Software Nerd

GM repays government loan with great fan-fare

2010-04-25T10:29:00.000-07:00

A few days ago, GM announced that they were repaying, in full, the loans from the U.S. and Canadian governments amounting to $8.1 billion. This was being repaid years before schedule.

Yet, the curious thing is that GM reported a loss of $4.1 billion for the period since the company was reorganized (July 10th 2009) up to the Dec 31st 2009.

Of course, it is possible to have positive cash-flows while having losses. A company like GM has many huge non-cash expenses. So, when I saw those two figures, I assumed that GM must have done well on the operational front, gaining cash with which to repay the loan, but must have taken a loss by putting a more realistic estimate on the amount they will owe on their pension plan (a book entry which does not affect short-term cash, but shows as an expense).

Turns out that it is not so innocent. Actually, the government gave GM a loan of $52 billion. Then, during the re-org, GM wrote off its debts to all sorts of folk, and also converted $43 billion of the government's loan to equity. The net effect is that the government gave GM $43 billion and got an ownership interest, and the government also gave GM $7 billion and called it a loan. GM took the $52 million and paid back the $7 billion loan, even while they lost another $4 billion. It is easy to do, and they can do it a few more times, before the government's $43 billion is all gone. The structure -- paying you back with your own money, while making losses on the use of the money -- is the classic structure of a Ponzi scheme.

Now GM's CEO, Ed Whiteacre, has an ad with himself in it, touting the repayment. Watch the ad with the renewed knowledge that this guy is lying. (His college professor probably taught him there was no objective reality anyway.)

Here's a more detailed article on the subject.

Greece's early retirement evasion

2010-03-13T08:57:00.000-08:00

One recent news item about Greece speaks about the early retirement ages in some professions. The law allows for early retirement if one works in a dangerous profession. Women in these professions can retire at 50, men at 55, and start to draw their pensions.

Stop here and think what professions may qualify. Coal miners are one such group. Another is bomb-disposal folk. Then there are odd ones: like "musicians playing wind instruments, who must contend with gastric reflux as they puff and blow." But, the plot thickens... over the years, various unions in Greece have fought to have their professions moved to this early-retirement category. So, they have the spectacle of hair-dressing being deemed worthy of an early retirement. I kid you not. And the craziest one I've heard: radio and television presenters (at risk from microbes on microphones!)

Greece has ended up with 14% of their workforce in this category, and consequently nearly the lowest average retirement age in all of Europe. A voting population in a democracy is obviously responsible when there is such blatant evasion of reality. Who do they think is going to pay their debts, if so many of them retire early? Once upon a time, they'd have printed more Drachmas, but they went and joined the Euro, which does not allow them to print willy-nilly. So, lacking the inflationist's ability to rob his creditors, they need to create or to get real wealth. And, for this, they turn to the Germans.

NPR did a story about this a few days ago, and they spoke a new hostility in Greece toward Germany. The country that screwed up, are being hostile to the country that can bail them out. Some of the more radical Greek radio shows are playing Hitler speeches and talking of a new form of Nazism that does not use tanks, but money. It is a despicable sight to see those who need charity spit in the face of those from whom they demand it as a right.

It is sad to see this happen in the land of Aristotle. I suppose it proves that greatness is not in one's genes.

The Jobs summit

2009-12-05T07:19:00.001-08:00

The President held a "jobs summit" on Thursday, supposedly to get ideas on how to increase the number of jobs in the country.

The answer is: get out of the way. Some ideas:

Slash the minimum wage: This will put a few people back to work.
Stop extending the duration for which people can receive unemployment relief. One senator wants to extend this in 2011. Some states have started borrowing money from the Feds to pay even the non-extended portion of relief.
Remove all mandates on health-care plans. Allow plans to cover whatever they agree to with their client. Also, remove the mandate for hospital emergency rooms to treat all comers with non life-threatening conditions)

Instead, the government will probably come up with some type of tax-credit that will necessarily misdirect resources. Even a simple credit for hiring would be disruptive. Worse, the government is likely to give special incentives to certain types of hiring: e.g. anything they consider a "green job".

