I hate slow pay. I hate it with a passion.
The world of business runs on a concept called trade credit. Trade credit basically means that you ship product to your customers before they actually pay for what they have bought. Similarly, if your suppliers extend trade credit, they let you have what you have ordered before money actually changes hands.
This is different then buying things with a credit card. When you use a credit card, the bank that issues the card transfers the money directly to the merchant, treating the balance due as an unsecured loan. The merchant gets paid right away, just as if you use cash, and therefore never takes on the risk of nonpayment. With trade credit, your vendors are supplying you with product solely based on your promise to pay up.
When I started in business, the standard terms for trade credit were Net 30 Days. That meant that one month after receiving product, you agreed to pay the net balance shown on the invoice. To manage your cash flow, you would hound your customers who went over the 30 day limit, knowing that you needed the money both to meet payroll and to keep your promises to your suppliers.
About ten years ago I started to see a change in these terms. Big companies started to demand extended terms. First sixty days, then 75 days, then even more then that. General Electric now has 120 day terms written into all of their contracts. Four months.
I think the move to extended terms was originally pushed by Wal Mart and the other big retailers, Lowe’s, Home Depot, Target and the like. Remember, the consumer pays for product before they take it out of the store. So if you turned your stock over fast enough, all of the cash required for your inventory was actually provided by the suppliers. For the big boys, it is a great idea. If you can get your vendors to pony up most of the working capital you need, that makes your return on equity look just a little bit better.
On the other hand, for a smaller company like the one I work for, this kind of trade credit policy puts you in a real bind. Our suppliers won’t extend 120 credit to us, either because they are so much bigger then us that we don’t have the leverage to force it, or because they are so much smaller that they couldn’t survive for that long.
For that matter, we don’t have enough cash to tie up four months worth of operating expenses in Accounts Receivable. So we are forced by our customers to borrow money for working capital.
I bring this up because our salesmen have heard rumors that next year GE is going to go to 150 days on their terms. They are a big enough customer that they will probably make it stick. After all, might makes right in situations like this.
But might does not necessarily make smart. By compelling their suppliers to focus on locating financing, and spending time keeping the bank placated, attention is necessarily shifted away from improving quality and delivery, and working on process improvements and product innovation. Not to mention, of course, that the interest charges you have to pay the bank reduce your profit margins.
But the real reason excessive slow pay is a bad idea is that it puts your supply chain in the hands of the bank. When you force your vendors to borrow money to meet payroll, the bank can shut your vendor down just by shutting off the line of credit.
Your vendor wants to keep you, the customer, happy. But your vendor’s bank does not care about you, the customer, at all. The bank cares about limiting its risk.
The more vendors you force to borrow money, and the more money you force them to borrow, the greater the odds that one of them will run into problems and be shut down. When your vendors shut down, you shut down.
Increasing leverage makes returns on equity look better, but it also increases systemic risk.
Isn’t that how the financial industry dug themselves into the hole?
Monday, May 11, 2009
Monday, May 4, 2009
Mystery of the Week
The big business story this last week was Chrysler Corporation filing for Chapter 11 bankruptcy. The goal is to have a quick, “surgical” bankruptcy, and emerge from court in a matter of weeks, not months.
When they come out of Chapter 11, the rough outline of the ownership structure will be the UAW holding about 50%, the bondholders holding about 10%, Italy’s Gruppo Fiat having up to a 35% stake, and the US government holding the remainder.
Here’s my question: What is Fiat doing for their share of the equity? Two things Fiat isn’t doing is ponying up any cash up front, or guaranteeing any of Chrysler’s existing debt.
I haven’t researched the deal very deeply. But on the surface it looks like Fiat will pick up a big share of the reconstituted Chrysler in exchange for—nothing!
Nice work if you can get it.
When they come out of Chapter 11, the rough outline of the ownership structure will be the UAW holding about 50%, the bondholders holding about 10%, Italy’s Gruppo Fiat having up to a 35% stake, and the US government holding the remainder.
Here’s my question: What is Fiat doing for their share of the equity? Two things Fiat isn’t doing is ponying up any cash up front, or guaranteeing any of Chrysler’s existing debt.
I haven’t researched the deal very deeply. But on the surface it looks like Fiat will pick up a big share of the reconstituted Chrysler in exchange for—nothing!
Nice work if you can get it.
Thursday, April 30, 2009
The More Things Change...
Kenyan politics are a mess. The political parties are largely linked to tribal groups in the country, and partisanship is vastly fiercer than here. Last year arguments over a disputed election dissolved into violence that convulsed the country for weeks and left a number of people dead.
Eventually a coalition government was formed and the violence burned itself out. But the parties involved in the coalition are still squabbling, and there are fears that the tensions simmering under the surface could break out again.
In response to this situation, a number of women’s groups in Kenya have called for a one week sexual boycott. The idea is that until the men start talking to each other instead of fighting each other, their wives will withhold their favors.
Just thinking about this idea brings a smile to your face. The concept of women using their sexual power to bring the men in their lives to heel seems rife with comic possibilities. Maybe it has already been done. Wasn’t there a movie along those lines…?
Actually, the idea is much older than that. The same concept forms the plot of Lysistrata, an ancient Greek play, written by the playwright Aristophanes in the 411 BCE. In his version, the city-states of Sparta and Athens are at war. The women of both cities cut the men off until they agree to make peace. The play is, of course, a satire. By poking fun at the men and women of Sparta and Athens, Aristophanes points out the absurdity of our behavior in both sexual politics and state politics. At the heart of the story is an incongruous concept: sex makes us crazy, but that craziness can make us behave more sanely with regard to larger conflicts.
Twenty-four hundred years ago Aristophanes looked at people and politics, and came up with an idea that resonates through the ages, right up to the present day.
That is why I am a conservative. The raw material of society is people. The human animal. Our motivations and desires are the same as they were millennia ago. The institutions, mores, and practices that persist over time do so for a reason: they work. Why they work may not be obvious to us, but we hazard the foundations of society when we make ill-considered alterations to institutions that have developed and held up over long periods.
I believe the current mania for “change” is ill-considered. History is littered with the wreckage of attempted utopian schemes. Until you change people, you better be careful when trying to change society. It has been over two millennia, and we are still waiting.
Even with a filibuster proof majority in the Senate, you cannot repeal the Law of Unintended Consequences.
Eventually a coalition government was formed and the violence burned itself out. But the parties involved in the coalition are still squabbling, and there are fears that the tensions simmering under the surface could break out again.
In response to this situation, a number of women’s groups in Kenya have called for a one week sexual boycott. The idea is that until the men start talking to each other instead of fighting each other, their wives will withhold their favors.
Just thinking about this idea brings a smile to your face. The concept of women using their sexual power to bring the men in their lives to heel seems rife with comic possibilities. Maybe it has already been done. Wasn’t there a movie along those lines…?
Actually, the idea is much older than that. The same concept forms the plot of Lysistrata, an ancient Greek play, written by the playwright Aristophanes in the 411 BCE. In his version, the city-states of Sparta and Athens are at war. The women of both cities cut the men off until they agree to make peace. The play is, of course, a satire. By poking fun at the men and women of Sparta and Athens, Aristophanes points out the absurdity of our behavior in both sexual politics and state politics. At the heart of the story is an incongruous concept: sex makes us crazy, but that craziness can make us behave more sanely with regard to larger conflicts.
Twenty-four hundred years ago Aristophanes looked at people and politics, and came up with an idea that resonates through the ages, right up to the present day.
That is why I am a conservative. The raw material of society is people. The human animal. Our motivations and desires are the same as they were millennia ago. The institutions, mores, and practices that persist over time do so for a reason: they work. Why they work may not be obvious to us, but we hazard the foundations of society when we make ill-considered alterations to institutions that have developed and held up over long periods.
I believe the current mania for “change” is ill-considered. History is littered with the wreckage of attempted utopian schemes. Until you change people, you better be careful when trying to change society. It has been over two millennia, and we are still waiting.
Even with a filibuster proof majority in the Senate, you cannot repeal the Law of Unintended Consequences.
Tuesday, April 28, 2009
Waterboarding and other unpleasantness
Some thirty years ago, I was a cadet attending ROTC summer training camp in Ft. Benning, Georgia. One day of the training was dedicated to adventure training. Rappeling, zip lines, biting the heads off chickens. That sort of thing.
At one point during the day, a group of cadets sat down with one of the training sergeants, a grizzled old Viet Nam vet. Somehow the discussion turned to the subject of questioning prisoners of war. The sergeant said that during the war, they would take two blindfolded VC up in a helicopter and start questioning them. Then they would tie a rope around one of them and throw him out of the chopper. The other would hear the screams as the man was pushed out, which was enough to get him to start answering questions.
Then the veteran said “If you really want information, you take the 9 volt battery out of the walkie-talkie handset, and press both terminals against the man’s temple. Bzzt! When he gets finished singing God Bless America, he’ll tell you anything you want to know.”
At this point he stopped and looked at the group of college students surrounding him, and saw the absolutely shocked faces. It was silent for a moment. Then, with dead sincerity, the sergeant said “That’s not torture. That’s interrogation.”
With the current media pyrotechnics about the Bush administrations “advanced interrogation” policies, it is worth noting this is not the first time we, as a society, have attempted to define the issue of what constitutes torture, and what is merely tough questioning. I think the question does not lend itself to bright and shining boundaries.
Pulling someone’s fingernails off with pliers? Yes, that’s torture. Sleep deprivation? Maybe. Now we’re in the grey area. Making a suspect wear women’s underwear, or having a woman lead him around with a dog leash? Please, you pay extra for that in Vegas.
But in struggling with these issues as policy is set, I have a suggestion. A modest proposal. Call it a version of sauce for the gander.
Have your attorneys draft memos outlining the limits of what is acceptable. This is just what the Bush administration did. Then take those same attorneys and subject them to the same interrogation techniques they proposed. If they say waterboarding is legal, waterboard ‘em. If they say exposure to cold is legal, stick ‘em in a meat locker. At the end of the process, is they still sign off on the memos, you have your policy.
Think of it as a new version of the Golden Rule. Not, “Do unto others as you would have done to yourself.” Not, “Do unto others as they would do unto you, but do it first.” No, not even the classic, “Whoever has the gold makes the rules.”
This version of the Golden Rule is “Don’t do anything unto others that you wouldn’t be willing to have done to yourself.”
At one point during the day, a group of cadets sat down with one of the training sergeants, a grizzled old Viet Nam vet. Somehow the discussion turned to the subject of questioning prisoners of war. The sergeant said that during the war, they would take two blindfolded VC up in a helicopter and start questioning them. Then they would tie a rope around one of them and throw him out of the chopper. The other would hear the screams as the man was pushed out, which was enough to get him to start answering questions.
Then the veteran said “If you really want information, you take the 9 volt battery out of the walkie-talkie handset, and press both terminals against the man’s temple. Bzzt! When he gets finished singing God Bless America, he’ll tell you anything you want to know.”
At this point he stopped and looked at the group of college students surrounding him, and saw the absolutely shocked faces. It was silent for a moment. Then, with dead sincerity, the sergeant said “That’s not torture. That’s interrogation.”
With the current media pyrotechnics about the Bush administrations “advanced interrogation” policies, it is worth noting this is not the first time we, as a society, have attempted to define the issue of what constitutes torture, and what is merely tough questioning. I think the question does not lend itself to bright and shining boundaries.
Pulling someone’s fingernails off with pliers? Yes, that’s torture. Sleep deprivation? Maybe. Now we’re in the grey area. Making a suspect wear women’s underwear, or having a woman lead him around with a dog leash? Please, you pay extra for that in Vegas.
But in struggling with these issues as policy is set, I have a suggestion. A modest proposal. Call it a version of sauce for the gander.
Have your attorneys draft memos outlining the limits of what is acceptable. This is just what the Bush administration did. Then take those same attorneys and subject them to the same interrogation techniques they proposed. If they say waterboarding is legal, waterboard ‘em. If they say exposure to cold is legal, stick ‘em in a meat locker. At the end of the process, is they still sign off on the memos, you have your policy.
Think of it as a new version of the Golden Rule. Not, “Do unto others as you would have done to yourself.” Not, “Do unto others as they would do unto you, but do it first.” No, not even the classic, “Whoever has the gold makes the rules.”
This version of the Golden Rule is “Don’t do anything unto others that you wouldn’t be willing to have done to yourself.”
Tuesday, April 21, 2009
Green Shoots and Other Images
Last week, Fed Chairman Ben Bernanke said he detected “green shoots” among the economic indicators he tracks. A nice metaphor for seeing signs of recovery from the current economic malaise. Beautifully timed to coincide with the annual rebirth of springtime.
At my company, we are also seeing some “green shoots” of our own. After dropping to a level less than half of what it was a year ago, orders from customers have rebounded somewhat. March financial results put us into the black for the year to date, April’s results will be better still, and the sales forecast for May/June is comfortable, if not stupendous.
It is infinitely less stressful to be focused on how much profit we can make, as opposed to having concerns over whether the month will show a profit or a loss. We have shifted over to the positive problem of “How do we make shipments on time with the resources we have?” as opposed to the negative problem of “Who is the next person to get laid off?” I’ve even had to call a few people back off layoff.
My problem is that I can’t confine myself to the springtime “green shoots” metaphor. I come back to other metaphors. Grimmer metaphors.
“We’re not out of the woods yet.” “The other shoe has yet to drop.” “The light at the end of a tunnel is an oncoming train.” “The economy is executing a head fake. It gets you moving one way, then whammo, it turns and goes the other.” “It’s always darkest just before it really goes pitch black.”
My gut feeling is that we are going to hear more bad news before the economy really recovers. So I am keeping cost controls in place, eliminating unnecessary expenses, and watching every hour of overtime like a hawk. I would say “plan for the worst, and hope for the best,” but I think hope is for suckers.
Some say the glass if half full. Some say the glass is half empty. I say the glass has a crack, and the water is running out.
Maybe that's why I don't get invited out much.
At my company, we are also seeing some “green shoots” of our own. After dropping to a level less than half of what it was a year ago, orders from customers have rebounded somewhat. March financial results put us into the black for the year to date, April’s results will be better still, and the sales forecast for May/June is comfortable, if not stupendous.
It is infinitely less stressful to be focused on how much profit we can make, as opposed to having concerns over whether the month will show a profit or a loss. We have shifted over to the positive problem of “How do we make shipments on time with the resources we have?” as opposed to the negative problem of “Who is the next person to get laid off?” I’ve even had to call a few people back off layoff.
My problem is that I can’t confine myself to the springtime “green shoots” metaphor. I come back to other metaphors. Grimmer metaphors.
“We’re not out of the woods yet.” “The other shoe has yet to drop.” “The light at the end of a tunnel is an oncoming train.” “The economy is executing a head fake. It gets you moving one way, then whammo, it turns and goes the other.” “It’s always darkest just before it really goes pitch black.”
My gut feeling is that we are going to hear more bad news before the economy really recovers. So I am keeping cost controls in place, eliminating unnecessary expenses, and watching every hour of overtime like a hawk. I would say “plan for the worst, and hope for the best,” but I think hope is for suckers.
Some say the glass if half full. Some say the glass is half empty. I say the glass has a crack, and the water is running out.
Maybe that's why I don't get invited out much.
Sunday, April 19, 2009
General Growth Shrinks Down to Nothing
General Growth, the second largest shopping mall operator in America, filed for Chapter 11 bankruptcy last week. General Growth had grown through a series of acquisitions over the years. The largest of these was an $11 billion buyout of the Rouse Company in 2004.
GG had paid for these acquisitions through the mechanism of taking on ever increasing loads of debt. At the time of their bankruptcy filing, they had over $27 billion in outstanding loans.
The mall operator was taken down by two interlinked factors related to the recession. First, the current economic downturn has caused a shake out in the retailing industry. Merchants are closing stores, leaving blank fronts inside the malls. Unrented spaces mean that the cash flow available to pay debt is reduced.
The immediate cause of the bankruptcy was the general credit crunch. Banks were simply unwilling to roll over loans that had come due from the real estate operator. Faced with demands for cash, the management of General Growth threw up their hands and declared “Game Over.”
First of all, who lends money to a mall operator named General Growth? The mall industry has been shrinking for years. Malls are based on the concept that you park your car and stroll through the mall to do your shopping. Overweight Americans don’t want to stroll. They want to drive up to one store, get what they want (note the distinction between get what you want and get what you need), and then get back in the car and drive to the next big box retailer. “I had to drive around that parking lot four times before a good parking spot opened up. It’s a good thing gas prices have dropped since last year.”
I’m no retail genius, but even I know that the mall industry has been shrinking. It would be like loaning money to a company called Smoking Crack, Inc. “Sure, that sounds like a great investment!”
But it is even more amazing that the managers of the company bet the stockholder’s money on a strategy that included piling on debt until they were unable to get it refinanced. Without spectacular amounts of leverage, the returns in the mall business might not have been great, but they sure would have been better than being wiped out.
So, another company build on leverage bites the dust. And the trend for 2009 continues…
GG had paid for these acquisitions through the mechanism of taking on ever increasing loads of debt. At the time of their bankruptcy filing, they had over $27 billion in outstanding loans.
The mall operator was taken down by two interlinked factors related to the recession. First, the current economic downturn has caused a shake out in the retailing industry. Merchants are closing stores, leaving blank fronts inside the malls. Unrented spaces mean that the cash flow available to pay debt is reduced.
