Wednesday, March 4, 2009

My Take on Some Factors in the Current Mess

I've been sitting on this post for a few weeks now. It is long and but I have bolded the main points if your mind is already weary at the end of the day.

As with any complex phenomenon, there are numerous factors that are involved. Some are closer in time, others are further out in time; some are more direct, some are less direct. To properly comprehend the events, one needs to give up on the linearity that is force-fed to us by the sound-bite driven society, and embrace both the complexity and the cyclicality in social phenomena.

Here is my ever-expanding list of factors that have contributed to the current financial mess. Keep in mind that these factors are often interconnected at many levels. The list is not meant to be exhaustive. It is just me sharing some random thoughts.

Unintended consequences and lack of foresight: Most of what we see can be tracked to unintended consequences: cash basis in municipal accounting = pension crisis (it's coming and you know it); community reinvestment act = subprime borrowers; loss of manufacturing base = disappearing middle class; governmental involvement in Area X = Area X becomes a boondoggle; lead paint testing legislation = small toymakers out of business; unrestricted low-end immigration = school, hospital and prison failures; restricted high-end immigration = outsourcing of cutting-edge research; forcing insurers to cover coastal areas = multi-billion dollar hurricane damages because of waterfront buildings; war on drugs = billionaire trafficers; war on poverty = multigenerational poverty; etc. You get the picture. The simplest prescription here is legislate less. Just that. Even better, have an expiration date on all laws.

Fiat money: As Bill Fleckenstein writes, "in a social democracy, all roads lead to inflation". Without honest money, the government will pay for its own growth via printing. There is plenty written on the topic should you want to educate yourself. Historically, paper money has failed. And failed. And failed again.

Federal Reserve: Here, as well, there is plenty to read about elsewhere, from the grandiose conspiracy theories (think Rothschilds, New World Order,etc) to the more benign views (lack of real independence, general boneheadedness, effectively pro-cyclical policies and so on).

Debt: I prefer calling "credit" by its real name, debt. For the etymologically inclined, it comes from " from de- + hab─ôre to have": the opposite of "to have." In a debt-based world, there is no wiggle room for firms and individuals to "ride it out" without substantial distress. Owning your own home (or enough of VNQ, the REIT ETF, currently yielding close to 13%, and using the dividends to pay your rent) is a whole lot better than having a mortgage when you lose your income. BTW you should always use the yield to find the upper value of your residence. Say your rent is $12,000/year. Dividends are taxed at 15%, so the effective yield is .85*13%=~11%. So the price of the place you live is $12,000/11%, or roughly $110 k. Do not pay more than this. The valuation through a real estate ETF yield should be the upper boundary of what you should pay because of the liquidity premium built in. You can sell out in seconds and the commissions are a whole lot lower than those of the real estate complex.
Now imagine losing your income with a mortgage, student loans, medical bills and credit card debt. Being debt-free is the best thing one can do for peace of mind.
At the corporate level, the picture is similar. Heavily indebted companies go into Chapter 7 or 11 once the tide goes out. With debt, there is NO room for maneuvering. End of story. Unless you are a politically connected firm that can provide a solid voting block and a stream of contributions.

Incentives for politicians: The incentives for our elected representatives do not work out in favor of the common good, as simple as that. Every district tries to be "ahead" by attracting more federal money than it actually contributes. More importantly, votes can be bought by the group (firefighters, teachers, auto workers) via generous giveaways while the group hurt, the taxpayers, is too heterogeneous to be pandered to. Very few politicians have the wherewithal to stand up to a decision that will give them more votes. So politicians spend money (and promise even more money) to people who vote for them en masse. By the time the bills come due, politician X (or GM manager Y) is long gone. See it in action in real time right now, Citi/banking lobby deliver contributions, the GM-UAW complex delivers votes. So both get bailouts when both deserve to be on the scrapheap of capitalism.

Political dynasties: This is also a problem, usually old money. There is a reason why the saying "short sleeves to short sleeves in three generations" exists, even in Chinese. We have very influential families whose scions have known nothing but priviledge, and have not made an honest buck their whole lives, and yet think they know what is best for everyone else. Do you think that Paris Hilton can re-create the Hilton hotel chain? Do you think that Carolyn Kennedy can run a successful bootlegging operation? Or that Rockefeller #X can run a gas station, let alone Standard Oil? It seems that many of them are so removed from the factors that created their intergenerational wealth that they forget the basics: freedom, industry, failure, success.

Lobbying groups: Unfortunately, the effective lobbying is done by the two most counterproductive groups in the economy, the dinosaurs of industry that are dying structurally or cyclically (auto, real estate) and the dinosaurs of the labor movement which, in my opinion, has outlived its usefulness. Who is not on the table? The mammals of course. The winners of tomorrow. They are getting taxed to death. Or not getting visas. So they just pack up and leave. See Research Recap's view on the reverse migration of Indians and Chinese. These are the future Microsofts, Googles and Amazons being chased out by the likes of Charles Grassley (R, Iowa) and other idiots.

