It's the Money, Stupid!

Sarah Palin announced her resignation from the governorship of Alaska just before the start of the holiday weekend. She will be leaving office 18 months early. From her prepared statement at the press conference where she made the announcement, it was not immediately apparent what her rationale was. The FBI has already issued a statement saying that Governor Palin was not the subject of any investigations, so a scandal concerning illegalities is a pretty remote prospect.

I can only come up with two possibilities.

First, she is leaving office in order to launch a full time bid for the Presidency. Alaska is too small a state, and too far away from the lower 48 to build a power base for a national office. To campaign effectively at teh national level, she will need to work full time, and relocate her base of operations.

If this is her reasoning, it is a dumb idea. Palin did so badly as a Vice-presidential candidate that her chances of winning the nomination were minimal to start with. You don't enhance your credentials for a higher office by quitting the lower office you currently hold.

Second, she has decided to hit the speaker circuit full time. Sarah Palin is a darling of the right, particularly the social conservatives who comprise so much of the base for the Republican party. Unencumbered by the demands and limits of holding office, she will be free to accept several engagements a week, exhorting the faithful at $30 thousand a pop.

To my mind, mercenary that I am, this seems a more plausible plan. After all, being a governor probably pays a couple hundred grand a year. She can make ten times that amount by using her celebrity. And once you've seen the bright lights of the big city, moving back to Fairbanks has got to be a big letdown.

Cashing in your chips while you've got the chance: it's the American Way, isn't it? Besides, she has all those mouths to feed!

Summer Jobs III

We now have completed three weeks of the Federal make work summer jobs program that was part of the stimulus package. Frick and Frack, the original two hires, have both flown the coop. Frack stopped showing up last Monday. Frick waited until last Wednesday to let us know that he was quitting the program.

So we went back to the well, and requested two more summer hires. After all, the grant money has to be spent. Let’s call the two new guys Heckyl and Jeckyl.

Heckyl came in last Wednesday and worked one day. He then had some kind of family emergency, and called in to let us know that he was going to skip Thursday. For regular hires, missing your second day of work is not a prescription for long employment, but Heckyl is only a part time summer hire, so what the heck.

Jeckyl stopped in last Thursday for a quick orientation, and was told to report to work Monday morning.

Fast forward to Monday morning. Wonder of wonders, Heckyl actually came back to go to work. Alas, Jeckyl was a no show. He probably developed a vision problem over the weekend: he just couldn’t see coming in to work.

This program is supposed to be reserved for the economically disadvantaged, job seekers between the age of 18 to 24. It’s easy to see why these jacklegs are in the economically disadvantaged category. When you only work a few days before quitting a job, it’s hard to get ahead in life. Even with the Federal government guaranteeing their paycheck, these clowns can’t hold a job long enough to get any usable experience.

This whole experience so far illustrates one of my general rules for predicting behavior:
Everyone wants a paycheck. Most people want a job. Some people want to work for a living.

So, we’ve put in a request for a new Jeckyl. We’ll call him Jeckyl II. I’ve a sneaking suspicion that we’ll be on to Tweedledee and Tweedledum before the summer is over.

Summer Jobs II

Frick and Frack, the two summer temps hired through the stimulus package make-work jobs program, have finished their second week of employment.

We can already see differences between the two. We started out knowing that due to the lack of training and experience, they would be about half worthless. For Frick, however, the dial has slid over to about 95% worthless. In two weeks he has left early or come in late four times. If he was a regular hire, that alone would be enough to get him shown the door. But he also has a propensity to leave a job half done. When all you are asked to do is sweep out a warehouse, to do the job poorly doesn’t speak well to your energy or enthusiasm.

One of the supervisors in the plant suggested that by the end of week three, we would have to fire Frick. “But he’s free labor,” I protested. “You get what you pay for,” came the response.

Frack, on the other hand, seems to work hard at whatever task he is assigned. Unfortunately, he didn’t show up for work this morning. Nor did he call in. The combination of the two usually indicates that someone has voted with their feet, and has resigned their position. This is actually superior to the more common approach of quitting work, but continuing to show up and draw a paycheck.

Anyway, we called the agency administering the make-work summer jobs grant, and asked them to call Frack and verify whether he was coming back or not. If he has quit, they promised to find a replacement, because “we have to spend the money.”