The immediate cause of the bankruptcy was the general credit crunch. Banks were simply unwilling to roll over loans that had come due from the real estate operator. Faced with demands for cash, the management of General Growth threw up their hands and declared “Game Over.”
First of all, who lends money to a mall operator named General Growth? The mall industry has been shrinking for years. Malls are based on the concept that you park your car and stroll through the mall to do your shopping. Overweight Americans don’t want to stroll. They want to drive up to one store, get what they want (note the distinction between get what you want and get what you need), and then get back in the car and drive to the next big box retailer. “I had to drive around that parking lot four times before a good parking spot opened up. It’s a good thing gas prices have dropped since last year.”
I’m no retail genius, but even I know that the mall industry has been shrinking. It would be like loaning money to a company called Smoking Crack, Inc. “Sure, that sounds like a great investment!”
But it is even more amazing that the managers of the company bet the stockholder’s money on a strategy that included piling on debt until they were unable to get it refinanced. Without spectacular amounts of leverage, the returns in the mall business might not have been great, but they sure would have been better than being wiped out.
So, another company build on leverage bites the dust. And the trend for 2009 continues…
Thursday, April 16, 2009
Tax Season is Over
The ides of April are behind us. The gust of wind that stirred the hair on the back of your neck yesterday was the collective sigh of relief from all the tax filers sending in their tax returns just ahead of the deadline. Following that was a minor breeze coming from the paid tax preparers who are standing down after frantic activity of the last few weeks. Tax season is over.
When I signed on with H & R Block to do taxes last year, I figured that getting customers was the easiest part of the business. After all, the only service with a comparable level of built-in demand is the funeral home industry. Taxes are inevitable for everybody, right?
Well, taxes may be inevitable, but paying someone else to do them for you is not. H & R Block reported that through March 15, the number of returns prepared were down 6.2% versus the same period a year ago. The news was even worse at Jackson Hewitt, the second largest tax preparation chain. They are forecasting a drop of 12% for the number of returns prepared for the 2009 tax season.
USA Today ran a story on this with the headline “Downturn has taxpayers filing solo.” The implication is that the recession has driven more tax filers to using at home software for their taxes to save money.
I think trying to tie this trend to the current recession is a lot of hogwash. More people are filing taxes using home computers because it is cheaper and easier. That is an attractive proposition all the time, whether there is a recession or not.
When I prepare someone’s taxes at an H & R Block office, I have to be paid (not bloody much pay, but money does change hands). Also, rent on the bricks and mortar office continues all year round, even though tax season only lasts three months. HRB maintains the computers the paid preparers work on as well.
With the home software, the cost of producing another copy of the program is a tiny fraction of those costs. If you use the on-line version of the tax software, even those costs are eliminated. It’s no surprise that the price of home preparation kicks the crap out of the price of a paid preparer. And you can do your taxes any time, day or night, in your underwear, should you so desire.
As home computers with high-speed internet connections have become ubiquitous, more and more people are choosing the less expensive, more convenient home tax prep over paid services. The new model of computers and internet is hollowing out the market for tax preparers. This is the same process that killed the travel agent business. With the exception of cruise specialists, there are no more travel agents, and there used to be at least one in every small town.
Is tax preparation going to the same route to extinction?
Probably not. The difference is that not everyone flies on the airlines, but everyone has to file a tax return. They also have to die, but that’s a different story.
Even though tax law is getting more complicated, doing your taxes yourself is getting easier as the software gets better, particularly if your taxes aren’t particularly complicated. This means that for paid tax services, the middle of the market is getting carved out.
Two groups are left over: early season filers and late season filers. The early season filers tend to be lower income. They are either computer illiterate, or they want access to the financial products that tax prep firms can offer (refund anticipation loans). The late season filers will be the people with complicated taxes (farms, partnerships, business owners). The late filers will need more tax expertise and judgement applied than they can get from a computer program.
The total market for tax preparation services will continue to shrink. But even if they close offices, the services will still have to cover a lot of overhead. I will predict that even as the industry shrinks, the prices charged will continue to increase. Of course, raising prices will accelerate customers switching to the do it yourself model.
I may do taxes with H & R Block again next year. But I wouldn’t buy their stock as a long term investment.
When I signed on with H & R Block to do taxes last year, I figured that getting customers was the easiest part of the business. After all, the only service with a comparable level of built-in demand is the funeral home industry. Taxes are inevitable for everybody, right?
Well, taxes may be inevitable, but paying someone else to do them for you is not. H & R Block reported that through March 15, the number of returns prepared were down 6.2% versus the same period a year ago. The news was even worse at Jackson Hewitt, the second largest tax preparation chain. They are forecasting a drop of 12% for the number of returns prepared for the 2009 tax season.
USA Today ran a story on this with the headline “Downturn has taxpayers filing solo.” The implication is that the recession has driven more tax filers to using at home software for their taxes to save money.
I think trying to tie this trend to the current recession is a lot of hogwash. More people are filing taxes using home computers because it is cheaper and easier. That is an attractive proposition all the time, whether there is a recession or not.
When I prepare someone’s taxes at an H & R Block office, I have to be paid (not bloody much pay, but money does change hands). Also, rent on the bricks and mortar office continues all year round, even though tax season only lasts three months. HRB maintains the computers the paid preparers work on as well.
With the home software, the cost of producing another copy of the program is a tiny fraction of those costs. If you use the on-line version of the tax software, even those costs are eliminated. It’s no surprise that the price of home preparation kicks the crap out of the price of a paid preparer. And you can do your taxes any time, day or night, in your underwear, should you so desire.
As home computers with high-speed internet connections have become ubiquitous, more and more people are choosing the less expensive, more convenient home tax prep over paid services. The new model of computers and internet is hollowing out the market for tax preparers. This is the same process that killed the travel agent business. With the exception of cruise specialists, there are no more travel agents, and there used to be at least one in every small town.
Is tax preparation going to the same route to extinction?
Probably not. The difference is that not everyone flies on the airlines, but everyone has to file a tax return. They also have to die, but that’s a different story.
Even though tax law is getting more complicated, doing your taxes yourself is getting easier as the software gets better, particularly if your taxes aren’t particularly complicated. This means that for paid tax services, the middle of the market is getting carved out.
Two groups are left over: early season filers and late season filers. The early season filers tend to be lower income. They are either computer illiterate, or they want access to the financial products that tax prep firms can offer (refund anticipation loans). The late season filers will be the people with complicated taxes (farms, partnerships, business owners). The late filers will need more tax expertise and judgement applied than they can get from a computer program.
The total market for tax preparation services will continue to shrink. But even if they close offices, the services will still have to cover a lot of overhead. I will predict that even as the industry shrinks, the prices charged will continue to increase. Of course, raising prices will accelerate customers switching to the do it yourself model.
I may do taxes with H & R Block again next year. But I wouldn’t buy their stock as a long term investment.
Monday, April 13, 2009
Is it safe to go back in the water?
Last week Wells Fargo announced record earnings for the first quarter of 2009. The stock market soared on the news, and reports started to circulate that the worst was over for this recession.
No so fast!
Wells Fargo’s results were driven by fees from a wave of refinancing. The refi boom came about because the Fed has dropped interest rates to the floor. Mortgage rates have followed. As a result, people who could have been refinancing existing mortgages to take advantage of the lower rates.
Everyone who refinances has to pay fees to the bank for handling the transaction. This is great for the bank, but it is a short term phenomena. Mortgage rates are sitting at about 4.5% right now. They aren’t going to go much lower, if any. We’ve got about one quarter more of refinancing, then everyone who wants to take advantage of the new lower rates will have done so, and the fee income is going to dry up again.
The real issue is whether Wells Fargo has finished writing off all the bad loans in their real estate portfolio. Since real estate prices are continuing to fall, I’m guessing that more bad news is going to come out. After all, WF posted a loss in the 4th quarter of last year almost equal to what they earned this quarter.
We’re not out of the woods yet.
No so fast!
Wells Fargo’s results were driven by fees from a wave of refinancing. The refi boom came about because the Fed has dropped interest rates to the floor. Mortgage rates have followed. As a result, people who could have been refinancing existing mortgages to take advantage of the lower rates.
Everyone who refinances has to pay fees to the bank for handling the transaction. This is great for the bank, but it is a short term phenomena. Mortgage rates are sitting at about 4.5% right now. They aren’t going to go much lower, if any. We’ve got about one quarter more of refinancing, then everyone who wants to take advantage of the new lower rates will have done so, and the fee income is going to dry up again.
The real issue is whether Wells Fargo has finished writing off all the bad loans in their real estate portfolio. Since real estate prices are continuing to fall, I’m guessing that more bad news is going to come out. After all, WF posted a loss in the 4th quarter of last year almost equal to what they earned this quarter.
We’re not out of the woods yet.
Thursday, April 9, 2009
Depression? What Depression?
My latest bedtime reading is a book called The Coming Great Depression by Harry S. Dent. I keep it on my nightstand, and read a few pages every evening before I go to sleep.
The Coming Great Depression? Sweet dreams, buddy!
Dent is primarily a demographer, and he uses demographic trends as a tool for forecasting the economy. His major point is that there is a strong correlation between birthrates and asset prices (stocks and housing), with a forty year time lag. Put another way, if the birthrate goes up this year, in forty years the stock market will go up as well.
The logic behind this observed correlation is simple. People in their late thirties and early forties are at their peak productive years in the workforce. Also, those are the years of peak consumption, as people raise families, move up to bigger houses, spend on their children’s education, etc.
The primary prediction of the book is that the current downturn is only the start of a longer down cycle. The down cycle will play out over the next 10 to 15 years. The bottom of the trough will occur in 2012 or 2013, with the next boom cycle starting in 2022.
After the post WWII baby boom generation, birth rates fell and we had what is called the baby bust generation that followed. What Dent calls the Echo Boom generation was born in the eighties, a time of increasing birth rates. The dearth of baby busters will cause the drop off in the economy, and the Echo Boomers will ignite the next growth cycle as they hit their peak productive and consuming years.
The author throws in a lot of other cycle analysis to support his arguments. He mentions commodity cycles, technology cycles, political cycles and others. The periodicity of these cycles range from 18 to 250 years in length. I’m not sure I buy the additional arguments. I mean, please. A 250 year cycle that he can predict will bottom out in the next ten years? It just sounds like looking for arguments to support a predetermined prediction.
The central demographic argument is compelling, however.
If we are headed into an economic trough that will last 10 to 15 years, than equity investing is a losing game until the next up cycle starts. Better to focus on building up your cash position and acquire high rated bonds.
The good news for me is that if Dent is right, the next upswing in asset prices will occur just as I am getting ready for retirement. A rising market will fund my golden years.
Of course, Dent also wrote a book called Dow 32,000 a few years back, at the height of the tech boom, and we know how that turned out.
I’ll take it all with a grain of salt.
The Coming Great Depression? Sweet dreams, buddy!
Dent is primarily a demographer, and he uses demographic trends as a tool for forecasting the economy. His major point is that there is a strong correlation between birthrates and asset prices (stocks and housing), with a forty year time lag. Put another way, if the birthrate goes up this year, in forty years the stock market will go up as well.
The logic behind this observed correlation is simple. People in their late thirties and early forties are at their peak productive years in the workforce. Also, those are the years of peak consumption, as people raise families, move up to bigger houses, spend on their children’s education, etc.
The primary prediction of the book is that the current downturn is only the start of a longer down cycle. The down cycle will play out over the next 10 to 15 years. The bottom of the trough will occur in 2012 or 2013, with the next boom cycle starting in 2022.
After the post WWII baby boom generation, birth rates fell and we had what is called the baby bust generation that followed. What Dent calls the Echo Boom generation was born in the eighties, a time of increasing birth rates. The dearth of baby busters will cause the drop off in the economy, and the Echo Boomers will ignite the next growth cycle as they hit their peak productive and consuming years.
The author throws in a lot of other cycle analysis to support his arguments. He mentions commodity cycles, technology cycles, political cycles and others. The periodicity of these cycles range from 18 to 250 years in length. I’m not sure I buy the additional arguments. I mean, please. A 250 year cycle that he can predict will bottom out in the next ten years? It just sounds like looking for arguments to support a predetermined prediction.
The central demographic argument is compelling, however.
If we are headed into an economic trough that will last 10 to 15 years, than equity investing is a losing game until the next up cycle starts. Better to focus on building up your cash position and acquire high rated bonds.
The good news for me is that if Dent is right, the next upswing in asset prices will occur just as I am getting ready for retirement. A rising market will fund my golden years.
Of course, Dent also wrote a book called Dow 32,000 a few years back, at the height of the tech boom, and we know how that turned out.
I’ll take it all with a grain of salt.
Friday, April 3, 2009
Crisis? What crisis?
A funny thing happened last week. I bought a car.
A small sport utility, actually. I leased the vehicle three years ago, and since it had low milage, I bought it when the lease expired. Plunked a couple thou down to keep the payment low and signed up for a 24 month payout.
Okay, you're still waiting for the comedy part to kick in, I know.
The funny part was how easy it was to get the loan. I walked into the dealership, signed some papers, and bang-zoom, drove off with the car. They'll send me the first statement at the end of this month.
Hahaha...wait, no that still isn't funny.
All right, so maybe it wasn't funny, at least not in the ha ha sense. More like it was funny in the peculiar sense.
You see, I keep reading about how the credit market is frozen up. I keep reading about how "we need to get the banks out loaning money again." But I didn't have a problem getting a loan. From where I'm standing, there is no problem borrowing money.
In all fairness, the interest rate was higher than I wanted to pay. My last car loan was five years ago, and at that time the best rate was 5%. This loan was at 7 percent. Given that the Fed funds rate is lower than it was five years ago, my new car loan is actually more profitable for the bank than the old loan was.
Also, I have a sterling credit rating, and I put a chunk of money down on the transaction. The odds of this loan going nipples up are vanishingly remote.
So maybe the problem is not that the banks aren't loaning money. Maybe the problem is that the banks aren't loaning money to poor credit risks.
Can you blame them? After all, it was loaning money to people who couldn't afford to pay it back that got the banks in trouble in the first place.
A small sport utility, actually. I leased the vehicle three years ago, and since it had low milage, I bought it when the lease expired. Plunked a couple thou down to keep the payment low and signed up for a 24 month payout.
Okay, you're still waiting for the comedy part to kick in, I know.
The funny part was how easy it was to get the loan. I walked into the dealership, signed some papers, and bang-zoom, drove off with the car. They'll send me the first statement at the end of this month.
Hahaha...wait, no that still isn't funny.
All right, so maybe it wasn't funny, at least not in the ha ha sense. More like it was funny in the peculiar sense.
You see, I keep reading about how the credit market is frozen up. I keep reading about how "we need to get the banks out loaning money again." But I didn't have a problem getting a loan. From where I'm standing, there is no problem borrowing money.
In all fairness, the interest rate was higher than I wanted to pay. My last car loan was five years ago, and at that time the best rate was 5%. This loan was at 7 percent. Given that the Fed funds rate is lower than it was five years ago, my new car loan is actually more profitable for the bank than the old loan was.
Also, I have a sterling credit rating, and I put a chunk of money down on the transaction. The odds of this loan going nipples up are vanishingly remote.
So maybe the problem is not that the banks aren't loaning money. Maybe the problem is that the banks aren't loaning money to poor credit risks.
Can you blame them? After all, it was loaning money to people who couldn't afford to pay it back that got the banks in trouble in the first place.
Tuesday, March 31, 2009
Quiznos Blinks
In the fast food sub sandwich category, the two biggest players are Subway and Quiznos. Due to a huge head start and relentless franchising, Subway is the dominant company in the marketplace. Their advertising has traditionally focused on differentiating their products from other fast food categories such as burgers and fried chicken.
Subway ads typically emphasize the fresh baked bread and the vegetable fixings piled on their sandwiches. They have positioned themselves as a lighter alternative to other fast food restaurants. Their spokesperson, Jared, has built an entire career around a friendly personality and the fact that he lost a lot of weight by eating Subway food.
Quiznos, on the other hand, has played off the category leader Subway. Quiznos ads have pointed out how much more meat is on their subs, and stressed the oven toasting. “If you want a sub,” they seem to say, “shouldn’t it be our sub and not theirs?”
As a consumer of both chain’s sandwiches, I can attest Quiznos does make a superior sub. What the Quiznos ads forget to mention is that it is also a more expensive sub. The price differential for the premium Quiznos product is $2-$3 more than Subway would charge.
Recently, Subway began a promotion centering around the concept of “the $5 foot long.” It started with selected foot long sandwiches being discounted down to a $5 dollar price. The promotion was so successful (aided by an incredibly catchy ad campaign) that the $5 foot long concept has been extended to all of their sandwiches.
The motivating idea behind the campaign is simple: more food for less money. It is the same animating concept behind McDonalds dollar menu.
Now Quiznos is responding with their own foot long product. The ads for the ciabatta bread sub emphasize the fact that it sells for only $4. In fact, the ad ends by repeating the price three times, albeit with a humorous twist. The new Quiznos ads are clearly a reaction to the Subway campaign. The message is “our sub is cheaper than their sub.”
The ads are funny and memorable. They feature the toasting oven as one of the characters in the ad. The oven’s voice is intended to resemble the HAL 9000 computer in 2001: A space Odyssey.
There are two ways to establish the value proposition in the mind of the consumer. One way is to emphasize the superior features or quality of your brand compared to the competition. The other way is to emphasize a lower price.
