Actual conversation from the tax desk:
“I need a big refund this year. I really need money. What can you do?”
“Well, I see you only have a little bit of income on your W-2, and you didn’t have them take any withholding out of your check. Your income is actually below the Federal filing limit, so the good news is that you don’t owe any taxes. But since you didn’t pay anything in, you aren’t going to get a refund.”
“I got almost $1000 last year, and I need money even more now. That’s why I came to you. Why can’t you get me a refund?”
“Looking at last year’s return, I see you had unemployment compensation all the previous year, and the state withheld taxes. That’s what you got back. Did the unemployment run out last year?”
“Yeah. That’s why I need a refund. I have a friend who came here, and she got a big refund. Why can’t you do that for me?”
“Since you don’t have children, you have to pay more in withholding than you owe in taxes to get a refund.”
“So you’re saying I’m not going to get a check?”
The sense of entitlement is astonishing.
Thursday, February 16, 2012
Tuesday, February 7, 2012
Making Ends Meet Via the IRS
People are always getting confused when I tell them that a lot of my tax preparation clients aren’t taxpayers. Instead, I classify them as taxfilers. The distinction comes from the reality that about 47% of American households do not pay income tax. Not only do they not pay into the Federal government, but they actually draw money out of the IRS. These are households that don’t pay taxes, but they sure do file, because otherwise you miss out on all that free government money.
The amount of money is significant, particularly when considered as a percentage of annual income. If you have two children, and earn $12,000 in wage income (pretty close to a full time job at minimum wage), the Federal government will give you $7000, or just over a third of your annual income.
Then you plug in the value of food stamps. The formulas are a little complicated, but in our example the annual benefit is around $5500 for a three person family, and $7000 for a family of four.
Using the family of four gives us earned income of $12,000, and total income of $26,000. So if you ever wonder how people make ends meet on a minimum wage job, the answer is that the 53% of us who pay taxes are picking up the slack.
The amount of money is significant, particularly when considered as a percentage of annual income. If you have two children, and earn $12,000 in wage income (pretty close to a full time job at minimum wage), the Federal government will give you $7000, or just over a third of your annual income.
Then you plug in the value of food stamps. The formulas are a little complicated, but in our example the annual benefit is around $5500 for a three person family, and $7000 for a family of four.
Using the family of four gives us earned income of $12,000, and total income of $26,000. So if you ever wonder how people make ends meet on a minimum wage job, the answer is that the 53% of us who pay taxes are picking up the slack.
Monday, February 6, 2012
GE's Superbowl Ads
Like a lot of other Americans, I watched the Superbowl last night. And like a lot of other Americans, I paid as much attention to the advertising as to the game.
Some of the ads were terrific, like the Doritos ads. I would rate some as a swing and a miss, like the Audi commercial featuring the vampires. Sure it was a cute concept, but if I'm going to spend over $35,000 buying an expensive imported sedan, I sure want more features than LED headlights. Sadly, no other selling point of the car was mentioned.
But the ads that had me scratching my head were the spots from General Electric. One was an ad featuring employees at a Schnectedy turbine factory talking about how they love their jobs. What was really weird about this ad is that 2/3's of the way through it morphs into a Budweiser ad.
The other GE ad was similar, featuring interior shots and voiceovers from employees of Appliance Park, where they build appliances. Mind you, this ad wasn't pushing GE appliances, it was pushing GE factories.
The two commercials totaled a minute and a half of running time, which means somebody at GE headquarters greenlighted spending $10.5 million of the shareholder's money on this boondoggle. I find this decision absolutely inexplicable. If you're selling beer, it makes a lot of sense to try and reach 100,000 million Americans at the same time. If you're selling power generation turbines, there has got to be a more cost efffective way to reach the 50 or 60 people who will be making that purchase this year than advertising on the Superbowl.
But really, these ads weren't even selling GE's products. They were selling the concept of General Electric itself. This kind of corporate image advertising belongs on the Sunday morning news shows, or maybe CNBC. But the Superbowl? I just don't get it.
For God's sake, next time but a dog into the commercial, okay.
Some of the ads were terrific, like the Doritos ads. I would rate some as a swing and a miss, like the Audi commercial featuring the vampires. Sure it was a cute concept, but if I'm going to spend over $35,000 buying an expensive imported sedan, I sure want more features than LED headlights. Sadly, no other selling point of the car was mentioned.
But the ads that had me scratching my head were the spots from General Electric. One was an ad featuring employees at a Schnectedy turbine factory talking about how they love their jobs. What was really weird about this ad is that 2/3's of the way through it morphs into a Budweiser ad.
The other GE ad was similar, featuring interior shots and voiceovers from employees of Appliance Park, where they build appliances. Mind you, this ad wasn't pushing GE appliances, it was pushing GE factories.
The two commercials totaled a minute and a half of running time, which means somebody at GE headquarters greenlighted spending $10.5 million of the shareholder's money on this boondoggle. I find this decision absolutely inexplicable. If you're selling beer, it makes a lot of sense to try and reach 100,000 million Americans at the same time. If you're selling power generation turbines, there has got to be a more cost efffective way to reach the 50 or 60 people who will be making that purchase this year than advertising on the Superbowl.
