A Different Look at GDP and Inflation

At Illusion of Prosperity, Stagflationary Mark posted this scatter-graph of quarterly GDP YoY growth and CPI data from Q1, 1948 through Q4, 2011.  Each point represents the differences from the medians of each data set for each of the variables, respectively.  This gives you a picture of time spent above and below what might be considered normal performance.

I wondered how this would look if each point were identified by presidential administration, and if this would suggest any particular narrative.  So I redid the graph, data from FRED, using mean instead of median as the determinant.  It is presented here as Graph 1, with each data point (256 total) color-coded by presidential party; red for Republicans, blue for Democrats.  The calendar quarter of each president's inauguration is allotted to the previous administration.

I've labeled the quadrants as follows, and indicated the frequency of data points populating each quadrant.

Here are the Mean and Standard Deviation values.

 

Graph 1  CPI and GDP, data from FRED

The GDP data has something close to a normal distribution, with approximate symmetry around the mean.  The CPI data does not.  For CPI, the highest frequency is 2 percentage points below the mean, and there is a long tail on the high side, so the distribution looks more like a Poisson type.

I've broken out presidential administrations, 3 or 4 to a graph, to avoid excessive clutter.  Graph 2 shows the administrations of Truman (light blue), Eisenhower (red), and Kennedy-Johnson (dark blue.)

Graph 2  CPI and GDP, Truman, Eisenhower, Kennedy-Johnson

Results during the Truman administration were erratic, with both inflation and deflation occurring, and GDP growth widely variable as the nation made post WW II adjustments, and several million G.I.'s reentered the work force.  Ike was an inflation hawk, and one of only two presidents to achieve below average inflation in every quarter of his administration.  (Take your guess now as to who the other might be.  All will be revealed in due time.)  Still, the road was bumpy, with GDP growth highly variable, and two rather severe recessions during his term.  The Kennedy-Johnson administration enjoyed superior economic performance and relatively low inflation, with only 6 quarters of below average GDP growth, and only five quarters of above average inflation during the entire 8 years.  This was one of only two administrations to avoid recession for an entire 8-year term.

Graph 3 shows the Nixon-Ford (orange), Carter (blue), and Reagan (red) administrations.

Graph 3  CPI and GDP, Nixon-Ford, Carter, Reagan

Here we find three increasingly extreme excursions into stagflationary territory, two under Nixon-Ford (remember Whip Inflation Now buttons?) and one under Carter. The first and mildest was in 1970, the second in 1974-5, and the last, in 1979-80 probably played a part in holding Carter to a single term.  Inflation far above average plagued both of those administrations.  Each spent time above and below average in GDP growth with term averages very close to the grand average.  However, Carter's last two years were consistently below average, and coupled with high inflation, earning him his moribund reputation.  Early in Reagan's first term, Volker finished slaying the inflation dragon.  But the cost was high in terms of depressed GDP growth, and during that time Reagan was extremely unpopular.  But, as the economy recovered, so did his reputation, and he is now remembered, for good or for ill, as one of America's most beloved presidents.  The remainder of his presidency resided along at least one of the two average lines, including four consecutive quarters of exceptional GDP growth coupled with only slightly above average inflation, spanning 1983-4.

Graph 4 shows the Bush Sr. (orange), Clinton (light blue), Bush Jr.(red), and Obama (dark blue) administrations.

Graph 4  CPI and GDP, Bush Sr., Clinton, Bush Jr., Obama

During the Bush Sr. administration, 11 of 16 quarters had below average GDP growth, 10 quarters had above average inflation, 8 of these quarters had both.  Clinton's term began and ended with below average GDP growth, but during his 8 years here were only 9 below average quarters.  Four of them occurred in sequence from Q2, 1995 to Q1, 1996, but the remainder of 1996 was quite strong, and Clinton was granted a second term. Clinton was both the other president who avoided having even a single quarter of above average inflation, and the other president who avoided having a recession during an entire 8-year term.  During the 8-year term of Bush Jr. there were only 4 quarters of only slightly above average GDP growth, occurring from 2003 to 2005.  There were 7 quarters of above average inflation, 3 of them just barely so in 2005-6, and the other 4 in 2007-8, just prior to the economic collapse.  The remainder of his term was in the mild doldrums region.  The collapse ushered in the Obama administration.  Within his first year, the economy was back into the mild doldrums area that has so far been typical of the current century. 

