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Free Market Failure is Reaching Dangerous Level and How It Began

LOCOM – Lower of Cost or Market – is an accounting principle intended to require public corporations to properly represent their value in public disclosures. It doesn’t always work that way, though.

Here is how it works: The value of an investment on the books of a corporation is entered at cost. It remains that amount until it is sold, except when the market value of the investment is lower than the cost of the investment. When that happens, the value of the asset must be written down to the market value with a compensating adjustment made to an equity or reserve account as a write off.

While this rule serves well when the value of an investment declines, it actually distorts a corporation’s value when the value of an investment is much greater than its cost.

The first time I recall this being important was after Reagan deregulated the market so we all could have the opportunity to be executives at our own corporations. Nice thought. It didn’t work.

What it actually started was arbitrage. Arbitrage, or the raiding of corporations, was the subject of Oliver Stone’s 1987 movie, “Wall Street.” The idea is to find corporations that have assets worth way more than cost, like Mickey Mouse did to Disney. After acquiring enough shares of a corporation to make some noise, they announce their intentions to purchase a controlling interest and sell off assets for market value.

In the case of Disney, they bought the corporate raiders out at inflated stock prices just to retain control of the operation. It cost them a lot of money to people who were all too willing to take it just because it was now allowed thanks to deregulation.

It worked out well for the owner of a former hardware chain out here called Pay N Pak, though. They were really cool stores, they were a terrific employer, and they were tremendous citizens in the community. It looked like they were going to hold out to fight the raiders, so the raiders kept buying the stock. Finally, they just sold their stocks to the raiders, took the money, and opened up Lowe’s. Then Lowe’s hired all the Pay N Pak employees so they could have really cool stores, be a terrific employer, and be tremendous citizens in the community.

The raiders got all the assets and liabilities to liquidate or operate as they saw fit as new owners; the old owners took the knowledge on what to do with those assets, and then raided the old corporation for the human assets that stock ownership does not include. The players got played!

We are seeing it operate differently these days. It is going unchecked. It is really dangerous. Teddy Roosevelt would not like what we are seeing. Neither would William Howard Taft.

Imagine the market value of a successful corporation that was started twenty years ago with some of its assets worth well more than they publicly disclose because of the LOCOM principle. There is no harm in selling the corporation for market value. That is what you would do if you were selling your house.

Once it is sold, it is under new ownership. The new owners can continue operating it as a successful corporation, they can try to improve it through more of a merger of brands, or they can use what they want and dispose of the rest. They may even be acquiring it because they want the land a person or corporation owns, and have no intentions of retaining operations, employees, or buildings. Those are all legitimate reasons for owners to sell, and buyers to buy, if that is what is best for them.

There are a couple of ways that this can be abused, though, that are quite dangerous. One way is that it is really being done to eliminate competition. That is not in the public interest, but it happens. If it is truly a mutually beneficial transaction that is an expansion of the buyer’s brand, or the seller’s brand for that matter, combined with the elimination of the other, it is fine. If it is an acquisition that would require approval, though, and its sole purpose is eliminating competition, the approval should certainly be denied.

The worst reason this happens is to control distribution of something in which the public has interests by eliminating alternatives, and then inflating the prices just because they can if there is no competion. In the case of broadcasting, such a move can made to influence an opposing viewpoint to get people to argue with one another over material designed to distract them from larger, but less entertaining, issues, or they can simply raise the prices both companies charge with one being the alternative to the other in some, if not many, markets.

We have been down this road before. Abusive and anti-competitive tactics were the basis of the landmark ruling against Standard Oil Company. Forming a cartel to fix prices was the basis of the ruling against Addyston Pipe & Steel Co. Cornering, or attempting to corner, a market for the purpose of controlling distribution through price gouging and limiting competition was a problem in the past, and it is becoming a problem again. Too much power in the hands of too few people has time and time again led to corruption to preserve an undeserved monopoly, which is one that exists for reasons other than superior service or unique product.

Thoughts that these types of abuses can be controlled within the market itself seem to disregard the history that the market has never controlled these abuses in the past. It has always taken intervention by the government on behalf of the public to prevent some people from trying to restrict what is available and how much it costs based on total control of a market for reasons other than superior service or unique product. It is highly profitable. People will try to do it. They should not be allowed to ruin something the public relies upon just because it is more profitable ruined when it need not be ruined for the public.

We have fallen in love with “bumper sticker logic.” If it sounds good, we like it. It doesn’t matter if the logic holds up to scrutiny and investigation. We brand that logic into our minds as a prejudice that overrides research and data contrary to the flawed logic, and hold onto it tightly so that those with whom we are popular because of that don’t get the wrong idea that we may be analyzing that prejudice for truth.

We do not believe that universal principles apply to anything we cannot see, or in ways we do not understand.

I was told in a discussion that I used displacement incorrectly. Displacement, he offered, is what makes a boat float. While displacement is certainly a factor in making a boat float, it is more important that there not be holes in the hull. The displacement does not change if there is a hole in the hull. The boat merely displaces water at the bottom of whatever it would float upon if there weren’t a hole in the hull. It still displaces water, but the hole in the hull does not allow the air, which weighs less than water, to displace enough less water to compensate for what happens when you put materials heavier than water in water. Perhaps the displacement considered in float includes the air inside the hull that prevents the boat from displacing water despite it is built of materials heavier than water. 

I did not think outside a box. There are no boxes that one must think outside of to understand truth. I would say those boxes are part of people’s imagination, but it is more accurate to describe them as part of people’s lack of imagination.

I have been told in discussions that gravity does not affect thoughts or economies, that engineering concepts cannot be applied to non-physical things, and that the proper way to evaluate things is to put them into boxes and think within those boxes. All of that is both faulty logic and ridiculous to believe. It is, however, popular, so we find our comfort in agreeing with other people with the same level of ignorance that we have because they will chime in to defend that erroneous logic. After all, they, too, limit their thoughts to include the same prejudices we have, and they are good people if you get to know them. It forms something like a common bond, even though everyone is there for different reasons, and some are there more than others. Something like gravity, although I’ve been told gravity does not affect thoughts. Those who have said that are incorrect. It is gravity. Literally, gravity.

Truth is not based on our opinions. Truth is not determined through popularity. Truth does not change because the faulty logic on a bumper sticker makes a nice mantra. We can either leverage truth, or we can defy it. However, we cannot change it just because it doesn’t align with our ignorance or prejudices.

LOCOM – Lower of Cost or Market – is an accounting principle intended to require public corporations to properly represent their value in public disclosures.

What we are seeing today all started with the corporate raiders who understood what that accounting principle really shows, and what can exist beyond it, and they went after the companies that existed beyond it.

That was then. What we are seeing today is worse than that. It is the evolutionary by-product of arbitrage. It is going unchecked, and it is reaching dangerous levels.

We should all be concerned about this, even if it does mean not trying to figure out whose label has what over the others’ label at the moment, with all of it confirmed by bumper stickers.


Some other things I've written about: 

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