Best of 2020: Building Strong Local Economies (without Cheesecake Factory)
When we originally published this piece on March 30, common stock for The Cheesecake Factory (CAKE) closed at $16.50. In the interim, the corporation has experienced back-to-back quarters of double-digit sales declines. They have furloughed workers and reduced capacity. They have diluted their share value with a large common stock issuance and their debt to equity ratio has more than doubled. They were investigated by the SEC for misleading shareholders and recently agreed to pay a fine—albeit a token amount of $125,000 — to settle the matter.
Despite this turmoil, as I write this, CAKE is trading near $37.00 per share, a 220% increase in its value since I announced that it, along with many corporations like it, were “rigged to blow” and were about to collapse. If anything says “2020” more than that, I don’t know what it would be.
In this piece, I suggested a financial disaster was imminent without “a quick resolution to this pandemic or ongoing and successful bailouts beyond any imaginable scale.” The pandemic is ongoing, but my imagination was clearly not big enough. We have bailed out all the big money players and, this time, didn’t even bother to talk about moral hazard. That’s because we’re way beyond moral hazard. We have embraced an economic system that is wholly immoral, and if you believe that is a statement about the other national political party, the one you don’t align with, you are part of the problem.
To me it is a very open question as to whether or not this will all be “successful”. I am skeptical of history concluding that we discovered some novel approach to finance. Instead, I suspect our innovation will merely be putting a new spin on the old practice of all failing empires: printing money while lying to itself.
Who knows; maybe if we just print the money we can fix everyone’s cul-de-sacs and give them a battery-powered Tesla SUV to drive from their sheetrock palace to the big box store in style. Why not? It’s as plausible a narrative as suggesting that printed money will be used to build shelter for the homeless, feed the poor, and create a green revolution instead of merely enriching the elites, fighting wars, and perpetuating the status quo just a little while longer.
My family and I live a block from St. Joseph’s Hospital, the largest medical facility in my county. We’ve been taking daily walks as a family the past two weeks and this weekend, as we walked past the hospital, my understandably anxious 15-year-old daughter had a lot she wanted to talk about.
We’ve had zero COVID-19 patients thus far, a number they expect to change soon, and she was concerned about that eventuality. She was concerned about her grandparents getting sick or worse, whether my wife or I would lose our jobs, how she was going to do remote schooling and whether there would be any city left to go back to.
She’s a very smart kid, and I’ve found her anxiety is soothed more by my being honest and direct than with any attempt to soften the situation. I told her the truth: the next couple of weeks will tell us whether, by all of us staying isolated, we’ve been successful in slowing the virus’ spread. If so, there will be a lot of second-guessing over the economic damage. If not, we’ll have a lot of economic damage, but we’ll also have a lot of physical human suffering.
The discussions being had on the tradeoffs between public health and the economy are ridiculous, at best. The hyper-partisan environment we find ourselves in makes reasonable discourse fraught, even at a time when we desperately need reasonable conversation. There are enormous public health costs to keeping American businesses closed, especially for the poor. There are enormous public health risks (and economic risks) for resuming commerce. It’s a sad commentary on the fractured state of America that adults can’t have this conversation.
The anxiety over job losses, business loss, and the potential for an eventual recovery are very real, for my daughter and anyone who is likewise thoughtful. Having businesses shut down amid quarantine is a nightmare for those business owners who are forced to lay off friends and trusted colleagues, not knowing if their enterprise will survive to rehire, or even reopen. Dreams are being shattered.
I want to give the anxiety some perspective and give a little hope to those of you sitting on the sidelines wondering how this will work out. My insights will not be comforting to small business owners, but might help those (like my daughter) who wonder if we will have a city left when this is over (we will). They will also be valuable as we make plans for what rebuilding needs to look like if we want our places to be stronger and more prosperous.
Six years ago, I wrote about what it takes to start a Dunkin Donuts franchise. That story has become core to the Strong Towns narrative because it essentially describes the difference between an investor and an entrepreneur.
The person who starts the local doughnut shop because they have a passion for doughnuts and want to make a living providing them to people within the community is an entrepreneur. The person who has a half million dollars in net worth (the minimum franchise requirement) and a quarter million dollars in cash on hand who is looking for a place to put it where it can earn an above-market rate of return is an investor.
Today, everyone is hurting. In the future, the entrepreneurs will come back. It’s not clear that the investors will. Let me walk you through this.
It's not the Main Street economy that is cratering. It is the financialized economy, which needs continuous growth and transactions to remain stable.
— Charles Marohn (@clmarohn) March 26, 2020
Main Street is hurting, no doubt, but we can pull together and get through. Everything with securitized debt is rigged to blow. https://t.co/ASCXcAUqk7
Last week, the Cheesecake Factory announced that they will not be paying their rent. So what? I’m sure the local diner here in town is also not going to be paying their rent. Obviously, there are a lot of landlords that are going to be missing rent checks. Why is this news with the Cheesecake Factory?
Both the local diner and the Cheesecake Factory are being forced to lay off employees. Both are having to deal with inventory going bad and becoming a loss. Both are going to have ongoing utility costs and other overhead expenses that are difficult, sometimes impossible, to cut back. But only Cheesecake Factory missing a rent payment is a life-threatening problem.