Here is one more graph, showing how each administration performed, as an average over its entire term.  Starting with Truman, the yellow line leads us to each successive administration, up to Obama.

Obama's position suffers from the recession he inherited.  Whether he gets reelected or not, his average will move up each remaining quarter of his presidency.  If he gets a second term, we can expect more of the doldrums we have experienced over the last two years.

This clearly belies the Romney claim that Obama's economic policies have failed.  His policies have moved us from near-depression to mere mediocrity.  That counts as some sort of success.

So, here is my narrative.  First off, one can argue that the president does not directly determine the economic fate of the country, and that is partly true.  The other part is that the president sets the policy and the tone, and that both of these things matter.

-  The only presidents to have achieved term averages in the prosperity quadrant were Democrats.
-  The only Republican to achieve above average real GDP growth was Reagan, and that was only by an increment.
-  The only president since Reagan to achieve higher GDP growth than his predecessor was Clinton, other than that, it's been a downward spiral.
-   Carter had below average GDP growth by a slight margin, but he beat every Republican other than Reagan, and he didn't trail him by much.
- The last 44 years have been characterized by secular decreases in both CPI inflation and GDP growth.
- They have also been characterized by Republican presidencies 64% of the time, decreasing regulation, lowered tax rates, safety net erosion, loss of labor union strength and participation, and the systematic undoing of of New Deal policies.

What I conclude is that New Deal (dare I say Keynesian?) policies were successful in generating real prosperity, and free market policies have been far less successful.  Over time, Reaganomic trickle-down, free market policies have given us first, the Great Stagnation, and ultimately the worst economic crisis in 80 years.  These policies were, by no coincidence at all, quite similar to those in effect when the Great Depression of the 30's happened - and also all the other earlier depressions that are no longer very prominent in people's memories.

As I said, policy matters - and it matters profoundly.

With that in mind, here is my question to the Fed:  Since the average of CPI inflation since WW II is 3.7%, and there is ample evidence that we can have very reasonable economic performance with inflation in that range, why have you set an inflation target that is effectively half of that level, while ignoring high unemployment -  the other half of your alleged dual mandate?

Of course, I'm being rhetorical.  It's because they are bankers, and inflation favors creditors, not lenders.  The fact is they don't care one whit about unemployment.

Policy.

It matters.

Update: Cross-posted at Angry Bear.

What Was America's Golden Age?

In comments at Art's place, Gene Hayward asked both Art and me to describe the characteristics of America's Golden Age.

This was the period following WW II, spanning roughly 1950 through the mid 70's, or perhaps a few years later, when the United States experienced robust GDP growth.  Though this growth was far from consistent, it was on average, considerably higher than what we have been able to achieve since.

I've looked a GDP a lot, and in a lot of different ways.  The tag list low in the right hand frame indicates over 40 posts on this blog tagged GDP.  Here is a fairly recent one with a graphic demonstration of how the Golden Age differed from the Great Moderation Stagnation that followed.  A more detailed graph with historical commentary can be found here.

The most important defining characteristic of the Golden Age is this GDP growth record.  The next questions are what were the causes and the results?

For causes, I would consider:

Steeply Progressive Tax Rates
Strong Unions
Social Safety Net
Growing Income in the Labor Force and an increased Standard of Living

Regulations on Businesses
Particularly the Strong Regulations on Banking and Finance enacted during the Great Depression, and most particularly Glass-Steagall.
Fiscal Policies consistent with Keynesian Economics

Results:

Robust middle class
Relative equality in income and wealth
Sharp reduction in the number of people in poverty
The Strong Economic Growth that characterized the period

One might consider that the results cycle back into the causes creating a virtuous spiral.  That's how I see it.

Another characteristic of this period was secular inflation.  In this environment, a commodity price shock can send inflation soaring, and that happened twice in the 70's.  I distinctly remember some time in '73 or '74 thinking that nobody would ever look back on that time as "the good old days."  Then disco music came along and sealed the deal, but that's another story.

