Around 3,000 stores will open this year, but more than 6,000 will close—and this at a time of high consumer confidence, low unemployment, and economic growth in the US. These factors are normally good for retail, but as Bloomberg notes, “more chains are filing for bankruptcy and rated distressed than during the financial crisis.”

What’s going on? Well, online is probably not the main culprit, although it doesn’t help. Most of the drivers of change are locked up in the financial system. 

Figure 1: retail retail estate loans going bad

 
Source: via Bloomberg

 Debt levels

The main cause is that the balance sheets of many of the retail chains are, says Bloomberg, “overloaded with root cause is that many of these long-standing chains are overloaded with debt—often from leveraged buyouts led by private equity firms.” As with Toys ‘R’ Us, there are billions of dollars sitting on balance sheets that can’t take that load. 

A lot of this debt falls due over the next five years. To give a sense of the scale of this, “$100 million of high-yield retail borrowings were set to mature this year, but that will increase to $1.9 billion in 2018.” And then it ratchets up again, to close to $5 billion a year between 2019 to 2025. 

It’s not just the retail sector; for the whole economy high-yield debt is on the increase.

Figure 2: The coming debt bubble (retail, left, all US debt, right)

Source: via Bloomberg

Capital markets

One of the other reasons that retailers have so far avoided the crisis is because interest rates have been so low as a result of the long wave of quantitative easing since the financial crisis. The Federal Reserve is now starting to push rates up, and that means that debt becomes more expensive. In addition, markets are no more sceptical about retail, so lenders will charge them higher interest rates. This has affected even blue-chip retailers like Nordstrom. The article notes that the founding family abandoned attempts to take the department store back into private ownership “because lenders were asking for 13 percent interest”. 

The long history

The US had too many stores even in the 1990s, even before e-commerce took off.  That is a legacy of over-building retail space when the suburbs were booming. The result was big-box drive-up retailers in every category. Now this demand is unwinding itself. One of the features of retail economics is that as sales slow, and you start approaching the breakeven point at which profits slide into losses, the relatively high fixed costs mean that a blip can turn quickly into a disaster, especially when stuttering performance is squeezing margins. The debt mountain on the balance sheets means that breakeven point is that much higher. 

Perfect storm

The result is, in systems terms, a negative feedback loop which has quite a long way to spiral. “That boom,” in Bloomberg’s words, “is finally going bust.” The rate of retail closures this year is running at twice the rate for 2016, and is close to the peak closure year of 2008, in the year of the financial crisis. 

The consequences get felt largely by the working poor, for retail is both “the largest employer of Americans at the low end of the income scale” and also a path to the middle class. Supervisors earn twice as much as cashiers, and are often promoted from their ranks. Although there are some compensating job gains in distribution centres, these are much less evenly spread geographically, than retail stores and tend to employ more men than women, so there’s a gender effect here as well. It’s not easy to see other routes to social mobility emerging for less educated workers. 

It is clear that American retail is in long-term decline. But one of the lessons of decline is that societies can manage slow decline a lot better than fast decline.  

Debt as control

So, reflecting on the Bloomberg article, can we blame private equity companies for behaving like private equity companies? Well, as their defenders would say, they have done nothing illegal here. It is in the nature of finance capital to exploit loopholes, or even to create them, to the advantage of investors and with no regard as to where or on whom the external costs fall. But there is, of course, a deeper point.

It would be easy to construct some balance of “fault” here, about the negligence of political systems that were happy to deregulate finance without creating compensating institutions to protect the rest of us. But, as every systems thinker knows, every system is perfectly designed to produce the outcomes it produces. On one reading, debt is not an unfortunate outcome—I’m drawing here on the work of the Italian sociologist Maurizio Lazzarato— but is an instrument of control, by the finance sector over the rest of society. In Russ Albery’s useful summaryl

The debtor is held to a tight moral standard of repayment of debts, and is morally condemned by all of society, including their peers, for a failure to repay. But there is little or no corresponding moral pressure on the creditor… To be a creditor is to have an agreed-upon, one-sided right to dictate to the debtor the terms on which they must conduct a portion of their life, and the larger the debt, the larger the portion.

Thanks to J Walker Smith for the tip about the article.

The immediate cause of HMV’s collapse, of course, was the British recession, which has gone on longer than anyone expected, and the economy is now teetering on the edge of an unprecedented triple dip recession. Here’s the NIESR chart showing comparative GDP since the pre-recession peak for the past six recessions. The black line at the bottom is the current recession, and yes, this chart should be on the wall of every economic policymaker in the UK.

