Software Nerd

Tuesday, October 28, 2008

Detroit needs a bankruptcy

In an attempt to bribe Michigan voters, both parties supported some government aid for the auto companies. Finally, a $25 billion package was approved. This is the last thing the auto companies need.

The U.S. auto companies are encumbered with costly union agreements and a complex dealer network. They cannot walk away from these obligations as long as they are regular, functioning companies. The U.S. auto industry needs a bankruptcy to clean house. If they are not viable, let them shut down. Let some of their assets disappear, let some of their employees move to other industries, let other car companies buy some of their factories and employ some of their people.

Ronald Reagan was stupid enough to bail Chrysler out many years ago; now, the government has repeated the mistake.

Now, GM wants to buy Chrysler but doesn't have the money. They say the cash they're getting from the government is not enough for such a purchase. So, GM is lobbying for the government to help them buy Chrysler. Sigh.

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Saturday, October 18, 2008

Social Security's Trust Fund

The Social Security's Trust Fund is a fiction. Basic problem: it is not a fund in the first place.

Joe Sixpack (or is it Joe Plumber?) might create a "home down-payment fund". He does this by putting aside some money and not spending it. The bank is his "lock-box". Imagine that he did something else: he loaned the money to himself and treated the IOUs written to himself as if they were a fund! For all his protestations that he owes money to himself, we would have to tell him that he has spent it, and the fund is fiction. The same with social security.

So, it really irritates me when newspapers who ought to know better, gloss over this, and pretend that this fiction is real. For instance, this New York Times story says:
If no changes are made, the Social Security trust fund is projected to deplete its reserves in 2041 and will begin paying out more than it collects in benefits even sooner, starting in 2017.

Both these dates are bogus. Firstly, there is no fund. Secondly, Social Security has already reached the point where collections are much neared payout levels than "fund" accounting would show. That second fiction is maintained through another ruse: over the original IOUs that Joe Sixpack wrote to himself, each year he write brand new IOUs to pay himself interest! The New York Times adds this fictional interest to the fictional inflows, to calculate a total collection that is significantly larger than it really is.

Summary: The first step toward reforming social-security is to be honest about what it is, and not to use terms like "fund" and "interest" that only obfuscate.

Appendix: Detailed numbers:

The Social Security administration (see page 2 on this PDF), shows the following for 2007:
  • "Fund" Income $ 772 billion
  • Outflows $ 624 billion
  • Surplus = $ 158 billion

However, about $95 billion of the inflows were fictional "interest" on the fictional "fund". Subtract that, and one gets an inflow of about $677 billion and the surplus comes down to $53 billion. (Aside: Out of these non-government receipts, $18 billion comes from "taxation of benefits". This is money that is taken from retirees who had the wsdom to get rich enough not to depend totally on social security.)

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Tuesday, October 14, 2008

Gathering Storm Clouds

If Obama is President, with a Democratic house, what economic damage would be added to our woes? I think such a government would focus on changes that do not increase the deficit too much. Within that theme, there are lots of bad possibilites:

Social security: Obama wants to raise the tax. This will fund the system, which recently slipped into deficit. On paper, this will also show the so-called "fund" increasing, thus appearing to push social security problems further into the future. With the recent stock-market collapse, alternatives like privatization would be laughed at. So, politically, there's a good chance this will pass. Also, the Dems might claim this is friendly to retirees. Florida is going to be important in 2012.

Unions: Democrats have been trying to push through a "card-check" system that would make it much easier for unions to move into companies like Walmart. In addition, there may be some subtle moves toward protectionism. These would likely be selective, seeking to protect unions in Ohio and perhaps in Michigan. With the dollar already low, U.S. exports are looking more attractive around the world; chance are the government will make some small protectionist moves and claim that the growing exports are their doing! Instead of restrictions on imports, expect hidden subsidies for U.S. companies -- something that will not be too cut-and-dried if other countries protest to the WTO. Expect things like the recent $25 billion guarantee to auto-companies.

Carbon Cap and Trade: Some scheme seems almost certain, since both candidates are pushing for it. The government might try to combine this with giving special offsetting favors to industries in Ohio (and maybe Michigan). Carbon caps can be structured to give existing companies a monopoly advantage. So, expect ertain businesses and unions, to be supporting the environmentalists.

Health Care: The government is going to try to push something through. They probably won't mess with the current employer-sponsored scheme for a while, but we can expect at least some tax on businesses that do not provide health-care. Perhaps they might come up with some rules that raise costs on places like Walmart, by claiming that Walmart let's the government subsidize their health-care costs. I don't think Obama will push to take over private insurance. The country is not ready, and he won;t want those costs on the budget in his first term.

