Where is the Center?

As Team Obama shifts from the campaign to the transition team, the analysis coming out of the media has also shifted. Some have suggested that the Obama administration will shift to the right once in office, attempting to find centrist positions to the tough issues. Looking at Obama's policy positions, I'm not holding out a lot of hope.

Governing from the center is raising taxes to pay for infrastructure spending. Governing from the left is raising taxes on some people to give transfer payments (excuse me, tax credits) to others.

Governing from the center is making an argument for expediting new nuclear power plants, to replace carbon dioxide emitting coal fired power plants. Governing from the left is placing a massive tax on energy (excuse me, a cap and trade system), while telling people that wind mills will replace the industries that you bankrupt.

Governing from the center is announcing that you will put your administration's political capital into redefining Federal law to recognize gay marriage. Governing from the left is declaring you will appoint judges who will rule based on their compassion for the downtrodden.

Governing from the center is coming out in favor of unionization, staffing the NLRB with pro-union partisans, and ramping up Justice Department investigations of companies accused of illegal antiunion activities. Governing from the left is tossing out 70 years of law backing secret ballot elections, and replacing it with card check legislation allowing for covert intimidation and coercion to determine the nature of the workplace.

Governing from the center is to propose raising the minimum wage to $9.25/ hour. Governing from the left is to propose raising the minimum wage to $9.25/hour, extend the FMLA in terms of employers affected, reasons for claiming leave, and amount of leave, and require employers to give employees 5 days of paid leave.

Governing from the center is to require health insurance plans to provide unlimited mental health benefits. Governing from the left is to require health insurance plans to provide unlimited mental health benefits, and then go on to require employers to health insurance to all employees as a mandatory benefit.

The Obama administration has the potential to make conservatives nostalgic for traditional tax and spend liberalism. Between unfunded mandates on business and tax and give policies, I'm gearing up for four years in loyal opposition.

How to Create Jobs, Not!

Part of an interview Barack Obama gave in San Francisco last January came to light over the weekend. In the interview with the San Francisco Chronicle, President-elect Obama made the following comments regarding coal-fired power plants:

“If somebody wants to build a coal plant, they can — it’s just that it will bankrupt them, because they are going to be charged a huge sum for all that greenhouse gas that’s being emitted.”

This comment was made in the context of explaining a cap and trade system for reducing greenhouse gas emissions. Since coal burning power plants emit more carbon per kilowatt than any other type of electrical generation, the penalties on those plants will be higher. The idea behind a cap and trade system is that, over time, the penalties for emitting carbon increase, until they become ruinous, and the carbon emitting power plants are shut down.

The goal of a cap and trade system is to drive carbon emitters out of business, while rewarding businesses that produce the same products in a carbon neutral way. In the context of power generation, coal-fired power plants are bad, solar and wind farms are good.

I bring this up by way of introducing the topic I really want to write about: the myth of the “green job.” The way this myth is presented is that by developing nonpolluting energy sources, all kinds of jobs with high pay and great benefits will be created. Since entirely new industries will be created in the field of clean energy, lots and lots of new “green jobs” will be added to the economy.

Yesirree, plenty of demand for windmill mechanics out there on the horizon. Sky’s the limit. Speaking of the sky, we’ll also need a bunch of solar mirror focusers. Step right up and get your job application here.

Now the problem I have with this line of argument is that job creation is being sold as one of the benefits of changing our energy infrastructure over to a less carbon intensive model. Try telling that to the guy who works in the coal-fired power plant that’s going to be taxed out of existence to pay for all those shiny new windmills. That poor schmoe is going to lose his job. So will the coal miners supplying him with fuel.

As I see it, employment in the energy industry is at best a zero sum game. For every job you create building or servicing windmills, or installing solar panels, you lose a job building mining equipment or transporting coal. There are going to be winners in new energy technologies, but there will be just as many losers in the old, reliable, proven technologies.

If we have to make this transition, if the survival of civilization requires it, than so be it. But don’t try and pitch it as a good way to create jobs.

We should pay more respect to the people who are going to lose their livelihoods after the companies they work for are bankrupted.

Hail to the King!

I don’t know if this is a function of the media coverage or a real phenomena, but it looks like a lot of the people at risk for losing their houses in the next wave of foreclosures will be the newly unemployed. Whenever I read an article about foreclosures, the stories feature people who just lost their job.

Now, as far as recessions go, this is not my first rodeo. We had spikes in the unemployment rate in 2001 and in 1991 when the economy contracted. But from my admittedly foggy recollection of news coverage from those days, I do not remember a lot of foreclosures being associated with the downturn.

To the extent that this is a real phenomena, I wonder if this is a function of increasing household leverage. During previous recessions, did folks have more savings that could tide them over a rough patch? Or is it that these days, the mortgages are so large that making the payments exhausts one’s savings more rapidly than in years past?

In an uncertain environment, you want to have more stored fat to carry you through the lean times. Whether because we’re leaner (financially, not physically) or because our burdens are heavier, it seems like people who lose their jobs in this recession are at much higher risk of a financial upset turning catastrophic.

I wonder if some people thought they were “storing fat” though their home equity. Either by making extra equity payments, or rising housing prices, maybe some thought they were storing up equity. The simultaneous drops in housing prices and credit availability have given the lie to that theory.

Cash is king right now, and cash is the only truly liquid investment. Times like these demonstrate the critical importance of keeping an emergency fund available.

Give the guy a break!

Sometimes the media coverage amazes me.

Take Joe the Plumber. The guy questions Barack Obama's tax plans at a campaign stop in Ohio. Based on Obama's answer to his question, the interaction gets posted to the internet, and is picked up by the McCain campaign, who used it in the last debate between McCain and Obama.

So apparently editors around the country start asking who is this Joe the Plumber, and what is his story. What seems like a hundred reporters sift through every public record on this guy, and report the following scoops:

His name isn't really Joe.
He doesn't hold a plumbing license.
At one point he was in arrears on his taxes.
The business he works for probably doesn't generate over $250,000 in earnings for the owner.

Who gives a crap.

What made the exchange newsworthy wasn't the question, or the questioner. It was the candidate's response. Barack Obama said "I think things go better when you share the wealth." What he meant was "I think things go better when I share your wealth." Barack Obama's tax plan proposes to use the government as the intermediary to transfer money from people who have it to people who don't.

Take from the rich and give to the poor.

As I have said before, Barack Obama will be the Robin Hood President.

And focusing on Joe, or Sam, or whatever his name is, distracts us from focusing on the candidate's proposals, and the implications of those proposals.

Tax Cut Semantics

When is a tax cut not a tax cut? Barack Obama claims that his economic proposals include tax cuts for 95% of Americans. But to do so would require redefining what it means to cut someone’s taxes. To understand what I mean, it’s necessary to illustrate the differences between tax deductions, nonrefundable tax credits, and refundable tax credits.

The basic concept behind income taxation is pretty simple. You take your income and subtract out deductions to come up with adjusted gross income (AGI). Then you multiply AGI by a percentage to figure how much tax you have to pay. The US tax is progressive. That is, the more money you make, the bigger the percentage you hand over to the Federal government.

Tax deductions are things like paying home mortgage interest, or saving for retirement by putting money into an IRA. You deduct the money you put into those things from your income. So if you are in a 15% tax bracket, for every dollar you put toward your IRA, your taxes are reduced by fifteen cents.

Your deductions can only drop your income down to zero. You can’t have negative income and get any kind of rebate from the IRS.

Then there are the tax credits, nonrefundable and refundable. After calculating how much tax you owe, based on your adjusted income, tax credits reduce the final sum of taxes paid. For every dollar of tax credit, your taxes are reduced by a dollar. For nonrefundable credits, you can reduce your tax liability down to zero, but then the game stops. With nonrefundable credits, you can’t have a negative liability and get any kind of a rebate from the IRS.

This brings us to refundable tax credits. With this type of tax credit, after your tax liability is reduced to zero, any credit left over is yours to keep. Which means the government sends you a check.

Tax deductions, nonrefundable tax credits, and refundable tax credits: guess which type the Barack Obama plan calls for when he says he’ll cut taxes for 95% of Americans? Now here’s the thing about this tax “cut.” After deductions from income, and existing tax credits, about 40% of American households don’t pay any income tax. But under the Obama plan, they would be getting money from the government.

So, getting back to our original question, when is a tax cut not a tax cut? When it’s welfare.

New Ideas for Spending Money

Where do they come up with this stuff?

In the face of a plunging stock market and moribund credit markets, both Presidential candidates are reaching deeper into their goodie bags to come up with new bribes, er, enticements to try and stimulate the economy. Sure, because $700 billion to buy up banks and mortgages wasn’t enough.

Last week John McCain fired off a salvo. He proposed rescinding the requirement that owners of IRA’s and 401K’s have to start taking withdrawals from retirement accounts starting at age 70 ½. Why force people to sell assets into a down market, when that just increases the downward pressure on stock values? Actually, I think this is a pretty good idea, but then again, I’ve never heard a good argument for why mandatory withdrawals from retirement accounts were necessary in the first place.

After meeting with his economic advisors over the weekend, McCain apparently felt that anything else they proposed was too gimmicky, so he hasn’t come out with anything new this week. Of course, there is one more presidential debate coming up, so maybe he’s saving up for that.

In the meantime, Barack Obama came out with multiple gimmicks, er, policy proposals this week. First, he wants to mail out a $1000 check to everyone whose household income was less than $150,000. He also wants to extend unemployment benefits for another 13 weeks. This looks like a straightforward increase in welfare to me, pure and simple.