With their new ads launching this new product, Quiznos has abandoned the superiority strategy of brand building. They are now trying to sell a cheaper sandwich than Subway. Once you start competing solely on price, it is tough to build your brand up as a premium product.
In the long run, this new direction will hurt Quiznos more than the short term market share gain helps them.
Subway ads typically emphasize the fresh baked bread and the vegetable fixings piled on their sandwiches. They have positioned themselves as a lighter alternative to other fast food restaurants. Their spokesperson, Jared, has built an entire career around a friendly personality and the fact that he lost a lot of weight by eating Subway food.
Quiznos, on the other hand, has played off the category leader Subway. Quiznos ads have pointed out how much more meat is on their subs, and stressed the oven toasting. “If you want a sub,” they seem to say, “shouldn’t it be our sub and not theirs?”
As a consumer of both chain’s sandwiches, I can attest Quiznos does make a superior sub. What the Quiznos ads forget to mention is that it is also a more expensive sub. The price differential for the premium Quiznos product is $2-$3 more than Subway would charge.
Recently, Subway began a promotion centering around the concept of “the $5 foot long.” It started with selected foot long sandwiches being discounted down to a $5 dollar price. The promotion was so successful (aided by an incredibly catchy ad campaign) that the $5 foot long concept has been extended to all of their sandwiches.
The motivating idea behind the campaign is simple: more food for less money. It is the same animating concept behind McDonalds dollar menu.
Now Quiznos is responding with their own foot long product. The ads for the ciabatta bread sub emphasize the fact that it sells for only $4. In fact, the ad ends by repeating the price three times, albeit with a humorous twist. The new Quiznos ads are clearly a reaction to the Subway campaign. The message is “our sub is cheaper than their sub.”
The ads are funny and memorable. They feature the toasting oven as one of the characters in the ad. The oven’s voice is intended to resemble the HAL 9000 computer in 2001: A space Odyssey.
There are two ways to establish the value proposition in the mind of the consumer. One way is to emphasize the superior features or quality of your brand compared to the competition. The other way is to emphasize a lower price.
With their new ads launching this new product, Quiznos has abandoned the superiority strategy of brand building. They are now trying to sell a cheaper sandwich than Subway. Once you start competing solely on price, it is tough to build your brand up as a premium product.
In the long run, this new direction will hurt Quiznos more than the short term market share gain helps them.
Tuesday, March 24, 2009
Take this TARP...Part II
Goldman Sachs, the big Wall Street investment bank, recently announced that they were going to try and repay their share of the Federal TARP bailout money ahead of schedule. The previously announced plan was to repay the Treasury by the end of this year. They have now said they could pay back the government as early as the end of April.
I can’t help thinking this is partially due to the furor over the AIG bonuses. Watching the AIG financial traders get used as a metaphorical piñata by the politicians and media has got to be a powerful spur to get out from under the Federal thumb. Who can blame them: would you want to have to answer to Barney Franks?
As in the case of Northern Trust, I think much of the political grandstanding over the AIG bonuses was overwrought and silly. But I also think that the sooner the government gets out of the ownership of financial institutions, the better for the country. So if the posturing and outrage spurs the managers of companies to put their houses in order and regain their independence, in the long run we will be better for it.
It is an ill wind that blows no good.
I can’t help thinking this is partially due to the furor over the AIG bonuses. Watching the AIG financial traders get used as a metaphorical piñata by the politicians and media has got to be a powerful spur to get out from under the Federal thumb. Who can blame them: would you want to have to answer to Barney Franks?
As in the case of Northern Trust, I think much of the political grandstanding over the AIG bonuses was overwrought and silly. But I also think that the sooner the government gets out of the ownership of financial institutions, the better for the country. So if the posturing and outrage spurs the managers of companies to put their houses in order and regain their independence, in the long run we will be better for it.
It is an ill wind that blows no good.
Monday, March 23, 2009
AIG: Hangin' too good for em! Tax the b***s!
I’m outraged about the AIG bonuses. And right now I’m not talking about how $165 million in retention bonuses was paid out to the traders in the Financial Products unit; the same guys who wrecked the company. I’m still hacked off about that, but right now I’m outraged at the actions of the US Congress in regards to the situation.
In a state of high dudgeon, the House of Representatives passed a special bill last week that imposed a 95% tax on those bonuses. The US is looking at a trillion dollar deficit this year, and Congress is wasting their time going after a small group of traders who are getting retention bonuses when they should not even have been retained. Part of the taxpayer bailout of AIG should have been firing those guys. Instead, they were allowed to stick around until they qualified for bonuses.
The thing is, they were allowed to stick around to the end of the year. They had contracts, and those contracts have to be honored.
Now Congress, after the fact, is trying to get the money back. The US Constitution prohibits something call a Bill of Attainder. A Bill of Attainder is an act of the legislature that targets specific individuals and punishes them without a trial. Confiscatory taxation designed to hit only a small group of people arguably fits that definition.
What should have happened is that at the time of the original bailout, before the Treasury acquired 80% of AIG, all of the employment contracts should have been rendered subject to renegotiation as a precondition to receiving the money. Alas, no one thought of that during the press of events. Too bad, so sad.
Much as it pains my partisan soul, I have to give the Obama administration a pass on this one. By the time Obama was inaugurated in January, the retention bonuses had already been earned.
Instead of grandstanding and hyperventilating about how they are going to get that money back, our elected representatives would more constructively spend their time learning the ins and out of the financial system they are being asked to continue to bail out. Yes the AIG bonuses are outrageous, but in the great scheme of things they are also miniscule.
I would say that Congress has bigger fish to fry, but technically, whales are mammals, not fish.
In a state of high dudgeon, the House of Representatives passed a special bill last week that imposed a 95% tax on those bonuses. The US is looking at a trillion dollar deficit this year, and Congress is wasting their time going after a small group of traders who are getting retention bonuses when they should not even have been retained. Part of the taxpayer bailout of AIG should have been firing those guys. Instead, they were allowed to stick around until they qualified for bonuses.
The thing is, they were allowed to stick around to the end of the year. They had contracts, and those contracts have to be honored.
Now Congress, after the fact, is trying to get the money back. The US Constitution prohibits something call a Bill of Attainder. A Bill of Attainder is an act of the legislature that targets specific individuals and punishes them without a trial. Confiscatory taxation designed to hit only a small group of people arguably fits that definition.
What should have happened is that at the time of the original bailout, before the Treasury acquired 80% of AIG, all of the employment contracts should have been rendered subject to renegotiation as a precondition to receiving the money. Alas, no one thought of that during the press of events. Too bad, so sad.
Much as it pains my partisan soul, I have to give the Obama administration a pass on this one. By the time Obama was inaugurated in January, the retention bonuses had already been earned.
Instead of grandstanding and hyperventilating about how they are going to get that money back, our elected representatives would more constructively spend their time learning the ins and out of the financial system they are being asked to continue to bail out. Yes the AIG bonuses are outrageous, but in the great scheme of things they are also miniscule.
I would say that Congress has bigger fish to fry, but technically, whales are mammals, not fish.
Tuesday, March 17, 2009
BankTracker: How bad is it at my bank?
I have found a new toy. The BankTracker website has been set up to use publicly available data to rate the health of banks. The site takes information that banks are required to report to the FDIC every quarter, and creates a ratio of troubled assets to capital and reserves.
The troubled assets are defined as loans that have not received a payment in 90 days, loans that are no longer accruing interest (usually this means loans that have not received a payment in 60 days), and the category of other real estate, which means property that the bank has already foreclosed on. The foreclosed property is carried on the books as having a value equal to the outstanding balance of the loan at the time of foreclosure.
The troubled assets are then divided by the combination of Tier 1 capital and loss reserves to come up with a ratio. On the BankTracker website, the ratio is expressed as the percentage of troubled loans to capital. For example, if a bank had $100 million in capital and $10 million in troubled loans, the website reports the ratio as 10. If the website reported the ratio as 130, that would mean that troubled loans were equivalent in value to 130% of the banks capital.
So go ahead and look up your bank and see where they stand. I did, and my bank’s ratio was about 30. Their problem loans add up to about 30% of their capital. Not that bad, although the median for all banks was about 10. Still, my bank has enough capital to ride out the current mess, as long as the number of problem loans doesn’t get worse.
Even banks with ratios over 100 can still survive. If a bank has problem loans in excess of the amount of capital they carry, and cannot recover any of the value of those loans, the bank is technically insolvent. But that doesn’t take into account the recovery value of the assets. Take the other owned real estate (foreclosed properties). If the bank sells those properties for 50 cents on the dollar, they only write off half the value of the property.
For all of the problem loans, they will move from non accruing status to 90 days late, into foreclosure. After foreclosure, they will be other owned real estate. Eventually, the foreclosed houses will sell, and whatever fraction of the loan value the bank recovers will be added to capital.
I don’t know what criteria the FDIC uses to determine their problem bank list. But I would guess that anyone with a problem loan to capital ratio exceeding 150% would be an excellent candidate.
The troubled assets are defined as loans that have not received a payment in 90 days, loans that are no longer accruing interest (usually this means loans that have not received a payment in 60 days), and the category of other real estate, which means property that the bank has already foreclosed on. The foreclosed property is carried on the books as having a value equal to the outstanding balance of the loan at the time of foreclosure.
The troubled assets are then divided by the combination of Tier 1 capital and loss reserves to come up with a ratio. On the BankTracker website, the ratio is expressed as the percentage of troubled loans to capital. For example, if a bank had $100 million in capital and $10 million in troubled loans, the website reports the ratio as 10. If the website reported the ratio as 130, that would mean that troubled loans were equivalent in value to 130% of the banks capital.
So go ahead and look up your bank and see where they stand. I did, and my bank’s ratio was about 30. Their problem loans add up to about 30% of their capital. Not that bad, although the median for all banks was about 10. Still, my bank has enough capital to ride out the current mess, as long as the number of problem loans doesn’t get worse.
Even banks with ratios over 100 can still survive. If a bank has problem loans in excess of the amount of capital they carry, and cannot recover any of the value of those loans, the bank is technically insolvent. But that doesn’t take into account the recovery value of the assets. Take the other owned real estate (foreclosed properties). If the bank sells those properties for 50 cents on the dollar, they only write off half the value of the property.
For all of the problem loans, they will move from non accruing status to 90 days late, into foreclosure. After foreclosure, they will be other owned real estate. Eventually, the foreclosed houses will sell, and whatever fraction of the loan value the bank recovers will be added to capital.
I don’t know what criteria the FDIC uses to determine their problem bank list. But I would guess that anyone with a problem loan to capital ratio exceeding 150% would be an excellent candidate.
Sunday, March 15, 2009
"...and negotiating for the company will be Bobo the chimp."
The big international insurance company AIG made the news again this weekend. No, they didn’t require another round of taxpayer funded bailout money. The $170 billion pumped in during the last three rounds seemed to have stabilized the patient for the time being.
The news this weekend was that AIG was going to pay out $450 million in “retention bonuses” to employees throughout the organization. These bonuses were apparently written into the employment contracts for executives at the various business units that make up AIG.
The amazing part about this is that $165 million of the retention bonus pool is allocated to the people at AIG’s financial products unit in London. These were the brainiacs who made all the bad deals that sunk AIG into such dire straits that they needed the $170 billion in the first place. Apparently the lawyers at AIG headquarters reviewed the employment contracts and concluded, “yup, we gotta pay ‘em.”
These guys in London inked deals that went bad to the tune of $60 billion in the last three months of 2008 alone. But they held their heads high and refused to quit, so by making it to the end of the year, they qualify for “retention bonuses.”
Who writes these contracts? This is the worst case of “head I win, tails you lose” I’ve seen all year.
According to news reports, the retention plan was set up early in 2008, before the realization set in about how bad the losses on the credit default swaps engineered at the financial products unit were going to be. AIG wanted to keep a number of executives from leaving, so the plan was set up to pay retention payments to senior people.
Call me crazy, but I’m not sure I’d want to keep the people around who wrecked the company and wiped out the shareholders. And the people who wrecked the company are still on the payroll, because they have a contract. For some reason, their business performance didn’t qualify as grounds for termination.
It kind of makes you wonder what you have to do to be fired for poor performance. Do you think being caught on videotape cutting a deal with Satan to sell him the souls of your customers would do it? Or would that qualify you for an additional bonus payment for “out of the box” thinking?
I wish I could get my hands on one of those contracts and see what it really says.
The news this weekend was that AIG was going to pay out $450 million in “retention bonuses” to employees throughout the organization. These bonuses were apparently written into the employment contracts for executives at the various business units that make up AIG.
The amazing part about this is that $165 million of the retention bonus pool is allocated to the people at AIG’s financial products unit in London. These were the brainiacs who made all the bad deals that sunk AIG into such dire straits that they needed the $170 billion in the first place. Apparently the lawyers at AIG headquarters reviewed the employment contracts and concluded, “yup, we gotta pay ‘em.”
These guys in London inked deals that went bad to the tune of $60 billion in the last three months of 2008 alone. But they held their heads high and refused to quit, so by making it to the end of the year, they qualify for “retention bonuses.”
Who writes these contracts? This is the worst case of “head I win, tails you lose” I’ve seen all year.
According to news reports, the retention plan was set up early in 2008, before the realization set in about how bad the losses on the credit default swaps engineered at the financial products unit were going to be. AIG wanted to keep a number of executives from leaving, so the plan was set up to pay retention payments to senior people.
Call me crazy, but I’m not sure I’d want to keep the people around who wrecked the company and wiped out the shareholders. And the people who wrecked the company are still on the payroll, because they have a contract. For some reason, their business performance didn’t qualify as grounds for termination.
It kind of makes you wonder what you have to do to be fired for poor performance. Do you think being caught on videotape cutting a deal with Satan to sell him the souls of your customers would do it? Or would that qualify you for an additional bonus payment for “out of the box” thinking?
I wish I could get my hands on one of those contracts and see what it really says.
Saturday, March 14, 2009
Orchestra Tuning (Off-topic Post)
I went to a concert by our local symphony orchestra this evening. Before they began playing the first piece on the program, the musicians did what they do at all symphonies, all over the world. They tuned up their instruments.
Is there any more wonderfully expectant sound in the world than a symphony tuning up? It is a sound latent with all the potential that the future holds.
It is the sound of predawn lightening of darkness, just before the sun breaks over the horizon. It is the sound of the first cup of coffee in the morning, before the day's business begins. It is the sound of the mad scramble to get dressed and ready for an evening out, just before you step out the door.
Often times, I enjoy those moments of anticipation when the orchestra tunes up as much as some parts of the actual program. Judging by the videos that others have posted on YouTube, I'm not the only one.
Is there any more wonderfully expectant sound in the world than a symphony tuning up? It is a sound latent with all the potential that the future holds.
It is the sound of predawn lightening of darkness, just before the sun breaks over the horizon. It is the sound of the first cup of coffee in the morning, before the day's business begins. It is the sound of the mad scramble to get dressed and ready for an evening out, just before you step out the door.
Often times, I enjoy those moments of anticipation when the orchestra tunes up as much as some parts of the actual program. Judging by the videos that others have posted on YouTube, I'm not the only one.
Tuesday, March 10, 2009
We Bring Good Things to Light?
GE stock has fallen precipitously in value over the last year. It was trading at a little over $6 per share last week, having come down from a high of $40+ in 2007. This is the same GE that builds both jet engines and refrigerators, light bulbs and MRI scanners. GE even owns NBC and Universal Studios. They are a leader in globalization, noted for having a deep management bench and the ability to develop talent. GE is one of the few American companies with AAA bond rating. The bluest of the blue chips.
And yet, panic selling drove the price down 45% in one month. This, despite the fact that the company was profitable last year. What gives?
The problem is that GE has xx in assets, but has yy in liabilities. If GE has problems paying back those liabilities, that spells real trouble for the stockholders. In corporate finance, the owners of the liabilities (bondholders) always get paid before the owners of the equity (stockholders). The reason the stock price has fallen so far is that the judgement of the market is that GE’s liabilities won’t be paid back.
You may think “What’s the problem? They’ve got a lot more assets than liabilities.” Well, maybe yes, and maybe no.
GE is really two companies. There is General Electric, which is the collection of industrial businesses that makes all the stuff. They have twice as many assets as liabilities. Then there is GE Capital. GE Capital provided half of GE’s profits for 2007. The problems are in GE Capital portfolio. In the 2007 annual report, GE Capital had $646 billion in assets, and $587 billion in liabilities. If the assets are worth only 10% less than what GE said they were worth a year ago, that would be enough of a fall in value to wipe out GE Capital’s equity, forcing the company to put more cash into the business.
GE Capital uses the AAA rating to borrow money cheaply. They then use that money to make loans. A lot of the loans are equipment leases. You want to lease a jet engine or MRI scanner, GE Capital will help you do that. But they make a lot of other types of loans as well. For a financing company, the money borrowed is a liability, and the loans made are the assets.
The market is concerned about writedowns hidden in the loan portfolio. Another way of saying that is that the assets are worth a lot less than what GE has been saying, and GE will have to ‘fess up soon.
I decided to go looking through the annual report to see if I could spot any potential problems. In corporate annual reports, the pesky details that can cause trouble are usually buried in the notes that follow the financial statements at the back of the report. Opening up the report almost at random, I found Note 12: GECS Financing Receivables.
Inside Note 12 was a line item for a division called GE Money, listing Non-US Residential Mortgages: $73.759 billion. So GE owns a mortgage company that is holding almost $74 billion in mortgages. I’m guessing that most of the mortgages are in the UK.