If they are starting to worry about using all of the money from the grant, and it is only week three, do you think we’re the only workplace having trouble keeping these guys on the job? It makes you wonder what the hiring criteria were for this program.

Sometimes you get what you pay for. Sometimes you pay for something, and you get nothing in return.

Iran's "Election"

Iran held what was ostensibly an election for President last week. The two main candidates were Mahmoud Ahmadinejad, the incumbent, and Mir Hossein Mousavi, a more moderate politician. Mr. Ahmadinejad was declared the victor.

The thing is, Ahmadinejad was declared the victor before the vote count was finished. And the announced vote tallies show him winning by a landslide, drubbing Mr. Mousavi by a margin of two to one. This despite polling that shows Ahmadinejad being increasingly unpopular, and support for Mousavi growing in the run up to the election.

So it looks like the election was stolen. Violent street protests have ensued, with the security services not being shy about bludgeoning and even killing the protestors.

Now, from an American perspective, I’m not sure it really matters who the President of Iran is. In Iran’s theocracy, real power resides with the Revolutionary council, a group of twelve Islamic mullahs. The Council has to approve the candidates before they can even appear on the ballot. So in that sense, both Ahmadinejad and Mousavi are products of the system, tools of the ruling clerics.

Here’s what scares me about the situation. Iran is enriching uranium so that they can build atomic bombs. This is perceived by most Westerners as adverse to our interests and destabilizing to the Middle East. The US and our allies are trying to deter Iran from pursuing this policy of pursuing nuclear ambitions.

The problem is that all of our tools diplomacy, both hard and soft, assume that the Iran state has a government that acts as a rational player. They don’t have to be reasonable, but they have to be sane. Sane men will not knowingly pursue policies that damage their own interests, and will pursue policies that enhance their interests. All of the carrots and sticks in the international system are based on that principle.

If the government of Iran is not rational, that is very frightening. Give insane men plutonium, and anything could happen. It is very difficult to deter insane men.

This brings me back to their Presidential campaign. The Iranians staged a major election, with months of campaigning. Then on election day, the whole process was revealed to be a sham. The election wasn’t just stolen. It was blatently, obviously stolen. It was stolen in a way that enraged the opposition, and sparked violence in the streets.

Now, that’s just crazy.

Health Care Assumptions

The Obama administration is getting ready to unveil their plan to massively restructure the delivery of health care in this country. One of the core rationales for this plan is to extend "access" to health care services. This argument overstates the case. I would argue that there is no problem with accessing health care in this country.

If you have a medical problem, you can go to any emergency room in the country. They must, by law, treat you without reference to your ability to pay. When you go to the emergency room, a doctor will (eventually) see you about your problem. If you are bleeding on the linoleum, you will move to the head of the line, guaranteed.

The problem is not that people want access to health care, and they can't get it. We already have universal access to health care. The problem is that people want unlimited access to medical care. The question is not whether everyone should have health care in this country. The question is whether everyone should have access to as much medical treatment as they want.

If we answer that question as a yes, then it leads inevitably to another question. how do we pay for it?

Summer Jobs

We picked up a couple of summer interns at my company this week. They came to us through a government program that is part of the Obama stimulus package. Basically, the government pays their wages and picks up their benefits (worker’s comp, FICA taxes), put they actually work for us.

Free labor. What’s not to like, right?

Actually, it is kind of a tricky prospect, trying to get useful output out of these guys. Business was slower earlier in the year when we signed on for this program, and we were working reduced hours. I had a concern that our regular workforce would perceive the summer workers as competing with them for work.

Fortunately, business has picked up from the low point last winter. But these guys (let’s call them Frick and Frack) know nothing about working in an industrial facility. Zip, zilch, nada. So to get any more output out of them than pushing a broom, they will have to be trained. I can’t even let them mop the floor after they’ve swept it without proper training. Oily mop water from an industrial facility has to be properly disposed of.

It is the classic investment problem. I have to invest resources into training Frick and Frack in order to turn them into usable resources in their own right (or, as I like to call them, interchangeable worker units). To train them I have to take my regular folks off their jobs to do the OJT. Too much training, and I can’t get my money back out of them by increased productivity, especially since they’re only here for the summer. Also, I have to keep regular work going while they are being trained.

Still, I want them to get more out of their summer job than just pushing a broom. So I’m looking for that balance point where we teach them enough for them to say they have learned something, but at the same time keep the training short enough to get some payback off the investment in training.

