writing about The New Columbia Knight-Bagehot Guide
business to Economics & Business Journalism
e d i t e d by
terri thompson
Writing About Business
Writing About Business The New Columbia Knight-Bagehot Guide to Economics and Business Journalism
Edited by Terri Thompson
Columbia University Press New York
Columbia University Press Publishers Since 1893 New York Chichester, West Sussex Copyright © 2000 Columbia University Press The press gratefully acknowledges the support of Dow Jones & Company in the publishing of this volume. Library of Congress Cataloging-in-Publication Data Writing about business : the new Columbia Knight-Bagehot guide to economics and business journalism / edited by Terri Thompson.— 2nd, totally rev. ed. p. cm. Originally published: New York: Columbia University Press, ©1991; 43 sections have been written specifically for this book. Includes index. ISBN 0-231-11834-1 (cloth : alk. paper) ISBN 0-231-11835-X (pbk : alk. paper) 1. Journalism, Commercial—Handbooks, manuals, etc. I. Thompson, Terri. PN4784.C7 W54 2000 070.4⬘86—dc21 00-059656 ∞ Casebound editions of Columbia University Press books are printed on permanent and durable acid-free paper. Printed in the United States of America c 10 9 8 7 6 5 4 3 2 1 p 10 9 8 7 6 5 4 3 2 1
Disclaimer: Some images in the original version of this book are not available for inclusion in the eBook.
Contents Preface and Acknowledgments The Guide
ix xi
Terri Thompson, Director, Knight-Bagehot Fellowship in Economics and Business Journalism
Writing About Business and the Economy
xv
Chris Welles, fellowship director, 1977–1985
PART I.
BASIC CONCEPTS
1. MACROECONOMICS
How Economic Systems Work
3
Barbara Presley Noble, ’96
The Political Economy of Government and Business
13
S. L. Bachman, ’98
Government Regulation and the Regulators
25
John J. Oslund, ’97
Economic Indicators
34
John C. Finotti, ’95
Demystifying the Federal Reserve
41
David M.Wessel, ’81
2.
MICROECONOMICS
Economics of the Firm
55
Vincent Chikwendu Nwanma, ’99
Business Management: Organization of the Firm
63
Scott Aiken, ’76
Sales and Marketing
72
Charles Butler, ’99
Accounting Principles and Practices
79
Ovid S. Abrams, ’76
CONTENTS
How to Read Financial Statements
98
Susan Scherreik, ’91
Covering Business in Your Town
106
Jacalyn DePasquale Carfagno, ’98
3.
CAPITAL MARKETS, BANKING,AND FINANCE
Where Wall Street Meets Main Street
112
Patrick McGeehan, ’94
The Stock Market
119
Sharon R. King, ’96
The Bond Market
128
John J. Doran, ’99
Derivatives and Other Exotic Securities
139
William Glasgall, ’78
Hedge Funds
147
Jaye Robinson Scholl, ’82
4.
INTERNATIONAL
Trade and Global Economics
156
Stephen H. Dunphy, ’76
International Business
163
Dave Lindorff, ’79
Global Financial Markets
173
Andrew Leckey, ’79
Covering the World Bank
180
Paul Sweeney, ’86
PART II.
PRACTICAL REPORTING AND WRITING TIPS
How to Use Numbers and Statistics
191
Julia Angwin, ’99
What You Can Get from Public and Private Companies
197
Leah Beth Ward, ’88
What the Government Has in Its Files James V. Grimaldi, ’93, and Lawrence J.Tell, ’83
205
CONTENTS
The Freedom of Information Act
212
Pamela G. Hollie
Internet Resources for Business Reporters
216
Robin D. Schatz, ’84
How to Use Electronic Data to Generate Company Stories
226
Michael Molinski, ’98
Live Sources—How Do You Get Them to Talk?
234
Peter Alan Harper, ’95
Conducting Live Television Interviews
239
Jan Hopkins, ’83
Business Journalism on TV
246
Mark Piesanen, ’96
Online Journalism
250
Gerri Willis, ’92
Ethics in Business Journalism
255
Aly Colón, ’83
Part III.
GETTING THE STORY: INVESTIGATIVE TECHNIQUES AND STRATEGIES FOR COVERING SPECIFIC BEATS
Personal Finance
265
Pauline Tai, ’89
The Insurance Industry
272
Joseph B.Treaster, ’96
Health Care
280
Trudy Lieberman, ’77
Technology and Telecommunications
291
Craig Miller, ’86
Media and Entertainment
301
Michael Connor, ’81
Real Estate and Urban Development
308
John Gallagher, ’87
The Retail Industry Mel Laytner, ’88
315
CONTENTS
The Environment
324
John M. Holusha, ’76
Labor and Workplace Issues
331
Kim Norris, ’96
Consumer Reporting
339
Frances Cerra Whittelsey, ’85
Taxes
347
Sandra Block, ’94
Not-for-Profit Institutions
352
Steve Askin, ’91
Founding the Fellowship
362
Stephen B. Shepard, editor-in-chief, Business Week
Glossary List of Contributors Index
365 407 410
Preface and Acknowledgments From conception to completion, this guide is a true collaboration and includes a collection of essays written and edited by some of the best practitioners of business writing today. More than sixty individuals contributed to this work as writers, editors, and reviewers. The essays were written by alumni of the Knight-Bagehot Fellowship in Economics and Business Journalism, a midcareer program at the Graduate School of Journalism, Columbia University. This guide is their gift to the Fellowship on its twenty-fifth anniversary. This is a second, totally revised edition of the Knight-Bagehot Guide, which was first published in 1991 and edited by Pamela Hollie Kluge. Though most of the material presented here is new, the mission of this guide is the same as that of the original— to demystify business and economics and to help journalists do an important job well. The idea to revise this guide grew out of discussions with members of the KnightBagehot Board of Advisors, including the Fellowship’s past directors. I wish to especially thank Chris Welles, who directed the program from 1977 to 1985, for his guidance and enthusiastic support of the Fellowship. His introductory essay puts business and economics journalism into an historical context. The Fellowship owes a special thanks to Stephen Shepard, editor in chief of BusinessWeek, who, with Soma Golden Behr, assistant managing editor of the New York Times, developed the idea for the Fellowship in 1975. With the encouragement of several deans, including Elie Abel, Joan Konner, and, most recently, Tom Goldstein, Columbia Graduate School of Journalism has provided a lively, innovative environment for economics and business journalism education to flourish. Several members of the Columbia University faculty, as well as many of the speakers and guests who take part in the nine-month Fellowship program, helped with the guide. Among these, I would like to thank Peter Bakstansky, Jim Carey, Tim Carrington, Evan Cornog, John Dinges, Franklin Edwards, Peter Garrity, Ray Horton, Maile Hulihan, Steve Isaacs, Myron Kandel, Catherine Lacoursiere, Marshall Loeb, Ed Martin, Joshua Mills, Floyd Norris, Jonathan Oatis, John Pavlik, Steve Ross, Rosalind Seneca, and Matt Winkler. For his loyal assistance, I also thank Robert Petretti. For guiding this book through the production process, I thank Ann Miller, executive editor at Columbia University Press, and the team at Impressions Book and Journal Services. The Fellowship is indebted to many corporations, foundations, and individuals for their annual financial support. Because of the commitment of these supporters, the Fellowship has been able to make a valuable contribution to journalism education, to
PREFACE AND ACKNOWLEDGMENTS
the profession, and to the public. The Fellowship is especially grateful to the John S. and James L. Knight Foundation, which has contributed $5 million to the program’s endowment; I wish to thank in particular Del Brinkman, who directs Knight Foundation’s journalism programs and has been a constant source of encouragement. Finally, I wish to thank my family—my father, John Thompson, for sharing with me his business acumen; my mother, Donna Thompson, for her spiritual guidance; and my husband, Peter Rosenthal, and son, Daniel, for their loving patience.
The Guide Terri Thompson
Much has changed in the decade since the guide was first published. In many ways, the world has gotten smaller as developments in technology and the growth of the Internet have brought us closer together. But one thing has not changed. Business and economics are complicated, and writing about them is risky. Every day holds a chance for mistakes, misunderstandings, and misrepresentations. This guide should help journalists, as well as students of business and public relations, reduce the risks and feel more confident in their writing. The essays assume the reader has little or no experience with economics or business terms and concepts, so the guide will be useful even to those who dodged college courses in economics, accounting, marketing, or finance. Some of the information may be familiar; some may seem technical and obscure. But all the topics covered are important to an understanding of the scope and demands of economics and business writing. There’s no such thing as a single business “beat.” Business reporting involves many beats, and journalists who cover business tend to be specialists. Those who cover the markets, for instance, are known as financial writers, whereas those who report on monetary or fiscal policy from Washington may call themselves economics correspondents. These essays were written by dozens of journalists in the belief that no single journalist could have written it all because no one has ever done it all or, at least, done it all well. Each of these essayists has in common a desire to learn and to improve business journalism. They all share a commitment to fairness and accuracy in their reporting. As Knight-Bagehot Fellows, they took time out of their careers to rigorously study business and finance. In this guide, they bring together hundreds of years of experience, and in their individual essays, they generously pass on their expertise and knowledge. As editor of the guide, I’ve tried to preserve the voice and opinions of each author. Any errors are undoubtedly the result of careless editing on my part and the authors should, of course, be absolved. The guide is divided into three parts. The first provides background and basic concepts of economics and business, including how economies are managed, how companies operate, how capital markets work, and how the rest of the world fits in. The second part gives practical reporting and writing tips, such as where to find the best resources and how to conduct interviews. Part III tells journalists how to tackle everyday
THE GUIDE
stories and describes investigative techniques and strategies for covering specific beats. Finally, the glossary at the end of the guide should prove a handy reference for anyone who writes about business and economics. To get the most from this guide, readers and teachers who use it as an aid to teaching may want to skip around and mix and match essays from the various sections. For example, you can put to practical use the essay from part II on what you can get from public and private companies by reading it concurrently with the essay from part I on how to read financial statements. Similarly, the essay on personal finance from part III should be read together with all of the essays from part I that deal with capital markets, particularly those on stocks and bonds.
Part I: Basic Concepts The economy may be journalism’s most intimidating subject. Economic stories never seem to be as clear or as meaningful as journalists would like. One reason for this is that economists, the economic translators, are seldom certain about what’s going on. And the federal government, despite its tinkering with interest rates or budgets, doesn’t really “manage” the economy. To put this into perspective, the guide begins with a section on macroeconomics. Macroeconomics is the study of whole economic systems, that is, it looks at the whole economic picture and takes into account general levels of income and output and how they relate to various sectors of the economy. Within this section, you will find essays on how economic systems work; how politics affect economic policy; and how government intervenes through regulation and, in the United States, through the Federal Reserve. Microeconomics, which is the study of individual areas of activity as opposed to the whole, is addressed in the next section. The text includes essays on the economics of the firm, business management, sales and marketing, and principles of accounting. Though each of these essays is useful to a reader who is learning how businesses are organized and run, the essays on how to read financial statements and how to cover business in your town are especially helpful to business reporters. Finance is a lucrative business for investment bankers, and Wall Street deal makers and their deals are often the focus of business coverage. But most newspaper business sections were created to inform shareholders—the owners of public corporations—of financial developments. A section on capital markets, banking, and finance begins with an essay on where Wall Street meets Main Street and includes essays on the stock and bond markets, derivatives and other exotic securities, and hedge funds. As world financial markets become increasingly linked as countries with centrally planned economic systems shift to market economies and trade expands, looking beyond our borders becomes increasingly important. This final section in part I of the
THE GUIDE
guide discusses world economics, international business, global financial markets, and the World Bank.
Part II: Practical Reporting and Writing Tips Part II of this guide is designed to provide practical information, such as how to find and develop sources. Since many of us who studied journalism or selected it as a profession did so to avoid mathematics, a “math phobia” permeates the field. Overcoming this fear may be a serious challenge for business specialists, because nothing is worse than confusing readers with misused or inaccurate numbers. For this reason, this section begins with an essay on how to use numbers and statistics properly when writing about business. Other useful essays discuss what you can get from public and private companies, what the government has in its files, where to find Web resources, how to use electronic data to generate company stories, how to get sources to talk, and how to conduct live interviews on TV. Two of our contributors have weighed in with critiques of television business journalism and the growing field of online journalism. Finally, we discuss ethics, a subject that should be important to all journalists but especially business journalists, who almost daily confront potential conflicts of interest. This essay suggests conduct guidelines for business reporters to ensure the highest level of integrity and credibility.
Part III: Getting the Story—Investigative Techniques and Strategies for Covering Specific Beats In part III, writers provide advice on several important beats, such as personal finance, insurance, taxes, health care, real estate, retailing, the environment, and workplace issues. These essays will help journalists learn how to cover specific industries, such as technology and telecommunications or media and entertainment, and how to keep the reader in mind when doing so. The guide does not attempt to answer every question about every type of business, but most of the important beats are covered here. And while many journalists will not need all the information in this guide, most business editors will. Sooner or later, all journalists confront stories they never foresaw, issues they never considered, information that baffles them. For those times in particular, we hope that you will keep the guide around as a handy reference.
Writing About Business and the Economy Chris Welles
For years, business, economics, and finance journalism was a bleak wasteland—“the most disgracefully neglected sector of American journalism,” according to former NBCTV correspondent and former dean of the Columbia Graduate School of Journalism School Elie Abel. If you did a lousy job covering city hall, couldn’t hack it writing obits, weren’t too swift taking classified ads over the telephone, then they sent you to the business section. Maybe they even made you business editor. That was the way it went at countless newspapers. And it wasn’t much better at most business magazines. Business writing was tedious and boring, little more than jargon-ridden rewrites of corporate press releases about earnings results and executive promotions. And because business writing was tedious and boring, smart journalists considering specializing in the field tended to conclude that business itself was tedious and boring. They regarded the business desk as a dead end. Writer Dom Donafede once described business reporters as “city staff castoffs and journalistic drifters, bit players in a raw profession, fulfilling a melancholy task requiring little talent and less imagination in a cramped corner of a newsroom.”1 Today, everything is changing. Business journalism isn’t just flourishing; it’s exploding. CNNfn, the financial network division of the cable news giant, employs more than 200 business journalists. Bloomberg L. P., which rapidly built a news and information empire, employs more than 800. According to one survey, more than 5,000 journalists have joined business news establishments in the past decade. Publications featuring business, finance, and economics news are proliferating. Business is now considered a glamour beat, almost as prestigious as the White House or the Paris bureaus. The ranks of business journalists now include some of the best-known and most talented editors and writers in the country. Readers of this book who may be attracted by the aura of glamour or the abundant job opportunities need to understand that the field of business is quite different from other journalistic specialties. Business writing requires special skills and presents often formidable demands and frustrations. Some of the difficulties stem from the complexity of the subject matter, such as the arcane intricacies of corporate financial statements. 1 Dom
Bonafede, “The Bull Market in Business/Economics Reporting,” Washington Journalism Review, July/ August 1980, 23.
WRITING ABOUT BUSINESS AND THE ECONOMY
The Internet can be very helpful, but ferreting out information requires special talents. Even more challenging is so-called “computer-assisted reporting,” for example, using computers and databases to establish discrimination in housing policies or determine a company’s workplace safety record. Other challenges are more subtle, such as the reluctance of many business executives and other story subjects to cooperate with reporters and the economic pressures that business interests can exert on the media. But having worked as a business journalist for 37 years, I can attest that the satisfactions much outweigh the frustrations. Some basic questions: Why has business journalism emerged from obscurity to prominence? Why has the field become so essential to readers and viewers? Why does it present journalists such unusual rewards and challenges? One big reason is that news about business, economics, and finance is going through one of the most dynamic, momentous, and exciting periods in its history. That means grist for endless stories. These are some of the major trends: The Internet. It is not exaggeration to say that the Internet will transform life as we know it. It is fundamentally changing the way we live, talk, work, play, shop, communicate, and much more. The impact of the Net on business will be especially dramatic. The first phase was the explosion of information availability. The second was so-called consumer “e-commerce,” such as buying books through Amazon.com. The third has been called e-process. Though less visible, it may be the most dramatic development of all. E-process changes business systems, generates new revenue sources, creates new competitive advantages, and increases new operating efficiencies. In their book Unleashing the Killer App: Digital Strategies for Market Dominance (Harvard Business School Press, 1998), Larry Downes, a consultant and speaker on the impact of emerging technologies on business strategies, and Chunka Mui, an expert on the potential of the digital future, said, “The Internet is remaking every company in every industry in the world—faster than anyone is willing to predict.” They add that the Net “is already moving from a source of business change to one of social and personal transformation.” The new economy. In the first edition of this guide, analysts bemoaned “stagflation,” a condition that was dragging down the economy. What a difference a decade makes. By 2000, the economy had been in a protracted expansion for almost a decade. Not only was it booming, it was also radically overturning long-held conventional economic wisdom. The economy was growing at a rapid rate, around 4 percent, while unemployment and inflation held steady at relatively low levels. Why? Believers pointed to a surge of productivity, the result of innovations in computing and telecommunications. Skeptics argued these conditions were one-time flukes—that inflation would flare up or the economy would slump. In short: more fodder for economics reporters.
WRITING ABOUT BUSINESS AND THE ECONOMY
Global capitalism. Not long ago, most markets were under the control of individual governments. Now we have moved toward a global system that nobody controls. The emergence of unfettered capitalism and worldwide markets has radically altered the flow of goods, services, and money, promoting trade, innovation, and growth. But uncontrolled markets have a downside: greater volatility and vulnerability to debilitating instability. Digital convergence. Telecommunications, television, and computers once operated in discreet realms. Now they are fusing into a single digitized system of electronic communications that allows images, text, sound, and video to be manipulated and transmitted. The possibilities are astronomical. Telecommunications is undergoing its own upheaval. The global telephone monopoly is collapsing. Most communications may be wireless and migrate to the Web. Biotech. Dolly, the cloned sheep, made a big splash in 1997. But Dolly was only a sideshow compared to the surge of innovations in genetics and biology that are revolutionizing medicine, agriculture, and industry. Scientists are already beyond understanding life; now they’re manipulating it. And as we learn how to play God, the toughest issues we confront may be ethical ones. Trading markets. Dealings in stocks, bonds, and commodities have changed very little over the past 200 years. Now, the new wave of electronic technologies is fundamentally remaking the New York Stock Exchange and other traditional exchanges. Much, if not all, of the action will soon be electronic. Physical trading floors will be only a memory. The winner at the end of the day? The investor. These complex trends about business, economics, and finance are as important as politics or international affairs. Most editors and reporters have come to appreciate the profound impact that business and economics have on our lives. Economics may seem arcane and abstract. Yet such indicators as interest rates, employment, installment credit, the consumer price index, housing starts, and consumer confidence data directly affect our jobs, our salaries, the taxes we pay, the interest on our mortgages, the return we get on our investments. Large corporations may seem remote and somewhat mysterious. But the decisions they make about where to build plants, the technologies they use, the kinds of goods and services they produce, and how they market and distribute their products play a huge role in the choices we have and the prices we have to pay for the things we buy. Finance, especially, can be very difficult to comprehend. Take derivatives and securitization deals. Many trillions of dollars’ worth of these instruments course through the financial markets every year, but only a tiny portion of the population has ever heard about them. Even fewer can explain them. Most consumers are familiar with such insti-
WRITING ABOUT BUSINESS AND THE ECONOMY
tutions as banks, savings and loans, insurance companies, credit unions, mutual funds, and real estate investment trusts. Still, few people really understand how those institutions behave—and misbehave. They can have a powerful impact on your wallet. As Woodward and Bernstein learned: “Follow the money.” Readers and viewers now depend on business and economics journalists to explain how business works and provide advice about a wide range of topics. Indeed, perhaps no other journalistic specialty provides consumers with information that is as essential to their daily lives. Other specialties offer intellectual stimulation, relaxation, diversion, titillation, and fantasy. But business and economics coverage offers information that people need and use. Consumers want easily understood guidance about practical matters such as how to buy a car or invest in the stock market. They want to understand how business and economics really work. They want to know who makes economic decisions for the country, how the Federal Reserve operates, what causes inflation and deflation, what moves the stock market, why the value of the dollar versus that of other currencies is important. They want to know what sorts of people run major corporations, their goals and priorities, their attitude toward ethical questions, how they decide on strategies to pursue and products to make, how they use power in Washington, and their attitudes toward the environment and to their employees’ health and safety. Newspapers, television, magazines, and other media have been responding to these needs. Big-city dailies such as the New York Times, the Washington Post, the Los Angeles Times, the Boston Globe, and the Chicago Tribune have substantially enlarged their news holes for business. So have papers in smaller cities such as Atlanta, Louisville, Denver, Miami, and Philadelphia. USA Today publishes one of the nation’s savviest business sections, often scooping the New York Times and the Wall Street Journal. The Journal, probably the most important business publication, has been rapidly expanding its coverage over the past few years. Both the Times and the Journal, as well as other papers, now have extensive on-line operations. The Financial Times has emerged as the best-read European financial newspaper and is expanding into the United States. Numerous new business magazines have sprung up, including Business 2.0, the Industry Standard, Red Herring, the Daily Deal, Bloomberg Personal Finance, and Fast Company. Some are very specialized, such as AlleyCat News, which covers New York’s “Silicon Alley.” Numerous online financial publications now exist. One notable site is www.thestreet.com, which is owned in part by the New York Times and covers the securities markets. But the best site by far is www.marketguide.com, a vast wealth of business and financial information. Not only does it provide extensive financial data, news, and research, it also offers extensive profiles on corporations. You can get bios of officers and directors as well as information on executive compensation and stock options. There are links to Securities and Exchange Commission filings and other materials. Most of the site is free, though some brokerage research reports cost $5 to $25 and sometimes more. Television pays a
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good deal of attention to business. Cable TV has been especially aggressive, notably CNN, CNNfn, and CNBC. In sum, the quality of business journalism has been improving greatly over the last decade. Reporters have been doing a better job digging behind the press releases to find out what really happens. Writing has become livelier and more accessible to consumers. To capture the drama of events such as corporate takeovers and CEO ousters, stories now include more personality profiles, color, anecdotes, and narrative. Business editors have overhauled their tombstone-like page designs and now use arresting graphics to explain often abstruse subjects. Still, editors staffing business sections realize that to cover the field effectively, reporters need specialized experience and training. Journalism has become more and more specialized. The old notion has faded that any good general-assignment reporter can turn out a quick, authoritative story on any subject. Business coverage requires more background knowledge than other fields. The world has become too complex. Readers demand more-sophisticated coverage. The Knight-Bagehot Fellowship is only one of several midcareer programs established to meet this need. Many large journalism schools offer business writing courses. Baruch College in New York City recently launched a master’s degree program in business journalism. More reporters are obtaining MBAs and economics degrees. Former Council of Economics advisor Gardner Ackley once remarked that he wished reporters who wrote about economic affairs had two qualifications: first, that they had taken a course in economics; and second, that they had passed the course. As the field of business journalism has progressed, Ackley’s remark may be on its way to coming true. Business and economics journalism still has plenty of room for improvement. The quantity of coverage is often more impressive than the quality. Many people, from consumers to corporate executives, still want a much broader perspective on the news. They want to understand more about how business, economics, and finance work. But too many older managing editors, who began their careers when the field was a wasteland, refuse to acknowledge changed perceptions and expect their business sections to get by with minimal staff. Too many business editors shy away from critical stories and refuse to allocate resources for investigative projects to take their coverage beyond the daily news flow. Too many reporters do not venture beyond handouts from and lunches with public relations people. Too many trade magazines are little more than sycophants for the industries they cover. In some ways, there has even been backsliding. Many newspapers have cut back on investigative reporting and tough business coverage of corporate behavior and other difficult topics. Instead they allocate more resources for personal finance, a course of action that is less likely to disturb managing editors and advertisers. Indeed, tenacious, iconoclastic investigative reporting is not exactly flourishing these days. Publications such as the New York Times, the Washington Post, the Wall Street Journal, Business Week, Fortune,
WRITING ABOUT BUSINESS AND THE ECONOMY
Forbes, Consumer Reports, and a handful of other publications routinely produce groundbreaking work. But after these, the list dwindles rapidly. One reason for this situation is that regularly taking on tough stories is daunting. Covering business and economics is more demanding than any other specialty, much more difficult, for instance, than writing about a football game, a school board meeting, a robbery, a new musical fad, or even a political campaign. Business and economics reporters must be able to understand the intricacies of the field and write about them in clear, concise, intelligible prose. And the fact that business and economics touch people’s lives so directly puts unusual demands on journalists for accuracy, reliability, and thoroughness. A careless mistake in an investment story can cost an investor thousands of dollars. Writing about economics poses other special obstacles. At first glance, it may seem an easy topic to cover because economists are typically eager to be interviewed by the press. Unfortunately, economists are notorious for their propensity to disagree with one another and to change their views from one moment to the next. It is often said that if you laid a thousand economists end to end, they would not reach a conclusion. Economic data are often no more helpful; the same figures can often be used to substantiate two completely disparate interpretations. In reporting an economics story, one discovers that it is virtually impossible to come up with a definitive answer to numerous conundrums, such as whether the dollar should sell higher or lower in foreign markets, whether a tax hike’s negative effects on consumer spending will outweigh the positive impact on the budget, whether the Federal Reserve’s raising interest rates to curb inflation will cause a painful slowdown. Economists still argue about whether Reaganomics was a dramatic success or a terrible failure. You can find plenty of economists on both sides of the issue. Despite appearances to the contrary, economics is as much an art as a science, closer to sociology than physics. If they work hard enough, reporters writing about a business event may come up with a reasonable approximation of reality. But reporters covering an economic trend must deal with far larger numbers of people and far more intricate patterns. Typically they find precision and tangibility very elusive. The best economics writers, though, do not resort to on-the-one-hand/on-the-other-hand stories. They strive to report the direction in which the preponderance of the evidence points. Reporting on business presents different dilemmas. In their attitudes toward the press, corporations are quite different from hospitals, schools, police departments, and other government or nonprofit organizations. Public entities recognize an obligation to serve the public and thus tend to be responsive to reporters seeking information. Corporations often do not feel that obligation. Though they are publicly owned in the sense that their stock is owned by investors, corporations really serve private ends— making money for their employees and their shareholders. Many corporate executives feel that the public has no special right to know about the inner workings of their com-
WRITING ABOUT BUSINESS AND THE ECONOMY
panies, other than Securities and Exchange Commission–mandated disclosure of financial statements and other required materials. Even some of the nation’s largest corporations are extremely secretive about their internal affairs. They actively advertise their products and employ public relations people to polish their images and spread the word about positive developments. Yet they are far less forthcoming to reporters about negative events. It is not unusual for a corporation to forbid its employees to talk to reporters seeking to write about the company. In recent years, though, corporations have been much more forthcoming. They have learned that stonewalling usually backfires. Even when a company has bad news to disclose, such as unusually weak earnings reports, corporate public relations executives know that cooperating with journalists can be beneficial to the firm. The savvy PR person is eager to talk about problems in order to put a positive spin on the event. But corporations may still have very good reasons to be reticent. They may not want to reveal their plans to competitors. And even if a company has bags of dirty linen that will eventually have to be aired, its executives may feel it’s better to say little and hope the matter goes away. Some business executives suggest that in this age of enlightened PR practices, journalists and executives can reduce the hostile feelings that have plagued relations between them. That’s certainly worth pursuing. But the fact remains that business and the press have inherently conflicting goals. One former Fortune editor, Dan Seligman, pointed out that a corporate executive “is not always looking for the unvarnished truth about his enterprise” and doesn’t “necessarily want coverage that is comprehensive, thoughtful, and fair.” He observed that “there is that inevitable collision of interests between a corporation that is concerned with its own public image and is eager to put its best foot forward, and the journalist who wants a story.” The business executive will want the journalist to print things that the journalist doesn’t want to print. And the journalist will want to print things that the business executive doesn’t want printed. It’s no surprise, then, that the relationship between business and the press has often been acrimonious, with heated recriminations on both sides. Business’s beef with the press is often well founded. Even seasoned journalists allow biases and preconceptions into their coverage. They tend to be skeptical of authority, large organizations, and repositories of power. And they are often suspicious of people who have made a lot of money. This sometimes leads business reporters to believe the worst about a corporation or about a wealthy executive’s motives, resulting in stories that are slanted or unfair. Relations between business and the press today are not exactly cordial. But the two sides seem to work with each other more easily than they used to. One reason: left-leaning, confrontational sixties-era writers have mostly faded away—except at the Nation and a few smaller publications. Today’s journalists tend not to hold strong ideologies or political affiliations. If they have such orientations, they tend to be liberal on social issues
WRITING ABOUT BUSINESS AND THE ECONOMY
such as welfare reform, but conservative on financial issues such as free markets. Whatever their leanings, journalists’ ideologies rarely seem to taint their writing. In short, the business versus press issue seems to have subsided. But many other issues complicate the journalist’s job. Business writers are frequently under pressure from their editors and publishers to take a softer line. Unlike story subjects in other fields, corporations have the power to exert considerable pressure. They sometimes retaliate against negative stories by canceling their advertising. Patrick J. Buchanan, who worked in the Nixon and Reagan administrations, once advised, “These puppies of the press need to be given an occasional jerk on the leash of the advertising dollar.” Journalists also have to reckon with the fact that their publishers often have close business and personal relationships with corporate executives and don’t like to embarrass their friends. Fear of angering advertisers or publishers often causes editors to spike negative stories. Some newspapers and TV stations have reassigned or even fired reporters who offended business interests. Large media organizations, which have broad advertising bases, can easily withstand these pressures. The Wall Street Journal, for instance, is seldom accused of caving in to business interests. But the situation is much different at smaller newspapers or broadcast stations, where the displeasure of only a few members of the local business community can have devastating financial consequences. Few small newspapers are willing to risk incurring the wrath of local bankers, realtors, insurance agents, or supermarket managers. In many communities, business doesn’t have to flex its muscle; self-censorship by editors usually ensures that business has little to be upset about. John F. Lawrence, former assistant managing editor for economic affairs at the Los Angeles Times, once observed that “the media are far more guilty of being too soft on business than being too hard.” The Internet and the World Wide Web are posing new issues for journalists. At a time when anyone can put up a Web site and start Webcasting, “The Internet makes us all journalists, broadcasters, columnists, commentators, and critics,” said Lawrence K. Grossman, a former president of NBC News and PBS, in the Columbia Journalism Review.2 Equipped with computers, cell phones, and other gadgets, amateurs are producing video, reviewing books, creating chat groups, and essentially covering the news. Tom Rosenstiel, director of the Project for Excellence in Journalism and Bill Kovach, former curator of the Nieman Foundation for Journalism at Harvard, are alarmed at the trend: “A journalism of unfiltered assertion makes separating fact from spin, argument from innuendo, more difficult and leaves the society more susceptible to manipulation.”3 Adds Grossman, “Notwithstanding their lack of professional training in journal2
Lawrence K. Grossman, “From Marconi to Murrow to—Drudge?” Columbia Journalism Review, July/ August 1999, 17. 3 Tom Rosenstiel and Bill Kovach, “And Now … the Unfiltered, Unedited News,” Washington Post, February 28, 1999, B5. Rosenstiel is director for Excellence in Journalism, funded by the Pew Charitable Trust.
WRITING ABOUT BUSINESS AND THE ECONOMY
ism’s canons of objectivity, accuracy and fairness, some, like Matt Drudge, are bound to become the next century’s media stars.” More disquieting is the crumbling barrier between advertising and editorial, a variation on business versus the press. Advertorials, infomercials, and “sponsored” editorials are relatively easy to spot. But more complex, sophisticated, and elusive arrangements are emerging. Perhaps the seminal example, in 1989, was an ingenious deal between Kmart Corp., Martha Stewart, Family Circle, and Better Homes & Gardens. Here’s how it went: Kmart would spend $20 million to publicize Stewart’s reconstruction of her country house in Connecticut, using products carried at Kmart. Family Circle would cover the project in a series of articles and would carry three advertorials purchased by Kmart. Stewart’s project would also involve Family Circle radio ads and sweepstakes developed by the publication for Kmart customers and employees. Stewart would become Kmart’s “lifestyle and entertainment consultant,” for which she would be paid $5 million a year. She would also become a contributing editor of Family Circle and would write home renovation articles. Kmart would buy more than 60 pages of advertising in Family Circle. The advertorials would also be featured in Better Homes & Gardens, and the magazine would be distributed in Kmart stores.4 Question: Is Martha Stewart (a) a journalist, (b) a consultant, (c) an entrepreneur, (d) a promoter, (e) a remodeler, or (f ) all of the above? The Internet is creating new twists on the traditional counterbalance of advertising versus editorial. In a recent issue of BusinessWeek, legal affairs writer Mike France detailed the blurring editorial distinctions in Web publications, such as joint ventures between media companies and electronic communications networks that trade stock. Especially insidious are new arrangements where media Web sites collect not advertising sales but a percentage of the sites’ online product sales. Said France, “This fundamental shift in the way the media make money could potentially change the way they cover the news. The more the press gets in the business of hawking products, the harder it will be to criticize those goods—and the companies making them. . . . E-commerce is going to force journalists to buddy up to advertisers in ways they never have before.”5 The ultimate threat to journalists may be the swift consolidation in the information/entertainment business. In a 1996 New Yorker article, writer Ken Auletta likened the industry to a Japanese keiretsu, a multi-industry cartel or “web of relationships.” That could lead to “implicit or explicit collusion” to raise prices, said Justice Department staff lawyer Philip Verveer. A chart accompanying the story showed how the major media companies—Microsoft, Disney/ABC, Time Warner, General Electric/ NBC, TCI, and News Corp.—both compete and collaborate with each other. Auletta 4 Randall Rothenberg, “Magazine and Retailer Join Forces [Martha Stewart],” New York Times, January 18, 1989, D16. 5 Mike France, “Journalism’s Online Credibility Gap,” Business Week, October 11, 1999, 122.
WRITING ABOUT BUSINESS AND THE ECONOMY
quoted Peter Barton, then president of TCI’s Liberty Media, which has interests in many media companies: “We make connections. The six executives of Liberty Media sit on more than 40 corporate boards. Their function is to act not just as watchdogs for our investments but as relationship managers [sic] with our partners. In this way, we can link pieces of our portfolio to create strengthened alliances, new business, and shared economics.” Said Auletta, “That’s not a bad definition of keiretsu.”6 Dean Alger, author of Megamedia: How Giant Corporations Dominate Mass Media, Distort Competition, and Endanger Democracy (Roman and Littlefield, 1998), takes the point a step farther. These cozy ties, he argues, fly in the face of “a fundamental democratic premise” that people should have a “diversity of truly independent sources of news and ideas on public affairs.” But that’s not happening, he says. “If a few Megamedia corporations control most of the major print, broadcast, cable, and other media that people most rely on as their main sources of information, opinion, and other creative expression, then this fundamental pillar of democracy is likely to be seriously weakened.” So take your pick. Lawrence Grossman says the traditional media are endangered species. Dean Alger says the traditional media may virtually squelch free speech. Whatever the case, there’s some good news for the journalist. Reporting has been undergoing a revolution. Not long ago, a typical investigative reporter’s MO would be to haunt the courthouse, dig into the innards of obscure government agencies, and thumb through thick files in library catacombs. Reporters still do that, of course. And face-toface interviews will never go out of style. But journalists spend much of their time these days gathering information on-line. It’s become essential for journalists to be well versed in these rapidly evolving techniques. The Internet and the Web let you gather more information faster than you ever dreamed possible. They can also make you more frustrated than you ever dreamed possible. That’s because you often have to wade through countless Web sites and other electronic venues to get the information you want. One very useful book is A Journalist’s Guide to the Internet (Allyn and Bacon, 1999) by Christopher Callahan, an associate dean of journalism at the University of Maryland at College Park. He details a wide variety of strategies on making the Net a reporting tool. His site, http://reporter.umd.edu, has numerous linkages to other sites. One ingenious feature is ProfNet, an e-mail system for finding expert sources. A request can be distributed to about 2,000 institutions worldwide, including 760 universities; 500 corporations; 380 PR firms; 300 nonprofit organizations and government agencies; and 100 think tanks, scientific associations, and labs. Queries should be directed to
[email protected]. If you’re an investigative reporter or want to become one, you should join Investigative Reporters & Editors Inc., the nation’s biggest and most enterprising organ6
Ken Auletta, “American Keiretsu,” New Yorker, October 20–27, 1996, 225–27.
WRITING ABOUT BUSINESS AND THE ECONOMY
ization of specialists in this field. Members can attend conferences and seminars, purchase its many books at discounted rates, and access many other services. The IRE Resource Center has more than 12,000 stories produced by leading journalists plus hundreds of tip sheets. Its very helpful and link-laden Web site is www.ire.org. IRE also produced perhaps the best book on reporting, The Reporter’s Handbook: An Investigator’s Guide to Documents and Techniques by Steve Weinberg (St. Martin’s Press, 1996), third edition. The group also publishes a book on computer-assisted reporting, ComputerAssisted Reporting: A Practical Guide, second edition, by Brant Houston (visit www. ire.org/carbook). Houston says he uses computers to do “far-reaching research through online data bases; to gather large numbers of records from government agencies; to analyze those records; and to use that analysis to launch stories from a higher level and with deeper context than ever before.” The Web site for that book is www.nicar.org. Other good books: Find It Online: The Complete Guide to Online Research by Alan M. Schlein (Facts in Demand Press, 1999) and Public Records Online, edited by Michael L. Sankey and James R. Flowers Jr. (Facts on Demand Press, 1999). A Web site is available for both books: www.brbpub.com. Finally, check out Forbes’s Interactive Money Guide, published in summer 2000. It rates 300 Web sites, many of them concerning investing and banking. Check out www.forbes.com. Some observers argue that despite IRE and the investigative reporting community, the business press is going soft. Many journalists pull down six-figure paychecks. Some are looking forward to cashing in their stock options—and gaining millions of dollars from some Internet initial public offerings. Business writers are also much more socially respected than in previous eras, sought out for conferences and book contracts. It’s the press’s job, according to A. J. Liebling, to “afflict the comfortable and comfort the afflicted.” Reporters are supposed to be gadflies, feisty, irreverent critics of the status quo and the conventional wisdom. Now, some observers say, journalists have joined the establishment. They have become defenders of the status quo. It is not always easy for journalists to resist subtle but powerful forces of co-optation. But there is a flip side to all the problematic demands, challenges, and pressures. Writing about business, economics, and finance is rewarding for the very reason that it can be so difficult and frustrating. Speaking as someone who wrote on a wide diversity of subjects before concentrating on business, I can say that nothing matches the special satisfaction and pleasures of business reporting: when the former executive finally decides to disclose to you the behind-the-scenes details of how a billion-dollar deal was put together, when you stumble on a document that provides conclusive evidence of a serious financial scam, when you finally figure out why the once high-flying corporation plunged into bankruptcy. To me, it’s more than worth the effort. And I’m sure that readers of this book, after they’ve been in the field for a while, will feel the same way.
PART I
Basic Concepts
MACROECONOMICS
1 How Economic Systems Work Barbara Presley Noble
In the long run, we are all dead.—John Maynard Keynes Imagine you are a maintenance worker at the Hoover Dam, that ambiguously compelling triumph of humans over nature on the Colorado River. Every morning you walk out onto a jetty that stretches partway across the bottom of the dam. Spray from the waterfall creates a fine mist. You look up. The dam looms over you, almost 800 feet in the air and a quarter of a mile wide. You’re a philosophical type, so every morning you let yourself be reminded how puny individual humans are. From the acute angle of the jetty, you can just barely see the entire dam, but you’ve worked there for years, you’ve seen it from all perspectives, you’ve heard how engineers talk about it. You have a strong sensation of the whole. If you had to describe it, where would you start? Even to an experienced eye, the parts aren’t always apparent, and when they are, they’re sort of nubbly, grey, and indistinguishable. Behold the macroeconomics beat, the Hoover Dam of economic journalism— daunting but fascinating, elegant yet overpowering. Macroeconomists study the institutions that make up the looming, nubbly, grey, indistinguishable parts of the whole national economy through time. Most journalists are just like the rest of the American population. We hear words like inflation, growth, monetary policy, unemployment, and productivity all the time; these words scoot tracelessly across our consciousness. We’ll have an intense discussion at a dinner party and realize we have no idea what we’re talking about, but we’ve passed the point where we feel we can backtrack to basic definitions without incurring serious career damage. At that point, fate inevitably intervenes. Your editor calls on Sunday night with an out-of-the-blue assignment. Be at the U.S. Labor Department early tomorrow morning
BASIC CONCEPTS
to get the latest figures on unemployment, one of the numbers—economic indicators— the government delivers to the public at regular intervals. It will be a piece of cake, the editor assures you. Get the numbers, make a few calls, file your story at noon. You hang up the phone and try to remember that sophomore economics class that used to have the same effect on you as a cup of warm milk and a story about baby ducks. Unemployment. People out of work, or not. Something to do with inflation, but what? Those numbers are among thousands that add up to the aggregate activities that comprise the complex national economy. Economists who do macroeconomic research study fluctuations in growth, or how the economy expands and contracts over time. Macroeconomics is, as one writer puts it, the “analysis of prosperity and recession.” Its sibling, microeconomics, covers behavior writ small: that of individuals and companies. Macro looks at behavior writ big: growth, employment, unemployment, inflation, international trade, gross domestic product, deficits. Macro is all the stuff that seems intimidatingly abstract. Yet, broken into constituent parts, both macroeconomics and microeconomics are very much the stuff of journalism, which is to say, of life. Virtually every well-defined area of economic research is also a well-established reporting beat: economic indicators, international trade, company news, consumer behavior, etc. There is no way to be a professional economist without learning some math and getting a graduate degree, but you can cover the economy without being a pro; you just need a working vocabulary, a grip on history, a basic library, and access to the Internet.
