A snake chokes on its own tail

“I don’t know why everyone thinks that Lockheed is managed so bad. Because I tell you it is not.”

– Daniel Haughton, CEO of Lockheed in 1971. His company was bankrupt and begging the government for a bailout

Children named “Max” must be having a hard time at school these days.

But not as hard a time as folks called Dennis Muilenburg.

The 737 Max scandal has grown so large that it’s being described as a threat not just to Boeing… but to the economic growth of the entire US by the Treasury Secretary Steven Mnuchin.

Think of that for a moment. A scandal for a single company is being dressed up as an excuse for poor growth in the largest economy in the world… ahead of time… by its government.

Says a lot about how fragile that economy might really be beneath the surface – or at least how fragile Mnuchin fears it is. You would think a man in that position would have a pretty clear idea of what’s going on in the US economy. Then again, considering the man proudly claims The Lego Movie is his greatest accomplishment, perhaps he’s not the most reliable gauge.

Still, Boeing’s Max scandal and the tragedies it has created should not be dismissed. It’s a brutal illustration of what’s become of major, blue chip stocks in a world where debt accumulation and executive compensation is incentivised over selling a product that isn’t defective, and actually strengthening the business.

Boeing is currently begging for a $10 billion loan from Citigroup, having taken out a $9.5 billion credit line in October.

Those are some big numbers. But let’s add some context.

Boeing was already in negative equity in September of last year. Those billions in additional debt are on top of $136 billion of other liabilities, weighing against $132 billion in assets.

But here’s the kicker: since 2013, in the years when these liabilities were being loaded up, and Max planes unfit for flight were (knowingly) being produced, Boeing spent $43.4 billion on share buybacks.

The company could have invested in creating a new and actually safe design. Plenty of that debt could have been paid off.

But no. There was a different agenda on the table: enriching management. Those buybacks inflated Boeing’s share price, and increased Boeing’s earnings-per-share ratio (by reducing the number of shares in existence). This process, a form of what is known as “financial engineering”, is particularly beneficial to those who are compensated through stock: like Boeing executives.

The de-fanging of debt

I may sound like a broken record here, but what’s happened at Boeing is a high-profile example of the moral hazard created by central banks, who by distorting the price of money, have distorted the incentives of those who have access to it.

Central bankers are of course not the ones who allowed defective aeroplanes off the production line. Nor were they the ones buying billions of Boeing stock (except for the Swiss National Bank, which may well have a load of it on its balance sheet). 

In a world of no interest rates, debt takes on a completely different nature. It goes from being a menacing snake that can instil a motivating fear, forcing a brutal efficiency, to a much more docile animal.

Why bother to get rid of it, when you can simply take out another loan when the debt comes due? Why invest in making new products at all, or improving them, when you can simply enrich yourself through financial engineering?

Without Albert Einstein’s eighth wonder of the world – compound interest – debt becomes a snake without fangs. It no longer has the menace that drives accountability and instils the fear that motivates action.

Lacking teeth to hurt itself, the snake doesn’t even bother to find prey, but simply begins swallowing its own tail. The self-cannibalisation of companies like Boeing have produced remarkably higher stockmarket valuations, but in this case, the snake appears to have choked.

Rewarding the snake

While there is plenty of credit that Boeing has yet to tap, plenty more of itself it has yet to eat, satiating its managers greed is no longer its top priority. The true extent of Boeing’s mismanagement has yet to be revealed, and there could be much rot in the business that has yet to be uncovered. Those assets may actually be worth a lot less than $132 billion, and those liabilities may be a lot more than $136 billion.

If the situation gets worse, I expect a bailout will be on the cards. While in recent history, bailouts have been reserved mostly for the banking system, Lockheed (prior to becoming Lockheed-Martin) was bailed out in the 70s. And in just the last few years, the US military has been making large orders of F-15 fighter jets it doesn’t need for no reason other than to keep its manufacturing supply chain alive, for when it needs to buy something it actually needs from it.

Mnuchin has already claimed Boeing’s woes will be a drag on the overall US economy – and nobody likes a drag on the economy during an election year.

The loss of a major employer isn’t what any government wants, especially if it’s an election year, and especially if it’s a major aerospace and defence contractor and a Cold War has begun.

But rewarding failure comes with a cost much greater than the reward itself…

Back tomorrow,

Boaz Shoshan
Editor, Capital & Conflict

Category: Market updates

From time to time we may tell you about regulated products issued by Southbank Investment Research Limited. With these products your capital is at risk. You can lose some or all of your investment, so never risk more than you can afford to lose. Seek independent advice if you are unsure of the suitability of any investment. Southbank Investment Research Limited is authorised and regulated by the Financial Conduct Authority. FCA No 706697. https://register.fca.org.uk/.

© 2021 Southbank Investment Research Ltd. Registered in England and Wales No 9539630. VAT No GB629 7287 94.
Registered Office: 2nd Floor, Crowne House, 56-58 Southwark Street, London, SE1 1UN.

Terms and conditions | Privacy Policy | Cookie Policy | FAQ | Contact Us | Top ↑