Senator Obama wants to impose a three month moratorium on foreclosures for any bank that accepts the Federal bailout money. You have to wonder what the economic point of this is. Does he anticipate that people will start paying their mortgages again after a three month grace period? Wouldn’t an increase in the number of foreclosures in process (loans go delinquent, but none ever get resolved) put even more stress on the banks that taxpayer money is going to bail out? The political point is a little more self evident: “Vote for me, folks, and I’ll give you three months free rent!”

Then there is the idea of removing penalties for 401K withdrawals. This allows you to get the tax break for contributing to a retirement plan, without actually having to forego the immediate consumption. Americans don’t save enough for retirement now, so let’s make it easier to consume instead of invest. This is the triumph of short term gratification over long term planning. Times may be tough now, but they will be even tougher when you are too old to continue working.

My personal favorite among Senator Obama’s new proposals is the tax credit for adding employees to the payroll. He has proposed a $3000 tax credit be given to businesses for every person they hire. This is basically offering a bribe to go out and hire people, but it is not even an effective bribe. In my hiring and firing, if I need to hire people, I hire them, and $3000 from the government isn’t nearly enough to sway my opinion. A new employee costs at least $20,000 a year. Unless you have enough business to justify that expense, a $3000 dollar subsidy doesn’t begin to cover that cost.

As a conservative, I long for the days when every problem didn’t automatically become the concern of the US government. Both parties seem to be caught up in the game of seeing who can offer more tax revenue to the citizenry. I’ll be happy in three weeks when the Pander fest known as the general election campaign is over.

If at first you don't succeed...leave it alone.

The crisis in the nation’s, and the world’s, credit markets continues to persist. From reading news reports, I hear that credit is “frozen,” and that “banks are afraid to lend to one another.” The standard line being used is that without access to credit, businesses cannot buy inventory or payroll, consumers cannot buy cars or houses, and the entire economy is in danger of grinding to a halt.

In the face of the credit market freeze, the Federal Reserve and the Treasury are announcing new actions almost every day to try and get the buyers of securities off the sidelines (there is no shortage of people wanting to sell IOU’s, just not a lot of people buying them these days).

In the last week the Fed has taken the following actions:
-It has started buying unsecured commercial paper. These are basically short-term loans made to individual companies for funding operations. They are usually not backed by any collateral.
-Fed Chairman Ben Bernanke promised to cut interest rates in a speech on Tuesday. That’s usually good for cheering up the markets.
-This morning, the Fed did cut interest rates, along with six other central banks around the world, in a coordinated action. Okay, now we know all of the central bankers are serious about restarting the stalled credit markets.
-The latest proposal that has been floated is a plan for the Fed to buy ownership stakes in banks.

All of this of course, is on top of the $700 billion Treasury bailout that passed Congress last week, also known as the mother of all interventions.

The first thing that strikes me about all of this is the emphasis on making loans and borrowing money as the engine of the economy. Wasn’t it too much borrowing, and lending to people who couldn’t pay the money back that got us into this mess?

The other thing that strikes me is the frenetic nature of the government’s actions. They want an immediate reaction, and when the market doesn’t oblige, they cough up another plan to see if that will give them an immediate reaction.

In the manufacturing arena, one reaction to problems is called "overadjusting the process." You take a part coming off the machine, measure it, and then tweak the machine. Then you do it again, and again, and again. The problem with that is that you never let the process stabilize to normal capability. Sometimes you have to resist the temptation to keep pulling on the levers and knobs, and just let the machine run for a while to determine your true process capability.

It feels like governments are trying to do the same thing. Every day a new program or intervention is announced, without giving the markets time to settle down and get used to the last adjustment. It probably doesn't help that it is an election year. My favorite metaphor for this is “pulling the plant out of the soil to check on the growth of the roots.”

There are a lot of people who work in the credit markets. Leave 'em alone to do their jobs, and eventually they will figure out how to muddle through. Interest rates will spike higher for awhile, even for ultrasafe borrowers like the state of California and AT&T. But as investors figure out that California is not going to default, trading volume will go up, and rates will come back down.

I have a lot of faith in letting people muddle through. It is not always efficient, and it is almost never pretty, but in my experience, letting people do their jobs seems to work.

A Tale of Two Deals

A little less than two weeks ago, Citibank agreed to take over the banking operations of Wachovia Bank. This was a deal engineered by the Treasury Department to protect depositors of Wachovia. Although Wachovia did not technically fail, this was certainly a shotgun wedding arranged by the regulators. Citibank agreed to pay $2 billion for Wachovia.

Interestingly, Citibank agreed to pay for the first $41 billion of losses on Wachovia’s loan portfolio. After that, the Treasury (meaning we the people) agreed to indemnify the folks at Citibank for any additional losses. In other deals of this type, the government has taken the losses up front, as a sweetener to get the acquiring party to do the deal.

For example, when Bear Stearns was acquired by JP Morgan Chase earlier this year, the Federal Reserve took $30 billion of bad assets off Bear Stearns’ books before the sale went through. Since the Wachovia deal is structured the other way around, Citibank has powerful incentives to keep the losses as low as possible. This tells me that nobody, and I mean nobody, really knows which loans are going to default, and what the recovery on the collateral will be when all the foreclosures are done and the houses resold. But I digress.

So anyway, the Treasury pushes through a crash sale of Wachovia to Citibank. Three days later Wells Fargo offers $15 billion to buy Wachovia in a separate deal. The CEO of Wachovia, using the keen business acumen honed by decades of experience in high finance, quickly realizes the Wells Fargo offer is about 750% better than the Citibank offer. Wow, maybe the guy is worth the $19 million in signing bonus and severance pay he’s going to get for six months worth of work.

Wachovia’s Board of Directors quickly approves the sale to Wells Fargo. Citibank, spurned at the altar as Wachovia elopes with Wells Fargo, cries foul. All three banks hire $400 an hour lawyers and go searching for judges who will rule in their favor. The corporate equivalent of a barroom brawl erupts. Or maybe a mud wrestling match.

The latest news is that the banks have called off their attack dogs, and some kind of compromise deal is in the works. All very entertaining, but what does it have to do with us.

Just this: the guys at Treasury put together the Citigroup-Wachovia deal, and less than a week later somebody else offers 750% more for the same assets. And let’s not forget that there is no risk to the taxpayers in the Wells Fargo offer. Thirteen billion dollars is a lot of money to leave on the table in a negotiation. I mean, it’s not exactly a rounding error.

I can’t really fault the T-men either. Their priority was to protect the depositors, and get the deal done as smoothly as possible, with minimal disruption to the financial markets. Getting the best deal possible was never even on their radar screen. For the Citigroup team, getting the best deal possible is always their primary consideration, and those boys have sharp elbows. For that matter, the same could be said for Wells Fargo.

But here’s the thing. Didn’t Congress just pass legislation allocating $700 billion of the government’s money (meaning we the people) to buy up financial assets? Didn’t the money get allocated to the Treasury Department? And aren’t the T-men going to buy those financial assets from banks like Citigroup and Wells Fargo? Using our money? Forgive me if I’m wrong, but isn’t the Treasury’s primary goal to support the banks, and not to get the best deal possible?

We the people are going to get rolled like a drunk on New Year’s morning.

It's been a wild ride so far!

The last month has been an amazing time to watch the financial markets. More and bigger changes have occurred among the major players in the US financial system than in the previous generation.

A quick recap:
The Federal government took over Fannie Mae and Freddie Mac, effectively nationalizing the US mortgage market.
Lehman Brothers goes bankrupt.
The US government buys 80% of one of the largest insurance companies, AIG, in exchange for an $85 billion loan.
Bank of America acquires Merrill Lynch.
After a run on deposits, Washington Mutual is taken over by Federal regulators and is sold to JP Morgan Chase. This is the largest bank failure in US history.
Just prior to failing, Federal regulators engineer a deal for Citibank to take over the banking operations of Wachovia bank.

While all that was happening, the last two major independent investment banks, Morgan Stanley and Goldman Sachs, decide to rewrite their charters to change to more ordinary commercial banks. This move will require them to continue the process of deleveraging that has been going on all year, and will also require them to accept a much higher level of regulation than they have previously had to deal with.

What else happened last week? Oh yeah, after the House rejected a $700 bailout of the financial markets, the Senate passed a sweetened bill, and the House accepted that. So now the Treasury is going to directly own $700 billion in mortgage packed securities. Since these will be distressed assets (otherwise why sell them to the bailout fund), it is likely the government will own mortgages with a face value of well over a trillion dollars.

So, while competition in the banking sector is being dramatically reduced, and the investment banking industry is essentially eliminated, the Federal government becomes the largest player in the mortgage market.

I thought we were supposed to be the guys who believed in free markets.

Financial Market Bailout, Take II

If at first you don’t succeed…

The government’s bailout plan for the credit markets passed in the US Senate last night, after failing in the House of Representatives on Monday. The revised legislation will probably come up for another vote in the House on Friday.

In the first stampeded rush to judgement, the unpopular bill failed, in part because of the very size of the package, and the unprecedented leeway the Treasury secretary was given in handing out $700 billion of the taxpayer’s money. Also disturbing many lawmakers, of both parties, was how quickly the message of the administration changed from “the system is stressed, but still working,” over to “if you don’t give us this authority, your ATM will stop working.”

In order to get more votes for the proposal (note I did not say “make the proposal more popular”) the Senate followed the time honored tradition of packing more lard into the pork barrel. The revised plan now includes an increase in insurance on bank deposits, up from $100,000 to $250,000. It now also includes a grab bag of tax breaks estimated to cost another $100 billion.

Great! Spending $700 billion in one fell swoop isn’t enough. Let’s plug another $100 billion on top of that. I thought this plan was half baked before. The Senate version looks like they pulled the cake out of the oven, saw it was half baked, and decided the answer was to add a bunch more ingredients to the mix.