Source: NIESR

Squeezed incomes

The Bank of England Chief Economist Spencer Dale put some numbers on this in a speech just before Christmas.

[P]rivate sector productivity … is around 15% below the level implied by a continuation of its pre-crisis trend. Over the same period, real product wages … have fallen by a similar amount. A quite remarkable degree of real wage adjustment. The fall in the terms of trade and the rise in VAT mean that real wages measured in terms of consumer prices – the so-called real consumption wage … have had to fall even further. No wonder that people are finding life tough.

Source: Bank of England

It’s just worth spelling this out. Real incomes have fallen by close to 10% since the financial crisis, and are are about 15% lower than they would have been had the economy stayed on trend. And in practice it’s worse than either of those figures suggest because more expensive imported goods and the VAT increase means relative prices have gone up while wages have fallen.

In turn, the reason for this is that it turns out that the economic multiplier that informed austerity economics was wrong. The theory was that the multiplier associated with public spending cuts was 0.5 – so each pound taken out of public spending would shrink the economy by just 50p. It turns out – and this is from a research paper (opens pdf) by economists at the archpriests of deficit reduction, the IMF – that the multiplier is larger (between 0.9 and 1.7). So every £1 taken out of the economy in public spending cuts shrinks the economy by between 90p and £1.70, and so the economy shrinks faster and further than expected. (John Lanchester explains all of this very well in a recent essay at the LRB).

Financial engineering

But there are other reasons, too, which have as much to do with the history of HMV and its former parent company EMI as the changing fortunes of the hard-format entertainment market. This is a story of businesses that are as interested in financial engineering as doing business.

HMV, for most of its life, was just a brand, which became part of EMI when its owner, The Gramophone Company, merged with the Columbia Gramophone Company in 1931. Spooling on fifty years, to 1979, and EMI merged with Thorn, an electricals manufacturer and retailer. And spool on another seventeen, to 1996. By this stage HMV, as an entertainment retailer, was one of three businesses within the overall group; Thorn and EMI (with HMV) were demerged, amid much shareholder excitement.  This was the rationale (opens pdf):

Following the Demerger, each group will be able to operate independently, taking into account its own distinctive strategic objectives, operational needs and philosophies, capital and dividend requirements, personnel needs and resources and product development and marketing policies. In addition, the Demerger will enable both groups to introduce share-based employee incentive plans, which will more directly reflect the performance of individual businesses and enhance the retention and motivation of employees.

Like many such assertions made by company Boards during the 1990s (such as the de-mutualisations in the financial services sector) this had more to do with looting the businesses (sorry, that should read “better utilising the businesses’ capital”) than improving their performance as businesses.

Private equity

Within two years, Thorn had been acquired by the Japanese group Nomura who sold most of it on to the private equity company. Terra Firma. EMI, for its part, spun out HMV in 1998 (private equity took a majority stake) and sold most of the rest of its stake when HMV floated on the stock exchange in 2002. It would have generated cash on both occasions but didn’t use the money well, being acquired in 2007 by Terra Firma (yes, private equity again), who sold it on to Citgroup (the bank, which held much of its debt) which then sold parts to different music industry buyers.

You might think there’s a story about the decline of Britain’s commercial and industrial base here, and you wouldn’t be wrong. HMV for its part continued to pick up record shops when the opportunity arose, acquired the bookseller Waterstones in 1998 and the smaller Ottakars chain later (the Ottakars assets were merged with Waterstones), and eventually, realising that music retail was slipping away, spent money acquiring music venues (such as Hammersmith Apollo). As its core entertainment retail business was squeezed, it sold these off to raise cash: Waterstones went in 2011 and the venues during 2012. One of the striking things about researching this story is that concerns about HMV’s debt levels have dominated since 2011, when it was partly re-financed by its bankers. Financial engineers love debt – it allows them to do all sorts of fungible things with balance sheets – but the combination of debt-funded business and falling sales is almost always fatal. As Simon Bowers blogged in the Guardian,

From that moment onwards [2011] HMV was to limp on as a corporate creature all but controlled by its debt commitments. A zombie.

Part 2 of this post is here. The picture at the top of this post is from the Wikimedia Commons, and is used with thanks under their Creative Commons licence.