In a larger sense, I want Frick and Frack to come out of this experience with more skills than they went in because they aren’t really free labor. After all, the government is picking up the check. Spending money just to create make-work jobs is a terrible use of the government’s limited resources. Spending the same money to help develop the next generation workforce makes a lot more sense to me.

After all, it’s my tax dollars at work.

Off Topic Post: Great Moments in "D'uh"

Breaking News! Adam Lambert, the runner up in this year's American Idol competition, has come out as a gay man. He made the announcement as part of an interview in this month's Rolling Stone magazine.

Really? Seriously? This is supposed to be news?

I mean, I watched all of about three minutes of American Idol this season, and I could have told you that Adam Lambert was gay.

All of you aspiring journalists out there, repeat after me: "Dog bites man, that's not news. Man bites dog, that's news."

False Modesty

Last week’s big business story was the bankruptcy filing by General Motors. The Federal government will be taking the lion’s share of the reconstituted entity once it emerges from bankruptcy court. In exchange for the billions that the Feds have already loaned GM, plus providing the debtor-in-possession financing, the government will have 60% of the equity. The UAW will have about 20%, and the secured bondholders will have the balance.

Just as in the case of Chrysler, the secured bondholders are getting the short end of the stick. Under normal bankruptcy law, the secured creditors usually get the majority of the equity in the company that emerges. In the case of these two car companies, the unsecured health insurance and pension claims of the union have been moved up in seniority, compared to the bondholders. Of course, this wouldn’t have anything to do with the fact that the UAW has supported Democratic candidates almost exclusively, with resources of both money and manpower. No, no, there’s no payola at work here.

What I found interesting about the deal was the government’s protests that they did not want to own a part of General Motors, let alone the majority stake. Over and over, spokesmen for the administration kept claiming that they did not want to be responsible for managing operations at a car company.

That reticence confuses me a little bit. After all, these are the same guys who are proposing to take control of the entire US health care sector in the interest of providing universal coverage. One out of every six dollars in this country is spent on health care, but the administration is not being shy about planning a massive restructuring. That restructuring will include a government owned health insurance fund that will compete directly with private health insurance companies.

Or how about energy, another major industrial area of the economy? The Obama administration is putting the finishing touches on their plan to completely restructure how electricity is generated and distributed in this country. Those plans include bankrupting the entire coal mining industry, and making obsolete any coal-fired power plants.

These guys aren’t shy about directly injecting government control over huge swaths of what is now private industry. The outlier is the automotive industry. For some reason, they don’t want to be in charge of that.

Just everything else.

"You can't handle the truth!"

I can’t figure out the appeal of California. As a former Floridian who has visited the Golden State several times, I thought the oranges tasted funny, the sunshine was the wrong color, and Disneyland was at best a prototype for the real theme park at Disney World.

On the down side, California suffers from earthquakes, mudslides, raging forest fires, occasional civil insurrection, and ridiculously expensive real estate. And the traffic is hellacious.

Now the state appears to be in complete meltdown. After the voters soundly rejected a mixed bag of referendums that raised taxes, redirected earmarked funds, and sold off assets, the state is announcing big cuts to try and balance the budget shortfall that approaches $24 billion. California may become the first state to declare bankruptcy.

In the middle of all this, the state’s finance director, Mike Genest, made the following extraordinary statement during a conference call with reporters last Friday:

“Government doesn’t provide services to rich people. It doesn’t even really provide services to the middle class.” He added: “You have to cut where the money is.”

Now, I’m sure Mr. Genest’s intention was to explain why the proposed budget cuts were hitting low income residents so hard. No doubt he was trying to answer a question along the lines of “Why do all of the cuts seem to target poor people?” or “Is this political payback because poor people tend to vote Democratic, and the governor is Republican?” Something like that.

As a middle class taxpayer, I interpret Mr. Genest’s statement a little differently:

“If you’re in the upper or middle class, you are not going to get your money’s worth from the state government. Never have, never will. Yeah, we’ve been screwing you out of your taxes right along. You got a problem with that?”

Kudos to Mr. Genest for his refreshing honesty, but if I was a California taxpayer I’d be a little bent right now.

Sonia Sotomayer

Sonia Sotomayer has been nominated to fill the position on the US Supreme Court left by the pending retirement of David Souter.

A graduate of Princeton and Yale Law School, Judge Sotomayer has been on the Federal Bench since 1992.