The government is responsible for prolonging this recovery. When the government acts to backstop failing businesses, falling home-prices, rising interest rates, and so on, they act to lessen the depth of the downturn. Any such attempt to lessen the depth of the downturn does two things: it lengthens the duration, and it sets things up for a future downturn.

If the government had not acted to "save" us all, unemployment would likely have fallen further and deeper, but we would likely have bounced back and would have been better off today. Instead, the government has bought a less deep downturn at the cost of prolonged misery for some citizens... ... and, the cost of this is in the trillions of dollars!

The main person responsible here is any American voter who thinks the government should "do something" about jobs.

Wages: Sticky on the downside

2009-11-08T12:07:00.000-08:00

Economists speak of wages being "sticky" on the downside. What they mean is this: companies are usually slow to cut wages. New hiring freezes up very fast at signs of an economic downturn. Layoffs take place pretty soon too -- at least in the U.S. (not so in Europe, with its laws). For current-workers, wage freezes are common. However, wage cuts seem to be a last resort.

For most companies, this is poor economics. For most companies that are slow to cut wages, the main factor is a misguided ethics. Contrary to left-wing myth, managers usually feel good about paying their employees what they consider to be a fair wage, and managers often think of employees as being part of their team. Managers often feel it is their responsibility to try to keep their employees' wages steady. In addition to this, employees think the same way too. Therefore, they would often see a cut in wages as unfair to them.

This downward "stickiness" means that markets take longer to readjust, and to rebound.

Sometimes, companies will try "job sharing". This allows workers to work part time for less pay. It has the effect of keeping more employees on the payroll. However, if it does not reduce the actual wages-per-hour, it does not address the real issue: cutting costs. (It can be a good managerial strategy in some more limited slow-downs.) During the depression, Ford company had many workers working 3 days a week. Instead, if they'd been working all five days for what was previously 5-days pay, the company would have been able to make more goods for less. This would allow them to cut prices to customers. If there is insufficient demand even at those lower prices, then it is better for the extra workers to work in some other industry. This process of falling prices for labor and for goods would quickly work its way though the system and the end result would be a more efficient placement of capital and employees across industries.

Instead, politicians always try to slow the re-adjustment. This was Hoover's huge mistake post 1929. He called in businessmen and got their geniune committment to slow the process of readjustment; though he criticized the Smoot-Hawley law, he did not veto it increasing protectionism that slowed the process of re-adjustment; finally, instead of allowing commodity prices to adjust downward, he supported them (farmers wanted their prices to stay high). On top of all this, there were public works and cheap credit: two other ways governments stifle re-adjustment.

History surely rhymes.

The 2010 Green Stimulus?

2009-11-02T16:31:00.000-08:00

After a sharp upward turn off its bottom, the stock market has paused. Talk of a second-stimulus is circulating. Today, the president met a few businessmen and one of the main ideas being pushed was the "retrofitting" of American homes, to make them more energy efficient.

That seems like something most politicians could get behind:

it spends money on jobs that voters will attribute to government ("the seen");
it bows to environmentalism, while not hassling big business directly as Cap-Trade might;
many (voting) home-owners getting the subsidy will think it is cool to get something for nothing, and then have lower energy bills on top of that; and,
most important -- the negatives are dispersed, and the inflationary component will probably not hit before the mid-term elections ("the unseen").
even the xenophobic Republicans could buy into a plan that "reduces our dependence of foreign oil"

If Obama gets some type of healthcare bill done, this is where he might turn his attention. So, I expect a "Green Stimulus" which is sold as something that will set America up for the 21's century and create lots of jobs.

Therefore, I expect to be on a roller-coaster for a few years.

1930 WSJ Blog

2009-06-07T05:07:00.000-07:00

Somebody has decided to read the Wall Street Journal from 1930 (library microfilm) and post a daily summary on a blog. The idea is to get a feel of that year, when the depression had just set it, to see if we can learn anything about our current situation.

A daily update is more detailed than I'd have liked. If he would do a summary paragraph or two each week, that would work well for me.

The blog is called "News from 1930"

Reverse Immigration

2009-06-05T06:14:00.000-07:00

This is a software-related post. Ignore it if that does not interest you.