Summary: Those are the most obvious moves that I could think of. The theme will be: important changes, but nothing that requires a tough political fight; only things where today's left-tilting electorate has been well-prepared.

I figure one might as well prepare one's activism and one's portfolio for these things today!

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Friday, October 10, 2008

Public Retirement Deficit -- another $700 billion?

Once the housing-related crisis is history, what other un-budgeted government payouts loom ahead? The big ones are Social Security and Medicare; but people know about those. One that is not as much on the radar is the shortfall in state government pension funds.

According to a PEW study "Promises with a Price" , "states’ retiree ... benefits ... due over the next [three] decades that can be conservatively estimated at $2.73 trillion. That includes about $2.35 trillion for a wide range of employee pensions, including those for teachers, and an additional $381 billion for retiree health care and other non-pension benefits for state employees only, excluding those for teachers and a handful of other groups. ... ... To their credit, states have socked away enough to cover about 85 percent of the pension bill. But there is very little put aside for non-pension benefits. All told, states face about $731 billion in unfunded bills coming due. "

Assumed Rate of Return: One major assumption is: how much will pension funds earn on their investments. Today, the plans assume a return of a little over 8% p.a. This is far from conservative for a pension-fund. As Berkshire's Charlie Munger's remarked (Wesco shareholder's meeting, 2008) pension funds rather take on more risk, than admit they cannot make 8% over the long term, which would mean an adjustment (requirement for new "top-up" funding) today.

A news-story about San Deigo shows some of the short-sightedness that goes on. The city was assuming an 8% return. Obviously this means that some years will be higher and others will be lower. The wise folk who run the city decided that in any year that they make more than the average 8%, they would use the "surplus" to re-calculate a more generous retirement package!
Similarly, during the late 1990's, when the stock-market boomed, some states skipped their funding, declaring a pension-funding "holiday".

If the recession we're currently in, and the government's shenanigans that promise big structural impediments to the markets, leads to a 6%-7% stock-market growth over the next decade or two (some would say I'm being optimistic), pension fund deficits will be significantly higher than $360 billion.

Assumed COLA: It appears that public pensions do get cost-of-living adjustments (COLA). Fortunately (for the government budgets) these seem to be decided by ad-hoc union bargaining, rather than by a strict formula linked to CPI. Nevertheless, if inflation ratchets up in the 2010's, we can expect calls for more COLA, and a higher bill.

Summary: $360 billion pension shortfall, and $370 billion) retiree health-care shortfall. If the stock-markets grows more slowly, the pension shortfall could be higher. If inflation grows faster, both the pension and healthcare shortfalls could be higher. A trillion might be a nice, round, conservative figure.

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Tuesday, October 07, 2008

Tomorrow's Sub-Prime Losers

Many have stopped giving mortgages to poor, high-risk borrowers. No surprise there. Indeed, in the current climate of fear and searching for new capital, the pendulum has swung to being extra-cautious.

Does this mean that poorer borrowers who might have otherwise been able to convince good lenders to give them a mortgage will have to wait a few years? No... it might have... in a free-market, but the Federal Housing Administration (FHA) has ridden to the rescue.

According to Bloomberg, over the next three years, the FHA will underwrite $300 billion worth of high-risk mortgages. How good are these mortgages, according to the Congressional Budget Office (not some free-market think tank, skewing the numbers): "The Congressional Budget Office estimates that 400,000 households will get FHA- insured loans and about one-third of those will fall behind again on their new loans."

Once more, fact trumps fiction!

Why aren't millions writing angry letters to Congress, protesting this bailout of Main Street?

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Saturday, October 04, 2008

Main Street vs. Wall Street (Part 2): Illustrated :)

In a previous post, I said that "Main Street vs. Wall Street" is an incorrect way to think of our current financial problems.

The issue is not money, not the $700 billion... but something more fundamental: the role of government. This might be a turning point (hopefully temporary) where the U.S. goes through a phase of relatively-increased class-warfare and (resulting) government control.

To understand the money involved, contrast this bail-out to the recent "stimulus checks". If I remember right, that was a government outflow of $150 billion. In contrast, the "bailout" is an outflow of $700 billion, of which much will flow back when the paper is sold. Even if we assume that the $700 will become $1 trillion; there's a good chance that a large chunk of that will be repaid by the mortgage holders. It all depends on the prices at which the government buys the paper, but it's pretty reasonable to assume that the net outflow will not be much more than $200 - $300 billion. (Even Paulson's assertion that there may be zero net outflows is not total hogwash.)