The Economic Point of View Academic controversies among economists strongly resemble arguments the various camps of Cold Warriors once had about the Soviet Union. The sides agree on the numbers but disagree on their implications and interpretations. Happily, enough paradigmatic unity exists among economists that their controversies rarely reach the general public. From a journalist’s perspective, the main duty of the macroeconomic theorist is to help government devise policies that will encourage the stability of the national economy, preferably in the direction of expansion. The perceptible disagreements among schools of thought usually concern the degree to which government should intervene when the economy slows down. Some argue that market forces are self-correcting and should be allowed to take their course, others believe government intervention can help markets work more efficiently. The first, classical view prevailed until the Great Depression, when John Maynard Keynes suggested that government intervention could help control cycles of boom and bust. Keynesian economics has become a shorthand for policy measures designed to increase demand for goods and services and thus expand employment, either to maintain growth or to pull out of recession.
HOW ECONOMIC SYSTEMS WORK
One economist’s “fine-tuning” is another economist’s “meddling.” Historically, these positions have been associated with political parties: Democrats favor public spending, which they believe benefits people who accumulate most of their wealth by earning a salary—the traditional constituency, that is, of the Democratic Party. Republicans typically favor lowering taxes or finagling with interest rates and the money supply, strategies that most directly affect the affluent. Changes in how people accumulate wealth, mainly the expansion of investing, have undermined the traditional divide. Whatever the traditional lines of conflict, as a practical matter, the American economy is never allowed to run its course when it begins to go really sour. The Federal Reserve Bank uses its power to impose monetary policy by raising and lowering interest rates to help stabilize prices. In effect it changes the cost of capital by making money more or less expensive to borrow, which in turn—theoretically—slows or stimulates the economy. Since research shows that many political issues come and go but voter anxiety about the economy is eternal—and motivates the typical couch potato citizen to vote— politicians don’t sit around quietly as the economy tanks. At the very least, Congress and the president will debate fiscal policy—government’s ability to spend money or lower taxes—to let the electorate know they are concerned.
An Economic Vocabulary
OUTPUTS product markets, which set prices on goods
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HOUSEHOLDS where individuals, as consumers, workers, and owners decide what they will “buy” (e.g., food, shelter, clothing) and “sell” (e.g., labor)
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SUPPLY
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The macroeconomic variables that affect flow in the system are as follows:
DEMAND
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BUSINESS which decides what it will “buy” (e.g., labor) in order to produce whatever it “sells” (e.g., shoes, horses, breakfast cereal)
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THE MARKETS where supply and demand is equilibrated (balanced)
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Many economists use what they call a circular-flow model to provide an overview of the interdependence of elements of the economy. It looks like this:
BASIC CONCEPTS
Growth Growth is measured in GDP, or gross domestic product, the collective physical measure of all the goods and services we as a nation produce: the cars, appliances, medical care, entertainment, etc., that we make for exchange among ourselves or with other countries in the world. GDP represents the sum of economic activity across the country. Real GDP—that is, GDP adjusted for inflation (or price increases)—has risen steadily over the last three decades, with occasional strays into recession. By definition, recessions are a decline in the GDP, a contraction in the economy for at least two consecutive quarters. (A depression is a larger and longer recession.) Recessions begin just after the peak of the previous expansion and end in a trough before the next expansion begins. Yes, that means we don’t always know—at the time—if we’re in an expansion or a recession. A recovery begins at the lowest point of the recession and lasts until GDP rises to its previous peak level, at which point the economy is in an expansion again. GDP is divided into consumption (durables, nondurables, services); investment (money spent on plant equipment and inventories and by households on housing, capital stock); government purchases, or the total local, state, and federal purchases of goods and services; and net exports (exports minus the cost of imported parts).
Unemployment The labor force is the total number of people (age sixteen and older) employed and unemployed. The unemployment rate is the percentage of the labor force unemployed but looking for work. The unemployment rate is a fungible item. Previously, the government gauged unemployment by the number of people who filed unemployment claims in a given month. However, because many people who are or become unemployed by the technical definition—that is, they are looking for work—don’t qualify for unemployment benefits, the result was a serious undercounting of the unemployed. Now the United States relies on the monthly Current Population Survey from the Commerce Department, which provides a more comprehensive set of numbers based on polls of households. Note that to be officially unemployed, a worker must be seeking employment. People without jobs who aren’t looking for work because they don’t think any exists have, in effect, dropped out of the labor force and become discouraged workers. The labor force participation (LFP) rate can be revealing. It is the percentage of the total working-age population that is in the labor force. In other words, the LFP rate is the relationship between who is eligible to work and who actually is working. Broken down demographically, variations in the LFP rate may offer clues to stories about social trends. As of the mid-1990s, the entry of women into the labor force in large numbers was
HOW ECONOMIC SYSTEMS WORK
probably the most significant economic shift of the post–World War II period. But in the latter part of the decade, participation by women leveled off and even dropped in some sectors. Why this occurred is not clear; a natural leveling off does not seem to account for the change. More research, particularly into both women and men’s changing relationships to work, is needed. Interested reporters should find and bond with social scientists who study the workplace. Economists talk about different types of unemployment: frictional, structural, and cyclical. The frictionally unemployed are people who haven’t had time to find a job yet because they are new to the labor force or are between jobs. Structural unemployment is a result of deep changes in the economy. Technological change may make some occupations obsolete. When people began driving cars instead of horses and buggies, a blacksmith’s skills were no longer necessary. The process by which jobs evolve and fade away as the skills they use become obsolete is called churning. Structural unemployment may also result from changes in international markets as lower-paid foreign labor becomes available to do work that previously went to higher-paid domestic workers. In the last two decades workers in many important American industries, such as steel and textiles, have lost jobs to lower-paid workers in developing countries. Cyclical unemployment refers to unemployment rates that rise and fall with the business cycle. The business cycle is not to be confused with short-term ups and downs in the economy. Technically, the business cycle is the rise or fall of actual GDP relative to potential GDP. People who are cyclically unemployed tend to be on the margins of the labor force, dropping in and out. During recessions they may become discouraged by bleak job prospects and stop looking for work. During expansion, they may be able to find work. Economists sometimes refer to Okun’s law and the Phillips curve. Okun’s law, named after Arthur Okun, the economist who developed it, describes the relationship between GDP growth and changes in the unemployment rate. High growth is associated with lower unemployment, and vice versa. The implication is that if the unemployment rate is high—how high is a matter of controversy—the country needs a period of fast growth to counteract it. If the unemployment rate is “about right”—another subject of controversy—it remains in a stable relationship with output. The Phillips curve was named after A. W. Phillips, a researcher who in the 1950s analyzed the relationship between wages and inflation in England from 1861 to 1957. In the contemporary version, prices replace wages. The curve suggests that an inverse relationship exists between unemployment and inflation. In other words, as unemployment declines or as more people are employed, inflation increases. A country can choose a strategy: to have low inflation, it must tolerate higher rates of unemployment; or it can support lower rates of unemployment by tolerating higher rates of inflation. The Phillips curve presumes that increases in wages will push prices up as companies pass on
BASIC CONCEPTS
the costs of higher wages to consumers. Policy makers want inflation and wages more or less in synch to prevent boom-bust cycles that make life difficult and foster political instability.
Inflation What is this thing called inflation that puts the knickers of policy makers, Wall Street traders, and the august chairman of the Federal Reserve Bank into a twist? Technically, it is the percentage change in the average price of all goods and services in the economy from one year to the next. Note that it is expressed as a rate, not as an absolute number. A high inflation rate means prices are increasing rapidly, out of synch with rising wages. Zero inflation means prices are staying more or less the same. High inflation punishes savers and people on fixed incomes because rising prices lower the buying power of their savings or income. Most economies run on borrowed money. An interest rate is the percentage of the loan amount that banks charge borrowers. The discount rate is the amount that banks charge each other (and that the central bank, called the Federal Reserve in the United States, charges its bank clients). A rise in interest rates is the likely first crude response to worry that inflation is on the horizon. Higher interest rates make it more expensive to borrow money, a situation that tends to slow activity. Lower interest rates make money less expensive, hence encouraging activity. High interest rates can have an effect on a wide range of borrowers, from large corporations trying to expand to families buying a house to students borrowing to pay for an education. In recent years, inflation has become much less volatile than it was in the 1970s, when Paul Volcker, then chairman of the Federal Reserve, imposed harsh anti-inflationary measures on the country and choked the life out of inflation (and out of a few Latin American countries). As this is being written, during the longest expansions since the end of World War II, inflation is virtually nonexistent. Nobody really understands why.
Productivity Productivity is a measure of the efficiency of the economy. It is a deceptively simple measure: Output (goods and services produced) divided by input (the number of worker hours) equals productivity. Increased productivity is the engine of economic growth. When growth in productivity is high and stable and inflation is low, economic growth occurs. Because of the difficulties of assessing productivity in an economy increasingly dominated by services rather than manufacturing, the topic may be a lively source for stories in the near future. The United States is widely believed to be the most productive country in the industrialized world, but its productivity has slowed over the
HOW ECONOMIC SYSTEMS WORK
long term. There is debate about whether productivity revived in the last five years of the century. Some economists, including Alan Greenspan, current chairman of the Federal Reserve, say the expansion the country enjoyed at the end of the 1990s represents gains in productivity related to technological innovation, including robotics and computing. Others argue that despite their ubiquitousness, computers don’t rival, say, the invention of the steam engine or widespread use of the telephone as instruments of increased productivity. Go figure.
Talking to Economists A little-known midcareer training trend of the early 1990s was the “economics for journalists” seminar run by economists. General-assignment reporters, often newly assigned to a business or economics beat, would spend a week or two immersed in basic economics, guided by experts. Invariably these gatherings began with a serial confessional as each participating reporter earnestly revealed a mission to explain complex economic issues to his or her newspaper’s readers, Joe and Jane Sixpack. Tweaking journalists hilariously for not thinking “like economists” was the most common form of blood sport at these workshops. The last thing the world needs is journalists who think like economists. More economists who think like journalists, perhaps, but not the other way around. Economists and journalists have very different missions in life. Although economics in the last three decades or so has become quantitative and specialized, fundamentally, economists still study scarcity and efficiency, or how humans make choices about limited resources as they try to feed, clothe, and reproduce themselves. Economists look at data, construct mathematical models, adjust the data, deconstruct the models—and try to explain to each other what the models mean. Fundamentally, our job as journalists is still to explain how the world those models describe works; to find a story, report it, and write it. We have a role as outsiders, challengers, and skeptics. If we cover the economy, the chicken salad of the beat is quantitative data issued weekly, monthly, quarterly, or whenever. But you can only write economic indicator stories for so long before your brain rots or you decide to go to law school. If you want to grab Joe and Jane Sixpack, or, for that matter, Biff and Buffy Chardonnay, you have to figure out how to talk to economists and dig stories out of their brains. I will paraphrase advice Richard Sutch, an economic historian at the University of California at Berkeley, gives to historians looking to use some of the techniques of economics in their own research.1
1
Richard Sutch, in Economics and the Historian (Berkeley: University of California Press, 1996).
BASIC CONCEPTS
1. Knowing a few basic concepts is enough to get you into the conversation with most economists. True, some have famously little enthusiasm for journalism. The format of the news story demands—well—news, and the more apocalyptic, the better. So when a reporter takes a little dip in GDP and turns it into the harbinger of another Great Depression, her editor may be satisfied, but in university economic departments across the land, lips will curl. Naive stories will kill your credibility. Learn enough not to sound naive. 2. Have patience for theory. Economics has become an esoteric field; many articles in academic journals are nothing but pages of formulas with an occasional transitional line of text. But the criticism that all economists are always out of touch with reality is a bum rap. People who study macroeconomic issues, especially, tend to emerge from mathematical model making to observe the real world for modifications. Those are the ones with whom you want to cultivate relationships. 3. Accept that data are more accurate than anecdotes. Journalists live and die by the anecdotal lead, particularly when trying to bring a complicated issue down to earth. Unquestionably, the anecdote is a good thing—most readers can be led to absorb complexity if they are interested in the people involved. But an individual’s experience can be misleading. In a series on downsizing, the phenomenon of large companies shedding mass quantities of employees, one of the country’s leading newspapers led off with the story of a former executive who had been unable to find work after losing his high-salary job. He became depressed about his prospects, his wife kicked him out of the house, and his children shunned him. Friendless and familyless, he ended up in a menial job at a highway rest stop. A sad story, of course, but in no way was it representative of the usual experience of redundant executives at the time. Most found jobs within a few months of leaving their previous companies. People aren’t averages; they may have idiosyncratic experiences, but their history should in a general way represent the numbers that support your premises in the story.
Suggested Readings Robert Skidelsky’s magisterial two-volume biography of John Maynard Keynes, Hopes Betrayed, 1883–1920 (1983) and The Economist as Savior, 1920–1937 (1986), provides a painless way to learn about Keynesian thought and about the economic roots of the cataclysmic events of the twentieth century. Several books on the impact of new technology and social change exist, and often they take you in unexpected directions. Among these: The Zipper: An Exploration in Novelty (1994) by Robert Friedel, and Dream Reaper (1997), by Craig Canine, an account of the evolution of farm combines and, as the author puts it, “the transformation of modern agriculture.”
HOW ECONOMIC SYSTEMS WORK
Among academics, Paul Krugman, perhaps the first “celebrity economist,” is inescapable. In books, articles, online (http:\\web.mit.edu/krugman/www/), and, most recently, as an op-ed columnist for the New York Times, the MIT economist pronounces, often quite wittily, on the issues of the day. Unlike many of his colleagues in the profession, he is able to write in plain English. Like many of his colleagues, he has no patience for the apocalyptic generalities that comprise most economic news reporting and become received wisdom in the media. He has been known to dismiss the work of some well-known, influential journalists with a scornful “not even wrong,” accusing them of touting fundamentally flawed theories. In books like The Age of Diminished Expectations (third edition, 1997), Peddling Prosperity (1994), Pop Internationalism (1996), and The Accidental Theorist (1998), Krugman gleefully kicks the legs out from under popular economic fads. From a journalist’s perspective, Krugman’s redeeming quality is an ability to grasp what the questioner is after—even when the questioner isn’t sure. That said, Krugman has been known to infuriate economically literate journalists, such as Robert Kuttner, of The American Prospect and Business Week and author of The End of Laissez Faire: National Purpose and the Global Economy After the Cold War (1991) and Everything for Sale: The Virtues and Limits of Markets (1996), for refusing to fully engage what Mr. Kuttner naturally regards as legitimate opposing arguments. Macroeconomics lends itself naturally to illumination by graphics, a fact demonstrated ably by several visual renditions of basic concepts. Atlas of the American Economy: An Illustrated Guide to Industries and Trends (1994) by Rolf Anderson (published by Congressional Quarterly) is packed with charts and graphs that illustrate the basic facts of the macroeconomy. The New Field Guide to the American Economy (1995) by Nancy Folbre and colleagues looks at some numbers behind the numbers, as does The State of the U.S.A. Atlas: The Changing Face of American Life in Maps and Graphics by Doug Henwood (1994). Both present a leftist take on the general macroeconomic model, revealing the cracks that economically vulnerable people can fall through. The New Illustrated Guide to the American Economy (1995), by Herb Stein and Murray Foss, is published by the American Enterprise Institute, the conservative think tank; the book is full of charts illustrating a commonsense, mainstream position on economic issues. It reflects a view that the American economy works most of the time for many of its citizens. A caveat: the graphics in these books are based on numbers current long before the book actually appeared (that is, when the author actually wrote the book). Any book based on current statistics is out of date by the time it is published. Even so, these four guides remain useful. Arguably the single most useful book for someone new to the economics beat is Tracking America’s Economy (third edition) by Norman Frumkin (1998). It is dense with numbers, definitions, and discussions with kernels of story ideas. It is not light reading,
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by any stretch of the imagination, but it is a book a reporter is likely to return to again and again. Modern Manors: Welfare Capitalism Since the New Deal (1997), by Sanford Jacoby, does a nice job of portraying the influence of so-called “manorial capitalism”—the strategy of providing relatively good working conditions and benefits to counter the influence of the incipient labor movement—on American economic development in the first third of the twentieth century. Manorial capitalism became the model for today’s socalled best practices companies, like Corning, IBM, Xerox, and others. A sobering account of what happens when good companies misread macroeconomic trends and then compound their mistakes with bad judgment is No Hands: The Rise and Fall of the Schwinn Bicycle Company (1996) by Judith Crown. One of the paradoxes of economic news is that there is almost never anything really new. Whatever is happening has happened before. To explain contemporary issues, it is often necessary to revisit historical events, to compare, for example, the wave of mergers in the late 1990s with the merger craze of the early twentieth century. A New Economic View of American History (second edition), by Jeremy Atack and Peter Passell, is a solid, readable survey of American economic history. Peter Temin’s Lessons From the Great Depression (1989) analyzes an era that had international social and economic consequences that continue to reverberate.
Sources of Data The Internet and World Wide Web have immensely simplified access to the numbers that go into macroeconomic research. All of the usual suspects have Web sites: the Organization for Economic Cooperation and Development (www.oecd.org); the International Monetary Fund (www.imf.org); the World Bank (www.worldbank.org). The regional Federal Reserve Banks also each have sites, and these are replete with interesting sources. You can start with the Federal Reserve Bank of San Francisco (www. frbsf.org) and make your way to the other regional banks from there. The San Francisco Fed has a useful feature, Ask Dr. Econ, to which the economically challenged may send in queries. The Dismal Scientist (www.dismal.com) is a commercial site with an amazing array of numbers, commentary, tools, and links. You can, for example, use its consumer price index calculator or producer price calculator to arrive at your own numbers. Journalists looking for story ideas and sources should bookmark the National Bureau of Economic Research (www.nber.org), which makes available research reports by economists who are interested in public policy issues. The nut of many a story has come straight from an NBER report.
2 The Political Economy of Government and Business S. L. Bachman
When Robert Rubin, the Clinton administration’s second Treasury secretary, announced his resignation on May 12, 1999, praise filled the newspapers and airwaves. “Rubin oversaw an increasingly sparkling U.S. economy. His leadership through the foreign economic crises of the last few years is credited with keeping bad situations from getting much worse and from threatening the U.S. economic expansion,” reported the Los Angeles Times. “He will leave a legacy of stunning success and near-universal respect,” wrote Robert Rankin in the San Jose Mercury News.1 The glowing tributes to the departing secretary ascribed his success to a calm personality in a frantic job, the credibility and knowledge he carried into government from many years on Wall Street, and his close working relationships with some other top policy makers in the administration. The nation was in the ninth year of an economic expansion, and it was still going strong at the time the former banker decided to return to the private sector. Many stories stopped there, adding nothing more than any reporter could assemble from a handful of clips in the morgue, freshened up by a few quotes from whoever was available for a quick interview. But what was really interesting about Rubin—and is often the most interesting thing to know about any person in a position to shape economic policy—was the set of ideas that animated the policies he pursued. When Rubin left public office, those ideas, and their consequences, remained imprinted on the government and policies he left behind. A story that explained those ideas and their consequences would tell not only what happened but also why. 1“Rubin’s
Legacy,” Los Angeles Times, May 13, 1999. Robert Rankin, “Rubin Leaves Cabinet at the Top of his Game,” San Jose Mercury News, May 13, 1999, were a few among many. See also “It’s Summers Time,” Business Week, May 24, 1999; “Triumph of an Eat-Your-Spinach Secretary,” Business Week, May 24, 1999; “Taking the Handoff: Brainy Economist Larry Summers Replaces Wall Street Wizard Rubin at the Treasury; Can He Leave Well Enough Alone?” Time, May 24, 1999; and Jodie T. Allen, Phillip J. Longman, Jack Egan, and Margaret Loftus, “Clinton’s New Money Man,” U.S. News & World Report, May 24, 1999.
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Best of all, the story would then be able to offer an analysis of what might happen next—the direction in which the administration’s policies, business pressure, and public opinion at large were heading.
Why Does Philosophy Matter? Political economy has two commonly used meanings. One is the description and analysis of the way government and economics interact in one place at one time. The political economy of a place—say, Egypt in the nineteenth century, Japan after World War II, or Silicon Valley in the late twentieth century—is the unique way in which government, politics, business, and people interact in that place, at that specific time. The other use of political economy is as a kind of shorthand. It refers to the philosophy of how government and the economy actually do, and should, interact. This essay will explore this second meaning of political economy. In addition, this essay will offer an introduction to the most commonly cited philosophers of political economy, as well as additional concepts that are useful for understanding how to use political economy in stories. Rubin’s story will serve as an occasional illustration of how to put the concepts to work. But in the end, the goal of this essay is to convince the reader that a little knowledge isn’t enough; a smart reporter should go on and read more about the philosophy of political economy.
Key Economists Five kinds of economic organization are generally recognized: subsistence, slavery, feudalism, capitalism, and socialism.2 Modern political economy—the philosophy of political economy—is usually traced back to Adam Smith, the first philosopher of capitalism. Before Smith, studies of the economic philosophies that shaped most economies generally were not codified into an identifiable body of thought. Feudalism, for instance, shaped much of European and Asian economic history. Feudalism is the organization of society and economy into a rigid political and economic structure that makes workers the vassals of people or institutions that control capital. The vassals are dependent on, and prevented from breaking free from, their masters. Feudalism left a legacy that is still felt in some countries. In Japan, for example, a feudal economic and political system hung on until the mid-nineteenth century, and in Pakistan, the economy in parts of the country could still be called feudal.3 2 Another, less common type of premodern political economy was the potlatch economy of the Pacific Northwest Native American tribes. A tribe would win power by showering other tribes with gifts, food, and good will in mammoth feasts known as potlatches. 3 For a thoughtful view of Japan’s politics and economics, see Patrick Smith, Japan: A Reinterpretation (New York: Vintage Books, 1998). Sr. Sreedhar, “Pakistan’s Economic Dilemma,” Global Beat, June 18, 1998 (http://www.nyu.edu/globalbeat/southasia/06181998sreedhar1.html).
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Adam Smith, father of the study of market economics and modern political economy. Courtesy of the Library of Congress.
In addition, some religions, notably Islam, could be considered philosophies of political economy. Koranic injunctions against usury have shaped some banks in the Islamic world, both in the past and today. Muslims consider the Koran, the holy book of Islam, to be the holy word of the prophet Muhammad, who, along with being a religious leader, perhaps could be considered the most important political economist to
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precede Adam Smith.4 But the world today largely operates on the principles of political economy spelled out by Smith and his intellectual descendants. In most of Europe, by the eighteenth century feudalism had broken down and economic exchanges had become less formalized, more free to respond to changing forces of supply and demand. Smith was the first philosopher-economist to put into writing the concept of the market economy. In The Wealth of Nations (1776) Smith tried to explain the pros and cons of the industrialization that was sweeping the British Isles. The book is best known for explaining the basic concepts of the markets that fueled the growth of modern industry. Among Smith’s most influential concepts was that of the “invisible hand,” the forces of competition that balance supply and demand. Another is that the division of labor allows individuals to specialize, to develop skills that will enable them to produce more of their product. If everyone’s a specialist, making what he or she is best at producing, then overall, the amount and quality of the goods produced will be greater than if everyone was obliged to complete all the separate steps in the production process. That’s about all that most people need to know, or do know, about Adam Smith. Reporters who read more, however, will learn that Smith’s descriptions of the workings of markets had more than one dimension. For instance, Smith deplored the way a completely free market shortchanged public goods such as education. That’s why Smith thought that governments should not rely solely on private markets to provide education. A reporter with more than a passing acquaintance with Smith’s writings would be able to add this extra dimension to today’s debates about free-market education policies claiming to be grounded in the ideas of Adam Smith.
After Adam Smith There are at least five other economists journalists should know—at least superficially, and in detail if possible. Here’s an introduction to the economic philosophers who followed Smith whose names and ideas have become the common currency of everyday business discussions and economic journalism: Karl Marx argued in the nineteenth century that economic relationships determine political and even personal relationships. The Communist Manifesto of 1848, a collaboration between Marx and Friedrich Engels, argued that unplanned capitalism must inevitably collapse and should be replaced by planned production. Marx’s philosophy is called dialectical materialism, the notion that all growth, social change, and economic development are the product of opposing forces competing for economic survival. 4
See Gatonye Gathura, “Banking on Islam,” World Press Review 43, no. 5 (May 1996): p. 35; Alan Sipress, “Religious Awakening in Muslim World Affects Islamic Banking Practices,” Knight-Ridder /Tribune News service, (March 1, 1996); Roula Khalaf, “Banking the Islamic Way,” World Press Review 42, no. 1 (January 1995): p. 35.
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Karl Marx argued that unplanned capitalism should be replaced with planned production. Courtesy of Socialist Labor Party.
Marx’s labor theory of value posits that every object is worth the value of the labor that goes into its production. David Ricardo was a nineteenth-century stockbroker who argued that trade could benefit nations by allowing each to produce what it was best at producing. This comparative advantage theory underlies the push for an open global trading system. John Maynard Keynes was the British economist who sold Franklin Roosevelt’s administration on the idea that the way out of the Great Depression was to use govern-
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ment money to boost employment, even if that meant running a federal budget deficit. Keynesian is shorthand for the theory that spending and consumption are such powerful drivers of economic growth that they should be boosted, even if governments have to run fiscal deficits to do so. Milton Friedman, the University of Chicago economist and 1976 Nobel Prize winner, argues in opposition to Keynes that markets work best with the least possible government intervention. He also has argued that the sole responsibility of a business is to make money. Friedman is associated with monetarism, the theory that economies expand and contract largely owing to the size of the money supply. One corollary is that government regulation has done more harm than good and that demand will match supply fastest with the least government intervention. Joseph Schumpeter wrote in the 1930s and 1940s that economies grow by process of business birth, failure, and rebirth. Occasional failure is as inevitable as it is important. The shorthand for this theory is creative destruction. He asserts that entrepreneurs are willing to try to succeed at a new enterprise knowing that many such new efforts fail. These are only thumbnail sketches. To really know the philosophies of these economists, a reporter should read their original works. Each of these philosophers and his ideas is associated with an era and with a pattern of economic and political organization. Adam Smith’s ideas, among the most durable, have been influential in shaping market-based economies throughout the world since the eighteenth century, especially in Europe and North America. Marx and Engels’s ideas have shaped the histories and economies of the former Soviet states as well as China, Cuba, Vietnam, and North Korea today. Any list of the five most influential economists will change with the times. This list, for instance, reflects a modern reevaluation of Schumpeter, who was all but forgotten between his death in 1950 and the resurgence in the popularity of his writings in the 1980s. Now Schumpeter is a favorite in Silicon Valley, where high-tech industry has flourished thanks to entrepreneurs taking risks on developing and selling new technology. The new products and companies often fail. That is accepted as a natural by-product of healthy and open competition, and entrepreneurs who fail once or twice prove their mettle by starting new companies. Schumpeter’s theories also lie behind the Grameen Bank, which gives out tiny loans to very poor women in Bangladesh. The women do not give the bank physical collateral, because they are too poor to own any. Instead they promise their honor and are organized into circles of borrowers. The group members are collectively responsible for seeing that each individual loan is repaid. Thanks to these tiny loans, millions of Bangladeshi women have become small-scale entrepreneurs and escaped desperate poverty.5 5
An easy-to-understand primer on these and other important economists is Robert L. Heilbroner, The Worldly Philosophers: The Lives, Times, and Ideas of the Great Economic Thinkers (New York: Simon & Schuster,
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Modern Political Philosophers Every reporter will probably add more names to this list of political philosophers. Americans, for instance, or anyone covering the United States, should be familiar with the opposing philosophies of Thomas Jefferson and Alexander Hamilton. Jefferson’s name is still invoked by people advocating reducing government to a minimum, in the belief that the people will govern themselves best if they are left alone as much as possible to sort out things among themselves. Hamilton’s name is still invoked to describe a government that exercises strong executive control.6 A supplementary list of modern thinkers whose ideas have become standard currency might include the following: John Kenneth Galbraith, a Keynsian, has been influential over the last forty years in arguing for decreasing expenditure of the nation’s wealth on private consumption and increasing spending on public services. Arthur Okun, a member of the Kennedy and Johnson administrations, argued that higher levels of economic growth are accompanied by lower unemployment. Okun’s law, based on his historical studies, posited that for every 2.2 percent of real growth in the gross national product (GNP), unemployment fell by 1 point. Arthur Laffer was one of the “supply-side” economists behind the Reagan administration’s 1981 tax cuts. Laffer supply-siders believed that reducing taxes would take money away from government and put it in the private sector, providing incentive for businesses to expand and thereby producing economic growth that would balance the loss of tax revenues. Amartya Sen, the 1998 Nobel Prize winner in economics, advocates a policy of moderating market inefficiencies with policies aimed at providing education and correcting social inequities.7 Other names worth noting are Robert Reich, the former Clinton labor secretary who moved to Brandeis University, and Lester Thurow, the Massachusetts Institute of Technology (MIT) economist who is known for popular concepts such as the “zero-sum society”—the theory that economic actors must carve shares from a pie whose size is fixed. Paul Krugman and Jeffrey Sachs, academic economists at MIT and Harvard, respectively, are leading theorists of international trade and globalization.8 1992). One of the best of the many books on the Grameen Bank is David Bornstein, The Price of a Dream: The Story of the Grameen Bank and the Idea That Is Helping the Poor to Change Their Lives (New York: Simon & Schuster, 1999). 6 See, for instance, Jeremy Atak and Peter Passell, A New Economic View of American History, 2d ed. (New York: Norton, 1994). 7 See Amartya Kumar Sen, Development as Freedom (New York: Knopf, 1999). 8 For example, see Paul Krugman and Maurice Obstfeld, International Economics: Theory and Policy (Menlo Park, Calif.: Addison-Wesley, 2000). See also Jeffrey Sachs, “International Economics: Unlocking the
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Again, these lists will vary according to the times and the country or culture being covered. In the years immediately after Ronald Reagan left office, for instance, the luster of Laffer’s ideas dimmed. Reagan’s combination of tax cuts, and later tax increases; cuts in social service spending; and strong defense spending left the nation with a record high public debt. Whether this was due to a fundamental flaw in Laffer’s theory or a flaw in the way the Reagan administration put it into practice remains a subject of debate.
Putting It All Together This array of economic philosophies gives thoughtful writers a way to add an extra dimension to stories about events. Stories about Rubin contained at least a couple of examples of how philosophies of political economy have shaped the real world. Rubin was particularly noted for two things: pushing Clinton to support a balanced budget in order to free up money from the public sector for private use, and his calm in the face of economic and political crises. Many Democrats had considered a balanced budget unnecessary ever since Keynes, in the 1930s, succeeded in reviving the Depression-wracked economy by increasing the power of ordinary people to spend money. In the short term, Keynes argued, getting people employed was more important than worrying about the possible inflationary effect of running a budget deficit. President Roosevelt went with Keynes’s ideas. To get money into the hands of citizens, Roosevelt’s New Deal ran a fiscal deficit and spent money to create jobs. Keynes believed that in flush times, the debt accumulated from those deficits should be paid off. But many Democrats came to consider government spending an important way of keeping people employed even during non-Depression years. Rubin, although a Democrat, believed that the debt was actually an economic drag and therefore caused unemployment. The government debt soaked up money from the market, and that money could be put to more efficient use by the private sector. Clinton’s 1993 adoption of a balanced budget, which involved cutting some favorite Democratic programs, was seen by some in his own party as a betrayal. But when the stock market skyrocketed and the jobless rate dropped in the 1990s, the philosophical gamble was widely believed to have paid off. The balanced budget released money into the private market, which, in combination with other factors, helped bring down interest rates and made it easier for companies to expand.
Mysteries of Globalization,” Foreign Policy, No. 100, Spring 1998 (Issue 110), p. 97–112, as well as William Greider, One World Ready or Not: The Manic Logic of Global Capitalism (New York: Simon & Schuster, 1997), and Thomas L. Friedman, The Lexus and the Olive Tree: Understanding Globalization (New York: Farrar, Straus, Giroux, 1999).
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There’s much more to the story of how and why the Clinton administration came to shape a balanced budget, of course. And yet, even in abbreviated form, this story demonstrates how economic philosophies can shape politics for decades, and how, in writing about the intersection of U.S. politics and economics, journalists benefit from knowing the origin of the ideological forces shaping the current political and economic landscape.
Theory and Practice Concentrating on one former official’s story to explain the complexities and importance of philosophies of political economy poses a risk. Reporters might get the impression that understanding political economy is all about understanding how economic theories are put to use in Washington, D.C., or London or Tokyo or some other political and economic capital. That would be a mistake. Understanding the philosophy of political economy is also about understanding how economic theory affects the lives of ordinary people. Generally speaking, the philosophies of Adam Smith and his market-oriented intellectual descendants—from Keynes to Schumpeter to Friedman—underlie the economies of today’s industrialized countries, as well as those of many industrializing countries. Marxism still forms the basis of the economies of former Communist countries, although many are making a transition from central planning to market economics. Sometimes, however, the influence of an economic philosophy is more local. Libertarianism, for instance, was the philosophical lodestone of Silicon Valley in the late 1980s and early 1990s. That fueled an anything-goes entrepreneurial culture and produced a flowering of high-tech companies and a great deal of personal wealth. There were drawbacks, however, to the culture of libertarianism. It encouraged a belief that the federal government in Washington was unimportant. Only a handful of companies had lobbyists in the nation’s capital or paid much attention to national politics. Opinions about the usefulness of the federal government changed when competition from outside threatened businesses. When Japanese competitors began taking business from the American semiconductor industry, manufacturers began looking to Washington for help. And when Seattle-based Microsoft swooped into Silicon Valley to buy new technologies, later burying the non-Microsoft innovations in favor of Seattle-grown products, Silicon Valley competitors such as Sun Microsystems looked to the federal Justice Department for help in determining whether Microsoft was acting as a monopolist. And now—no surprise—Silicon Valley companies send more lobbyists, and campaign contributions, to Washington. Libertarianism is probably still more popular in Silicon Valley than in other parts of the country. But in the end, one little region of California couldn’t, and ultimately didn’t want to, pursue a political economy that was significantly different from the nation’s.
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Political Economy for the Internet Age? As stated at the start of this essay, knowledge of the philosophies of political economy should help a reporter identify the prevailing thinking and explain current policies. But does the work of the already influential philosophers suffice to describe the emerging economic scene? Or is a new philosophy needed? First, what is new about the Internet Age economy? In a word: links. Economic crises that used to affect only a few markets now can affect the whole globe. That is not entirely new; at the turn of the century, American investors suffered repeated losses from buying bonds floated by countries that later defaulted. What is new is that financial transactions are so much speedier now, and they continue to accelerate with each advance in telecommunications technology. Ideas about what makes economies grow and how growth translates into better lives for ordinary people are also more linked now than they were half a century ago. The command economies of China, the former Soviet Union, and other countries that followed Marxist economic philosophy consistently failed to produce as much economic growth as did the supply-and-demand economies of countries that followed Adam Smith and his intellectual descendants. And so, in the Internet Age, capitalism has emerged as the leading economic philosophy in most of the world. But what kind of capitalism? Most governments are trying to do whatever the financial markets demand to attract investment capital. But the linking of all financial markets is, in turn, reducing the freedom of nations to keep their political and economic systems closed, yet still attract the outside investors needed for economic growth. Is there a philosophy that explains how political economy will—or should—act in this speeded-up world? Should markets be regulated by some yet-to-be-invented international entity so that inequalities produced by the unfettered operation of this huge, internationally linked capital market can be reduced? Is there a philosophical reason to impose such restrictions? Money can move quickly, but people cannot. Investment and disinvestment may occur so quickly that whole communities are left spinning in a state of disorganization, gasping for investment capital that has suddenly dried up. Apart from being disruptive, is that fundamentally unfair? Do communities, and individuals, need to suffer so much for the sake of economic growth? And if the growth is felt by a nation, but individual communities still suffer, is that fair? The philosophy of David Ricardo, which underlies the open trading system, argues that allowing each community to produce what it can most efficiently, and encouraging efficient producers to trade, will lead to benefits for both parties. But people who op-
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pose pulling down barriers to trade argue that the cost to society of sudden disruptions caused by open trading is greater than the benefits. The argument against allowing unrestricted movement of investment capital is similar.9 Let’s return to Rubin’s story to try to get a handle on whether the dominant philosophy of political economy is changing in the Internet Age. Rubin was known for his equanimity, what could be called a calm-in-the-face-of-the-storm attitude. That calm exterior, and his long experience on Wall Street, helped in several crises when he had to sell economic leaders on difficult policies—such as staying in, instead of pulling out from, countries in economic turmoil. A Time magazine article lists three such incidents: in 1997, when South Korea’s economy was battered by economic turbulence in Asia; in 1998, when Russia defaulted on its government bonds; and in the 1999 currency crisis in Brazil.10 Rubin believed that markets best heal themselves if left alone by government and if not disrupted by major players suddenly abandoning markets suffering shortterm trouble. Significantly, Rubin was not alone in his beliefs. He was part of a three-man team that helped defuse these three crises. His two partners were Federal Reserve chairman Alan Greenspan and deputy Treasury secretary Lawrence Summers. The article refers to the three officials, who worked so well together to stem a series of economic panics, as the “three marketeers.” By retreating from, if not abandoning, Keynesianism the three marketeers represented a major shift in American political and economic thinking about the way government budgets and power should be used to stimulate economic growth and employment. Moreover, Greenspan has been strongly influenced by the theories of writer Ayn Rand, a libertarian whose “objectivist” philosophy shaped Greenspan’s confidence in the resilience of markets as an expression of people’s ability to heal themselves if left alone to do so. Thanks to Greenspan, Rand’s name might appear on some reporters’ lists of influential political economists. But does this objectivist-market pragmatism amount to a philosophy? The three marketeers’ work cries out for description in the form of a new theory for managing the all-markets, all-the-time world of instant communication, and blink-of-the-eye movements of huge waves of capital. At this writing, no new philosophy of political economy has emerged to sum up or codify the changes of the Internet Age. And most discussions of political economy still 9 Recent critiques of the global economy include Robert Kuttner, Everything for Sale: The Virtues and Limits of
Markets (New York: Knopf, 1997); William Wolman and Anne Colamosca, The Judas Economy: The Triumph of Capital and Betrayal of Work (Menlo Park, Calif.: Addison-Wesley, 1997); and the writings of George Soros, Saskia Sassen, Sumner M. Rosen, and many leaders of the trade union movement. 10 Joshua Cooper Ramo, “The Three Musketeers,” Time, Feb. 15, 1999, 34–42.
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start and stop with the first political economist of the modern age, Adam Smith. But keep reading, and maybe a different dominant and persuasive voice will emerge. In the search alone, there’s a story. And if a new political economy for the Internet Age does emerge, it will need to be analyzed, evaluated, and tested in real life. In that process, too, lie many more stories about the political economy of government and business.
3 Government Regulation and the Regulators John J. Oslund
Still one more thing, fellow citizens—a wise and frugal government, which shall restrain men from injuring one another, which shall leave them otherwise free to regulate their own pursuits of industry and improvement, and shall not take from the mouth of labor the bread it has earned . . . this is the sum of good government. . . .—Thomas Jefferson, March 4, 1801 Every man holds his property subject to the general right of the community to regulate its use to whatever degree the public welfare may require it.—Theodore Roosevelt, August 31, 1910 In the century that separated the free-minded comments of Thomas Jefferson and the trust-busting proclamations of Teddy Roosevelt, regulation of American business and commerce first took shape in ways that remain relevant for the business journalist today. Railroads stitched together the American continent between 1830 and 1900, linking the Atlantic and Pacific oceans and affording communities along their rights-of-way access to national and international markets. Petroleum was first produced in commercial quantities beginning in 1859, ushering in the oil age. Electromagnetic current was harnessed to make long-distance communications possible via telegraph and wireless radio transmissions. The steam engine and, later, the electric motor powered foundries and factories that produced the staples of a budding industrial economy—steel, lumber, manufactured goods, automobiles. Whereas the eighteenth century is noted for its political revolutions, the nineteenth century is known for the industrial revolution, which spawned the technologies that promised to enhance the lives of U.S. citizens and advance the economy and the nation. The formative period of government regulation of U.S. business lasted about one hundred years—from the 1870s to the outburst of deregulation during the administrations of Jimmy Carter and Ronald Reagan.