But really, these ads weren't even selling GE's products. They were selling the concept of General Electric itself. This kind of corporate image advertising belongs on the Sunday morning news shows, or maybe CNBC. But the Superbowl? I just don't get it.
For God's sake, next time but a dog into the commercial, okay.
Friday, February 3, 2012
What % Are You?
Here is a wonderful toy from the New York Times website. It is an interactive tool that tells you how high (or low) on the income distribution your household income places you. What I particularly like is that you can drill down geographically. So first, you get national ratings. Then you can go down to the state level, and even into local income distribution.
I'm doing better than I would have thought from the state of my bank account.
I'm doing better than I would have thought from the state of my bank account.
Tuesday, January 31, 2012
Adventures in Taxland, Part I
As a sideline, I do taxes for other people. It is hard to make much money, since it is only a part time seasonal gig, but I enjoy the work, and the stories are terrific. I plan to share some of those stories on this blog (with identities suitably masked), and this is the first from this season.
Since I started with my current company, I have always heard bad things said about our largest competitor. There are a number of players in the paid tax preparation market, ranging from CPAs to cash advance stores to sole practicianers who work out of their homes. But our competitive focus is on the large, multi-office chains. The biggest of these shall remain nameless, but their initials are JH.
I have always heard it said that "we don't do things like JH" or "those guys at JH don't care what they put on a tax return." If we were a bar, we would make cracks like "you can't find a clean glass in that place." I have always taken that trash talking with a grain of salt. After all, we're not over there every day; how do we know what they are doing? Still, running down the other guy is a good way to build morale in your shop.
But this week a woman came in asking us to review the work she had had done at JH. According to the woman, they had prepared and filed her tax return using her last pay stub from 2011. Once she had received her W-2, she realized that it did not agree with what she had filed, and she asked us to take another look.
IRS regulations say you are not supposed to file a tax return without the W-2 in hand. If a client comes into our office without one, we try and find one online, or failing that, we turn them away until they get that all important document from their employer. Clients don't care about this, of course. In their rush to get their hands on a tax refund, they will say or do anything to try and short circuit the process. But the paid preparer is supposed to care.
In this case, the pay stubs had not shown all of the earnings and withholding from the woman's job. Because her withholding was not all reported, it reduced her refund. Since she received both Child Tax Credit and Earned Income Credit, those were undercalculated as well. All told, not following the rules would have cost this woman hundreds of dollars in her refund.
To get the rest of her refund, the new client will have to file an amended return. The amendment will have to be mailed in, and she will have to wait a couple of months to receive the balance of her refund. Since my office will get paid for reworking her return and preparing the amendment, she will end up with less money then she would have gotten if she had come to us in the first place.
So maybe there is a difference in tax preparation services after all.
Since I started with my current company, I have always heard bad things said about our largest competitor. There are a number of players in the paid tax preparation market, ranging from CPAs to cash advance stores to sole practicianers who work out of their homes. But our competitive focus is on the large, multi-office chains. The biggest of these shall remain nameless, but their initials are JH.
I have always heard it said that "we don't do things like JH" or "those guys at JH don't care what they put on a tax return." If we were a bar, we would make cracks like "you can't find a clean glass in that place." I have always taken that trash talking with a grain of salt. After all, we're not over there every day; how do we know what they are doing? Still, running down the other guy is a good way to build morale in your shop.
But this week a woman came in asking us to review the work she had had done at JH. According to the woman, they had prepared and filed her tax return using her last pay stub from 2011. Once she had received her W-2, she realized that it did not agree with what she had filed, and she asked us to take another look.
IRS regulations say you are not supposed to file a tax return without the W-2 in hand. If a client comes into our office without one, we try and find one online, or failing that, we turn them away until they get that all important document from their employer. Clients don't care about this, of course. In their rush to get their hands on a tax refund, they will say or do anything to try and short circuit the process. But the paid preparer is supposed to care.
In this case, the pay stubs had not shown all of the earnings and withholding from the woman's job. Because her withholding was not all reported, it reduced her refund. Since she received both Child Tax Credit and Earned Income Credit, those were undercalculated as well. All told, not following the rules would have cost this woman hundreds of dollars in her refund.
To get the rest of her refund, the new client will have to file an amended return. The amendment will have to be mailed in, and she will have to wait a couple of months to receive the balance of her refund. Since my office will get paid for reworking her return and preparing the amendment, she will end up with less money then she would have gotten if she had come to us in the first place.
So maybe there is a difference in tax preparation services after all.
Wednesday, January 25, 2012
Mitt Romney's Tax Returns
Mitt Romney really took a beating over his failure to release his tax returns before theSouth Carolina primary. What I think he should have said was this:
"The Republican nominee traditionally releases his tax returns after he is designated the nominee, typically in April. If I am my party's nominee, I will follow that tradition. My opponents in this primary want me to release my tax return information now. They claim it is that is so that I can be 'vetted' by they and the media.