This one looks like a slam dunk. Her presence on the Court does not significantly alter the liberal-conservative dynamic, as Justice Souter usually voted with the liberal bloc. To vote against Sotomayer would be to vote against a woman and a Hispanic. Besides, even if all of the Republicans in the Senate voted against her, they don’t have the votes to stop her nomination. The Repubs know it, the Dems know it, so there will be plenty o’ grandstanding, which will change the end result not one iota.

Since this was a done deal, I wasn’t going to exert a lot of energy on it. Then I read that Judge Sotomayer said this: “I would hope that a wise Latina woman with the richness of her experiences would more often than not reach a better conclusion [as a judge] than a white male who hasn’t lived that life.”

Now, when I first read that, I thought “No way. That has got to be an Internet hoax in the making.”

Well, it turns out that she really did say that, as part of a speech she gave in 2001. Apparently the snippet is taken out of context. The full text of the speech can be found here.

Even if you accept her point that being a woman Hispanic makes her a better judge in areas of sexual and racial discrimination, and I’m not sure I do (after all, there’s a reason why the statue of justice is wearing a blindfold), it raises a question for me.

If being a woman and a Hispanic makes you a better judge in some types of cases, where does it make you a worse judge?

Now that’s a question I like to see asked.

Car Wars, Part III

In my previous posts regarding the Obama administration’s new automotive fuel economy standards, I have intimated why I do not think mandating a huge increase in mileage is a workable idea. In this post I want to counter one of the arguments that has been raised in favor of the idea.

I’m talking about the “national standard” argument. Basically, this argument goes that it is better that we now have a new federal standard, as opposed to a “patchwork” of different fuel efficiency standards in various areas of the country. With a single standard, manufacturers can focus all of their engineering efforts on meeting the Federal goals, rather than trying to develop different cars for different states.

This argument is crap. It’s hogwash. No, it’s hogwash on steroids.

A little history is in order. A few years back, California announced that in the interest of controlling pollution from automobiles, the state was going to come out with a mileage standard for cars sold in California. This mileage standard was considerably in excess of Federal standards at the time.

The car companies sued to halt this action, arguing that mileage standards were the business of the Federal government. The Bush administration agreed with them. What the car companies really objected to was that the new California mileage rules would force them to develop cars that few people wanted to buy, and abandon vehicles that people did want to buy. Since the California market is so large, you can’t afford not participate in it. A classic Catch 22: they don’t want to meet the California standard, but they can’t afford to give up the California market.

But the car companies could have chosen to embrace the California standards. And the mix of cars developed for the strictest mileage standards in the country would meet the requirements of every other region as well.

Fast forward to the present day. The Obama administration has preempted the California attempt to impose higher fuel economy. How did they do it? By adopting the California standard!

Now, call me crazy, but I don’t think there is much preemption in capitulation.

The Obama administration has basically turned over control of the fortunes of a large, strategically important industry to the pollution control bureaucrats of a single state.

It may be a new Federal standard, but these actions are a betrayal of the Federal system.

Car Wars, Part II

I have a clarification on my previous post regarding the new Federal automotive fuel efficiency standards. The 35 mpg requirement is for passenger cars and light trucks combined. The requirement for passenger cars is that the corporate average hits 42 miles per gallon.

I was curious as to how many cars currently on the market meet that standard. So I visited the official EPA fuel efficiency website (www.fueleconomy.gov). They have a searchable database where you can look for cars that meet differing levels of fuel efficiency. Do a search at meet or exceed 40 mpg, and you come up with two, count ‘em two, models. If you want a car that meets the 2016 standard today, you can get a Toyota Prius or a Honda Civic Hybrid.

It kind of reminds me of Henry Ford’s old dictate regarding the Model T. “You can have it in any color you want, as long as it’s black.”

Typically, cars are developed in what’s called a platform. The platform includes the chassis, the suspension, the powertrain; basically, all of the guts and structure between the seats and the body panels. Usually, more than one model of car is built off of the platform. For example, the Honda CR-V is built off the Civic platform. The Ford Fusion and the Mercury Milan also share a platform.

Developing a new platform takes between three and five years. Not only does the platform have to be engineered, but a lot of the subassemblies will also be new designs. Then the tools to build the new parts have to be designed and built. Once the new parts are made, then the assembly processes to make the subassemblies have to be designed and built. I have seen times where getting just one part for a new automotive subassembly took over 18 months between the first quotation to delivery of production parts.