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Tipping the Balance of Power The industrial revolution gave rise to powerful industries—the rail and oil trusts, the telegraph and telephone monopolies—that eventually came to be viewed as threats to the public welfare. So great were the commercial advantages of these newfangled devices that those who controlled them had the power to make or break entire communities. Those entrepreneurs fastest off the mark could drive their competitors into ruin by charging far below costs. Then, once the competition had surrendered the market, the survivor could charge as it pleased for the products and services on which every thriving community had come to depend. These predators of the private sector flourished after the Civil War ended in 1865, amassing unprecedented corporate wealth while selectively controlling the levers of modern industry. The nation’s commercial landscape, which had always been dotted with small firms, shops, and farms, began to be eclipsed by giant corporations and groups of corporations organized into trusts. The names that became synonymous with these trusts include John D. Rockefeller (Standard Oil), Collis Potter Huntington (Central Pacific Railroad), Edward Henry Harriman (Illinois Central and Union Pacific railroads) John Pierpont Morgan (J. P. Morgan & Co. investment bank; U.S. Steel Corp.), Cornelius Vanderbilt (New York Central Railroad), and James J. Hill (Great Northern Railway; lumber and mining interests). A quote believed to be attributed to Huntington captures the ruthless entrepreneurial spirit of these empire builders: “Everything that is not nailed down is mine,” Huntington said. “And anything I can pry loose isn’t nailed down.” Thirty years of feverish expansion by American businesses had tipped the balance of power toward large corporations and away from citizen-lawmakers and consumers. By 1890 the U.S. Congress had worked up an appetite to harness big business. John Sherman, a U.S. Senator from the Rockefeller empire’s home state of Ohio, authored the Sherman Antitrust Act, which outlawed “any combination or conspiracy in restraint of trade.” The measure eventually became a key tool for modern-era regulators when, twentyone years after its passage, the U.S. Supreme Court upheld the breakup of Rockefeller’s Standard Oil empire in 1911. Also added to the regulators’ tool bag in this trust-busting era were the following: • The Interstate Commerce Commission. Formed in 1887 as the first independent agency of the federal government, the ICC regulated railroad rates and, later, trucking industry rates until the 1980s. For better or worse, the ICC became the model for the regulation of the telecommunications industries, including radio, television, and telephone companies.
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• The Clayton Antitrust Act. This 1914 amendment to the Sherman Act outlawed predatory pricing schemes (used to drive competitors out of business) and interlocking directorships, which allowed a few board members to control several companies that otherwise might compete with one another. The Clayton Act also permitted citizens to file lawsuits against monopolists and collect triple damages if they won in court. The act also established the Federal Trade Commission. The Clayton Act also affirmed the rights of labor unions to strike, boycott, and picket while limiting the power of government to intervene in labor disputes by restricting the use of federal injunctions, which were frequently invoked to order striking workers back to work. Collectively, these measures began to define the commercial playing field and establish rules of the game that all players—labor, capital, and government—were obliged to follow. Free-market competition was, and still is, thought to be the economy’s most efficient regulator. Yet when a private business threatened to tip the balance of power in an industry, regulators now had the tools to restore competition.
Traders versus Takers In the United States, government’s role in the economy has primarily been as referee rather than as player. This is in stark contrast to governments in socialist and communist economies, where the private sector was either hobbled or outlawed altogether and the tools of production lay in the hand of government. In her book Systems of Survival: A Dialogue on the Moral Foundations of Commerce and Politics, Jane Jacobs points out how human beings have over the years adopted two distinct behaviors: Taking—appropriating food, water, and shelter from one’s surroundings in the same way that animals survive in the wild Trading—obtaining the necessities of life from others by striking bargains with them that are mutually acceptable. Our system in the United States, and in other capitalist economies, is based on trading. What is interesting about Jacobs’s analysis—and what is relevant to an understanding of government regulation—is that trading cannot flourish without a system of law and order that ensures a reasonably level playing field. One key to a trading economy is that consumers must be free to make their own choices about which goods and services to buy. Whether you’re buying canned soup or Internet access, you either voluntarily come to terms with the seller or you walk away from the deal and look for another competitor with whom you can strike a better one.
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Coercion corrupts this system. Without this freedom of choice, the economically strong exploit the weak, distort competition, and eventually weaken the economy. Laws such as the Sherman Antitrust Act and the Clayton Antitrust Act are examples of economic regulation designed to protect consumers indirectly, by ensuring competition. And in cases where competition was not possible or feasible (such as railroads and electric utilities), the government permitted regulated monopolies whose operations were closely monitored by public commissions, such as the ICC. In other words, economic regulation uses the power of government to ensure that businesses remain traders and don’t become takers. But other reasons for government regulation have little to do with protecting competition. The most obvious of these is the need to protect lives and property.
The Rise of Government Regulation On April 14, 1912, the luxury liner Titanic struck an iceberg in the North Atlantic and began to sink. The supposedly unsinkable ship had the latest in communications technology on board, a ship’s radio that was thought to provide an extra margin of safety. Alas, events would prove otherwise. The ship’s radio operator broadcast an urgent call for help over the Titanic’s wireless radio. Although shore stations in the United States picked up the desperate signal, efforts to mount a rescue mission were frustrated by wireless broadcasters on shore who interfered with each other’s signals and ultimately prevented a coherent message from getting through to potential rescuers. As a result, 1,513 of the 2,220 people on board the big ship perished. When word spread of the missed rescue opportunity, public outcry led to tight federal regulation of broadcast radio spectrum, and that regulation continues to this day. Time and again since the Titanic disaster, regulation has followed calamity the way night follows day. This cycle helps to explain America’s next significant period of regulation—the 1930s. Crises in agriculture, finance, and banking contributed to the Great Depression in ways that government lawmakers were determined to fix. For the business journalist, the most important regulations to come out of the Depression-era banking crisis include the 1933 Glass-Steagall Act, which authorized deposit insurance and prevented banks from owning brokerages, and the Securities Exchange Act of 1934, which created the Securities and Exchange Commission, the federal agency that regulates stock offerings. Democratic president Franklin Roosevelt, a champion of the labor movement, also signed the National Labor Relations Act in this period, which extended protections to union-organizing activities. Many of these measures were passed in reaction to a crisis—the stock market crash of 1929 or the bank panic of 1933, for example. After a spate of airliner crashes in the 1930s, the Civil Aeronautics Act of 1938 was passed to regulate and promote the airline
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industry. And many of the regulations coming out of the Depression era inserted government regulators into day-to-day business decisions in ways that Jefferson could not have conceived or condoned. But the world had grown complicated and dangerous by the late 1930s. Radio offers one useful example. Although radio frequencies had been allocated by government for nearly 20 years for technical reasons (to prevent interference and avoid repeats of the Titanic rescue debacle, for example), the power of this electronic medium to inform and persuade the citizenry was only just beginning to be appreciated. While Roosevelt used his “fireside chats” to calm and reassure a nation wracked by depression, Adolf Hitler used radio broadcasts in Germany to inflame nationalist passions and bring his Nazi party to power. Wary of the political power of this new medium, and aware of the special technical considerations that accompanied the technology, U.S. lawmakers enacted the Federal Radio Act of 1927. The act’s three primary provisions held that: 1. There would be no private ownership of radio spectrum; instead, federal licenses would be granted entitling the holders to operate for a specific length of time, subject to renewal. 2. Radio spectrum was to be considered a national asset to be allocated under the “public convenience and necessity.” 3. The Federal Radio Commission was established to implement the act and allocate spectrum. By 1934, the act had been amended and the Federal Communications Commission was established to regulate radio, television, and long-distance telephone service. Variations on this now-familiar regulatory scheme occurred in strategic sectors of the U.S. economy—transportation, banking and finance, power utilities, and the television and telephone industries. In most cases, a company needed permission from the government to enter the market, whether it was a bank charter, a radio frequency, a railroad right-of-way, or an air route. The flip side was that once granted, license renewals were routinely issued. Therefore, it became easy for incumbents to expand and grow stronger and difficult (sometimes impossible) for newcomers to enter the market. What bank would loan money to a broadcaster or airline that didn’t have a license to operate? Regulation tended to protect these businesses from competition as much as it protected the public from calamity. And it was inefficient. The ICC, for example, set freight rates for transporting such commodities as grain, steel, coal, and manufactured products by rail and truck. Complying with ICC regulations was so burdensome and timeconsuming that the agency exempted from its jurisdiction the transport of fresh fruits and vegetables. The reason? The produce would have spoiled long before it reached market if it had to be shipped under the ICC’s regulatory scheme.
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The Fall of Regulation For nearly forty years, this regulatory trade-off seemed worth the price. Government anointed a few competitors in key industries, and these companies dependably delivered their vital services to consumers and other businesses. Price increases were simply passed along to consumers, who had little choice but to pay them. The formula worked until the mid-1970s, when two separate but related events occurred—the oil crisis of 1973–1980 and the emergence of persistent high rates of inflation. The oil crisis burst on to the front pages in 1973, when the oil-producing nations in the Middle East came together to fix oil prices on the world market. This cartel, called the Organization of Petroleum Exporting Countries (OPEC), gave the world a lesson in monopolistic behavior that oil-dependent nations would not soon forget. By agreeing among themselves to abide by certain production quotas, the OPEC nations could control the world’s supply of oil. And because demand exceeded the artificially constrained supply, the cartel also controlled oil prices. It was exactly the kind of trust that Teddy Roosevelt’s trustbusters had fought against in the United States at the turn of the century. The OPEC oil trust operated on a global scale, however. Gasoline prices at U.S. pumps rose from 25 cents a gallon in 1968 to nearly $2 a gallon at the height of the crisis in 1975. The transfer of wealth to oil-rich nations from oil-dependent ones sparked political debates as fear spread that the U.S. economy would literally run out of gas. As fuel prices soared, adding to inflationary pressures, lawmakers pondered a solution. The problem was not so much a lack of non-OPEC oil, but a lack of incentive to produce oil—especially in the United States. That’s because the U.S. government regulated domestic oil production by setting prices. Domestic oil producers could not recover the costs of exploring for oil and producing it when government regulators set the price they could charge for their product too low. The solution? Deregulate the U.S. oil industry, remove production restraints, and allow prices to float freely at market rates. Economic theory suggested that supply and demand would come into balance and prices would moderate. Still, it required a great leap of faith for U.S. lawmakers to abandon a regulatory formula that had worked so well since the New Deal era and embrace market forces as the primary means of allocating scarce resources. Long lines at the gas pump and sporadic violence sparked by the shortages persisted through the 1970s as OPEC kept its thumb on the world’s oil spigot. Oil shocks and high inflation dogged the Nixon and Ford presidencies. An economy built on the assumption of cheap oil sputtered and stalled. President Jimmy Carter, a Democrat elected in 1976, fared no better on the economic front as double-digit inflation eroded everyone’s earning power. But the seeds of a solution were sown when, at Carter’s urging, Congress passed the Airline Deregulation Act of 1978. Bitterly opposed by the airlines and their powerful
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unions, the act was approved nonetheless by Democratic majorities in both houses of Congress. Government airline regulators no longer would set fares. Instead, market forces of supply and demand would determine ticket prices. And newcomers could compete on any air routes without first obtaining permission from government bureaucrats—as long as they met industry safety standards.
Deregulation Airline deregulation led to a succession of new carriers entering the market in the 1980s, including such names as People Express, New York Air, and Air Florida. All these new carriers offered low fares, which they could afford mainly because they operated less expensive aircraft with nonunion labor. Established airlines such as American, United, Delta, and Northwest fought back by slashing labor costs where they could, lowering fares, and creating loyalty incentives such as frequent flyer programs that reward regular customers with free tickets. Airlines that could not compete—Braniff International, Pan American World Airways, Eastern Airlines—eventually went out of business, casualties of the marketplace. On balance, airline deregulation is considered a success. The cost of air travel actually fell. And the lower prices attracted more customers. The number of Americans who had flown on an airliner climbed from fewer than one in four in the 1970s to four out of five in 1990. Yet competition in the airline industry is imperfect, and consumers and regulators in certain markets are unhappy. If Carter was willing to experiment with deregulation, his successor, Republican Ronald Reagan, was willing to embrace it as the solution to nearly every economic ailment. In rapid succession, the railroad and trucking industries were deregulated and the price of domestic oil was decontrolled. The appetite for competition also spread to the U.S. courts, where federal antitrust enforcers and officials of AT&T agreed (after eight years of litigation) that the world’s largest telephone company would be unbundled. The breakup of Ma Bell in 1984 took AT&T out of the business of providing local telephone service and handed that business to regional Bell operating companies such as Nynex, Bell Atlantic, Ameritech, and U.S. West. Those local service providers continue to be regulated by state public service commissions, which set rates for basic telephone service. AT&T retained its long-distance business but now had to share that market with new telecommunications companies such as MCI and Sprint. The landmark Telecommunications Act of 1996 set a timetable to permit telecommunications companies that once provided only telephone, cable, or data transmissions to provide all three—and wireless, too. As a result, future competition in the “local loop” (the part of the telephone network that connects a home or apartment to the global network) can come from cable, wireless, or long-distance companies. Or perhaps
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those services will come from a new and largely unregulated communications medium— the Internet.
Regulation Is Alive and Well During the last twenty years of the twentieth century, U.S. regulators favored market solutions over administrative solutions. In industry after industry, regulations that kept competitors out of markets, protected incumbents, and set prices have been dismantled. But the term deregulation is a misnomer. The first industry to be “deregulated”—the airline industry—is actually still heavily regulated. Although government bureaucrats no longer dictate routes and ticket prices, airline operators must be approved by the U.S. Department of Transportation. The Federal Aviation Administration (FAA), an agency of the Transportation Department, requires that all aircraft be registered and maintained, with accurate records kept of all work performed. Pilots and mechanics must be licensed, must pass regular proficiency and medical exams, and must submit to random drug testing. Airspace the planes fly through is controlled by federally employed air traffic controllers. Should an airline want to raise money from the capital markets, it must (like any other public company) register its stock offering with the SEC, disclose the required financial information, have its financial books audited, and regularly report all significant company developments to shareholders and the SEC. For business journalists, the question is not whether a business is regulated but rather the purpose and scope of the regulations. Though regulations dictating pricing and market conditions have largely been repealed, regulations to protect the public and the environment and to prevent the destruction of a market are alive and well. Telephone companies and electric and natural gas utilities are subject to both state and federal regulations. And most state public service commissions still set rates for residential telephone, gas, and electricity service. Deregulation of the utility industry is now under way, a process that is designed to offer consumers more choice. But the appearance of competition does not portend the demise of regulators. Cable television is typically regulated by cities, which grant exclusive franchises to cable operators. In return, these cities generate revenue from franchise fees. What will happen when a local cable company also offers telephone service? Or when an electric utility wants to sell its customers telephone and Internet service? Expect regulators to fight hard to protect their turf—and their revenue streams—as the digital convergence unfolds. Banking laws such as the Glass-Steagall Act, which prevented banks from owning brokerages, have been eased—a development that accounted for a flurry of bankbrokerage mergers in the latter half of the 1990s. But the financial services industry remains one of the most heavily regulated industries, with oversight of banks conducted by the Federal Reserve, the Comptroller of the Currency, and state authorities.
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Food companies, drug companies, and makers of medical devices are all subject to Food and Drug Administration regulations. Here, too, regulations have been eased and approval processes streamlined in recent years with the aim of getting more life-saving products to market faster. But the regulatory hurdles remain formidable, and for good reason. After all, lives are at stake. Beyond these industry-specific regulators, every U.S. business is subject to the following: • Federal (and state) pollution-control regulations. The most important of the federal laws are the Clean Air Act of 1970; the Clean Water Act of 1977; and the Comprehensive Environmental Response, Compensation, and Liability Act of 1980 (also known as the Superfund Act). • Workplace rules. The federal government also imposes regulations administered by the Occupational Safety and Health Administration. Federal statutes protect the rights of the disabled (the Americans with Disabilities Act), minorities and other protected classes (the Equal Employment Opportunity Act), and retirees (the Employee Retirement Income Security Act). As the economy grows more global and more complex, regulations and the philosophies that justify them also must change. Safety regulations mandated for piston-powered airplanes do not make economic sense in the jet age. Technological innovation forces change that regulators must accommodate. Indeed, the advent of the Internet is testing regulators at this very moment. But lives and property will always need to be protected. And unchecked corporate power can still distort markets and weaken the economy. Like the tides, regulatory fervor ebbs and flows. For example, in May 1999, twentyone years after the introduction of airline deregulation, the U.S. Justice Department sued American Airlines, accusing the carrier of predatory pricing. The civil case followed a year-long Justice Department investigation focusing on the market power of major airlines that dominate passenger traffic at hub airports such as those in Dallas–Fort Worth, Minneapolis–St. Paul, and Detroit. The allegation? That certain major airlines drive small, low-cost carriers out of these “fortress hubs” by pricing fares below cost until the small airlines leave the market. Then the big carrier raises fares. Sound familiar? Today’s mightiest corporations do not control railroads, oil wells, or steel mills. They control information, networks, and air routes. Yet when Justice Department lawyers took Bill Gates and his company, Microsoft, to court in 1998, they invoked the Sherman Antitrust Act, the law that heralded the start of big-business regulation in the United States 108 years before Windows 98 hit the computer screen.
4 Economic Indicators John C. Finotti
Every month we’re bombarded with a flurry of economic statistics. Reports on consumer spending. Manufacturing productivity. Auto sales. Housing starts. Prices. Wage rates. Unemployment rates. Trade balances. There’s even an index telling us whether we—as consumers—are confident about the future. Some economists analyze as many as a hundred different economic indicators, some subsets of other indicators. Businesspeople use these economic statistics to decide whether to increase production just as money managers use them in scanning for promising investments. Although the indicators do help quantify aspects of the economy and forecast its likely course, financial journalists are wise to approach them with skepticism. They are far from perfect, are open to conflicting interpretation, and don’t mean much of anything unless viewed in a longer-term context. The journalist’s job is to find a simple yet meaningful way to make the numbers make sense. Relating indicators to the average citizen is no small task. Though anyone can grasp what it means to lose a job, buy a car, or build a home, extrapolating what it means if legions of people do likewise within our world economy is quite a different matter. What’s important is to tie each individual statistic to people and the quality of their life whenever possible. Try to point out examples, such as an actual plant closing or opening, that can make the picture more vivid, and never use an indicator without at least briefly explaining what it actually measures. Economists disagree as to which indicators are the most important. Unemployment statistics and trade balance numbers rank high because the first affects interest rates and the second affects the U.S. dollar. If forced to select the preeminent indicator, however, many economists say they’d go with the gross domestic product, the most comprehensive measure of economic growth. When you examine economic data, it’s important to remember that any one indicator viewed in isolation probably won’t give you a focused snapshot of the overall direction of the economy. “The biggest problem most people make is not putting economic data in context,” says Lynn Reaser, an economist at Bank of America. “One needs to look at a basket of numbers to glean the overall picture.” Moreover, she adds, “Don’t overreact to any one month. It’s extremely important to look at trends.”
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So, with those thoughtful words in mind, let’s take a look at some of the more commonly used economic indicators and what they mean.
Gross Domestic Product When you’re setting off to explore any economy, one of the first stops ought to be a look at how productive that economy is or isn’t. Perhaps the best way of doing this is to examine a key economic indicator called the gross domestic product, often abbreviated as GDP. Stated simply, the GDP is the total value of goods and services produced by the nation, regardless of whether the producer is a U.S. firm or a foreign one located here. It is our single most comprehensive indicator of the health of the economy. In the U.S., the GDP is calculated by the Commerce Department and released quarterly. What makes up the GDP? In a complex and vibrant economy like that of the United States, perhaps millions of different kinds of goods and services are included in economic production. The sheer number boggles the mind. To simplify the challenge, we can break the GDP into two basic groupings of production output. The first of these consists of goods and services generally purchased by private households. These goods and services are well known to us; they include everything from cars, clothes, and food to haircuts, health care, and lawn-care services. This kind of production is called consumption, and all of the goods and services included in it are called consumers’ goods. But what about all of those things produced in the economy that don’t reach our kitchen table or garage, such as roads, machines, and office buildings? This category of goods is called investment goods or capital goods. It also includes the outputs of educational skills in schools and the value of research and development, often called human capital. When Commerce Department statisticians calculate the nation’s GDP, they tally up four separate categories of output: (1) All the money spent on personal consumption, (2) private investment outlays, (3) all government purchases, and (4) the export balance, or the net value of U.S.-made goods sold overseas. Traditionally, GDP is divided into agricultural, mining, construction, manufacturing, and services sectors. Our economy has changed dramatically over the years. Services now account for about 70 percent of GDP. Now that we’ve seen what makes up GDP, let’s look at how to use it. In essence the movement of the GDP is an indication of the economy’s performance; it tells us whether we have more goods and services we can buy. If the value of production is increasing, then more people are likely to be working. Likewise, if the output of goods and services is on the rise, it means people are probably earning more money. But like most important indicators, GDP has its weaknesses as well as its strengths. For starters, because GDP deals in dollar values, it has to be corrected for inflation. Overall increases in prices can lift GDP, masking any real boost to production. Accurately stripping away all of the effects of inflation is difficult. So a degree of uncertainty always
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exists about measuring GDP from one year to the next. Another problem involves using GDP to track trends over the years as a result of changes in quality of goods and services. The constant upgrading of quality means some goods last much longer than before. At the same time, however, the introduction of technologically improved goods means more new goods are constantly being introduced into the marketplace. Moreover, GDP does not tell us the ultimate use of all this production. Nor does it give any indication about the distribution of goods and services among the nation’s population. Still, the GDP is the easiest assessment tool we have for measuring the overall activity of the economy. If we want to go beyond this simple yardstick and explore the economy in greater depth, plenty of other indicators are available to us.
Employment Another key indicator of the economy’s overall activity is employment. Actually, when it comes to looking at employment data, the figure that most economists consider first is the unemployment rate. The unemployment rate is the number of unemployed workers as a percentage of the total workforce. The Federal Reserve follows unemployment statistics closely because, its classical economists believe, a low unemployment rate will put upward pressure on wages as employers are forced to pay higher and higher amounts to attract workers, thereby leading to higher inflation. Rises in the unemployment rate usually indicate a slowing economy. So the Fed might ease credit and cause interest rates to drop. But some economists, including Lester Thurow at MIT’s Sloan School of Management, question this thinking, partly, they argue, because the unemployment rate probably doesn’t accurately reflect the real rate of unemployment. Unemployment statistics count as “unemployed” only those individuals, age sixteen or older, who aren’t employed but tried to find a job within the preceding four weeks. In fact, at any given time perhaps five to six million people of working age may have officially dropped off the ranks of the unemployed because they are not actively seeking a job. Regardless, employment data can give us another quick look at the hiring decisions companies are making, and presumably whether the economy is strengthening or weakening. The Bureau of Labor Statistics (BLS) releases wage and employment data at the beginning of each month. You can access the statistics from the BLS Web site, www.bls.gov. When you use recently released employment data, it’s important to remember that they will be revised later on, like many other economic statistics. So if there appears to be a startling change in direction, keep in mind that the data could be misleading. Because the regular unemployment figures can be bounced around by sampling vagaries, many economists prefer the nonfarm payroll employment numbers. This measure
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of the labor force considers hours, wages, and earnings. It’s a major factor in estimates of industrial production and personal income. The BLS also computes the quit rate, which measures the number of people who leave their jobs as a percentage of those employed. A high quit rate often means that workers are confident that plenty of jobs are available.
Retail Sales Consumer spending now makes up about two-thirds of the U.S. economy. It’s no wonder, then, that retail sales figures have become an important gauge of economic activity. A variety of retail sales reports are released monthly. At the beginning of each month, for example, auto manufacturers release monthly auto sales activity for the preceding month. Large department store chains also release preliminary sales data each month. For overall monthly retail sales figures, however, you’ll have to wait until the middle of the month for the Commerce Department to release its retail sales numbers. As you might guess, an increase in retail sales most likely indicates a pickup in the economy. If workers are earning more and feel more secure in their jobs, they’re more inclined to spend money. The increase in consumption means more production and, consequently, more employment. Conversely, a drop in sales could indicate that consumers are growing cautious. If consumers are buying, manufacturers must be producing, right? We can get a fix on companies’ monthly production levels from indexes such as the one released by the National Association of Purchasing Managers (NAPM). The NAPM index, issued at the beginning of each month, technically measures the lead times for deliveries and indicates whether the manufacturing sector is growing or contracting. Similarly, manufacturer’s new orders provide an indicator of manufacturing output and can foreshadow upcoming cyclical trends in the economy.
Construction Spending The Commerce Department also issues monthly construction spending reports. When first released, the reports, which are seasonally adjusted to reflect the swings in construction activity, are estimates; these are followed by actual spending figures when they become available. The figures are broken down into public and private spending. Private construction spending includes homes, hotels and motels, and office buildings, whereas public spending includes government projects such as schools and other educational facilities as well as utilities. Residential construction, usually measured as housing starts, is closely followed by economists and investors because its turning points have accurately predicted changes in the business cycle in the past. A solid level of housing starts usually speaks well for the
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coming year and is a solid barometer of economic optimism. Generally, a rate of starts above 1.5 million is considered an indication of a strong economy in the year ahead.
Inflation Until now we’ve looked primarily at production aspects of the economy, concentrating on issues such as what and how much are we producing and consuming, and how many of us are working or not working. But another key component of the economy, and one on which the Federal Reserve and other key policy experts focus, is the trend in the prices we’re paying for all of these things being produced, whether autos, food, or homes. When these prices rise, it’s called inflation. The consumer price index, or CPI, is the most widely used gauge of inflation. The CPI measures changes in the prices of consumer goods. The index, based on a list of specific goods and services purchased in urban areas, is released monthly by the Labor Department. The CPI includes the volatile food and energy sectors. When you’re examining consumer prices, it’s helpful to strip away these two volatile sectors to get at the core rate of inflation. The core rate includes prices for most other purchases, everything from medical care to airline tickets to clothing. In an effort to anticipate price increases before they hit consumers, economists also keep a keen eye on the prices manufacturers are paying for the raw materials they use to produce finished consumer goods. This is called the producer price index, or PPI. It is also released monthly, but it’s not as widely reported in the general media as the CPI, which has a much more immediate impact on Americans’ wallets.
Trade Balance A trade deficit is an excess of imports over exports, whereas a trade surplus is an excess of exports over imports. The balance of trade is made up of transactions in merchandise and other movable goods and is one of the factors making up the larger current account, which includes services, tourism, transportation, and interest and profits earned abroad. An important factor affecting balance of trade is the strength or weakness of U.S. currency. For example, although a strong U.S. dollar is often considered a cause for rejoicing, many exporting U.S. manufacturers prosper when our currency is relatively weak, because foreign buyers are able to buy more U.S. goods with their relatively more valuable currency.
Cost of Capital The cost of borrowing money, or the level of interest rates, greatly affects economic activity. If mortgage rates rise, consumers naturally cut back on buying homes. Housing
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is among the most interest rate–sensitive industries. Higher interest rates also dictate whether companies will expand their manufacturing facilities. In both cases, higher interest rates that prevent borrowing send a ripple throughout the economy. Numerous types of interest rates exist, but two key rates can give you an overall indication of where rates in general are heading. The first is the Fed Funds rate, which is the rate banks charge each other for overnight loans. As such, it is considered the benchmark for most other rates. Movement of the Fed Funds rate typically will presage changes in many other rates as banks pass along their higher cost of borrowing to businesses and consumers. The other key rate worth following is the so-called long bond, the thirty-year Treasury bond. It’s an important indicator because it fairly reflects how the financial markets view the economic scene. The thirty-year bond rate is a good synopsis of the bond markets’ mentality.
Predicting the Future If you want to try to handicap economic conditions in the coming months, the index of leading indicators is the way to go. The index is intended to forecast economic activity as far as six months in advance. It is computed by the Conference Board, a New York nonprofit business-research group, from data provided by the U.S. Department of Commerce. The index consists of ten indicators, including average workweek of production workers, weekly claims for state unemployment insurance, new orders for consumer goods and materials, and change in manufacturers’ unfilled orders. They cover a wide range of economic activity, from stock prices and building permits to growth in the money supply to consumer confidence.
Useful Publications Getting on the press mailing list of the Department of Commerce and the Bureau of Labor Statistics is one way to keep up with economic indicators and changing forecasts. Another is to subscribe to periodicals through the U.S. Government Printing Office (GPO), which sells information from a wide variety of federal government agencies. You can purchase these products at U.S. government bookstores located in twenty-four cities throughout the country, or you can search and browse online and place orders via fax, mail, or telephone. You can find the GPO’s online bookstore at www.access.gpo.gov. Here is a partial list of available publications: Compensation and Working Conditions. Issued quarterly; includes the employment cost index and information on safety and health statistics, work stoppages, and annual
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union membership data. Special articles present an array of information and statistics on compensation, including wages and salaries, benefits, safety and health, and other workplace issues. CPI Detailed Report. Issued monthly; reports on consumer price movements of urban consumers and urban wage earners through statistical tables and technical notes. Current Industrial Reports. Issued monthly; presents tables and statistics based on a survey of manufacturers on total production, value, shipment, and consumption of various products manufactured by industries in the U.S. Economic Indicators. Issued monthly; gives pertinent economic information on prices, wages, production, business activity, purchasing power, credit, money, and Federal finance. Employment and Earnings. Issued monthly; provides current data on employment, hours, and earnings for the United States as a whole, for states, and for more than 200 local areas. Housing Starts. Issued monthly, contains the number of new nonfarm and total housing units started, categorized by ownership, location, and type of structure. Monthly Labor Review. Issued monthly; keeps professionals in economics, industrial relations, business, and human resource management up-to-date on developments in the economy, labor-management relations, business conditions, and social trends. Includes objective analyses on the labor force, wages, employee benefits, prices, productivity, economic growth, and occupational injuries and illnesses. Survey of Current Business. Issued monthly; gives information on trends in industry, the business situation, outlook for business conditions, and other points pertinent to the business world.
5 Demystifying the Federal Reserve David M.Wessel
Given its power to influence the economic lives of the American people and American business, the Federal Reserve is the least-covered institution in Washington, D.C., and perhaps in our entire society. The United States concentrates more economic power in the Fed than in any other institution. No giant commercial bank, no industrial conglomerate, no software monopolist comes close to having as much power. And with the exception of the Supreme Court, no other arm of government is so independent. The president of the United States can order the launch of nuclear missiles on his own, but he can do nearly nothing to influence the economy without the approval of Congress and the cooperation of the Fed. The Supreme Court, which has overturned presidential and congressional economic policies, hasn’t ever restricted the Fed’s freedom to manipulate interest rates. Although the Constitution gives Congress and the president the authority to force the Fed’s hand, they have never used it. Yet while hundreds of reporters cover the presidential nominating conventions— where the outcome is rarely in doubt and the proceedings are choreographed for television audiences—only a handful of reporters (besides those employed by specialized financial wire services) cover the Federal Reserve on a regular basis. It’s true that the Fed has, until very recently, made life miserable for reporters who tried to cover it; one writer has described the Federal Reserve as an “intentional mystery.” But much of the fault lies with the press. Too few reporters and editors in print and broadcast media have been willing to do the work needed to understand the Fed, to cultivate sources there, and to cover it aggressively. The goal of this chapter is to help change that.
Monetary Policy:The Basics An economy that has no money does not need a central bank. But in such an economy, people can get what they want only by bartering tomatoes for tea bags, or by relying on a medium of exchange with intrinsic value, such as gold. Modern economies rely on money that has no intrinsic value, paper currency, for instance. They need some entity to regulate it. That’s the job of the central bank—the Federal Reserve, the new European Central Bank, the Bank of Japan, and so on. A central bank controls the supply of money,
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i.e., the supply of currency, coins, checking account deposits, money market funds, and other funds that can be obtained quickly and can be used to buy goods and services. In a market economy, the price of something is determined by demand and supply. The price of money is the interest rate one has to pay to get it. When the Fed expands the supply of money, it tends to push the price (interest rates) down. When it contracts the money supply, it tends to push the price (interest rates) up. By so altering the price of money, the Fed can affect the ability and willingness of consumers and businesses to borrow and, thereby, their willingness and ability to buy goods and services. The more costly a car Interest Rates over Three Decades % 18 17 16 15 14 13 12 11 10 9 8 7 6 5 4 3 2
0
1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999
1
3-Month Treasury Bill
Prime Rate
Federal Funds Rate
Commercial Paper
The federal funds interest rate is currently the Fed’s primary tool for influencing rates throughout the economy. Other short-term interest rates tend to move with the federal funds rate. Source: Federal Reserve (These rates are averages for the twelve months ending December.)
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loan, the fewer cars sold. The more costly a mortgage, the fewer houses sold and built. The more costly a business loan, the fewer machines or computers sold. Manipulating the money supply and interest rates is known as monetary policy, as distinguished from fiscal policy, which refers to government spending and taxing. The Fed has nearly exclusive control over monetary policy. The president and Congress control fiscal policy. Although borrowing costs are the prime channel for monetary policy, the Fed can affect the economy in other ways, too. It can directly alter the availability of bank loans. It can also influence the economy when, either by moving interest rates or just uttering the right combination of words, it moves the stock and bond markets (and increases or decreases the wealth of American households) or affects the foreign-exchange value of the dollar. But mostly the Fed works through the banking system. By law, every bank must hold a fraction of its deposits as reserves. Reserves consist of cash in bank vaults or noninterest-bearing deposits at the Fed. The Fed sets the fraction of deposits that must be held as reserves; this is known as the reserve requirement. When a bank runs short of reserves for some reason, it often borrows them from another bank in a market called the federal funds market. The cost of borrowing in this market is the federal funds interest rate. This rate is currently the Fed’s primary tool for influencing interest rates throughout the economy. Other short-term interest rates—such as banks’ prime interest rate, the rate on three-month Treasury bills, and the rate that companies pay on unsecured IOUs known as commercial paper—tend to move with the federal funds rate. Assume the Fed’s policy committee (more on this later) wants to reduce the federal funds interest rate to stimulate borrowing and spur economic activity. It will instruct the trading desk at the Federal Reserve Bank of New York to add reserves to the banking system. The trading desk will then buy government securities from investors, not directly but operating through brokerage firms, banks, or other intermediaries that deal in U.S. government securities. The Fed pays for the securities, and the proceeds of these sales are deposited by the investors in banks, thereby increasing reserves. This reduces the demand (and therefore the price) for reserves in the federal funds market, and the federal funds interest rate falls. When the Fed buys government securities from investors, it literally creates money to pay for them. That’s why central banks are said to own the printing press. (Actually, in terms of physical currency, the Treasury’s Bureau of Printing and Engraving owns the presses. But the Fed is its only customer; hence the legend “Federal Reserve Note” at the top of every dollar bill.) When the Fed wants to push up the federal funds rate, the Federal Reserve Bank of New York sells government securities in the market. Buyers pay for them, reducing the reserves in the banking system, thereby driving up the interest rate in the federal funds market. In such circumstances, the Fed is actually extinguishing money. Federal law also gives the Fed the ability to lend money directly to banks through what’s known as the discount window. The rate it charges on such loans is the discount
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rate. This emergency source of credit is an important source of stability to the banking system and the economy. The Fed is ready to lend to solvent banks when they unexpectedly can’t get money anywhere else. But its significance to monetary policy of this “lender of last resort” role has diminished in recent years. In the 1920s, the discount window was the primary conduit for supplying reserves to the banking system and therefore was the main conduit for monetary policy. But as the federal funds market developed, direct borrowing from the Fed became less important. Today, the significance of changes in the discount rate is largely symbolic. The rate to watch is the federal funds rate. That’s all there is to it. Everything else is detail.
How the Fed Works:The Theory The Federal Reserve Act says that the Fed’s job is to “promote effectively the goals of maximum employment, stable prices and moderate long-term interest rates.” Many at the Fed, and some outside economists and politicians, believe that statement is vague and contradictory. In particular, they see the goals of maximum employment and stable prices as inconsistent. If the Fed really tried to maximize employment in all circumstances, prices would rise; if it tried to stabilize prices in all conditions, it would have to let employment fall. Proposals to alter the Fed’s charter to make price stability its sole goal have
DEMYSTIFYING THE FEDERAL RESERVE
failed to get much support in Congress. And some economists say that’s just as well. Former Fed vice chairman Alan Blinder, now teaching at Princeton University, argues that the law conveys precisely the right message: in steering the economy, the Fed is always balancing its responsibility to resist inflation with its responsibility to avoid recession. Fed governor Laurence Meyer describes the Fed’s job as “leaning against the cyclical winds,” by which he means that the Fed should use interest rates to slow the economy when it is growing too fast and threatening to generate inflation, and spur the economy when it is growing too slowly and threatening to generate higher unemployment. Although Fed chairman Alan Greenspan has endorsed legislation to make price stability the Fed’s sole goal, he also has argued that the best way to achieve the maximum sustainable rate of economic growth over time is to keep the inflation rate low. This implies that Greenspan doesn’t see any troublesome inconsistency in the law. Moreover, whatever the shortcomings of the wording of the statute, the Fed is generally regarded to have done a reasonably good job for the past decade, and that diminishes the interest in altering its charter. The Federal Reserve System, created in 1913 and structured by a series of political compromises, is an unusual agency. It consists of the Board of Governors in Washington, D.C., and twelve regional Federal Reserve Banks. The Board of Governors has seven members, each of whom is appointed by the president and confirmed by the Senate to serve terms that last for fourteen years (although few people actually serve that long). The regional banks, in contrast, are technically private companies owned by the commercial banks in their territories. The presidents of the regional Fed banks are appointed by the private-sector boards of directors of their institutions, subject to approval by the Fed governors in Washington. Neither the Congress nor the president has any direct say in picking either the presidents or the boards of directors of the regional Fed banks. And unlike most other arms of the federal government, the Fed makes money by earning interest on the government securities in its portfolio; it keeps what it needs to pay its expenses and turns the rest over to the Treasury. It does not rely on congressional appropriations, which gives it unusual independence. Monetary policy decisions are made by the Federal Open Market Committee (FOMC), which consists of the seven governors and the twelve bank presidents. Only five of the presidents have a vote at any one time, the president of the New York Fed plus the presidents of four of the other banks, who serve in rotation. The committee meets behind closed doors about every six weeks, sometimes more often by telephone, to decide whether to change the Fed’s target for the federal funds rate. The chairman has the power to move rates between meetings. Decisions of the committee are made by majority vote, although influential chairmen, such as Greenspan, effectively call the shots. Summaries of the discussions are released after a six-week lag. Full transcripts are released after five years. Both are posted on the Fed’s Web site (www.federalreserve.gov).
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The underlying justification for this unusual and, to some, undemocratic arrangement is this: democracies are inflation prone, so politicians, who believe that inflation is bad but don’t trust themselves to be able to resist it, delegate monetary policy to an independent institution. At any given moment, a little more inflation can be appealing; over time, however, a little more inflation can become a lot more inflation, and that is very unappealing. Here’s how Mr. Blinder explains it: “Why should the central bank be independent? The essence of my answer is disarmingly simple. Monetary policy, by its very nature, requires a long time horizon. . . . But politicians in democratic—and even undemocratic—countries are not known for either patience or long time horizons. Neither is the mass media or the public. . . . So, if politicians made monetary policy on a day-to-day basis, the temptation to reach for short-term gains at the expense of the future (that is, to inflate too much) would be hard to resist.” Mr. Blinder says the reasoning is the same as that of Ulysses: “He knew he would get better long-run results by tying himself to the mast, even though he wouldn’t always feel very good about it in the short run!”1 The worldwide trend is to make central banks more independent than they have been. In Germany, where the hyperinflation of the early twentieth century has seared 1
Alan S. Blinder, Central Banking in Theory and Practice (Cambridge: MIT Press, 1998), pp. 55–56.
DEMYSTIFYING THE FEDERAL RESERVE
the collective memory of the citizenry, the Bundesbank, created after World War II, was even more independent of the elected government than the Fed. That has had a strong influence on the architecture of the new European Central Bank that oversees monetary policy in eleven European countries. Until recently, the central banks in Britain and Japan were under the thumb of the finance minister (the counterpart of the U.S. Treasury secretary), but both countries have moved to make their central banks more independent, a reflection of the prevailing political economic orthodoxy. And the International Monetary Fund, as a condition of its loans, has pushed South Korea and other countries to make their central banks more independent. By law, the chairman of the Fed must report to Congress twice a year, usually with a written report and an appearance before the Senate and House Banking Committees. The Fed chairman is often called to testify at other times. Because he knows that the Fed’s independence depends on Congress—which has delegated to the Fed its constitutional power “to coin money and regulate the value thereof ”—he usually accepts such invitations and assiduously courts influential members of Congress.