Yet, there is such a ruckus about the bailout, while many people I know ("Main Street" folk) were glad to get the stimulus checks. Why? Because it is not the amount, it is about the perceived unfairness. This perception is creating an environment where voters are more disposed toward socking it to the rich. This structural change has more serious consequences than the bailout itself.

Here's an illustration: On the left is Wall Street, consisting of good guys and bad guys. On the right is Main Street, with both good and bad. In both places, there is more good than bad (the illustration does not do that enough justice).

Using this map, the politicians want the battle to be fought left to right (Wall Street vs. Main Street). The real battle ought to be fought top to bottom. If the responsible home owners and borrowers and the responsible bankers team up, they do not have to subsidize the irresponsible.

The politician fears that: they will not need him any more. instead, he looks at this and sees lots of money on the left and lots of votes on the right. So, that is the battle that he promotes, because only he has the legal power to take that money from the left and hand it over for votes on the right.

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Friday, October 03, 2008

Emergency Legislation we really need

There is one piece of emergency legislation that we really need right now: temporary suspension of CRA-related review of bank mergers and acquisitions.

I'm politically savvy enough to know that the CRA isn't going to be repealed any time soon. However, political pressure can be brought so that the government temporarily suspends (they might call it "give a lower weight to") past CRA compliance, when approving buy-outs.

This will allow sound banks that have money to bid for poor banks, even if the sound bank has not done what the government wanted under CRA. There is a large example of that right now. The government told Wachovia to merge with Citibank, and as part of the deal, the government underwrote some of the riskier Wachovia assets.

Now, Wells Fargo -- probably the best bank among the super-large, national ones -- has offered to buy Wachovia for more, and without requiring the government to underwrite risky assets. It is imperative that the government does not stand in the way of this merger. If Wachovia has made some commitments to Citi, let the courts decide that; but, the executive and legislature must not favor one over the other for CRA reasons... let the higher bidder win.

An activist group from Florida is up in arms about the Wells Fargo offer. Here is their criticism: "[Wells Fargo] has virtually no CRA presence in Florida. It exists mainly to fulfill objectives derived from its California headquarters with little or no input from Floridians. They have showed total disregard for Florida’s minority and under-served communities... ”

It is sick that these cannibals aren't happy they devoured their previous golden geese; they want the old parasitical rules to apply to those who are still standing. In the spirit of "emergency" the government may go light on a CRA-review and let the deal go through. I intend to write to to the President and my legislators, telling them I'd like to see a formal emergency suspension of CRA reviews.


Thursday, October 02, 2008

Wall Street vs. Main Street - Faulty conceptualization

The "bailout" is being framed as "Wall Street versus Main Street". Bush, Paulson, Obama and McCain, all say this package is not for Wall Street, but really for Main Street. Detractors say they don't want Main Street bailing out Wall Street. The battle of the two streets is the battle of class-warfare.

However, our problems were not caused by the rich to be paid for by the middle class. Primarily, this is a government-caused problem: caused by messing with the economy, distorting the price-mechanism, and the risk-tolerance of market-players. Even secondarily, it is not the rich (Wall Street) who took advantage of this (or were led astray); nor was it the middle class (Main Street) who were left out of the craziness. No, that is faulty categorization.

The fallen: People who took advantage of, and were misled by, government actions came from both places: on the one hand they were people who were buying more home than they would have if the government had not engineered artificially low interest rates and artificially low risk-premiums. And, then there were investors who bought into the same "reality".

The responsible: Meanwhile, people who stayed away from the fray also came from both Wall Street and Main Street. Many banks kept their distance from the madness, and some investors started selling Fannie and Freddie stock when those two began delving into sub-prime paper. On Main street too, many people did not use their homes as piggy-banks; and even today one in three U.S. homeowners own their homes 100%, with zero mortgage debt. Even among those who can get loans (incomes over $150,000 a year), 20% do not carry mortgages.

The tab: It is also false to say that Main street picks up the tab. The rich pay taxes too!

In summary: The Main Street vs. Wall Street classification is misleading. It would be clearer to use a different distinction.

Bonus: Here's a transcript of an interview with John Stumpf, CEO of Wells Fargo, a bank that has not made the news because it is safe and sound. It's boring today, and was not sexy yesterday. These are the types of people that make America great.


Wednesday, October 01, 2008

Reason vs. Emotion -- Disney Cartoon

The "Adventures in Existence" blog points to an interesting Disney cartoon film from WW-II times, titled "Reason vs. Emotion". The cartoon portrays Hitler as using emotions to undermine reason, and exhorts the viewer to use reason.