The real reason they want that information is so they can attack me for having more money than they do. I can understand that, but I'm not going to indulge them. As President, my policies will not be about attacking the rich (like the current administration), or about blaming the poor (like some of my opponents in this primary). Instead, my administration will concentrate on policies that create an economic environment where everyone's talents will take them as far as they can go. Americans aren't focused on envy of those who have more--they want the chance to do better on their own, without handouts from the government.
Yes, I'm wealthy. But nobody gave that money to me. I earned it by helping build businesses that returned money to their investors. I think that the Democrats are the party of class warfare and income redistribution. Republicans are the party of opportunity. So I'm not going to open the door for my primary opponents to attack me in that fashion."
Of course, he didn't say anything of the kind. He waffled on the issue, and it cost him. Big time.
"The Republican nominee traditionally releases his tax returns after he is designated the nominee, typically in April. If I am my party's nominee, I will follow that tradition. My opponents in this primary want me to release my tax return information now. They claim it is that is so that I can be 'vetted' by they and the media.
The real reason they want that information is so they can attack me for having more money than they do. I can understand that, but I'm not going to indulge them. As President, my policies will not be about attacking the rich (like the current administration), or about blaming the poor (like some of my opponents in this primary). Instead, my administration will concentrate on policies that create an economic environment where everyone's talents will take them as far as they can go. Americans aren't focused on envy of those who have more--they want the chance to do better on their own, without handouts from the government.
Yes, I'm wealthy. But nobody gave that money to me. I earned it by helping build businesses that returned money to their investors. I think that the Democrats are the party of class warfare and income redistribution. Republicans are the party of opportunity. So I'm not going to open the door for my primary opponents to attack me in that fashion."
Of course, he didn't say anything of the kind. He waffled on the issue, and it cost him. Big time.
Wednesday, January 11, 2012
Liquidity Preference, Opportunity Costs, and Arbitrage: Home Mortgage Edition
I was at a social outing last week, and during the conversation the subject turned to mortgages. The host averred his strong preference for not carrying a mortgage. “Just pay it off, and then you don’t have to worry about making that payment every month. Besides, I can’t stand paying all that interest every year.”
Now, most Americans do not have the wherewithal to pay off their mortgage 100%. Indeed, for most people paying off a car loan would be a stretch. But I could, and yet I continue to carry both a car loan and a home mortgage. So I thought I would write about why it can be a good idea to continue carrying debt, when you have enough assets to pay it off.
First and foremost, cash keeps your options open. Let’s say you have $100,000 in debt. Also suppose you have $100,000 in cash. You could extinguish all of your outstanding debt. But then, you would no longer have any cash on hand. You better hope the transmission in your car doesn’t go out, or the roof doesn’t leak, or any of a hundred possible contingencies does not occur. Because then you’ll wish you had held on to more of that cash.
The desire to keep cash on hand to cope with life’s curve balls is what finance professors call liquidity preference. Personal finance experts recommend you keep three to six months worth of cash on hand for just that reason. Okay, but going back to our hypothetical example, unless you’re a member of the 1%, you probably do not need $100,000 on hand to fund your lifestyle for six months, or even a year. Why not pay down the mortgage?
You give up the chance to do something better with the money, what economists call opportunity costs. Let’s run a more complicated version of our original scenario. This time we’ll start from the same place: a $100,000 mortgage and $100,000 in cash. Now we decide to hold $50,000 in cash for emergencies. We can use our remaining $50,000 in one of two ways. We can either pay off $50,000 of our mortgage, or we can pay $50,000 of Verizon stock. Verizon currently has a dividend yield of 5.15%, so our fifty grand would give income of $2575 a year. There is a little risk with holding the stock, but unless people stop making phone calls it is a pretty safe bet.
For the mortgage, assume a 15 year fixed rate mortgage at 3.5%. If you borrow $100,000, you will pay $3418 in interest the first year, and have dividend income of $2575. The net cost of the borrow and invest strategy is $843.
If you down debt and only have a $50,000 mortgage, you will pay $1709 interest the first year. Paying down debt will cost you $866 over the alternative strategy. Since the interest payments will drop each year of the mortgage, but the dividend payment should remain constant, the borrow and invest strategy will outperform the pay down debt strategy by a greater amount every year. By the fifth year, you will be $1152 ahead with the borrow and invest strategy.
Borrowing at a low interest rate and investing at a higher rate is an example of arbitrage, and it is one of the ways that the big boys on Wall Street earn their huge bonuses. They add a lot more zeroes to their numbers, of course.
I’m not saying you shouldn’t pay down debt, and there is something to the psychological lift you can get from not owing any money. But being debt free is not necessarily the best strategy for maximizing your financial well being.
Now, most Americans do not have the wherewithal to pay off their mortgage 100%. Indeed, for most people paying off a car loan would be a stretch. But I could, and yet I continue to carry both a car loan and a home mortgage. So I thought I would write about why it can be a good idea to continue carrying debt, when you have enough assets to pay it off.
First and foremost, cash keeps your options open. Let’s say you have $100,000 in debt. Also suppose you have $100,000 in cash. You could extinguish all of your outstanding debt. But then, you would no longer have any cash on hand. You better hope the transmission in your car doesn’t go out, or the roof doesn’t leak, or any of a hundred possible contingencies does not occur. Because then you’ll wish you had held on to more of that cash.