How the Fed Works:The Practice Okay, so much for all this political science. How does the Fed really work? The Fed is a big institution with all sorts of internal politics and bureaucratic inertia. It has some very powerful individuals at the top who make the decisions that matter most. The Fed has a clearer sense of its mission than many other institutions: it sees itself as the bulwark against inflation. Those Fed officials and staffers who were at the Fed, or were watching it closely, during the late 1970s and early 1980s are scarred by the memories of the Fed’s past mistakes. In retrospect, mainstream economists widely agree that the Fed allowed too much inflation in the late 1970s. To break the back of inflation in the early 1980s, the Fed raised interest rates sharply, causing the worst recession since the Great Depression. Those at the Fed who lived through this painful period argue that the Fed should nip inflation in the bud or strike preemptively to prevent the inflation genie from getting out of the bottle. But today, the days of double-digit inflation seem very far away. As this essay is written at the end of 1999, inflation is almost nonexistent. For all practical purposes, the Fed has achieved its goal of price stability. Few, if any, Fed officials want to drive the inflation rate any lower. Most would like to prevent it from rising above current levels. A few are willing to risk a little increase in inflation because they doubt that a small increase, in today’s environment of global competition and rising productivity, would spark an inflation bonfire. At any particular moment, the Fed has to decide whether the economy needs a dose of interest rate reductions or a dose of interest rate increases or nothing at all. Sometimes the call is an easy one. Usually, it isn’t. In the first half of 1999, for instance, the Fed had
BASIC CONCEPTS
a tough time reading the economy, which didn’t seem to be behaving as it had in the past. The unemployment rate had fallen to a twenty-nine-year low, well below the point that had sparked inflationary wage increases in the past. The U.S. economy was growing faster than the Fed believed was safe. (Once an economy reaches full employment, the Fed figures, it can grow only as fast as the growth in the supply of workers and the growth in their output per hour of work, or productivity. An economy that grows faster than that generates inflation.) The Fed and private forecasters had been expecting the economy to slow, but it had defied their prediction. Yet, except for a surge in oil prices, there were few tangible signs of inflation. The summary of the Fed’s meeting in late March 1999 revealed that some Fed officials feared their inflationary good luck was about to run out and wanted the Fed to begin to raise interest rates. Other Fed officials thought the economy was changing, that inflation was less likely to accelerate than in previous periods, and that the Fed should be careful not to punish an economy that was enjoying the benefits of technology-driven increases in productivity growth. The Fed did nothing, although in May 1999 it warned that it was contemplating higher rates and did lift rates later in the year. There is some science to this, but not a whole lot. Transcripts of FOMC meetings reveal them to be a bunch of (mostly) white (mostly) smart (mostly) guys sitting around talking about the economy and trying to figure out where it’s going—and sometimes fretting about their inability to keep their secrets from leaking to the press. FOMC meetings have a certain ritual to them. For a description of a typical meeting, see Fed governor Laurence Meyer’s April 1998 lecture at Oregon’s Willamette University titled “Come with Me to the FOMC,” available on the Fed Web site (http://www.federalreserve. gov/BoardDocs/Speeches/1998/199804022.htm). But in the end, the Fed has to combine economic theory, predictions of its computerized models, advice of its staff, and the sentiments of financial markets with its best judgment. And nearly all the time, the members of the FOMC do what the chairman thinks is right. A few independentminded members may formally dissent from time to time, but enough others will follow the chairman’s lead. During his career, Greenspan accumulated a substantial amount of credibility—both inside and outside the Fed—and had as much clout inside the organization as any of his predecessors. When some Fed officials wanted to raise interest rates in the mid-1990s, he resisted. That turned out to be the right call; inflation didn’t materialize. Greenspan’s stature grew as a result. Making monetary policy is the Fed’s most important function, but not its only one. The Fed, along with other state and federal agencies, regulates the banking system. In cooperation with the Treasury, it handles the U.S. response to international economic issues, both coordination with other rich countries and responses to economic and financial crises. The Fed’s 220 economists in Washington inquire into all sorts of economic issues, from the amount of U.S. currency circulating outside the borders to the track
DEMYSTIFYING THE FEDERAL RESERVE
record of community colleges. And the economists at the twelve regional Fed banks are, among other things, experts on the economies of their regions. In addition, as Greenspan regularly demonstrates, the chairman of the Fed is a person of enormous influence in Washington on other matters, such as pushing politicians to reduce the budget deficit or protect the surplus and influencing the debate over reform of Social Security.
Covering the Fed Covering the Fed ought to be viewed like covering anything else. Over the past decade the Fed has made it easier for outsiders to figure out what it’s doing. A decade ago, the Fed didn’t even disclose when the FOMC changed its target for the federal funds rate. It signaled a change to financial markets by the manner in which the New York Fed bought or sold Treasury securities. The public knew what was happening only if a newspaper reporter could confirm the market’s suspicions. Fed documents were available on the day of release only to those reporters who could get them from the Washington headquarters. Transcripts of FOMC minutes were kept, but hardly anyone knew that. Today, the Fed announces at the end of a meeting if it is changing the target for the federal funds rate, explains the reason for the change, and sometimes even explains what it’s contemplating for the period ahead. And, while transcripts of FOMC meetings are released with a five-year lag, all Fed public documents are posted within minutes on its Web site, where any reporter can get them. (For more on the changes at the Fed, see William Pesek Jr.’s piece, “The Secret’s Out: What Will Fed Watchers Do Now that Greenspan Tells It Like It Is?” in Barron’s, April 19, 1999, p. 29.) Here are a few general principles to remember. Learn the lingo. Like many disciplines, economics has its own language. Fedspeak is a dialect of that. To cover the Fed, you’ve got to learn the lingo so you can translate it for readers, listeners, and viewers. The publications listed at the end of this chapter can help, and so can reading the text of Fed statements on its Web site and comparing them to stories in the Wall Street Journal, the New York Times, the Washington Post, Business Week, and the Economist. Even for a Fed official, Alan Greenspan is hard to understand sometimes. Veteran reporters get with the Zen of Greenspan by listening to (or reading) all his speeches and congressional testimonies. It’s the only way to tell when he is repeating something he has said dozens of times before, and when he is saying something new and significant. Translate. The Fed does not speak in words that ordinary Americans understand. Reporters who cover the Fed learn to speak that language, but they should never use it untranslated in their stories. Monetary policy is too important to be left to the high priests. For example, on September 17, 1999, Greenspan said, “As a result of vast effort
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and an estimated $50 billion of expenses by the private sector, enough of our critical infrastructure has been judged Y2K-compliant to view the probability of any systemic breakdown as negligible, even granting the uncertainties associated with our interconnections with less-prepared foreign countries.” Translation: Odds are that Y2K won’t be a catastrophe even if some other countries aren’t as prepared as we are. In another typical comment, this time before the Committee on Banking and Financial Services on July 22, 1999, Greenspan said, “While product prices have remained remarkably restrained in the face of exceptionally strong demand and expanding potential supply, it is imperative that we do not become complacent. The already shrunken pool of job-seekers and considerable strength of aggregate demand suggest that the Federal Reserve will need to be especially alert to inflation risks. Should productivity fail to continue to accelerate and demand growth persist or strengthen, the economy could overheat. That would engender inflationary pressures and put the sustainability of this unprecedented period of remarkable growth in jeopardy. One indication that inflation risks were rising would be a tendency for labor markets to tighten further. But the FOMC also needs to continue to assess whether the existing degree of pressure in these markets is consistent with sustaining our low-inflation environment. If new data suggest it is likely that the pace of cost and price increases will be picking up, the Federal Reserve will have to act promptly and forcefully so as to preclude imbalances from arising that would only require a more disruptive adjustment later—one that could impair the expansion and bring into question whether the many gains already made can be sustained.” Translation: There isn’t any inflation problem now, but we can never let anyone, particularly the markets, think we’re relaxed. With unemployment so low, we’ve got to worry about inflation. If unemployment continues to fall, we’re going to get really worried. But we’ll raise interest rates only if new data convince me that the pace of price increases is likely to accelerate. Learn the players. Not all Fed officials were created equal. The chairman is always more important, of course. But some members of the Board of Governors and some regional bank presidents are more influential or more interesting than others. And some senior Fed staff members are as important as or even more important than the typical governor or bank president. To judge the significance of a particular official’s comments, whether in a speech or in an interview, you need to know whether he or she matters. Watch the bond market. The Fed does. There is a constant dance between the Fed and the financial markets. The Fed looks to financial markets for investors’ collective judgment about the prospects for the economy and inflation. An increase in the yield (or effective interest rate) on ten-year Treasury notes, for instance, often suggests that the bond market is expecting faster economic growth or higher inflation—and that will be noted by the Fed. But the financial markets also reflect investors’ expectations about
DEMYSTIFYING THE FEDERAL RESERVE
what the Fed is going to do next. When the Fed talks about lifting interest rates, bond market yields rise; if the Fed changes its mind, yields may fall. The bond market’s guesses about the Fed aren’t always accurate. Neither are the opinions of Wall Street Fed watchers. But they are an important indicator to the Fed, and to reporters who cover it. Look at the world the way the Fed does. To understand what Fed officials are saying, to figure out what they are going to do next, and to understand why they move interest rates, you have to be able to put yourself in their position. The textbook-style speeches that many (though not all) Fed officials deliver make interest rate decisions sound easier than they are. They tend to talk more about the long-term goals and strategies and less about the near-term trade-offs and political realities. But when they make decisions, they have to think about the latter: If we raise rates now, will we become ensnared in a presidential election? Have we prepared financial markets for a move? Would we be better off waiting another six weeks? What are the risks of acting now versus waiting? A good reporter covering the Fed can discern what factors are more important to the most important officials and try to weigh them as a Fed official does. Don’t look at the world the way the Fed does. For all its power and (current) reputation, the Fed doesn’t have a monopoly on economic wisdom. Despite the political cartoons that suggest otherwise, Greenspan is not the modern Oracle of Delphi. In 1990, the Fed was slow to see an approaching recession. With the benefit of hindsight, most outside economists agree that the Fed didn’t cut interest rates quickly enough. In the early 1990s, some top Fed officials dismissed newspaper reports of a credit crunch (a reluctance of lenders to lend) that proved to be accurate. In early 1998, some key Fed officials were convinced that inflation was just around the corner; they were wrong. But most of all, the Fed is paid to worry about inflation first. That can sometimes blind the Fed to other important developments in the economy; reporters must not miss those developments. Use the Fed. Fed officials, Fed economists, and Fed publications are a great resource for economics and business reporters who will never write a word about monetary policy. The Fed, for instance, has the best government data on the wealth of American families, how it is distributed, and how it has changed over time. It keeps tabs on the length of the average car loan (53 months, as of March 1999). The Fed keeps close track of short- and long-term developments in the banking industry and in securities markets of all sorts. Fed bank presidents and economists are expert on their local economies, and their periodic reports from businesses in their regions (known as the “beige book” for the color of its cover) can be a good source of story ideas and qualitative intelligence on the current state of the economy. Fed governors and their top aides are careful students not only of the U.S. economy, but also of the economic policies and challenges in other countries. Fed chairman Alan Greenspan was among the very first prominent economists or public policy officials to predict that advances in
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computer and communications technology were likely to produce an epochal shift in productivity growth.
References The Fed itself publishes several useful—and Fed-friendly—publications that explain how and why it does its job. Most of them are free. Among the most useful are the following: M.A. Akhtar, Understanding Open Market Operations (New York: Federal Reserve Bank of New York, 1997). Ann-Marie Meulendyke, U.S. Monetary Policy & Financial Markets (New York: Federal Reserve Bank of New York, 1998). A Day at the Fed (New York: Federal Reserve Bank of New York, 1998). In Plain English: Making Sense of the Federal Reserve (St. Louis: Federal Reserve Bank of St. Louis, n.d.). The Federal Reserve System: Purposes & Functions (Washington, D.C.: Federal Reserve System Board of Governors, 1994). The Federal Reserve Today (Richmond, Va.: Federal Reserve Bank of Richmond, 1998). U.S. Monetary Policy: An Introduction, Q&A (San Francisco: Federal Reserve Bank of San Francisco, 1995).
Other Useful Publications Steven K. Beckner, Back from the Brink: The Greenspan Years (New York: Wiley , 1996). A financial wire service reporter’s account of the first part of the Greenspan years at the Fed, drawn largely from transcripts of Federal Open Market Committee meetings. (hardcover) Alan S. Blinder, Central Banking in Theory and Practice (Cambridge: MIT Press, 1998). This is a thoughtful series of lectures, a bit technical for the neophyte, delivered at the London School of Economics by the former vice chairman of the Fed, who is now teaching at Princeton University. (hardcover) Bob Davis and David Wessel, Prosperity: The Coming 20-Year Boom and What It Means to You (New York: Random House/Times Books, 1999). Chapter 10 of this book (coauthored by the person who wrote this chapter) explains how the Fed works, and particularly how Fed chairman Alan Greenspan approaches the economy and the issue of productivity. (paperback) William Greider, Secrets of the Temple (New York: Touchstone/Simon & Schuster, 1987). A pathbreaking work of reporting on the Fed of the 1980s intertwined with the author’s argument that inflation is bad for the rich and the bankers and good for working people. (paperback) Matt Marshall, The Bank: The Birth of Europe’s Central Bank and the Rebirth of Europe’s Power (New York: Random House Business Books, 1999). A readable account of the creation of the European Central Bank by a former reporter for the Wall Street Journal. (hardcover)
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Fed Web Sites The Fed’s Board of Governors and each of the twelve regional banks maintain a Web site. The Board of Governors site (www.federalreserve.gov) posts all of the speeches and congressional testimony of Fed chairman Greenspan and the other governors, summaries of the Federal Open Market Committee meetings, and transcripts of old meetings. It also has economic data, text of the Fed’s summary of regional economic conditions, and the often technical but sometimes interesting research papers by the Fed’s 220 economists. You can get to the individual Federal Reserve Bank Web sites at www.federalreserve. gov/otherfrb.htm. Each one posts the speeches of the bank president, electronic copies of bank publications and research, press releases, and such, but several have particularly useful features. Here are some highlights: Philadelphia (www.phil.frb.org): In 1990, the Philadelphia Fed conducted The Survey of Professional Forecasters, the oldest quarterly survey of macroeconomic forecasts in the United States. Each quarter about three dozen economists are surveyed, offering a handy way to track the changing consensus among forecasters about both the nearterm direction of the economy and the long-term expectations for inflation. Cleveland (http://www.clev.frb.org): The Cleveland Fed calculates and posts an alternative measure of the consumer price index, a weighted median of the various components that it argues is a more meaningful inflation gauge than the one more often cited in the press, a variant of the CPI that takes out food and energy prices because they are so volatile. San Francisco (http://www.frbsf.org): The San Francisco Fed publishes some lively explanations of monetary policy (click on Economic Education, Publications, and Resources. See also the “frequently asked questions.”). Its research director periodically posts a monthly commentary on the economy called FedViews (click on Inside the FRBSF, News and Views). The San Francisco Fed also maintains the Fed in Print directory and includes a section called “Ask Dr. Econ” where visitors can pose questions to the Fed staff. Minneapolis (http://woodrow.mpls.frb.fed.us): The Minneapolis Fed site includes a calculator that allows you to fill in the blanks in this sentence: “If in PICK A YEAR, I bought goods and services for PICK AN AMOUNT, in PICK ANOTHER YEAR, the same goods or services would cost THIS AMOUNT.” It also posts copies of its monthly magazine, The Region, which is usually more interesting than typical Fed publications. St. Louis (http://www.stls.frb.org): The St. Louis Fed’s site includes a huge financial and economic database called FRED as well as a macro that allows you to calculate annual growth rates. Its International Economic Trends has data and charts on the world economy.
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Dallas (http://dallasfed.org): The Dallas Fed, which has one of the jazzier Web sites, posts its most recent example of what it calls “Greenspeak,” the pithy or not-so-pithy comments of Fed chairman Greenspan. It also publishes annual reports that include provocative, upbeat analyses of the U.S. economy. Copies of these analyses are on its Web site; the print versions are easier to read and can be obtained from the Dallas Fed’s public relations office at 2200 North Pearl Street, Dallas, TX 75201 (phone: 214-922-6000). Chicago (http://www.frbchi.org): The Chicago Fed site offers calculators for figuring compound interest rates and the principal and interest on a fixed-rate mortgage as well as a useful “frequently asked questions” page. The Consumer and Economic Development Research and Information Center (CEDRIC) page has research related to consumer and small-business financial behavior, community development, and the like. New York (http://www.ny.frb.org): The New York Fed site includes a mini-profile of each of the major economic indicators and other educational materials, including a simulation, intended for high school students, of a Fed policy meeting. The quarterly report on the U.S. government’s intervention, or lack thereof, in foreign exchange markets is a useful overview of global market developments, though it is a bit dated. The site also links to a calculator that helps you determine the value of savings bonds. Richmond (http://www.rich.frb.org/eon/index.html): This site includes Equilibria Chat, a place where economics teachers can post questions and get answers that anyone can read.
Other Web Sites An independent left-leaning organization, the Financial Markets Center, has a Web site (www.fmcenter.org) that features critiques of Fed decisions and statements. An independent right-leaning organization, the Shadow Open Market Committee, composed of economists who emphasize the importance of the money supply in understanding the direction of the economy, periodically releases evaluations of Fed monetary policy. It will happily put you on its mailing list but doesn’t currently maintain a Web site. To be added to the mailing list, write Jean Patterson, GSIA, Carnegie-Mellon University, Pittsburgh, PA 15213. A group of private economic forecasters and analysts maintains a site (www. dismal.com) that keeps tabs on the economy and on Federal Reserve policies. The European Central Bank’s Web site (www.ecb.int) includes a lengthy “monthly bulletin” that provides a comprehensive review of recent European economic trends as well as statistics and speeches. Transcripts of the ECB’s on-the-record press conferences are also posted. The International Monetary Fund (www.imf.org) posts its World Economic Outlook, which includes its advice to central bankers around the world.
MICROECONOMICS
6 Economics of the Firm Vincent Chikwendu Nwanma
The underlying theory in microeconomics is that an individual economic unit—a person, a family, or a firm—is engaged in an optimization activity: to maximize its benefits and minimize costs. Take the example of a gold-mining firm that has just been granted a license to prospect for the precious mineral on a large concession. At the end of the prospecting exercise, the firm’s managers are convinced that a reasonable amount of proven resources exists underground. Now the firm must make some vital decisions. Should it commit funds to plant and machinery? Should it go ahead and blast the rocks? The answers to these questions lie in the firm’s estimates of the costs and benefits associated with the project. While a firm strives to achieve its goal of profit maximization, it faces constraints imposed by several factors. These include resource limitations and the nature of the industry in which it operates. If the firm is the only one of its kind in the industry, and thereby a monopoly, it can wield a lot of power in the market. It can, for instance, charge a higher price for the commodity than would be possible in a competitive environment. In a competitive market, the individual firm is simply one out of several producers, and therefore has fairly limited power to raise prices. Even in seemingly competitive markets, however, firms can achieve significant influence through product differentiation.
Nature of Industry as a Determinant of Corporate Behavior Virtually every firm a financial reporter writes about belongs to an industry. The nature of that industry determines some of the characteristics of that firm. Reporters should
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therefore take a close a look at the industry as they strive to explain the firm’s corporate behavior. What are the distinctive characteristics of the industry? Take the computer chip industry, especially the portable subsector of laptop computers. This industry is characterized by rapid changes in technology, changing or evolving standards (such as highercapacity storage and system memory, need for low power consumption, smaller size, lower weight), continual new product development, and price competition. Each of these characteristics has an implication for firm behavior and overall industry structure over time. For example, a rapidly changing technology implies that incumbent firms and potential entrants into the industry should be capable of engaging in research and development (R&D) to keep up with the competition. This could effectively become a barrier to entry for new firms and, by default, a safeguard for existing firms with deep pockets. Journalists can therefore explore these industry characteristics in depth as they try to report on both current and future profitability in the industry. Long-term profitability in an industry should tend toward normal profits, defined as the level of return that investors require to prevent them from moving their capital to alternative investments. However, the length of time it takes to achieve this level depends on two major factors. The first of these is the industry’s stage of development; the return should be expected to occur earlier in mature markets than in younger ones. The second is the ease with which the competition can duplicate or surpass existing technology. In other words, if the barrier to entry created by technology is high enough to deter many of the potential entrants, then current players in the industry can expect to dominate the market for a long time. Let’s look, then, at potential indicators of barriers to entry. Among these are product differentiation—the ability (or lack of it) of a producer to distinguish its product from others through the inclusion of different features; economies of scale—whereby lower unit costs are achieved at higher levels of output; and capital requirements—the amount of funds and equipment that a company needs to operate in the industry. Product differentiation creates a barrier to entry by establishing brand loyalty, which may be difficult for a new entrant to break without incurring heavy advertising expenditures. Without product differentiation, consumers treat each firm’s product as simply a commodity, and they are free to choose any one out of the several available. So in a market with highly differentiated products, the reporter should seek to understand how this environment affects the behavior of existing firms as well as its impact on new firms’ entry into the industry. In reporting on any industry, the journalist should also explore the full implications of technology for players in the industry. If the technology a particular industry uses is changing quickly, what does that mean to potential entrants and to existing firms, espe-
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cially marginal firms—those whose long-run average costs are the industry’s highest? Such firms usually have the lowest rates of profitability. They are usually the first to exit the industry in the event of major structural changes, such as increases in costs or the entry of a major player with new technology that is efficient enough to produce the product at a significantly lower cost. Obviously, profitability among firms in the same industry will vary according to their respective levels of efficiency. The most efficient will have the lowest cost and therefore the highest level of profit. But the marginal firms truly set the market price, because their costs—and therefore prices—determine the ruling market price. This is true because they must sell at prices that are high enough to cover their costs, which are the highest in the industry. Thus their prices become the industry benchmark, and new entrants with higher costs—and higher prices—may have difficulty surviving in the industry. As a result, entry by new firms into the market depends on the cost structure of the firms on the margin. A new firm can survive in the market only if its costs are lower than those of the marginal firms. Thus, as part of any analysis of a firm’s chances in its current industry or a proposed market, a reporter should examine the firm’s costs in relation to its competitors or, in the case of new entrants, to the high-cost producers in the market.
Strategy as a Response to the Nature of Industry As the previous section made clear, firms constantly seek to develop strategies that can help them meet the challenges posed by the nature of the industries in which they operate. Indeed, we can view these strategies as firms’ forward-looking responses to the constraints that the structure of their market environment imposes on them. So financial reporters should look at a firm’s announced strategy within the context of its industry structure, both its current structure and that of the foreseeable future. In industries with fairly stable characteristics, firms may fashion their strategies to address tomorrow’s issues in today’s industry context. However, where the nature of the industry is known to be changing—for various reasons, including entry and exit of firms—it is more realistic to have corporate strategies that address the expected changes. Let’s illustrate these issues with different examples and industry settings. The price of gold fell by more than 30 percent over a three-year period beginning in 1996. The price fall had a significant impact on gold industry profitability. Of the marginal firms, several closed down; the more profitable ones acquired many others. The steep fall in price affected the structure of the industry in a notable way. Many of the surviving firms began to add low-cost surface mines to their portfolios. Although surface mines have lower operating costs than underground mines, they often produce lowgrade ores that yield lower grams of gold per ton of ore. In addition, surface mining leads to the cutting of a much larger volume of earth, often to the ire of environmental-
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ists, who accuse mining firms of destroying the environment. Thus, while analyzing a company’s strategic moves, whether within the mining industry or in any industry impacted by declining prices, the journalist should look beyond the mere issue of price fall. It is equally important to examine the company’s alternative actions along with their consequences. A second example comes from the computer chip industry. As noted earlier, this industry, especially the portable subsector, is characterized by such factors as rapidly changing technology, continual new product development, and price competition. These factors influence corporate strategy and choices in the industry. Reporters should therefore explore these factors in stories explaining firms’ behavior in this market. Take, for example, NeoMagic Corporation, one of the firms in the industry and a leading manufacturer of chips for notebook computers. It achieved spectacular success through product differentiation, which it established by integrating logic, analog functions, and memory onto a single graphic chip. This differentiation has paid off handsomely for the company. In an industry filled with rapidly changing technology, it’s clear that many original equipment manufacturers (OEMs) prefer chips that combine several functions.
The Individual Firm: Competitive Advantages, Strengths, and Weaknesses A firm’s strategy must reflect and draw from its distinctive advantages and strengths. At the same time, it must provide an effective means of minimizing the firm’s vulnerability to its weaknesses. A firm can derive its competitive advantage from a number of factors, including the following: Relationships with Suppliers and Buyers. If a firm has a dominant position in its relationships with its suppliers and buyers, then it is in a position to exert a significant level of influence on the market. For example, it can influence the markets (i.e., the price) for both the resources it must purchase and the products it sells. Complete Mastery of Its Niche Market. A company can establish a dominant position in its market by concentrating on a segment of its industry. This is apparent in the example of NeoMagic, which specializes in the manufacture of graphic accelerator chips for laptop computers. Though such a strategy may prove successful, as it was for NeoMagic, the reporter should be able to take a critical look at the potential impact of this specialization on the company and to put the advantages of such a strategy in proper context. Does it constitute a threat to the company’s long-term survival, especially in the event of major changes in the industry? The reporter should be able to undertake a comparative analysis of the firm and its competitors by looking at the benefits and potential costs of a strategy. As we saw earlier, strategies can also be sources of a
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firm’s weaknesses. For example, by following this strategy of specialization, NeoMagic clearly risks being unable to respond to a decrease in demand for accelerator chips for laptops. In the event of such a development, the diversified firms in the industry, such as ATI Technology and Intel, will fare better than a highly specialized firm such as NeoMagic. Risk Factors. Generally, the risk factors a company faces are either industry-wide or firm-specific. Industry-wide risk factors include changes in the price of the product, the introduction of a substitute product, and changing technology. Firm-specific risk factors arise from choices the company makes, such as its dependence on a segment of the industry or on a group of buyers and suppliers of materials. We have already discussed some of these factors in the case of NeoMagic. For instance, its dependence on the laptop niche market, as we saw earlier, makes it vulnerable in the event of a major depression in this subsector. A company can eliminate or minimize its firm-specific risks by undertaking strategic reforms such as diversification. In the same way, a large conglomerate can eliminate some of its risks by divestiture. Usually, this step of undertaking strategic reforms follows when a firm asks itself this strategic question: What business should we be in? In telling the story, reporters should strive to identify some of these factors and the implications they have for the firm. When interviewing the company’s senior managers, knowledgeable—and prepared—financial journalists should be able to discuss the risks of doing business and what management is doing about them.
Barriers to Entry and Enterprise Profitability Microeconomic theory consists of two periods of analysis: the short run and the long run. The main distinction between the two is that while in the short run some costs are fixed, in the long run all costs are variable. Another significant difference is that in the long run, firms exit and enter the market, depending on their perceptions of trends in the industry. The impact of a firm’s entry into an industry results in lower profits to existing firms. Under perfect market conditions, prices fall as a result of the entry of new firms, leading to the establishment of a new market equilibrium. In imperfect markets, the fall in profit comes through a reduction of market share. A firm’s share of the market shrinks as a result of entry by others, and it must lower its price to sell more of its products. Therefore, in the long run, profitability will fall to normal levels unless barriers to entry exist in the industry. Indeed, a better way of looking at both short-run and long-run analyses is to see the former as a process of determining who is making money now and the latter as determining who will make money in the future. In long-run analysis, we are essentially comparing the industry’s past with its future.
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Industries with high barriers to entry share characteristics such as product differentiation, high capital requirements, and economies of scale. In reporting on an industry, a reporter should be able to look for these characteristics and determine their impact, both current and potential, on corporate behavior and profitability in the industry. A market that is characterized by rapid changes in technology—usually as a result of innovation—is likely to experience a high barrier to entry. With constantly changing technology, only companies with pockets deep enough to allow them to engage in R&D and accommodate initial losses can survive in the long term. It is therefore possible that in the long run, companies will consolidate, as the stronger ones acquire the weaklings. Though acquisition by a stronger firm may be a new firm’s exit strategy, companies that fail to keep pace with technological advancements in their industry often simply have to yield to advances from suitors, or, in the alternative, they go under. An industry may also experience increasing entry by new firms. High growth rates; high profitability of existing firms; and low barriers to exit, such as inexpensive plant, property, and equipment (PPE) costs and high liquid assets, are some of the factors that can encourage entry into an industry. Here, reporters should go beyond basic microeconomic theory and take a critical look at the firm’s (or industry’s) published accounts to get a clear picture. For a measure of short-run profitability, look for an indicator such as return on equity (ROE), also known as return on average equity. How does the current ROE compare with the historical trend or the equity premium on risk-free investments? This is also referred to as the hurdle rate for equity investments. If investors in a particular industry are currently receiving a rate of return that is lower than what they demand as compensation for risk taking, then chances are they will soon look for alternative areas in which to invest. A comparative analysis of firms’ balance sheets should be able to show which firms are making a profit in the short run. The analysis will also give an indication of possible attractions into the industry. For instance, low PPE relative to the overall capital of the firm may indicate low barriers to exit. Technology-based industries were previously thought to require the investment of large sums in PPE. This is changing, however, as companies begin to subcontract their manufacturing processes to third parties. This strategy obviates the need for a large capital outlay on fixed assets. More importantly, it removes the firm’s need to try to keep pace with changing technology, especially in industries undergoing rapid technological change. With this strategy, a firm can have access to a state-of-the-art technology without investing in it. The result is that such firms carry very low PPE on their balance sheets. Another possible barrier to entry is what is commonly called natural monopoly. This exists in cases where the market size is thought, at least initially, to be too small to accommodate more than one player, such as was the case of the supplier of electricity or
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telecommunications services. Natural monopolies are caused by economies of scale. In other words, as the level of production increases, the fixed costs are spread over larger outputs, thereby leading to lower average fixed costs. In most cases, however, as the market grows and demand for the service or product increases, it becomes clear that one supplier is insufficient to meet the demand. In many cases and in different ways, natural monopolies have given way to competition. This has been done by either splitting the monopoly (as in the case of the AT&T breakup in 1984) or introducing competition through market reforms, especially in former centrally planned economies, such as the former Soviet Union, Bulgaria, and Albania.
Costs:Where They Come From,What They Do An understanding of the nature and functions of costs is fundamental to an appreciation of most corporate decisions and actions. Costs to a firm originate from various sources. In most cases, different departments of the firm, such as engineering, research, marketing, accounting, and production, supply cost estimates. Whatever their source, it is important that costs be handled correctly. Without doubt, costs are central to a firm’s decisions. If an action—the execution of a new project, the introduction of a new product or service—had only benefits and no costs, then the decision would be straightforward. Opportunity (or Real) Cost. The basic principle in the determination of costs is that all resources, as long as they have economic value, have alternative uses. Therefore, every resource used in the production process implies a cost to the firm in the sense that it is no longer available for another use. This is the concept of opportunity or real cost of an action. It is important to determine the value of that alternative use, so that this value or cost is imputed and the actual cost of the action is calculated. For example, if a firm decides to use a piece of land for agricultural purposes, the financial cost of that piece of land may be easily calculated from the firm’s financial statements. But the real cost of the decision is all the possible alternative uses for the piece of land. A factory could have been built on it, or perhaps it could have been converted into a golf course. A reporter may note here that although the financial costs are easy to determine given the prevailing cost of funds in the capital and money markets, the real costs depend on the general health of the economy or the specific industry in question. Thus, real costs resulting from corporate decisions or actions are a good measure of the preferences of the firm’s managers. They show also the managers’ forecast of where the economy will go in the future, and the industry or sector where they want to channel their resources. In this regard, a firm must assign a value to each resource in determining the true value of its operations or products. This is not as simple as it sounds because not all the costs are easily identifiable. It may be easy to include the cost of raw materials or inter-
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est (cost of capital). But it is less easy to identify and include the depreciation of machinery and equipment as cost. In the same way, it may be difficult to include the cost of an asset (e.g., a house that a firm inherited from one of its directors). Although the house cost the firm nothing, its cost to the firm must be charged against the revenue it has been generating. This is because the house has an alternative use. The firm could rent it out and earn a rental income from it. In this case, that rent is the real cost of using the house for the firm’s business instead of renting it out. It is important for reporters to investigate whether a firm does in fact follow the principle of charging all relevant resources. If not, corporate profits may be overestimated or underestimated, the latter result occurring where irrelevant costs are included. Fixed and Variable Costs. Fixed costs are production insensitive in that their levels do not change with the level of output produced by firm. These are otherwise known as overhead costs. On the other hand, variable costs are production sensitive costs in that their amount depends on the firm’s level of production. A firm incurs variable costs only when it produces, but overhead costs are incurred whether it is producing or not. Sunk Costs. Because a firm incurs costs at different stages in the process of executing a project, some of those costs become sunk. Once sunk costs are incurred, they become irrelevant in determining whether the project should continue or be terminated. The concept of sunk costs is important in understanding some of the decisions that companies take with respect to projects. At the beginning of this chapter, we talked about a gold-mining company that has been granted a prospecting license. Once the prospecting is over, the money spent on it becomes a sunk cost, in that it does not influence the firm’s decision on whether to go ahead with the project. At this stage, the company needs to determine what action it can take to cut further losses. In other words, its decision should be influenced only by avoidable costs. Suppose that at the end of the prospecting phase the gold-mining firm decides that the quality of the resource found on its concession—as indicated, for instance, by an assay result—does not warrant the commitment of more funds to the project. In this circumstance, the funds spent on prospecting should be treated as a sunk cost—and a bygone. Only future expenditures, which are still avoidable at this stage, are relevant here, and these are the costs the company should consider. Indeed, microeconomics suggests that the decisions a firm makes are an attempt to either maximize its profits or minimize its costs, and ultimately, this theory is what guides management’s strategic thinking.
7 Business Management: Organization of the Firm Scott Aiken
Business reporters can gain a lot of information about a company and how it is structured from printed materials or Web site information. Corporate materials, including documents filed with the Securities and Exchange Commission (SEC), give the reporter basic facts and background, all orchestrated (often very skillfully) to present the company in the way it wants to be perceived. But to give the public a complete story, one with context and insight, the reporter has to talk to the company’s management. At this point, it becomes vitally important to know who is who, what the manager or executive’s own perspective is likely to be, and why it is (or is not) worthwhile talking to that person about the developing story. On the road to this point, the reporter probably will—and should—speak with the company spokesperson, someone bearing a title that includes the words corporate communications or public relations. By and large, these individuals are competent, even excellent sources of facts, figures, and company policy. But the better they are, the more willing and able they will be to connect the reporter with senior management. These are the executives who have responsibility for the bottom line, or company strategy, or marketing, or environmental or legal matters. By being prepared, asking the right questions, and sharply focusing the proposed line of questioning, the reporter can help the spokesperson select the appropriate senior manager. So it is important that you do some homework before making that first call. It is essential that you understand the responsibilities, knowledge, and perspectives of the company executive to be interviewed. Later in this essay we will consider appropriate questions for different executives. As a generalization, different executives have different expertise and different perspectives on the corporate elephant. Probing the vice president of human resources for information about what goes on at the hot strip mill in an integrated steel mill, or the marketing strategy for a new consumer product, is a waste of her time as well as yours. Asking the company’s general counsel—the number-one lawyer—about an environ-
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mental or safety issue will yield a response different in tone and content from what you will get from the chief operating officer or the director of environmental engineering. The reporter should always seek to talk to the executive with authority and responsibility for the issue at hand. Understanding different management responsibilities helps pry open corporate doors. It is equally useful when the reporter is seeking to learn about a new product, a service, a sale, an acquisition, an expansion, or some other significant piece of “good news.” When the subject is manufacturing, the best information likely will come from a manager or executive in charge of the process, such as the chief operating officer. When the subject is marketing, look for the vice president of marketing or the vice president of strategic planning.
Organizational Structure Whether the corporation’s product is a service, a metal part, a machine, or a consumer product, organization is key to success in the marketplace. Whether it is a Silicon Valley startup or giant Microsoft; an old-line automobile manufacturer; or a maker of soap, towels, toothpaste, or light bulbs, having the proper organization affects the corporation’s ability to grow and return value to its owners (shareholders) in dividends and stock price appreciation. For this reason, well-run corporations spend a lot of time and energy on getting the management structure right. The right structure promotes and facilitates communication and understanding between the executives and customers. The customer is not always an individual consumer. For a consumer product giant like the Procter & Gamble Co., a very important customer is an intermediary—the supermarket chain. For a big steel mill, the customer is the manufacturer of automobiles and major appliances; these are the “consumers” of flat-rolled steel. Customers also include employees, suppliers, shareholders, and other stakeholders. The company codifies its structure in an organization chart, or org chart for short. The organization chart shows the formal structure. (In today’s stakeholder-conscious world, the org chart may put the customer at the top to remind employees of who ultimately pays the bills.) Beyond the formal structure, the organization chart tells a great deal about company priorities and even values. Where in the organization of the manufacturer is the responsibility for worker safety? To whom does that manager report? Where in the chemical company are the planning and operational responsibilities for environmental matters? Where in the department store or mass merchandiser’s chain of command is the person with authority for customer service? What is the procedure for complaints? One major online service
BUSINESS MANAGEMENT: ORGANIZATION OF THE FIRM
used to confine customer billing issues to the financial department, where the numbers people dealt with them as numbers rather than as individuals. How seriously do the board and management take the corporation’s responsibility to the community? What is the role of social responsibility in this company? Who in the organization has charge of these issues? Does that manager report to the CEO, to the president, or to a vice president of miscellany? Learning the answers to these questions can provide they were by the NHTSA investigation, anecdotes, information from the microfiche, interviews with automotive experts, and so on. My stories ran on the Internet, on the Web site SIS (Shop Information Services), a nonprofit consumer site that I cofounded and edited but that closed for lack of funding. We sent press releases about the story to dozens of reporters, partly as promotion of the Web site and partly in the hope of stimulating other reporting efforts. To its credit, USA Today ran stories, one of which, in May 1998, put the complaint total at that time at 15,000. The TV magazine show Inside Edition also did the story and received so many phone calls in response that they nearly downed their phone system. On all counts—reader interest, size of the problem, the mystery element—this was an important story. But for the most part, it remained untouched by the media. The explanation for that, unfortunately, is that fear of upsetting advertisers and losing advertising revenue causes serious censorship of consumer stories. Every community in America has its auto dealerships. Auto dealers are both respected members of the business community and heavy advertisers. It is the rare media owner who is willing to risk advertising revenue by allowing aggressive consumer reporting about an industry that contributes so much to its revenue base. In place of consumer reporting these days, we have “money reporting,” endless advice on how to invest; use various kinds of credit to make purchases; and, sometimes, how to find the best prices. Tame generalities replace specifics and brand names, while printed or video press releases substitute for reported stories.
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Times change, however. Types of reporting go in and out of vogue. And consumer reporting is very much alive at oases such as Consumer Reports; on some television magazine shows, which have less to fear from advertisers; and in alternative media such as the magazine In These Times. Even more important, public response to well-done consumer stories is just as enthusiastic as ever. Postscript: General Motors finally announced a partial recall of its SUVs—on July 17, 1999, the day after John F. Kennedy Jr. died in a plane crash. As a result, the GM story was buried or not reported at all. NHTSA allows the automakers to pick their time and manner of announcing defects.
42 Taxes Sandra Block
In 1381 A.D., an unpopular poll tax sparked the first peasant rebellion in English history. Before peace was restored, the country’s treasurer and chancellor were relieved of their jobs as well as their heads. In modern times, levying taxes has become less hazardous but no less popular. In the United States, a rebellion over an unpopular tax on tea united the colonies and led to the American Revolution. And true to our heritage, we’ve been arguing about taxes ever since. When President Grover Cleveland enacted an income tax in 1894, the Supreme Court ruled the law was unconstitutional. The decision forced supporters of the tax to seek a constitutional amendment giving Congress the right to impose income taxes without first receiving approval from the states. The Sixteenth Amendment to the Constitution was ratified in 1913, clearing the way for Congress to impose a personal income tax. Initially, the tax ranged from 1 percent to 7 percent of income of more than $3,000. After World War II, the minimum rate was raised to 23 percent and the maximum was lifted to 94 percent. Today, federal tax rates range from 15 percent to 39.6 percent. Many states also impose an income tax, which adds to an individual’s tax bill. The U.S. income tax was designed to be progressive, which means the more you make, the more you pay. But in reality, it’s not that simple. The tax code is loaded with deductions on everything from charitable contributions to second homes. Though the deductions are there for any taxpayer who qualifies, they’re more frequently used by wealthy individuals who have the means and incentive to hire professional tax preparers. In the mid-1980s, Congress tried to eliminate some of the most egregious deductions in the Tax Reform Act of 1986. But despite that effort, many Americans believe the tax code unfairly penalizes middle-class taxpayers. Texas business magnate H. Ross Perot and, more recently, publisher Steve Forbes made the complexity and inequity of the tax code a key element of their presidential campaigns. At this writing, both men have attracted more attention than votes, and the tax code remains as convoluted as ever.