I’ve heard of smearing lipstick on a pig, but who knew they had invented lipstick body wash?

Adding to the hysteria has been the behavior of the stock market. The House fails the bill, and the market drops 700 points! The bailout is resurrected in the Senate, and the market leaps 500 points! The market opens quiet, waiting to see if the revised bailout passes the House!

I’m put in mind of the two year old who throws a tantrum in the aisle of the grocery store until the parent buys them the candy they want.

Try this on for size: leave the markets alone. If the credit market starts to seize up, let it. In the short run, interest rates will go up, and it will be harder to get loans. But after a while, the boys and girls on Wall Street will figure out that if they don’t play nice, their jobs will go away, and the markets will start functioning again.

At least, that’s my theory. I call it “Free Market Economics.” It’s too bad that we’re not going to see that theory tried out.

No Skin in the Game

Congress and the Bush administration have agreed to terms on a $700 billion bailout package for Wall Street. Under the plan, the Treasury will purchase mortgage-backed securities that no one else wants to buy from banks. This infusion of cash will recapitalize the banks and hopefully stimulate inter-bank trading to resume at something close to normal levels.

For the taxpayer’s $700 billion, we get several things. First, the government gets the securities, which will hopefully be worth something. The idea is that the Treasury can get a better deal by waiting for the right buyer to come along. Right now, panic selling has these securities worth pennies on the dollar. By driving panic out of the market, the prices of these mortgage-backed assets will recover some of even most of their value. If they don’t recover in value, the taxpayer will eat the loss.

In addition to the bonds themselves, the government will get warrants that give the Treasury an equity stake in the companies that participate in the plan. So if the stocks of the banks go up, post rescue, the government (i.e., the taxpayers) will recover some value. Finally, there are some limits on senior executive compensation that go along with accepting the government’s largesse.

We have been assured that this bailout was necessary to prevent total collapse in the banking system. The end was near! If that had happened, consumers would have been unable to get mortgages or car loans, and businesses would have been cut off from lines of credit necessary to continue operations. If you accept that, congress and the administration had no choice but to act. The problem is, I’m not buying it.

I understand that the rates banks charge each other for short term loans have spiked in he last two weeks, and that trading in the credit markets has been at much lower volumes that usual. But nobody has connected the dots to show why the credit markets wouldn’t calm themselves without the largest government intervention in history. Nor has anyone made the case for why credit worthy borrowers would not have been able to get loans, even if the interest rate was higher than it would otherwise be.

Nobody in the banking industry has come forward to say: “I’ll take the hit. Passing this legislation is so important that I will forego salary and bonus for 2008.” Kenneth Lewis, the CEO of Bank of America, which just acquired Merrill Lynch, wrote an editorial in Friday’s Wall Street Journal urging passage of a bailout plan. But since Bank of America is in such good shape that they don’t need the help, I guess ol’ Ken doesn’t feel the need to sacrifice any of his hard earned compensation to convince Main Street voters that the crisis is as dire as portrayed.

When Lee Iacocca was brought in to turn around Chrysler in the early eighties, he asked congress for loan guarantees to help him raise money for the turnaround plan. In order to build credibility for the effort, he agreed to forego salary and bonus until the company returned to profitability. I sure would like to see some of the Wall Streeters volunteering to do something similar.

If the situation is as serious as it is reputed to be, that is the least that they could do. Of course, maybe the end wasn’t so near. Maybe the taxpayers just got played.

Would you buy a used car from these men?

I watched a little of the C-SPAN coverage of the Paulson/Bearnke show last night. This was the Senate hearing where the Treasury Secretary and the Federal Reserve Chairman were pitching their plan to use $700 billion to buy up mortgage bonds and rescue the financial markets. As I understand it, their contention is that unless the government buys up all of these assets, the banks will not trade with each other, leading to other businesses and consumers being unable to get credit to run or expand their operations.

The august personages that sit on the Senate Banking Committee were, not surprisingly, reluctant to hand over an amount greater than the entire defense budget to two bald guys sitting at a folding table saying “yup, we really do need that much money.”

Based on the short section of the hearing that I watched, I felt like this was the gist of things:
Q: What assets will are you buying?
A: We don’t know yet. No point in thinking about that until you know you’ve got the money in hand.

Q; How will you price the assets you are buying?
A: We think we’ll use a reverse auction, but we’re not sure yet. The method of making purchases will vary based on the type of asset we are buying. Can we have the money now?

Q: How will you know if the prices you pay are fair prices?
A: Well, at this point we don’t know. We plan to hire some really smart guys to figure that out, just as soon as you give us statutory authority to spend enough money to buy Switzerland.

Q: What will you do if the taxpayers buy all of the crummy assets from Wall Street, and those guys turn around and award themselves multi-million dollar bonuses as a result?
A: We agree that would make the taxpayers feel cheated. But what is important here is that if you don’t hand over the money, the Wall Street boys will throw a tantrum and push us into a recession.

Q: Secretary Paulson, what kind of government oversight is included in your plan?
A: I never needed government oversight when I was running Goldman Sachs and awarding myself multi-million dollar bonuses, but there is this tweedy looking nerdy guy next to me. Would he count? On second thought, I welcome additional government oversight, just as long as they don’t get in the way while I’m writing checks.

Can you spell “half baked?” I wouldn’t give these guys any (more) money either.

It's the Leverage, Stupid!

It has been an amazing couple of weeks in the financial markets. Fannie Mae and Freddie Mac: nationalized. Lehman Brothers: bankrupt. Merrill Lynch: acquired by Bank of America. Insurance company AIG: 80% owned by the Federal government. Last week’s news is that commercial bank Washington Mutual and investment bank Morgan Stanley are both searching for buyers to acquire them before they go the way of Lehman Brothers. This week’s news is that the Federal government is engineering a $700 billion plan to acquire troubled mortgage assets from Wall Street companies.

And all of this is on top of the collapse of Bear Stearns and IndyMac Bank earlier this year, not to mention the massive multibillion write offs that have hammered almost every large financial institution in the country.

The root of this turmoil is the collapse of the housing bubble. Houses that used to sell for $500,000 are now selling for $350,000. Houses that were selling for 250,000 are now selling for $175,000. More declines in housing prices are forecast for next year. People who purchased houses with 100% loan to value mortgages, or who pulled all of the equity out of their house with home equity lines of credit (HELOC, in banking jargon), are being foreclosed upon in record numbers, leaving their bank with collateral that is now worth less than the balance owed on the loans.

But there have always been foreclosures, big bankruptcies have occurred before. What makes the impact of current conditions so severe? In a word: leverage.

One of the reasons the stock market crash of 1929 led directly to the Great Depression was leverage on the part of individual investors. During the stock market boom of the twenties, investors could buy 5 shares of stock while putting in the cash for only one share. The rest of the money was borrowed. The practice of buying stock with borrowed money is called buying on margin.

When the market crashed in 1929, stock values dropped low enough that the cash the investors had put in was wiped out. The brokerage that had loaned them the money then turned around and required the investors to come up with more cash. This is known as a margin call. In 1929, the margin calls set up a feedback loop. To raise cash, investors sold more stock. The increased selling lowered prices further, which led to more margin calls. More margin calls, more selling, lower prices, more margin calls. Rinse, repeat.

The problem was set off because investors had borrowed too much money compared to the equity they put into their portfolios. They did it because the more shares they controlled with borrowed money, the bigger the return on the equity they had put in. At least, that was true as long as stock prices were going up.

Borrowing money, or leverage, amps up returns when assets prices are rising, but it has the reverse effect when asset prices are falling. Falling like they are these days.

Leverage is everywhere in today’s economy. Let’s say you buy a new car that costs $25,000. You trade in your old car for $5000, and finance the rest. In this instance, you have leveraged your equity (the value of your trade-in) by a factor of four. If you buy a house with a standard 20% down payment, you are leveraged four to one.

Industrial companies use leverage as well. They finance their operations through a combination of stockholders equity (capital) and debt instruments like corporate bonds. Usually the ratio is less than one to one. That is, they have more capital than debt. The thing about debt is that you always have to make the interest payments. With equity, you can always cancel your dividend when you hit a rough patch.

In the last few years, Wall Street firms have piled on an astonishing amount of leverage. The investment bank Goldman Sachs has leverage of 22 to 1 currently. Before it collapsed, Lehman Brothers had leverage ratios of over 30 to 1. That means it only took a 3% loss to wipe out the equity in the firm.

But despite the media coverage, we can’t blame all of the current financial crisis on greedy Wall Street financiers. There is plenty of mud to throw at Main Street folks as well.

Consider a homeowner who buys a $200,000 house and takes out a $160,000 mortgage. That guy is leveraged 4 to 1, right? Now watch the homeowner take out a $30,000 HELOC a year later. Now the homeowner is leveraged 19 to 1. That’s getting up into Wall Street territory. During the bubble inflation years, it was possible for subprime borrowers to take out 100% loan to value mortgages. The banks went to people who had a history of not paying off their debts, and let them take on leverage ratios of over 100 to 1. That’s like giving a six year old a can of gasoline and a book of matches, and then telling the kid to go out and play.

Now our financial system is burning down around us.

Debt is a good servant, but a bad master.

The Fundamentals of the Economy

John McCain gave a speech yesterday where he said "The fundamentals of the economy are strong." He was immediately excoriated for that remark.

"How out of touch is that guy? Wall Street is collapsing! People are losing their homes to foreclosure! Gas prices are up! I found a double yolked egg when I went to make breakfast this morning! Damn Bush and those neocons!"

You know what? All of those things may be true (except for the double yolk egg part. I usually eat cereal for breakfast). But I happen to agree: the fundamentals of the economy are strong.

