fund. Everybody needs to do their part, including corporations (which means - stop hiding your profits overseas and pay your fair share of taxes).

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