Anger and Distrust It’s human nature to resent turning over a portion of your hard-earned income to the government. But that’s only one of the reasons the Internal Revenue Service (IRS) stirs
GETTING THE STORY
such anger among average Americans. Other factors, which can be the basis for numerous tax stories, include the following: Taxpayer abuse. The IRS possesses power that is unequalled in U.S. law enforcement, and it’s not afraid to use it. If the IRS presents you with a tax bill and you decline to pay, the agency can garnish your wages, raid your business, and place a lien on your property. When singer Willie Nelson failed to pay a $16 million delinquent tax bill, the IRS seized his ranch, his cars, his guitars, and his gold belt buckles and sold them at auction. And the IRS doesn’t limit its muscle to celebrities. In 1994, ten IRS agents showed up at a woman’s home at 7:30 A.M., confined her to a room, and searched her house. They left with eighty-six family photographs, according to congressional testimony from the woman’s lawyer. The purpose of the search: the IRS believed the woman’s father had understated the value of some family furniture. The case was eventually dropped, but the pictures weren’t returned for more than three years, the woman’s lawyer said. Stung by a bad image and pressure from Congress, the IRS has taken major steps to become more taxpayer friendly. It has created a taxpayer advocate’s office, with a tollfree number to serve aggrieved customers. It is installing expensive computer technology designed to speed up processing of filings and reduce errors. It has hired more people to answer its telephones and set up a Web site (www.irs.gov) that provides answers to many common questions. Bewildering regulations. More than half of all U.S. taxpayers pay a professional to do their taxes. Among taxpayers who must file Form 1040 instead of the shorter 1040EZ or 1040A, the figure jumps to more than 90 percent. Sales of tax-preparation software, such as Quicken’s TurboTax and H&R Block’s TaxCut, are booming. Most people don’t like spending $50 to $200 to get their taxes done, but many feel they have no choice. Tax rules have never been so complex, even for individuals who aren’t particularly wealthy. The growing complexity of tax filings isn’t really the IRS’s fault. The blame lies with politicians, including some of the same individuals who routinely lambaste the IRS for its lengthy filing requirements. The Sixteenth Amendment gave Congress the power to “lay and collect taxes,” and neither Congress nor the White House has been shy about exercising that authority. The reason: taxes represent a powerful way to encourage some activities and discourage others. By making interest on home mortgages deductible, the tax law promotes home ownership. Large excise taxes on cigarettes are intended to encourage smokers to chew gum instead of smoke. In 1997, Congress adopted the Taxpayer Relief Act, a package overflowing with provisions targeted at families with children, college-bound students, and small investors. Unfortunately, to take advantage of the new benefits, middle-class families have
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had to wrestle with arcane provisions of the tax code originally intended for highincome taxpayers. The confusion was evident in early 1999, when taxpayers began filing their returns for 1998, the first full year for many of the changes. Though many families qualified for a new tax credit, thousands of taxpayers failed to mark a credit amount on their tax form. Demonstrating its new commitment to customer service, the IRS went ahead and gave the credit to more than thirty thousand taxpayers, giving them a largerthan-expected refund.
Writing about Taxes Though major overhauls of the tax code are infrequent, tax law is an ever-changing organism subject to new regulations, court decisions, and considerable interpretation. Tax stories come with a built-in advantage, since most readers want to know how tax law changes will affect them. As you tackle this important beat, maintain a “what’s in it for me” approach, and you’ll probably keep your readers’ attention to the end of the story. Here are some tips and traps to keep in mind when writing about taxes: Beware of biases and develop reliable sources. If you’re writing about federal taxes, basic broad-brush information comes from the U.S. government. Start with the public affairs division of the IRS in Washington, D.C., which can come up with statistics and technically correct information on the current law. But be aware that the information the IRS provides reflects the government’s view and may omit, ignore, or dismiss conflicting views handed down by the courts or held by tax experts in the private sector. However, while the official government view should not be accepted as gospel, neither should moaning from the private sector about the dire impact of tax changes go without circumspection. Look for reliable, articulate sources in the accounting profession who can discuss the conventional wisdom and help you analyze the implications of changes in tax laws. If you don’t know any accountants in your area, call the public relations office of the American Institute of Certified Public Accountants at 212-596-6200 for suggestions. You may have to make several calls before you find a CPA who can explain taxes in understandable terms. But it’s worth the effort. A good CPA can help you provide valuable advice to readers who can’t afford professional tax assistance. Subscribe to annual tax guides from Ernst & Young, J. K. Lasser, and H&R Block. Updated every year, each has its own strengths and weaknesses, so it’s a good idea to have all three. Another good source for tax information is the Internet site for Commerce Clearing House (CCH), www.cch.com. CCH puts out expensive compilations of tax laws and regulations for accountants and other people who care deeply about taxes. But it also offers summaries of tax rules and changes, and its experts are patient and helpful.
GETTING THE STORY
Get to know your readers’ tax concerns. If taxpayers in your area earn an average salary of $29,000 a year, they probably won’t be interested in proposals to impose new excise taxes on yachts and luxury cars. However, they probably would pay attention to a flat-tax plan that would phase out income taxes for families with income of less than $30,000 a year. Other factors to consider: whether your area has a large population of retirees, college students, or single parents. All of these groups have specific tax concerns. For news outlets with a national audience, examples are a crucial element in developing the impact of tax legislation, and CPA and tax-publishing firms are usually glad to provide them. The trick is to choose examples that apply to broad categories of taxpayers. When writing about a tax cut, for example, you might want to use anecdotes that show how the cut would affect a lower-income family with children, a single person with a moderate income, an affluent couple with children, and a retired couple. Take on the IRS. If you take on the tax beat, you’ll hear plenty of stories from anguished readers who claim to have been abused or confused by the IRS. The trouble with these stories is that they’re usually anecdotal, and all you hear is the victim’s version. Citing privacy laws, the IRS rarely comments on individual cases. That may be changing. In early 1999, the Washington Post solicited horror stories from its readers for a feature targeted to run four days before the April 15 tax deadline. Rather than issuing the standard “no comment” or complaining about the certainty of more bad press, the IRS made a deal: if the individuals in the stories agreed to sign a waiver, the IRS would discuss their cases with the Post. The IRS not only kept its word, but it also apologized to two of the people who detailed their tax nightmares in the newspaper. It assured one of the taxpayers that there was no assessment on her property lurking in its files, despite earlier notices to the contrary. It told another aggrieved taxpayer that there had never been a lien against his property, despite warnings to that effect. So if a reader calls with what appears to be a true tale of abuse, don’t assume the IRS won’t comment. If you’re lucky, you may get a good story and solve your reader’s problem, too. In any event, don’t hesitate to call the IRS with questions, no matter how basic. IRS officials have promised to be more responsive to the people they serve. Hold them to their word.
Tax Talk adjusted gross income: An individual’s gross income reduced by certain adjustments allowed by
law, such as alimony payments and contributions to retirement accounts. capital gain and loss: The gain or loss arising from the sale or exchange of capital assets, such as
securities or real estate. You determine the gain or loss by comparing the amount you receive from the sale to the amount you originally paid. If you receive more than the original cost, plus certain adjustments, you have a gain; if you receive less, you have a loss.
TAXES
deductions: Expenses allowed by law that reduce your taxable income. Common examples of itemized deductions are mortgage interest, charitable contributions, moving expenses, medical expenses, and losses from a business or investment. The value of a deduction varies depending on one’s tax bracket. A $1,000 deduction, for example, will save someone in the 33 percent bracket $330 in taxes; but it will save someone in the 15 percent bracket only $150 in taxes. Taxpayers who don’t itemize their deductions are permitted to take a standard deduction. This fixed deduction varies depending on several factors, such as marital status and age, and is adjusted for inflation. In tax year 1999, for example, the standard deduction for a single taxpayer who didn’t itemize was $4,300. depreciation: A deductible business expense that reflects a reasonable allowance for wear and tear of property. Only property that has a useful life of more than one year and is used for business or income-producing purposes may be depreciated. Depreciation may be calculated under various methods, depending on the laws in effect at the time the property is put into service. earned income: Compensation, such as wages, salary, bonus, and tips, that one receives for per-
forming personal services. personal exemption: An automatic deduction from your taxable income. You qualify for a per-
sonal exemption unless you’re listed as a dependent on someone else’s tax return. For tax year 1999, the amount of the personal exemption was $2,750. The deduction is phased out for some wealthy taxpayers. taxable income: The amount of income on which your federal income tax is figured. This is your adjusted gross income after you’ve subtracted the standard deduction, your personal exemption, and all other deductions. tax credits: Items that directly reduce the amount of your tax liability. For example, if you have
two children and qualify for the $500 child tax credit, the amount of tax you owe will be reduced by $1,000. Credits are usually more attractive than deductions because they come right off the top of your tax bill. tax shelter: An investment designed to generate maximum write-offs in the early years of the in-
vestment so that wealthy investors can offset their taxable income from other sources.
43 Not-for-Profit Institutions Steve Askin
What booming sector of the U.S. economy—with $700 billion per year in revenue and annual growth of 11 percent—attracts little attention on Wall Street and produces neither stock appreciation for investors nor revenue for tax collectors? The “industry” in question is the incredibly diverse, often underreported nonprofit sector. Huge portions of the U.S. economy, ranging from hospital care to higher education to the arts, are dominated by nonprofit organizations. In many communities, nonprofits are the largest local employers. Not-for-profit charities step in to sustain social services when budget cuts reduce government funding. Nonprofit foundations enliven political debate by funding research and activism across the political spectrum, from the Soros Foundation’s controversial support for drug decriminalization to the Scaife Foundation’s equally controversial role in the creation and growth of conservative think tanks. Nonprofit groups have benefited enormously from the economic growth of the late 1990s. The nation’s largest social service charity, the Salvation Army, received almost $1.2 billion in donations in 1998, up 16 percent in a single year. The assets of the Lilly Foundation, the nation’s largest foundation at the end of the 1990s, soared by 21 percent to $15.4 billion in the same year, thanks to the strong performance of its pharmaceutical industry stock holdings.1 The majority of nonprofit organizations fall into one of two broad categories.2 Private foundations, the nation’s 40,000 grant-making organizations, control $330 billion in endowment funds and give out almost $20 billion a year.3 Public charities—with combined annual revenue of more than $700 billion a year and assets totaling more than $1.3 trillion4—carry out charitable, religious, educational, health care, cultural, social, 1 American Association of Fund Raising Counsel, “Total Giving Increased 10.7% in 1998, Announces Giving
USA,” press release, May 25, 1999; Debra E. Blum, Paul Demko, Marilyn Dickey, Holly Hall, and Domenica Marchetti, “A Banner Year for Big Charities,” Chronicle of Philanthropy, November 5, 1998, p. 1. 2 A number of other classes of not-for-profit organizations—including fraternal organizations, trade associations, and labor unions—are also recognized under federal tax law but will not be the focus of this essay. 3 The Foundation Center, “Highlights of the Foundation Center’s Foundation Giving, 1999 Edition,” on the World Wide Web at http://fdncenter.org/grantmaker/trends/fg99_high.html. 4 National Center for Charitable Statistics, “Reporting Public Charities in the United States, by Type, Circa 1997,” on the World Wide Web at http://nccs.urban.org/factsht.htm. Note that the revenue and asset totals
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and scientific activities. Journalists who focus on nonprofit enterprise from a business perspective will find it useful to further subdivide charities into three categories. One group—including most medical, social service, and cause-oriented charities— have extensive public fund-raising programs. Many states subject these fund-raising charities to detailed financial disclosure requirements. The Better Business Bureau and other consumer watchdogs of fund-raising have promulgated voluntary public accountability standards that mandate additional disclosures, including public release of audited financial statements. Organizations with active fund-raising programs sometimes release even more information than is required even by these standards, using annual reports or other publications to offer additional financial detail, describe major programs, or highlight leading donors. A second group—including most nonprofit health care institutions and some other social service organizations—obtain their revenue almost entirely from service fees or government grants. These organizations face less state-level scrutiny and are less likely than the fund-raisers to make financial disclosures beyond those that federal law requires. Nonetheless, federally mandated disclosures provide a wealth of financial information. The third group—churches, synagogues, mosques, and other religious institutions (but not church-related colleges or health care institutions)—are also generally exempt from government-mandated disclosure requirements. Very small groups in any of these three categories—specifically those with annual revenues under $25,000—are generally exempt from disclosure requirements.
Disclosure Documents The law treats tax-exempt status as a privilege, not a right. A nonprofit organization cannot simply deem itself exempt and not pay taxes; it must formally seek and obtain an exemption. Unless the tax-exempt group is organized as a church, public disclosure of financial information is part of the price paid for this privilege. Nonprofit disclosures include many kinds of information that other businesses keep confidential. In the for-profit world, even a multibillion-dollar company can choose to reveal almost nothing about its finances if it neither sells shares to the public nor invests in highly regulated industries for which special disclosure rules exist (such as broadcasting, health care, and insurance). In the nonprofit sector, the federal informational tax returns for groups with more than $25,000 in annual revenue are a matter of public record. The public filings are designed to help the public understand how a nonprofit cover 218,000 “public charities” that report their financial data to the Internal Revenue Service. They exclude private foundations, religious congregations, and groups that fall below federal filing thresholds.
GETTING THE STORY
organization actually spends its money. They also contain information useful for determining whether nonprofits meet legal requirements, including the obligation to provide a community benefit and to not provide excessive financial benefits to officers, executives, board members, or other private parties. These disclosure documents can be a vital tool for in-depth reporting on local economic trends, as the Minneapolis Star Tribune has demonstrated with its annual “Nonprofit 100” survey.5 The paper’s most recent survey revealed that Minnesota’s nonprofits employ one-twelfth of the state’s work force and that the state’s largest nonprofits, led by the $2.6 billion-a-year Mayo Clinic, boast revenue growth of twice the rate of their for-profit counterparts. Form 990 is the key to understanding a charitable organization’s financial condition and spending patterns. It can answer these vital questions: • How much money does the group receive? This is listed by income category (government grants, private donations, investments, sales of goods or services, and so forth). • How much does the group spend on fund-raising, administrative overhead, and program services? • How large a profit (referred to as excess or deficit for the year) does it earn? • How much wealth (referred to as net assets or fund balances at end of year) has it accumulated? • How much money, if any, does it spend on lobbying and political action? • Does the organization have business income or taxable subsidiaries? How do these relate to its charitable purpose? For some stories, Schedule A can prove even more interesting. It provides the following: • Dollar figures for payments to the group’s five highest paid employees and five highest paid professional service contractors. • Additional information on political activities. • Information on transactions with officers, employees, and businesses with which they are associated. • Details of affiliations with other tax-exempt organizations. Investigative reporters who know where to look can also use the public record as the starting point for stories that do the following: 5
Patrick Kennedy and John J. Oslund, “The Star Tribune Nonprofit 100,” Minneapolis Star Tribune, November 9, 1998, p. 1D.
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• Expose excessive salary payments and unusual benefit packages for top officers. • Uncover improper deals between nonprofit organizations and business executives on their boards. • Unravel the complex corporate structures linking some charitable groups to dozens of nonprofit and for-profit subsidiaries. • Find out if the organization is accruing enormous profits (euphemistically referred to in the nonprofit world as excess of revenue over expenses) while pleading poverty to donors. • Find out how much of the money raised actually goes to charitable activities and how much goes to consultants, telemarketers, and other fund-raisers. • Dig deep into the strategic planning of major nonprofit enterprises, such as hospitals and universities, especially when they use tax-exempt bonds to fund expansion. To look deeply into the organization you can also take these steps: • Request Form 990 and Schedule A for all of the group’s nonprofit affiliates. You will find that nonprofit hospitals and universities in particular often have complex corporate structures that may involve dozens of related institutions. Looking at any one of these in isolation presents an incomplete picture. A close look at compensation and contractor data (which may reveal that a top officer is receiving payments from multiple affiliates or that a board member of one entity has contracts with another) is especially important if you suspect that insiders are using the nonprofit to improperly enrich themselves. • Request Form 1023 or 1024, the original application for tax exemption. These forms will help you determine whether the group’s current activities serve the charitable purpose that won it tax exemption. Make sure officials supply all attachments to the original application, including articles of incorporation or other founding documents and any correspondence with the Internal Revenue Service (IRS) regarding questions the government raised about the application. • To find out how much money, if any, the group earns from business activities not related to its charitable purpose, ask officials to voluntarily provide Form 990T. (Disclosure of this document, unlike the other filings, is optional.) Read these documents carefully, but don’t trust everything you read. Journalists who work the nonprofit beat say that tax forms are notoriously unreliable and incomplete. When the Chronicle of Higher Education investigated college lobbying, for example, the weekly trade journal found that “several major universities with a significant presence in Washington reported little or no lobbying on their tax forms.” The Chronicle’s Douglas Lederman concluded that “like much of the material on the [Form 990] tax form, the
GETTING THE STORY
reporting about lobbying is almost skimpy, and sometimes misleading.”6 Chronicle reporters compiling an annual survey of college presidents’ salaries have found that some schools withhold salary information, despite IRS disclosure requirements, and that among those that do disclose, “There is great variety in how the forms are filled out.”7 Private foundations file a separate IRS form, 990-PF, that lists foundation officials; provides financial data; and, most important, gives a complete list of grants made. These forms are a gold mine for in-depth reporting on the impact of grant-giving organizations, as the Washington Post demonstrated in a 1999 series on anti-Clinton funder Richard Mellon Scaife. The Post used 990-PFs and other documents to demonstrate Scaife’s role in helping “fund the creation of the modern conservative movement in America.” A database compiled from these documents identified 8,800 grants from Scaife family charities over four decades, including $340 million given to conservative causes and institutions, providing the crucial foundation for the Post’s conclusions about Scaife’s seminal role.8
Obtaining Forms 990 and 990-PF Charities and foundations are required by law to let members of the public examine Forms 990 and 990-PF. For years, journalists and researchers complained about the difficulties they sometimes encountered getting Form 990. Nonprofits were required to let you examine their Form 990s, but they didn’t have to give you copies. IRS disclosure offices took months to respond to FOIA requests and all too often reported that forms were missing. New rules and new technologies have dramatically reduced the difficulty of obtaining these filings. Under rules that became effective June 1999, every charity must immediately provide copies of its Form 990 and related documents to all in-person requestors or post them on the World Wide Web. They must respond to written requests within thirty days. Officials who ignore the new rules face substantial fines. Because any member of the public can request these documents, you need not mention your media affiliation when making a request.9
6
Douglas Lederman, “In Reporting Lobbying Expenses, Some Institutions Do Not Reveal All. On a federal tax form, only 75 of 475 colleges said they had spent money on the activity,” Chronicle of Higher Education, October 23, 1998. 7 Kit Lively, “What They Earned in 1995–96: the Data on Private-College Leaders,” Chronicle of Higher Education, October 24, 1997. 8 Robert G. Kaiser and Ira Chinoy, “Series: The Right’s Funding Father,” Washington Post, May 2 and May 3, 1999. 9 Department of the Treasury, Internal Revenue Service, “Public Disclosure of Material Relating to TaxExempt Organizations,” 26 CFR (Code of Federal Regulations), Part 301 and 602.
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Public disclosure received a further boost when two nonprofit groups dedicated to helping donors give wisely—Philanthropic Research Inc. and the Urban Institute’s National Center for Charitable Statistics—teamed up with the IRS to make Form 990 information available on the Internet. Two separate Web sites showcase the fruits of this collaboration: • www.guidestar.com offers summary financial information for more than 700,000 nonprofit organizations and online copies of the entire form for some of them. • A related site, http://nccs.urban.org/product.htm, offers powerful online tools for comparative analysis. The site’s online database includes thirty-five key financial variables for each Form 990 filer for the years 1990–1998. You can sort the data by state, year, or type of organization. This powerful tool makes it possible to chart overall financial trends for your state’s nonprofit organizations or compare any one institution’s performance with that of its peers. If you don’t find all the documents you need on the Web, you can still obtain them directly from the nonprofit organization. In addition, organizations can provide documents you probably won’t find on the Web, including attachments to their Form 990s and some related correspondence with the IRS. For information on foundations, the Foundation Center is the best place to go. The Foundation Center annually obtains every Form 990-PF from the IRS and makes them available at its libraries in New York, Washington, Atlanta, Cleveland, and San Francisco. These libraries—and 200 cooperating collections around the country—also offer a wealth of reference information on grant giving. Though 990-PFs are not yet generally available on the Web, much of the information they contain is summarized in Foundation Center publications and online databases. You can find the Foundation Center on the World Wide Web at http://www.fdncenter.org, or contact their New York headquarters at 212-620–4230.
How Charities Raise Money Valuable though they are, federal filings don’t tell the full story. Nonprofit finance experts at the Urban Institute’s National Center for Charitable Statistics warn that many organizations make errors in their filings and that some may deliberately “shift expenses from one category to another” to make reports look better.10
10
Urban Institute, National Center for Charitable Statistics, “Guide to Using NCCS Data,” on the World Wide Web at http://nccs.urban.org/guide.htm.
GETTING THE STORY
In examining dozens of organizations for a 1994 book on conservative religious organizations,11 I found significant contradictions between federal and state filings. Federal filings by one group reported that fund-raising absorbed 26 percent of revenue, whereas more detailed filings with the State of New York suggested that professional fund-raisers may have kept half the money raised. 12 State records—usually housed in a special charities unit under the secretary of state or attorney general—are especially useful for probes of fund-raising practices and relationships between commercial fund-raisers and their clients. In many cases, the state requires detailed disclosures from every organization raising more than a specified amount of money within its borders, even if its headquarters is located elsewhere. A number of states also require some or all nonprofits to provide additional general financial information not found on Form 990. When the Orange County Register dipped into records at the California attorney general’s Registry of Charitable Trusts, it came up with a well-timed pre-Christmas exposé of dubious fund-raising appeals. Telemarketers had collected $6.8 million for local charities over two years but passed on less than $1 million to the sponsoring groups, the paper found.13 A similar statewide probe by the Sacramento Bee revealed that fundraisers for ninety-three law enforcement–related charities actually gave those groups less than 20 percent of the $24.7 million they raised in 1995.14 Some commercial solicitors kept as much as 99 percent of the money they raised. The most shocking finding in both reports: in California, as in many other states, it’s not illegal for commercial fundraisers to keep almost all the money they raise, as long as they and the “charities” they represent make the required public disclosures. For a comprehensive chart of state-by-state regulatory contacts and filing requirements, obtain the Annual Survey of State Laws Regulating Charitable Solicitations, prepared by the American Association of Fund-Raising Counsel (AAFRC) Trust for Philanthropy, 25 W. 43d Street, New York, NY 10036, 212- 354-5799, www.aafrc.org. You can also use the Maryland Secretary of State’s Web site, www.sos.state.md.us/sos/charity/html/ otstates.html, as a starting point for state-level information gathering. It lists state charity regulators across the country and provides links to some of them. When you are requesting state charity information, it’s often wise to ask for the entire file, not just specified documents. California and New York, among other states, 11 Steve Askin, A New Rite: Conservative Catholic Organizations and Their Allies (Washington, D.C.: Catholics for a Free Choice, 1994). 12 Ibid., p. 67. 13 Marla Jo Fisher and Kim Christensen, “Turning Up Heat on Phone Fraud,” Orange Country Register, December 22, 1997, p. A1. 14 Nancy Weaver Teichert, “What Price Charity Drives?” Sacramento Bee, September 28, 1997, p. A1.
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maintain thick public-inspection files. In some states, these files may include officials’ notes and correspondence regarding apparent irregularities and omissions in the material filed. Because state charity regulators focus on the fund-raising side of nonprofit enterprise, they are most helpful if you’re trying to understand donor-supported groups but less so if you’re looking at a hospital, university, or other institution supported primarily by service fees or government funds.
Use Tax-Exempt Bond Documents to Dig Deeper Every charity is partly a business operation, but some are more businesslike than others. A nonprofit hospital, university, or other institutional service provider has the same need for investment capital as any other business, but unlike its for-profit counterparts, it can’t raise money from investors. Federal tax law provides nonprofit institutions a critically important alternative: subject to approval by an appropriate state or local government agency, they may use tax-exempt bonds to raise money. When it issues bonds, the nonprofit organization must comply with Securities and Exchange Commission (SEC) disclosure rules. It must produce an Official Statement similar to the prospectus that accompanies a corporate bond offering. The Official Statement will provide you with audited financial statements. It may also provide information on the issuer’s market strategy, major competitors, future business plans, potential financial risks, and corporate leadership. After bonds are issued, the nonprofit must audit its financial statements annually and periodically issue public notices of material events (developments that could affect the value of the bonds or the organization’s ability to pay its debt). Instead of filing with the SEC, the nonprofits provide these disclosure documents to several SEC-designated, privately run, nationally recognized municipal securities information repositories (NRMSIRs). Any NRMSIR should be able to tell you by phone or via its Web site if your subject is a bond issuer and provide the filings for a modest fee, but the list of active NRMSIRs changes periodically. At this writing, you can obtain (for a fee) listings of issuers of tax-exempt bonds and access to their filings from DPC Data Inc., 201-346-0701, or on the World Wide Web at www.dpcdata.com. The SEC can provide you a current list of other NRMSIRs. Some state authorities attach additional disclosure conditions to the issuance of taxexempt bonds. In California, for example, hospitals that issue such bonds must report to the state on their programs of care for the poor and must make lists of their affiliated physicians available to anyone who requests them.
GETTING THE STORY
Expert Advice Several consumer watchdog groups specialize in monitoring and evaluating nonprofits. Like the state regulators, these groups focus principally on groups that raise funds from the general public. But they may also have some information on the fund-raising arms of universities, hospitals, and other fee-for-service-driven nonprofits. Nonbinding but widely accepted standards promulgated by two of the consumer groups—the National Charities Information Bureau (NCIB) and the Philanthropic Advisory Service of the Council of Better Business Bureaus (PAS)—also stress the organization’s obligation to make key documentation publicly available. Is 40 percent of revenue too much to spend on fund-raising? Does a $10-million-ayear organization with $40 million in the bank really need to keep raising funds? NCIB’s Standards in Philanthropy are a widely recognized benchmark for answering questions such as these about the appropriateness of an organization’s spending, governance, and donor-accountability mechanisms. The NCIB also publishes detailed rankings and detailed reports on hundreds of charities. For more information visit its Web site, www.give.org, or call 212-929-6300. As does NCIB, PAS evaluates and reports on the compliance of hundreds of national charities with a set of standards covering governance, fund-raising, and charitable spending. Both the reports and the standards can be found on the Web at www.bbb.org, or contact the PAS by phone at 703-276-0100.
From the Horse’s Mouth NCIB and PAS specify that fund-raising charities should provide members of the public copies of their audited financial statements and other basic information on request. Most legitimate public charities will readily do so. Most organizations with active fund-raising programs also produce TV programs, tear-jerking fund-raising mailings, glossy annual reports, and other materials aimed at potential donors. One of the most dramatic recent charity exposés, the Chicago Tribune’s series on international child sponsorship charities, used the average person’s reaction to tear-jerking TV fund-raising ads as its starting point. In 1995, Tribune reporters signed up as child sponsors with four of the largest child sponsorship agencies. Two years later, the paper dispatched reporters to Asia, Africa, and Latin America to find out how the programs actually affected the sponsored children’s lives. “A few children received nothing at all, or next-to-nothing,” the paper found. “Others received a hodgepodge of handouts. One child died.”15 According to Tribune follow-ups, the series prompted false advertising in15
Chicago Tribune, “The Miracle Merchants,” March 15 and 22, 1998. Available on the World Wide Web at http://www.chicagotribune.com/ws/children/.
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vestigations that led to out-of-court settlements reforming the advertising practices of two charities; persuaded one group to hire a former Watergate prosecutor as its internal “inspector general”; and helped persuade a leading association of private international aid agencies to develop and monitor compliance with a new set of child sponsorship standards.16 16
Chicago Tribune, December 13 and 31, 1998; January 27, 1999.
44 Founding the Fellowship Stephen B. Shepard
The Walter Bagehot Fellowship, renamed in 1987 the Knight-Bagehot Fellowship in Economics and Business Journalism, has endured for twenty-five years, training more than two hundred journalists in economics and business—and vastly enriching our profession’s coverage of those often difficult subjects. I had the great privilege of starting the program in 1975 and serving as its director in that rewarding first year. Before its origins recede from memory, let me tell you how it all came about. The person who thought up the program was Elie Abel, then dean of the Graduate School of Journalism at Columbia University. At the time, I was an editor at Business Week and an adjunct professor at the J-School. Together with my good friend Soma Golden of the New York Times, I was teaching a spring-semester seminar on economics and business writing. In the early 1970s, the class was small, perhaps seven or eight students. Business reporting in those days just didn’t have the glamour of politics, the trench-coat intrigue of foreign news, or the social relevance of urban affairs. But then in the mid-1970s, business and economics became front-page news. There was the oil crisis, the near-bankruptcy of New York City, and the mysterious simultaneous appearances of both inflation and recession—a phenomenon so new that we had to coin a word for it: stagflation. Suddenly business news was hot. Our seminar grew—to fifteen students one year, twenty-two the next. When we realized what was happening, Elie Abel got a bright idea: establish a program, similar to the Nieman program at Harvard, for working journalists who wanted to spend an academic year at Columbia. They would study economics and business, drawing on the resources of the entire university—from the business school and the economics department to the law school and the school of international affairs. The program would be rigorous: five courses per semester, at least two of them for credit. Yes, that meant final exams, a novel idea for a Nieman-type program. In addition, the program would be rooted in the journalism school, with special seminars and dinners tailored to the needs of journalists. We were acutely aware that we were training journalists, not academics. Because Soma was in a new job at the Times, we all agreed that I should run the program. Business Week offered me a year’s leave if we could get the program up and run
FOUNDING THE FELLOWSHIP
ning by September 1975. That was a tall order, largely because we weren’t sure where the money would come from. There was another pesky question: what name should we give the program? Surprisingly, the funding was easier than the naming. Elie decided we wouldn’t proceed unless we had our finances guaranteed for five years. Rather than doing it in dribs and drabs, he asked only a handful of corporations and foundations for relatively large donations. Among those that responded: Alcoa Foundation, AT&T Foundation, Exxon Education Foundation, IBM Corporation, and Prudential Insurance. The name? Again, it was Elie’s idea: name it after that eminent Victorian, Walter Bagehot, who was editor of the Economist a century ago. But Elie and I were worried about the choice. Why an Englishman? And why someone whose name was sure to be mispronounced? Well, we couldn’t think of an eminent American, a Walter Lippman of economics. As for the pronunciation, we simply decided the heck with it. Those who didn’t know his name would just have to learn. (It’s pronounced baj–et.) And so the program was born. We advertised, mailed flyers, did some recruiting— and about forty applications came in for ten places. I was the admissions committee, with Elie looking over my shoulder. Somehow, on very short notice, we attracted a good group of fellows. I remember Doreen Chu Jagoda, then with the Today Show, struggling with a statistics course until she mastered it. And Phil Moeller, then business editor of the Baltimore Sun, outshining MBA candidates in the business school. I remember, too, the cooperation we had from Bob Yavitz, dean of the B-school; Professors Gagan, Thomas, and Seneca from the economics department; and numerous guests who came to our dinners—from Paul Volcker, later chairman of the Federal Reserve Board, to Frank Cary, CEO of IBM. Not least, I remember how much I learned, too—from the seminars and from the fellows themselves. By May 1976, it was time for all of us to leave: the fellows to their original jobs, and I to a new job as a senior editor at Newsweek, where I stayed for five years before returning to Business Week. It was Soma’s turn to run the program for a year. I’m grateful to her and the other directors who followed: Chris Welles, recently retired from Business Week; Mary Bralove, formerly of the Wall Street Journal; Pamela Hollie Kluge, also from the New York Times, who teaches journalism at Ohio State University; Pauline Tai from Money magazine; and for the last eight years Terri Thompson, a 1981 fellow, who had worked at Business Week and U.S. News & World Report. All of them, in different ways, greatly enriched the program, thus contributing to the vast improvement in our profession’s coverage of business and economics and in the public’s understanding.
Glossary abandonment: The voluntary surrender of a capital asset that is no longer useful or valuable. Damaged or obsolete assets may be abandoned. The sale of abandoned assets may result in a capital gain or loss. Abandonment value is the amount that can be realized as a result of liquidation. ability to pay: A doctrine that states that those who can pay taxes should. It assumes that the ben-
efits of government spending will be received by people other than those who pay the taxes. accelerated depreciation: A method to permit greater amounts of deductions from the loss of
an asset’s value than from the straight-line depreciation method, which assumes equal depreciation during each year of the asset’s life. Acceleration is expressed as a percentage. acceleration clause: A provision in an indenture (bond contract) that authorizes a trustee to collect all the outstanding principal and interest on the issue, even if there is one default on payment of principal or interest by the debtor. accounts payable: A list of the amounts a company owes its suppliers of goods and services. Open
accounts are payable in 30, 60, or 90 days. Accounts payable debts appear under the current section of the balance sheet. Payroll, notes, and taxes aren’t included. accrued interest: Interest paid to bondholders at stated times, usually twice a year. If a bond is
sold, the usual practice is for the new owner to pay the old owner the amount of earnings—the accrued interest—when purchasing the bond, because payment for the full amount of earnings will be made to the new owner at the end of the period. accumulated earnings tax: A penalty charged companies that earn net profits far in excess of
their reasonable needs. It is a tax designed to encourage companies to pay their excess income to shareholders in the form of dividends. acid test ratio: A ratio used to measure the extent of cash available to meet current debt obliga-
tions. It is found by dividing cash and receivables by current liabilities. An acid test ratio of one-toone is considered acceptable in most industries. acquisition: The acquiring of control of one company by another. In a friendly takeover, the potential buying company may offer a price above the market price established by trading on an exchange and may offer inducements to attract shareholders of the company to sell their shares to the acquirer. An acquisition may result in a merger or consolidation. acquisition cost: The price and all fees required to obtain a property. Fees will include attorney’s
fees, loan fees, and appraisal costs.
GLOSSARY
actual cash value: Sometimes used as a substitute for market value. Also, a contract’s value at
maturation or redemption. adjustable-rate mortgage (ARM): A real estate loan that allows the interest rate to change at specific intervals over the life of the loan. administrative law: Decisions from government agencies, with no specific legislative approval or judicial precedent, that become binding on businesses or individuals unless challenged and overturned by the courts. affiliated company: Each of two companies that are allied because one owns less than a majority
of the voting stock of the other or because both companies are owned by a third company. In banking, such a company is owned or controlled by a bank or its shareholders, and its officers are also directors of the bank. aftermarket: Describes the trading in a security following its initial public offering. after-tax basis: Used for comparing returns on corporate bonds and municipal tax-free bonds. For example, a corporate bond paying 12 percent would have an after-tax return of 8.64 percent for someone in a 28-percent tax bracket. A nontaxable investment paying 8.64 percent would yield a higher return. agglomeration: The accumulation of several diverse unrelated activities under one corporate en-
tity, such as a holding company. Conglomerates are agglomerations. aggregate demand: The total quantity of all goods and services purchased in an entire economy,
expressed in terms of dollars expended. aging schedule: A report showing how long accounts receivable have been outstanding. It gives the percentage of receivables not past due and the percentage of those past due in categories of one month, two months, etc. agreement of sale: A written agreement between seller and purchaser; also called a contract of
sale. American depository receipt (ADR): A receipt issued by U.S. banks to domestic buyers as a
substitute for direct ownership of stock in foreign companies. ADRs are negotiable and are used by foreign corporations to sell shares in the United States. American Stock Exchange (AMEX): The second-largest exchange in the United States, located in the financial district of New York City. Formerly known as the Curb Exchange, it is now owned by the National Association of Securities Dealers. amortization: An accounting term referring to the reduction of debt by periodic changes to assets or liabilities, such as the payments on mortgages. A systematic write-off of costs incurred to acquire an intangible asset such as patents and copyrights. annual report: A formal annual financial statement issued by a company. Designed to be read by
shareholders, it shows assets, liabilities, and earnings. A longer, more detailed account of the company’s financial results can be found in the 10-K, a document required by the Securities and Exchange Commission.
GLOSSARY
annuity: A series of payments of a fixed amount for a specified number of years, usually a contract
sold by insurance companies that carries an income benefit for life. The basic purpose is life insurance, but it is most commonly used for retirement planning. antidumping duty: An import tariff that is imposed for the purpose of raising the domestic price
of a product being exported by another country at an unjustifiably low price. antitrust laws: Legislation principally designed to protect competition by outlawing monopolis-
tic and anticompetitive practices. In the United States, the major federal antitrust law is the Sherman Act of 1890. appreciation: An increase in the value of an asset. Investors, such as homeowners, invest for appreciation, which may result from prices keeping up with inflation, increased demand for housing, or shortages. arbitrage: Simultaneous purchases and sales of an asset in different markets with a profitable price
or yield differential. Arbitrage positions are completely hedged—the performance of both sides of the transaction is guaranteed at the time the position is assumed—and are thus without risk of loss. arbitrageur: A person or entity practicing arbitrage; usually the individual is a broker-dealer. arbitration: A remedy to disputes when the alternative is litigation. The process results in a deci-
sion that is binding for both parties. arrearage: Overdue payment, sometimes an omitted dividend on a preferred stock. articles of incorporation: Also called certificate of incorporation, a document that formally indi-
cates the approval of authorities for the creation of a corporation. asked price: A stock market term indicating the lowest price that a holder of a security will take.
Also called a quotation, it is compared to the bid, which is the highest price offered by a potential buyer. assessment: A claim that a certain payment is required, usually a tax levied by the government or
a regulatory agency. Often a penalty payment. assets: The properties or items with value that are owned by an individual, business, or institution. Liquid, or current, assets include cash and other items that can be converted to cash within twelve months. Long-term assets are equipment and machinery and other capital assets after accounting for depreciation. Prepaid and deferred assets are items such as insurance, rent, and interest. Intangible assets include such items as patents and copyrights. assumable mortgage: A loan on a property its owner can assign to a buyer upon sale of the property. In other words, if a home with a mortgage with an interest rate of 9.5 percent is purchased, the new owner can assume the mortgage at the same rate. at the close: An order to buy or sell a security within the final thirty seconds of trading. Brokers
will not guarantee such orders. at the opening: An order to a broker to buy or sell a security at the price that applies when an ex-
change opens. If the order isn’t executed at the time, it is canceled automatically.
GLOSSARY
auction market: A system of trading securities through brokers or agents on an exchange. Buyers
compete among themselves for the most advantageous price. authorized stock: The total amount of capital stock that a company has approved for sale. The amount it actually sells is issued stock; the amount it holds for possible future sales is authorized but unissued stock. average life: The weighted average time for the return of principal, where the weights are the prin-
cipal payments for each period. averages: Ways of measuring the trend of securities prices. One of the most popular is the Dow
Jones average of thirty industrial stocks listed on the New York Stock Exchange. The prices of the thirty stocks are totaled and then divided by a divisor intended to compensate for the past stock splits and stock dividends. Changes in this index have little relationship to the price changes. baby boomers: Individuals born in the years immediately following World War II. Because of its
size, this group has influenced businesses’ marketing habits. backward vertical integration: A company increases its control over its supply systems by tak-
ing ownership of its suppliers or by becoming its own supplier. This strategy streamlines the company, provides better cost controls, and eliminates middlemen. It allows companies to lower costs and become more competitive. balance of payments: A record of a nation’s international economic transactions, including such
items as exports, imports, foreign aid, and international investments. balance of trade: The difference between the goods and services exported by a country and the
goods and services imported into that country during a given period. The measurement may represent trade between two countries or between one country and the rest of the world. If exports are less than imports, the result is a trade deficit. If imports are more than exports, the result is a trade surplus. balance sheet: An itemized financial statement showing assets, liabilities, and net worth of a com-
pany on a given date. Liabilities always equal assets, hence the name “balance sheet.” bank holding company: A company owning 25 percent or more of the voting stock in a bank or
in several banks. Holding companies are regulated by the board of governors of the Federal Reserve. bankruptcy: Insolvency of an individual or corporation because of an inability to repay debts. In
the United States, there are two kinds of legal bankruptcy under the 1978 Bankruptcy Reform Act—Chapter 7, or involuntary bankruptcy, which calls for liquidation and for a court-appointed trustee, and Chapter 11, or voluntary bankruptcy, which calls for reorganization. In this latter case, the debtor remains in possession of the property and in control of the assets and operations. The goal of bankruptcy is the orderly settlement of debts. barriers to entry: Market or industry conditions that confer cost advantages to existing firms
and thereby discourage entry by new firms. One barrier to entry is a natural monopoly, where the market size is considered too small for more than one firm.
GLOSSARY
barter: To trade goods without using money. It is one of the earliest trading practices but is still
used by economies in which the population has little or no confidence in the banking system or in the value of the money. In the international arena, barter is common among countries with unattractive currencies. For example, many of the trade deals between Russia and other countries involve barter since the ruble is not convertible into other currencies. basis point: One gradation on a 100-point scale, which represents 1 percent. Used to express vari-
ations in yields. A measure of a bond’s yield, equal to 1/100th of 1 percent of yield. For example, the difference between 10.73 percent and 10.77 percent is four basis points. bear market: A prolonged period of falling stock prices, usually the result of declining economic activity or the anticipation of an economic downturn. bear raid: An illegal act in which investors manipulate the price of a stock downward by selling
large number of shares. bearer bond: A bond that doesn’t have the owner’s name registered on the books of the issuer and
is therefore payable to the holder. bearer security: A security that doesn’t state the name of the owner and is therefore considered to
be owned by the person who holds it. Beige Book: A periodic report on regional economic conditions, named for the color of its cover, prepared by the regional Fed banks before each meeting of the Federal Open Market Committee and released to the public. bellwether: A security that is considered an indicator of the movement of other stocks in the same market. International Business Machines, because of its size, has long been considered a bellwether stock. In bonds, the twenty-year Treasury bond is considered a market bellwether. Best’s Rating: A rating of the financial soundness of insurance companies. The top rating is A+. bid and asked: A stock market term. The bid is the highest price anyone is willing to pay. The
asked is the lowest price anyone will take. Big Board: The New York Stock Exchange. Big Three: Refers to automakers General Motors Corporation, Ford Motor Company, and Chrysler Corporation. Black Friday: A term referring to a sharp drop in the financial markets on September 24, 1869,
when a group of financiers attempted to corner the gold market. A depression followed. Another Black Friday occurred in 1873. Black Monday: The name given to a major stock market correction on October 19, 1987. The shock of a more than 500-point drop on that day was felt around the world. Investors were warned of the drop the previous Friday. A similar pattern of trading occurred in 1989, but the drop of nearly 200 points did not create a second Black Monday. block: In the stock market, a large holding of stock, usually 10,000 shares or more.