This is not to say that things are booming, because they're not. I work for a company that makes subassemblies for the major appliance market. We've taken a big hit this year, both in sales that are off because of the slowdown in the housing market, and in our costs, because commodity and energy prices are up so much this year. I've had to conduct several rounds of layoffs to get our company's workforce down to the right size for our current volume of business.

But we're still selling product, still meeting payroll, still investing for the future in both people and equipment. Just as you can have slow sales, but a fundamentally sound business, so too can you have a recession, even a severe recession, and still have a fundamentally sound economy.

I don't want to make light of the real suffering going on out there right now. People are losing their jobs and their houses, and that has just got to suck. High gas and food prices are taking a bite out of my income just like everyone else's. But I went out jogging the other day, and I noticed a funny thing: there was no blood in the streets. I would have noticed too, becuase it hadn't rained for several days.

Layoffs are up, but 94% of us still have a job. Foreclosures are up, but over 97% of homeowners are still making their mortgage payments. The stock market is down, but it is not shut down. You can still buy and sell stocks. At a personal level, it easier to get a table at the local Outback Steakhouse, but only after 8:00 at night. The dollar doesn't go too far if you're in France for vacation, but it still spends just fine in Wal Mart or Target.

At least, I think it still spends fine in Wal Mart or Target. I haven't bought anything at either store in months. Gas prices are up, so I compensated by cutting back on the amount of Chinese made crap I buy.

My point, however, is that the economy is still functioning. People are adapting and adjusting to tough times, and when this deleveraging process we're going through runs it's course, we are going to get back to growing and creating businesses. We're going to do this without a lot of help from the government, by the way.

The people who work for my company are coping with the current economic environment in a variety of ways. Some are carpooling to work to save gas. Some are finding second jobs to replace the overtime they've lost. Some are cutting back vacation plans. One thing they are not doing is cutting back on helping each other. When a coworker or family member hits a rough spot, they chip in to help to the same extent as in better times. At a fundamental level, they are muddling through this rough patch. So, yeah, I think John McCain is right when he says that the fundamentals of our economy are strong.

Tough times never last, but tough people do. At the core, Americans are tough people.

Little Houses on the Prairie

Have you heard about the Tiny House movement? This is a very loose grouping of individuals, foundations and companies that are championing the concept of living in very small houses. As in a house of about 100 square feet, on the extreme end. I had a friend with a bigger tree house than that when I was a kid.

The New York Times had a front page article on the subject this week. You can read about it http://www.nytimes.com/2008/09/11/garden/11tiny.html

The people who espouse the cause of tiny houses seem to fit into two categories. Some of them talk about the desire to simplify their lives, break free from materialistic consumer culture, ala Thoreau when he moved to Walden Pond. Others appear to be motivated by Green movement considerations. They talk about reducing their footprint, carbon and otherwise.

The companies that identify themselves as Tiny House companies both build these houses and sell plans. Most of these tiny houses are built on a trailer chassis, so the builder can make the house and then have it towed to the home site. Since the companies profiled in the Times article sold only a few hundred sets of plans combined last year, I think KB Homes and Toll Brothers are safe for the time being.

Now, I have to admit that the thought of reducing my maintenance and utility expenses can be mighty attractive at times. My wife and I live in a 3000 sq. ft. house. I think it’s ridiculous to have only two people in a house that size. She thinks that if she had more closet space, she could go out and buy more clothes, and if she had a larger attic, she could store more of her collection of Santas to bring out at Christmas (150 at last count). We continue to live in a 3000 square foot house, so I don't think aI need to tell you who wins the argument.

There does seem to be a holier than thou element to this whole business. “Look at me, I only need 500 square feet.” “That’s nuthin’. I’m down to 250 square feet. That’ll really save the planet.” If you really want to save money and simplify your life, you don’t need a specially built house.

A small living space built on a trailer chassis? Here in Red State country, we call that a single-wide mobile home.

Sarah Palin, Take Two

One of the things that annoyed me about the press coverage on Governor Sarah Palin over the Labor Day weekend was the question posed by several news outlets, including the New York Times and Newsweek. Along with the stories about her daughter’s pregnancy and her husband’s twenty year old DUI, this question kept popping up: Was Sarah Palin properly vetted? This is kind of like asking someone if he’s stopped beating his wife yet.

The subtext of this question seems clear to me. When someone asks “Was she properly vetted,” what they really mean is “How could you have picked her without getting our seal of approval first?”

The arrogance this reveals on the part of the national media, those based in New York and Washington, is appalling.

Sarah Palin is a state governor, which is a pretty small club. She was elected after her second statewide political race, having unsuccessfully run for lieutenant governor in 2002.

She has been governor of Alaska for the last twenty months. During that time, she has been continuously vetted by her constituents, the citizens of Alaska. And they must like what they see, because Sarah Palin has an 80% approval rating.

This is the highest approval rating for any governor. It may be hard to believe, but you can have good sense, even if you don't live in Washington or New York.

Sarah Palin, Take One

As the whole world knows by now, last week John McCain announced that he had selected Alaskan governor Sarah Palin as his Vice presidential pick. Like everyone else outside of Alaska, my first thought was: Who?

After several days of 24 hour news coverage, a number of negatives, and potential negatives have come to light regarding Governor Palin. Some of the fodder for attacks against her was apparent immediately. Before being elected governor of Alaska in 2006, her total experience as an elected official was as city councilwoman and mayor of Wassila, Alaska, a small town of about 10,000.

Some of the other issues surrounding Palin are that her 17 year old daughter is pregnant, as mayor of Wassila she hired a lobbyist to get earmarked money (a practice she now opposes), and she has been accused of firing a member of her cabinet because he would not fire her ex-brother-in-law as a state trooper. Oh, yes, her husband had a DUI twenty years ago.

The fact that Sarah Palin was a relative unknown, new to the national media spotlight, combined with these revelations about her past, have made many in the media speculate that she was insufficiently vetted for the VP slot.

In spite of these concerns, I think that John McCain made a brilliant political move with this pick.

Both campaigns selected VP candidates to combat perceived weaknesses of the presidential candidate. Barack Obama picked Joe Biden to shore up the tickets foreign policy credentials. John McCain picked Sarah Palin. What does she bring to the party?
-As a pro-life, NRA lifetime member, she energizes the Republican base of social conservatives, who have never been excited about McCain.
-At 44 years old, she counterbalances the 72 year old McCain, bringing a sense of youth to the ticket.
-As a governor, she has more executive experience than the rest of both tickets combined. She is also a politician who is a complete Washington outsider. You could not get farther from Washington and stay in the continental US. This co-opts Obama’s theme of change, and reinforces McCain’s reputation as a maverick, independent of the current administration.
-Did I mention that she’s a woman? Both tickets now offer a chance to make a historic choice.

Sarah Palin also brings a stealth weapon to the campaign: her husband, Todd Palin. A large part of why Hillary Clinton was able to stay in the primary race for so long was because Barack Obama could not “close the deal” with a key demographic in big industrial states: white, blue collar men. Todd Palin is the epitome of that demographic. He works as a production operator in the oil industry, when he’s not working as a commercial salmon fisherman. In his off time, he wins long distance endurance snowmobile races. The “First Dude” of Alaska is clearly a man’s man.

Reformer, fiscal and social conservative, telegenic hockey mom with five kids. Sarah Palin is the red state answer to Carla Bruni Sarkozy.

Taxes and Fairness

When people talk about everyone paying their fair share of taxes, what they usually mean is that someone else is going to pay more. But that raises the question: how much is the fair amount to ask people to pay, and how much more than that is unfair?

There are two ways of looking at that question. The conventional way is to look at someone who pays, oh say 20%, and determine that they could afford to pay more. So for this example, we could decide that 25% is that person’s fair share. After all, we're only asking that person to give up another 5% of their income. They can afford it, right?

To look at this from another perspective, let us examine a hypothetical economy. In our small scale imaginary model, there are only 25 income earners. The distribution of income among these households is as follows:
1 @ $1,000,000
14 @ $100,000
10 @ $10,000
So the top 4% of households earn 40$ of total income.

Let us further assume the following tax policy: the first $10,000 of income is exempt from tax. After that, up to $100,000 is taxable at 10%. Income above $100,000 is taxed at 20%.

Under this scenario, tax payments break down as follows:
$1,000,000 household: $189,000 (10,000*0%+90,000*10%+900,000*20%)
$100,000 households: $126,000 (14*(10,000*0%+90,000*10%))
$10,000 households: $0
Total taxes: $315,000

What this means is that 4% of the taxpayers are covering 60% of the total tax payments. Meanwhile, the bottom 40% of households are paying…nothing. Somehow that doesn’t strike me as fair play.

Of course, the example shown above is a completely imaginary, highly simplified economy. Let’s see what the numbers are for a real world economy, like, for instance, the United States.

According to the Heritage Institute, in 2004 the top 5% of taxpayers had 29% of the reported income, but paid 58% of the taxes. Expand that group to the top 10% of income, and the numbers climb to 39% of the total income and 71% of the taxes paid. Meanwhile, the bottom 50% of income earners paid less than 3% of the total taxes.

Maybe my example wasn’t so far fetched after all.

My policy point is this: if, as a society, we have decided that we have cut government spending as much as we can, and we need more tax revenue, let’s raise everyone’s taxes. We can have a debate about making the system more progressive, or less progressive. But if we are going to hit the high income folks up for more money, the low income folks should have to pay something in as well.

And maybe, if everybody has to kick into the pot, we’ll discover as a society that maybe we can do without some government spending after all.

A Simple Plan

We have a host of economic problems facings us these days. If not already in one, we seem to be sliding into a recession. Although the unemployment rate is low, a lot of people are underemployed, wither working part time or in jobs for which they are overqualified. Americans undersave, risking an insecure retirement down the line. The weak dollar is contributing to the rise in oil prices, generating inflation.