Attached to the line items was a reference to subnote (A). In little, tiny print, subnote (A) included the following statement: “approximately 26% of this portfolio comprised loans with introductory, below market rates that are scheduled to adjust at future dates; with high loan-to-value ratios at inception; whose terms permitted interest-only payments; or whose terms resulted in negative amortization.”
Yikes. Let me translate that for you: “GE holds over $19 billion dollars of toxic subprime mortgages in a collapsing real estate market.” After those UK homeowners stop paying, GE will foreclose, and then sell the houses for half. My back of the envelope calculation is that GE will have to write down that sliver of their portfolio by about $10 billion dollars. The total reserve for losses in their Financing Receivables is only $4.3 billion.
GE recently eliminated 70% of their dividend. This contributed mightily to the free fall in the stock price, but it will free up $9 billion a year in cash to apply to other uses, like writing off foreclosed mortgages. I have a feeling that they are going to need the cash.
The 2008 annual report is due any day now. I can’t wait to read it.
And yet, panic selling drove the price down 45% in one month. This, despite the fact that the company was profitable last year. What gives?
The problem is that GE has xx in assets, but has yy in liabilities. If GE has problems paying back those liabilities, that spells real trouble for the stockholders. In corporate finance, the owners of the liabilities (bondholders) always get paid before the owners of the equity (stockholders). The reason the stock price has fallen so far is that the judgement of the market is that GE’s liabilities won’t be paid back.
You may think “What’s the problem? They’ve got a lot more assets than liabilities.” Well, maybe yes, and maybe no.
GE is really two companies. There is General Electric, which is the collection of industrial businesses that makes all the stuff. They have twice as many assets as liabilities. Then there is GE Capital. GE Capital provided half of GE’s profits for 2007. The problems are in GE Capital portfolio. In the 2007 annual report, GE Capital had $646 billion in assets, and $587 billion in liabilities. If the assets are worth only 10% less than what GE said they were worth a year ago, that would be enough of a fall in value to wipe out GE Capital’s equity, forcing the company to put more cash into the business.
GE Capital uses the AAA rating to borrow money cheaply. They then use that money to make loans. A lot of the loans are equipment leases. You want to lease a jet engine or MRI scanner, GE Capital will help you do that. But they make a lot of other types of loans as well. For a financing company, the money borrowed is a liability, and the loans made are the assets.
The market is concerned about writedowns hidden in the loan portfolio. Another way of saying that is that the assets are worth a lot less than what GE has been saying, and GE will have to ‘fess up soon.
I decided to go looking through the annual report to see if I could spot any potential problems. In corporate annual reports, the pesky details that can cause trouble are usually buried in the notes that follow the financial statements at the back of the report. Opening up the report almost at random, I found Note 12: GECS Financing Receivables.
Inside Note 12 was a line item for a division called GE Money, listing Non-US Residential Mortgages: $73.759 billion. So GE owns a mortgage company that is holding almost $74 billion in mortgages. I’m guessing that most of the mortgages are in the UK.
Attached to the line items was a reference to subnote (A). In little, tiny print, subnote (A) included the following statement: “approximately 26% of this portfolio comprised loans with introductory, below market rates that are scheduled to adjust at future dates; with high loan-to-value ratios at inception; whose terms permitted interest-only payments; or whose terms resulted in negative amortization.”
Yikes. Let me translate that for you: “GE holds over $19 billion dollars of toxic subprime mortgages in a collapsing real estate market.” After those UK homeowners stop paying, GE will foreclose, and then sell the houses for half. My back of the envelope calculation is that GE will have to write down that sliver of their portfolio by about $10 billion dollars. The total reserve for losses in their Financing Receivables is only $4.3 billion.
GE recently eliminated 70% of their dividend. This contributed mightily to the free fall in the stock price, but it will free up $9 billion a year in cash to apply to other uses, like writing off foreclosed mortgages. I have a feeling that they are going to need the cash.
The 2008 annual report is due any day now. I can’t wait to read it.
Monday, March 9, 2009
Another Step Closer to the Edge
I have encountered more evidence of the incipient collapse of our civilization. Barbie Totally Stylin’ Tattoos. Yes, our friends at Mattel have come up with a doll that little girls can “customize” by covering the toy in designs using the included “tattoo gun.”
Mothers will be so proud of the creative work of their daughters. It just brings a tear to your eye.
What’s next? “Baby’s First Body Piercing” kits?
Mothers will be so proud of the creative work of their daughters. It just brings a tear to your eye.
What’s next? “Baby’s First Body Piercing” kits?
Thursday, March 5, 2009
Not Long Before the End
The final collapse of Western civilization may be near. There are signs and portents, for those who know how to interpret the omens.
Take, for example, the case of Latreasa Goodman. This is a woman in Florida who went to McDonalds and ordered the 10-piece Chicken McNuggets with fries and a drink. After paying for the items she was informed that they were out of McNuggets. The manager refused to give her a refund, instead offering any other item off the menu. Our gal Latreasa did not want any other item, she wanted her McNuggets, or she wanted her money back.
Faced with this impasse, she had at least three choices on how to handle the situation:
A) Take her fries and drink, losing her $3.49, and drive off, never go back to that McDonalds.
B) Choose another item to go with her fries and drink, drive off, and never go back to that McDonalds.
C) Call 911.
Ms. Goodman picked option C. Three times. The first time she called, the 911 operator actually agreed to dispatch a police officer to the scene, but the police apparently did not show up fast enough to suit Ms. Goodman. Hence calls two and three.
When the police finally showed up, they cited Ms. Goodman for abuse of the 911 emergency system. Her riposte is classic: "This is an emergency. If I would have known they didn't have McNuggets, I wouldn't have given my money, and now she wants to give me a McDouble, but I don't want one. This is an emergency."
I love the way she repeated that it was an emergency, just in case they didn’t understand the first time she said it.
The astonishing thing to me is the sense of entitlement possessed by this woman. The cops spent more money in gas driving out to where she was than the value of the dispute, but she obviously didn’t care about anything else other than getting what she wanted.
One lone nut job does not a trend make, I know, but to me this woman epitomizes the trend toward total reliance upon government for the solutions to all problems. God forbid she solve the problem peacefully on her own.
You can listen to recordings of the 911 calls, and see a previous mug shot of Ms. Goodman here.
Take, for example, the case of Latreasa Goodman. This is a woman in Florida who went to McDonalds and ordered the 10-piece Chicken McNuggets with fries and a drink. After paying for the items she was informed that they were out of McNuggets. The manager refused to give her a refund, instead offering any other item off the menu. Our gal Latreasa did not want any other item, she wanted her McNuggets, or she wanted her money back.
Faced with this impasse, she had at least three choices on how to handle the situation:
A) Take her fries and drink, losing her $3.49, and drive off, never go back to that McDonalds.
B) Choose another item to go with her fries and drink, drive off, and never go back to that McDonalds.
C) Call 911.
Ms. Goodman picked option C. Three times. The first time she called, the 911 operator actually agreed to dispatch a police officer to the scene, but the police apparently did not show up fast enough to suit Ms. Goodman. Hence calls two and three.
When the police finally showed up, they cited Ms. Goodman for abuse of the 911 emergency system. Her riposte is classic: "This is an emergency. If I would have known they didn't have McNuggets, I wouldn't have given my money, and now she wants to give me a McDouble, but I don't want one. This is an emergency."
I love the way she repeated that it was an emergency, just in case they didn’t understand the first time she said it.
The astonishing thing to me is the sense of entitlement possessed by this woman. The cops spent more money in gas driving out to where she was than the value of the dispute, but she obviously didn’t care about anything else other than getting what she wanted.
One lone nut job does not a trend make, I know, but to me this woman epitomizes the trend toward total reliance upon government for the solutions to all problems. God forbid she solve the problem peacefully on her own.
You can listen to recordings of the 911 calls, and see a previous mug shot of Ms. Goodman here.
Monday, March 2, 2009
Northern Trust: "Take this TARP and Shove It..."
Two weekends ago Northern Trust sponsored a PGA tournament in LA. As part of their sponsorship, they flew hundreds of their clients and employees out to California for the event. Northern Trust’s guests were put up in fancy hotels, and treated to several parties, with big name entertainment such as the bands Chicago, Earth Wind, and Fire, and Sheryl Crow.
When news of this sponsorship broke, Congressman Barney Frank fired off an outraged letter, demanding that Northern Trust pay the Treasury back the amount that they spent on this event. His position was that since the bank had not refused Federal TARP money last year, it "demonstrates extraordinary levels of irresponsibility and arrogance" for the bank to spend money marketing to it’s clients in a way that Barney Frank disapproved of.
Last week Northern Trust defended itself by pointing out that it was profitable, and that it was funding a marketing plan out of those profits, not out of the TARP bailout money. They also pointed out that the Federal money was actually a loan, and that they had made the interest payments back to the Treasury on time.
Now the other shoe has dropped. This weekend Northern Trust announced that it would be returning the $1.6 billion given to it by the Treasury as soon as possible. In essence, they have told the Federal government “You can take your unsolicited bailout money, and your unsolicited advice on how we should run our business, and put them both where the sun don’t shine!”
Northern Trust does most of its business with institutions and high net worth individuals (AKA rich folks). Thy put the trust in trust funds. The execs at NT must have figured that if they went with the sackcloth and ashes marketing advocated by the new Puritans in Congress and the media, they stood to lose a lot of business. As long as they had the Federal money on their books, they were going to continue being attacked for following a strategy that has made them one of the banks that don’t need a bailout. So to preserve their successful business model, they decided to return the money.
One question pops up for me. Just how much money do you have to have in a bank to get treated like a Northern Trust client? I keep what I consider a fair chunk of money on deposit at my bank, and I don’t get freebies like getting flown out to a California golf tournament, and being put up at the Ritz Carleton. My bank won’t even give me a coupon for the get away weekend at the local Red Roof Inn.
Or how about the Sheryl Crow concert? Shoot, I’d be happy with a Sheryl Crow CD! No, the only freebie I’ve gotten from my bank was a pad of Post-it notes, and I had to distract the banker to get those (“Look, it’s Hailey’s comet!” Point with the left hand, snatch with the right).
When I grow up, I want to be a Northern Trust client.
When news of this sponsorship broke, Congressman Barney Frank fired off an outraged letter, demanding that Northern Trust pay the Treasury back the amount that they spent on this event. His position was that since the bank had not refused Federal TARP money last year, it "demonstrates extraordinary levels of irresponsibility and arrogance" for the bank to spend money marketing to it’s clients in a way that Barney Frank disapproved of.
Last week Northern Trust defended itself by pointing out that it was profitable, and that it was funding a marketing plan out of those profits, not out of the TARP bailout money. They also pointed out that the Federal money was actually a loan, and that they had made the interest payments back to the Treasury on time.
Now the other shoe has dropped. This weekend Northern Trust announced that it would be returning the $1.6 billion given to it by the Treasury as soon as possible. In essence, they have told the Federal government “You can take your unsolicited bailout money, and your unsolicited advice on how we should run our business, and put them both where the sun don’t shine!”
Northern Trust does most of its business with institutions and high net worth individuals (AKA rich folks). Thy put the trust in trust funds. The execs at NT must have figured that if they went with the sackcloth and ashes marketing advocated by the new Puritans in Congress and the media, they stood to lose a lot of business. As long as they had the Federal money on their books, they were going to continue being attacked for following a strategy that has made them one of the banks that don’t need a bailout. So to preserve their successful business model, they decided to return the money.
One question pops up for me. Just how much money do you have to have in a bank to get treated like a Northern Trust client? I keep what I consider a fair chunk of money on deposit at my bank, and I don’t get freebies like getting flown out to a California golf tournament, and being put up at the Ritz Carleton. My bank won’t even give me a coupon for the get away weekend at the local Red Roof Inn.
Or how about the Sheryl Crow concert? Shoot, I’d be happy with a Sheryl Crow CD! No, the only freebie I’ve gotten from my bank was a pad of Post-it notes, and I had to distract the banker to get those (“Look, it’s Hailey’s comet!” Point with the left hand, snatch with the right).
When I grow up, I want to be a Northern Trust client.
Thursday, February 26, 2009
Northern Trust: "I'm shocked, shocked to discover..."
There has been another dust up this week regarding a bank that received Federal money not spending their resources as the legislators would wish. Northern Trust Bank, a Chicago based institution, sponsored a golf tournament in Los Angeles last weekend. As part of their sponsorship, they paid for employees and clients (mostly clients) to fly in for the event. The bank paid for the guests to stay in expensive hotels, and sponsored lavish parties, headlined by the artists Chicago, Earth,Wind & Fire, and Sheryl Crow. Suffice it to say that big bucks were spent, and a good time was had by all.
Since Northern Trust was the recipient of $1.6 billion from last year’s Federal bailout package, outraged howls from Congress ensued when details about the swanky soirees hit the media. Representative Barney Franks, chairman of the House Banking Committee, fired off a letter to Northern Trust, castigating the bank for their “arrogance and irresponsibility” and demanding Northern Trust return to the Treasury a sum equal to what was spent on the event. The letter was cosigned by seventeen other Democratic congressmen.
This is the kind of political grandstanding that explains why politicians should not be in charge of the banking system in this country. Among all the screams of “an outrage, simply an outrage,” and “have they no shame,” several facts about the issue have been drowned out.
First, Northern Trust signed the five year sponsorship contract for this golf tournament in 2007, before the whole banking mess started. Furthermore, blocks of hotel rooms, caterers and bands for events like this are usually booked six months or more in advance, with sizable deposits paid. In other words, these expenses were committed to long before any of the Federal bailout package was even thought of, let alone handed out. What was Northern Trust supposed to do, break the contracts and lose all the prepaid expenses?
Even more important, keep in mind that Northern Trust did not ask for money from the Treasury. Northern Trust is a profitable bank. Even after all the prepaid expenses for the golf event, they earned over $600 million in 2008. They accepted the money from the Treasury’s Troubled Asset Relief Program (TARP) because they were asked to take the money.
The Treasury Department wanted all of the twenty largest financial institutions in the country to take money from the bailout fund. The idea was that if only banks in trouble got bailout funds, it would be a red flag to investors and depositors. The Treasury didn’t want to start a run on the very banks that most needed their help. So banks that did not need a capital infusion were arm-twisted into taking the money, right along with the banks that were on the edge of insolvency. In Northern Trust’s case, the TARP money came in the form of a loan, and they are paying almost $80 million a year back to the Treasury.
I borrowed money from a bank to buy my home. I make my mortgage payments on time, and have never been late. As long as I keep making those payments, I don’t think the bank has a right to tell me I can’t serve steak if I have a barbeque in my backyard. The same principle applies here. Congress (or more to the point, individual representatives) doesn’t have the right to tell profitable businesses how they should operate.
And here’s my final point on the Northern Trust story for today: when Northern Trust throws a big party in LA, doesn’t that stimulate the economy? If you are a hotel maid, or a catering server, or even a roadie for Sheryl Crow, aren’t you benefiting from these parties? Those people have jobs, and are probably grateful to be working in today’s economy.
The US government is about to start spending almost $800 billion on a stimulus package to put people to work. Maybe Congressman Franks should not be in such a big hurry to stop private institutions from doing the same thing.
Since Northern Trust was the recipient of $1.6 billion from last year’s Federal bailout package, outraged howls from Congress ensued when details about the swanky soirees hit the media. Representative Barney Franks, chairman of the House Banking Committee, fired off a letter to Northern Trust, castigating the bank for their “arrogance and irresponsibility” and demanding Northern Trust return to the Treasury a sum equal to what was spent on the event. The letter was cosigned by seventeen other Democratic congressmen.
This is the kind of political grandstanding that explains why politicians should not be in charge of the banking system in this country. Among all the screams of “an outrage, simply an outrage,” and “have they no shame,” several facts about the issue have been drowned out.
First, Northern Trust signed the five year sponsorship contract for this golf tournament in 2007, before the whole banking mess started. Furthermore, blocks of hotel rooms, caterers and bands for events like this are usually booked six months or more in advance, with sizable deposits paid. In other words, these expenses were committed to long before any of the Federal bailout package was even thought of, let alone handed out. What was Northern Trust supposed to do, break the contracts and lose all the prepaid expenses?
Even more important, keep in mind that Northern Trust did not ask for money from the Treasury. Northern Trust is a profitable bank. Even after all the prepaid expenses for the golf event, they earned over $600 million in 2008. They accepted the money from the Treasury’s Troubled Asset Relief Program (TARP) because they were asked to take the money.
The Treasury Department wanted all of the twenty largest financial institutions in the country to take money from the bailout fund. The idea was that if only banks in trouble got bailout funds, it would be a red flag to investors and depositors. The Treasury didn’t want to start a run on the very banks that most needed their help. So banks that did not need a capital infusion were arm-twisted into taking the money, right along with the banks that were on the edge of insolvency. In Northern Trust’s case, the TARP money came in the form of a loan, and they are paying almost $80 million a year back to the Treasury.
I borrowed money from a bank to buy my home. I make my mortgage payments on time, and have never been late. As long as I keep making those payments, I don’t think the bank has a right to tell me I can’t serve steak if I have a barbeque in my backyard. The same principle applies here. Congress (or more to the point, individual representatives) doesn’t have the right to tell profitable businesses how they should operate.
