Proceed with Caution

Published December 2009

During the summer of 1998, America watched as both Mark McGwire and Sammy Sosa laid waste to one of the national pastime’s most haloed records – Roger Maris’ 61 home runs set in 1961. The fact that not one, but two players could destroy a 37-year-old mark in the same season was met with amazement as well as a healthy dose of cynicism.

Conspiracy theories abounded regarding a souped-up baseball, likely blessed by Major League Baseball as a means of adding more excitement to the game and capturing the attention (and dollars) of the Nintendo Generation. Over the course of the next decade, fans learned that it was the players and not the baseballs that were souped-up. Baseball subsequently cracked down on performance enhancing drugs and the game returned to a pre-steroids normal, with no player hitting more than 50 homers in either of the past two seasons.

We’re now learning that an eerily similar scenario has been playing out within our own economy for the past two or three decades. The performance enhancement drugs have been excessive personal debt and complex engineered financial products like derivatives and credit default swaps.

The Great Recession served as a painful cleansing period to rid the drugs from our system. Unlike baseball, however, it is unlikely that life will return to a pre-recession normal. That’s because our dependence on excessive debt has been developing for over 30 years. One can’t expect to return to their fitness level of 30 years ago after three decades of bad habits simply because they have dutifully dieted and exercised for the past 22 months.

Rather, our economy is likely headed for what’s being referred to as a “New Normal” with a growth rate roughly two-thirds of that to which we’ve become accustomed. The other one-third was driven by purchases based on bad debt.

What does that mean in tangible terms? Instead of roughly 18 million domestic auto sales per year, we’ll see about 12 million. Single family housing starts will drop from an annual peak of 1.5 million per year to 1.0 million. Similar drops are predicted for other big ticket purchases typically financed. The impact is huge when one considers all of the jobs supporting those industries and all of the tax revenues those industries generate.

Headlines recently announced that the recession is over based on positive GDP growth, but it’s important to realize what has driven that growth: businesses cautiously adding to their inventories after months of bleeding them down to very low levels and government incentives in the form of first time home-buyers’ credits, Cash for Clunkers, and other programs. Unfortunately, both inventory adjustments and government spending are temporary. Indeed, some prognosticators are already forecasting the next downturn.

Businesses will quickly adjust production to match actual consumer needs. The Fed’s approach to solving a debt problem by taking on more debt seems akin to Major League Baseball solving its steroids problem by offering free prescriptions to pitchers. Ultimately, two near certainties will be required to service the expanding federal debt: higher tax rates and fewer funds available for legitimate government programs.

What does all this mean to your organization? For businesses, unless your company provides truly innovative products and services, expect slower rates of growth. Count on lower rates of return when making future investment calculations. And for goodness sakes, mind your balance sheet! Now is not the time to bet the farm.

For public entities struggling through this year’s budget cuts, realize that 2009 and 2010 are not anomalies. It took decades of debt abuse to get us here and it will take years to work itself out.

For both private and public organizations, the world has changed. Traditional methods of addressing temporary corrections will prove inadequate. The New Normal requires a new set of rules regarding underperforming assets. The New Normal requires a culture of continuous improvement whereby all survivors are continuously looking for better ways to accomplish work.

It’s often said that baseball mirrors life. Ten years after its Steroid Summer, baseball appears to be flourishing once again. True, attendance was down roughly seven percent this past season. And whenever a player experiences a power surge whispers of steroids can still be heard. But for the most part, the health of the national pastime appears safe. We can only hope as much for our economy.

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