Shortly thereafter, Volker came along and slayed the inflation dragon.  Since then, we have had secular disinflation.  As you can see in the link above, in this environment, commodity price shocks have not caused inflation spikes.

The Reagan administration vigorously continued the deregulation trend started under Carter, and dramatically changed the tax code (lowering tax receipts relative to GDP, and shifting the burden from the rich to the declining middle class.)

Since then - except for Clinton bucking the trend, at least partially - it's been all lower taxes and deregulation.  This has skewed both income and wealth toward those that already have the most.  The result has been the Great Stagnation, and the slow strangulation of the American Economy.

No Speculation About Oil Prices

I think I can show that oil prices are not behaving in a completely supply-demand determined way.  We'll look at price activity, volatility, and an estimate of what rational pricing might be.

First, here is Brent Crude spot price activity since 1987, data from the U.S Energy Information Administration.  I've taken a weekly average of daily data, and plotted it as of each Friday (it was just a lot easier than trying to work their data table into a daily data plot.) Also included is a 55 week moving average.

As you can see, the price really took off after 2000.  Coincidentally, the Gramm–Leach–Bliley (Financial Services Modernization) Act of 1999, which undid portions of the Glass-Steagall of 1933, was signed into law on Nov 12 of that year, and the Commodities Futures Modernization Act of 2000 was signed into law on Dec 21 of that year.  These new laws allowed mega-consolidation in the finance industry and prohibted the regulation of certain speculative activities.

Here is the same data, separated into two graphs around the year 2000.  Also shown are the 55 week moving average, and an envelope one standard deviation above and below the average.  St Dev is based on the same 55 data points as the moving average.  The sections of the price line that extend above the {Avg + St Dev} line are highlighted.

The entire data set contains 1166 points.  Of these, 428, or 36.7%, lie more than 1 Standard deviation above the moving average.  For the segment through 1999, 156 of  574 points, or 27.18%, lie above the St Dev envelope.  For the segment 2000 on, 227 272 of 592 points, or 45.95%,  lie above the St Dev envelope.

For data normally distributed around the mean, about 1/3 of the data points should lie outside the 1 St Dev envelope, half above and half below.   I'm no statistician, but this is not a well behaved data set.  Clearly, there is a powerful high-side bias.  What could be the cause?  Here are some possibilities.

1) Supply-demand forces in a growing world economy are so skewed to the demand side that this is that natural result.
2) External forces, such as panic due to war and instability in the Middle-East, have irrationally raised prices.
3) Speculative forces with a strong long-side bias have skewed the market away from a supply-demand determined price level.
4) Withheld supply due to OPEC activities, contango (hoarding on leased tankers), and the disruption of Iraqi supply for the last decade have unnaturally skewed the supply component.

My view is that possibilities 2 - 4 are all operating to some degree.

I have no way of evaluating 2 and 4. However, 4 seems reasonable, in view of the classic description of inflation: too many dollars chasing too few goods.  This effect could also spill into into futures speculation, where the amount of oil traded is finite, but the amount of speculative money available appears not to be.

Update:  To be clear, I'm not talking about CPI inflation, I'm talking about commodity-specific inflation.   I believe that financial tail-chasing has not been limited to oil speculation.  There is enormouse wealth in the world, and to a large extent, it is not being devoted to legitimate investment.  It is being devoted to computer generated program tradign that skims tiny fractional percentage gains thousands of times per day to skim money away fro tose who use eschanges for valid purposes.

And maybe we can get a handle on speculation.  My hypothesis is that deregulation in the 1999-2000 time frame has enabled and encouraged speculative rent-seeking activities in the oil futures market, which has inflated the price of crude.  One way to go at it is to have a look at volatility.  We already have standard deviation in our hip pocket.  Let's see what we can do with it.

Here is standard deviation, based on 55 consecutive data points, divided by the average of those data points.  Just for kicks, included are a 55 point moving average of the St Dev in red  (for what it's worth -  not much, I'd say) and a best fit (least squares) trend line. 