I have a cure for all of that. Buy American.

I have to confess, I have been a Galactic-class pain in the rear on this subject for at least twenty years. For a long time, Christmas morning conversations went like this:
“Gee mom, thanks for the tie, let me just check the label. Oops, says here Made in Italy. You’ll just have to return it.”
“But dear, all of the silk ties were Italian.”
“It would have been okay if you had just gotten me postage stamps as a gift. Like I asked you to.”
This issue was finally resolved with the advent of restaurant gift cards.

Still, hear me out on this one. When you buy Chinese made products, you put a bunch of Chinese to work, plus one retail sales clerk. When you purchase American made goods and services, you put more Americans back to work. Basically, your dollars have a multiplier effect, creating jobs for more of your countrymen than when you imported products.

It’s not just patriotic, either. When you buy American, you are putting your money into the pockets of potential customers. Think about it, how many of your customers live outside the United States? Unless you work for Boeing or Hollywood, probably not too many.

I can hear someone whining now: “Nothing’s made in this country anymore!” Since I have worked for manufacturing companies for the last twenty years, this is one of my personal pet peeves (#3994, to be exact). However, I do concede that it can be difficult to find US made products sometimes. My advice in that regard is to do without. I mean, do you really need another picture frame/stuffed animal/baseball cap/kitchen gadget? Our homes are filled to overflowing with possessions now. Why keep spending your money on more stuff? Stop the insanity! Just say no!

If you stop buying offshore stuff, you’ll have more money for other things, like saving for retirement. Also, since we as a country currently buy so much more than we sell, we’ve reached a point where our dollars are worth less and less every year. If we stop buying stuff we don’t need, it will strengthen the dollar, making it cheaper to buy the things we do need, like imported oil.

I’m not advocating that we be slavish about this. We all have some things we just aren’t going to do without. For me, it’s coffee.

Bad Timing Award, 2008 Edition

Kia Motors, the Korean car company, has just launched an ad campaign to tout their newest model, a V-8 powered SUV called the Borrenga. The tagline of the ads are that you’re not surprised when a luxury SUV is advertised with various clichés (show the car going off-road, show a symphony orchestra to suggest the harmony of the ride, etc.), but you will be surprised when you see the Kia name badge on the front grille. This is Kia’s attempt to move into the luxury segment of the car market.

Car companies don’t make the decision to do this kind of platform launch lightly. It takes years to develop these vehicles. Hundreds of millions of dollars are spent to build the tooling and production processes involved in a totally new car. Just the budget for the TV advertising alone can run upwards of $20 million.

It’s just a shame that they have come to the culmination of this process just in time to watch the market for big SUV’s crash and burn. Too bad, so sad, sucks to be Kia Motors.

I bring this up by way of pointing out that the domestic automotive manufacturers were not alone in their plans to continue selling large numbers of big cars in the North American market. The American car companies have gotten a lot of bad press because of their overreliance on pickup trucks and SUV’s. But for fifteen years the best selling vehicle in America was the Ford F-150 pickup. What would you expect Ford to do, stop making them?

Even Toyota, probably the best car company in the world, got hammered by the shift in the market. They built the brand new San Antonio assembly plant in 2006 to build the Tundra full size truck. Because sales fell off so much, Toyota has closed the plant for three months this summer while they work off inventories. They were building another plant in Tupelo, Mississippi to build trucks. It now looks like that plant will be retooled to build hybrid Priuses.

A number of commentators have written about how the government should have forced the manufacturers to raise the average mileage on the cars they sell. As if it should be illegal to sell a car that gets less than 30 miles to the gallon.

It’s not like the car companies didn’t offer fuel efficient vehicles for sale, because they all do. Even Ford, GM, and Chrysler. But they kept making full size vehicles because that’s what we wanted. That is why all of the car companies kept developing full size cars and trucks, including Kia.

Being able to buy what we want, and being able to make what people want to buy. It’s a little concept that I like to call freedom.

Take from the rich...

Last spring, John McCain floated a proposal to suspend Federal gasoline taxes for the summer driving season. This was a bad idea, widely criticized. It would have taken millions out of the Federal highway fund those taxes go into, leading to shortages of money to keep roads and bridges in repair. It would have led to increased gasoline demand, keeping prices elevated. Finally, it would have saved the average family only about $3 a week.

Barack Obama opposed the gas tax holiday proposal, for all of these reasons. He got a lot of favorable press at the time for being wiling to take an unpopular stand and tell people the truth.

Now Obama has come out with some ideas of his own. He has proposed selling oil out of the Strategic Petroleum Reserve. He also wants to place a windfall profits tax on large oil companies, and then provide a $1000 rebate to every American family out of that tax.

His campaign released a statement that actually said “Barack Obama will require oil companies to take a reasonable share of their record-breaking windfall profits and use it to provide direct relief worth $500 for an individual and $1,000 for a married couple.”

He might as well have said: “Vote for me, folks, and I’ll give you $500 in exchange for providing me the privilege of riding on Air Force One.”

His response to two different proposals reveals a mindset that taxes are good, and should not be lowered. Profits are bad, and should be taxed.

George W. Bush is often metaphorically referred to as a cowboy. This has both good and bad connotations. The cowboy is an icon for strength and self-reliance, admirable qualities. In the pejorative sense, calling someone a cowboy implies a lack of control and finesse. The European press has this in mind when they disparage President Bush as a cowboy.

Based on this part of his energy policy, a different mythic figure springs to mind with regard to Barack Obama. While the cowboy is an iconic American image, Obama is associated with a European figure. This is only fitting, given his wild popularity on the other side of the Atlantic.

He’s Robin Hood.

Let the Games Begin

There is breaking news on this summer’s salmonella outbreak. At first the Centers for Disease Control thought the bacteria was coming in on tomatoes, so stores and restaurants pulled tomatoes from the shelf. Then after ruining this year’s tomato crop for farmers, the CDC announced that no, it wasn’t tomatoes, it was actually Serrano peppers from Mexico that were to blame.

Me, I kept eating salsa. Over 1300 people came down with salmonella poisoning during this outbreak. But I would guesstimate that over 130 million people ate some combination of tomatoes and/or peppers during the time period between the start of the outbreak and the location of the source of contamination. So the odds of getting salmonella were about the same as the risk of being stung to death by killer bees, and only a little riskier than being ripped to pieces by a pack of dogs. Most of us don’t build our lives around avoiding bee stings and dog bites.

I don’t want to make light of salmonella. One of my coworkers got it a couple of years ago, and he said he remained curled around the toilet for three days, because there was no point in going anywhere else. He wouldn’t wish it on his worst enemy. About one in five of the people who came down with the stpaul strain involved with this outbreak were hospitalized.

Well, one of the hospitalized people has hired an attorney. And who has the attorney sued? Not the CDC, for missing the source during the initial investigation. Not the farmer, who was the actual source of contaminated produce (how much money could a Mexican pepper farmer have, anyway?). No, no, the attorney has sued Wal-Mart. Wal-Mart sold this guy the peppers that made him sick.

This attorney actually has a practice dedicated to suing companies based on food borne illnesses. According to the press release, his position is that Wal-Mart should have known that the peppers had salmonella and prevented them from being sold. I guess that Wal-Mart is supposed to check every box of produce from every source for every possible contaminant and pathogen.

I fell for the guy who got sick, but suing the supermarket is not the answer. If this suit is successful, what’s next? Suing the supermarket for selling honey and dog food?

Food Police

Last week the Los Angeles City Council passed what has to be a candidate for the worst new law of 2008. In the district of South Central Los Angeles, a thirty-two square mile area with over 500,000 residents, the new ordinance places a one year moratorium on building new fast food restaurants.

This part of LA has the highest percentage of obesity in the city. Fully 30% of the adults are obese. So the rationale behind this law is that the rate of obesity is connected with the prevalence of fast food restaurants in this area. By blocking new McDonald’s or KFC’s for a year, the goal is that planning for healthier food choices can be accomplished.

This plan is so ludicrous that one scarcely knows where to begin attacking it. Let’s start by pointing out how hard it is to define what a fast food restaurant is. I have not read the ordinance itself, but it apparently contains language about restaurants with limited menus. Well hello, but I’ve eaten in bistros where the night’s offerings were the five or six items chalked up on the menu board at the entrance. By a limited menu definition, the bistro would be fast food. Of course, the bistro chef could counter that he had been cooking all day, so the food wasn’t exactly fast.

Maybe by fast food they mean a lack of table service. By that definition, a salad bar restaurant would be excluded, even though we can all agree that a salad bar could provide healthy food. Although, after loading up on the cheese and creamy dressing, you could debate that point.

What if you opened a new supermarket in South Central LA. Would the deli be able to sell rotisserie chicken? Would the market be able to put in a salad bar? I’m sure the planning department bureaucrats will be able to provide the answers to these kinds of questions. Eventually.

If you’re in a hurry for those answers, well, that’s just too bad. It’s your own fault for not getting a safe city job.

Even assuming we have a common definition of fast food, I don’t quite understand the theory that preventing fast food outlets will spur the development of other types of restaurant. Somehow I can’t envision Wolfgang Puck announcing plans to open “Spago in the ‘Hood.” When Emeril Lagasse is siting his next place, I’ll bet he doesn’t count the number of Wendy’s in the area.

Aside from the practical difficulties of helping Angelinos lose weight by using the blunt instrument of restricting their eating choices, it is troubling to consider the worldview that informs this experiment in social policy.

To wit: the residents of South Central Los Angeles are children, incapable of making decisions that affect their own lives without the wiser heads of the LA City Council stepping in to protect them from their poor decision making.