And here’s my final point on the Northern Trust story for today: when Northern Trust throws a big party in LA, doesn’t that stimulate the economy? If you are a hotel maid, or a catering server, or even a roadie for Sheryl Crow, aren’t you benefiting from these parties? Those people have jobs, and are probably grateful to be working in today’s economy.
The US government is about to start spending almost $800 billion on a stimulus package to put people to work. Maybe Congressman Franks should not be in such a big hurry to stop private institutions from doing the same thing.
Monday, February 23, 2009
Sunday, February 22, 2009
Gaming the System
Despite the forest of laws that make up the Federal tax code, on a conceptual level the income tax system is pretty simple.
First, you total up your income. Next, you subtract deductions from income to arrive at your taxable income. Multiply that by the appropriate tax rate, and you arrive at your tax liability. Once you know your tax liability, you apply any applicable tax credits. Credits reduce your tax liability, dollar for dollar. The result of these calculations is the amount of income tax you owe the Federal government.
The last step in the process is to compare the amount of tax you have prepaid (aka withholding) to the amount of income tax you owe. If you had more withheld more than you owe, the IRS sends you a refund. If you withheld less than you owe, you get the pleasure of writing the IRS a check for the difference (cue the wailing and gnashing of teeth).
Clear as mud, right?
For wage slaves like me, and historically for most of us, it was difficult to beat the system. Your employer reported your wages directly to the IRS. For those of us who didn’t get the free use of a car and driver, there wasn’t much chance to under report income, aside from the odd garage sale now and then. You had to be unusually creative to come up with enough deductions to exceed the standard deductions, so that avenue for chicanery was also closed off to most of us.
So most of us were just resigned to paying taxes. Depending on your withholding you might get a big refund or you might have to pay in a little at the end of the year, but unless you owned a business with a lot of cash income, your opportunities for cheating on your taxes were pretty limited.
But with the Earned Income Credit, the opportunities have gotten much broader based. Remember, tax credits affect your tax liability on a dollar for dollar basis. This makes them six to ten times more powerful than hiding income or making up deductions, depending on your tax bracket. At the 15% tax bracket, you have to come up with $6.67 dollars of deductions to reduce your taxes by $1.00. One dollar of tax credit reduces your tax liability by $1.00.
But it gets better, because tax credits come in two flavors: non-refundable and refundable. With non-refundable credits, you can reduce your taxes to zero, but after that they don’t do much good. Once your tax liability is zero, you get your withholding refunded, but that’s all.
But the Earned Income Credit is a refundable credit. This means that even if you owe no taxes, you get the whole credit added to your refund. As an example, suppose an individual is a single parent with two children, and the individual earns $18500 per year. To make ends meet this person has the children enrolled in Medicaid, lives in government subsidized Section 8 housing, and receives food stamps (all non-taxable).
This person would file as head of household with three personal exemptions. With a standard deduction for head of household at $8000, and $10500 in personal exemptions, the taxable income in this case is $0. The individual gets all of their withholding back in the refund. But he also gets $4056 from the government in EIC.
The thing about these credits is that they provide huge incentives to game the system. So in the example I’ve just laid out, if the taxpayer was living with his girlfriend, and she also had earned income, his EIC would be reduced if they got married. If a single parent is living with a partner who pays more than half the household expenses, the parent is ineligible for the EIC. But all you have to do is fail to mention the partner when you do your taxes, and bang-zoom, you get that fat check of free government money.
Let’s say your niece lives with your mother, who is surviving off social security. For tax purposes, you claim that your mother and niece live with you, which makes you eligible to claim the niece for EIC. So what if you moved out of your mom’s house years ago. She doesn’t have earned income, so she can’t take advantage of the credit. Someone has got to take advantage of the government in that family.
The EIC can provide the equivalent of two or three months worth of wages for some low income earners. That’s a pretty strong incentive to cheat the system.
I used to think it was only the wealthy who cheated on their taxes. But anyone can play at being Tom Daschle these days.
First, you total up your income. Next, you subtract deductions from income to arrive at your taxable income. Multiply that by the appropriate tax rate, and you arrive at your tax liability. Once you know your tax liability, you apply any applicable tax credits. Credits reduce your tax liability, dollar for dollar. The result of these calculations is the amount of income tax you owe the Federal government.
The last step in the process is to compare the amount of tax you have prepaid (aka withholding) to the amount of income tax you owe. If you had more withheld more than you owe, the IRS sends you a refund. If you withheld less than you owe, you get the pleasure of writing the IRS a check for the difference (cue the wailing and gnashing of teeth).
Clear as mud, right?
For wage slaves like me, and historically for most of us, it was difficult to beat the system. Your employer reported your wages directly to the IRS. For those of us who didn’t get the free use of a car and driver, there wasn’t much chance to under report income, aside from the odd garage sale now and then. You had to be unusually creative to come up with enough deductions to exceed the standard deductions, so that avenue for chicanery was also closed off to most of us.
So most of us were just resigned to paying taxes. Depending on your withholding you might get a big refund or you might have to pay in a little at the end of the year, but unless you owned a business with a lot of cash income, your opportunities for cheating on your taxes were pretty limited.
But with the Earned Income Credit, the opportunities have gotten much broader based. Remember, tax credits affect your tax liability on a dollar for dollar basis. This makes them six to ten times more powerful than hiding income or making up deductions, depending on your tax bracket. At the 15% tax bracket, you have to come up with $6.67 dollars of deductions to reduce your taxes by $1.00. One dollar of tax credit reduces your tax liability by $1.00.
But it gets better, because tax credits come in two flavors: non-refundable and refundable. With non-refundable credits, you can reduce your taxes to zero, but after that they don’t do much good. Once your tax liability is zero, you get your withholding refunded, but that’s all.
But the Earned Income Credit is a refundable credit. This means that even if you owe no taxes, you get the whole credit added to your refund. As an example, suppose an individual is a single parent with two children, and the individual earns $18500 per year. To make ends meet this person has the children enrolled in Medicaid, lives in government subsidized Section 8 housing, and receives food stamps (all non-taxable).
This person would file as head of household with three personal exemptions. With a standard deduction for head of household at $8000, and $10500 in personal exemptions, the taxable income in this case is $0. The individual gets all of their withholding back in the refund. But he also gets $4056 from the government in EIC.
The thing about these credits is that they provide huge incentives to game the system. So in the example I’ve just laid out, if the taxpayer was living with his girlfriend, and she also had earned income, his EIC would be reduced if they got married. If a single parent is living with a partner who pays more than half the household expenses, the parent is ineligible for the EIC. But all you have to do is fail to mention the partner when you do your taxes, and bang-zoom, you get that fat check of free government money.
Let’s say your niece lives with your mother, who is surviving off social security. For tax purposes, you claim that your mother and niece live with you, which makes you eligible to claim the niece for EIC. So what if you moved out of your mom’s house years ago. She doesn’t have earned income, so she can’t take advantage of the credit. Someone has got to take advantage of the government in that family.
The EIC can provide the equivalent of two or three months worth of wages for some low income earners. That’s a pretty strong incentive to cheat the system.
I used to think it was only the wealthy who cheated on their taxes. But anyone can play at being Tom Daschle these days.
Monday, February 9, 2009
A Noun is the Name of a Thing
I signed on with H&R Block to be a tax preparer this year. I did it both for the experience, which I figured would help with my own taxes, and because I hoped to make a little extra money. As a first year preparer, it turns out I was wrong about making any real money, but that is a topic for another post.
So I have been working part time the last two weeks doing taxes, and have done about 20 returns so far. Most of the people who file early are getting big refunds, but I didn’t realize how big until I started processing their taxes. The vast majority of the tax returns I’ve done have gotten way more money back from the IRS then they paid in withholding.
The language we use around taxes is completely misleading. Take someone who pays $2000 in withholding and gets all $2000 back, plus another $3000 in top of that. Should we be calling that a tax refund? Normally a refund is the return of money paid in. The return of withholding counts as a refund, but what about the other $3000? Instead of calling that part of their refund, wouldn’t it be more accurate to call it welfare?
At an even more basic level, why are we calling everybody taxpayers? Half the households in America pay no income tax. A more accurate term would be tax filers. Actually, if you get more tax money out then you pay in, doesn’t that make you a tax receiver?
I'm not done with the subject of taxes, there will be more to come. By the way, my opinions are my own and in no way should be considered to represent H&R Block in any way.
So I have been working part time the last two weeks doing taxes, and have done about 20 returns so far. Most of the people who file early are getting big refunds, but I didn’t realize how big until I started processing their taxes. The vast majority of the tax returns I’ve done have gotten way more money back from the IRS then they paid in withholding.
The language we use around taxes is completely misleading. Take someone who pays $2000 in withholding and gets all $2000 back, plus another $3000 in top of that. Should we be calling that a tax refund? Normally a refund is the return of money paid in. The return of withholding counts as a refund, but what about the other $3000? Instead of calling that part of their refund, wouldn’t it be more accurate to call it welfare?
At an even more basic level, why are we calling everybody taxpayers? Half the households in America pay no income tax. A more accurate term would be tax filers. Actually, if you get more tax money out then you pay in, doesn’t that make you a tax receiver?
I'm not done with the subject of taxes, there will be more to come. By the way, my opinions are my own and in no way should be considered to represent H&R Block in any way.
Thursday, February 5, 2009
Another Fine Mess
Another Obama nominee has run into tax problems, this time by proxy. The husband of Hilda Solis, the nominee for Labor Secretary, owns an auto repair business in California. It has now come to light that this business had a number of outstanding state and county tax liens against it. The oldest liens were sixteen years old, and the total value of the liens was $7630. According to news reports, Sam Sayyad, Ms. Solis’ husband, was not even aware of the outstanding liens until asked about them.
There are two ways you can look at this story. One, you can spin this into a partisan attack on the administration. “Look at these guys: first Geithner, then Daschle, then Killefer, and now Solis. These guys are all crooks and tax cheats.”
This dog won’t hunt. Daschle and Killefer have withdrawn. This flap about Solis is much ado about nothing. $7630? Please, get serious. If her husband didn’t get something so penny ante resolved before this, it was because he really didn’t know about the tax liens.
I think a more interesting take on the situation was the point I brought up in my last post. Governmental regulation can be so pervasive, and yet so obscure, that even people who intend to be in compliance may not know they are in violation of one regulation or another.
No, Sam Sayyad is not a crook. He is just an honest businessman trying to run his company and make a little money doing it. But if the people on the pro-regulatory side of the aisle can’t keep even with the current level of regulation and taxes, surely that has to be an argument against adding to the burden.
There are two ways you can look at this story. One, you can spin this into a partisan attack on the administration. “Look at these guys: first Geithner, then Daschle, then Killefer, and now Solis. These guys are all crooks and tax cheats.”
This dog won’t hunt. Daschle and Killefer have withdrawn. This flap about Solis is much ado about nothing. $7630? Please, get serious. If her husband didn’t get something so penny ante resolved before this, it was because he really didn’t know about the tax liens.
I think a more interesting take on the situation was the point I brought up in my last post. Governmental regulation can be so pervasive, and yet so obscure, that even people who intend to be in compliance may not know they are in violation of one regulation or another.
No, Sam Sayyad is not a crook. He is just an honest businessman trying to run his company and make a little money doing it. But if the people on the pro-regulatory side of the aisle can’t keep even with the current level of regulation and taxes, surely that has to be an argument against adding to the burden.
Wednesday, February 4, 2009
Trouble in Paradise
Two of President Obama’s appointees withdrew their nominations yesterday. In both cases the reason for their withdrawal was the exposure of problems with filing and paying taxes. Tom Daschle, the former majority leader of the US Senate, pulled out of consideration to be Secretary of Health and Human Services. His tax faux pas was failing to list the use of a car and driver as compensation when he reported his income. The vehicle was provided to Mr. Daschle by one of the companies he worked for. The rule is pretty simple. If you pay for a car and driver yourself, you can use the milage driven for business purposes as a tax deduction. If you accept a car from someone else, the value of that service is compensation, the same as getting paid.
The other nominee was Nancy Killefer, who had been tapped to become the nation’s Chief Performance Officer. Ms. Killefer, a senior partner at the McKinsey management consulting firm, failed to pay the unemployment insurance premiums on her personal household staff of two assistants and a housekeeper.
This is so rich a situation that one scarcely knows where to begin, but time is short, so I’ll start by venting my spleen on the low hanging fruit.
Chief Performance Officer? What the hell kind of job is that? Apparently someone had the bright idea of creating a new position, based in the White House, tasked with finding and eliminating wasteful spending by the government. ‘Cause having Inspector Generals in every government department wasn’t enough. No, we needed a new government waste czar.
Here’s a little hint for you: the position of Chief Performance Officer is a terrific example of government waste. Criminy, the job title is it’s own punchline.
Now let’s talk about the tax issues, starting with Ms. Killefer’s. This is pretty simple. With household help, such as maids, nannies, drivers, cooks, and personal assistants, the rule is pretty simple: either you pay an independent contractor for services rendered, or you have employees. With independent contractors, they have to deal with the taxes and government paperwork on their own. With employees, you have to deal with those hassles for them. Every small business owner in America has learned that lesson.
I can only guess at why Ms. Killefer did not pay the unemployment insurance for her employees. Perhaps she believed that she did not have enough employees to fall under the requirements of the law. The District of Columbia disagreed. The funny thing is that there are employee leasing firms that will handle all of those messy details for you. Heck, any temp agency could have handled the payroll issues, for a markup of the employees’ wages. Why didn’t she just do that?
By the way, did she provide her employees health insurance? That’s a question I’d like to have answered.
Mr. Daschle apparently had the use of the car and driver for three years before he got around to talking to his accountant about it. The value of those services was about $300,000, based on the amount of taxes paid to settle the issue. By the way, this is the same sort of tax issue that fat cat corporate types run into, when they use the company jet to fly their spouses on vacation. If you use the company vehicle for personal purposes, the cost is income to you. Does that make Mr. Daschle a fat cat corporate type?
One Republican has already quipped: “No wonder the Democrats don’t mind raising taxes. They don’t intend to pay them!”
Now, these were probably unintentional violations of local and Federal laws. Both individuals have admitted they made a mistake and made restitution. But these are supposed to be the best and the brightest, and they can’t figure out how to comply with government requirements.
After all, the incoming administration is pro-government regulation. They believe that more government, not less, is the solution to the nation’s problems, yet some of the very people selected to put new programs in place are not in compliance with the existing regulatory scheme.
How will the rest of us cope, after they’ve had more time to put their agenda into place?
The other nominee was Nancy Killefer, who had been tapped to become the nation’s Chief Performance Officer. Ms. Killefer, a senior partner at the McKinsey management consulting firm, failed to pay the unemployment insurance premiums on her personal household staff of two assistants and a housekeeper.
This is so rich a situation that one scarcely knows where to begin, but time is short, so I’ll start by venting my spleen on the low hanging fruit.
Chief Performance Officer? What the hell kind of job is that? Apparently someone had the bright idea of creating a new position, based in the White House, tasked with finding and eliminating wasteful spending by the government. ‘Cause having Inspector Generals in every government department wasn’t enough. No, we needed a new government waste czar.
Here’s a little hint for you: the position of Chief Performance Officer is a terrific example of government waste. Criminy, the job title is it’s own punchline.
Now let’s talk about the tax issues, starting with Ms. Killefer’s. This is pretty simple. With household help, such as maids, nannies, drivers, cooks, and personal assistants, the rule is pretty simple: either you pay an independent contractor for services rendered, or you have employees. With independent contractors, they have to deal with the taxes and government paperwork on their own. With employees, you have to deal with those hassles for them. Every small business owner in America has learned that lesson.
I can only guess at why Ms. Killefer did not pay the unemployment insurance for her employees. Perhaps she believed that she did not have enough employees to fall under the requirements of the law. The District of Columbia disagreed. The funny thing is that there are employee leasing firms that will handle all of those messy details for you. Heck, any temp agency could have handled the payroll issues, for a markup of the employees’ wages. Why didn’t she just do that?
By the way, did she provide her employees health insurance? That’s a question I’d like to have answered.
Mr. Daschle apparently had the use of the car and driver for three years before he got around to talking to his accountant about it. The value of those services was about $300,000, based on the amount of taxes paid to settle the issue. By the way, this is the same sort of tax issue that fat cat corporate types run into, when they use the company jet to fly their spouses on vacation. If you use the company vehicle for personal purposes, the cost is income to you. Does that make Mr. Daschle a fat cat corporate type?
One Republican has already quipped: “No wonder the Democrats don’t mind raising taxes. They don’t intend to pay them!”
Now, these were probably unintentional violations of local and Federal laws. Both individuals have admitted they made a mistake and made restitution. But these are supposed to be the best and the brightest, and they can’t figure out how to comply with government requirements.
After all, the incoming administration is pro-government regulation. They believe that more government, not less, is the solution to the nation’s problems, yet some of the very people selected to put new programs in place are not in compliance with the existing regulatory scheme.
How will the rest of us cope, after they’ve had more time to put their agenda into place?
Thursday, January 29, 2009
Viscous circles, Virtuous Cycles, and the Stimulus
The US House passed a $813 billion dollar stimulus package spending bill yesterday. The vote went along party lines, with the Republicans, in a remarkable show of party unity, voting 100% opposed. It will now proceed on to the Senate.
There has been a steady drumbeat of bad economic news in the last few weeks, with a number of major companies, from Alcoa to Starbucks, announcing major job cuts. Both consumer and business confidence are at low ebbs. So I think a stimulus package is probably a good thing at this point. But I think there hasn’t been much discussion about the purpose behind the stimulus. Put another way, what is the stimulus intended to accomplish?