Let’s say, worst case scenario, we’re in some type of lockdown on and off for the next 12 months or more. Restaurants are destroyed as a business model. The local diner has not paid rent for a year and neither has the Cheesecake Factory.
When things reopen, what happens to the local diner? The person or entity operating that building is going to be desperate to fill it. They’ve lost a lot of rent and need to generate some cash. They are going to seek someone who can fill that space and the most likely candidate is going to be the business that is in there, the local diner. The second most-likely candidate will be a local diner just like the one that was forced out of business. The local diner will work out the rent situation with the owner of the building – they might even get a break on their rent – because everyone involved needs it to happen. For the local diner, there is a clear path to reopening.
Not so with the Cheesecake Factory. The Cheesecake Factory Incorporated (ticker symbol CAKE) started the year with $58 million in cash. That sounds like a lot, but last year CAKE spent $55 million in debt payments on a total of $2.3 billion in liabilities. The Cheesecake Factory is a huge debt machine first, a restaurant second. Their investors used their size and the easily accessible credit (for businesses of their size) to rapidly expand.
They also used this easy credit, made available to them (but not the local diner), to buy back their own shares. Last year, CAKE spent $51 million buying back its shares, a strategy designed to boost stock prices and, as a result, executive compensation. Cheesecake Factory has spent $425 million over the past four years buying back shares and paid investors $210 million in dividends while adding $1.6 billion to their debt load. This is a great game for investors so long as the market goes up.
When Cheesecake Factory doesn’t pay their rent, the owner of the building takes that financial hit (more on that in a future column), but when that building is ready to reopen, there isn’t going to be a Cheesecake Factory left to reopen. Much of that $2.3 billion in liabilities is debt owed in the corporate bond market. When they default on that debt – and without massive, ongoing bailouts, they will default – The Cheesecake Factory Incorporated is going to be forced into bankruptcy (and your pension is going to take a whack too). It doesn’t matter if the local franchisee/investor wants to reopen. It doesn’t matter if the landlord wants them back. As a failed investment, they will be sold off for scraps to repay (to the extent possible) thousands of different bondholders. As. They. Should. Be.
When we watch politicians in Washington DC scramble to save the economy, understand that they are not trying to save the family diner. Or the local equivalent in any other industry. Sure, they will wrap their rhetoric in the idea of small businesses, but local businesses are resilient. I’m not suggesting it won’t be messy or pain free, but they’ll pick up the pieces and bounce back. They are strong and everyone in their simple financial chain has huge incentives to make it work.
No, “saving the economy” right now means saving the financialized economy, the debt machines used by investors to accelerate financial returns. You don’t have a Cheesecake Factory in your town because the people in your community are in love with Cheesecake Factory. It’s there because one set of bond investors can get favorable returns loaning another set of equity investors large sums of money to replicate Cheesecake Factory establishments in cities across North America. That people like the food is necessary, of course, but that’s not why it’s there.
So, when the financialized part of the economy slows down or seizes up, the whole thing implodes. Kaboom! If this quarantine goes on in one form or another for even four months, there will be no suburban commercial development left. Much of the new, affluent places in the flashy parts of major cities and pop-up urbanism will be gone too. It’s financially tied to credit markets, which is the master they serve, not local demand.
Short of a quick resolution to this pandemic or ongoing and successful bailouts beyond any imaginable scale, the places that will recover the quickest and most completely from this crisis will be the ones dominated by local entrepreneurs, not investors.
This insight provides some guidance on how we rebuild. If we want a Strong Town, we must stop tilting the playing field against the small businesses, against the local entrepreneur. We need to lower the bar to entry for small business startup, make their path easier, and even show them preference over their investor competitors.
There are any number of ways this plays out, but here are a few that are top of mind for me right now:
Don’t require parking, a costly and unnecessary burden on small businesses but a competitive advantage for their investment rivals.
Lower the bar of entry for people wanting to use existing buildings. Allow them to be successful before throwing the code book at them.
Don’t subject the modest reuse and transformation of an existing building to the same standards, or even the same review process, as the new structure out on the edge of town.
Prioritize walking and biking, which generally advantages local enterprises, over auto throughput capacity, which plays to the strengths of investor-led enterprises.
Advantage your local enterprises by sizing streets for truck delivery, not long-haul tractor trailers.
Stop giving tax subsidies to investor businesses (even locally owned franchises), especially those that directly compete with existing entrepreneur-led enterprises.
Make local community development financing available only to enterprises with local owners using local financing.
The leadership of every municipality today should be going around to its locally owned and operated businesses providing assistance in filling out SBA loan applications (which have a provision for loan forgiveness, making the loan a grant). Don’t bother with the Cheesecake Factory or the like; there are legions of national lobbyists, politicians, and pundits already working on their behalf.
The coronavirus has revealed to everyone just how fragile the underlying economy is. Less than two weeks of shutdown and it all blows up. That’s a byproduct of financialization, the desperate bargain we made with Wall Street over the last couple of decades to keep our top-down, centralized Suburban Experiment going. Our local communities need to get out of this debtor’s prison.
We can build strong and resilient places, communities that will be there for you in hard times, that have the capacity to bounce back stronger than ever. Let’s take this time of transition and dedicate ourselves to making ours a Strong Town.
The Christmas Cookie Inflation Index has risen 12.0% in the last year. This is compared to the official inflation rate of 3.2%.