As a political conservative, I believe that we institute governments among ourselves for the primary purpose of protecting our freedoms. That includes the freedom to make dumb choices. Now, government is restricting freedom in the name of helping the citizens. “It’s for your own good.”

A lot of the rationale for this new law is to control Medicaid costs. After all, obese people have higher rates of diabetes, heart disease, and high blood pressure. A few years ago, the states’ Attorneys General piled on to attack the tobacco companies. The legal reasoning was that because states paid for half of Medicare expenses, they had the right to appropriate the profits of the tobacco industry. A variation of this argument is now being extended to cover what we eat. “If we are going to pay for your health care, than we have the right to regulate your choices that affect your health.”

The scary part of this argument is that almost every activity involves choices that have the potential to adversely impact our health. If we buy into the argument paying for health care gives government the right to regulate your activities, where do we stop?

“Our studies show that the citizens are not getting enough exercise. Therefore we have banned elevators in high obesity areas. Enjoy your climb, sir!”

The scariest part of this whole story: the LA City Council passed this moratorium unanimously.

Be afraid. Be very afraid.

Bad News, Good News

I noticed something interesting in the news today. I was reading an article about the housing market, detailing that housing prices nationwide have dropped about 18% in the last year. The news article went on to state that more bad news was expected, as housing prices were expected to drop an additional 15-20% before leveling off at the end of 2009.

Why is it bad news when housing prices drop? Shelter is a basic human need. Housing is a product that we all use, and many of us would like more of. If housing prices fall, than buyers who were priced out of the market can now buy. Other buyers can now afford more house. From this perspective a drop in housing prices is good news.

“Oh, but what about the poor house sellers,” you may say. “Now they aren’t making any money when they sell their property.” Well, when big screen TV’s drop in price by 50% in a year, I don’t hear any boohooing over the fate of the poor TV manufacturers. What I hear is “Now I’m gonna get me a 54” wide screen. In HD. When those linemen hit that quarterback, I’m gonna see his ribs crack! A bigger TV is my right as an American. I heard it says so in the Constitution.”

Anyone who has lived in their house for five years or more isn’t going to be hurt by the drop in housing prices. Anyone looking to buy their first house is going to be helped by the drop in housing prices.

But what about the people losing their houses due to foreclosure? Well, they aren’t losing their houses because prices are dropping. They are losing their houses because they are not paying the mortgage. In many cases, they can’t afford the mortgage because the house was too expensive for their income.

The history of the housing boom over the last six years was people taking on more and more debt to buy ever more expensive houses. They were able to take on this debt because of mortgage products such as “liar’s loans” and negative amortization loans. The current process of price correction is mostly painful to the lenders, who are suffering the losses from loaning more money than people can afford to pay.

Housing prices are going to continue to slide until someone with the median household income can afford the mortgage payments on the median priced house. The faster that happens, the faster the housing sector, and the economy as a whole, will recover.

And that will be good news for everyone.

Locking the barn door ...

A week ago the Federal Deposit Insurance Corporation (FDIC) took over California based IndyMac Bank. It was reopened on Monday, July 14 as IndyMac Federal Bank. On Monday and Tuesday of last week there was extensive news coverage of depositors lined up at the bank to cash out their accounts. The lines went around the block. Some people had lined up hours before the bank was due to open. They brought lawn chairs.

This behavior was both predictable and inexplicable. Predictable, because humans are prone to panic when they’re threatened with ruin. Losing access to all of your money because your bank locks its’ doors fits my definition of ruin. So it is completely understandable that some of the depositors would act out of fear.

Inexplicable, because there was never any risk that the depositors would lose a nickel due to the bank being closed. None.

Banks are required by law to buy deposit insurance from the Federal government. The more deposits the bank has, the more they pay in premiums. The deposit insurance guarantees that the depositors will get their money back if the bank fails for any reason. So you have to wonder why the people lined up, since they derived no advantage from doing so, but they did lose the opportunity to do something more profitable with their time.

I also wonder why the media coverage didn’t do a better job of pointing out this foolishness.

Federal deposit insurance does have a limit. You are only insured up to $100,000 held in any one bank. If you have multiple accounts at one bank, even if they are joint accounts with someone else, the total insurance coverage is still a total of $100,000. Many of the people interviewed in line at the bank had assets way over the limit with IndyMac Bank. Given how easy it is to keep accounts at several banks, you really have to question what these guys were thinking.

Even in an industrial, post-modern society like ours, the old expression “Don’t keep all your eggs in one basket” still makes sense.

Beer Wars II: Winners and Losers

The battle for Anheuser Busch appears to be over. AB accepted a an offer at $75 a share from Belgian brewer InBev. I should say Belgian headquartered brewer InBev, since the brands produced by the company include German Beck’s, English Bass Ale, and a slew of Brazilian and other Latin American beers.

As part of the deal, InBev has promised not to close any of AB’s twelve US breweries, and to keep the US headquarters in St. Louis. These promises, of course, are worthless. InBev will do what it pleases with the US assets once the deal is closed. However, they probably will keep the headquarters in St. Louis and all the breweries open for now. After all, you have to have the headquarters somewhere, and with transport costs rising, keeping production close to your markets makes sense.

As the deal moves to closing, it is possible to make out who some of the winners and losers are going to be. The people least affected by the merger will be Budweiser consumers. InBev will almost certainly make no changes to the AB products.

Winners
Anheuser-Busch Stockholders: These guys are the big winners. Six months ago AB stock was selling for around $45 a share. Now they are getting $70 a share. In cash. None of this business of you get so much cash, and so much InBev stock. The green folding stuff. That’s a 55% return on your investment. Warren Buffett owned around 5% of Anheiser-Busch. The guy looks more like a genius than ever. Banks and real estate are collapsing around our ears, and he sticks in his thumb and pulls out a plumb. Amazing.

Anheuser-Busch competitors: InBev and AB have promised annual savings of $1.5 billion a year. To do that, there are going to be big layoffs (see Losers, below) and a reduction of advertising. Aggressive cost cutting causes turmoil in an organization. As InBev assimilates AB that will be a massive distraction within the AB ranks, at the same time the marketing budget is getting chopped. Look for Anheuser-Busch to loose market share to their rivals.

Losers
InBev stockholders: InBev stock has dropped about 10% from just before they announced their off for Anheuser-Busch to today. InBev is doing the deal to continue growing their earnings. But paying off the $52 billion they are borrowing will reduce their earnings in future years, unless they can find synergies or cost savings. There are not a lot of synergies in this deal. InBev is not going to sell more Michelob in Europe, and Americans are not going to switch to Stella Artois from Miller Lite. Unless the management of Anheuser-Busch was incompetent, the cost savings (read: layoffs) will cause them to lose market share. Somehow I don’t think that Belgians are going to be better at managing the US beer market than Americans. If you want proof, check out the new Stella Artois commercials running on TV. Bottom line, InBev earnings go up in 2008, then stagnate or decline in 2009 onward.

Anheuser-Busch Middle Management: This is where the ax is going to fall. As part of their defense against the takeover, Anheuser-Busch has already announced a plan to cut 10% of the salaried workforce. InBev will use that as a starting point. Adding insult to injury, the career paths of the survivors in headquarters just got cut short, since the top jobs will now be filled by Belgians on what Europeans will consider a hardship tour. The next six to eighteen months will have the staff more focused on spreading rumors, backstabbing, and running for cover than on reading the market and building their brands. The beneficiaries of this bloodletting and attendant confusion will be AB’s competitors (see Winners, above).

St. Louis: As the home of Anheuser-Busch, St. Louis benefited enormously. Not only did AB have a huge payroll, but they were a soft touch for every philanthropic organization in their hometown. Going forward, not only will the payroll be smaller, but approvals on community support will have to be approved in Belgium, and the decision makers in Brussels will be a lot more focused on bringing the money home to support their favorite causes.

There are winners and losers in every deal. One thing that’s not going to change, however, is the beer. Love it or hate it, Budweiser is still going to taste the same this time next year.

You Can't Make This Stuff Up

The Democratic Party will hold their national convention in the mile high city of Denver this August. As part of the planning for this major event, rules have been issued to govern the suppliers of various items used at the convention.

A big part of the push is to apply strict environmental rules to the activities. Leading the charge is Denver’s mayor, John Hickenlooper, who calls green activities “the new patriotism.” Somehow I wasn’t aware that there was anything wrong with the old patriotism. In charge of the greening of the convention is Andrea Robinson, the first ever Director of Greening. She couldn’t do it alone (it must take a village), so she hired an Official Carbon Advisor.

To test whether the balloons were biodegradable, Ms. Robinson buried some in a compost heap to bake away into fertilizer. The initial results from this test were not promising, so she added more liquid and reburied the balloons. Maybe the biodegradable balloons were only half-baked, only needing more time to become fully baked.

Then there are the fanny packs and baseball caps to be given away to each of the delegates. They are to be made with union labor. Out of organic fabric. Apparently the official merchandiser is having a hard time locating a supplier. According to Bob DeMasse: "We have a union cap or an organic cap. But we don't have a union-organic offering." I suspect that union caps cost twice as much as other suppliers, and organic caps also cost twice as much. Combine the two, and maybe Mr. DeMasse just didn’t want offer items that cost four times the market rate. Or maybe to switch over to organic cloth would have required the union shops to renegotiate their contracts.

The best part is the catering rules. For example, no fried food. Zip, nil, nada. This, of course, makes sense from the viewpoint of the party espousing national health care. After all, is the government is going to pay for your medical care, the government should be able to control what you eat. It’s for your own good.

My personal favorite is the rule that states every meal should include "at least three of the following colors: red, green, yellow, blue/purple, and white." (Garnishes don't count.) I can’t figure out whether this is supposed to be more nutritious, or if it is a way of demonstrating the Democratic Party’s commitment to diversity.