Over the 8 years, U.S. salaries in software-development jobs have not risen much. Meanwhile, salaries for similar jobs in India have continued to rise. (The same relative change is probably true across other industries as well.)

Salaries in India can still be 25% of U.S. salaries. However, there are additional costs when the customer is in the U.S. Today, large U.S. companies budget India-based work at about 50% of U.S. based work. An experienced U.S.-based programmer may cost $120k to $140K, when one adds salary, health-insurance, company-paid social-security, and U.S. based infrastructure. An equivalent India-based employee would cost about $60k-$70k, when all costs are considered.

That is still a large difference, but much narrower than it used to be a decade ago. It has been interesting to see how such changes take place. The process is slow, giving companies and employees a fair amount of time to adjust. And, it is slow for "natural" reasons, not because of some government protectionism. A decade ago, many companies were still wary of off-shore development. They began to dabble and test the waters. Then, in the 2000's -- especially with the cost-cutting required after the stock-market bust -- some companies actually set themselves targets: e.g. "in 5 years, 20% of our development must be done off-shore".

The process would have been even slower if the free-market had prevailed. In a free-market, one would have had more immigration from India to the U.S. This would have reduced the wage-differential by lowering U.S.-based costs, while one would have seen India-based cost rise slightly more than they otherwise did. In the end, one would have had significantly more U.S.-based wealth-creation.

Now, with the downturn, companies are again under cost-cutting pressure, and looking to off-shore development as one means.

In February, IBM did something I've never heard of before. While laying of software-developers, they offered to transfer them abroad, to India, China or Brazil (1). IBM would help them move and also help them get set-up. However, once there, the U.S. workers would have to accept local levels of salaries and benefits. I doubt many people took up this offer, but it is good to see IBM being creative about this, and offering their employees a solution that is far better than being jobless.

Reverse immigration would be a true sign of the decline of the U.S. As an immigrant myself, I understand there are costs (in terms of friendships, proximity to family, familiarity with one's environment, and optional cultural values like food) in moving far from home. So, when people vote with their feet, it is a serious indicator. I don't expect this, but nor would I rule it out ... some two decades hence.

Notes:
(1) Computerworld, Feb 6, 2009 "Workers Losing Jobs at IBM Get Overseas Option"

Time for another default?

2009-06-01T12:54:00.001-07:00

Should the U.S. declare a default on its governmental debt?

I never imagined I would suggest that the U.S.A. renege on its borrowings, but I'm starting to entertain the idea as a "lesser evil". Federal debt was about 55% to 65 % of GDP at the start of 2007; now, with all then new government spending and "rescuing", it is slated to rise to 90% of GDP by 2011.

This 90% number understates the magnitude, because the government has also taken on large, new "off balance-sheet" obligations. For instance, in 2007, the government's official position was that it was not responsible for money borrowed by Fannie and Freddie. A CBO report, from 2001, said this:

A typical disclosure from a Fannie Mae prospectus states, "The Certificates, together with interest thereon, are not guaranteed by the United States. The obligations of Fannie Mae are obligations solely of the corporation and do not constitute an obligation of the United States or any agency or any instrumentality thereof other than the corporation."

However, when push came to shove and the U.S. government (ex Treasury Secretary Paulson) did not dare insist on the explicit provision in the prospectus. Instead, late in 2008, the government decided to make the guarantee of Fannie/Freddie debt explicit. Later, the government also guaranteed debt of certain banks.

The US is in the exact position in which many poor borrowers find themselves: they don't know how they'll repay their debt tomorrow, but they really, really need the money just now. It is always easier to push the problem to the future, and borrow now. This does not work unless lenders evade too. Politicians are usually happy to evade this way, and to push any problem beyond the next election. In this case, the major lenders are politicians too, with foreign central banks holding large amounts of US government debt.

As a U.S. taxpayer, I will end up paying for this evasion. Continued evasion simply means that the U.S. will be encouraged to borrow more, and to inflate more, and waste more. The solution is simple: recognize the problem now, and begin to deal with it. A default would be a rude wake-up call: something that nobody could evade. It would make the poor creditworthiness of the U.S. government explicit. If we need a default to scare everyone into action before things get still worse, a default would be a lesser evil.