Most of the rhetoric has been about job creation. The debate has been couched in terms of what puts people back to work faster, spending or tax cuts. My perspective is that the emphasis on job creation is misplaced. As a conservative, I would argue that the purpose of government is not to guarantee everybody a job (an impossible task in any case). The major purpose of government is to safeguard our liberties, with a minor in promote the general welfare.
The purpose of the stimulus should be to create an inflection point in the general trend line of the economy. To do that, we need to break up the current negative feedback loop driving decision making.
I can see my mother now, saying “What the Hell does that mean?”
First, let’s talk about inflection points. Anytime you look at a graph, the line is trending downward over time, or it is trending upwards over time. If you have a graph that shows both, the spot where the trend changes from down to up or up to down is the inflection point. The economy is trending down right now, and from the news, it is trending down pretty steeply. What the stimulus should do is reverse that trend, to get the economy growing again. That will be difficult because the downward trend is being fed by a negative feedback loop.
Here is the mechanism at work: demand is soft, so companies layoff workers. Once they are laid off, those workers cut back on their spending. Since they are not spending, demand for products and services drops further. With lower demand, more companies announce layoffs, leading to another round of reduced spending, lower demand, and more layoffs. The cycle feeds on itself. Another term for a negative feedback loop is a viscous circle.
Adding to the problem are the effects of fear. People who haven’t lost their jobs yet say “I could be next,” and cut back on their spending as well to conserve cash. This is perfectly natural (by which I mean I’m doing it too), but it steepens the decline.
In a growing economy, as demand increases, businesses hire more employees. Those new employees start spending more, increasing demand, leading to more hiring, driving spending higher, and so on. This is a positive feedback loop, also known a virtuous cycle. Once businesses increase in confidence, they start investing in capital. Capital investment both drives the cycle higher and leads to productivity improvement, bringing higher standards of living as well as more jobs.
The emphasis on turning the economy around versus merely creating jobs is critical. A goal of job creation will lead to an expansion of government payrolls. The easiest way to make sure everyone has a job is to keep hiring. But once you add government positions, it is hard to remove them. You end up with higher government costs for the long term.
An emphasis on a short term surge to kick start the private sector leaves the long term heavy lifting to the private sector. And it is the private sector which will develop the productivity improvements that will raise living standards in the long run.
There has been a steady drumbeat of bad economic news in the last few weeks, with a number of major companies, from Alcoa to Starbucks, announcing major job cuts. Both consumer and business confidence are at low ebbs. So I think a stimulus package is probably a good thing at this point. But I think there hasn’t been much discussion about the purpose behind the stimulus. Put another way, what is the stimulus intended to accomplish?
Most of the rhetoric has been about job creation. The debate has been couched in terms of what puts people back to work faster, spending or tax cuts. My perspective is that the emphasis on job creation is misplaced. As a conservative, I would argue that the purpose of government is not to guarantee everybody a job (an impossible task in any case). The major purpose of government is to safeguard our liberties, with a minor in promote the general welfare.
The purpose of the stimulus should be to create an inflection point in the general trend line of the economy. To do that, we need to break up the current negative feedback loop driving decision making.
I can see my mother now, saying “What the Hell does that mean?”
First, let’s talk about inflection points. Anytime you look at a graph, the line is trending downward over time, or it is trending upwards over time. If you have a graph that shows both, the spot where the trend changes from down to up or up to down is the inflection point. The economy is trending down right now, and from the news, it is trending down pretty steeply. What the stimulus should do is reverse that trend, to get the economy growing again. That will be difficult because the downward trend is being fed by a negative feedback loop.
Here is the mechanism at work: demand is soft, so companies layoff workers. Once they are laid off, those workers cut back on their spending. Since they are not spending, demand for products and services drops further. With lower demand, more companies announce layoffs, leading to another round of reduced spending, lower demand, and more layoffs. The cycle feeds on itself. Another term for a negative feedback loop is a viscous circle.
Adding to the problem are the effects of fear. People who haven’t lost their jobs yet say “I could be next,” and cut back on their spending as well to conserve cash. This is perfectly natural (by which I mean I’m doing it too), but it steepens the decline.
In a growing economy, as demand increases, businesses hire more employees. Those new employees start spending more, increasing demand, leading to more hiring, driving spending higher, and so on. This is a positive feedback loop, also known a virtuous cycle. Once businesses increase in confidence, they start investing in capital. Capital investment both drives the cycle higher and leads to productivity improvement, bringing higher standards of living as well as more jobs.
The emphasis on turning the economy around versus merely creating jobs is critical. A goal of job creation will lead to an expansion of government payrolls. The easiest way to make sure everyone has a job is to keep hiring. But once you add government positions, it is hard to remove them. You end up with higher government costs for the long term.
An emphasis on a short term surge to kick start the private sector leaves the long term heavy lifting to the private sector. And it is the private sector which will develop the productivity improvements that will raise living standards in the long run.
Tuesday, January 27, 2009
Ski Trip '09
I just got back from my annual ski trip this weekend. Although I live in Tennessee, I still go out with the Ski Club of Sarasota. This marked my nineteenth year of going skiing with the club. This year I went on one of the trips organized by the Florida Ski Council. The Council puts together several trips a year where all of the member clubs send a contingent. This allows the Council to pool the buying power of the various clubs, and negotiate a better deal from the ski area.
This year’s trip was to Snowmass, a resort located near Aspen.
Now, the thing about skiing is that after you schuss down the hill, you have to spend about seven to ten minutes riding the ski lift back up the hill. Since you get on the lift in the order in which you reach the bottom of the run, the people who ride up with you are a pretty random assortment of the people who are skiing that day.
It is very quiet on the lift, so I kill time by yakking with my fellow passengers. It was an interesting cross section of Americans, with more than a few Australians thrown in. A couple of quick impressions were formed:
A ski vacation to a destination resort like Snowmass is an expensive undertaking. With everything in, from airport parking and baggage charges down to the $23 cheeseburger lunch on the mountain, I dropped about $2000 per person for the trip. In tough economic times, you would expect a big ticket discretionary expense like a ski vacation to be dropped by a lot of people. Anecdotally, this appeared to be the case, as a number of my fellow travelers noted the complete lack of lift lines. This was confirmed by one property manager I rode up with, as he told me bookings in the properties he managed were off by over 30%.
Counterintuitively, this same property manager told me that some of the owners he represented were turning down low-ball offers to rent houses. These owners would turn down valid offers at below the listed rental rate, preferring to take themselves out of the market before they cut their price. I can only conclude that represents either A) a failed negotiation: the owners who turned down the offer will wish they had accepted it when no other offers come along; or B) the owners do not care if their property is drawing an income or not.
Since houses in the Aspen area sell for millions of dollars, proposition B supposes that there is a significant population of owners who can afford to park millions of dollars of equity into property that they only use a few weeks out of the year.
I’m in the wrong line of work!
This year’s trip was to Snowmass, a resort located near Aspen.
Now, the thing about skiing is that after you schuss down the hill, you have to spend about seven to ten minutes riding the ski lift back up the hill. Since you get on the lift in the order in which you reach the bottom of the run, the people who ride up with you are a pretty random assortment of the people who are skiing that day.
It is very quiet on the lift, so I kill time by yakking with my fellow passengers. It was an interesting cross section of Americans, with more than a few Australians thrown in. A couple of quick impressions were formed:
A ski vacation to a destination resort like Snowmass is an expensive undertaking. With everything in, from airport parking and baggage charges down to the $23 cheeseburger lunch on the mountain, I dropped about $2000 per person for the trip. In tough economic times, you would expect a big ticket discretionary expense like a ski vacation to be dropped by a lot of people. Anecdotally, this appeared to be the case, as a number of my fellow travelers noted the complete lack of lift lines. This was confirmed by one property manager I rode up with, as he told me bookings in the properties he managed were off by over 30%.
Counterintuitively, this same property manager told me that some of the owners he represented were turning down low-ball offers to rent houses. These owners would turn down valid offers at below the listed rental rate, preferring to take themselves out of the market before they cut their price. I can only conclude that represents either A) a failed negotiation: the owners who turned down the offer will wish they had accepted it when no other offers come along; or B) the owners do not care if their property is drawing an income or not.
Since houses in the Aspen area sell for millions of dollars, proposition B supposes that there is a significant population of owners who can afford to park millions of dollars of equity into property that they only use a few weeks out of the year.
I’m in the wrong line of work!
Thursday, January 15, 2009
"Who is this guy FICA..."
Timothy Geithner, the president of the Federal Reserve Bank of New York, is Barack Obama’s nominee to become the next Treasury Secretary, i.e., the guy who hands out all the fat checks of bailout money. During his confirmation hearings, it has come to light that he filed his taxes improperly for three years running, and had to pay a bunch of back taxes. With interest.
Here’s what happened: In 2001, 2002, and 2003, Geithner was employed by the International Monetary Fund. Because the IMF is an international organization, they do not collect Social Security and Medicare taxes from their US employees (I remember the Friends episode where Rachel got her first paycheck ever: “Who is this guy FICA, and why does he get so much of my money”).
Now, the US employees of international organizations such as the IMF are not exempted from Social Security and Medicare taxes. Instead, even though the employees get a W-2, they also have to pay self employment taxes. That tax rate is about 15%, because the employee pays both halves: the half that is normally withheld from a paycheck, and the half that the employer normally pays without reporting it on the pay stub.
I remember the first time my wife took a foray into owning her own business, and encountered this self employment tax. Wife (in tears): “I worked so hard for that money. Now I have to pay 15%, plus more for income taxes? I don’t think it’s fair for the government to get so much of my money.” Husband: “Welcome to the Republican Party, my love.” But I digress.
Apparently, Mr. Geithner failed to report this self employment tax for those three years (plus a small portion of 2004, but who’s counting?). He did his taxes himself for 2001, and then used an accountant for 2002 and 2003 tax years. This oddity of being an employee, but still having to pay self employment taxes, only hits a few people. So it is perhaps understandable that both he and his accountant missed it. When the IRS caught up with him, he ‘fessed up and paid a settlement. No harm, no foul, right? Anybody can make a mistake, right?
Except that there are a couple of things that stand out in this situation.
First of all, the Treasury Secretary oversees the Internal Revenue Service. Shouldn’t the guy overseeing tax collection be able to, oh, I don’t know, do his own taxes without screwing it up?
Secondly, it turns out that the people who run the payroll at the IMF do know about this self employment tax loophole. For the US employees who have to pay the self employment tax, they add money to your salary to cover the 7.5% that the employer normally pays. The practice is called “grossing up,” as in they increase your gross pay by 7.5%.
Where it gets really interesting is that the gross up pay is paid out quarterly. So this raises the question: what did Geithner think those extra payments were for? Good behavior?
Think back sixteen years. When Bill Clinton was elected, his first pick for Attorney General was Zoe Baird. Ms. Baird, a high powered corporate attorney of considerable experience, was torpedoed when it came to light during the confirmation process that she had used an undocumented immigrant as household staff for several years, and that she had failed to pay the proper taxes for her employee. It was felt that the most senior law enforcement official in the US shouldn’t be someone who had broken the law.
Sixteen years later, a completely different political climate reigns. Mr. Geithner is almost certainly going to sail on to confirmation in the Senate. Still, it makes me wonder. How many other US employees of the IMF have gotten their taxes wrong this way?
Here’s what happened: In 2001, 2002, and 2003, Geithner was employed by the International Monetary Fund. Because the IMF is an international organization, they do not collect Social Security and Medicare taxes from their US employees (I remember the Friends episode where Rachel got her first paycheck ever: “Who is this guy FICA, and why does he get so much of my money”).
Now, the US employees of international organizations such as the IMF are not exempted from Social Security and Medicare taxes. Instead, even though the employees get a W-2, they also have to pay self employment taxes. That tax rate is about 15%, because the employee pays both halves: the half that is normally withheld from a paycheck, and the half that the employer normally pays without reporting it on the pay stub.
I remember the first time my wife took a foray into owning her own business, and encountered this self employment tax. Wife (in tears): “I worked so hard for that money. Now I have to pay 15%, plus more for income taxes? I don’t think it’s fair for the government to get so much of my money.” Husband: “Welcome to the Republican Party, my love.” But I digress.
Apparently, Mr. Geithner failed to report this self employment tax for those three years (plus a small portion of 2004, but who’s counting?). He did his taxes himself for 2001, and then used an accountant for 2002 and 2003 tax years. This oddity of being an employee, but still having to pay self employment taxes, only hits a few people. So it is perhaps understandable that both he and his accountant missed it. When the IRS caught up with him, he ‘fessed up and paid a settlement. No harm, no foul, right? Anybody can make a mistake, right?
Except that there are a couple of things that stand out in this situation.
First of all, the Treasury Secretary oversees the Internal Revenue Service. Shouldn’t the guy overseeing tax collection be able to, oh, I don’t know, do his own taxes without screwing it up?
Secondly, it turns out that the people who run the payroll at the IMF do know about this self employment tax loophole. For the US employees who have to pay the self employment tax, they add money to your salary to cover the 7.5% that the employer normally pays. The practice is called “grossing up,” as in they increase your gross pay by 7.5%.
Where it gets really interesting is that the gross up pay is paid out quarterly. So this raises the question: what did Geithner think those extra payments were for? Good behavior?
Think back sixteen years. When Bill Clinton was elected, his first pick for Attorney General was Zoe Baird. Ms. Baird, a high powered corporate attorney of considerable experience, was torpedoed when it came to light during the confirmation process that she had used an undocumented immigrant as household staff for several years, and that she had failed to pay the proper taxes for her employee. It was felt that the most senior law enforcement official in the US shouldn’t be someone who had broken the law.
Sixteen years later, a completely different political climate reigns. Mr. Geithner is almost certainly going to sail on to confirmation in the Senate. Still, it makes me wonder. How many other US employees of the IMF have gotten their taxes wrong this way?
Monday, January 12, 2009
Bernie Madoff's Victims
I’ve been reading a lot about Bernie Madoff in the news recently. Bernie is the Wall Street financier who has owned a securities trading firm for four decades. He was one of the pioneers of electronic trading, and was actually president of the NASDAQ organization for a couple of years. As a market maker, he was one of the most respected members of the Wall Street finance community.
He also ran a money management firm, noted for taking cash from wealthy individuals and other money management firms and producing consistent, steady returns of 1% to 2% a month.
Except that it now appears that Bernie wasn’t actually investing the money he was given. He was making up the posted gains, and using the money new investors gave him to pay cash distributions to older investors. A Ponzi scheme. The biggest, longest lasting Ponzi scheme in history.
So now I am reading stories from people who lost everything from a couple of hundred thousand dollars to a couple of million dollars up to institutions that have lost billions of dollars. Estimates of total losses have run as high as $50 billion dollars.
But here’s what I want to know: Can you truly lose money that you never had? For example, I read one account of an investor who put $25,000 into a fund that invested with Madoff in 1992. Even though the investor pulled out cash distributions every year, his investment had grown to $150,000. In his account, the investor said he had lost all $150,000.
The thing is, the investor never had $150,000. He only thought he had that much because Madoff told him he had that much. The most he ever had at risk was the original $25,000, and he had probably gotten most of that back in distributions over the years. So what is the true loss?
A Ponzi scheme is essentially a zero sum game. A zero sum game is one where the winnings of some of the players are offset by the losses of the other players. The individual running the scheme, in this case, Bernie Madoff, takes a cut off the top. Madoff’s skim, however, appears to be miniscule compared with the sums invested. I mean, the guy lived well, but not that well.
When all the forensic accounting is completed, the losses of later investors are going to be balanced with the gains of the earlier investors. And once that accounting is done, the losers are going to hire lawyers and try and get their money back from the winners.
Thousands of plaintiffs and defendants, all using lawyers to fight over money. Now that’s not a zero sum game. That’s a negative sum game.
Except for the lawyers.
He also ran a money management firm, noted for taking cash from wealthy individuals and other money management firms and producing consistent, steady returns of 1% to 2% a month.
Except that it now appears that Bernie wasn’t actually investing the money he was given. He was making up the posted gains, and using the money new investors gave him to pay cash distributions to older investors. A Ponzi scheme. The biggest, longest lasting Ponzi scheme in history.
So now I am reading stories from people who lost everything from a couple of hundred thousand dollars to a couple of million dollars up to institutions that have lost billions of dollars. Estimates of total losses have run as high as $50 billion dollars.
But here’s what I want to know: Can you truly lose money that you never had? For example, I read one account of an investor who put $25,000 into a fund that invested with Madoff in 1992. Even though the investor pulled out cash distributions every year, his investment had grown to $150,000. In his account, the investor said he had lost all $150,000.
The thing is, the investor never had $150,000. He only thought he had that much because Madoff told him he had that much. The most he ever had at risk was the original $25,000, and he had probably gotten most of that back in distributions over the years. So what is the true loss?
A Ponzi scheme is essentially a zero sum game. A zero sum game is one where the winnings of some of the players are offset by the losses of the other players. The individual running the scheme, in this case, Bernie Madoff, takes a cut off the top. Madoff’s skim, however, appears to be miniscule compared with the sums invested. I mean, the guy lived well, but not that well.
When all the forensic accounting is completed, the losses of later investors are going to be balanced with the gains of the earlier investors. And once that accounting is done, the losers are going to hire lawyers and try and get their money back from the winners.
