Wednesday, April 28, 2010

Social Utility

Eliot Spitzer, the disgraced former governor of New York, has written a piece attacking the investment bank Goldman Sachs for the on-line magazine Slate. In the column Spitzer raises the concept of “social utility.” He challenges Goldman Sachs to prove that the firm is socially useful by answering a series of questions regarding their internal trading operations.

The clear implication of the article is that Goldman Sachs is not “socially useful,” and therefore, should be eliminated, or at least reduced, by government fiat.

What a load of rot! That Spitzer can pronounce this pernicious twaddle with a straight face establishes that he hasn’t the faintest conception of how a free society functions.

You can deplore that the casino-like trading activities of Wall Street firms have swamped their traditional capital raising and capital allocation functions. You can be concerned that the lack of regulation of credit default swaps and other arcane financial instruments allowed some financial firms to pile up so much risk that they almost crashed the worldwide financial system. You can even argue that Goldman Sachs should not be allowed to sell securities that they have taken short positions against.

But banning or prohibiting activities because they lack “social utility”?

You would have a hard time providing an argument for the “social utility” of baseball cards, or beanie babies, Hummel figurines, but markets exist for all of those. The essence of a free market is that sellers offer something for sale, buyers offer payment, and a bargain is made between two willing parties. At no point does anyone have to meet a standard of serving a hypothetical greater good.

The essence of a free society is that you don’t have to justify your actions. You do have to take responsibility for them. If I wanted to light my farts on fire, and post the video on YouTube, I could do it, and I can’t think of anything of lower social utility than that.

And yet, a surprising number of people have chosen to spend their leisure in exactly that fashion.

Thursday, April 15, 2010

Beware the Ides of April

April 15 is Tax Day, the last day for filing your income taxes withourt incurring a penalty. The media has been full of stories about the run up to today. The thrust of most of the stories has been don’t be late, the deadline is looming.

The implication is that there are hordes of people out there who have not yet filed their taxes. The funny thing is, I worked as a paid tax preparer for H & R Block this year, and I was finished doing taxes in early March. As a matter of fact, 75% of the customers are handled during the first peak, from mid-January to early February.

After the first peak, the balance of the clients fall into three categories:
People with insanely complicated tax returns, who take months to get their paperwork in order.
Congenital procrastinators, the kind of folks who would be late to their own funeral.
People who still owe money to the IRS, over and above any withholding or prior payments.

If you’re going to get a refund, you will want to file as early as possible. After all, why leave a pile of money sitting in the government’s hands when it could be sitting in yours? And the vast majority of filers do get a refund.

First of all, almost half of all households pay no Federal income tax. The tax arm of Deloitte and Touche estimated that a married couple with two small children would have to have an income exceeding $50,000/year before they generate the first dollar of income tax liability. They will get all of their withholding back.

Many of those in the lower half of the income scale not only owe no money for taxes, but they also get significant income from the government, due to refundable credits such as the Additional Child Tax Credit and the Earned Income Credit. Of the returns I processed, most fit into this category. Only a handful actually paid income tax, and even those had a tax liability less than their withholding, so even they got a refund.

In the interest of full disclosure, I also got a tax refund, due to overwithholding on my part. I didn’t do a single return this year where the taxpayer had to send additional money to the IRS.

I guess my point is that the media shouldn’t make such a big deal about what the last day for filing your taxes is. Instead, they should run stories on February 1, the due date for employers to send out the W-2 forms needed to file your taxes. For most households, that is the primary, or even only, document they need to get their refund.

Now that would be news you could use.

Monday, April 12, 2010

Changing the Rules of the Game

Obamacare has been passed into law and signed. Despite fulminations from conservatives, it is unlikely to be repealed or found unconstitutional. All we can do now is wait for the unintended consequences to show up. Yet, like a moth to the flame, I am still drawn to write about the intertwined issues of health care and health insurance.

At the root of Obamacare is a profound shift in the understanding of what health insurance (or any insurance) is designed to do. The core concept driving any insurance plan is risk management. Basically, the lucky are subsidizing the unlucky.

If a tornado blows away your house, your neighbors who were missed are paying for your rebuilding through their policy payments. “Wow,” they think, as they write out the check, “that tornado just missed my street.” Or let’s say you beat the actuarial odds and die young. Your beneficiaries are taking advantage of all the other policy holders who didn’t die that year. “Gosh,” they think, sitting at the funeral, “that could have been me that got hit by that freak meteorite strike.”

The thing about the lucky subsidizing the unlucky is that you can never know in advance in what category you’re going to end up. So you pay your premiums, and you’re grateful if you never have to use the insurance.