Unfunded promises/mandates: Just read the Bloomberg piece cited below. Very simple incentives game: I get elected by you so I promise you a lot of money in the future. Of course, it is off the books so no one will know until I retire and you collect. Deal?
Another unfunded mandate is Congress requiring the hospitals to treat everyone in ER. Of course they do not get paid half the time so you end up with ridiculous hospital bills for everyone else. There has to be a better way.

Political involvement in industrial policies: I have no idea if Congress is constitutionally allowed to engage in industrial policy except for some indirect methods, like imposing duties. What we are seeing is a complete farce, where innumerate elected officials decide on what is good business plan. So you get preliminary results, like giving Chrysler billions as they fire hundreds of thousands. Great. But let's try to ban businesses with expansion potential, like nuclear power plants.

Income taxes: income taxes are an ever-growing cancer in modern society. Simply puy, income taxation is wrong. As a society we should tax whatever we want to discourage: smoking, alcohol, gasoline usage, and so on. I always thought that work was good and that idleness is bad. Now if I am idle, I do not get penalized. But if I work, there is income taxes, medicare taxes, social security taxes, state taxes and local taxes taken off the top. And the more I work, the more productive I am, the more they take. Doesn't make sense, does it? How about paying me the honest amount, and taxing my purchases via a national sales tax? As simple as that. In one step, the government can encourage both working and saving, which is an unequivocally good thing.

IRS: Should be abolished. Creators of value-transfer from producers to tax preparers.

Labor unions: This is tricky because there is no one standing up for the little guy (true). Unions were really needed 100 years ago. However now they have morphed into completely parasitic organizations who want only upside with no downside. Sorry, no free lunch here. A new union drive at a location is symptomatic with poor management . And most of what a union provides is readily achievable without one, if management is smart (often, they are not). If you look at the big industrial bks, they are mostly with union labor. Why? Unions increase the fixed costs but become variable on top if the operation is profitable. Capital can't win even when it wins. So it moves to China.
I have worked at a place with a union and it is a mixed bag: there is some sense of fairness and stability. But there is no flexibility and no reward for individual performance. And the latter are crucial for the success of any enterprise. Also it gave me a look into the Teamster organization, and I do not think that the union employees (who live off the contributions) have the best interest of the rank-and-file employees in mind. Check out the Teamsters for Democratic Union for more info.

Trial law/tort reform/jackpot justice: A bit ironic that we have two lawyers trying to "fix" the healthcare system. But this is besides the point. Liability risks in the US for any business, not just doctors, are not only high, but also unpredictable. Unpredictable costs are bad in any environment so you get less investment and higher prices because businesses have to price in the risk of some ridiculously arbitrary damage award against a slip-and-fall, or an allegedly defective product. Those damages have to be capped at the federal level. And while you are at it, get rid of class action suits. They suit no one but the lawyers. I remember getting a 30c settlement from Verizon. Guess who made the big money there, and, more importantly, did it help the "victims"?

Governmental expansion/reduction of freedom (DOE, DOL, DOD, etc.): I think the best critiques of the governmental departments are on the Libertarian Party site. The DOE is a complete, abject failure and has to be disbanded immediately. Mrs. Obama just told DOE employees that she's proud of the work they do. And the new secretary is from the Chicago School District. Well, then how come the two daughters were in a private school? The DOD has overexpanded the US military presence to unsustainable levels and further creates enrmous burdens on the taxpayer via VA benefits, as well as gigantic waste via misguided, and corrupt, purchasing contracts. Most departments can be done away with and taken down to the state level.

Government spending vs. investment/consumption: Government spending is inherently inefficient. The money from it comes from taxes which means they are removed from productive endevors in the private system, where people have value-creation in mind. A government beaurocrat has no value endeavors, their only interest is their self-interest: perpetuate the program so that my job is safe as I rack up guaranteed raises and pensions. To guard against that is very simple: limit the size of the government. Let people decide what to do with their own money.

State and federal overlap: There sre substantial, and very costly, overlaps between federal, state and local activities. This leads to perverse incentives, such as maxing out healthcare spending at the state level to get the federal matching. I am all for solving things locally: if you want to pay for the healthcare of non-tax-paying people, sure, go ahead.

Lack of tolerance for sacrifice: This is very mucha cultural thing of a generation that has grown up without having to postpone gratification. Buy it now, buy something bigger, and so on. This sort of attitude-- I know it is a stretch but I do believe it-- leads to an every expanding public and private debt. Greenspan did not want to economy to readjust after the stock bubble so we got the incredible malinvestment in real estate. Well, the bills are now coming due. You can see that at the private level, savings are up and debt is down: private borrowers do not have a lot of wiggle room. But what is the government doing? Borrowing record amounts! Does this make any sense?

Glorification of instant gratification: I should have probably merged this with the paragraph above. The average consumer has to come to terms that you cannot have everything, right away. You cannot buy a house with no money down. You should not buy a car you cannot possibly afford. You should not go to a cruise for which you have no money. Very simple. And yet, we have been operating in a world where it all magically seemed possible. Again, the bill is due.