Well - the trend line slopes up a bit, but that's not really a lot to go on.  On the other hand, the entire 90's lie below the trend line.  In fact, except for the 1990 price spike, most of the of the St Dev values prior to about 1999 lie below the trend line.  Let have a closer look.

Here, the data are divided into two segments,  up through 1999, and 2000 and beyond.   For the early segment, the St Dev/ Price line is in dark blue and the 55 week average is in red.  For the latter segment, the lines are light blue and yellow, respectively.  Now, the trend lines tell an interesting story.  For the early period, the trend line is essentially flat, with a slight downward slope.  For the latter period, the slope is clearly upward.  Despite the localized gyrations, we can see that prior to deregulation, volatility had no trend.  After deregulation the trend is up.

Up to 1999, St Dev / Price averaged 12.65% (exclusive of the 1990 spike, taken as August, 1990 through January, 1991 the value is 12.01% )  From 2000 until now, the St Dev / Price averaged 15.06%.

So, what we see is that since since deregulation, prices have gone up, volatility has gone up, and upside bias in the data set has gone up.  Let's resurrect possibility 1) and see if demand pressure can be the cause.  To get a handle on this, I took a closer look at my speculative idea from the previous post, and extrapolated prices forward from 1990, based on hypothetical constant growth rates.  Originally, I took a SWAG at the 1990 average price, and came up with $30 per barrel.  With a growth rate of 4% over 21 years, that would result in a current price of $68.36.  The 4% growth rate came from a generous estimate of World GDP growth over the period, assuming a direct, linear link between GDP growth and demand for petroleum.

Here is a graph based on the data instead of a SWAG.  It shows constant price increase rates of 3, 4 and 5% per year, based on the actual 1990 average price of $23.66.  The first thing to note is that my $30 SWAG was more than $6 too high.  The next thing to notice is that 1990 was the worst possible year to select, given the point I'm trying to make.  Due to the local spike, the 1990 average of $23.66 is almost $5 higher than the 1987 to 1993 average of $18.84.  So, if anything, my estimate of $68.36 is artificially high.

Still, I went with the 1990 average for this chart.  Extrapolations are based on growth rates of 3 (yellow), 4 (red) and 5(green)% from the 1990 average of $23.66.  This gives current price estimates as follows.

At 3%   $43.34
At 4%   $53.02
At 5%   $64.09

I'm not suggesting that this is a fool-proof method.  However, it is gratifying that it is more-or-less consistent with the oil industry estimation of a supply-demand determined price.  Further, these price growth estimates are quite generous, since estimates of petroleum demand growth are in the range of 1.6 to 2.3 %.

My conclusions:
1) The price of oil is far above rational, market-based pricing.
2) While other distortions and manipulations are likely to play a part in an inflated price, it's not clear how they could contribute to increased volatility.
3) Unregulated, excessive speculation, with a long side bias is indisputably taking place.  I believe this is a major contributor to excessive price inflation, and the sole contributor to excess volatility.

Do you have a better idea?  Let's hear it.
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Graph Fights!

It all starts with this post in January by John Taylor, where he talks about the (pretty reasonable sounding) correlation between business investment and unemployment.   Other than agreeing with this statement by Krugman  .  .  .

But when Taylor leaps from that correlation to saying that what we need for economic recovery is to “lighten up on the anti-business sentiment coming out of Washington,” I wonder what is going on in his head.

.  .  .   I have no dog in the fight, and can sit back and watch with growing amusement.

Mark Thoma supplies links, so I don't have to.  But it takes a few click-throughs to get to this one by Noah Smith, which, because of its insights, really should not be missed.

Another insight worth noting is this one from a much younger John Taylor, quoted by Justin Wolfers.

Behind the use of time-series estimation is the assumption that the structure and coefficients to be estimated remain stable over the sample period…  If this assumption is in fact not correct, the estimated function would have little use either as an explanation of the causes of murder or of the policy implications of changing the value of an exogenous variable in the structure.

I think about and use time series data a lot - in fact as recently as yesterday.  So this is something worth keeping in mind when any of us look at those kinds of data series.  Though I'm usually looking for what changed, rather than some underlying determinant.