For me, these rules are a taste of what the Democratic Party would enforce on the entire country. If they win enough power in the next election.

Too bad we can't burn hot air!

The topic of offshore oil drilling is in the news these days. The Bush administration has proposed opening up areas of the coastal shelf that are under federal jurisdiction to oil exploration. With gasoline prices flirting with $4 a gallon, this was predictable. Equally predictable were the chorus of critics lining up to oppose the administrations proposals.

Their objections range from a concern that offshore rigs will hurt tourism on the beaches to fears about global warning. The folks bringing up the argument about tourism may have a point. But I do wonder: how do they think those tourists are getting to the beach? Rickshaws?

I do want to share my take on some of the other objections to offshore drilling that have been raised.

Offshore drilling won’t lower gas prices, because it will take five to ten years before offshore fields start producing.
This claim is absolutely true, and if your only reason for advocating a return to offshore oil exploration is to cut gas prices right now, you are selling an idea that won’t work. To a large extent, however, the increase in prices is due to increased demand from fast growing emerging markets such as China and India. As those economies grow richer, their demand will only continue to increase, while supply from existing oil fields shrinks. Even if demand (and prices) drop in the near future as conservation efforts take effect, prices will inevitably move higher in the future. So even if offshore drilling doesn’t lower gas prices in 2008, it will keep them from going even higher in 2018.

The oil reserves in offshore fields would only supply enough oil to replace imports for three years.
Actually, it would take ten to twenty years of production to deplete the new offshore oil fields that would be developed if the moratorium on exploration is repealed. This means that a more accurate way of stating this claim is that the reserves in offshore fields would only supply enough oil to replace 30% of imports for ten years. That would be a major boost to any strategy for energy independence for America. It would also do a lot to improve our current trade imbalances, supporting our currency.

We need to work on conservation, not expanding the supply of oil.
The current high gasoline prices seem to be doing a pretty good job of encouraging conservation. Americans are driving about 4% fewer miles than a year ago, and demand for fuel efficient hybrids and other small cars has exploded, while demand for big pickups and SUV’s has collapsed.

Using more oil makes global warming worse.
If we don’t burn oil, then electric utilities are faced with a couple of choices. (A) Burn more coal, or (b) rolling blackouts. Option (c), of course, is build more nuclear power plants, but even if we start today, it will take decades to replace all of our power generation infrastructure. In the meantime, oil fired power plants generate more power with less carbon output than the alternatives. Unless you prefer blackouts.

The attitude of those who oppose offshore oil exploration seems to be that we should not be using petroleum at all. That is not a realistic goal. Play a little thought experiment with me. Assume that one day soon, due to some miracle, it rains Toyota Priuses everywhere. So everyone switches to driving hybrids, all at once. Average fuel efficiency triples overnight. Guess what: every one of those cars still has a gasoline engine. We are still going to need to use oil.

No matter what we do in terms of conservation and developing energy alternatives, we’re going to be using a lot of oil for a long time to come. We can continue to rely more and more on getting that oil from countries where America is disliked, in essence enriching our enemies. Or we can do everything within our power to keep greater independence from foreign sources. Offshore drilling will be only one part of any strategy for maintaining a high energy society. It is, however, a necessary part.

Beer Wars

One of the big stories in the business press this last week has been that the Belgian headquartered beer maker InBev has come out with an offer to buy American beer maker Anheuser-Busch, maker of Budweiser and Michelob. Rumors of this deal have been circulating for several months now, resulting in a rise in Anheuser-Busch’s stock price, which as recently as March was trading for around $45 per share. InBev’s offer is at $65 a share.

The first thing to note is that this deal is almost certainly going to go through. InBev has the financing in place to make an all cash offer. On the day the offer was announced, it was at a price 10% above the closing price of Anheuser-Busch stock the day before the announcement. So the holders of Anheuser-Busch stock (the stock symbol is the cutesy BUD, by the way) collectively have a choice: take $65 a share for their stock, or watch the stock price slide back down into the low $50’s is the deal falls through. Hmmm, $65 or $55. Which one would I take? An old saying that involves wishing in one hand springs to mind right now.

Anheuser-Busch is a family run corporation. The current CEO is August Busch IV, who follows August Busch III. But AB is not a family owned company. The Busch family owns only 4% of the stock. They may have stocked the board of directors with their friends, but if they reject the offer, the board members will have a hard time explaining why they turned down InBev’s offer.

Anheuser-Busch is an acquisition target because of their very success. AB’s market share of the US beer market peaked at 52% a few years back. It has since dropped back to about 50%. If they got any bigger, it would attract attention from the Dept. of Justice Antitrust division. So they have no room to grow in the US market. But what the public stock markets demand above all else is earnings growth. As long as AB was growing, they would have a high stock price. Once growth cooled off, the stock price would sag. The single minded focus on the US market meant that they were slow to grow internationally. Low growth, combined with a lack of globalization, made Anheuser-Busch a target. The weak US dollar makes it a relative bargain.

But not that much of a bargain. Although InBev gets to show earnings growth by folding AB’s earnings in with their current operations, they have to justify paying a premium for Anheuser-Busch to their stockholders. The new owners are unlikely to increase sales, given that they would already control 50% of the market. Brewing is a pretty mature industry, so it’s difficult to see where InBev could squeeze any cost out of manufacturing or distribution. They could save money by cutting back on advertising and brand building in the short run (so long to the Clydesdale commercials at the Superbowl), but longer term that will lead to a loss of market share, and lower earnings.

So aside from increasing InBev’s earnings in the short run, I don’t see any logic for this deal in the long run. This may be why InBev’s stock price has been dropping on the Belgian stock exchange.

If this deal does close, I can predict two consequences: One, a less interesting Superbowl come next February. Two, celebrations by the folks who run Miller, Coors, and Sam Adams.

Ed McMahon

“Call no man happy, until he’s dead.”—Herodotus

Every so often real life intervenes in an argument, bringing a concrete example to an abstract argument so spot on that you could not make up a more telling example. Such an event can be pulled from last week’s news stories.

For those who missed the story, Ed McMahon’s house in Beverly Hills is being foreclosed on. Yes, that Ed McMahon. “Here’s Johnny!” “Send in your reply to Publisher’s Clearing House. You may already be a winner.” That guy.

Ed McMahon earned millions annually as a top ranked television personality and pitchman. Make that: he earned millions annually for decades. He is now over $644 thousand in arrears on a $4.6 million mortgage is took out only a few years ago.

When asked about why he is in arrears, his response is that it is because of his inability to work for the last eighteen months due to a neck injury.

The dude is 85 years old! Who the heck goes through life thinking that having to work in your eighties to keep from getting evicted is a workable game plan?

I have been arguing that true wealth is not related to your lifestyle, or to how much you earn. True wealth starts when you have the financial security to continue with your current lifestyle, even if you can no longer continue working. Exhibit number oneof how not to do this is Ed McMahon. I rest my case.

The Three Zones of Wealth

In my last post I talked about wealth, and how you could define being wealthy. Being wealthy is not defined by your earned income, and is certainly not defined by your lifestyle. With the collapse of the housing bubble, we are seeing plenty of people who are not only losing their jobs, but whose lifestyles were supercharged by pulling equity out of their homes and spending it. The lifestyle was never sustainable over the long term, and the job loss just accelerated the crash.

For me, wealth means passive income. Loosely defined, passive income is money that comes to you with little or no work on your part. Another way of putting it is with the old saying “Have your money work for you, instead of you working for your money.”

Just because you have passive income doesn’t mean you’re wealthy, however. You have to have enough of it. I’ve got both interest and dividend income that I list on my tax return, but I’m a long way short of being able to retire.

And that brings me to what I really want to write about today. I view wealth as happening in three zones, each of which defines a different way of looking at what it means to be wealthy.

The first of these zones is what I call retirement wealthy. Sometimes I hear this being described as financial independence. You enter this zone when you have enough passive income to pay for your current lifestyle. Once your dividends (or royalties, or rent, or bond interest) are enough to cover your expenses, you’ve got a choice: keep working for income, or retire and do what you want to do. I think this is what most people would define as being rich.

To achieve this state, you have to work both offense and defense. Offense, in terms of increasing your passive income (maxing out your 401K, e.g.) and defense, in terms of decreasing your living expenses (drive used cars, clip coupons).

The next zone of wealth starts where considerations of defense can fade away. You want to go to Tahiti for a week? Charter the jet! Seventy-two inch TV catch your eye? Buy it! This is the level of wealth where you have people to handle the mundane details of daily life. You don’t sit around the house all day waiting for the cable guy. That’s what the housekeeper is for.

Once you have entered the first zone of wealth, the longer you keep working, the closer you get to the second zone. After all, if you are not spending all of your passive income, then it will continue to compound on you. Money is the only animal that will only breed in captivity.

The third zone of wealth is what I call Future Old Money. I saw an interview with the country singer Garth Brooks once. One of the things he said was “I have more money than my children’s children will be able to spend.” Future old money. Fifty years from now, Garth’s grandkids will be toasting him at their dinner parties for making their lives of leisure possible.
Most personal finance writers concentrate on the first zone of wealth. After all, that is the zone that all of us can reach. It only takes time, discipline, and a modicum of knowledge. And most of the focus is on what I call defense, reducing expenses, if only to free up capital to invest.

To get into the second and third zones, however, you’ve got to win big. Even if we saw a way to do that, most of us don’t have enough appetite for risk to get there. I certainly don't.

The Nature of Wealth

Last week I was in Nashville, and the friends I was with took us on a tour of Belle Meade, which is the high rent district of Nashville. We passed mansion after mansion. Acres of perfectly groomed landscaping. Then we passed the Belle Meade Country Club. My friends insisted that only “old money” could belong. No parvenu with only a couple of hit country albums need apply.