The desire to keep cash on hand to cope with life’s curve balls is what finance professors call liquidity preference. Personal finance experts recommend you keep three to six months worth of cash on hand for just that reason. Okay, but going back to our hypothetical example, unless you’re a member of the 1%, you probably do not need $100,000 on hand to fund your lifestyle for six months, or even a year. Why not pay down the mortgage?
You give up the chance to do something better with the money, what economists call opportunity costs. Let’s run a more complicated version of our original scenario. This time we’ll start from the same place: a $100,000 mortgage and $100,000 in cash. Now we decide to hold $50,000 in cash for emergencies. We can use our remaining $50,000 in one of two ways. We can either pay off $50,000 of our mortgage, or we can pay $50,000 of Verizon stock. Verizon currently has a dividend yield of 5.15%, so our fifty grand would give income of $2575 a year. There is a little risk with holding the stock, but unless people stop making phone calls it is a pretty safe bet.
For the mortgage, assume a 15 year fixed rate mortgage at 3.5%. If you borrow $100,000, you will pay $3418 in interest the first year, and have dividend income of $2575. The net cost of the borrow and invest strategy is $843.
If you down debt and only have a $50,000 mortgage, you will pay $1709 interest the first year. Paying down debt will cost you $866 over the alternative strategy. Since the interest payments will drop each year of the mortgage, but the dividend payment should remain constant, the borrow and invest strategy will outperform the pay down debt strategy by a greater amount every year. By the fifth year, you will be $1152 ahead with the borrow and invest strategy.
Borrowing at a low interest rate and investing at a higher rate is an example of arbitrage, and it is one of the ways that the big boys on Wall Street earn their huge bonuses. They add a lot more zeroes to their numbers, of course.
I’m not saying you shouldn’t pay down debt, and there is something to the psychological lift you can get from not owing any money. But being debt free is not necessarily the best strategy for maximizing your financial well being.
Monday, January 2, 2012
The EEOC muddies the waters.
The New Year opens with a classic example of regulatory overreach. The EEOC has issued an opinion letter questioning whether employers who require a high school diploma for job openings are not violating the Americans with Disabilities Act (ADA). The EEOC’s reasoning is that a blanket requirement would discriminate against individuals who have a learning disability that prevents them getting a high school diploma, but who could learn to do the job in question with reasonable accommodations.
Frankly, although I have not yet heard of a potted plant graduating from high school, I suspect anyone with a pulse who showed up every day could. A for effort and all that. I just have to wonder how severe a learning disability has to be if you can go to school every day and still not complete the requirements for graduation. Based on my experience hiring high school graduates, the requirements for graduation certainly don’t include literacy.
Businesses don’t require high school diplomas because of the intellectual content of the job. It is more of a determinant of character than anything else. If you can’t make it through high school, you have to suspect problems like lack of focus, disrespect for authority, or sheer laziness. All characteristics that don’t exactly endear you to first line supervisors. Maybe over time those problems get resolved. After all, almost everybody eventually grows up. But if that is the case, you can always go back and get a GED.
Approximately 10% of Americans between the ages of 16 and 24 are classified as high school dropouts. Maybe some small percentage of that group has learning disabilities that prevent them from graduation, but don’t prevent them from being good employees. My own highly unscientific survey leads me to think the number is higher with advancing age. Given enough time a river will rub all the rough edges off all the stones in the streambed. But in the meantime employers should be allowed to impose filters on the applicant pool, to narrow the choice of candidates for a job offering. A high school diploma is one that has stood the tests of time and experience.
It’s not clear to me why the EEOC is inserting the government’s snout into private relationships like the hiring decision without presenting any evidence that a large pool of applicants is being discriminated against. Or, for that matter, telling employers what would constitute a reasonable accommodation.
Thursday, December 15, 2011
Loewe's and Religious Discrimination
There has been a minor kerfluffle regarding the giant home improvement retailer Loewe’s this past week.
There is a show called “All American Muslims” on TV. This show, centered on the large Muslim community in Dearborn, Michigan (also home to Ford Motor Company’s headquarters), is designed to show American Muslims assimilating into American culture. Something along the lines of “See, we’re not all terrorists. We’re just like everyone else. We just don’t serve bratwurst at our backyard barbeques. Or beer.” I have to admit I’ve never watched the program, but apparently Loewe’s was a major advertiser.
So Loewe’s was contacted by a Christian interest group called FFA. These guys felt that “All American Muslims” was actually Islamic propaganda, softening us up for the stealth jihad agenda of imposing Sharia law on the United States. FFA began organizing a boycott of Loewe’s.
In response to their threats, Loewe’s decided to pull their ads from the program. This decision got them in hot water with a bunch of other people. Crying out “Religious discrimination” a number of other commentators are calling for a boycott of Loewe’s.
Of course, Loewe’s did not pull their ads because of religious discrimination. If they were concerned about Islam, they never would have run the ads on the show in the first place. Loewe’s in neither pro Islam or pro Christianity. What Loewe’s is in favor of is DIY home improvement.