Fannie/Freddie debt was different from direct U.S. government debt, because it did not have an explicit government gurantee. This is debt the government did not have to take on. This debt would have been the ideal candidate for a default, because it could be done while upholding true government debt. Even a small gesture -- for instance, if the government had said they would guarantee a part (say 80%) of the Fannie/Freddie debt -- would have put lenders on notice.

Major lenders to the U.S. governments are not idiots! Until recently, with debt around 60% of GDP, they could have held up hope that future U.S. taxpayers would foot most of the bill. Some evasion was involved, and the big lender of the recent few years --the Chinese government -- had its own political reasons to evade. However, the recent U.S. government spending has worried them, and the Chinese have been scolding the U.S., saying the government needs to be more careful with spending.

This week, we saw a small example of the pressure that lenders can bring to bear. Secretary Geitner has just gone to China and is reassuring them that the U.S. will try not to exceed an annual deficit of 3% of GDP. These are promises, promises... If the U.S. had insisted that the lenders to Fannie/Freddie at least take a "haircut", that would have been something concrete, a real loss rather than a probable one.

What would have happened if the government had not backed Fannie/Freddie 100%? It is possible that the recession would have got deeper faster. Instead of being able to keep interest rates low, anything like a default would have sent interest rates up. Home prices might have dropped even lower than they did, unemployment might have risen higher, the stock market may have gone lower. However, the economy would have readjusted to the new realities rapidly. That is what happens when the amount of evasion is lessened: people not only adjust to the new reality, but -- in terms of real wealth -- build up from that base more rapidly than from an economy propped up by inflation.

It is less than a century since the U.S. defaulted on its debt, when F.D.R. brazenly rescinded its promise to pay its debts in gold. A dollar used to be a promise to pay about 1/21th of an ounce in gold. In about a year, it was changed to a promise to pay 1/35th of an ounce. The SCOTUS upheld this as being constitutional. Creditors would only get 57% of their loans back! It was a dishonorable act.

I think the U.S. should pay back its creditors. This is a rich country, that produces a great deal of wealth every year. If the government did not fritter away such a large portion, we could easily do the honorable thing. I fear though, that we have to choose between a small dishonor today that serves as a wake up call, or a much worse fate in the future.

The Aftermath of Financial Crises

2009-04-26T19:43:00.000-07:00

In their paper, "The Aftermath of Financial Crises", economists Reinhart and Rogoff look at data from other financial crises (from across the world). They ask: to what extent did key indicators like unemployment and GDP deteriorate, and for how long?

They document a lot of variation among the various crises. Here are the averages they found, across the various crises. (The figures in parentheses are the current US figures for this crisis.)

Unemployment: Up 7%, across 4.8 years (US current: up 4%)
House prices: Down 35%, across 6 years from the top (US current: down 28%)
Equity prices: Down 56%, across 3.4 years (US current: down 42%)
Per capita real GDP: Down 9% across 2 years (US current: down 1%)

There is a lot of variation among the different episodes included in this sample. Still, they were all chosen because they were largely bank/financial/credit crises. (So, for instance, the dot.com bust-up is not included.)

I found graphs of U.S. data for three of the above measures (from the late 1980's to today). Then, I marked the averages from the study on the graph, to answer the question: if this US crisis turns out to be about averages, how far are we from the turning point. [I did not graph the real per capita GDP. Instead, the real GDP is shown -- i.e. not per-capita].

In summary, if the current US recession is typical, we can expect another year of flat or falling real GDP (falling per capita); unemployment would go to 11% over the next three years or more; house prices would come down a bit more and not recover for another 5 years.

An average does not tell us what will really happen; but it does provide a feel for the order of magnitude that is typical, to allow us to use that as a benchmark.

Protestant Reformation

2009-01-10T11:17:00.001-08:00

"The Reformation" spread across Germany and Scandinavia around 1530. In the 1530's, Henry VIII had famously broken with the Catholic Church. Though he do so partly because he wanted a divorce, he probably could not have done so without the numerous English noblemen and clergy who agreed with the ideas of the Reformation, and wanted change for their own reasons. About 30 years later, Mary Queen of Scots abdicated her throne in the face of the Scottish Reformation.