There are other lessons here about cherry picking, data analysis, and data mining that should make you cautious of any graphic presentation - no matter how convincing it seems to be.

One of my father's catch phrases was, "Figures might not lie, but liars sure know how to figure."  He was born in April, but was certainly no fool.

Update:  Just to be clear, I'm not calling Taylor or anyone else a liar.  The quote above from my dad, in red,  is a general caution, not an indictment.

Update 2:  Karl Smith weighs in, and finds: "In short, in either of these basic comparisons I just don’t see a lot of there there." 
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The Great Recession

Brad Delong dicusses a proper understanding of the Great Recession, it's causes and  cures, as well seven types of incorrect zombie analysis.

Read it all here.  It's 9500 words, and well worth your while.
  
Major theme:  It's Milton Friedman's fault for allowing people to believe that complex problems have simple solutions.

His social libertarianism prevented him from acknowledging that attempting to keep money growth constant was a (valid) example of government intervention.   "He sold the Chicago school an interventionist, technocratic managerial optimal monetary policy under the pretense that it was something -- laissez faire -- that it was not."  In doing so, he denied the Keynesian approach of more complicated interventions.   Since about 1980, his approach has failed, and in 2008 even extraordinary money growth could not prevent extraordinary levels of unemployment.  This left many economists with no foundation for understanding, and they simply started to either make stuff up on the fly or fall back on ideas that were discredited 80 years ago.

Wrong Models and Stuff They Made Up  (See Delong at the link for details and refutations)


Low Marginal Product Workers - We have 10.5 million unskilled workers who cannot be hired because their value is below minimum wage.   (Niall Ferguson, Tyler Cowan)

Structural Unemployment -  We have 12 million workers with the wrong skill sets (or locations) who need to be retrained (or relocated.)   (Narayana Kotcherlakota)

Overaccumulation of Capital - The problem is not a shortfall in aggregate demand, but a surplus of aggregate supply.  Thus, the economy needs to "liquidate" via unemployment, bankruptcy and obsolescence.  (Marx, Hayek, Mellon, Hoover)  BTW This is the Marxian argument of capitalism consuming itself and collapsing - thus, the logical solution, via Marx and rejected by the others is socialism.  The others took the collapse to be temporary, and when the dust cleared the whole cycle could start all over again.  So, take your lumps and shut the hell up.

Uncertainty - The election of Commie-socialist-Muslim-anti-imperialist-foreign-born dictator B. Hussein Obama and the specter of deficits and burdensome regulations he is oh-so-likely-to-impose has scared the wrinkled green shit out of capitalism; and so it is paralyzed like a deer in the headlights. (Alan Greenspan, Rethug Politicians, Rethug Sycophants, Idiots)

The Need to Control Inflation and Avoid Crowding Out - Further stimulative policies will cause a burst of inflation, raise interest rates, crowd out private investment and stifle economic growth long term. (John Cochran)   The inflation premium today on  10 Yr TIPS is 2.283%, on 30 Yr TIPS it's 2.355% (difference from non-indexed bond.)  Draw your own conclusions about inflation expectations.
 
Banking and Fiscal Policy Unnecessary -  Per Friedman, Fed open market operations are sufficient.  We can certainly see how well that is working.  (Nobel Prize winner Robert Lucas, who in his own words admits, "I really don't get it.")  Lovely.  Say and Mill got it back in 1829.

Banking and Fiscal Policy are Ineffective - This is a crowding out/future tax increase argument that simply bears no relationship to the real wold.  (Eugene Fama, Nobel Prize winner Myron Scholes)

As I've stated before, thinking like an economist means that zombie ideas eat your brain.

So - are we screwed, or what?
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Good Debt, Bad Debt

Reminding us that all debt is not created equal, Krugman offers:

Whenever the issue of fiscal stimulus comes up, you can count on someone chiming in to say, “Only a moron could believe that the answer to a problem created by too much debt is to create even more debt.” It sounds plausible — but it misses the key point: there’s a fallacy of composition here. When everyone tries to pay off debt at the same time, the result is contraction and deflation, which ends up making the debt problem worse even if nominal debt falls. On the other hand, a strong fiscal stimulus, by expanding the economy and creating moderate inflation, can actually help resolve debt problems.

