Finally, A Rap Song About Being Frugal!

Slim Thugga started it with his “I don’t make it rain, I make it drizzle” personal finance ebook, How to Survive in a Recession. Now with Macklemore’s Thrift Shop, seen above, what we have is a downright trend of frugal rapping. Finally, rap songs about money and not in the traditional “I’ve got a condo around my neck” way. Best line from Thrift Shop: “They be like, ‘Oh, that Gucci – that’s hella tight’. I’m like, ‘Yo – that’s fifty dollars for a T-shirt.'”  Rap evolving. I love it.

 

Debt Kills…RIP Twinkies?

Today’s guest post comes from William over at Drop Dead Money. I really enjoyed meeting William at FinCon12 and he definitely writes some of the most entertaining, informative posts around. Leave him a comment and let him know what you think or say hello on Twitter!

Image: Wikimedia Commons

I don’t think I ever ate more than a single Twinkie in my life. You know, as somebody once said: try everything, keep that which is good — that kind of thing. But there can be no doubt that, for better or for worse, the Twinkie is an icon of America.

As is the case with so many icons, Twinkies have a question mark or two swirling around their virtue. Through the years, it has had its share of critics and would-be assassins. If we had a penny for every scathing review of Twinkies’ nutritional value, we’d all be millionaires.

These days it seems icons of dubious nutritional value are under attack everywhere. In France, they’re indulging their penchant for dramatic outrage as we speak (or read) over something called Nutella. Nutella is a chocolatey nutty spread most French parents put on their kids’ lunch sandwiches. (Personal confession and disclaimer: our pantry reached out and snagged a jar. Don’t ask me how, but it did. Stuff’s not bad at all.)

Well, the French government decided recently Nutella isn’t healthy enough and they could not longer allow parents of today to continue the wanton destruction of future generations that their parents perpetrated on the planet. Disregarding the fact that the passers of the law themselves are Nutella graduates, they decided that the future of French humanity requires government intervention of the most serious kind: taxes. Butter, eggs, pâté and cheese are what France should be built on, it seems, but not Nutella. Politics being politics, they couldn’t just single out a product and tax the living daylights out of it, so they fine-combed the ingredient list until they found something they could pick on. And so the government of France decided to triple the tax on… palm oil. Even though the tax is on palm oil, every citizen of France knows the real target is Nutella. (The fact that the parent company is Italian presumably has nothing to do with this brouhaha.)

Twinkies, though, were not attacked by our government. While Twinkies never were the poster child for health food, it wasn’t all that harmful, either, truth be told. Sure, if you eat a million Twinkies you’d look silly, but so would you if you ate a million muffins, chocolate bars, or even carrots.

And so our government, our infinitely wise government, passed on the opportunity to obliterate Twinkies.

That task, as it turned out, was accomplished by a more effective public enemy: debt. That’s right: debt killed the mighty Twinkie.

How?

Private Equity

The corporate debt ogre is like a chameleon, changing its name with every economic cycle. Back in the 80s and 90s it was called leveraged buyouts, done by LBO funds. Junk bonds were often the source of money for these funds, characterized by more hubris than common sense. When those funds were exposed as nothing more than the age-old ugly corporate debt monster, they changed their names to things like private equity funds.

Was there ever a more inappropriate name for something as “private equity?” Because there is usually very little equity involved in these things. Oodles of debt is what they usually are, with as little equity as meat in a strip of bacon. Private equity funds (or LBO funds, or whatever they will be called five years from now) usually spring up at a time when banks have too much money to lend.

These funds typically raise a million dollars and borrow ten. Then, with their eleven million dollars, they buy a low growth business that generates a lot of free cash flow. Their hope is that in time, this cash flow will enable them to pay off their debt so they can sell the company and move on to the next thing. Once they own the company, they try to speed up the payout by squeezing more cash out of their acquisition.

As a concept, buying solid companies with debt is as old as the ages. J.P Morgan used it a hundred years ago to become one of the most powerful men on the planet. Henry Kravis of KKR does the same thing today. In the UK , Jim Slater of Slater Walker did it back in the seventies.

Debt Kills

However, for every buyout success, there are ten failures. J.P. Morgan himself discovered that when his White Star Line’s flagship, the Titanic, sank. The company went under soon after its flagship. What sank the White Star Line was not an iceberg, but debt.

The reason leveraged buyouts fail so often is because they typically are done near the top of the economic cycle, when bank debt is plentiful and lending standards are low.

Armed with more money than brains, these private “equity” funds go searching for decent businesses with solid cash flows.  Then they look at the best case cash flow scenario and project it to keep growing from there. Armed with lovely spreadsheets they approach the owners of these businesses and make them a ridiculous offer. No sane person can turn down such a ridiculous offer, and so the business changes hands.

The previous owners take their windfall and go on their merry ways. Before long, the new owners discover this thing called the economic cycle when it crashes, as it always does after a boom period. Then they can’t make the payments on the debt.

And then the solid company, the one whose good products, good workforce, good vendors and good customers, simply disappears.

All because of debt.

I received my first lesson in how this works back in the late 80s. We lived inSouthern Californiaat the time, and we loved a local company, RB Furniture. It was a good company, making good products, and it was growing, as good companies making good products tend to do. However, they got bought out by a leveraged buyout fund run by Gary Winnick. Of course, the company failed when the recession of 1991 rolled around. And we lost our favorite furniture company. Compared to good people losing good jobs, that was nothing, of course. But it was my first close-up acquaintance with the evil of corporate debt.

And the 18,500 people working for Hostess stand to lose their jobs now, because of debt. If the company had been owned by owners with lower (or no) debt payments to make, Twinkies would still be corrupting (or pleasing, depending on your view) the nation, one cream filled angel cake roll at a time and we wouldn’t be talking about it.

Twinkies, of course, may survive. The rights may be bought by someone else, who may employ some of the workers and equipment.

But, if they do the deal with too much debt, we will see this scenario play out again. They may blame the unions, and they may blame the fickle consumer. But the real culprit will be, as it usually is… debt.

Debt does kill. It’s no accident that Warren Buffett’s businesses run with low debt levels. It’s no accident that Heinz Ketchup survived the Great Depression and flourished because they passionately avoided debt.

Debt (or short term loans) on an individual level leads to hardship. It’s true in the business world, too.