Super-fast revolution: What amazes me is this: Martin Luther nailed his "95 Treatises" to a church door in 1517. Just 20 years, saw change across many countries. How did it spread so fast? Were people so angry about the existing corruption and the status-quo? Many noblemen saw the reformation as a way to increase their local political power: was role did this play compared to the intellectual argument? I need to get a good book about the history of the Reformation.

Marx and Russia: Karl Marx published the "Communist Manifesto" in 1848. The Russian revolution took place 70 years later, in 1917. Since Communism wanted to overthrow the church, the rulers, and the middle class, it is not surprising that it took longer than the Reformation, even though it occurred in a time when ideas travelled more quickly.

A picture: Here are time lines for Luther and Marx, with Rand thrown in as a bonus.

Notice how rapidly Luther's ideas took hold.

Also, when a young Objectivist is pessimistic, tell him that we've got till 2026 if we go at the pace of the Communist revolution!

Starnesville

2008-12-04T04:12:00.000-08:00

When I first drove through Detroit, I saw a poverty-stricken city, with burnt-out homes, tall abandoned office buildings and hotels with boarded doors and broken windows, and liquor-stores neighboring some reverend's loudly-advertised house of redemption. Poverty was not all, though. Worse still were the wide, well-laid boulevards, and the intricately carved stone facades... the evidence of better times. Not just poverty, but decay.

The industrial equivalent can be found driving into Chicago. One drives past Gary, Indiana, with huge factories standing abandoned.

But the "prize" for resembling Starnesville (from Atlas Shrugged), probably goes to a "Detroit suburb" built in the Brazilian jungle.

Mean Bankers

2008-11-23T10:07:00.000-08:00

In Atlas Shrugged, Part 1, Ch X: a businessman wanna-be whines "... I worked like a dog, trying to get somebody to lend us the money. But that bastard Midas Mulligan put me through the wringer." Mulligan is portrayed as a tough banker who was able to identify people with good credit (who would pay him back, and then some) from bad.

It was he who had invested in Rearden Steel at its start, thus helping Rearden to complete the purchase of the abandoned steel mills in Pennsylvania. When an economist referred to him once as an audacious gambler, Mulligan said, "The reason why you'll never get rich is because you think that what I do is gambling." [Atlas Shrugged]
I was reminded of Mulligan, when I read the following description of James Stillman, a prosperous banker from the late 1800's:

"A caller would enter Stillman's office, assured, perhaps a little enthusiastic. Without a word the dark, elegant little man at the big clean desk would motion him to a chair upon which the light fell full. He would look at him, quite impassively, through veiled, impersonal eyes. The man would begin stating his case.

Minutes would pass. The caller would make assertions that seemed to require response. Not a sound from the grave, composed Buddha at the desk, whose eyes seemed to have penetrated through the other to some distant spot in the room. The visitor would fidget, cough, and finally finish what he had come to say.

Invariably would follow a long, cruel pause.

Then, as if from far away, [Stillman] would begin to speak. In low, impressive tones he would rip the proposal to shreds". (Source: John Wrinkler, quoted in Money of the Mind, James Grant, 1992 page 67)

Consider this though: despite the description above, Stillman is said to have made many loans, actively prospected for new business, and his bank expanded rapidly. [Source: James Grant 1992]

If only we had some more mean bastards running our banks, we would be in better shape today.

Detroit needs a bankruptcy

2008-10-28T16:00:00.000-07:00

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.

Social Security's Trust Fund

2008-10-18T08:00:00.000-07:00

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.)

Gathering Storm Clouds

2008-10-14T18:14:00.000-07:00

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!

Public Retirement Deficit -- another $700 billion?

2008-10-10T17:43:00.000-07:00

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.

Tomorrow's Sub-Prime Losers

2008-10-07T17:30:00.000-07:00

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?

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

2008-10-04T18:50:00.000-07:00

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.

Emergency Legislation we really need

2008-10-03T09:10:00.000-07:00

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.