GLOSSARY
blowout: A quick sale of all shares in a new offering of securities, which results in a high stock
price. In a blowout, investors have difficulty getting the number of shares they want. blue-chip stock: Common stock of a nationally known company that has a long track record of profitability, growth, and dividend payout. The company usually has a reputation for good products and services. blue-sky laws: State laws that protect the public against securities fraud. The term is said to have
its origins in a ruling by an unknown judge who commented that a particular stock had about the same value as a patch of blue sky. boardroom: Historically, a room for registered representatives and customers in a broker’s office
where the opening, high, low, and last prices of stocks were posted on a board throughout the day. Such postings are now done electronically. bond: A certificate of indebtedness, an IOU, that obligates the issuer to pay interest coupons at
regular intervals to the purchaser and to repay the principal on a specified date. Bonds are usually issued to obtain financing for a fixed asset such as a hospital. bond equivalent yield: Interest rates comparable to the rate earned on a Treasury note or bond,
computed on a semiannual basis over a calendar year. bond funds: Registered investment companies with assets invested in a portfolio of bonds. bond pricing equations: The mathematical relationship between the bond’s cash flows, rate of
interest, maturity, and price. bond rating: An evaluation of the likelihood that a bond issuer will default. Standard & Poor’s, Moody’s Investors Service, and Fitch Investors Service provide analysis of the bond issuers. The highest rating is AAA. D means default. book: A notebook stock specialists use to keep a record of buy and sell orders. It provides a record of the sequence of orders brokers leave with the specialist. book value: The value of an asset on the balance sheet or the asset value of a company’s securities.
On tangible assets, the value is calculated as actual cost minus allowances for depreciation. When using the term for stocks, remember that book value isn’t the same as market value. bottom line: The net profit or loss for a transaction or for a company’s business activity. Usually
refers to the earnings statement corporations issue and means net income or profits after taxes, expenses, and extraordinary items. break-even point: The point at which revenues equal cost. Young companies talk in terms of
reaching the break-even point about three to five years after the beginning of operations. For investors it means no profit, because the transaction, net of commission costs, is a wash. breakout: The movement of a stock above or below a range bounded at the upper end by the se-
curity’s previous high and at the lower end by the lowest price at which the security has traded. Bretton Woods: In June 1944, forty-four nations met in Bretton Woods, New Hampshire, to
prepare for European reconstruction after World War II. The World Bank, officially called the International Bank for Reconstruction and Development, and the International Monetary Fund
GLOSSARY
(IMF) were the resulting world agencies. This was the beginning of efforts to establish a world economic order. A fixed exchange rate system, later abandoned, was established based on the U.S. dollar. broker: An agent who handles public orders to buy and sell securities, commodities, real estate, or
other financial or tangible property. Brokers usually work on a commission basis. broker loan rate: The interest rate bankers offer stockbrokers who ask for loans to cover the se-
curities positions of their clients. The loan rate is usually close to the prime rate. buffer stock plan: A method to smooth out the peaks and valleys in economic fluctuations. For a
company it means building inventories during recessions to create additional employment and reducing inventories during inflationary periods. bull market: A prolonged period of rising stock prices. bunching: A ticker tape pattern in which a series of trades in the same security appear consecu-
tively. bundling: The decision by a company to sell two or more products together. burnout: When tax shelter benefits are exhausted and investors begin to receive income from the investment. business cycle: A recurring pattern of expansion and contraction in the level of business activity. A measure of the level of activity of a nation’s economy, measured by the pattern of movement in real gross domestic product (GDP). The business cycle has three stages, namely recession (characterized by falling real GDP), recovery (the stage immediately following a recession in which real GDP is growing but still below the previous peak), and expansion (where the level of real GDP is above the previous peak). business-to-business marketing: Unlike consumer marketing, which is directed toward the in-
dividual end user, business-to-business marketing is the selling of products from one business to another. Often referred to as industrial marketing. buyback agreement: A contract with a provision that allows a seller of a property to repurchase
it at a stated price within a certain period. buy on bad news: An investment strategy that assumes that just after a company announces bad
news the stock price will fall to a point below what it is worth and that it will rise again when the news improves. buy on margin: Buying securities with credit provided by a broker through a margin account.
Such activities are regulated by the Federal Reserve Board. buyout: The purchase of control of a company through negotiation or a tender offer. The purpose
of a buyout is to acquire the assets and operations of the company. In a leveraged buyout, a small group, using borrowed funds, buys the company with the idea of repaying the loan from cash generated by the company or from the sale of its assets. buy the book: An order to buy the shares of a single stock that are available from all dealers or
brokers of the stock at the current offer price.
GLOSSARY
bylaws: Guidelines addressing the internal management of an organization. For companies, the
bylaws are initially drawn up at incorporation but may be amended by a vote of shareholders at a later date. call: In banking, a demand to repay a loan usually after a debtor has failed to meet some condition
of the loan. In bonds, it means that the issuer of the bond has redeemed it. In options, it means the right to buy a specific number of shares at a specified price by a fixed date. callable: A bond issue, all or part of which may be redeemed by the issuing corporation under
specified conditions before maturity. It also applies to preferred shares. call option: The right to buy 100 shares of a stock or stock index at a predetermined price before
a preset deadline in exchange for a premium. For buyers who expect a stock to rise, call options allow a profit from a smaller investment than it would take to buy the stock. call premium: The amount in excess of par value that a company must pay when it redeems a
security. call privilege: A provision in a bond or preferred stock agreement that gives the issuer the right to
redeem the security at a specified price. capital asset: An asset with a life of more than one year. capital expenditure: Outlay of money to acquire or improve capital assets such as buildings and
machinery. capital flight: The movement of large sums of money from one country to another that allows the investor to escape political or economic turmoil or to benefit from investments with higher returns. capital gain/capital loss: The profit or loss from the sale of a capital asset, usually described as short-term (twelve months or less) or long-term (more than twelve months). capitalism: An economic system based on the assumption that the marketplace will determine the amount of goods produced and the prices of those goods. At the core is private ownership of production and property, and a minimum of government involvement is assumed. A pure capitalist economy doesn’t exist; most economies are mixed. capital markets: Transactions involving financial instruments with maturities of greater than
one year. capital stock: Shares representing ownership in a business; includes preferred and common
stock. capital structure: The financing of a firm represented by its long-term debt, preferred stock, and
net worth (capital, capital surplus, and retained earnings). capitalization: The total of the securities issued by a corporation that may include bonds, debentures, and preferred and common stock. The securities are often accounted for by different methods. Bonds and debentures are listed at par or face value, preferred and common stock at par or stated value.
GLOSSARY
carry forward: A method companies use to reduce federal income taxes. Losses can be carried forward and used to offset income in future years. cartel: A group of businesses or nations that agrees to influence prices by influencing the produc-
tion and marketing of a product. The Organization of Petroleum Exporting Countries (OPEC) is the most famous of the contemporary cartels. The United States prohibits such organizations. cash cow: Business that generates a steady and predictable flow of cash. Such a business usually has
a well-established brand name with high consumer recognition. Stocks that are cash cows have dependable dividends. cash cycle: The time between a company’s purchase of raw materials and its collection of accounts receivable from the sale of the finished product. cash flow: The money that an enterprise can depend on to pay for operations and debt. A com-
pany has a positive cash flow when more cash comes in than goes out. A negative cash flow is the opposite situation. Investors focus on cash flow because it is an indicator of the company’s ability to pay dividends. cash flow yield: The yield to maturity of a portfolio or a security with uneven cash flows. cash sale: A stock exchange term referring to delivery of the securities on the same day as the
transaction. Normally, delivery may come several days after a trade. caveat emptor: A principle in commerce that warns that without a warranty, the buyer takes on
the risk of quality. central bank: A nation’s principal monetary authority, the responsibilities of which include issuing currency and regulating the supply of credit. In the United States, the central bank’s functions are the responsibility of the Federal Reserve System, which acts through monetary policy. centrally planned economy: Considered the opposite of capitalism in that central authorities,
rather than the market, are responsible for the national economy, including what is produced at what quantities and at what price to consumers. churning: Excessive trading of a client’s account. This illegal practice increases a broker’s commis-
sions but usually leaves the client worse off or no better than before. classified stock: More than one class of common stock, usually created with the intention of giving a minority of shareholders control of the company. In cases of Class A and Class B stocks, one class usually retains voting rights whereas the other has only equity participation. Because the voting rights remain in the hands of a minority, often a family, issuing classified stock is an antitakeover tactic. closed corporation: A firm owned by a few people, usually management or family members.
There is no public market in the shares. Also called a private corporation. closed-end management company: An investment company that operates a mutual fund with
a limited number of shares outstanding. collateral: An asset pledged to a lender until a loan is repaid. If the borrower defaults, the lender
has the legal right to seize the collateral and sell it to pay off the loan.
GLOSSARY
collusion: When two or more enterprises work together to provide benefits that would not exist
for them if the market were free to function and economic forces determined supply and demand. commercial paper: Short-term obligations with maturities ranging from 2 to 270 days, issued by banks, corporations, and other borrowers to investors with temporarily idle cash. Such instruments are unsecured and usually discounted, although some are interest bearing. Investors like such forms of debt because, if the paper is issued by top-rated companies and backed by bank lines of credit, the investment is relatively safe. Maturities are flexible and the rates are usually a bit lower than bank rates. commitment fee: A fee paid to a lender for a formal line of credit. common stock: Units of ownership in a public corporation. Holders of such stock are entitled to vote on the selection of directors and other important corporate matters. Shareholders are also entitled to a share in the earnings of the company through dividends. common stock ratio: The percentage of total capitalization represented by common stock. For
purposes of analysis, the ratio depends on the stability of the company’s earnings. A high ratio can mean lack of leverage. Generally, if the ratio is below 30 percent, analysts take a careful look at the company. communism: In its pure form, an economic system with only one class, the proletariat, which contributes the labor of individuals to society according to their abilities. There is no need for government in such a plan. Since no pure example exists, the economies closest in principle to communism are the centrally planned economies.
Communist Manifesto: A pamphlet written by Karl Marx in 1848 describing the abuses of capitalists during the Industrial Revolution. It was written to encourage workers to overthrow capitalism and establish socialism. comparative advantage: The theory that countries will trade the goods that they are most effi-
cient at producing and that both buyers and sellers will gain more economic benefit from the exchange than if they had refrained from trade. composition: An informal reorganization that voluntarily reduces a creditor’s claims on the
debtor firm. compound interest: An interest rate that applies when interest in succeeding periods is earned
not only on the initial principal but also on the accumulated interest of prior periods. With simple interest, returns aren’t earned on interest received. compounding: The mathematical process of determining the final value of a payment or series of
payments when compound interest is applied. conglomerate: A corporation that has diversified its operation usually by acquiring enterprises in widely varied industries. consolidated tape: The NYSE and AMEX ticker systems that report transactions on the NYSE
and regional exchanges as well as all transactions of AMEX-listed companies. consortium: A group of companies formed to promote a common objective or engage in a project of benefit to all its members. It usually means sharing resources or technology.
GLOSSARY
consumer price index (CPI): This index is based on the price of about 400 items that are selected to represent the movement of prices of all goods. The index has been altered and redefined many times since it was initiated after World War I. Available from the U.S. Department of Labor’s Bureau of Labor Statistics, the monthly number is an indicator of inflation in the economy. contraction risk: The risk to the investor in mortgage-backed securities due to decreases in the
prepayment rate. When the prepayment rate increases, typically when interest rates have fallen, the effective maturity of the security shortens. contrarian: An investor who does the opposite of what most investors do at any given time. Such
investors buy when others are selling and sell when others are buying. controlling interest: Ownership of more than 50 percent of a corporation’s voting shares. A smaller interest, owned individually or by a group in combination, can create a situation of controlling interest if the other shares are widely dispersed and not actively voted. conversion price: The dollar value at which convertible bonds, debentures, or preferred stock can
be converted into common stock, as announced when the convertible is issued. conversion ratio: The relationship that determines how many shares of common stock will be re-
ceived in exchange for each convertible bond or preferred share when conversion takes place. It is determined at the time of issue. convertible securities: Usually bonds or preferred stocks that are exchangeable at the option of
the holder for common stock of the same company. cooling-off period: An interval of about three weeks between the filing of a preliminary prospec-
tus with the Securities and Exchange Commission and the offer of the securities to the public. cooperative advertising: An arrangement under which the manufacturer and the retailer share
the cost of advertising a product. cornering the market: Illegal activity resulting from the purchase of a security or commodity in
such volume that the buyer achieves control over the price. correction: A reverse movement, usually downward, in the price of a stock, bond, commodity, or
index. Whenever a market moves in one direction over a long period, a correction is expected. correspondent: A financial organization, usually a securities firm or a bank, that performs serv-
ices for another in a market that is inaccessible to the other. cost of capital: Rate of return that a business could earn if it chose another investment with
equivalent risk. Cost of capital is also calculated using a weighted average of the firm’s cost of debt and classes of equity. cost-push inflation: Inflation caused by rising prices that follow on the heels of rising costs. Also called sellers’ inflation, the term recognizes that the economy may depart from stability. Council of Economic Advisers: A group of economists appointed by the U.S. president to provide counsel on economic policy. The advisers help prepare the presidential budget message to Congress. coupon: The periodic (annual, semiannual) payment of a bond as a proportion of principal.
GLOSSARY
coupon rate: The annual coupon of a bond divided by the bond’s principal. covenant: Clauses in loan agreements designed to protect the lender. Covenants may include terms that limit total indebtedness or restrict dividends or acquisitions. crash: A precipitous drop in stock prices and economic activity, as in the crash of 1929, which
brought on the Great Depression. Crashes usually follow a loss of investor confidence that occurs during times of anticipated high inflation. The October 19, 1987, stock market drop doesn’t meet this criteria, so many argue that it was not a crash but rather a correction. creative destruction: The theory that economies grow because companies both succeed and fail.
The entrepreneur is the catalyst, the person willing to take the risk of failure to achieve success. credit rating: Formal evaluation of an individual’s or a company’s credit history. For corporations, Dun & Bradstreet is the primary source of credit ratings. For individuals, TRW provides ratings. Standard & Poor’s and Moody’s provide credit ratings for bonds. crowding out: When heavy federal borrowing occurs at a time that businesses and consumers also
want to borrow money, the latter may be prevented from entering the market for funds. Because the government can pay any interest rate it must to get funds, and individuals and businesses can’t, high interest rates discourage nongovernment borrowers. This circumstance can slow economic activity. crown jewels: The most desirable pieces of a diversified company measured by asset value, earning power, and business opportunities. The crown jewels are usually the targets of takeover attempts in that they can be sold off easily and usually at a profit. cumulative dividends: A protective feature on preferred stock that requires all past preferred div-
idends to be paid before common dividends can be paid. cumulative preferred: A stock provision that requires that common stock dividends not be paid
until the omitted dividends of the preferred stock are paid. cumulative voting: A voting method that improves minority shareholders’ chances to get repre-
sentatives on the board of directors. It allows shareholders to cast all of their votes for one candidate, an exception rather than the rule. Curb Exchange: Nickname for the American Stock Exchange. Before 1921, the exchange operated out-of-doors and was known as the New York Curb Exchange. currency controls: Rules that make authorities responsible for exchange of currencies with other nations. When currency controls are used, the currency is inconvertible since all buying and selling of foreign money is carried out through a designated government agency in order to establish rates favorable to products and businesses the government wants to protect. currency futures: Contracts in futures markets for delivery in a major currency such as U.S.
dollars, British pounds, French francs, Japanese yen, etc. Currency risks can be hedged with these futures. current ratio: A method to determine financial soundness; current assets divided by current lia-
bilities. It shows a company’s ability to pay current obligations from current assets.
GLOSSARY
current yield: The earnings on an investment based on market value or the amount paid for the investment. It is the actual rate of return, so a bond with a maturity value of $1,000 that pays 10 percent interest would pay $100 a year. But if the investor buys the bond for $900, the current yield would be 11.1 percent. Calculate current yield by dividing the annual coupon of a bond by the bond’s market price. cutoff point: The minimum rate of return on acceptable investment opportunities. cyclically sensitive: Industries or economic conditions that grow faster than the gross domestic product during expansions and decline faster during a slowdown. cyclical stock: A stock that tends to rise quickly when the economy turns up and fall quickly when it turns down. Cyclical stocks include housing, automobiles, and paper. daisy chain: Trading between market manipulators to create the appearance of active volume. This
is done to lure legitimate investors. Once the price is driven up, the manipulators unload their holdings, leaving unwary investors without buyers to trade with. Das Kapital: The famous presentation of Karl Marx’s theories, which state that the value of a good is based on the labor put into it. The final editing of the 1867 book was done by Fredrich Engels. date of record: The date on which shareholders must officially own shares to be entitled to a div-
idend. Also called the record date. day order: An order to buy or sell that, if not executed, expires at the end of the trading on the day
it was entered. dealer: An individual or firm in the securities business that acts as a principal rather than an agent. Usually a dealer buys for his or her own account and sells to customers from his or her inventory. debenture: A general debt obligation backed only by the integrity of the borrower rather than by specific property. An unsecured bond is a debenture. debt instrument: A written promise to repay a debt—a bill, note bond, banker’s acceptance, cer-
tificate of deposit, or commercial paper. debt retirement: Repayment of debt. Usually a company retires debt by setting a little money aside each year in a sinking fund. debt-to-equity ratio: Total liabilities divided by total shareholders’ equity. This ratio shows
whether owners’ equity can cushion creditors’ claims in the event of liquidation. decision tree: A series of branches drawing various courses of action so that the alternatives are clear and the most efficient course of action is apparent. declare: To authorize payment of a dividend on a specified date; an act of the board of directors. deep discount bond: A bond selling for a discount of more than 20 percent of its face value. default: Failure to fulfill a contract. Usually default refers to the failure to pay interest or principal
on debt obligations. deficit: Excess liabilities and debts over income and assets.
GLOSSARY
deficit financing: Borrowing by a government agency to make up for revenue shortfall. It stimu-
lates the economy for a while, but eventually can become an economic drag by pushing up interest rates. deflation: Decline in the prices of goods and services. The reverse of inflation, it is not the same as
disinflation, which is a slowing in the rate of price increases. delisting: Removal of a company’s security from an exchange because the firm doesn’t meet the re-
quirements for listing. Requirements might be minimum financial ratios or sales performance. demand-pull inflation: Price increases occurring when supply doesn’t adequately meet demand. denomination: The face amount or par value of a security that the issuer promises to pay on the
maturity date. For example, municipal bonds are usually sold in denominations of $5,000. depreciation: A loss in the value of an asset, which in accounting terms can create tax-free income
equal to the loss in the value of the asset. depression: An economic situation that occurs when prices fall, purchasing power is reduced, supply exceeds demand, unemployment rises, and business activity decreases. devaluation: A lowering of the value of a country’s currency relative to gold or other currencies. Devaluation can also result from a rise in the value of other currencies. dip: A slight drop in securities prices after a sustained uptrend. Analysts advise investors to buy on
dips, since the assumption is that the drop in prices is momentary. direct mail: Though often a costly means of advertising, this method allows a marketer to target an audience and deliver a personalized message. Increasingly, companies are using databases to track prospective customers and tailor a message directly to them. disclosure: Release by companies of all information, positive or negative, that might affect invest-
ment decisions. Disclosure is required by the Securities and Exchange Commission and the stock exchanges of all member companies. Businesses may also have internal disclosure requirements for directors, executives, and officers. discount: For bonds and preferred stock, the amount these securities may sell below par value. discount rate: The interest rate used in the discounting process. Also, the interest rate the Fed
charges on loans it makes directly to banks; changes in this rate have largely symbolic importance. discretionary account: An account in which the customer gives a broker or other individual the right to buy or sell securities on behalf of the owner. diversification: The spreading of investments among different companies in different fields. Investors also seek diversification of their securities portfolios. dividend: Payment designated by the board of directors of a corporation to be distributed pro rata among the shares outstanding. Preferred shares get a fixed amount; common share dividends may vary. dividend yield: The ratio of the current dividend to the current price of a share of stock.
GLOSSARY
dollar cost averaging: A system for buying securities at regular intervals with a fixed dollar
amount. Because investors buy only the amount of shares the fixed dollar amount can afford, they buy more shares when prices are low and fewer when prices are high. double exemption: Refers to securities that are exempt from state and federal income taxes. double taxation: Short for double taxation of dividends. The federal government taxes corpora-
tions’ profits as corporate income, and the portion distributed to shareholders as dividends is taxed again as personal income. Dow theory: Market analysis based on the performance of the Dow Jones industrial and transportation stock price averages. The theory says the market is in a basic upward trend if one of these averages advances above a previous important high, accompanied or followed by a similar advance in the other. When both averages dip before previous important lows, this is considered confirmation of a basic downward trend. It is not a method of forecasting. duration: The weighted average term to maturity of all the cash flows of a bond or bond portfolio where the weights are the present values of the cash flows. earnings report: A statement, also called an income statement, a company issues to show its profits or losses during a designated period, usually three months or a quarter. Quarterly statements as well as six-month, nine-month, and annual reports are issued. economic cost: The total cost of producing a product; includes both the financial cost as well as
the alternative cost measured in terms of the opportunity cost. It takes into account the alternative uses to which materials used in production could have been put. economies of scale: The phenomenon whereby lower unit costs are achieved at a certain level of activity than at lower levels. This results largely from the fact that as the level of production increases, the fixed costs are spread over larger outputs, thereby leading to lower averaged fixed cost. equity: The net worth of a business, consisting of capital stock, capital surplus, earned surplus, and
sometimes net worth reserves. The common equity is the part of total net worth that belongs to the common shareholders. euro: The common currency adopted by eleven of the fifteen members of the European Union. As
in the United States, a single set of interest rates and a single central bank exist within the euro zone. eurocurrency market: The market for credit transactions that are denominated in any currency
except that of the host and are subject to few rules and regulations of the host. Also known as the external market. eurodollars: Dollar-denominated deposits held out of the United States in foreign banks and in
foreign branches of U.S. banks. Eurocurrencies are currencies held out of the country (or region) of origin. exchange rate: The rate at which one currency can be exchanged for another. excise tax: A tax on the manufacture, sale, or consumption of specified commodities.
GLOSSARY
ex dividend: Also called without dividend. The buyer of a stock selling an ex dividend doesn’t re-
ceive the recently declared dividend. Every dividend is payable on a fixed date to all shareholders holding stock at another earlier specified date, called the date of record. When stocks go ex dividend they are designated in the stock tables with an x. exercise price: The price that must be paid for a share of common stock when it is bought by ex-
ercising a warrant. ex-rights: The date on which stock purchase rights are no longer transferred to the purchaser of
the stock. extension risk: The risk to the investor in mortgage-backed securities due to increases in the prepayment rate. When the prepayment rate decreases, typically when interest rates have risen, the effective maturity of the security lengthens. extra: Shorthand for an extra dividend, which may be in stock or cash. This payment is in addi-
tion to the usual payment to shareholders. face value: Value of a bond that appears on the face of the security. Usually it is the amount the is-
suing company agrees to pay at maturity. It is not the same as market value. factoring: A method of financing accounts receivable. A firm sells its accounts to a financial insti-
tution, which serves as the factor. The receivables are then sold. If accounts prove uncollectible, the factor can’t turn to the original seller. federal funds interest rate: The rate at which banks lend to each other overnight. This rate, which is influenced but not completely controlled by the Fed, currently is the primary target of Fed policy and the benchmark for other short-term interest rates. federal open market committee: The committee that sets interest rate policy. The committee, which meets once every six weeks or so, consists of all seven members of the Fed board in Washington, plus presidents of the twelve regional Fed banks, five of whom have votes at any one time. The chairman of the Federal Reserve Board chairs the committee. The president of the New York Fed is the vice chairman. Federal Reserve Banks: Twelve regional institutions, technically private institutions owned by
the commercial banks in their territories, that carry out all the operations of the Federal Reserve, including processing checks and economic research. Their presidents deliberate on monetary policy. Federal Reserve Board: Formally, the Board of Governors of the Federal Reserve System. Consists of seven persons appointed by the President of the United States and confirmed by the U.S. Senate for fourteen-year terms. feudalism: The organization of society and economy into a rigid political and economic structure
that makes workers the vassals of people or institutions that control capital. The vassals are dependent on—and prevented from breaking free from—their masters. Financial Accounting Standards Board (FASB): A private agency that operates as an account-
ing standards–setting body.
GLOSSARY
financial markets: Markets for the exchange of capital and credit such as stock markets, bond
markets, foreign exchange markets, and commodities markets. financial statement: A record of the financial condition of a business, association, or individual.
It includes a balance sheet and income statement and may also include net worth. financial year: A hypothetical year, containing 360 days, in which every month is assumed to
have exactly 30 days. first in, first out (FIFO): An inventory valuation in which raw materials and finished goods pur-
chased first in the inventory are charged against the goods most recently sold. During times of rapid inflation, FIFO inflates profits in that the least expensive inventory is charged against current sales. fiscal year: An accounting year that ends on a date other than December 31. fixed exchange rate: In 1944, the Bretton Woods International Monetary Conference set up a
system of fixed exchange rates based on a set relationship between the dollar and other currencies. The United States abandoned the arrangement when President Richard Nixon took America off the gold standard. flat tax: A tax applied equally to all income levels. Supporters of a flat tax say that if people were
able to keep larger portions of a higher income, they’d have an incentive to earn more and therefore stimulate the economy. float: The amount of funds tied up in checks that have been written but are still in the process of
collection. floating exchange rates: Currency values that move up or down with world supply and demand.
The rates are based on a number of factors, including national reserves of hard currency such as gold. Rates are closely linked to the rate of inflation or interest rates. floor broker: A member of the stock exchange who executes orders to buy and sell listed securities
on the floor of the exchange. flowchart: A visual representation of the steps in a procedure such as the manufacture of a prod-
uct. A flowchart may also depict a method of solving a problem. foreign trade zone: A designated area, sometimes a port, where goods may be stored or inspected
without duties being assessed. Also called a free trade zone. formula investing: A technique in which an investor might shift funds from common shares to
preferred shares or bonds when a selected market indicator rises above a certain predetermined level. The investor then might return to common stock when the indicator drops. forward market: The market for delivery of a currency or commodity on a chosen future date at
a rate set now, the forward rate, with payment on delivery. forward rate: A rate of interest for a specific interval of time starting on a specific date in the future. 401(K) plan: A salary reduction plan allowing employees to contribute pretax earnings to a company pool of investments. The earnings are taxed when they are withdrawn, usually at retirement.
GLOSSARY
franchise: A license to operate an enterprise, such as the stores of an ice cream chain. The franchisee has the right to use the franchiser’s logo and other products and services. In broadcasting, a local or state government may grant a broadcaster a franchise to serve a designated area. fraud: Intentional deception, such as nondisclosure of information or misrepresentation, that re-
sults in injury to another party. full disclosure: Under the Securities Act of 1933, the Securities Exchange Act of 1934, and re-
quirements of the stock exchanges, public companies must make certain, but not all, information about their operations available to the public. fully diluted earnings: Figure, usually expressed per share, that assumes the exercise of all outstanding stock options and warrants as well as the conversion of convertible bonds and preferred stock. It reflects all the potentially dilutive elements. funded debt: Usually interest-bearing bonds or debentures, but may include long-term bank
loans. futures contract: An agreement to buy or sell a commodity or financial index that specifies a fu-
ture date of delivery or receipt of goods or financial instruments. Futures are used as a hedge. They include commodities traded in future markets such as corn, soybeans, and pork bellies as well as oil and metals, financial instruments, and stock index futures. future value: The value at a future date of principal invested now at either a simple or a com-
pound rate. General Accounting Office (GAO): A congressional agency organized in 1921 to review federal
financial transactions. general mortgage bond: A bond that is secured by a blanket mortgage on the company’s prop-
erty but may be outranked by one or more other mortgages. general partner: A partner whose liability in a partnership is not limited. generic brand: An unadvertised, plain-label product that usually sells at prices well below those of
advertised brand-name products. gift tax: A tax levied by the state or federal government when assets are transferred from one per-
son to another. GINNIE MAE: The nickname for the Government National Mortgage Association, which issues
mortgage-based securities. Glass-Steagall Act of 1933: Legislative act that prohibits banks from owning brokerage firms
and engaging in investment banking activities. However, bank holding companies may hold a subsidiary broker-dealer organization. glut: Overproduction that economists define as a situation where the available supply will not be
bought at the current price. going public: A term used to describe a private company’s selling its shares to the public for the
first time.
GLOSSARY
golden handshake: Early retirement incentives. golden parachute: A contract that provides lavish benefits to executives who leave their jobs. Parachutes are associated with antitakeover measures, since many provide such expensive benefits to executives forced to leave a company after an acquisition that the contracts make acquisitions too costly to undertake. Shareholders have challenged golden parachutes because they discourage takeovers, which can bring investors high returns. gold fix: The price of gold as set by dealers. This price setting takes place twice a day in London. The fix is the fundamental worldwide price and reflects market conditions. goodwill: An intangible business asset that reflects a company’s relationship with and reputation among unions, suppliers, customers, or the communities it serves. One way a company can build goodwill is through charitable gifts. An acquiring company may calculate a part of its purchase price on goodwill. grandfather clause: An exemption for people already engaged in a business that is coming under
new regulations. greenmail: In potential acquisitions, a hostile suitor might acquire a large number of a company’s
shares, then negotiate with the company for the repurchase of the shares by the company at a premium to its market value in exchange for abandoning the takeover. Paying greenmail to the hostile suitor is considered an unethical act if the higher share price is not offered to all shareholders. Green Revolution: Rapid changes in the methods and technology of agriculture. Gresham’s law: An economic theory relating to the value of money. The law says that people will
save or hoard what they believe to be good money, and spend the bad. In other words, people may spend dollars and save gold if they perceive that dollars have less value. gross income: Earnings before deductions. growth fund: A mutual fund invested in growth stocks. These funds tend to be more volatile than
conservative investments such as money market funds. growth stock: Company stock with a record of rapid earnings growth. hedge: A method to reduce risk that may involve the purchase of a derivative security, such as options
or futures, in order to reduce or neutralize all or some portion of the risk of holding another security. hemline theory: The theory that stocks move in the same direction as women’s hemlines. Short
skirts are considered bullish. Long skirts are said to be a bearish indicator. hidden asset: Value that is understated on a company balance sheet because of deliberate action of
the company’s management or because of an accounting procedure. holding company: A corporation that owns the securities of another and in most cases has voting
control. holding period yield: The return realized from a security sold before maturity. hot stock: Stolen securities or newly issued stock that rises quickly in price.
GLOSSARY
hybrid annuity: An insurance company product that lets the investor mix the benefits of a fixed annuity, which offers a fixed rate of return, and a variable annuity, which offers a higher rate of return but a greater risk. hypothecation: The pledging of securities as collateral without losing possession of them. The
creditor has a right to have the securities sold to settle the debt. implied forward rate: A forward rate of interest that causes the investment return of two short-
term instruments to equal the return of a single long-term investment. independent broker: Members on the NYSE floor who execute orders for other brokers. Formerly known as two-dollar brokers, from the time when they received $2 per hundred shares executed. index: A statistical measurement expressed in percentages of a base year. A frequently used base
year is 1967 (identified as 100), because that year predates the oil crisis and other unusual economic events of the 1970s and 1980s. inflation: Rising prices for goods and services. Generally, the economic assumption is that buying power declines because an abundance of cash is in circulation, often the result of government spending. inflationary spiral: A condition of inflation in which price increases occur at an increasing rate,
resulting in a rapid loss in the value of currency. initial public offering (IPO): A company’s first stock offering to the public. Issuing an IPO is
also called going public. insolvency: A condition in which a company can’t meet its financial obligations when they come due. Generally, insolvency means more liabilities than assets at a given time. institutional investor: An organization that invests its own assets or those held in trust for oth-
ers. Such investors include pension funds, insurance companies, banks, and universities. interest: Payments borrowers pay lenders for the use of money. A corporation pays interest on
bonds to its bondholders. interest-on-interest: That part of bond earnings derived from reinvesting the coupons at the
prevailing interest rate until maturity. interest rate: The ratio of the earnings on an investment to the principal invested. The annual
rate of interest is the rate of interest divided by the fraction of the year the investment is outstanding. intrinsic value: The difference between the exercise price of an option and the current cash value
of the underlying security, expressed in dollars. investment banker: Also known as an underwriter, the middleman between the corporation issuing new securities and the public. The usual practice is for investment bankers to buy a new issue of stocks or bonds directly from a corporation for resale. A group may form a syndicate to sell the securities to individuals and institutions.
GLOSSARY
IRA (individual retirement account): A pension plan with some tax advantages. Investments
can be made in mutual funds, stocks, and other instruments. Many are self-directed, which means investors may choose their investments. Investors begin drawing from the fund at retirement, or no sooner than age 591/2. J-curve: An economic description of a turnaround. In theory, the present situation continues for a
while, then bottoms out and improves quickly, forming the shape of a J if graphed. job security: A way of talking about the chance of dismissal. A job with the government is said to
have high job security, whereas a job in the private sector has less job security. joint venture: An agreement between at least two parties to work together for a limited time or for
a single project. journal: A book of original entry that records every financial transaction of the business. Accounts
are posted to the ledger from the journal entries. junk bond: A term referring to bonds rated BB or lower by rating agencies, such as Standard &
Poor’s. The lower the rating, the riskier the investment. However, the returns for junk bonds rise with the risk, which is why they also are called “high-yield bonds.” Junk is often associated with leveraged buyouts and takeovers by companies with little or no credit history or a poor borrowing track record. Keogh Plan: Named for New York congressman Eugene J. Keogh, a plan created in 1962 to allow self-employed people to save for retirement. It is a tax-advantaged personal retirement program that allows the individual to invest in stocks, bonds, mutual funds, annuities, partnerships, and other assets. Keynesian economics: The theories of John Maynard Keynes, a British economist who is best
known for his theory that to avoid depression, government should spend more to encourage investment and higher employment. Keynes said that insufficient demand creates unemployment, and excessive demand creates inflation. He endorsed government manipulation of the economy. labor efficiency variance: The difference between actual hours worked and the standard hours of actual production, multiplied by the standard labor rate. This gives the difference in costs attributed to changes in labor efficiency. labor-management relations act: The Taft-Hartley Act of 1947, which outlawed unfair labor
practices by unions and allowed suits for breach of contract against unions, among other provisions. Laffer curve: A supply-side economics approach named for economist Arthur Laffer, who postu-
lated that noninflationary growth is spurred by tax policies that encourage investment and productivity. In short, an increase in the marginal tax rate will raise total revenue, but only for a short time. At a point, rising tax rates result in decreasing tax revenues. lagging indicator: A statistic that doesn’t change until after the economy has changed. Con-
struction is a lagging indicator because the economy may adjust to the expectations for construction when plans are announced, even though the actual construction may take many months to complete.
GLOSSARY
laissez-faire: Minimal government involvement in business affairs. In 1776, Adam Smith in The
Wealth of Nations called this theory the “invisible hand,” since it allowed businesses to seek their maximum opportunities without interference. Deregulation is seen as a movement toward a laissezfaire philosophy and a retrenchment from Keynesian economics, which advocated government intervention. last in, first out (LIFO): Inventory accounting method that records the cost of items brought out of inventory in reverse order from those that enter the inventory. It may result in an artificially low inventory balance sheet. law of diminishing returns: As more and more cost is expended on a given task, the benefits per
unit of cost become less and less. It often applies to the addition of labor. At a certain point, adding more labor will not add significantly to production, whereas the labor costs will continue to rise at a constant rate. law of supply: An economic principle that assumes that if market forces are operating, producers will produce goods when the profit is highest. leading indicators: Measures of the health of the national economy issued by the U.S. Commerce Department’s Bureau of Economic Analysis, These indicators measure a number of sectors, including employment, business formation, and consumer demand. letter of intent: Written indication that an action may be taken. When two companies come to a
preliminary agreement—possibly about a merger—they may issue a letter of intent. leverage: The effect on a company’s per-share earnings when the company has interest to pay on
bonds or preferred stock, or both. Leverage may be good when earnings are good. But leverage may be bad for a company when earnings drop, since the effect of leverage is to direct funds away from the payment of dividends to common shareholders and toward the payment of others. liabilities: All claims against a corporation, which may include wages, dividends, accrued taxes, mortgage bonds, etc. There are short-term liabilities and long-term liabilities. Liabilities must equal assets on a balance sheet. LIBID: London interbank bid rate is the interest rate at which banks in London are prepared to ac-
cept short-term deposits. It is the other side of the market from LIBOR. LIBOR: London interbank offered rate is the primary fixed-income index reference rate used in the
euromarkets. Most international floating rates are quoted as LIBOR plus or minus a spread. In addition to the traditional eurodollar and sterling LIBOR rates, yen LIBOR, D-mark LIBOR, and Swiss franc LIBOR are also available and widely used. liquid assets ratio: The ratio of liquid assets to current liabilities, used to assess the adequacy of
liquid funds of an organization. liquidation: The process of converting securities or other property to cash. However, in business it
usually means the dissolution of a company. The cash remaining after the sale is used to pay off the company’s indebtedness. liquidity: The ease with which an asset can be converted to cash.
GLOSSARY
listing: The act of being included on a stock exchange. Stocks are listed on exchanges and must
meet exchange requirements or standards. The New York Stock Exchange, for example, requires a minimum of 1.1 million shares outstanding and that the company being listed has net income of over $2.5 million. long: Referring to ownership of securities, options, or futures. Someone who is short has sold the
securities. A broker who is long has more securities than he or she has sold. maintenance call: A call made for additional money or securities when a brokerage customer’s
margin account equity falls below the requirement of the National Association of Securities Dealers (NASD). If the account isn’t brought up to compliance, the client’s holdings may be sold to make up the shortfall. managed money supply: Also called a controlled money supply, a decision to make short-term ad-
justments in the supply of money rather than relying on factors out of the control of the government. It is a method of monetary policy. manipulation: An illegal act of buying or selling a security for the purpose of creating a false or
misleading appearance of active trading for the purpose of raising or depressing the price to induce purchases or sales by others. manufacturer’s reps: Salespeople who work on contract for a number of varying manufacturers. They are generally paid purely on commission, thus reducing a company’s overhead costs. margin: The amount a customer pays when using a broker’s credit to buy or sell a security. Since
1945, Federal Reserve regulations have required a minimum, which has ranged from 50 percent recently to 100 percent. margin call: A demand for a customer to put up money or securities with the broker. A call is
made when a purchase is made, as well as when a customer’s equity in a margin account declines below a minimum standard set by the exchange or the customer’s broker’s firm. market price: The last reported price at which a stock or bond is sold. It may also be the current
quote. market segmentation: The practice of selling to different groups of consumers who are identified by certain characteristics common to them. matched orders: Normally, the illegal buying and selling of orders to create the impression of ac-
tivity in a security, which causes an upward price movement. However, it’s the job of specialists to create an opening price on the NYSE by counterbalancing orders or trades to narrow the spread between prices. This is a legal activity to produce orderly markets. mercantilist theory: A popular belief in the early 1700s and 1800s that nations would greatly
benefit from holding precious metals. Policies achieving this goal were encouraged. Mercantilism is the “beggar thy neighbor” policy of accumulating trade surpluses no matter how much pain doing so inflicts on one’s neighbor who has the corresponding trade deficits. merger: Any combination of enterprises. Mergers are of many types, such as the horizontal
merger that combines direct competitors with similar markets and products. A vertical merger
GLOSSARY
combines customer and company or supplier and company. A merger may also result in extended product lines. minority interest: Shareholders who own less than half the shares of a company. monetarist: An economist who believes that changes in the growth of the rate of money supplied
to the system have important effects on spending, price, production, and employment. An effective way to control a nation’s economy is through monetary policy. monetary policy: Government influence over the economy by its control of money and interest
rates. The Federal Reserve System does this by using open market operations, changing reserve ratios, and influencing the discount rate. This act of controlling the growth of the money supply and short-term interest rates in turn influences the foreign exchange value of the currency. money market: The market for short-term funds. Instruments are debt securities, usually with maturities between one day and one year. Instruments consist of short-term securities and bank loans. Securities are usually only of the highest credit quality. A place to invest temporarily excess funds. money market fund: A mutual fund whose investments are in money market instruments such
as federal securities, CDs, and commercial paper. Its intent is to make such instruments, normally purchased in large denominations by institutions, available indirectly to individuals. mortgage: A transaction in which purchased property is used as collateral for the loan that is then used to buy the property. Mortgages for homes are normally written for fifteen- or thirty-year periods. mortgage passthroughs: Mortgage-backed bonds created from a pool of residential mortgage
loans in which all payments, minus a servicing fee, are passed through, pro rata, to the bond investors. mutual fund: Fund, operated by investment companies, that raises money from shareholders to
invest in bonds, stocks, options, commodities, or other securities. Mutual funds normally offer investors a choice of an aggressive or a conservative strategy to earn returns. naked position: Describes an option that isn’t offset by an equal and opposite position. In other
words, the position isn’t hedged, so the risk is greater than for a covered position. NASD: The National Association of Securities Dealers, an association of brokers and dealers in the
over-the-counter securities business. NASDAQ: The automatic quotation system of the National Association of Securities Dealers. It provides brokers and dealers with price quotes for over-the-counter stocks. national debt: Money owed by the federal government. It includes Treasury notes, bills, and
bonds. The interest on the national debt is an annual expense that results from balancing the deficit against the surplus for any given year. nationalization: The takeover of a private company by a government. Sometimes the company is
compensated, sometimes not.