Because of the enormous cost of developing a new platform, particularly once you get to the stage of building production tools, car companies usually bring only one platform to market in any one year.

To arrive at the mandated targets will require new platform development for almost every platform over the next 8 years. If you listen carefully, you can hear faint screams of agony coming from all directions. Those are the screams of product planners and design engineers from all over the world being told about the new North American standards they will have to meet, and the timetable for meeting them.

Car Wars

I have been hearing on the news today about the new deal to raise automotive fuel efficiency standards. The average passenger car mileage will increase from the current 27.5 miles per gallon to 35.5 miles per gallon in 2016. From the news coverage I’ve seen so far, it is not clear if that 35.5 mpg figure also applies to light trucks. Last year Congress passed a law requiring light trucks to hit fuel efficiency standards of 27.5 mpg by 2020, but that is now superceded by this new EPA rule.

For car makers, fuel efficiency is governed by a concept known by the acronym CAFÉ: Corporate Average Fuel Efficiency. The concept is pretty simple. The average fuel efficiency of all of the cars a manufacturer sells has to hit the government’s target. If you sell one Ford Fusion (26.5 mpg) and one Ford Fusion Hybrid (38.5 mpg), your CAFÉ rating is 32.5 mpg.

If you are Ford Motor, and you want to sell a muscle car like a Mustang (22 mpg) you have to sell another car that gets 49 miles to the gallon to hit the new standard. The latest version of the Toyota Prius only gets 44 mpg, so even that would have to increase by 11% to average out with a Mustang.

The new fuel efficiency standards represent a 30% increase over a seven year time period. To hit these targets, what all of the car companies are going to have to do is predictable. Cars are going to get (much) smaller, lighter, and less powerful. They are also going to become much more expensive.

A lot more cars are going to be hybrids. Since every hybrid has dual drive systems, one gas and one electric, there are a lot more components per car than a standard powertrain. More components, more cost.

For cars with more powerful engines, the prices will also go up. Why? Well, how else can the car companies convince you to buy a car that would lose a collision with a dog, when what you really want is a big honkin’ pickup truck? After all, the evidence of the marketplace is clear. Given a choice, Americans like to drive SUV’s and pickup trucks. In 2007, the top three best selling vehicles in North America were all full size trucks.

In the news coverage so far, everyone has been all smiley and happy, singing kumbaya over how great this is. So far, nobody has bothered to ask any automotive design engineers what they think about this. Those poor bastards are probably sitting in bars, trying to drink themselves into a catatonic stupor.

Tomorrow morning, they are going to have to wake up with a hangover, go in to work, and start trying to figure out how to retool 80% of the industry capacity to build small cars on lines configured to make big trucks and SUV’s. They have to do this during a major recession, with forecasted sales volume at 60% or less of what is was just a couple of years ago. And, oh yeah, the head of California’s pollution control board announced plans today to start work on the next major ratcheting up of fuel efficiency standards.

Work in the auto industry? I’d rather take on a career juggling chain saws. Flaming chain saws.

Third

How does Nancy Pelosi stay on as Speaker of the House? She's a pit bull partisan politico, schooled in old school urban machine politics. That extraordinary dedication to partisanship was obviously useful as House Minority Leader, making plans for her party to recapture control of the House of Representatives. But the Speaker of the House, isn't she at least nominally supposed to be for American interests, and not just the interests of the Democrats Party?

Last year, in passing the $700 billion bank bailout legislation, she had a chance to reach across the aisle and get bipartisan support. Whether you thought the bank bailout was a good idea or not, members of both parties thought it was a necessary action for the time. It was considered important to get bipartisan support for the commitment of so much money, so suddenly. So Speaker Nancy showed up to make a speech on the House floor in support of the legislation.

Now, I'm no speech writer, but if I was I would have put together a message somewhere along these lines:
"Ladies and gentlemen of the House. I have come before you today to speak in support of the legislation on the floor today. $700 billion dollars is a lot of money, but we are in the middle of an unprecedented economic crisis. Our banking system has seized up, and is in danger of collapsing. The experts we have consulted have agreed that if we do not do something to turn the situation around, our economy will undergo a calamity which will hurt all Americans.