Wall Street vs. Main Street - Faulty conceptualization

2008-10-02T17:46:00.000-07:00

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.

Reason vs. Emotion -- Disney Cartoon

2008-10-01T19:24:00.000-07:00

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.

Long Bets

2008-08-20T14:02:00.000-07:00

I came across web-site called "Long Bets". The idea of the site is that people can make a bet about something happening/not happening, 2 years or more in the future. The stakes are held in escrow, and given to a charity named by the winner.

The bettors don;t just bet; they're expected to provide a brief argument for their side. Also, the site allows membership, who can vote and discuss.

The largest stake is a $1 million bet between Warren Buffett and a money-manager. Mr. Buffett is betting that the stock market average will do better than a "fund of hedge funds" after fees/costs are accounted for.

Some bets have already been decided. In 2002, Dave Winder (a dot.com CEO) bet $2000 that "in a Google search of five keywords or phrases representing the top five news stories of 2007, weblogs will rank higher than the New York Times' Web site".

The site is like a less busy, more long-term version of a sites like inTrade.

Influence - by Cialdini

2008-08-16T10:56:00.000-07:00

A pretty young girl stops man on a sidewalk. She has a sheaf of papers, and wants to ask him a few questions about food and drink. The man exaggerates about how much he goes out to restaurants etc.. The girl then makes her pitch for a dine-out card. The card makes sense if he does go out as much as he claims. The man is embarrassed. He might even buy, to avoid admitting he exaggerated. If he does, he has been "influenced" by something other than rationality.

Cialdini's book, "Influence: The Psychology of Persuasion" recounts various methods used to influence people (e.g. by the use of similarity, or by the use of authority figures). Cialdini presents a wide range of examples. He explains why the Chinese had such "great" results with American POWs, with the minimal use of violence. He analyses the good-cop/bad-cop routine. He summarizes many sociology experiments. Using all these examples, he classifies the "influences" into major categories, and provides suggestions about how to deal with them.

Unlike some other authors, Cialdini does not take a cynical attitude. He does not use the various experiments (e.g. the famous Milgram electric shock experiment) to bold a thesis about the irrationality of man. He simply makes the case that people can and do act irrationally at times, and that others take advantage of this. He postulates that many of the irrational habits have their roots in useful habits (e.g. authority figures are often right), and that mostly we need to simply be aware of the potential traps, and have some pre-planned ways to deal with them.

Not an earth-shattering book if one has read similar ones (say, about sales-techniques). If one has not, then this is a good place to start.

Charles Munger

2008-08-06T05:11:00.000-07:00

I am a fan of Warren Buffett, despite his awful views on political science.

Buffett's business partner is the lesser-known Charles Munger. He has better political views than Buffett. However, like Buffett, he is a very steady, rational and thoughtful person. Here is a long (1;45 hrs) video of Munger giving a talk at Caltech, for anyone who is curious as to what it might take to be one of the richest men in the world.

Rights: French and American

2008-07-30T21:28:00.000-07:00

Here is how a intelligent Harvard professor begins a blog post:

All societies must set limits on health care....
This opening sentence is not the focus of his post, and he probably thinks it is uncontroversial. Laissez-faire is often seen as just another way in which a society sets limits on health care: i.e. by letting individuals decide. The formulation is thus seen as neutral: encompassing all types of systems, from Communism to Capitalism.

However, the formulation reflects a very specific way of looking at political systems.

As illustration, compare the French and American revolutions. Both desired new political systems, based on rights, but they had different perspectives.

The Americans saw rights in the design of man's nature. The key question they asked was: what rights does a man need as protection against tyrants democratic society at large, to make it worth his while to engage in society while pursuing his happiness? Meanwhile, across the pond, the French revolution was conceptualized more as a class-struggle. Perhaps this is understandable, given the historical setting. Their concept of rights came much more from a notion of egalitarianism. The key question here was: how do we design a more egalitarian society?

The French-inspired view is now so prevalent that people (like the professor quoted above) consider it as uncontroversial. They take a system-design perspective, rather than the perspective of what is morally due to an individual person. Finally, this view leads to the type of democracy that the American founders feared.