GLOSSARY
natural monopoly: A market that is said to be too small to accommodate more than one pro-
ducer or player. negative yield curve: When yields on short-term securities are higher than those on long-term
securities of the same quality. This is the reverse of a normal yield curve, when long-term securities have a higher yield because interest rates tend to be higher for long-term investments to encourage investment. High interest rates in the short term can produce a negative yield curve. neoclassical economics: Economic theory that flourished from the turn of the nineteenth century until the adoption of Keynesian economics. The assumption was that market forces would always lead to efficient allocation of resources and full employment. Keynes maintained that at times, the market would fail and it was the responsibility of government to intervene. net: The result after everything has been deducted. It is both a noun and a verb, in that one can net
a million dollars. Net is also the difference between business additions and subtractions. Net assets, for example, are the difference between total assets and total liabilities. net asset value: Net asset per share is calculated by taking the market value of all securities owned and deducting the liabilities. The balance is divided by the outstanding shares. net income/net profit: Also called the bottom line, the amount remaining after all expenses and
taxes are paid or deducted from the proceeds of a venture. For businesses, the net income is expressed in dollars and in per-share earnings. net operating income: The earnings of an enterprise after the expenses of its operation are deducted but before taxes and financing expenses are deducted. net worth: The capital and surplus of a firm, including the paid-in capital and retained earnings.
Usually refers to the worth of common shareholders rather than preferred shareholders. New Deal: Political and economic policies under the first two administrations of President
Franklin D. Roosevelt aimed at overcoming the miseries of the Great Depression. new issue: The first time a company sells stocks or bonds. Proceeds may be used to retire outstanding securities, to improve plants or buy new equipment, to raise additional working capital, or to acquire public ownership in the company for private owners. New York Futures Exchange: A subsidiary of the New York Stock Exchange devoted to the trad-
ing of futures products. New York Stock Exchange (NYSE): The largest organized securities market in the United
States. Founded in 1792, it is a nonprofit corporation governed by a board of directors. The Exchange doesn’t buy, sell, own, or set the prices of securities traded on the Exchange. NYSE Composite Index: The index covering price movements of all common stocks listed on the New York Stock Exchange. It is based on the close of the market December 31, 1965, as 50.00 and is weighted according to the number of shares listed for each issue. The index is computed continuously and printed on the ticker tape. Point changes in the index are converted to dollars to measure the changes in the average price of listed stocks.
GLOSSARY
niche market: A segment of an industry or market whose particular needs a firm decides to serve
based on the firm’s unique advantages or capabilities to produce products that meet such needs. no-growth: A condition reflecting no change in the gross domestic product from year to year. no-load: Refers to mutual funds that have no sales charges. Shares are bought directly from the fund companies rather than through a broker, as is the practice with load funds. noncumulative preferred stock: Preferred stock in which unpaid dividends don’t accrue; omit-
ted dividends are lost. not-for-profit: An incorporated organization in which the activity of the enterprise is directed to-
ward some charitable, humanitarian, or educational purpose. Such groups are exempt from corporate income taxes and some donations are tax-deductible to the supporters of the enterprise. obligation bond: A mortgage bond with a face value greater than the value of the underlying property. The difference compensates the lender for costs exceeding the mortgage value. obsolescence: The process whereby property becomes useless as a result of scientific or techno-
logical changes; does not refer to physical deterioration. occupational hazards: Conditions in a work environment that increase workers’ probability of
death, disability, or illness. odd lot: Less than a round lot, which is a stock trading unit of 100 shares. Okun’s law: Named for economist Arthur Okun, the rule says that at levels higher than full employment, a change of 1 percent in the unemployment rate will cause a change of 3 percent in the nation’s total output. oligopoly: Market domination by a few large suppliers. In a true competitive situation, there will
be a large number of small suppliers. open account: Status of an account until final payment is made to a creditor, at which time the account becomes closed. open bid: A method to set the price of work or goods that allows bidders to quote a price at which
they can provide the needed services. The bidders have the right to reduce the price to meet the quotes others make for the same work. The winner is the one who submits the lowest acceptable bid. open-door policy: A national trading policy that allows equal treatment for foreign as well as
domestic citizens and products. In the workplace, a policy encouraging an informal environment. The manager, for example, might leave his or her door open to encourage interaction with employees. open-end contract: A contract providing an unspecified amount of goods or services over a
length of time. open market: Usually means a lack of restrictions on the price or type of goods traded. In the
Federal Reserve system, refers to the activities of the Securities Department and the operations used to regulate money supply.
GLOSSARY
open outcry: A method of trading used on commodity exchanges. Traders come together in a
trading ring or pit where they shout their buy or sell orders. The two sides make a contract in the open. operating ratio: A number of ratios reflect the financial strength of a company’s operations. The
ratios usually show the relationship between various income and expense figures taken from the profit and loss statement or asset and liability figures taken from the balance sheet. Common ratios relate sales to cost of goods sold, operating expenses to operating income, net income to net worth, or debt to equity. opportunity cost: The cost of taking one course of action rather than another. Cost is associated
with forgoing a particular opportunity. ordinary interest: Also called simple interest, it is interest based on a 360-day year rather than a 365-day year; the latter is called exact interest. original equipment manufacturer (OEM): A company that manufactures a product and sells
it to a reseller. origination fee: A borrower’s fee, usually associated with a mortgage. It may cover the cost of is-
suing the loan, making credit checks, appraisal, or completing a title search. outsourcing: Using other firms to provide goods or services rather than producing them in-house.
Many clothing manufacturers outsource to foreign manufacturers in Hong Kong or Taiwan because labor is cheaper there or manufacturing technology is more advanced. A company outsources when another company can do the job more cheaply. overage: The opposite of shortage. overhang: A large block of securities or commodities contracts that if released on the market would result in a drop in prices. overhead: Cost not directly related to the production of a product but associated with the activity
of a firm, such as the cost of a corporate attorney. over-the-counter (OTC): A market for securities of companies that are usually small and often
young. Generally, these companies are without sufficient shares, shareholders, or earnings to enable them to be listed on the AMEX or the NYSE. The market is conducted over the phone. OTC dealers may act either as principals or as brokers for customers. The NASDAQ provides quotes. Pac-Man defense: Named for a once-popular video game, refers to a defense a company uses to
fight off corporate mergers and acquisitions. Instead of stubbornly opposing a takeover, the target company turns the tables and makes a counteroffer to buy the unwelcome suitor. paper profit: Unrealized gain in an investment or portfolio. The profit is calculated by comparing
the current market price to the investor’s cost. par: Equal to the face amount or stated value of a negotiable instrument, stock, or bond. It is not the actual value in the open market. At par means that the securities sell at their stated value.
GLOSSARY
par value: The face value or the value of a stock for accounting and tax purposes. The market
value of the stock is the price at which it actually trades. For bonds, the par value usually refers to the maturity value. Parkinson’s law: A rule describing the paralysis of organizations. Named for C. Northcote
Parkinson, describes an organizational infection called injelitis, which causes firms to become moribund, resulting in little constructive activity or accomplishment. patent pending: Statement issued from the U.S. patent office when a patent search is being con-
ducted in the United States and other countries to determine if the invention is really new and therefore patentable under law. paternalism: A management style that assumes that the ultimate responsibility for employee wel-
fare rests with the employer. The company decides what is best for the employees and makes benefit decisions, job assignments, and promotions for the employees. penny stock: A stock that sells for less than $1 a share. Such stocks are generally issued by compa-
nies with a short history of sales and earnings performance. Penny stocks are more volatile than those of large, well-established enterprises on large equity exchanges. per capita: Calculated to reflect the cost or value per individual. per diem: The daily rate an employer pays employees who are traveling on company business. Per diem is provided to cover expenses. It is not considered earned income. perfect competition: The ideal condition for competition—large numbers of sellers and buyers.
Also called pure competition, perquisites: Benefits other than wages, such as the use of a corporate health club or the assignment of a secretary. Also called perks. personal income: A component of the national account, the total of all income including wages
and salaries, rental income, and dividends. Peter Principle: Based on a book, The Peter Principle and Why Things Always Go Wrong by Lawrence J. Peter, theory that maintains that people rise in their careers to the level of their own incompetence. Phillips curve: The inverse relationship between inflation and unemployment. Whenever unem-
ployment is low, inflation tends to be high. Whenever unemployment is high, inflation tends to be low. planned economy: An economy in which government planning dominates the economic activ-
ity. Market forces, the basis of capitalism, are not allowed to function freely. Socialist, and especially communist, economies are planned economies. poison pill: A defense against takeovers, a strategy to make a company’s stock less attractive to acquirers. Shareholders have challenged the use of this strategy because it may prevent them from realizing a handsome return on their stock investments in the event of a takeover. portfolio: All the securities, including stocks, bonds, real estate, and certificates of deposit, owned
by an individual or organization.
GLOSSARY
portfolio theory: An investment strategy designed to allow an investor to classify and control the
kind and amount of risk and return. The point is to select the portfolio that will provide the highest return. positive leverage: Use of borrowed funds that increases the return on an investment. positive yield curve: When interest rates are higher on long-term debt than on short-term debt
securities. A positive yield curve is the expected situation for investments of the same quality. A negative yield curve exists when interest is higher on short-term debt securities. poverty: An inexact measure of income and wealth based as much on perception as on actual cal-
culations. Generally it means income and wealth at or below subsistence level. preferred stock: A class of stock without ordinary voting rights but that allows the owners certain
privileges, including preference over common stockholders in the payment of dividends or in the liquidation of assets. premium: Usually an incentive payment. In insurance, refers to the fee paid for the policy. In stocks, the amount paid over the market price for shares. For example, an acquirer may pay a premium to entice shareholders to sell the acquirer their holdings. Premium may also refer to the trading price of a new issue above its offering price. prepayment: Unscheduled early repayment of principal. prepayment risk: The risk to the investor in mortgage-backed securities due to changes in the
prepayment rate. present value: The value today of a future payment discounted at an appropriate rate of interest. presidential election cycle theory: Some investment advisers maintain that major stock market
moves can be predicted on a four-year presidential election cycle. Historical patterns show that incumbent presidents seek to encourage an economic program that flowers by election day. price/earnings ratio (P/E): A standard measure of risk; the market value of a share of stock di-
vided by earnings per share for a twelve-month period. A low P/E ratio is considered relatively safe, but less likely to increase in a rising market. primary market: The first market for new issues of securities. When a stock-issuing company
sells new securities directly to the public, it gets the proceeds. Once investors hold the shares they may buy or sell them among themselves in the secondary market and keep the proceeds. A stock exchange is a secondary equity market. prime rate: The lowest interest rate commercial banks charge their best customers, usually large, strong corporations. The rate is determined by market forces affecting a bank’s cost of funds and the rates that borrowers will accept. Banks may offer some customers discounts on the prime rate. principal: The person for whom a broker executes an order, or a dealer who buys or sells for his or her own account. Also refers to an individual’s capital or the face amount of a bond. private-label brand: A manufacturer’s products on which a retailer or wholesaler, such as a grocery store, has placed its own name.
GLOSSARY
private placement: The direct sale of securities by a company to institutional investors, such as insurance companies. Because the securities don’t involve the public, private placements don’t come under the jurisdiction of the SEC. privatization: In general, when a firm shifts ownership from public to private investors. For a
publicly held company, this may mean going private by repurchasing its outstanding stock from public shareholders. In an international context, privatization is associated with economic restructuring in which state-owned enterprises are sold to the private sector. producer price index: Measure of inflationary trends based on changes in wholesale prices. The index is broken down into components that reflect the price of products as they move through manufacturing and distribution before reaching the consumer. profit and loss statement (P&L): A summary of a company’s sales and expenses during an accounting period. It is the same financial statement referred to as the operating statement or income and expense statement. profit center: A unit of a company that operates in a decentralized environment. Profit centers
have a calculable rate of return and may report sales and earnings independent of the parent company. profit margin: Generally, the ratio of net profits, after taxes, to sales. But profit margins may also
involve a calculation of the return on sales based on gross profit or operating profits. profit sharing: An employee benefit that allows workers to share in the firm’s profits. The com-
pany makes contributions to an account for the employee. The profit sharing may be given in cash or invested for the employee. profit taking: The selling of appreciated stock by investors to realize their profits. This term is of-
ten used to explain a downturn in equity markets. program trading: Strategy used by institutions that calls for buying and selling stocks in a program or index on which options and futures are traded. Computers assist in the buying and selling with the objective of capturing the arbitrage profits available when stock indexes and their futures or options are being traded. prospectus: An official selling document registered with the Securities and Exchange
Commission that the issuing entity must provide to investors in new securities so that they can evaluate the investment before purchasing it. It describes the history, lists officers, and outlines the financial background of a company, a partnership, a mutual fund, or other investment. proxy: A person with the authority or power to act for another. Shareholders may vote by proxy. In some cases, a proxy is a power of attorney. proxy fight: A way to gain control of a company. The goal is to get enough shareholders, through
the votes of their proxies, to vote out a company’s board of directors, unseat the management, and replace these with candidates sympathetic to those seeking control. Proxy fights usually erupt between factions within the company, but they may also involve shareholders outside the company who seek support for a takeover.
GLOSSARY
proxy statement: Information the Securities and Exchange Commission requires companies to give shareholders before the solicitation of proxies. The statement lists the board of directors and the directors to be elected by a vote of the shareholders in person or by proxy. Other information about the company, including resolutions and changes in corporate procedure, is outlined in the statement. punitive damages: A form of punishment that increases the damages for wrongdoing by providing compensation above the actual damages. purchasing power: The value of money measured in terms of the goods and services it buys. The index of consumer prices, with calculations for inflation, is used to determine purchasing power. put: An option to sell a specific security at a specific price within a designated period. quota: A quota sets a maximum, minimum, or both for the quantity of goods in circulation. In in-
ternational trade, it is used to regulate the amount of imports of certain goods into a country. Quotas are a form of protectionism. raid: An attempt to acquire enough shares of a company to gain control of it. Companies are usu-
ally not aware a raid is coming and are therefore too surprised to mount an immediate defense. Sometimes a raid may involve selling stock rather than buying it. But selling isn’t a raid unless the seller’s intention is to buy the stock back at a lower price. raider: An individual or company seeking control of an enterprise by buying its stock. Implies that
the target company hasn’t been asked to negotiate. However, a raider cannot act in secret for long, since the Securities and Exchange Commission requires that any purchase of 5 percent of a public company’s stock must be announced in a Form 13-D, which states the purpose of the stock purchase. It is after this filing that many companies realize that there is interest by a raider. rally: A rapid rise in the overall market or in an individual stock following a period of decline in the general price level. random walk: A stock theory based on the belief that stock price movements are completely random and unpredictable. rate of return: Generally, earnings as a percent of investment. For stocks, the dividend yield is calculated by dividing the annual dividend by the stock purchase price. rating: A measure of the likelihood that a bond issuer will repay the principal amount at maturity
and meet the scheduled interest payments. Bonds are rated by agencies such as Standard & Poor’s Corporation (highest rating, AAA) and Moody’s Investor Service Inc. (highest rating, AAA). real estate investment trust (REIT): Usually a publicly traded company set up to manage a portfolio of real estate for shareholders. Several types of REITs exist, including ones that lend money to building developers. recession: A downward turn in economic activity. Though they define it differently, most econo-
mists accept that a recession consists of at least two consecutive quarters of decline in the gross domestic product.
GLOSSARY
record date: The date a shareholder must be registered on the stock book of a company in order to receive a declared dividend or to vote on company affairs. red herring: A preliminary prospectus that is not complete or final. It is identified by its red cover. red ink: Slang for a loss. refinancing: A technique for increasing debt or exchanging one debt agreement for another. In
personal finance, one usually refinances to lower the interest rate on a loan or change the method of payment. In bonds, the issuing party may retire existing bonds and issue new debt. In almost all cases, the result is a longer payment period. Also called refunding. registration: The Securities and Exchange Acts of 1933 and 1934 state that securities must be
reviewed by the Securities and Exchange Commission before they can be sold to the public. Registration outlines the plans and financial health of the company issuing the securities. reinsurance: An insurance company practice for sharing risk. One company will accept a policy
and then sell all or part of it to other insurers. The companies that assume part of this risk are paid part of the premium fee the first company collects from the insured. reorganization: When a troubled company continues to operate but its assets are restated to re-
flect their current market value. Not to be confused with bankruptcy, when a company is liquidated. A provision of bankruptcy law does allow a company to reorganize to meet its obligations to creditors. But reorganization doesn’t necessarily mean a company is considering bankruptcy. reserve: Some of a company’s earnings, put aside to pay upcoming expenses such as dividends, improvements, or retirement costs. Often a company has hidden reserves, the result of understatements on the balance sheet. Governments maintain reserves in foreign currencies and gold to pay for imports and foreign debts. reserve requirement: The Federal Reserve System requires member banks to maintain a certain
level of cash or other liquid assets as a percentage of demand deposits. The higher the reserve, the tighter the money supply and the slower the economy grows. residential mortgage: Fixed- or variable-rate loan secured by real estate, used to finance the purchase of residential property. Typical residential mortgages have level payments and fixed interest rates and are self-amortizing. resistance level: The ceiling of the expected price range for a stock or commodity. The lower end of the range is called the support level. When a stock breaks through the resistance level, that occurrence usually causes investors to reevaluate a company. retained earnings: A portion of a company’s earnings, after dividends are paid, that the company
puts back into its operations. Also called undistributed profits. The earned surplus is an important part of a company’s shareholders’ equity. return on equity: A percentage that reflects how well a company is doing against itself and com-
petitors. It is calculated by dividing common stock equity at the beginning of an accounting period into net income (before paying the common stock dividends but after paying preferred dividends). The resulting percentage can be used to compare a company’s performance against that of other companies.
GLOSSARY
revenue: Figure that measures all the money that comes into a business or government during a
certain period. The figure is more comprehensive than sales in that it also includes capital gains and dividends and other sources of funds that are not derived from the daily activities of the enterprise. reverse split: A method companies use to reduce the number of shares in public hands while rais-
ing the value of each share. For example, if there are 100 million shares in public hands valued by the equity market at $1 each and the company announces a 1-for-10 split, the number of shares outstanding is reduced by 10 million and each share rises in value by $10. rights offering: The right that companies sometimes give common shareholders to buy newly issued shares at a discount from what the public might pay at a later date. The company offers the stock to shareholders through investment bankers. risk: The possibility of an economic loss. Foreign exchange risk is the possibility of an economic loss
due to adverse movements in exchange rates. Interest rate risk is the profit impairment due to unexpected movements in interest rates. risk arbitrage: Strategy that involves the simultaneous purchase of stock in a company being acquired and the sale of stock in the company that is acquiring it. The profit, if any, is made when the price of the target company’s shares rises and the acquiring company’s shares fall, as they often do in takeover situations. round lot: This standard unit of trading is 100 shares for stocks and $1,000 par value for bonds.
Sometimes for thinly traded stocks, a round lot may be as small as 10 shares. run on the bank: When depositors lose confidence in the banking system and withdraw their
money. If a run is serious enough, a bank might fail, as hundreds did during the Great Depression of the 1930s. S corporation: Short for subchapter S corporation, a common form for small businesses. It re-
quires that all earned profits and other income be passed to the shareholders each year. The shareholders are taxed as a partnership. sales: The total dollar amount of goods and services sold by an enterprise. Sometimes called rev-
enues, sales are actually a part of revenues, which include other company income such as dividends and capital gains. sales compensation: Salespeople generally are paid in two forms: They receive a base salary plus
a commission. Commission payouts can vary from company to company, but they are based on a percentage of the product revenue a sales rep has generated. sales forecast: A salesperson’s estimate of what he or she expects to sell in a coming period. Sales
managers generally ask their salespeople to prepare sales forecasts. The managers use this data to generate a forecast for the entire sales division, enabling corporate executives to project profits and losses. Saturday night special: A once-popular surprise takeover tactic that was curtailed by the
William’s Act of 1968, which put severe restrictions on how tender offers (a public offer to buy stock from shareholders) should proceed. The technique gets its name from 1960s takeover maneuvers that were planned on weekends for announcement on Monday morning.
GLOSSARY
savings: In economics, income minus expenses. However, this assumes that all income is either
spent or saved, which isn’t always the case. The savings rate is the rate at which savings occur out of income. Because savings is an indicator of the economy’s potential for growth and investment, the proportion of additional income that will be saved rather than consumed is important and is called the marginal propensity to save. Say’s law: Named for nineteenth-century French economist J. B. Say, law that maintains that supply creates its own demand. Therefore, whatever quantity is supplied, it is assumed that the same amount will also be demanded. scope economies: The financial benefit of combining operations instead of undertaking them individually. For example, if a firm produces two products separately, it may find it advantageous to produce them together. seat: An expression for the right to trade directly on the floor of major securities exchanges. The
number of seats is fixed, so an informal market exists among those who buy and sell seats. secondary market: Any market in which existing securities are traded (as distinct from the primary market, in which securities are first issues). A stock exchange is the secondary market for share trading. securities: A general term for stocks, bonds, and other instruments of ownership or debt used to finance business and government. Securities and Exchange Commission (SEC): Established by Congress to help protect in-
vestors, the Securities and Exchange Commission administers the Securities Act of 1933, the Securities Exchange Act of 1934, the Securities Exchange Amendments of 1975, the Trust Indenture Act, the Investment Company Act, the Investment Advisers Act, and the Public Utility Holding Company Act. securitization: The process of converting loans, leases, or other financial commitments into
bonds or other debt market instruments. A simple example would be a portfolio of residential mortgages used to created mortgage passthrough securities. seizure: Government takeover of management and control of a private enterprise. Though seizures
are common in drug-related cases and in some instances of real estate fraud, in a larger economic context, they are rare. senior preferred: Class of preferred stock that has priority over junior preferred stock; both have
priority over common stock. share of the market: The percentage of total sales of a product. A company will seek to expand its market share through advertising, pricing, and other competitive tactics. The larger a producer’s market share, the easier it is for that producer to control prices and profit. shares outstanding: The authorized shares of a corporation in the hands of shareholders. Authorized shares are the maximum number of shares a company can issue under its charter. shark repellent: A number of measures a company may take to prevent a takeover. Tactics may
include poison pills or golden parachutes. The point of shark repellent is to increase the cost or the difficulty of taking over a company.
GLOSSARY
shell corporation: Usually an incorporated company with no significant assets or operations. Such companies are often formed to obtain financing to begin business. They are highly risky investments. Often describes fraudulent tax evasion schemes. Sherman Antitrust Act: Law, passed on July 2, 1890, enacted to curb the growing concentra-
tions of economic power during the industrialization of the United States. short: Owing money or securities. An investor is in a short position when he or she has sold secu-
rities with the obligation to close the position by buying the same securities at a later date. silent partner: Usually, a general partner with no role in management but who receives a share of
the investment and shares in the liability. A silent partner may also be a limited partner with no direct role in management and no liability beyond the individual investment. sinking fund: When a firm has an obligation to redeem its bonds, debentures, or preferred stock,
it may decide to regularly set aside a certain amount of money in a sinking fund to pay these obligations. This isn’t the same as a reserve fund in that sinking funds are generally required by bond or preferred stock charters. Adam Smith: Theorist of market economics, known for the theory that the invisible hand of
competition guides markets, and the wealth of nations increases with the division of labor. socialism: An economic system associated with central planning. The government owns the major means of production. Social Security: A federal plan designed to provide a safety net for individuals and families. It
provides continuing income when family earnings are reduced because of retirement, liability, or death. The fourth and newest component of the U.S. system is Medicare. soft money: A term used in many ways, often refers to money that is tax deductible. In currency
markets, however, it refers to money that is risky to hold because it fluctuates in value or has no value outside of specific trading circles. In the case of Russia’s ruble, the currency is set at unrealistic exchange rates and is therefore not easily converted to other currencies. Hard money refers to gold and convertible currencies. solvency: The ability to repay debts. sovereign risk: The likelihood that a government will default on its loan or fail to honor other
business commitments because of a national policy change. The United States is able to attract foreign investment because it has a low sovereign risk. special drawing rights (SDR): A measure of a nation’s reserve assets in the International Monetary Fund (IMF). These rights are designed to supplement the reserves of gold and convertible currencies (or hard currencies) used to maintain stability in the foreign exchange markets. specialist: A member of the New York Stock Exchange whose job is to match buy and sell orders
and to maintain an orderly market in securities registered to the specialist. Maintaining an orderly market may mean that the specialist must buy or sell for his or her own account when a temporary disparity exists between supply and demand. The specialist acts as a broker’s broker. specie: Money that has an intrinsic value, such as gold or silver coins.
GLOSSARY
spin-off: A new corporation created from a subsidiary or division of an existing corporation. Often, new shares are issued in the newly created company. Shareholders of the parent company receive shares in the new company in proportion to their original holdings. The total value of the shares in the spin-off and the existing parent company would retain about the same value at the time of the spin-off. split: A method of distributing shares to the public in which existing shareholders are given addi-
tional shares based on their holdings. For example, in a two-for-one split, shareholders receive an additional share for each one they hold. Sometimes new stock is exchanged for all old shares, so a shareholder gets two new shares for each old share. In a two-for-one split, the number of shares doubles and the price of the stock (at the time of the split) is reduced by half. spot market: The market for immediate delivery of a currency or commodity at a rate set now,
the spot rate. Immediate usually refers to two business days from order to settlement. spot rate: The yield to maturity of a zero coupon bond. spread: Generally, the profit from selling at a higher price than the purchase price. In securities,
the bid minus the offering price. For an underwriter of securities, the profit in a public offering. spreadsheet: A company ledger showing in columns and rows the company’s financial situation.
It may include a balance sheet, income statement, and sales report. Securities analysts use spreadsheets in researching companies and industries. stagflation: A combination of the words stagnation and inflation. The word was coined in the 1970s to describe a condition of slow economic growth and high unemployment occurring at the same time as rising prices. Standard & Poor’s Index: A gauge of market performance that includes the price movements of
500 publicly traded industrial, transportation, financial, and public utility stocks. stock: Units of a company that represent partial ownership. The purchasers of these units have
rights as owners and may receive income through dividends. Stock may be bought or sold without an effect on a company’s operations. In a stock market, the price of the stock, also called shares, is set by the buyers and sellers of the stock. stock option: Options, or rights, that allow an employee to purchase a stated number of shares of capital stock—almost always stock of the corporation for which he or she works—at a stated price per share. The purpose of options is to provide incentives for employees and to reward executives. straight-line depreciation: A method of depreciation in which the falling value of an asset is written off in equal amounts each year. It is based on the fact that for tax and accounting purposes, assets lose value over time. In the case of real property, the time may be eighteen years. strike: A labor-organized work stoppage with the purpose of exerting pressure on management to
agree to better working conditions and usually associated with the negotiation of a new labor contract. Union members may take a strike vote to authorize action. Sometimes strikes are used to force management to accept a union as a bargaining agent. subordinated: Word suggesting that others have priority. In the case of loans, subordinated debts
have a secondary claim to assets after those with higher claims.
GLOSSARY
subscription privilege: The right of common shareholders to purchase new issues of a company’s
stock. The privilege must be exercised within a stated period of time, usually a month or two. subsidiary: Usually, a company owned by another and considered part of its parent’s operations.
Technically, it is a company more than 50 percent owned by another. subsistence: In reference to standard of living, at a maintenance level without prospect for
growth. As a theory of wages, it says that if wages fall below the subsistence level a labor force cannot be maintained. substitute goods: Goods that perform about the same function or satisfy wants equally. The sig-
nificance of substitute goods is that small price changes in certain goods may result in large changes in the quantity of goods demanded, if a close substitute exists whose price doesn’t change. sunk costs: Costs that, depending on the stage of a project, have been incurred and are therefore
considered unavoidable in the execution of the project. Although they are already incurred, sunk costs do not affect the decision to go ahead with the project and thus are considered bygone. Costs can be described as sunk only at decision points where the firm is faced with the question of whether to continue or discontinue the project. sunshine laws: A response to the Watergate years when the public was concerned with govern-
ment secrecy, these laws refer to state or federal laws that require meetings of regulatory bodies to be held in public or for their decisions and records to be disclosed. The most important of the laws is the Freedom of Information Act, which makes most documents of federal agencies available to the public. supply-side economics: A theory championed by Arthur Laffer in the late 1970s that says that
drastic reductions in tax rates should stimulate productive investment by corporations and wealthy individuals, with the result benefiting the entire society. swapping: Selling one security and buying a similar one almost at the same time to take a loss, usu-
ally for tax purposes. sweat equity: The unpaid personal time and effort put into a project, usually real estate. sweatshop: A place of employment with unacceptable working conditions, usually low pay and inhumane treatment of the employees. syndicate: Investment bankers who agree to raise capital to purchase the securities of an issuer.
Also called an underwriter, a syndicate works with the selling group to market shares or units of the issue at a fixed price. takeover: A change in the controlling interest of a corporation. A takeover may be friendly or unfriendly and involves a takeover company and a target company. Target companies may resist a takeover by using a number of tactics to make the purchase unattractive. tariff: Usually, a federal tax on imports or exports exercised in order to raise money, although the
effect may be to discourage trade of certain goods. The term also refers to fees or charges for freight. taxable income: The amount of income after deductions that is subject to tax. For an individual,
it is called adjusted gross income. For a corporation, it is the net income before taxes.
GLOSSARY
tax credit: A direct dollar-for-dollar reduction in tax liability. It differs from a tax deduction, which reduces taxes only by the percentage of a taxpayer’s tax bracket. tax-deferred investment: An investment whose accumulated earnings are free from taxation un-
til the investor takes possession of them, such as an individual retirement account. tax-exempt investment: An investment, such as municipal bonds, that allows investors to col-
lect interest without paying taxes on the income. Though the returns on such investments are less than those on taxable investments, the tax-free status is supposed to compensate for the lower return. This tax status is allowed in order to encourage investments in such activities as state hospital construction. Some investments are double or triple tax free, which means that the investor pays no federal, state, or local tax on the income. tax shelter: A method investors use to legally avoid or reduce taxes. Depreciation and depletion
are two common methods of reducing taxes. Tax reform in the 1980s greatly reduced the benefits of tax shelters. tenancy in common: In real estate, the ownership of property by two or more people, each of
whom has an undivided interest without the right of survivorship. tender offer: A public offer to buy shares from existing stockholders of a public corporation. The tender offer states the terms and price of the offer. Shareholders usually receive a premium above current market price for their shares, subject to the tendering of a minimum and maximum number of shares. term loan: A loan of typically two to ten years given by financial institutions, such as a finance
company, for equipment or working capital. term structure of interest rates: A chart plotting the spot yields of a family of zero coupon
bonds having similar properties (such as credit risk and marketability) against the maturity of the bonds. thrift institution: Institution that collects consumer deposits and makes loans mostly to individuals, i.e., savings and loans, savings banks, and credit unions. Traditionally, thrifts provided loans for residential housing, but they now make commercial and consumer loans as well. Credit unions are still limited primarily to making auto and other consumer loans. tick: A movement in a security. Analysts watch ticks to get a feel for the trend in price for a stock
or security. An up-tick describes a transaction made at a price higher than the preceding transaction price. tight market: In an active market, bid and offer prices tend to occur within a narrow range.
When the difference in bid and offer shrinks and the spread narrows, the market is tight. The opposite is a slack market. tight money: Situation in which obtaining credit becomes more difficult. Usually the result of a Federal Reserve Board action to restrict the money supply. tip: Information passed on to an investor that may encourage the purchase or sale of an investment.
Because tips are information not readily available to the public, investors who act upon such information may open themselves to charges of insider trading.
GLOSSARY
total return: The realized return of a bond that is held to maturity. Total return includes coupons,
return of principal, and interest earned on reinvested coupons (interest-on-interest). trade deficit: Condition in which the volume of goods and services sold is less than the amount
purchased. The result is a negative balance of trade. It is the opposite of surplus. trademark: Any designation, such as a name, design, or color, that distinguishes a product or a
company from others. Trademarks are protected by law from infringement. trading range: The highest and lowest prices at which securities trade. In commodities, it refers to
the limit a commodities exchange sets for a single commodity. transaction: A business occurrence involving two or more persons or business entities in which
goods or services are exchanged for monetary consideration—cash or deferred payment. A mere promise or agreement to do something is not a transaction if money is not involved. For example, John’s promise to pay Tom $500 to supply editorial services becomes a transaction for bookkeeping purposes only when John makes a payment to Tom (either in advance or when the work is completed) or when Tom supplies an invoice claiming $500 for services rendered. treasuries: U.S. government debt secured by the full faith and credit of the federal government.
Issued in various schedules and maturities, income is exempt from state and local but not federal taxes. trial balance: A list of debit and credit balances taken from all ledger accounts. trickle-down theory of economics: The idea that if individuals and businesses are allowed and
encouraged to flourish, then their prosperity will eventually benefit everyone through improved economic activity. triple-witching hour: The last Fridays of March, June, September, and December, when options and futures on stock indexes expire at the same time. Unusual activity results from large trades by arbitrageurs and other hedgers. trust: A legal relationship that allows an owner of property to hand over title of the property to another, called a trustee, for the benefit of a third party, called a beneficiary. trustee in bankruptcy: Court-appointed trustee who will administer the affairs of a bankrupt
company or individual. turnaround: Reversal. Assuming that a company is doing poorly, a turnaround is a reversal of this
condition. Markets and economies can make turnarounds, too. undercapitalization: A shortage of funds. This condition exists when a business does not have
enough money to carry out normal business functions. underemployed: Describes the condition when employees’ jobs fail to take advantage of their ed-
ucation, talent, or experience or do not require their full capabilities. underground economy: An unrecorded part of the economy made up of legal and illegal activities. Most of the transactions are made in barter or in cash to avoid taxation or detection by government or law enforcement agencies.
GLOSSARY
undervalued: Not reflecting the full value. When a company’s stock does not reflect the full value of the firm’s assets, it is said to be undervalued. Undervalued companies are frequently targets of takeover attempts, since acquirers can buy assets cheaply this way. Value is determined by estimating the profit that might result from liquidating the company. underwriter: In stock investment, one who buys stock from an issuing company and then sells it to the public. The profit is the difference between the price paid to the issuer of the investment and the public offering price. In insurance, the underwriter assumes the risk of the policy and collects a premium. unearned income: For tax purposes, income from sources other than salaries, wages, and tips,
such as dividends, interest, and rent. union rate: Through collective bargaining, a union sets an hourly rate for wages for its members.
The rate is usually the minimum that will be paid for a particular job classification. union shop: A company where all the employees must be members of the union. unissued stock: Stock that has not been sold to the public. A company’s balance sheet shows the number of shares authorized by the company and how many are issued and unissued. The unissued stock doesn’t pay dividends and can’t be voted. usury: A level of interest rates above that permitted by state law. Usury limits vary according to the
type of lender and the type of loan. value-added : Benefits of a product or service to the consumer that extend beyond the price.
Increasingly, many marketers are realizing that price alone will not win them buyers. In addition to the product, they may have to include value-added services such as extended warranties or speedier delivery to win over prospects. value-added tax (VAT): A method of taxation, common in European countries, charged against
the steps of production that add value to a product. Taxpayers, therefore, pay the difference between the cost of a good at the beginning of its processing and the amount of value added at each step of production. venture capital: Financing needed to begin a business, usually a risky or unproved venture. In ex-
change for the capital, the investor gets partial ownership of the business. High-risk venture capital also offers the potential for substantial profits. vertical spread: An investment strategy that calls for simultaneous buying and selling of options
on the same security, with the options having identical expiration dates but different strike prices— the predetermined exercise price of the stock option. vesting: Process by which employees receive employer-contributed benefits, such as a pension fund, after they work at a company a minimum number of years. By federal law, employees at most firms are fully vested within seven years. volume: The number of shares traded during a period of time. Daily volume of the entire market indicates investor interest, and periodic comparisons point to trends that technical analysts use to forecast movements. The NYSE alone can handle in excess of 600 million shares a day.
GLOSSARY
wage freeze: A limit on pay increases for workers, instituted by a government or a company to contain costs. On a national scale, wage freezes are usually accompanied by price freezes. When such freezes are eliminated, the result is usually a rapid escalation of wages and prices. wage-push inflation: An economic condition when wages increase faster than productivity such
that costs rise and therefore the prices of goods increase. warrant: A certificate issued directly to shareholders giving them the right to purchase securities at
a predetermined price, usually for a predetermined time. wasting assets: Resources, such as oil or gas, that are depleted over time by extraction. watch list: Securities singled out for special surveillance by brokerage firms or regulatory organi-
zations. Firms on the list may be takeover targets or companies with high stock activity. welfare economics: An economic specialty that concentrates on the effect of different actions on
the well-being of the nation and its population. white-collar workers: People who do nonmanual work, such as administrators and professionals.
Blue-collar workers are factory workers and other people who wear uniforms, which in the past were often blue. white knight: A suitor who comes to the rescue of a company that is fighting off a takeover at-
tempt by another company. wholesaler: This word has several meanings. In business, it is a middleman who takes delivery
from producers of goods for resale and distribution to consumer outlets, such as supermarkets or retailers. It also refers to a broker/dealer who trades securities with other broker/dealers for prices below market value or for a selling concession. wildcat strike: An illegal, unannounced work stoppage while a labor contract is still in effect. Like other strikes, wildcat strikes arise over wages and working conditions. working capital: Also referred to as net working capital, the difference between a company’s current assets and current liabilities. The calculation is used to judge the strength of cash flow and management of financial resources. World Bank: The common name for the International Bank of Reconstruction and Development. write-off: An elimination of an item from the financial statement. Write-offs occur when assets are
worthless or when debts cannot be collected or other negative events affect operations. The effect is to reduce profits or book value. Yankee bond: A bond issued outside the United States but registered for sale in the U.S. and traded in dollars. yen bonds: Bonds denominated in Japanese yen and valued by investors who want to diversify
their holdings in currencies other than dollars or German marks. Yen bonds are still a small factor in international credit markets. yield: Also referred to as the return (it does not involve capital gains or losses), yield is expressed as
a percentage of dividends or interest paid by a company to the current price of the security.
GLOSSARY
yield curve: A chart plotting the yield to maturity of a family of bonds having similar properties
(such as credit risk and marketability) against the maturity of the bonds. yield to maturity (YTM): The single rate of interest that discounts all future bond cash flows, both coupons and principal, back to the present value. The YTM is the same as the internal rate of return. Zaibatsu: A large Japanese complex of industrial enterprises controlled by a small group, usually
one or two families. The term is widely, but usually incorrectly, used to refer to Japanese trading companies. zero-base budgeting: Budgeting that requires justification for all expenditures. Therefore, all
lines on the budget begin at zero. Funding is provided according to merit. zero coupon bond: A security sold at a deep discount from its face value. Since the rate of return is achieved by gradual appreciation of the security, there are no interest payments. The face value is redeemable at maturity.
Contributors Ovid S. Abrams, a 1976 fellow, is a senior editor at Standard & Poor’s, a division of McGraw-
Hill Companies. He is also an adjunct professor at Baruch College, CUNY. Scott Aiken, a 1976 fellow, was business editor of the Cincinnati Enquirer in the late 1970s and
formerly headed the Freedom of Information Committee for the Society of Professional Journalists. He is currently president of Scott Aiken Public Relations. Julia Angwin, a 1999 fellow, is a technology reporter for the Wall Street Journal. Steve Askin, a 1991 fellow, is assistant research director of the Service Employees International
Union (SEIU) and editor of the SEIU research manual. His investigative reporting on business issues has appeared in Business Week, the National Catholic Reporter, and many other publications. Sarah L. Bachman, a 1998 fellow, was an editorial writer and reporter for the San Jose Mercury
News. She is now a visiting scholar at Stanford University’s Asia/Pacific Research Center, where she is working on a book/photography/curriculum project about child labor. Sandra Block, a 1994 fellow, is a reporter for USA Today, most recently covering mutual funds, taxes, retirement, and individual investing. Charles Butler, a 1999 fellow, is a senior editor with SmartMoney magazine. He was editor in chief of Sales & Marketing Management Magazine from 1993 to 1998. During that time, the magazine won ten Jesse H. Neal awards for business journalism. Jacalyn DePasquale Carfagno, a 1998 fellow, is business editor of the Lexington Herald-Leader. Frances Cerra Whittelsey, a 1985 fellow, is an editor and writer who has made frequent ap-
pearances on television and radio in connection with her book on gender-based pricing. Aly Colón, a 1983 fellow, is on the ethics faculty of the Poynter Institute for Media Studies. Michael Connor, a 1981 fellow, is a correspondent for Reuters. John J. Doran, a 1999 fellow, was founding editor of Reuters Municipal Bond news service. He is
currently an editor at Reuters. Stephen H. Dunphy, a 1976 fellow, was business editor for the Seattle Times from 1978 to 1992. He currently writes an economic news column for the newspaper. John C. Finotti, a 1995 fellow, is an associate editor at Florida Trend Magazine. John Gallagher, a 1987 fellow, is a business reporter for the Detroit Free Press. He writes about urban and economic development and other issues.