This started me thinking on the subject of wealth (admittedly, a topic never too far from my thoughts).

How do define wealth? How would you know if you are wealthy? If you are not yet wealthy, but hope to be, how do you define the goal?

A lot of people would define it in terms of your possessions and entertainment. If you have the biggest house, the fanciest car, the most toys, you’re wealthy. Similarly, if you fly to Europe on vacation, or dine out at the most expensive restaurants, you’re wealthy.

I’m not sure I agree with that stance. Consider the real estate bubble, now collapsing. There were plenty of people, especially in the more overheated markets of California and Florida, who repeatedly refinanced their houses, cashing out the equity. They then spent the cash on the very things listed above. But now that the boom has come to a halt, those people are losing their lifestyle, along with the ability to refinance.

If your lifestyle has that little security, I would not consider that as true wealth.

Other people might define wealth in terms of the income that someone earns. “He’s a doctor, they’re all rich.” “CEO’s make the big bucks.”

I think the problem with that definition is that you have to stay on the treadmill to keep earning that money. It’s kind of like a shark: if you stop swimming, you sink to the bottom and die.

So for me, wealth is an issue of how much passive income you have. Passive income is money that comes to you without your having to work for it. The source of the money is something you own, or even who you are. Dividends. Profits from a business that someone else manages. Interest on bonds. Even capital gains from selling appreciated assets (after all, somebody had to make money in California real estate). All of those are examples of passive income.

Passive income can also come from pensions and social security. Even though you had to work to pay into the system, you aren’t working for the money now. As long as you can manage to stay warmer than room temperature, they are going to continue sending you checks.

So, by my definition, if you want to be wealthy, you need to develop sources of passive income.

Card Wars

I realized something today. I don’t know the interest rate on either of my two credit cards. I use an American Express card for most purchases, and I have a Visa for the places that do not accept Amex.

The topic came up because I was talking about personal finance with a coworker at lunch today. We were discussing how people can get in over their heads with credit cards, and how that can force people into bankruptcy. She told me that she didn’t understand that, because she had a low rate on her credit card. “It’s only 2.9%, but I don’t even pay that because I pay off my balance every month.”

I also pay off my balances in full every month. And because I have been doing that for as long as I can remember, the interest rate on the card is irrelevant to me. What is relevant to me is that I get air line miles from my credit card.

The important thing to remember about the credit card industry is that they make money from two income sources. First, they make money from the interest charges paid by cardholders. But a more reliable source of income is the fees they charge merchants to process the transaction. These charges can be upwards of 2% of the cost of the item being charged.

So let’s say you’re American Express. Most Amex users are businesses who pay their bills in full every month. When I charge something using my card, Amex pays the merchant 98% of the purchase price right away. I pay Amex 100% back, on average a month after I buy the item. If you are getting 2% a month for the use of your money, that becomes a 24% rate of return on an annual basis.

Since American Express is raising capital in the public markets, their cost of capital is (just a guess) around 6% a year. With borrowing money at 6%, and getting a return of 24%, the differential is an 18% return. If you are making that kind of return, you can offer considerable rewards as part of your marketing plan.

But not considerable cash back. If Amex offered 1% cash back, that would lower the differential to 6% a year, which doesn’t leave a lot left over after operating and marketing costs are taken out. So the card companies that offer that kind of cash back are depending on the first source of income: interest charges paid by cardholders.

So far, I know of only one credit card company that would let me check out the tradeoffs involved in getting rewards such as cash back. So I checked out the Capital One Card Lab, which you can find here. With excellent credit, a menu of options pops up. Choosing one option, like 1% cash back, removes other options, like some of the interest rate choices.

Ohhhh, a game! Let’s play!

After playing a few rounds, I settled in on 2% cash back on gas & groceries, with no annual fee. If I agreed to a 20% APR, they’ll set the APR at zero for the first year. So I could use their money for a year, while my cash was earning interest in a money market account. All I have to do is remember to pay it off in full at the end of the year, and every month thereafter, and I never have to pay that 20%.

A 2% reduction in gas and grocery costs, paid for by someone else? This is a game I just might play.

Politicians are the same all over the world.

There was an article in the New York Times today, regarding the reaction by Indian economists and politicians to comments made by President Bush about the increase in global food prices. In a news conference in Missouri on May 2, part of the President's answer to one question was the following, referring to the growing middle class in India:

“When you start getting wealth, you start demanding better nutrition and better food, and so demand is high, and that causes the price to go up.”

This has apparently ignited a storm of criticism in India. You can read the article here. The comments cited by the Times ranged from insulting President Bush's intelligence (nothing new there) to claims that Americans are causing food shortages in Africa by overeating. This puts me in mind of those dinner time conversations growing up. You know the one:

"Billy, you clean your plate. Think of the starving children in Africa." "But ma, I already weigh 190 pounds, and I'm only 12."

That the Indians have taken umbrage with the President's remarks shows that they have collapsed the distinction between explaining an event, and placing blame for the same event. Globally, grain prices have risen significantly in the last year or so. Why?

Part of the answer is that demand for grain is up. Not from Americans. We're huge overeaters, but we've been the most obese people in the world for at least a decade now. Well, with the rapid development in China and India over the last decade, meat consumption in those countries has gone up, right along with rising incomes. Not to American levels, but higher than it has been. The increase in meat consumption helps explain why global demand for grain has increased.

The situation in India and China has changed, and knowing that helps our understanding of the situation. That's a long way from blaming them. Americans are the last people in the world to blame anyone for wanting to eat better. If anything, we're more likely to start sharing recipes. Still, the Indians are insulted, and their politicians have turned around and started blaming us for the rise in food prices.

And in an odd way, that gives me some hope for a better world. Their politicians are just as capable of knee jerk reactions that make them sound like idiots as ours are. Maybe by focusing on our similarities (even the embarassing ones) instead of our differences, we can build bridges of understanding to other parts of the world. This incident may help us to realize that despite our surface differences, we're really all the same inside.

Nah!

Pennies From Heaven: An Update

In the weeks since I first posted about picking up pennies off the ground, I've managed to find one penny lying around. Then on Friday I picked up a dime outside of the movie theater, and Saturday morning I spotted a quarter in a public park. That got me thinking about the subject again.

For the last month I'm up about forty cents. Clearly picking up change is not going to make a meaningful difference in one's financial status, whether you make the effort to bend over and grab, or not. So if there is going to be any value to the practice, it lies in the metaphorical realm. That is to say, that picking up loose change becomes a shorthand expression, an encapsulation if you will, of your entire outlook towards your finances. By defining who you are, the metaphor can then influence your financial behavior in other areas of your life.

The simplest way of expressing the metaphor is "I'm so cheap I pick up pennies in the street." Viewed that way, the practice becomes a physical reminder of the importance of frugality. If the memory of the effort expended to gain every penny is actually imprinted in into your muscles, you are less likely to be extravagent with your dollars.

I want to take the metaphor to another level, however, and view the practice as a expression of how we look for opportunity. I think there is a risk for searching for pennies on the ground. That risk is that we can become focused on looking on the ground, to the exclusion of keeping our eyes looking at where we want to go.

I prefer to take a more positive take on the situation. I like to think that although my focus remains on where I'm going, I have expanded my attention to take in more of what's going on around me. This expanded focus allows me to spot opportunities that might otherwise seem to humble to be worth pursuing. Sometimes those opportunities pay off bigger than you expect.

Like looking for pennies, and spotting a quarter.

Energy Saving Tip: Wash Your Car

I washed and waxed my car this weekend for the first time in months. The weather finally cooperated, with clear skies and a warm sunny day. When I finished, I felt extra virtuous: not only did the car need a bath, but I improved my fuel efficiency at the same time.

Here's the science part: A dirty car has a rougher surface finish than a clean, freshly waxed car. That rougher surface finish creates more wind resistance, forcing the engine to work harder to overcome the drag. Hence, washing your car gives you better mileage.

Frankly, I'm not sure that the gain is all that significant. You probably get a much bigger mileage boost by driving with the windows closed. Driving with the windows down turns your car into a giant wind scoop, which can increase drag by up to 10%. But every little bit helps.

Besides, I was going to wash the car anyway. I think that one of the keys to saving money is to find ways to save by moving in a direction you were headed anyway. If you see a coupon for something you use regularly, cut it out. You don't have to be looking for pennies on the ground, but if you spot one, pick it up. (I picked up a penny today on the floor of my gym.) Saving money doesn't always have to be about sacrifice or struggle. Sometimes it can be about spending a pleasant hour or two outdoors on a spring day.

By the way, my ride looks great.

Great Moments in "Duh"

Here’s a headline from today’s New York Times:
As Pump Prices Soar, Buyers Flock to Small Cars

Repeat after me: “When man bites dog, that’s news. When dog bites man, that’s not news.”

There was one piece of interesting information in the article, however. Last April, four cylinder engines outsold six cylinder engines in the US. What is interesting is that the milestone was reached, not that the market share of smaller engines increased.

The market share effect is simply a rational response to changed market conditions. When gas prices go up and consume a larger share of income, people find ways to consume less gas. In the short run, they try and drive less. You eliminate unnecessary trips; combine multiple errands into one drive. These are behavioral changes.

Longer term, people make bigger structural changes, like buying smaller cars that get better mileage. For many families, the cars they drive are either the first or second largest concentration of capital they have, after their houses. As that capital is fully depreciated, and comes up for replacement, people are buying more efficient vehicles.

Despite all the complaining about high gas prices, however, I haven’t seen any increase in carpooling. This indicates to me that people are more willing to devote higher percentages of their income to gas, rather than make that big a behavioral change. At least so far.

So when we see a shift in the number of carpoolers, that will be news.