What Loewe’s is opposed to is the same thing every giant corporation is opposed to: getting their brand identity tied up into controversy. A little buzz about the show that gets people to tune in and be exposed to your advertising: good. A little buzz about your running your ads on that show: bad.
So now Loewe’s is trapped in a classic no win scenario. Continue to run the ads, and risk angering the hard Christian right. Pull the ads, and risk angering the ACLU types and the not insignificant Muslim-American community.
I don’t feel sorry for Loewe’s, though. Nor do I have a lot of sympathy for the FFA, the Muslim-American community, or the ACLU types. My sympathy is reserved for the low level media buyer who decided to place the ads on “All American Muslims” in the first place. Because that poor schlemiel is the guy who placed a multibillion dollar retailer right in the middle of a no win scenario. And somebody is going to have to pay for that mistake.
It’s a dreary, sad thing, losing your job in the middle of the holiday season.
There is a show called “All American Muslims” on TV. This show, centered on the large Muslim community in Dearborn, Michigan (also home to Ford Motor Company’s headquarters), is designed to show American Muslims assimilating into American culture. Something along the lines of “See, we’re not all terrorists. We’re just like everyone else. We just don’t serve bratwurst at our backyard barbeques. Or beer.” I have to admit I’ve never watched the program, but apparently Loewe’s was a major advertiser.
So Loewe’s was contacted by a Christian interest group called FFA. These guys felt that “All American Muslims” was actually Islamic propaganda, softening us up for the stealth jihad agenda of imposing Sharia law on the United States. FFA began organizing a boycott of Loewe’s.
In response to their threats, Loewe’s decided to pull their ads from the program. This decision got them in hot water with a bunch of other people. Crying out “Religious discrimination” a number of other commentators are calling for a boycott of Loewe’s.
Of course, Loewe’s did not pull their ads because of religious discrimination. If they were concerned about Islam, they never would have run the ads on the show in the first place. Loewe’s in neither pro Islam or pro Christianity. What Loewe’s is in favor of is DIY home improvement.
What Loewe’s is opposed to is the same thing every giant corporation is opposed to: getting their brand identity tied up into controversy. A little buzz about the show that gets people to tune in and be exposed to your advertising: good. A little buzz about your running your ads on that show: bad.
So now Loewe’s is trapped in a classic no win scenario. Continue to run the ads, and risk angering the hard Christian right. Pull the ads, and risk angering the ACLU types and the not insignificant Muslim-American community.
I don’t feel sorry for Loewe’s, though. Nor do I have a lot of sympathy for the FFA, the Muslim-American community, or the ACLU types. My sympathy is reserved for the low level media buyer who decided to place the ads on “All American Muslims” in the first place. Because that poor schlemiel is the guy who placed a multibillion dollar retailer right in the middle of a no win scenario. And somebody is going to have to pay for that mistake.
It’s a dreary, sad thing, losing your job in the middle of the holiday season.
Thursday, December 8, 2011
Illegal Immigration: Forever Guilty?
I recently read a story in the news about a Mexican woman who had been deported after living in the US for 21 years. Both her children were US citizens, and she had left them behind. The immigration laws had effectively broken up her family.
Obviously the woman was cherry picked to put current immigration law in the worst possible light. But it does make you think about the nature of the crime she had committed.
Most crimes are crimes of commission, as in committing a felony. You steal an old lady’s purse. You assault someone. You burn down a house. Other crimes are crimes of omission. For example, if you fail to file a tax return, you have broken the law.
Illegal immigration, on the other hand, is neither a crime of commission or of omission. The reason we deport illegal aliens is not because they have entered the country, but because they are in the country. The crime is being here. Illegal immigration is an ontological crime. The only other ontological crime I can think of is DUI. Even if you are driving under the speed limit and obeying all posted traffic signs, if you get stopped by the cops and blow a high level, it is off to the pokey you go.
With DUI though, eventually you sober up. You never stop being an illegal immigrant. Even if you hold down a job for decades, pay taxes, and own property. There is something about that situation that offends my sense of fair play.
Any talk of amnesty for illegal immigrants is a hot button issue, sure to start a fight. But maybe we shouldn’t be using the word “amnesty.” Maybe we should be talking about a statue of limitations instead.
Obviously the woman was cherry picked to put current immigration law in the worst possible light. But it does make you think about the nature of the crime she had committed.
Most crimes are crimes of commission, as in committing a felony. You steal an old lady’s purse. You assault someone. You burn down a house. Other crimes are crimes of omission. For example, if you fail to file a tax return, you have broken the law.
Illegal immigration, on the other hand, is neither a crime of commission or of omission. The reason we deport illegal aliens is not because they have entered the country, but because they are in the country. The crime is being here. Illegal immigration is an ontological crime. The only other ontological crime I can think of is DUI. Even if you are driving under the speed limit and obeying all posted traffic signs, if you get stopped by the cops and blow a high level, it is off to the pokey you go.