CONTRIBUTORS
William Glasgall, a 1978 fellow, is a senior editor at Business Week and is responsible for covering
personal investing, financial strategies, and lifestyle. James V. Grimaldi, a 1993 fellow, is national legal affairs staff writer for the Washington Post’s
business section. Peter Alan Harper, a 1995 fellow, is a national business writer at the Associated Press, where he has covered bankruptcy, the New York City economy, emerging markets, and race and economics. Pamela G. Hollie, director of the Knight-Bagehot Program from 1987 to 1990, is Kiplinger
Professor in Public Affairs Journalism at Ohio State University. John M. Holusha, a 1976 fellow, is a reporter for the New York Times. His beats have included au-
tomotive, manufacturing, and the environment. Jan Hopkins, a 1983 fellow, is an anchor with CNN Financial News. As a result of her live cover-
age of the stock market crash of 1987, CNN won its first Peabody Award. Sharon R. King, a 1996 fellow, is a freelance writer based in New York City. Mel Laytner, a 1988 fellow, reported for United Press International and NBC News for fifteen
years in New York, London, and Jerusalem. He is currently a principal of Laytner’s Linen & Home. Andrew Leckey, a 1979 fellow, is a syndicated investment columnist for the Chicago Tribune and
a syndicated television reporter for the Quicken.com Money Reports. The author of six books, he is also a teaching fellow in business journalism at University of California, Berkeley. Trudy Lieberman, a 1977 fellow, is director of Consumers Union’s Center for Health Care Choices and a contributing editor for the Columbia Journalism Review. She was formerly health policy editor for Consumer Reports. Dave Lindorff, a 1979 fellow, has reported from Japan, the former East Germany, the U.K.,
Taiwan, Puerto Rico, Malaysia, and Laos as a freelance journalist. He spent five years as contributing editor based in Hong Kong for Business Week and is the author of Marketplace Medicine: The Rise of the For-Profit Hospital Chains (Bantam, 1992). Patrick McGeehan, a 1994 fellow, is the Wall Street reporter for the New York Times. Craig Miller, a 1986 fellow, is a technology writer and Emmy-winning program host who has ap-
peared on numerous cable/satellite networks, including CNN, MSNBC, The Discovery Channel, and HGTV. Michael Molinski, a 1998 fellow, is mutual funds editor at CBSMarketWatch.com in San Francisco
and former emerging markets correspondent for Bloomberg News. He is author of Investing in Latin America: Best Stocks, Best Funds (Bloomberg Press, 1999). Barbara Presley Noble, a 1996 fellow, is a freelance writer and an adjunct professor at Columbia Graduate School of Journalism. She is the former workplace columnist for the New York Times. Kim Norris, a 1996 fellow, is assistant business editor of the Detroit Free Press.
CONTRIBUTORS
Vincent Chikwendu Nwanma, a 1999 fellow, is a freelance journalist based in Lagos, Nigeria. John J. Oslund, a 1997 fellow, is assistant business editor of the Star Tribune of Minneapolis. Mark Piesanen, a 1996 fellow, has produced business segments for the CBC and for the primetime evening newscast on MSNBC. Currently he is a business consultant with ArthurAndersen USA. Robin D. Schatz, a 1984 fellow, is a department editor at Business Week. Susan Scherreik, a 1991 fellow, is personal finance editor at Business Week. Jaye Robinson Scholl, a 1982 fellow, is West Coast editor at Barron’s magazine. Stephen B. Shepard, who founded the Knight-Bagehot Fellowship in 1975, is editor in chief of
Business Week. Paul Sweeney, a 1986 fellow, is a contributing editor at U.S. Banker magazine. His work has ap-
peared in the New York Times, the Boston Globe, Institutional Investor, Inc. magazine, and Business Week. Pauline Tai, a 1989 fellow, is a writer-consultant based in Hong Kong. Previously she was manag-
ing editor of the Dow Jones China Report, a reporter at Money and the Wall Street Journal, and a former director of the Knight-Bagehot Fellowship. Lawrence J.Tell, a 1983 fellow, was a staff writer for Barron’s and legal affairs editor at Business
Week, before becoming a business private investigator. He is currently president of InterSource International Inc. Terri Thompson, a 1981 fellow, is director of the Knight-Bagehot Fellowship at Columbia
Graduate School of Journalism. Joseph B.Treaster, a 1996 fellow, is a financial news reporter at the New York Times. Leah Beth Ward, a 1988 fellow, is Carolinas enterprise reporter for the Charlotte Observer. Chris Welles, who was director of the Knight-Bagehot Fellowship from 1977 to 1985, recently
retired as a senior editor at Business Week. David M.Wessel, a 1981 fellow, is currently Berlin bureau chief for the Wall Street Journal and coauthor of Prosperity: The Coming 20-Year Boom and What It Means to You. Gerri Willis, a 1992 fellow, is associate editor at Smart Money.
Index Abel, Elie, 362–63 Abrams, Ovid, 79 absolute returns, 151 accounting principles and practices, 79–97; balance sheet, 93–95; balance sheet ratios, 95–96; basics of, 80–83; double-entry principle, 82; earnings statement, 91–93; financial statements, 83–90; fundamental accounting equation, 81; international standards, 97; journal entries (example), 85–90; terminology of, 81–82; trial balance sheet, 90–91. See also financial statements accounts receivable, 101 accredited investors, 147 accrual method of accounting, 80 acid-test ratio, 96 action (debit), 82 actuary, 273, 284, 289 additional paid-in capital, 95 adjusted gross income, 350 advertising, 73, 75, 305–6 African Development Bank, 184 Age of Diminished Expectations, The (Krugman), 11 Aiken, Scott, 63 Airline Deregulation Act of 1978, 30 airline industry, 28, 30, 33 alternative investments, 147–48 American depository receipts (ADRs), 120, 125, 177 American Enterprise Institute, 11 American Institute of Certified Public Accountants (AICPA), 97 American Society of Journalists and Authors, 172 American Stock Exchange, 121 Americans with Disabilities Act, 33 amortization, 81, 92 Anderson, Rolf, 11 Angwin, Julia, 191 annual report (10-K), 83, 99, 197–98 Armstrong, Michael, 241–43 Asian Development Bank, 184
Asian financial crisis, 157–59, 176, 185 Asian Pacific Economic Cooperation, 162 Askin, David, 148 Askin, Steve, 352 ask price, 121 assets, 81 AT&T antitrust case, 31 Atack, Jeremy, 12 auction market, 121 auditing function, 80 auditor’s report, 104–5 averages, 193 Babai, Don, 186 Bachman, S. L., 13 Bagehot, Walter, 363 Bagehot (Walter) Fellowship, 362 balance sheet, 83, 90–91, 93–95, 100 Bank for International Settlements (BIS), 139, 145 Barings collapse, 139, 144 Barnes, Galen R., 277 barriers to entry, 59–61 Barron’s Dictionary of Business Terms (Friedman), 320 basis swap, 143 bear market, 122 “beige book,” 51 below investment grade bonds, 116 Biaggi, Mario, 236 bid price, 121 “big bath” write-offs, 103 Black, Fischer, 141 Black Monday, 125 Black-Scholes option pricing model, 141 Blake, Gil, 148 blinded study, 286 Blinder, Alan, 45–46 Block, Sandra, 347 Bloomberg functions for business journalists, 231–33 blue chips, 120 board of directors, 66, 71
411
bond market, 39, 50–51, 128–38; basic concepts, 128–31; corporate market, 134–36; general resources, 131–33; municipal market, 136–38; Treasury market, 133–34 Bond Market Association (BMA), 131 bookkeeping, 82 book value, 100 book value per share, 96 bottom line, 91 Brautigan, Richard, 291 Brazilian market, 160 Bretton Woods Conference, 182 Brill, Steve, 249 brownfields, 329–30 Buffett, Warren, 98, 102–3 building a book (of orders), 114 bulletin board system, 121, 220 Bundesbank, 47 Bureau of Labor Statistics (BLS), 36, 39, 315 Bush, George, 272 business consolidation, 110 business crime, 171 business cycle, 7 business environment, 5; government regulation of, 33; political economy of, 13–24; pollution control regulations, 33; workplace rules, 33 business journalism: ethics in, 255–62; Freedom of Information Act and, 212–15; live interviews, 234–38; local reporting, 106–11; news resources for, 111; numbers and statistics use in, 191–96; online journalism, 250–54; private company information, 201–4; public company information, 197–201; television journalism, 246–49. See also electronic financial data; government documents; Internet resources; specific industries business management, organization of the firm, 63–71 business-to-business (B-to-B) marketing, 73, 76 Butler, Charles, 72 cable television, 32 call option, 140 call provisions, 270 Canine, Craig, 10 capital formation, 112 capital gain and loss, 350 capital goods, 35 capitalism, 14 capitalization weighted index, 120 capital markets, banking and finance, 112; bond market, 128–38; derivatives and other exotic securities, 139–46; global financial markets,
INDEX
173–79; hedge funds, 147–55; market makers, 113–15; stocks versus bonds, 115–16. See also stock market Capitol Hill, as information source, 209–10 Carfango, Jacalyn, 106 carrying cost, 142 Carson, Rachel, 324 cartel, 30 Carter administration, 25, 30–31, 240–41 cash flow, 312 cash flow from operations, 102 cash method of accounting, 80 cash plus marketable securities ratio, 96 Cato Institute, 187 Celarier, Michelle, 181 Cerra Whittelsey, Frances, 339 certified financial management (CFM), 79 certified internal auditor (CIA), 79 certified public accountant (CPA), 79 CES (Consumer Electronics Show), 292 chairman of the board of directors, 65–66, 71 channel stuffing, 101 chartered accountant, 79 Chatzky, Jean Sherman, 251 Chavez, Cesar, 335 Chicago Board of Trade, 146 Chicago Board Options Exchange (CBOE), 141, 146 Chicago Mercantile Exchange, 146 chief executive officer (CEO), 65–67, 71; global CEO, 178–79; interviews with, 68–69; strategic questions for, 69 chief financial officer (CFO), 67, 71; financial questions for, 70 chief operating officer (COO), 67, 71; operations questions for, 69 China’s market reforms, 163–64 churning, 7 Ciesielski, Jack, 102 Citigroup, 113–14 city hall, as information source, 207–8 Civil Aeronautics Act of 1938, 28 Clausen, A. W., 236 Clayton Antitrust Act, 27–28 Clean Air Act of 1970, 33 Clean Water Act of 1977, 33 Clinton administration, 20–21 code of ethics, 261–62 Colón, Aly, 255 combined ratio, 273 COMDEX trade show, 292 “Come with Me to the FOMC” (Meyer), 48 commercial banks, 112
INDEX
Committee to Protect Journalists, 168 commodities, 271 common stock, 125 Commonwealth Fund, 284, 288 Communist Manifesto (Marx), 16 company profits, 269 comparative advantage theory, 17 comparative store sales, 315 Compensation and Working Conditions, 39 competitive advantage, 58 computer chip industry, 56, 58 Conference Board, 39 confidence level, 195 Conning & Company, 277 Connor, Michael, 301 consolidation, 110 construction spending, 37–38 Consumer Electronics Show (CES), 292 consumer goods, 35 consumer price index (CPI), 38 Consumer Product Safety Commission, 342 consumer reporting, 339–46; consumer movement and, 343–44; enforcement agencies, 342; experts and, 344–45; fairness in, 341–42; getting the story out, 345–46; news sources, 342–43; role-playing and, 341–42 consumption, 6, 35 contango, 142 controlled clinical trials, 286 controller, 67 convergence, 291, 302 corporate behavior, nature of industry and, 55–57 corporate bond market, 134–36 corporate culture, 65 corporate filings, Internet and, 222–23 corporate values, 65 cost of capital, 38–39 cost of goods sold, 92, 94 costs, 61–62 county clerk, as information source, 206–7 coupon payments, 129 courthouses, as information source, 206–7 “Covering Managed Care—A Resource Guide for Reporters and Editors,” 285 Coy, Peter, 217 CPI Detailed Report, 40 Cramer, James, 253 creative destruction, 18 credit, 82 creditors, 81 credit risk, 268 credits (loans), 183 Cronkite, Walter, 303
Crown, Judith, 12 current assets, 94 Current Industrial Reports, 40 current liabilities, 95 current liquidity ratio, 96 Current Population Survey, 6 current ratio, 96 cyclical industries, 230 cyclical unemployment, 7 database marketing, 73 debit, 82 debt markets, 115 deductions, 351 DeFillippo, Robert, 278–79 DeLollis, Barbara, 278 Democratic Party, traditional economic policy of, 5, 20 depletion, 94 depreciation, 81, 92, 351 depression, 6 deregulation, 25 derivatives markets, 139–46, 270; basics of, 141–42; regulation of, 144–45; resources for, 146; virtual securities, 140 Diageo Plc., 179 direct marketing, 73 discount (on bond), 129 discount rate, 8, 44 discount window, 43 discouraged workers, 6, 332 disintermediation, 304 dividend, 92–93, 116 division of labor, 15 Dodd, David L., 127 Doran, John J., 128 double-blinded study, 286 double-entry principle, 82 Douglas, Alan, 239 Dow Jones Industrial Average (DJIA), 120 Dow Jones Transportation Index, 121 Dream Reaper (Canine), 10 Drudge, Matt, 250 Dunphy, Stephen H., 156 earned income, 351 earnings, 91 earnings from operations, 102 earnings per share (EPS), 92–93, 125 earnings statement, 83, 91 eBay, 116–18 EBITDA (earnings before interest, taxes, depreciation, and amortization), 70
e-commerce, 293 economic growth, 6 economic indicators, 4, 34–40, 268–69; construction spending, 37–38; cost of capital, 38–39; employment data, 36–37; gross domestic product (GDP), 35–36; inflation, 38; of local and regional economy, 106–7; predicting the future, 39; retail sales, 37; trade balance, 38; useful publications for, 39–40 economic philosophers: key economists, 16–18; modern thinkers, 19–20 Economic Policy Institute, 332 economic vocabulary, 5–9 economies of scale, 61 Economist as Savior, 1920–1937, The (Skidelsky), 10 economists, tips for conversations with, 9–10 efficient market theory, 125 electronic financial data: analyzing company data, 228–29; Bloomberg functions for business journalists, 231–33; comparing, 229; contextualizing, 227–28; finding sources, 226–27; to generate company stories, 226–33; trend indentification, 229–31 Ellul, Jacques, 296 e-mail list, 219–20 Employee Benefit Research Institute, 284 employee empowerment, 65 Employee Retirement Income Security Act, 33 Employment and Earnings, 40 employment data, 36–37 End of Laissez Faire: National Purpose and the Global Economic After the Cold War, The (Kuttner), 11 Engels, Friedrich, 16, 18 enterprise profitability, 59–61 environmental data, 328–29 Environmental Defense Fund (EDF), 187, 327 environmental groups, 327–28 environmental journalism, 324–30; brownfields, 329–30; other issues, 330 environmental justice, 326–27 environmental organizations, 187 Environmental Protection Agency (EPA), 328 Equal Employment Opportunities Act, 33 equity, 310 equity hedge funds, 147 equity market, 115 e-tailing, 322–23 ethics in business journalism, 255–62; code of ethics, 261–62; excellence and, 256–57; gifts, 258–61; holding a story, 259–60; reading stories in advance, 257–58; stock ownership and, 257
INDEX
European Bank for Reconstruction and Development, 184 European Central Bank, 41, 47, 54 European-style option, 141 European Union (EU), 160 executive organization, 65–68; interviews with senior management, 68–70 expense ratio, 273 expenses, 92 extraordinary items, 92 Fabozzi, Frank, 132 factor markets, 5 Federal Aviation Administration (FAA), 32 Federal Communications Commission (FCC), 29 Federal Election Commission (FEC), 209 federal funds market, 43 Federal Open Market Committee (FOMC), 45, 48 Federal Radio Act of 1927, 29 Federal Reserve, 5, 8, 12, 36, 38, 224; basic working of, 41–44; discount window/rate, 43–44; federal funds interest rate, 43; general principles for journalists, 49–51; practice and mission, 47–49; publication resources and references, 51–52; reserve requirement, 43; theory of, 44–47; Web sites, 53–54 Federal Reserve Act, 44 Federal Trade Commission, 27, 342 Fed Funds rate, 39, 43 fee-for service, 289 feudalism, 14, 16 Fidler, Stephen, 181 FIFO (first in, first out), 94 Financial Accounting Standards Board (FASB), 97, 146 financial assets, 269–70 financial markets: derivatives, 139–42; futures market, 142–43; IPO markets (underwriting activities), 114–18; market makers and, 113–15; stocks versus bonds, 115–16; swaps markets, 143–44 financial planners, 266 financial statements, 83–90; auditor’s report, 104–5; management’s discussion and analysis (MD&A), 100; private companies, 201–4; public companies, 197–201; reading, 98–105; story in the statements, 100–102; write-offs against earnings, 102–4 Finotti, John, 34 firm’s strategy: competitive advantage, 58–59; costs and, 61–62; executive organization,
INDEX
65–68; interviews with senior management, 68–70; niche markets dominance, 58; organizational structure, 64–65; risk factors, 59; and suppliers/buyers, 58 fiscal policy, 5, 43 5 percent rule, 199 fixed assets, 81, 94 fixed costs, 62 fixed-income security, 130 flipping, 117 float, 125 fluid percentages, 192 Folbre, Nancy, 11 Food and Drug Administration (FDA), 33, 342 Ford, Henry, 65 foreign business reporting, 163–72; business crime, 171; company profiles, 170; foreign correspondent of, 165–66; globalization, 171; information sources, 166–70; international trade, 170; labor and environment, 170; making it pay, 171–72; market liberalization, 170; multinational corporations, 170–71; what to cover, 170–71; World Bank, 180–87 foreign correspondent, 165–66 foreign currency translations and transactions, 92 foreign press clubs, 168 Form 4, 200 Form 8-K, 199 Form 10-K, 198 Form 10-Q, 198–99 Form 990, 354–57 Form 990-PF, 356–57 forums, 220 Foss, Murray, 11 Freedom of Information Act (FOIA), 205, 210–15; exemptions to, 213–14; getting help, 214–15; requesting information under, 212–14; tips for reporters, 215 frictional unemployment, 7 Friedel, Robert, 10 Friedman, Jack P., 320 Friedman, Milton, 18 Friends of the Earth, 187 Frumkin, Norman, 11 fund of funds, 152 futures, 140 futures markets, 142–43 futurist, 292 Galbraith, John Kenneth, 19 Gallagher, John, 308 Gartner Group, 293
Gates, Bill, 33 GDP (gross domestic product), 6, 35–36 General Agreement on Trade and Tariffs (GATT), 162 generally accepted accounting principles (GAAP), 79, 97, 99, 274 general obligation bonds (GO), 136 Gibson, William, 296 Gilder, George, 291 Glasgall, William, 139 Glass-Steagall Act, 28, 32, 113 global economy, 23, 156–62, 171; Asian financial crisis and, 157–59; European Union (EU) and, 160; resources for, 161–62; Russian financial crisis, 159 global financial markets, 173–79; rewards versus risks, 175–78 Golden, Soma, 362 “Goldilocks” growth, 160 Goldman, Sachs & Co., 113–18 Goldstein, Steven, 274 go long/short, 150 government, political economy of, 13–24 government documents: Capitol Hill, 209–10; city, county, and state filings, 207–8; in courthouses, 206–7; getting the documents, 210–11; Internet sources, 224; political records, 209; regulatory agencies, 208–9; as source of information, 205; what to ask for, 206–10; where to go, 206–10 government regulation, 25–33; current environment, 32–33; deregulation, 31–32; derivatives markets, 144–45; fall of, 30–31; historical background of, 25–28; major laws of, 26–27; pollution control, 33; the regulators and key industries, 28–30; rise of agencies and laws, 28–29; traders versus takers, 27; workplace rules, 33 Graham, Benjamin, 127 Grameen Bank, 18–19 Granite Capital Management, 148 Grant, Lorrie, 236 Great Depression, 4, 17, 28 greenfields, 329 Greenspan, Alan, 9, 23, 45, 48–51 Grimaldi, James V., 205 gross domestic product (GDP), 6, 35–36 Grove, Andy, 304 growth, 6 growth stocks, 120, 125 Guide to SEC Filings, 201 Hamilton, Alexander, 19
Handbook of Fixed Income Securities (Fabozzi and Pollack), 132 hard assets, 271 hard window, 183 Harper, Peter Alan, 234 Harriman, Edward Henry, 26 Harvard Pilgrim Health Care Foundation, 288 health care industry, 280–90; absolute and relative risk of treatments/cures, 285–86; business stories, 280–81; causal inferences and association, 287; clinical stories, 285; conflicts of interest, 288–89; cost shifting, 282–83; glossary for, 289–90; health policy issues, 280–81; key concepts, 281–89; loss ratios, 283–84; peer review, 287–88; quality issues, 283; research studies, 286; resources for, 289; risk selection, 281–82; sources of information, 284–85 health maintenance organizations (HMOs), 283, 289 hedge funds, 147–55; current status of, 150–52; defining the industry, 150; good/bad leverage, 150; styles and investment goals, 152–54 Heilbroner, Robert L., 18n Henwood, Doug, 11 Heritage Foundation, 187 high-yield bonds, 116 Hill, James J., 26 historical spread, 229 Hitler, Adolf, 29 HMOs (health maintenance organizations), 283, 289 Hollie, Pamela G., 212 Holsendolph, Ernest, 236 Holusha, John, 324 Hopes Betrayed, 1883–1920 (Skidelsky), 10 Hopkins, Jan, 239 households, 5 housing starts, 37, 40 human capital, 35 Huntington, Collis Porter, 26 hyperinflation, 46 income statement, 83, 100 index fund, 125 Index Medicus, 287 index of leading indicators, 39 individual investor, 269 industrial revolution, 25–28 industry structure, 55–57; barriers to entry, 56; corporate behavior and, 55–57; life cycle analysis, 56; product differentiation, 55–57; profitability trends, 56; strategy as a response to, 57–58
INDEX
inflation, 6–8, 35, 38, 268; unemployment and, 7 initial public offering (IPO), 114–18, 125 in process research and development, 103 inputs, 5 inside director, 66, 71 Institute of Certified Financial Planners, 266 Institute of Medicine (IOM), 283 institutional investor, 125 insurance cycle, 274 insurance industry reporting, 272–79; fundamentals of business, 273–75; getting the story, 275; regulation of, 276–77; trends, 275–79 insurance product, 270 intangible assets, 81 intangibles, 94–95 intellectual property, 306–7 Inter-American Development Bank, 184 interest income, 92 interest rate, 5, 8, 268 interest rate risk, 268 Internal Revenue Service (IRS), 347–48, 350 International Association for Financial Planning, 266 International Bank for Reconstruction and Development (IBRD), 183 international business, 163–72. See also foreign business reporting International Development Association (IDA), 183 International Federation of Journalists (IFJ), 168 International Finance Corp. (IFC), 183–84 International Labor Organization, 166 International Monetary Fund (IMF), 12, 47, 54, 158, 160–62, 166, 184–85; history, mission, and goals, 182–84; as journalistic subject, 180–85; sources and stories development, 185–87 International Swap & Derivatives Association (ISDA), 144, 146 international trade, 156–57, 170 Internet resources: bond market resources, 131–32; business resources of, 305; corporate filings, 222–23; derivatives and swaps, 144–45; economic data sources, 12; e-mail newsletters, 219–21; for experts and sources, 223–24; Fed Web sites, 53–54; financial sites, 225; government agencies, 224; market data, 225; news resources, 111; online communities, 219–21; online journalism, 250–54; political economy and, 22–24; public company disclosures, 197–201; resources for business reporters, 216–25; search engines and portals,
INDEX
218–19; SEC’s Web site, 99; stock exchanges, 225; World Wide Web and, 221–22 Interstate Commerce Commission (ICC), 26, 29 inventories, 94 inventory turnover ratio, 320 investment banks, 112 investment goods, 35 investment grade bonds, 135 investment vehicles, 269–71 invisible hand of market forces, 15 Islam, 15–16 Jacobs, Jane, 27 Jacoby, Sanford, 12 January effect, 126 Japan’s political economy, 14 Jefferson, Thomas, 19, 25 Jett, Joseph, 234–35, 238 joint and several liability, 329 Jones, Alfred Winslow, 147, 150, 155 “Journalist’s Guide for Health Stories, A,” 287 junk bonds, 116, 135 Kaiser Family Foundation, 284 Kaku, Michio, 292 Kellen, Konrad, 296 Keynes, John Maynard, 3–4, 10, 17–18, 20 Keynesian economics, 4, 18, 23 King, Sharon R., 119 Knight-Bagehot Fellowship in Economics and Business Journalism, 362 Kohler, Horst, 183 Kramer, Larry, 253 Krugman, Paul, 11, 19 Kuttner, Robert, 11 labor force, 6 labor force participation (LFP), 6–7 labor unions, 332 labor and workplace issues, 331–38; demographics, 336–37; productivity, 332; technologies, 337–38; unions, 332–35; working conditions, 335–38 Laffer, Arthur, 19–20 Law of Large Numbers, 194–95 Laytner, Mel, 315 leading in the polls, 195 Leckey, Andrew, 173 Leeson, Nicholas, 144 leveraged contracts, 142 liabilities, 81 libertarianism, 21
Lieberman, Trudy, 280 LIFO (last in, first out), 94 Light, Larry, 277 Lindorff, Dave, 163 lines of business, 71 liquid assets, 81 liquidity risk, 268 list serv, 219–20 load (initial sales charge), 177 loan facilities, 184 local business journalism, 106–11; big businesses (players) in town, 107–9; local and regional economy, 106–7; strategy for reporting, 109–11 long bond, 134 long bond rate (30-year), 39 long-run analysis, 59 long-short strategy, 150 Long-Term Capital Management (LTCM), 144, 148, 150 long-term liabilities, 95 loss ratio, 273 macroeconomics: basic concepts and terms of, 3–12; circular-flow model, 5; defined, 4; government policy and key participants, 4; Internet research sources, 12; suggested readings for, 10–12. See also economic indicators; Federal Reserve; government regulation; political economy macro hedge funds, 149 Madison, James, 212 make-good, 75 making a number, 318 Malkiel, Burton G., 124 Malone, John, 303 managed care, 289 management’s discussion and analysis (MD&A), 100 “manorial capitalism,” 12 manufacturer’s new orders, 37 margin, 318 margin dollars, 318 margin of error, 195 market capitalization, 126 market correction, 122 market crash, 122 marketing. See sales and marketing market liberalization, 170 market makers, 113–15 market neutral hedge funds, 153 markup, 318 Marsh & McLennan Companies, 275
Marx, Karl, 16–17 Marxism, 21 mathematics in business journalism, 191–96; averages (mean), 193; average versus the individual, 193–94; fluid percentages, 192; Law of Large Numbers, 194–95; normal distribution, 195; static percentages, 192; surveys and polls, 195–96; units of measure, 191, 192 McGeehan, Patrick, 112 McGrath, John, 179 McNamara, Robert S., 183 mean, 193 media and entertainment, 301–7; advertising, 305–6; convergence of media and markets, 302–3; intellectual property and regulation, 306–7; technology influences, 304–5 median, 193 Medicaid, 290 Medical Letter on Drugs and Therapeutics, 289 Medicare, 290 MEDLINE, 289 Merrill Lynch & Co., 113 Mexican financial crisis, 184–85 Meyer, Laurence, 45, 48 microeconomic theory, 55; barriers to entry, 59–61; corporate behavior and nature of industry, 55–57; economics of the firm, 55–62; enterprise profitability, 59–61; organization of the firm, 64–68; sales and marketing and, 72–78 Microsoft, 21, 33 Miller, Craig, 291 Molinski, Michael, 226 monetarism, 18 monetary policy, 5; basic workings of, 41–44; defined, 43; Federal Open Market Committee (FOMC), 45 monopoly, 60–61 Monthly Labor Review, 40 Moody’s, 166 Morgan, John Pierpont, 26 Morgan Stanley Capital International (MSCI) Europe, Australasia, Far East (EAFE) Index, 177 Morgan Stanley Dean Witter & Co., 113 most active stocks, 126 multinational corporations, 170–71 municipal (muni) bond, 136–38 Municipal Securities Rulemaking Board (MSRB), 131 mutual funds, 230, 270 Nasdaq Composite Index, 120–21
INDEX
Nasdaq 100 index, 121 Nasdaq stock market, 119, 121–22 National Advertising Division (NAD), 342 National Association of Home Builders, 314 National Association of Insurance and Financial Advisors, 278 National Association of Insurance Commissioners, 278 National Association of Purchasing Managers (NAPM), 37 National Association of Realtors, 314 National Association of Securities Dealers, 121 National Bureau of Economic research, 12 National Conference of State Insurance Legislators, 278 National Highway Traffic Safety Administration (NHTSA), 339, 343 National Labor Relations Act (NLRA), 28, 334 National Labor Relations Board (NLRB), 334 nationally recognized municipal securities information repositories (NRMSIRs), 359 National Women’s Health Network, 286 National Writers Union, 171–72 natural monopoly, 60–61 Natural Resources Defense Council (NRDC), 327 Nelson’s Directory of Business Research, 110 net book value per share of common stock, 96 net income, 93 net sales (revenue), 92 network, 290 net working capital to total assets ratio, 96 net worth to total debt ratio, 96 New Deal program, 334 new issues, 120 New York Stock Exchange (NYSE), 119, 121 niche markets, 58 Nobel, Barbara P., 3 Nokia Corp., 178 nonfarm payroll employment, 36 nongovernmental organizations (NGOs), 166, 182 nonprofit organizations, 207. See also not-forprofit institutions normal distribution, 195 Norris, Kim, 331 not-for-profit institutions, 207, 352–61; disclosure documents, 353–57; expert advice, 360; Form 990, 354–55; fundraising of, 357–59; investigative tips, 353–57, 359; obtaining Form 990 and 990-PF, 356–57; Schedule A, 354–55; tax-exempt bond documents, 359; Web sites for information, 357
INDEX
notional position, 144 Nwanma, Vincent, 55 “objectivist” philosophy, 23 observational studies, 286 Occupational Safety and Health Administration, 33 offering registration statement, 200 offshore funds, 151 oil crisis, 30 oil industry, deregulation of, 30 oil trusts, 25–26 Okun, Arthur, 7, 19 Okun’s Law, 7 Ollila, Jorma, 178 one-to-one marketing, 73–74 online journalism, 250–54 open market activities, 133 open outcry system, 142 operating income, 92 operating managers, 67 opportunity (or real) costs, 61 organization, executive, 65–68; glossary of organization management, 71 organizational structure, 64–65 organization chart (org chart), 64 Organization of Economic Cooperation and Development (OECD), 12, 162 Organization of Petroleum Exporting Countries (OPEC), 30 original equipment manufacturers (OEMs), 58 Oslund, John J., 25 outputs, 5 outside director, 66, 71 oversubscribed offering, 115 over-the-counter (OTC) market, 121, 134 owner’s equity, 81 Oxfam International, 187 Paltrow, Scot, 278 participative management, 65 par value, 95, 129 Passell, Peter, 12 peak of economic cycle, 6 Peddling Prosperity (Krugman), 11 Peiser, Joseph, 275 penny stocks, 120 percentage points, 196 personal computer (PC) revolution, 291 personal exemption, 351 personal finance reporting, 265–71; product research, 267–68; tips for starting, 267–69; understanding your reader, 266–67
personal interviews, 234–38; importance of preparation, 235–36, 240, 244; live television interviews, 239–45; search for new perspectives, 237–38 Pesek, William, Jr., 49 phantom stock, 201 Phillips, A. W., 7 Phillips curve, 7 Piesanen, Mark, 246 point-of-sale (POS), 321 point-of-service (POS), 290 political economy: defined, 14; economic philosophers, 14–18; of government and business, 13–24; the Internet age and, 22–24; theory and practice, 21; why philosophy matters, 14 political records, as information source, 209 Pollack, Irving, 132 polls and surveys, 195–96 pollution control regulations, 33 Pop Internationalism (Krugman), 11 portals, 218 Porter, Michael, 237 posting, 219 potlatch economy, 14n Poynter Institute for Media Studies, 256 predatory pricing, 33 preferred provider organization (PPO), 290 preferred stock, 126 premium (on bond), 129 prepayments and deferred charges, 94 price weighted index, 120 primary dealers, 133 principal, 129 principal risk, 268 private companies, researching information on, 201–4 producer price index (PPI), 38 product differentiation, 55–57 productivity, 8–9 productivity gains, 332 product markets, 5 profit, 91, 321 profit maximization, 55 promissory notes, 95 property, plant and equipment (PPE), 60 prospectus, 114, 200 proxy statement, 104, 198 public companies: annual report to shareholders, 197–98; disclosure requirements, 197–201; Form 4, 200; Form 8-K, 199; Form 10-K, 198; Form 10-Q, 198–99; proxy statement, 198; registration statements, 200–201; Schedule 13-D, 199–200
put option, 140 quarterly report (10-Q), 83, 100 quick-asset ratio, 96 quiet period rule, 200 quit rate, 37 railroad industry, 25 Rand, Ayn, 23 randomization, 286 randomized control trials, 286–87 random sampling, 195 Random Walk Down Wall Street, A (Malkiel), 124 Rankin, Robert, 13 rating agencies, 135, 137 rating sweeps, 306 reaction (credit), 82 Reagan administration, 25, 31 real costs, 61 real estate and urban development, 308–14; architect, 313; broker, 312; construction lending, 309–10; contractor, 312–13; developer, 311; identifying the players, 310–11; lender, 311–12; regulator, 313; tax lawyer, 313–14; trade associations, 314 real GDP, 6 recessions, 6 recovery phase of economic cycle, 6 red herring, 114, 200 registration statements, 200–201 regulatory agencies, as information source, 209 Reich, Robert, 19, 291 relative returns, 151 rent roll, 312 Reporters Committee for Freedom of the Press, 214 Republican Party, traditional economic policy of, 5 reserve requirement, 43 restructuring charges, 102 retail industry, 315–23; data sources for, 315–19; e-tailing and, 322–23; inventory turnover, 320; location factor, 319–20 retail investor, 126 retail sales, 37 retained earnings, 95 return on average equity, 60 return on equity (ROE), 60 revenue, 92 Ricardo, David, 17, 22 risk arbitrage, 152 risk premium, 135
INDEX
road show, 114 Robertson, Julian, 147 Robert Wood Johnson Foundation, 284 Rockefeller, John D., 26 Roosevelt, Franklin D., 17, 20, 28, 334 Roosevelt, Theodore, 25 Rubenstein, Howard, 235 Rubin, Robert, 13, 20 Russell 2000 index, 120–21 Sachs, Jeffrey, 19 sales and marketing, 72–78; four P’s of, 74; function of, 74–77; the Internet and, 77; reporter’s angle on, 77–78; in search of stories, 73–74 Salinger, Pierre, 297 Salomon Smith Barney, 113 same store sales, 316 Santa Claus rally, 126 Schatz, Robin D., 216 Schedule A, 354–55 Schedule 13-D, 199–200 Scherreik, Susan, 98 Scholes, Myron, 141 Scholl, Jaye Robinson, 147 Schumpeter, Joseph, 18 Scott, David L., 124 search engine, 218 “Secret’s Out: What Will Fed Watchers Do Now that Greenspan Tells It Like It Is?, The” (Pesek), 49 Securities and Exchange Act of 1934, 28 Securities and Exchange Commission (SEC), 28, 63, 79, 83, 98–99, 114, 151, 177, 197, 205, 224, 276, 359 selling price, 318 Sen, Amartya, 19 “7 percent solution,” 114 shareholder, 119 shareholders’ equity to debt ratio, 96 Shepard, Stephen B., 362 Sherman, John, 26 Sherman Antitrust Act, 26, 28 short interest, 126 short-run profitability, 59–60 short-sellers hedge funds, 154 shrinkage, 318 Siegel, Jeremy J., 124 Silent Spring (Carson), 324 Skidelsky, Robert, 10 slavery, 14 Sloane, Leonard, 277 Small Business Administration (SBA), 204
INDEX
Smith, Adam, 14–16, 18, 21, 24 socialism, 14 Society of American Business Editors and Writers (SABEW), 261 soft money, 209 soft window, 183 Soros, George, 147 spam, 220 special drawing rights (SDRs), 184 speculative grade bonds, 135 spiders, 218 spread, 116 Standard & Poor’s (S&P), 166 Standard & Poor’s 500 Index (S&P 500), 120 Standard Industrial Classification Manual, 315 stand-by arrangements, 184 state filings, as information source, 206–7 statement of cash flows, 100 statement of operations, 100 static percentages, 192 statistical significance, 194 Steele, Bob, 256, 260 Stein, Herb, 11 Steinhardt, Michael, 147 stock, 95, 115, 119 stock appreciation rights (SARs), 201 stockholders’ equity, 95 stock index future, 126 stock market, 119–27; defining the markets, 122; glossary of terms, 125–27; indexes, 120–21; reporting tips, 123–24; where stocks trade, 121–22; writing about, 123 stock market crash, 122 stock option, 126 Stocks for the Long Run (Siegel), 124 strike price, 141 structural unemployment, 7 subsistence, 14 Sullivan, Brian P., 277 Summers, Lawrence, 23 sunk costs, 62 Superfund Act, 33 “supply-side” economists, 19 Suriewicki, James, 251 Survey of Current Business, 40 surveys and polls, 195–96 Sutch, Richard, 9 swap, 140 swaps market, 143–44 swaptions, 140 Sweeney, Paul, 180 sweeps, 306
Systems of Survival: A Dialogue on the Moral Foundations of Commerce and Politics ( Jacobs), 27 table of organization (T/O), 71 Tai, Pauline, 265 T account, 82 taking behavior, 27 tangible assets, 81, 271 taxable income, 351 tax credits, 351 taxes, 347–52; glossary of terms, 350–51; regulations for, 348–49; writing about, 349–50 taxpayer abuse, 348 tax shelter, 351 technology and telecommunications, 291–300, 304–5; convergence, 291; “experts” and reporter as translator, 293–95; media hype of, 295–98; searching news value in, 298; sources of information, 298–300; technorealism, 296–97; trade show of, 292–93 Telecommunications Act of 1996, 31 telecomputer, 291 television interviews, 239–45; dos and don’ts of, 244–45; importance of preparation, 240–44 television journalism, 246–49; audience demographic and dynamics, 246–47; point and share ratings, 248–49; transition to, 247–48 Tell, Larry, 205 Temin, Peter, 12 Thai baht collapse, 158 Thalhimer, Mark, 250 thirty-year bond rate, 39 thread (topic), 219 Thurow, Lester, 19, 36 Tillinghast Towers-Perrin, 277 Toxic Release Inventory (TRI), 328 Tracking America’s Economy (Frumkin), 11 trade, 156–62 trade balance, 38 trade disputes, 161 trade secrets, 213 trading economy, 27 trading pits, 142 Transparency International, 187 Treaster, Joseph B., 272 Treasury bill, 133 Treasury bond, 134 Treasury market, 133–34 Treasury note, 134 trial balance, 90 triple-witching hour, 126
trough of economic cycle, 6 trust-busting laws, 26 trusts, 26 turns, 320 underwriter, 290 underwriting activities, 114, 273 unemployment, 6, 332; inflation and, 7; types of, 7 unemployment rate, 36 Uniform Commercial Code (UCC) records, 203 United Nations (UN), 182 U.S. Census Bureau, 224 U.S. Commerce Department, 6, 35, 37, 39 U.S. Conference of Catholic Bishops, 187 U.S. General Accounting Office (GAO), 184, 210 U.S. Government Printing Office (GPO), 224 U.S. Labor Department, 38 U.S. Tax Court, 206–7 unqualified approval (opinion), 104 upfront, 306 upfront markets, 75 value investing, 126 Vanderbilt, Cornelius, 26 variable costs, 62 Vogel, Steve, 278 Volcker, Paul, 8 Wagner Act, 334 Wallace, Mike, 235–36
INDEX
Wall Street Words (Scott), 124 Ward, Leah Beth, 197 Wealth of Nations, The (Smith), 15 Welch, Jack, 179 Welles, Chris, xv Wessel, David, 41 Williams, Brian, 248 Willis, Gerri, 250 Wilshire 5000 index, 121 Winbush, Don, 235 Wolfensohn, James D., 183 women, labor force participation, 7 workplace issues, 331–38. See also labor and workplace issues workplace rules, 33 World Bank, 12, 143, 161, 166; history, mission, and goals, 182–84; as journalistic subject, 180–87; Operations Evaluation Department (OEC), 186; sources and stories development, 185–87 World Debt Tables, 186 World Development Indicators, 186–87 World Development Report, 181, 186 World Trade Organization (WTO), 161–62 World Wide Web. See Internet resources write-offs against earnings, 102 Y2K readiness, 293 yield, 129 “zero-sum society,” 19 Zyman, Sergio, 73–74