Thousands of plaintiffs and defendants, all using lawyers to fight over money. Now that’s not a zero sum game. That’s a negative sum game.
Except for the lawyers.
Thursday, January 8, 2009
Happy New Year, Part II
In my last post I discussed the theme of deleveraging for 2009. By deleveraging, I mean reducing the ratio of debt to equity on both household and corporate balance sheets.
There are a number of ways an individual household can reduce leverage. Probably the most painful is to have your house foreclosed on. Since a home mortgage is typically the largest source of debt for a family, losing your home means losing most of your debt all at once. Not recommended, but if your mortgage payment is greater than market rent, moving into a rental will free up your cash flow.
A bankruptcy is less effective at reducing leverage than foreclosure. Most states protect your home equity during a bankruptcy filing. You can drop most of your credit card payments, but you still have the debt associated with your mortgage. Foreclosure and bankruptcy have got to be the two most painful ways of deleveraging.
The least painful way to reduce debt is to reduce current consumption and divert more of your cash flow into paying off debt. Whether paying off credit cards or making extra equity payments on a mortgage, either way you are reducing household debt.
Actually, it may be even less painful to increase income and put that extra money into debt retirement. Start up a sideline business or get a part-time second job. But in today’s market, those options may not be as readily available as they were even a year ago.
In the struggle to pay off debt, there are two schools of thought on which debts to pay of first. One school holds that the best idea is to focus most of your effort into paying down the debts with the highest interest rates. That way you lower the burden of finance charges faster. The other school of thought is to pay down the smallest debts first. This technique gives you small victories as you eliminate one debt after another.
Whichever technique you use, I’m more interested in the timing of the payoffs. Unless you are paying truly outrageous interest rates, the best response to an uncertain employment outlook is to build your cash position with additional savings.
Consider: both foreclosure and bankruptcy are not a function of the amount of debt carried. They are a function of cash flow. If you do not have enough cash to make all of your payments every month, you start to fall behind. It is the inability to make payments that drives people into bankruptcy. Exacerbating this is that most lenders pile on late fees and higher finance charges once you have late or missing payments.
Let’s say you are doubling up on the equity payment on your mortgage, and have been for years. The extra equity payments have shortened the term of the mortgage. You will pay it off in 15 years instead of 30. In the meantime, however, you have to keep making your payment every month.
Now you lose your job. If all your extra cash went towards paying down the mortgage, and you don’t have a substantial cushion, you are one month away from being delinquent on your mortgage. The fact that you made all those extra payments won’t cut any ice with the bank. They still want their payment every month.
So my plan is to continue making all my payments every month while I increase my cash reserve. Once I have enough extra money put away to extinguish a debt like a car loan, then I’ll pay it off all at once. It will require more discipline to hold onto the cash, rather than funneling the money directly to the lenders on a month by month basis. I may have to pay more in finance charges. But I’ll sleep better at night knowing I have the ability to ride out any unforeseen financial storms.
In a world of rising unemployment and falling real estate values, cash really is king.
There are a number of ways an individual household can reduce leverage. Probably the most painful is to have your house foreclosed on. Since a home mortgage is typically the largest source of debt for a family, losing your home means losing most of your debt all at once. Not recommended, but if your mortgage payment is greater than market rent, moving into a rental will free up your cash flow.
A bankruptcy is less effective at reducing leverage than foreclosure. Most states protect your home equity during a bankruptcy filing. You can drop most of your credit card payments, but you still have the debt associated with your mortgage. Foreclosure and bankruptcy have got to be the two most painful ways of deleveraging.
The least painful way to reduce debt is to reduce current consumption and divert more of your cash flow into paying off debt. Whether paying off credit cards or making extra equity payments on a mortgage, either way you are reducing household debt.
Actually, it may be even less painful to increase income and put that extra money into debt retirement. Start up a sideline business or get a part-time second job. But in today’s market, those options may not be as readily available as they were even a year ago.
In the struggle to pay off debt, there are two schools of thought on which debts to pay of first. One school holds that the best idea is to focus most of your effort into paying down the debts with the highest interest rates. That way you lower the burden of finance charges faster. The other school of thought is to pay down the smallest debts first. This technique gives you small victories as you eliminate one debt after another.
Whichever technique you use, I’m more interested in the timing of the payoffs. Unless you are paying truly outrageous interest rates, the best response to an uncertain employment outlook is to build your cash position with additional savings.
Consider: both foreclosure and bankruptcy are not a function of the amount of debt carried. They are a function of cash flow. If you do not have enough cash to make all of your payments every month, you start to fall behind. It is the inability to make payments that drives people into bankruptcy. Exacerbating this is that most lenders pile on late fees and higher finance charges once you have late or missing payments.
Let’s say you are doubling up on the equity payment on your mortgage, and have been for years. The extra equity payments have shortened the term of the mortgage. You will pay it off in 15 years instead of 30. In the meantime, however, you have to keep making your payment every month.
Now you lose your job. If all your extra cash went towards paying down the mortgage, and you don’t have a substantial cushion, you are one month away from being delinquent on your mortgage. The fact that you made all those extra payments won’t cut any ice with the bank. They still want their payment every month.
So my plan is to continue making all my payments every month while I increase my cash reserve. Once I have enough extra money put away to extinguish a debt like a car loan, then I’ll pay it off all at once. It will require more discipline to hold onto the cash, rather than funneling the money directly to the lenders on a month by month basis. I may have to pay more in finance charges. But I’ll sleep better at night knowing I have the ability to ride out any unforeseen financial storms.
In a world of rising unemployment and falling real estate values, cash really is king.
Saturday, January 3, 2009
Happy New Year!
At the beginning of the New Year, I like many others, make resolutions for the coming twelve months. Sometimes these resolutions actually come to fruition (2008: start a blog), sometimes the hard realities of December bear no resemblance to the wishful thinking of January (2008: increase the value of my portfolio by 15%). Nonetheless, I find value in the exercise of goal setting. It helps define my priorities for the coming year.
Sometimes as you take stock at the end of one year, and you review progress against your goals, it becomes an exercise in shoulda, woulda, coulda. For example, I sure wish I'd gotten 100% into cash in the first half of 2008. Ah well. I'll just keep telling myself that I'm investing for the long haul. That makes it feel okay. Really, it does.
Anyway, I've decided that my financial theme for 2009 is deleverageing. My spell check doesn't like the term, so maybe deleverageing isn't in the dictionary yet. By the term the current financial crisis is in the history books, it will be.
In financial terms, leverage is a way of expressing the ratio of debt to equity. For example, if you buy a house with a 20% down payment, and take out a mortgage for the other 80%, you have leveraged your equity four to one. As you make your mortgage payments, your reduce the leverage as you build equity. This happens very slowly in the first years of the mortgage, than picks up speed as a larger and larger percentage of your mortgage payment is focused on paying down the principle balance.
The current crisis in the financial markets was brought on by excessive leverage during the housing bubble, both by consumers and institutions. Consumers bought houses with no money down (essentially infinite leverage), or they extracted all of the equity from their houses through home equity lines of credit. After all, if the value of housing had kept going up, they would have created equity out of thin air. Why not borrow against that? It seemed like a good idea at the time.
On the institutional side, banks were dumb enough to make those loans. The investment banks on Wall Street were dumb enough to repackage those loans and resell them, and institutional investors like insurance companies and pension funds were dumb enough to buy them. After all, if the home owners stopped paying their mortgages, the collateral (the houses) would be worth more than the original loans. Why not loan against that? It seemed like a good idea at the time.
It seemed like such a good idea that the Wall Street investment banks borrowed hundreds of billions of dollars to amplify the returns on the firm's capital. After all, bonuses were paid based on returns on capital. These guys were capitalists, says so right on the brochure. So when the housing market started to turn downward, a lot of the banks and investment banks were highly leveraged, 20 to 1 or even 30 to 1.
The upside of leverage is that when you are making gains, those gains are amplified by the amount of leverage. The downside of leverage is that when you are taking losses, the losses hit your capital by the same degree that gains boost it. So if you are leveraged 20 to 1, that means you have 20 dollars of debt for every dollar of equity. A 5% loss on the value of your assets is enough wipe out your equity.
Picture a bank holding most of it's assets in residential mortages. Foreclosure rates have more than doubled since 2007, and housing prices have dropped an average of 18% in the last year. Banks are taking losses of way more than 5% on their loan portfolios. When your debt is greater than the combination of your assets and your equity, that is the technical definition of insolvency, also known as bankruptcy. Ouch.
Financial institutions have spent the last year trying to raise capital, either by selling shares of preferred stock or by selling assets or by raising cash by cutting expenses like dividend payments. If leverage is the ratio of debt to equity, having more capital lowers leverage. For consumers, leverage is also being reduced. When you mail the keys to your house back to the bank, and move into a rental, you have reduced your personal leverage by the amount of your mortgage loan.
The bottom line is that when you reduce debt, you deleverage your financial position. So the process of reducing debt is deleverageing, however you spell it.
The thing about deleverageing is that it is a lot less painful when you do it willingly, before circumstances force you into it. It is a lot easier to tighten one's belt and build your rainy day fund, than it is to deal with foreclosure, or even escalating late payments because you missed a credit card payment.
Having established the theme of deleverageing for 2009, the next question is whether it is better to pay down debt or build up cash. I'll take up that issue in another post.
Sometimes as you take stock at the end of one year, and you review progress against your goals, it becomes an exercise in shoulda, woulda, coulda. For example, I sure wish I'd gotten 100% into cash in the first half of 2008. Ah well. I'll just keep telling myself that I'm investing for the long haul. That makes it feel okay. Really, it does.
Anyway, I've decided that my financial theme for 2009 is deleverageing. My spell check doesn't like the term, so maybe deleverageing isn't in the dictionary yet. By the term the current financial crisis is in the history books, it will be.
In financial terms, leverage is a way of expressing the ratio of debt to equity. For example, if you buy a house with a 20% down payment, and take out a mortgage for the other 80%, you have leveraged your equity four to one. As you make your mortgage payments, your reduce the leverage as you build equity. This happens very slowly in the first years of the mortgage, than picks up speed as a larger and larger percentage of your mortgage payment is focused on paying down the principle balance.
The current crisis in the financial markets was brought on by excessive leverage during the housing bubble, both by consumers and institutions. Consumers bought houses with no money down (essentially infinite leverage), or they extracted all of the equity from their houses through home equity lines of credit. After all, if the value of housing had kept going up, they would have created equity out of thin air. Why not borrow against that? It seemed like a good idea at the time.
On the institutional side, banks were dumb enough to make those loans. The investment banks on Wall Street were dumb enough to repackage those loans and resell them, and institutional investors like insurance companies and pension funds were dumb enough to buy them. After all, if the home owners stopped paying their mortgages, the collateral (the houses) would be worth more than the original loans. Why not loan against that? It seemed like a good idea at the time.
It seemed like such a good idea that the Wall Street investment banks borrowed hundreds of billions of dollars to amplify the returns on the firm's capital. After all, bonuses were paid based on returns on capital. These guys were capitalists, says so right on the brochure. So when the housing market started to turn downward, a lot of the banks and investment banks were highly leveraged, 20 to 1 or even 30 to 1.
The upside of leverage is that when you are making gains, those gains are amplified by the amount of leverage. The downside of leverage is that when you are taking losses, the losses hit your capital by the same degree that gains boost it. So if you are leveraged 20 to 1, that means you have 20 dollars of debt for every dollar of equity. A 5% loss on the value of your assets is enough wipe out your equity.
Picture a bank holding most of it's assets in residential mortages. Foreclosure rates have more than doubled since 2007, and housing prices have dropped an average of 18% in the last year. Banks are taking losses of way more than 5% on their loan portfolios. When your debt is greater than the combination of your assets and your equity, that is the technical definition of insolvency, also known as bankruptcy. Ouch.
Financial institutions have spent the last year trying to raise capital, either by selling shares of preferred stock or by selling assets or by raising cash by cutting expenses like dividend payments. If leverage is the ratio of debt to equity, having more capital lowers leverage. For consumers, leverage is also being reduced. When you mail the keys to your house back to the bank, and move into a rental, you have reduced your personal leverage by the amount of your mortgage loan.
The bottom line is that when you reduce debt, you deleverage your financial position. So the process of reducing debt is deleverageing, however you spell it.
The thing about deleverageing is that it is a lot less painful when you do it willingly, before circumstances force you into it. It is a lot easier to tighten one's belt and build your rainy day fund, than it is to deal with foreclosure, or even escalating late payments because you missed a credit card payment.
Having established the theme of deleverageing for 2009, the next question is whether it is better to pay down debt or build up cash. I'll take up that issue in another post.
Monday, December 29, 2008
The Joy of Christmas Past
You don’t have to be much of a curmudgeon to appreciate the pleasures that come with the end of the Christmas season on December 26. The palpable slowing down of pace after the last minute frenzy of gift buying, wrapping, and delivering. The slackening of traffic on the roads, combined with the ability to get a parking spot at the mall. The chance to rest up after the round of Christmas festivities, and gather strength for the onslaught of New Year’s Eve. But for me, this year, there is one special blessing, post holiday.
They’ve stopped playing “Christmas Shoes” on the radio.
You know the song. It’s the one about the guy who’s in the store when he sees a little kid who needs money to buy a pair of shoes for his dying mother. The poor sap rediscovers the true meaning of Christmas when he forks over the dough for the kid to get the shoes. Just in case you forgot, here are the lyrics to the refrain.
“Sir I wanna buy these shoes for my Momma please
It's Christmas Eve and these shoes are just her size
Could you hurry Sir?
Daddy says there's not much time
You see, she's been sick for quite a while
And I know these shoes will make her smile
And I want her to look beautiful
If Momma meets Jesus, tonight.”
What a batch of hooey! What a load of hogwash! The pathetic absurdities of this song beggar the imagination. Consider the baloney you’re being asked to accept when you listen to this load of rubbish.
First, the kid knows his mother’s shoe size. What? I don’t know my mother’s shoe size, and I’ll bet you don’t either. Hellfire, I was well into my twenties before I could have reliably stated that my mom had feet. It just never entered my consciousness.
Second, what kind of shoes are these? Jimmy Choo’s? Manolo Blahnik’s? I mean, seriously, what kind of little kid pays attention to shoe fashion? The only reason I know those names is from watching “Sex and the City” reruns on cable, and I had to Google the names to get the spelling right.
Third, the song posits that what a dying woman wants most before she passes away is a new pair of shoes. Now, you usually can’t go wrong betting on the shallowness and materialism of the American consumer, but the woman is going to die, for cripe’s sake! If I was dying, that sure wouldn’t be the top of my Christmas list. A miracle cure, that’s what I want Santa to drop down my chimney. Or maybe just more morphine to keep the pain pump fully stocked up. But shoes?
What kind of store is this, anyway? Probably a department store, because the narrator isn’t there to buy shoes, he is just there to “pick up a few things.” That raises another question. The kid is described as “dirty from head to toe.” In most upscale stores, the staff wouldn’t let a dirty street urchin wander around, pawing through the merchandise and panhandling from the customers to pay for shoes. The staff would call security, assuming they didn’t just give the kid the bum’s rush on their own. I can picture the response when the kid first walked into the store: “Hey, kid, keep your grubby hands off. That’s cashmere!”
Here’s my theory: the kid and the salesclerk are running a scam. The store overstocked on cheap Chinese knockoffs of designer shoes. The kid spots a mark, turns on the waterworks, and the sucker pays for them. The suddenly overjoyed scamster goes out the front door, and comes around and in through the back door, ready to resell the same pair of shoes with the next mark to walk in. Meanwhile, the clerk cleans up on commissions. Hellfire, the clerk is probably the kid’s real mother! They probably share a good horse laugh over the suckers they rooked when they get home.
Cheating sentimental saps, all in the service of pure commercialism. There’s a Christmas anthem for you. At least we’re all done with that now. That song is off the playlists.
At least until next year.
They’ve stopped playing “Christmas Shoes” on the radio.
You know the song. It’s the one about the guy who’s in the store when he sees a little kid who needs money to buy a pair of shoes for his dying mother. The poor sap rediscovers the true meaning of Christmas when he forks over the dough for the kid to get the shoes. Just in case you forgot, here are the lyrics to the refrain.
“Sir I wanna buy these shoes for my Momma please
It's Christmas Eve and these shoes are just her size
Could you hurry Sir?
Daddy says there's not much time
You see, she's been sick for quite a while
And I know these shoes will make her smile
And I want her to look beautiful
If Momma meets Jesus, tonight.”
What a batch of hooey! What a load of hogwash! The pathetic absurdities of this song beggar the imagination. Consider the baloney you’re being asked to accept when you listen to this load of rubbish.
First, the kid knows his mother’s shoe size. What? I don’t know my mother’s shoe size, and I’ll bet you don’t either. Hellfire, I was well into my twenties before I could have reliably stated that my mom had feet. It just never entered my consciousness.
Second, what kind of shoes are these? Jimmy Choo’s? Manolo Blahnik’s? I mean, seriously, what kind of little kid pays attention to shoe fashion? The only reason I know those names is from watching “Sex and the City” reruns on cable, and I had to Google the names to get the spelling right.
Third, the song posits that what a dying woman wants most before she passes away is a new pair of shoes. Now, you usually can’t go wrong betting on the shallowness and materialism of the American consumer, but the woman is going to die, for cripe’s sake! If I was dying, that sure wouldn’t be the top of my Christmas list. A miracle cure, that’s what I want Santa to drop down my chimney. Or maybe just more morphine to keep the pain pump fully stocked up. But shoes?