With DUI though, eventually you sober up. You never stop being an illegal immigrant. Even if you hold down a job for decades, pay taxes, and own property. There is something about that situation that offends my sense of fair play.
Any talk of amnesty for illegal immigrants is a hot button issue, sure to start a fight. But maybe we shouldn’t be using the word “amnesty.” Maybe we should be talking about a statue of limitations instead.
Wednesday, November 30, 2011
And Then There Were None
AMR, the parent company of American Airlines, filed for Chapter 11 bankruptcy reorganization yesterday. I’m pretty sure AA was the last major air carrier to do so, having been proceeded in bankruptcy court by Continental, USAir, United, Northwest, and Delta, along with lots of smaller airlines.
Interestingly, AMR still had billions of dollars left in the bank. Looking into the future, the management of the company felt that they were better served by filing now, rather than waiting another couple of years and filing for reorganization after running out of cash. This was a preemptive strike.
Although the shareholders got wiped out, they didn’t lose much, since the stock price is down about 90% in the last year. Management’s stock options are worthless, but they’ll be issued a bunch of new shares when the company emerges from the bankruptcy process. Passengers are okay, since the company has already announced they will continue to honor prepaid tickets and frequent flyer miles. The big loser in this process is going to be the employees.
When a company goes through Chapter 11 reorganization, contracts, particularly union contracts, can be renegotiated. And by renegotiated, I mean that the company can dump the pension plan, drop healthcare for retirees, and cut wages and benefits unilaterally, shoving the changes down their unions’ collective throats. We know that the company can do this, because that is pretty much what every other airline has done in bankruptcy.
After all their major competitors went through bankruptcy, American Airlines was stuck in the unenviable position as the airline with the highest costs. And since prices in a market are determined by the producer with the lowest costs, that explains why American lost money in 15 of the last 16 quarters.
American has been trying to wring concessions from their unions to avoid the step they took yesterday, but without much success. You cannot really blame the unions for being intransigent. Having to accept permanent downward mobility is a bitter pill to swallow. Now the concessions they would not agree to will be imposed on them, and maybe more to boot. After all, management will want to emerge from bankruptcy court as the new low cost provider.
Meanwhile, low cost carriers Jet Blue and Southwest continue to expand and prosper.
Interestingly, AMR still had billions of dollars left in the bank. Looking into the future, the management of the company felt that they were better served by filing now, rather than waiting another couple of years and filing for reorganization after running out of cash. This was a preemptive strike.
Although the shareholders got wiped out, they didn’t lose much, since the stock price is down about 90% in the last year. Management’s stock options are worthless, but they’ll be issued a bunch of new shares when the company emerges from the bankruptcy process. Passengers are okay, since the company has already announced they will continue to honor prepaid tickets and frequent flyer miles. The big loser in this process is going to be the employees.
When a company goes through Chapter 11 reorganization, contracts, particularly union contracts, can be renegotiated. And by renegotiated, I mean that the company can dump the pension plan, drop healthcare for retirees, and cut wages and benefits unilaterally, shoving the changes down their unions’ collective throats. We know that the company can do this, because that is pretty much what every other airline has done in bankruptcy.
After all their major competitors went through bankruptcy, American Airlines was stuck in the unenviable position as the airline with the highest costs. And since prices in a market are determined by the producer with the lowest costs, that explains why American lost money in 15 of the last 16 quarters.
American has been trying to wring concessions from their unions to avoid the step they took yesterday, but without much success. You cannot really blame the unions for being intransigent. Having to accept permanent downward mobility is a bitter pill to swallow. Now the concessions they would not agree to will be imposed on them, and maybe more to boot. After all, management will want to emerge from bankruptcy court as the new low cost provider.
Meanwhile, low cost carriers Jet Blue and Southwest continue to expand and prosper.
Sunday, November 20, 2011
Penn State: What would you do?
I've been following the unfolding mess at Penn State for the last couple of weeks. For anyone who hasn't watched the news, a grad jury investigation has handed down indictments after investigations that went on for months. A retired defensive coach, who was still active on the Penn State campus, was charged with 40 counts (40!) of child molestation, over a period going back at least 12 years. Also indicted were the school's athletic director and the VP for Finance and Administration, charged with lying to the grand jury about an incident that occurred in 2002.
In the second act of the drama, Penn State's legendary football coach, Joe Paterno, as well as the university president, were both fired. The trustees felt they had not done enough to push the investigation of the retired coach, Jerry Sandusky. In 2002 they were given specific and credible allegations that Sandusky had been caught having sex with a minor on campus. They called him in and told Sandusky that he was not to bring any more children onto the campus. That was it. No police investigation, no attempt to identify the minor.
The third act of the drama has just begun. Lawyers have been parachuting into Pennsylvania, ringing doorbells in the search for more victims. The taxpayers of Pennsylvania are going to be on the hook for a big settlement by the time this is all through.
One of the more inexplicable aspects of the story was that not once, but twice, individuals walked in on a middle aged man clearly having sex with a young boy. In both cases, they did nothing to intervene, but merely turned around and walked out.