"That is why I am asking all of you, both Republican and Democrat, to support this bill. As members of opposing political parties, we can have very real differences, both practical and philosophical, on a range of issues. But as Americans, we can put those differences aside, and work together when the chips are down to find solutions for the critical issues that this country faces. In this time of crisis, let us show a united face to the world."

She could have made a speech like that. Instead, we got this:


Now, after inveighing against the evil Republican Party for allowing war criminals to torture innocent civilians, it turns out that Speaker Pelosi had been repeatedly briefed by the CIA on what interrogation tchniques were planned for use, as well as what was actually being done to terrorists that had been captured. At the time, she never raised a note of protest.

When this information came to light, first she denied ever having this information. Then she agreed, yes, she did have the information, but only because a staffer had attended the briefing and had told her. Then, she said the CIA had lied about briefing her. Then she said the CIA misleads Congress all the time. She's got more twists and turns then a snake. Here's a news story on her press conference:


After watching this story, you have to believe that Nancy Pelosi has no commitment to the truth at all, only what she can spin to her political advantage. You know what the scary part of that is? She is third in line for the Presidency, right after Joe "Don't fly on airplanes, they're deathtraps!" Biden.

I really hope President Obama's stop smoking program is working.

Reserve Currency: I'll Reserve Judgement On That

Nouriel Roubini came out with an Op-Ed piece in the New York Times this week. In it, he raises a warning flag. The Chinese, who fund the US government deficit by being the biggest buyers of Treaury bonds, and who have a gigantic stockpile of dollars, are starting to make noises that they don’t want the dollar to be the world’s reserve currency anymore.

In the post-World War II economic system, the dollar became the world’s reserve currency. That means that for globally traded commodities, the deals are priced in terms of dollars. World oil prices are in dollars per barrel.

It also means that for a number of currencies, if you want to change over to another currency, you have to use dollars to complete the two halves of the transaction. For example, to convert Danish kronar into Thai baht, you first trade your kronar for dollars, then trade the dollars for baht.

If you want to be part of the world trading system, you have to keep a stockpile of dollars on hand to fund your buying and selling.

Because everybody has to have dollars, that keeps demand for greenbacks high. This allows the government to keep interest rates low in financing the deficit. It also allows American consumers to run up massive trade deficits, since exporting countries have to accept US currency. Our status as the world’s reserve currency keps the dollar strong, leading to low interest rates and inexpensive imports.

Mr. Roubini’s warning is that unless we get our fiscal house in order, the Chinese currency, the renminbi, will supplant the dollar over the next ten years. Historically, reserve currencies have always come from creditor nations, not borrower nations. If the renmenbi surplants the dollar, our currency will fall preciitously in value. This will cause a spike in interest rates as the government will have to entice investors into continuing to fund our deficits. Also, commodity prices will inevitably rise in dollar terms.

I hate to argue against anyone who is advocating more fiscal restraint, but I don’t find Mr. Roubini’s nightmare scenario to be particularly frightening.

First, to function as a reserve currency, the renminbi would have to be widely traded on currency markets, and before that could happen the Chinese would have to allow it to float, or move up and down in value, vis a vis other currencies. But the Chinese keep the value of their money pegged against the dollar. It is only in the last couple of years that even limited trading of the currency has been allowed.

It is precisely because the renminbi is pegged against the dollar that the US continues to run such a massive trade deficit with China. Otherwise the dollar would already have dropped in value against the renminbi, making Chinese imports more expensive. And the Chinese get something out of the deal. US demand for cheap Chinese imports is driving the extremely rapid industrialization of the Chinese economy.

In addition to the practical difficulties (many of which Mr. Roubini himself lists out), as a manufacturing manager I think the benefits of a falling dollar would vastly outwiegh the costs. Yes, commodity prices would increase. But for the last ten years the Chinese have used an artificially low currency to take market share from companies like mine. Instead of continuing to fight one long rear guard action against off-shore competitors, we could use our advantages of lower freight costs, higher productivity, and shorter lead time to take back business that has been lost. Maybe we could even expand into new markets and products.

If being the reserve currency has allowed Americans, both collectively and individually, to be irresponsible, than losing that status would be a change for the better. It is the difference between empowerment and enablement.

Pay Me Now or Pay Me Later

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?

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.

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.

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.”

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.

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…

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.

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.

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.

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.

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.

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.

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.

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.

"...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.

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.

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.

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?

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.

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.

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.

All Labor is Honorable

This was just too good to pass up.

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.

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.

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.

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?