What kind of store is this, anyway? Probably a department store, because the narrator isn’t there to buy shoes, he is just there to “pick up a few things.” That raises another question. The kid is described as “dirty from head to toe.” In most upscale stores, the staff wouldn’t let a dirty street urchin wander around, pawing through the merchandise and panhandling from the customers to pay for shoes. The staff would call security, assuming they didn’t just give the kid the bum’s rush on their own. I can picture the response when the kid first walked into the store: “Hey, kid, keep your grubby hands off. That’s cashmere!”
Here’s my theory: the kid and the salesclerk are running a scam. The store overstocked on cheap Chinese knockoffs of designer shoes. The kid spots a mark, turns on the waterworks, and the sucker pays for them. The suddenly overjoyed scamster goes out the front door, and comes around and in through the back door, ready to resell the same pair of shoes with the next mark to walk in. Meanwhile, the clerk cleans up on commissions. Hellfire, the clerk is probably the kid’s real mother! They probably share a good horse laugh over the suckers they rooked when they get home.
Cheating sentimental saps, all in the service of pure commercialism. There’s a Christmas anthem for you. At least we’re all done with that now. That song is off the playlists.
At least until next year.
Wednesday, December 17, 2008
Closing Down
Chrysler has announced that starting tomorrow, they are closing all thirty of their manufacturing sites for a month. This is being billed as a cash conserving move on their part. This is being treated as a major news story, getting coverage on the networks and all the major newspapers. Of course, I have a reaction to this story. Ready? Wait for it.
Big, fat, hairy deal. Do they want us to think that this is a last ditch effort to save the company, because they didn't get their Federal bailout check?
My company shut down operations for the entire week of Thanksgiving. We came back to work on December 1, worked production until December 9, then closed up and sent the production associates home until January 5. Our maintenance crews are going home at the end of this week, and they'll be off for two weeks. So between November and December, we've taken four weeks off, just like Chrysler. We're doing this because orders are down, and you cannot keep building product when your customers aren't buying, just like Chrysler.
The difference is that we didn't issue a press release just because we are closing down for inventory reduction at the end of the year. We would rather be running production, but in today's environment, it is just a sound business decision, to cut production to balance inventories. You don't see us threatening the economy of Tennesse with collapse if we don't get a bailout.
In their campaign to get hold of Federal bailout money, the domestic car companies and the UAW have consistently presented the worst case scenario to support their claim on Federal money. "If you don't give us $30 billion, RIGHT NOW, we are going bankrupt, one out of every five Americans will be unemployed, and a new Great Depression will sweep the country."
It is the industrial equivalent of extortion. And it's getting old.
Big, fat, hairy deal. Do they want us to think that this is a last ditch effort to save the company, because they didn't get their Federal bailout check?
My company shut down operations for the entire week of Thanksgiving. We came back to work on December 1, worked production until December 9, then closed up and sent the production associates home until January 5. Our maintenance crews are going home at the end of this week, and they'll be off for two weeks. So between November and December, we've taken four weeks off, just like Chrysler. We're doing this because orders are down, and you cannot keep building product when your customers aren't buying, just like Chrysler.
The difference is that we didn't issue a press release just because we are closing down for inventory reduction at the end of the year. We would rather be running production, but in today's environment, it is just a sound business decision, to cut production to balance inventories. You don't see us threatening the economy of Tennesse with collapse if we don't get a bailout.
In their campaign to get hold of Federal bailout money, the domestic car companies and the UAW have consistently presented the worst case scenario to support their claim on Federal money. "If you don't give us $30 billion, RIGHT NOW, we are going bankrupt, one out of every five Americans will be unemployed, and a new Great Depression will sweep the country."
It is the industrial equivalent of extortion. And it's getting old.
Monday, December 15, 2008
Investment Scam of the Year
The latest shock to come out of the financial industry on Wall Street is the Bernie Madoff scandal. Mr. Madoff has been involved in Wall Street business for almost fifty years. He was the head of NASDAQ for several years, and his securities firm occupies three floors of a downtown skyscraper.
The primary business of his firm was to act as a market maker, taking orders to buy and sell a number of stocks. However, he also ran an investment advisory firm, taking in money and investing it for people and institutions. At the beginning of the year this arm of his business reported holding $17 billion in other people’s money.
It now appears that the investment advisory part of his business was actually running like a giant Ponzi scheme, where the money that new investors put in was used to pay dividends to older investors. Hit by requests for $7 billion in redemptions by investors this quarter, the house of cards came tumbling down. Mr. Madoff’s own estimate of total losses to investors was $50 billion.
This is an amazing story, and it is only starting to unfold. From what little has been revealed so far, several aspects of the situation boggle the mind.
First, how did one guy pull this off? From all reports, only a couple of dozen people worked on the floor of the building where the investment firm was located. Most of the employees were on the two floors where the legitimate business was located. How did Mr. Madoff handle the mundane details like keeping everyone’s theoretical balance straight, or mailing out statements and dividend checks? Normally, managing billions of dollars takes hundreds of people. Of course, it is a lot easier when you aren’t actually managing the money. Still, the logistical details of a fraud this size must be daunting.
How do we know that Mr. Madoff was acting alone? Because he says so. At this point, if Bernie Madoff said the sun came up this morning, I would have to look out the window to check. I suspect this morality play has more villains than just Mr. Madoff.
The other astonishing part of this story is the victims of the scam. Some of the investors were relatively wealthy individuals who were taken in, and are now ruined. Mr. Madoff’s reputation and longevity, as well as his charm, had to help in duping his victims. But the big money came from other Wall Street investment firms, as well as a slew of international banks. How did these guys fall asleep at the switch?
It apparently never crossed their collective mind that Madoff was scamming them. I can just picture the due diligence meeting. “Bernie? Bernie Madoff? I’ve known the guy for years. We take steam together down at the club. Twice a week, regular as clockwork. He says he needs another billion? So send him a check. Electronic transfer would be even better.”
Then again, these were some of the same sharp guys who were buying subprime mortgages up until a year ago, so I guess we shouldn’t be too surprised that they got taken.
I’m sure that the “Law and Order” screenwriters are already working on a “ripped from the headlines” story.
The primary business of his firm was to act as a market maker, taking orders to buy and sell a number of stocks. However, he also ran an investment advisory firm, taking in money and investing it for people and institutions. At the beginning of the year this arm of his business reported holding $17 billion in other people’s money.
It now appears that the investment advisory part of his business was actually running like a giant Ponzi scheme, where the money that new investors put in was used to pay dividends to older investors. Hit by requests for $7 billion in redemptions by investors this quarter, the house of cards came tumbling down. Mr. Madoff’s own estimate of total losses to investors was $50 billion.
This is an amazing story, and it is only starting to unfold. From what little has been revealed so far, several aspects of the situation boggle the mind.
First, how did one guy pull this off? From all reports, only a couple of dozen people worked on the floor of the building where the investment firm was located. Most of the employees were on the two floors where the legitimate business was located. How did Mr. Madoff handle the mundane details like keeping everyone’s theoretical balance straight, or mailing out statements and dividend checks? Normally, managing billions of dollars takes hundreds of people. Of course, it is a lot easier when you aren’t actually managing the money. Still, the logistical details of a fraud this size must be daunting.
How do we know that Mr. Madoff was acting alone? Because he says so. At this point, if Bernie Madoff said the sun came up this morning, I would have to look out the window to check. I suspect this morality play has more villains than just Mr. Madoff.
The other astonishing part of this story is the victims of the scam. Some of the investors were relatively wealthy individuals who were taken in, and are now ruined. Mr. Madoff’s reputation and longevity, as well as his charm, had to help in duping his victims. But the big money came from other Wall Street investment firms, as well as a slew of international banks. How did these guys fall asleep at the switch?
It apparently never crossed their collective mind that Madoff was scamming them. I can just picture the due diligence meeting. “Bernie? Bernie Madoff? I’ve known the guy for years. We take steam together down at the club. Twice a week, regular as clockwork. He says he needs another billion? So send him a check. Electronic transfer would be even better.”
Then again, these were some of the same sharp guys who were buying subprime mortgages up until a year ago, so I guess we shouldn’t be too surprised that they got taken.
I’m sure that the “Law and Order” screenwriters are already working on a “ripped from the headlines” story.
Sunday, December 7, 2008
The 5% Solution
As part of the news coverage concerning the Federal bailout of the Big 3 domestic automakers, I have seen stories about how the president of the United Auto Workers, Ron Gettelfinger, has been meeting with other leaders of the union to discuss how labor is going to have to put some cost saving ideas on the table to help the Big 3 avoid bankruptcy. Obviously, it is the union's interest to avoid a Chapter 11 filing, because a bankruptcy trustee could unilaterally make changes to union contracts to preserve the value of the business for the creditors. It's better to volunteer givebacks before they are imposed upon you.
First and foremost should be the Jobs Bank. That is the part of the contract that says laid off UAW workers get to receive 95% of their hourly pay and full benefits while waiting for another job position to open up. Since the domestic manufacturers have been cutting headcount for years, the new job positions never do open up. The UAW members merely collect full wages and benefits, while doing no work for the company. The Jobs Bank has been bleeding the car companies for years now. The union says that the Jobs Bank is not that much of a problem, since there are only about 3500 employees currently in the program.
Only 3500! Wages and benefits for the average Big 3 autoworker are $75 per hour (compared to $45 per hour for Japanese transplants like Toyota and Honda). Simple math tells us that $75/hour times 1800 hours/year time 3500 equals $472 million dollars a year in potential savings. Now I've gotten kind of numb from listening to all the big numbers thrown from all of the different Federal bailouts so far this year, but $472 million sounds like a lot of money to me.
But I've got another idea for changing the UAW contract with the domestic automakers. This won't help stave off bankruptcy in the short term, but in the long run could help them regain some of their lost competitiveness. I call it the 5% solution.
The concept is simple, change the contract to allow management to fire up to 5% of the UAW workers every year, no questions asked. That means no seniority, no grievances filed, no arbitration. Management would have to follow Federal law, which prevents firing people based on their membership in a protected class (race, gender, age, etc.). Other than that, pull whoever you want and give them the boot. Management would not be required to exercise this right, they would merely have the option.
In Right to Work states, employment law features a doctrine known as employment at will. Employment at will assumes that the work relationship is mutually agreed upon, and that either party has reciprical rights to terminate that relationship at any time. Simply put, you can tell the boss to take this job and shove it. The boss can give you the boot. All I'm proposing is to apply this doctrine to the UAW contracts, subject to a limit of 5%.
Consider the effect this change would have. As things stand now, to terminate a union worker requires cause, and proving cause requires evidence that will stand up in a legal proceeding. Being lazy and inefficient doesn't qualify as just cause. But if you could fire 5% without having to show cause, think about the impact that would have on the organization.
You could let the maintenance worker go who has a lot of seniority but can't fix equipment, and keep the newer guy who can actually keep the machines running. Or how about the stock handler who has spent his years finding the best places to hide, and always shows up five minutes after he has been paged. Or the assembler who sends parts with a quality problem down the line instead of raising the flag about the issue. "Not my problem" the assembler says. Think about what it would do to efficiency to get rid of the shirkers and malingerers who drag down the whole team.
Management would not even have to use the option for it to have a salutary effect on the organization. Whe they know they can be fired, almost everyone will hustle harder to impress hte boss. The worst will pick up the pace significantly, and even the best will put out a little extra effort. When they see the bar being raised, employees will be more focused throughout the organization.
Some will complain that my idea will mean the end of job security, and will shift the balance of power away from labor and deciviely towards management. Well, right now the industrial workers with the most contractual rights on job security are the UAW workers. That's what the Jobs Bank was all about. But you have to ask yourself: How much job security do you have if your employer is on the brink of bankruptcy?
The only real job security is when the company is winning in the marketplace. It's time for a change in how the unions do business.
First and foremost should be the Jobs Bank. That is the part of the contract that says laid off UAW workers get to receive 95% of their hourly pay and full benefits while waiting for another job position to open up. Since the domestic manufacturers have been cutting headcount for years, the new job positions never do open up. The UAW members merely collect full wages and benefits, while doing no work for the company. The Jobs Bank has been bleeding the car companies for years now. The union says that the Jobs Bank is not that much of a problem, since there are only about 3500 employees currently in the program.
Only 3500! Wages and benefits for the average Big 3 autoworker are $75 per hour (compared to $45 per hour for Japanese transplants like Toyota and Honda). Simple math tells us that $75/hour times 1800 hours/year time 3500 equals $472 million dollars a year in potential savings. Now I've gotten kind of numb from listening to all the big numbers thrown from all of the different Federal bailouts so far this year, but $472 million sounds like a lot of money to me.
But I've got another idea for changing the UAW contract with the domestic automakers. This won't help stave off bankruptcy in the short term, but in the long run could help them regain some of their lost competitiveness. I call it the 5% solution.
The concept is simple, change the contract to allow management to fire up to 5% of the UAW workers every year, no questions asked. That means no seniority, no grievances filed, no arbitration. Management would have to follow Federal law, which prevents firing people based on their membership in a protected class (race, gender, age, etc.). Other than that, pull whoever you want and give them the boot. Management would not be required to exercise this right, they would merely have the option.
In Right to Work states, employment law features a doctrine known as employment at will. Employment at will assumes that the work relationship is mutually agreed upon, and that either party has reciprical rights to terminate that relationship at any time. Simply put, you can tell the boss to take this job and shove it. The boss can give you the boot. All I'm proposing is to apply this doctrine to the UAW contracts, subject to a limit of 5%.
Consider the effect this change would have. As things stand now, to terminate a union worker requires cause, and proving cause requires evidence that will stand up in a legal proceeding. Being lazy and inefficient doesn't qualify as just cause. But if you could fire 5% without having to show cause, think about the impact that would have on the organization.
You could let the maintenance worker go who has a lot of seniority but can't fix equipment, and keep the newer guy who can actually keep the machines running. Or how about the stock handler who has spent his years finding the best places to hide, and always shows up five minutes after he has been paged. Or the assembler who sends parts with a quality problem down the line instead of raising the flag about the issue. "Not my problem" the assembler says. Think about what it would do to efficiency to get rid of the shirkers and malingerers who drag down the whole team.
Management would not even have to use the option for it to have a salutary effect on the organization. Whe they know they can be fired, almost everyone will hustle harder to impress hte boss. The worst will pick up the pace significantly, and even the best will put out a little extra effort. When they see the bar being raised, employees will be more focused throughout the organization.
Some will complain that my idea will mean the end of job security, and will shift the balance of power away from labor and deciviely towards management. Well, right now the industrial workers with the most contractual rights on job security are the UAW workers. That's what the Jobs Bank was all about. But you have to ask yourself: How much job security do you have if your employer is on the brink of bankruptcy?
The only real job security is when the company is winning in the marketplace. It's time for a change in how the unions do business.
Thursday, December 4, 2008
The gurus have spoken!
Well, it's official.
The National Bureau of Economic Research came out Monday and announced that the US economy was in a recession. Their statement said that the economy had been contracting since December 2007. That means this recession has already gone longer than the post World War II average, which is ten months.
Yup, it's official: the economy has been contracting for a whole year now. This makes me want to channel the late, great "screamer" comedian, Sam Kinnison:
WELL, WHAT WAS YOUR FIRST CLUE?! WAS IT THE 50% COLLAPSE IN HOUSING STARTS? THE TRIPLING IN THE FORECLOSURE RATE? MAYBE IT WAS FACT THAT THE BIG THREE DOMESTIC CARMAKERS ARE ON THE VERGE OF BANKRUPTCY? OR COULD IT BE THE COMBINATION OF HUNDREDS OF BILLIONS IN BANK LOSSES, THE FAILURE OR FORCED MERGER OF MAJOR INVESTMENT BANKS, AND THE TOTAL FREEZE UP IN THE CREDIT MARKETS?
The business I work in has been hunkered down in survival mode all year, but the official announcement is just now being made. It hardly seems worth calling a news conference to announce the finding. What great finding will be announced next? Water is wet? Gravity pulls you down? Oh, I know: The Earth revolves around the Sun!
Now, if somebody knew when the recession would end, and the economy start growing again, that would be news you could use.
The National Bureau of Economic Research came out Monday and announced that the US economy was in a recession. Their statement said that the economy had been contracting since December 2007. That means this recession has already gone longer than the post World War II average, which is ten months.
Yup, it's official: the economy has been contracting for a whole year now. This makes me want to channel the late, great "screamer" comedian, Sam Kinnison:
WELL, WHAT WAS YOUR FIRST CLUE?! WAS IT THE 50% COLLAPSE IN HOUSING STARTS? THE TRIPLING IN THE FORECLOSURE RATE? MAYBE IT WAS FACT THAT THE BIG THREE DOMESTIC CARMAKERS ARE ON THE VERGE OF BANKRUPTCY? OR COULD IT BE THE COMBINATION OF HUNDREDS OF BILLIONS IN BANK LOSSES, THE FAILURE OR FORCED MERGER OF MAJOR INVESTMENT BANKS, AND THE TOTAL FREEZE UP IN THE CREDIT MARKETS?
The business I work in has been hunkered down in survival mode all year, but the official announcement is just now being made. It hardly seems worth calling a news conference to announce the finding. What great finding will be announced next? Water is wet? Gravity pulls you down? Oh, I know: The Earth revolves around the Sun!
Now, if somebody knew when the recession would end, and the economy start growing again, that would be news you could use.
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