Homeownership cult: I am neither pro or con: depends on the individual situation. If a person has trouble managing rent and credit card debt, or personal finance in general, it is a safe bet that they should not own. If a person is just starting out with a career and there is chance she will move with the company a couple of times to get promotions early on, again, probably a good renter. If house prices in your area are so high that on a monthly budget basis you're better off renting vs. buying, again rent (NYC is a prime example, even the boros and NJ). If you have strong family ties to one area, you're settled in and financially secure, sure, buy.
But what we have had for many years is the glorification of ownership. Again, the bill is due.

Misdirected immigration policies: There is something wrong if you have (1) millions of natives on welfare, (2) illegals flooding the labor market with no restrictions and (3) huge restrictions on educated, law-abiding individuals. Most other OECD countries have well-established points-based merit immigration systems. Works great: they siphon brains out of countries where the opportunities do not exist, often structurally. But not in the US (there is a small, really high end program). Here we have the "diversity lottery" which gives green cards at random to people from "underrepresented" countries. So Canada, the UK and Mexico are excluded. Let's scrap the whole thing, please. Why can't we have people with high earnings potential coming here? Or, even worse, people educated here, frequently on scholarships, have to leave? Immigration here is discussed in a sound-bite environment as if it is a monolithic problem. It is not: you want the smart people here. Unless, of course, you are in Congress. Right now the profits from the exploitation of illegals are privatized (by the employers) while the costs are socialized (failing schools, crime, failing hospitals, kidnappings, etc.) How does this factor in the current situation? You are adding costs to the taxpayers without adding to the taxpayer base because the regulations chase away the productive immigrants. Look at California for an illustration.

Public education in its current state/math/innumeracy: Innumeracy is a big, big problem. Even the lawyers at the SEC are innumerate, per Harry Markopolos. If people only understood how compound interest works, we would not be in half the trouble we are in, at the personal and at the governmental balance sheet level. Money is not free. Interst on interst compounds quickly. Thinking in terms of monthly payments and not in terms of actual interst cost is destructive to your financial well-being.
Innumeracy also explains why there is no outcry in the mass media or Congress over the bailouts. Most participants do not have a firm graps on what the extra zeroes mean. I am willing to bet that if you asked the average member of congress to write out by hand in numbers 1 trillion and 250 million dollars, they will get it wrong. So will the average Joe on the street.

Personal irresponsibility: Think about learned helplessness and victimhood mentality. Now move that to the top corporate level. You get the picture. In both cases you have misaligned incentives. Look at AIG: the incentives made their financial products group short an incredible amount of volatility. AIG thus far has cost the taxpayer over $100 billion. Why are there no comp clawbacks? How baout clawbacks from all members of Congress over the last 20 years? You also see this at the personal level: poor smokers get free treatment, morbidly obese patients get motorized wheelchairs on the taxpayers' dime. Why?

Welfare state: Now with mortgage benefits included. I am not advocating against basic social safety nets but there must be checks and balances: if you are on welfare, do not go out and have more babies. If you have food stamps, don't buy soda. I really do not want to be paying for your obesity twice. But perpetuating and increasing welfare rolls are bad news for the budget and the economy.

Employer-based healthcare: You should know how the system came about-- back in teh 40's, employers could not raise wages. So they started adding benefits. Like healthcare insurance. Unintended consequence #1: your healthcare is tied to your employment. An employer should not be in the business of providing healthcare. Period. Unitended consequence #2: entrepreneurship becomes much riskier and more difficult because one loses his coverage if he goes out on his own, and two, it is prohibitively expensive to offer coverage to prospective employees. The end result is a loss in the vigor of the economy. Uninteded consequence #3: uncompetitive producers here export the jobs elsewhere. Even to Canada, like Microsoft or GM. The bill for this system, along with the government promises, is also due.

Glorification of college education: Like homeownership, it does not make sense for everyone. Especially with costs going up (and the loan balances going up), the equation goes against college education more and more. This is particularly true in the Humanities. What can you do, six years later, with an MFA? Complete fraud. Easily $50k in floating-rate debt and working at Starbucks. But they had a "great experience." Wonderful. Now lick the stamp for the envelope you'll be sending over to Sallie Mae for the next 15 years. Even worse, people who just do not have either the mental capacity or the character required to finish school in 6 years. Investing in education makes sense when there are actual benefits accrued to the recipient. It seems to me that we have a malinvestment in education, and the results are starting to show up as other countries take on the leadership role in technology.

Automobile-based lifestyle: I like cars as much as the next guy but I am not sure we have the technology to adjust without stress once the wells run dry. And we have this auto industry, too. And the highway network to maintain, while abandoning rail. Individual auto transportation is also very energy inefficient. The bill for this is already due: the high oil prices of last summer I think gave us a taste of what is to come if this lifestyle model scales globally, and helped push us into a deep recession.

Lowest-common denominator mainstream media: Yeah, I know, they are in business to make a buck so they have to expand their audiences. But please, can someone ban Jerry Springer? I went to the gym during the daytime, and I had forgotten he exists. Remember watching some episode in college. He's still around and kicking. Former mayor of Cincinnati. I guess Cleveland with Kucinich does not feel alone. But I digress. Is the mass media lowering the average IQ of the population? I'd say so and I think it is a problem.

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