Delong adds:

There is nothing wrong with what Paul says. But I think it is incomplete, and that there is a better way of getting to the right conclusion.

The problem was created by too much risky debt and not enough safe debt. The result is that right now there is an excess demand for safe assets--like U.S. government securities. 

. . .

If our big problem were too much debt we would not be here, in depression. Too much debt generates inflation. The things that generate depression are shortages of financial assets, and excess demand for some class of financial assets then produces  .  .  .

Both posts are worth reading.  And what all of this casts into bold relief is the grotesque fiscal irresponsibility of the previous president, and the difficulty of cleaning up after his messes - further complicated by the fact that there are so many of them, in so many places.  Also, the gutting of regulations since Reagan has allowed capitalism to morph into the robber-baronism and economic disparity that ultimately brought on the other Great Depression.  Which is more or less why capitalism fails.

Alas, Obama lacks whatever it takes to get the country back on the right footing in the face of idiotic Repugnicant obstructionism.   And the public seems to be in the grip of right-wing populism - possibly the single most destructive political force known to man.

We are so screwed.

Money Illusion Delusion

This is going to be a long post with lots of words and graphs.  Grab an apple or your favorite quaff, put your feet up and your thinking cap on.

Over at The Money Illusion, Scott Sumner, an Economist with a PhD in economics from the U. of Chicago recently posted an entry with the title: America’s amazing success since 1980: Why Krugman is wrong.

His thesis is that neoliberal economic policies promote economic growth, and further, that a country's growth rate relative to other countries is a direct result of having or not having employed neoliberal policies.

I am about to deconstruct Sumner's methodology and eviscerate his conclusions.  First, though, a disclaimer.  I am not an economist. I do not speak the jargon, and am unfamiliar with many of the concepts.  However, I have a technical background, two masters degrees (Chemistry and an MBA) some proficiency in math, critical thinking skills, a finely-honed sense of skepticism, and the ability to graph data sets.  Most importantly, I believe in data-driven conclusions, not conclusion-driven data mining.

Next, let's take note of the kerfuffle Mike Kimmel and Spencer over at Angry Bear got into with Sumner.  This illustrates the hazard of getting into a point-counter point with someone who is ideology driven, especially after he has framed the debate in a way that is favorable to his conclusions.   The thing to do, I'm convinced, is go after their basic assumptions, and refute them with actual facts.  That will be my goal in this post.

Regulation, Regulation, Regulation

It's hard to beat Krugman if you're looking for down to earth reality on any topic he chooses to address.

Those who think that “too big to fail” is the essence of the problem have to explain why Canada, with basically just five banks, has avoided crisis. Those who blame the Fed for keeping interest rates too low too long have to explain why Canada, which basically had the same interest rate experience we did, didn’t have anything like the same problems.


So what’s Canada’s secret? Regulation, regulation, regulation. Much stricter limits on leverage, much stricter limits on unconventional mortgages, and an independent consumer protection agency for borrowers.

(Emphasis added.)

Without regulation, the fox is in charge of the hen house, and - sooner or later - the wolf will be at your door.  It's twue, it's twue.
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Was the Sarbanes-Oxley Act Harmful to Business? Part 2.1

In Part 2, I mentioned in passing how the short-term view of shareholders can impede the long-range planning of corporate executives.

Here is an elaboration on how hostile market conditions can damage the long range health of a company, and thus influence the decision to go private.  I'll editorialize and say that this is a basic, systemic flaw in free-market capitalism.

But these explanations miss the chief culprit: public markets have become a hostile environment for corporations.

Stocks fall out of bed when companies miss earnings or revenue guidance. Concerns that don’t show enough growth are told either to improve margins (which usually leads to cost cutting, a short-term expedient that simply starves the enterprise) or to rid themselves of mature businesses, no matter how much cash they throw off, so that the remainder will garner a higher earnings multiple. And analysts are even lobbying for changes in areas once considered to be management’s purview, such as pricing, wage levels, and employee benefits, at successful, premium multiple companies.

