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.