In watercooler conversations about this situation, the conventional wisdom is "I would have done something. I would have gone in there and torn that guy off the kid." I'm guessing that most of us would do no such thing. Why do we think we would behave in a more heroically active fashion than the 28 year old grad student who walked in on Sandusky and his victim in 2002.
History is full of examples of people not taking an active stand on behalf of their morals. In 1964 Kitty Genovese was knifed to death on a public street. At least a dozen people heard her cries for help, and no one intervened. In the sixties, sociologist Stanley Milgram conducted a series of studies where subjects administered what they thought were serious electrical shocks to others, solely because a man in a lab coat told them to. Recently, in China, a small child was struck by a car on a busy street. A number of people passed by in vehicles and on foot without stopping to help.
We all like to think we would act to help others, step in to right a wrong, even if there was some risk to ourselves. Sadly, the evidence indicates otherwise.
Wednesday, November 9, 2011
Another Inspirational Story from Occupy Wall Street
Really, you can't make this stuff up.
This is the lead of an article in The Nation, about an artist participating in the Occupy Wall Street protest in New York:
One scarsely knows where to begin. What kind of elementary school has full time drama teachers? What exactly do they do? Put on the school pagent? I think this was the plot of an episode of Modern Family last year.
Apparently UConn offers a Master's program in puppetry. Who knew? Maybe the program was endowed by Jim Henson: the Kermit the Frog chair in puppetry studies, with the Miss Piggy fellowship available to selected students.
"puppeteers aren't exactly in high demand" Nah, really? Ya think?
But here's the $64 question: What kind of person borrows $35 grand to get an advanced degree in puppetry? I can understand having a passion for puppets. People have passions for all kinds of things. It's part of what makes the world such a varied and interesting place. I can even understand the impulse to try and make a living at it. The idea of making your avocation your vocation is deeply appealing.
But this guy quit a full time job in order to invest three years and $35,000 of somebody else's money in a pursuit so ludicris that it reads like the punchline to a joke. And now he is protesting because "the system" is unfair. It's guys like Joe who give the Occupy movement the high standing it currently enjoys among the employed.
This is the lead of an article in The Nation, about an artist participating in the Occupy Wall Street protest in New York:
A few years ago, Joe Therrien, a graduate of the NYC Teaching Fellows
program, was working as a full-time drama teacher at a public elementary school
in New York City. Frustrated by huge class sizes, sparse resources and a
disorganized bureaucracy, he set off to the University of Connecticut to get an
MFA in his passion—puppetry. Three years and $35,000 in student loans later, he
emerged with degree in hand, and because puppeteers aren’t exactly in high
demand, he went looking for work at his old school.
One scarsely knows where to begin. What kind of elementary school has full time drama teachers? What exactly do they do? Put on the school pagent? I think this was the plot of an episode of Modern Family last year.
Apparently UConn offers a Master's program in puppetry. Who knew? Maybe the program was endowed by Jim Henson: the Kermit the Frog chair in puppetry studies, with the Miss Piggy fellowship available to selected students.
"puppeteers aren't exactly in high demand" Nah, really? Ya think?
But here's the $64 question: What kind of person borrows $35 grand to get an advanced degree in puppetry? I can understand having a passion for puppets. People have passions for all kinds of things. It's part of what makes the world such a varied and interesting place. I can even understand the impulse to try and make a living at it. The idea of making your avocation your vocation is deeply appealing.
But this guy quit a full time job in order to invest three years and $35,000 of somebody else's money in a pursuit so ludicris that it reads like the punchline to a joke. And now he is protesting because "the system" is unfair. It's guys like Joe who give the Occupy movement the high standing it currently enjoys among the employed.
Thursday, November 3, 2011
The Christmas Economic Stimulus
Keynesian economists argue that when the economy is not providing enough jobs, the problem is a lack of demand. If more consumers were clamoring for additional goods and services, businesses would hire workers to provide them. If borrowers are tapped out, either overloaded with debt or saving more because of uncertainty, they cannot increase spending.
Governments, however, can usually continue borrowing even if individuals cannot. When the economy is in recession, the government can run a deficit, and spend the money to pump up demand. Once demand is higher, businesses will hire more workers. With more money in their pockets, workers will spend more, creating even more demand. Once the consumer demand recovers, government can then drop the deficit spending, as aggregate demand will have recovered. Keynes likened it to priming a pump.
This is the economic theory behind the various government stimulus packages that we have seen in the last few years. President Obama’s job program proposal was another along these same lines. It did not get off the ground, due both to partisan politics and a legitimate concern that the Federal government is already carrying too much debt.
It occurs to me, however, that the private sector is about to undergo a burst of increased demand. It’s called the Christmas selling season.
Goods are moving from the warehouses onto store shelves in anticipation of Black Friday. Retailers are hiring additional staff to handle the expected surge in buyers. And the increase in demand is not just limited to presents. At my employer, we are already making deposits for the caterer and DJ at our annual Christmas party. Folks are booking airline flights as they plan their holiday travel.
Viewed as a temporary increase in demand, the holiday season fulfills the same function of a government stimulus package. But we all know what happens after the first of the year. Seasonal workers get laid off. The inevitable credit card bills arrive, causing December’s free spending consumers to retrench in January. Economic activity drops back down again as people tighten their belts.