Companies’ efforts to please the markets have gone to such extremes that they are damaging, not just to individual companies, but also to the economy as a whole.

Many organizations are deferring high-payoff projects simply to bolster current earnings. One example: a telecom cancelled an ad program to promote second phone lines to retail customers. These second lines are one of their most profitable services, and the past campaigns had an 11 month payback. But that isn’t attractive enough in the current environment.

Was the Sarbanes-Oxley Act Harmful to Business? Part 2

It has been proposed that Sarbanes-Oxley (SOX) drove many previously public companies into private hands, with the explicit assumption that this is a bad outcome.  I have no basis to judge the queston of whether this is good or not, and would welcome relevant facts and informed opinion.

There can be no doubt that many companies chose to either go dark or go private in the wake of Sarbane-Oxley (SOX), and that the passage of SOX was a precipitating factor.  The considerations driving the decisions among public, private, or "dark" (fewer than 300 shareholders, limited reporting requirements) ownership are many and complex.

Here are some factors that encourage going private;

Undervalued Shares make private or dark ownership an attractive bargain.

High costs, including compliance costs - namely SOX, make public status less attractive.

Lack of interest from market analysts and institutional investors diminishes benefits of public status.

Thin trading volumes and share price volatility lead to economic uncertainty for shareholders.

Business maturity, with low growth prospects but healthy cash flow, mitigate the need for liquidity.

A small number of individuals already own the majority of stock.

Owners have more tax planning flexibility, and control over estate planning.

For most of these, money is the driver, either for the insiders or for the profitability of the company - not necessary consistent or even compatible goals.  Still, these are all valid, sensible, perhaps even honorable reasons for going private.  Other reasons can come in to play though, that might be more shady, or even nefarious:

SOX specifies stiff penalties for wrong-doing, and holds the CEO and CFO responsible for doing right.  So, if any wrong-doing is part of your game plan, you'd best get out of the public arena.

Compensation and financial details can be kept secret, for good or for ill.

Scrutiny of all kinds can be avoided, with the possibility of also avoiding litigation, for good or for ill.

On the other hand, though, corporate management can focus on running the business properly, with a long-range view, rather then trying to please often fickle shareholders whose time horizon is the next quarterly statement.

Companies that went public at high evaluations in the 90's can provide windfalls by going private again at cheap evaluations in a down market.  Clearly, value perception is a big driver, according to Edward E. Nusbaum, chief executive officer of the global accounting, tax and business advisory firm Grant Thornton.

"During bear markets, many smaller publicly traded companies feel that the market is inadequately valuing their company," Nusbaum says. "In many of these cases, shareholders can unlock some of this unrecognized value by going private."

Further, he also stated:

"with the public markets in disarray the benefits of being a public company certainly have diminished for some small and mid-sized companies."

Even given all of this, there is one big exogenous factor that is vitally important in the public vs. private ownership decision: the type and amount of available financing.

Bharath and Dittmar also examined the impact of market and macroeconomic forces on firms' decisions to go private. They found that the likelihood of going private increases significantly in high sentiment and hot private equity markets and decreases in hot IPO markets. Further, supply of debt in the economy and costs of bankruptcy may be influencing factors, as well, they say.


"Since 2000, we have seen a resurgence in going-private transactions, fueled by the development of the private equity market," Dittmar said. "Given the size and growth of this market, it is important to understand the economic forces that determine these decisions.

 
There are downsides to going private.  The transition costs can be considerable, and the cost of capital will almost certainly increase.   Going either way in the public - private decision is, to some extent, driven by direct, or even immediate financial gain by those in a position to take advantage of it.

We can safely say that the passage of SOX tipped the balance in favor of going private for many companies.  But let's not overstate the effect - realistically, it is one factor out of many.

The premise that companies leaving the public arena due to the passage of SOX is a bad thing is simply that: a premise.
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Was the Sarbanes-Oxley Act Harmful to Business? Part 1

Dale, in comments to D.S. #14, asserts unequivocally that SOX, as it is called, reduced the number of U.S. IPO's (I'm being generous to him in stating it that way,) that the expense of over $4 million per year drove hundreds of publicly traded companies private, and that it has not met any of its goals.

