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The Family Business is a Haven from Financial Craziness

The Chicken Littles of the media are again loose in the barnyard.  “The sky is falling (subprime mortgages are collapsing)!”  “The sky is falling (hedge funds are imploding)!”  The sky is falling (a recession is possible)!”

In his forthcoming book The Speculation Economy: How Finance Triumphed Over Industry, Lawrence E. Mitchell, a George Washington University Law School professor, correctly identifies the culprit underlying all of this falling sky.  The growing preeminence of finance over operations has caused stock market considerations to trump the actual workings of business and common sense.  In a world where the game is to extract value as quickly as possible, the long, hard process of building value is considered a fool’s occupation.  The rewards come from gaming the system—not from increasing production efficiency, controlling costs, and serving customers.

Why would anyone make a loan to someone who wanted to buy a house but who neither put his own money into the deal nor was asked to prove creditworthiness by demonstrated income and/or assets?  Because Wall Street wanted to buy such mortgages, so it packaged risk into so-called “securities” sold to people aggregating and managing other people’s money.  Reality was irrelevant to those who “derived” trading schemes designed to extract value—until they didn’t anymore.

Hedge funds are another example of the same game.  A hedge fund is supposed to hedge against market movements by unhedged interments.  But hedge fund managers receive 2% of net value (assuming handsome compensation) and 20% of profits earned on other people’s money.  Others take the risk, hedge fund managers reap rewards.  Heads I win, tails you lose.  Hedge funds that are collapsing made highly leveraged bets on long positions, according to economist Ben Stein, who describes the activity as “just gambling.” 

All this gaming may or may not lead to a recession.  Recessions are periods of time when the self-correcting mechanisms of free market are at work repairing the damages of excess, bad judgment, misguided governmental actions, and yes, even fraud.  For a period of time, the economy fails to perform at record levels.  Some experience pain.  Some who experience pain deserve it.  Some unfortunates do not.

The part of the economy least affected by all of this hoopla and turmoil is the family businesses.  Even families who own businesses in home building and mortgage banking who have long experiences, understand risk, and have put some money away for a rainy day will survive the current disruptions in the market.  Family businesses will continue to create value by focusing on customers, improving productivity, and controlling costs.  This is the recipe for success in any operations-focused business.  The lesson should not be, however, to avoid debt at all costs.  Family businesses tend to be very risk adverse in this regard, often avoiding the use of debt even in cases where it can add value to the business.  The objective is to judiciously use debt and to appropriately manage risk as part of the process of building value. 

Understanding that markets are cyclical and require judgment and patience is part of the wisdom that trans-generational business experience provides.  In fact, the “sky is falling” mentality can create unique opportunities for family businesses that have socked capital away for a rainy day.  As investors pull their money out of the markets, and the self-correcting mechanisms of the markets are at work, opportunities to buy undervalued assets, businesses, or investments present themselves to those who have patience and capital. 

Stein’s August 26, 2007, column in the New York Times was entitled “Avoid the Craziness and No One Gets Hurt.”  Family businesses have their own craziness, but it is typically not the kind that confuses extracting value with building value.  By focusing on business rather than on finance, family businesses are ideally positioned to avoid the craziness and most of the hurt.

And they have just the right perspective to understand that the sky is not falling.  Indeed, long-term opportunities are now arising as the short-termers depart their games. 
 
 

 

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