At the heart of Obamacare is a radical conceptual shift. Instead of the lucky subsidizing the unlucky, the basic principle is now going to be the healthy subsidizing the unhealthy. Hence the push to require younger, healthier people to buy insurance, at the same time lifetime limits on care and exclusions for preexisting conditions are dropped. If you are sick, you are going to get all of the medical care your doctors want to give you, and the people who are well are going to have to pay for it.

The thing is, lucky or unlucky is pretty much a random event. For healthy versus unhealthy, there is not so much randomness involved. If you see someone who smokes, it is predictable that heart disease and breathing problems are in their future. Looking at someone who is grossly obese, you know they can plan on developing type II diabetes, followed by back pain, followed by joint replacement surgery. These tend to be chronic conditions. They can be managed, but somebody’s going to have to pay for them. The healthy are being asked (well, actually told) to foot the bill.

The thing about most insurance is that it is inherently fair. That’s why I willingly pay the premiums. But as someone who likes to eat, but has the self discipline to push away from the table, as someone who sweats it out at the gym several times a week, as someone who has never taken up smoking, I look at many of the unhealthy and question how fair it is that I’m being asked (well, actually told), that I am responsible for paying for the consequences of other people’s behavior.

Those of us who work hard at managing our risks should not have to subsidize the reckless. Frankly, I’ve got better ways to spend my money.

Tuesday, April 6, 2010

Positive Problems

Last January, late in the month, it was like somebody turned a switch. All of a sudden the phone started ringing with customers expediting their orders and increasing their release quantities. Ever since we've been playing catch up. The biggest issue has been getting enough raw material in house to support the increase in production.

This is an example of what I call "positive problems." These are the problems caused by growth in your business. Although stressful, they are drastically superior to the other kind of problem. For example, I'd rather spend my day wrestling with the question "how I am going to get raw material here to keep production going?" as opposed to the question "what am I going to do with all of the workers and not enough orders?" Or worse yet, "where is the cash coming from to meet payroll?"

The turn in the economy is beginning to look like a broad based phenomena to me. I spoke with one of our customers today, and she told me that her whole day had been spent expediting suppliers to cope with increases in customer demand. Upstream in my supply chain, lead times are moving out from both the steel mills and brass mills with whom I do business.

This increase in activity probably won't show up in the official government statistics for another quarter, but from where I'm sitting it looks like the growth cycle has picked up steam. I'm even hiring a couple of new people. In the meantime, we're considering working some overtime. That hasn't happened for well over a year.

Thursday, April 1, 2010

Starbucks Begins Paying Dividends

Last week Starbucks announced a big change in their financial policies.  For the first time, the Seattle based company will begin paying dividends to stockholders.  The company is touting this as proof that their turnaround plan is working.  I’m skeptical.  The management team may be turning the company around, but the fact that they are starting to pay dividends indicates to me that the company may have its best days as an investment behind it.

 

Think of it this way: Imagine that you have a business that is profitable.  You have a decision to make.  What are you going to do with the profits?  You basically have two choices.  One choice is to take the money out of the business, and give the profits back to the owners of the company.  The alternative is to take the profits, and reinvest them back in the business.  With the alternative of reinvestment, your hope and plan is to grow the business, and thereby make future profits even larger than they are now.

 

As an investor, a growing company provides a better return than an equally profitable company that is not growing.  Picture two businesses.  One business is going to earn a dollar a share this year, next year, and the year after that.  The other business is going to earn a dollar a share this year, $1.50 next year, and $2.00 per share two years out.  Which business would be worth more to you?  You pay more today to capture the larger future cash flow.

 

The anticipation of larger future profits results in a higher multiplier between the current earnings and the price of a share of stock.  Growing companies command a higher price/earnings ratio.  As the manager of a business, you want to grow your earnings, because that makes the business more valuable, providing the highest return to the owners, the stockholders.  Besides, most senior corporate execs have a large chunk of their compensation in stock options.  Increasing the value of the shares benefits them personally.

 

But there is a risk with this model.  What if you reinvest your profits in the business, but you fail to grow your earnings?  Well, the technical term for this process is “pissing your money away.”  The market hammers you for that.

 

If you think you have lots of opportunities to grow your business, you should reinvest your profits back into the business.  If you don’t think you have as many chances to grow your earnings, then it becomes time to start pulling money out and giving it back to the owners.

 

The fact that Starbucks is going to start paying a dividend, returning profits to the stockholders, indicates to me that the management of the company thinks the days of their fastest growth are behind them.  Which means as an investment, it is time to look for the next company that has the potential to grow quickly.

 

Starbucks.  I love the coffee, but I’m not so wild about the investment.