Let's do some fact checking.

In this post, we'll consider IPOs.  Here (above and in the link)  is a chart of venture capital backed IPO's per year, as mentioned in a Business Week article for the years 1980 through 2008.  The latter, of course, was a dismal year for a variety of reasons.  The text of the article informs us that the average number of venture capital backed  IPO's in the 80's was 52, while the average of the naughts through '08, was 49.   Scant difference, especially considering that in the post-bubble shock and recession of  '01 to '03, IPO activity was torpid, and close to non-existant in the recession starting year of '08.    The chart also reveals how Dale cherry-picked 1996 as a bench-mark year, with over 250 VC IPO's, the second highest year of the 1980 - 2008 period.   In my chart, above, the pink line is a 5 year average, to smooth out yearly abberations, such as the big drop in 1997-8.

Now (chart above) look at the number of VC IPO's from '03 through '07. There appears to be a release of pent-up demand in '04, followed by very respectable, and growing activity after '05 until the '08 collapse.  Raw data found here.   Venture capital backed IPO's are only a portion of the total, which also includes buy-out backed IPO's, and a remainder with financing unspecified.  VC IPO's represent new companies going public for the first time, and are the sub-group most relevant to the discussion.  Private equity IPO's are essentially reverse LBO's, and not relevant.  

For comparison, here is chart of relative performance of the S&P 500 stock index, which I am taking as a proxy for general stock market pricing activity.  Data from Yahoo Finance, graph by me.  The graphed line is the percentage increase of the annual S&P average for the subject year, compared to the prior year (YoY.)

Correction:  Wrong data in the graph: see Update 1.


I'm not suggesting anything like perfect correlation to the IPO chart, but there is a general similarity.  Which only makes sense.  When you go public, you want as rich a capitalization as you can get, and an up-market is clearly better than a down-market.

So, sorry Dale.  Your first point is very unconvincing.  Realistic relevant factors influencing IPO activity appear to be general stock market performance in the year leading up to the IPO (no surprise) and the availability of VC money (also no surprise.)  The Business Week article, which never mentions SOX, suggests that VC IPO activity might now be permanently low, inhibiting total innovation, because venture capital is limited.    

It closes with this thought:

All of this could prove problematic for entrepreneurs who need VC-style equity investments. If there are fewer VC firms around to put several million into a high-growth startup, some of those firms aren't going to get the investment that they need. And that could mean fewer successful companies like Google (GOOG) and Genentech (DNA) that provide jobs for many people and innovative products that are valuable to all of us.

Update 1:   I made a data manipulation error in constructing the Relative S&P Performance graph above.   The graph actually represents a year over year change in the running three year average of performance - hence a smoother plot.  I graphed the wrong column from my spread sheet.  Corrected chart follows.  YoY performance in the 80's was generally good, but erratic.  The 90's were up-up-and away.  The naughts were like Ohio - zeros on the ends, "hi" in the middle.  This shows why 2004 was a much better year for IPOs.  It was a much better year for the market.

In fact, here (below) are IPOs plotted (blue line) along with the S&P performance - rescaled and translated to fit on the same chart (yellow line.)  Through the 80's and the noughts, they track together quite well.  Through the 90's bubble - not so much.

Update 2:   As I've indicated, IPO activity in 2004, was pretty robust.  Interestingly, it involved not only domestic IPOs, but also a sharp increase in foreign companies listing on U.S. exchanges, as this article from AltAssets indicates.  The end of the article quotes Scott Gehsmann,  North American leader of PricewaterhouseCoopers Global Capital Markets Group.

'In fact, across virtually every metric - number of deals, size of deals and IPOs by industry sector - 2004 saw a sizable increase over 2003. Moreover, the sharp rise in IPO activity suggests that the enhanced reporting requirements of Sarbanes-Oxley have not had the dampening effect on IPOs that some had predicted,' Gehsmann continued.

The number of non-US companies completing IPOs in the US markets also more than tripled in 2004, with Chinese companies leading the way.

I think Gehsmann might have a better understanding in his field of expertise than Ron Paul does.
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