So when the private sector does a stimulus package, the effects are short term in nature. I wonder why we think it will be longer lasting when the government does it?
Governments, however, can usually continue borrowing even if individuals cannot. When the economy is in recession, the government can run a deficit, and spend the money to pump up demand. Once demand is higher, businesses will hire more workers. With more money in their pockets, workers will spend more, creating even more demand. Once the consumer demand recovers, government can then drop the deficit spending, as aggregate demand will have recovered. Keynes likened it to priming a pump.
This is the economic theory behind the various government stimulus packages that we have seen in the last few years. President Obama’s job program proposal was another along these same lines. It did not get off the ground, due both to partisan politics and a legitimate concern that the Federal government is already carrying too much debt.
It occurs to me, however, that the private sector is about to undergo a burst of increased demand. It’s called the Christmas selling season.
Goods are moving from the warehouses onto store shelves in anticipation of Black Friday. Retailers are hiring additional staff to handle the expected surge in buyers. And the increase in demand is not just limited to presents. At my employer, we are already making deposits for the caterer and DJ at our annual Christmas party. Folks are booking airline flights as they plan their holiday travel.
Viewed as a temporary increase in demand, the holiday season fulfills the same function of a government stimulus package. But we all know what happens after the first of the year. Seasonal workers get laid off. The inevitable credit card bills arrive, causing December’s free spending consumers to retrench in January. Economic activity drops back down again as people tighten their belts.
So when the private sector does a stimulus package, the effects are short term in nature. I wonder why we think it will be longer lasting when the government does it?
Tuesday, October 25, 2011
Occupy Wall Street Continued
The Occupy Wall Street movement has more legs than I originally gave them credit for. The protests have spread to an increasing number of cities, including a number of international sites. There are clearly a lot of people out there who both feel disenfranchised from the current economic system, and have too much time on their hands.
But I still don’t see any evidence of a coherent program of policy demands coming out of the protests. The op-ed writer Tina Depuy has put out a column that claims there is a demand: economic justice. In fact, she repeats the term “economic justice” five or six times in the course of the column. To me, trying to figure out what “economic justice” means is like looking at a Rorshach blot test. You can read anything into it that you want to see.
If you have $100,000 in student loans, maybe economic justice is having the debt written off by the bank. But if you are a stockholder in a bank, why should you write off those loans? Wouldn’t that make you poorer? What if you are a pension fund that has invested in student loans? Don’t you need the students to repay their loans so you can continue making payments to retirees who are depending on those checks? Writing off the debts of 20 somethings and sticking it to 70 somethings doesn’t seem very just to me.
How about the money paid to Wall Street bankers? You could consider it economically unjust that they are making such huge bonuses. But is bankers are going to have their incomes cut, shouldn’t we look at other highly paid individuals, like movie stars and athletes? Take the Yankee player A-Rod, for example. His salary alone is more than the total payroll of half the teams in Major League Baseball, yet the Yankees got eliminated early this year. Paying somebody that much for losing doesn’t seem very just to me.
Then there is joblessness. People need jobs! Of course, the last time I checked, the military was still recruiting. But the folks of OWS probably don’t want those jobs. They want the jobs they want.
Now, if you want to reinstate the Glass-Steagall Act, I could see how that could be a useful policy to advocate for. But I would bet that not one in a thousand of the OWS protestors world-wide could tell you what the original Glass-Steagall Act did, so somehow I doubt that is driving the train.
The problem with fuzzy concepts like “economic justice” is that they mean something different to almost everyone, which is like saying that they mean nothing at all.
But I still don’t see any evidence of a coherent program of policy demands coming out of the protests. The op-ed writer Tina Depuy has put out a column that claims there is a demand: economic justice. In fact, she repeats the term “economic justice” five or six times in the course of the column. To me, trying to figure out what “economic justice” means is like looking at a Rorshach blot test. You can read anything into it that you want to see.
If you have $100,000 in student loans, maybe economic justice is having the debt written off by the bank. But if you are a stockholder in a bank, why should you write off those loans? Wouldn’t that make you poorer? What if you are a pension fund that has invested in student loans? Don’t you need the students to repay their loans so you can continue making payments to retirees who are depending on those checks? Writing off the debts of 20 somethings and sticking it to 70 somethings doesn’t seem very just to me.
How about the money paid to Wall Street bankers? You could consider it economically unjust that they are making such huge bonuses. But is bankers are going to have their incomes cut, shouldn’t we look at other highly paid individuals, like movie stars and athletes? Take the Yankee player A-Rod, for example. His salary alone is more than the total payroll of half the teams in Major League Baseball, yet the Yankees got eliminated early this year. Paying somebody that much for losing doesn’t seem very just to me.
Then there is joblessness. People need jobs! Of course, the last time I checked, the military was still recruiting. But the folks of OWS probably don’t want those jobs. They want the jobs they want.
Now, if you want to reinstate the Glass-Steagall Act, I could see how that could be a useful policy to advocate for. But I would bet that not one in a thousand of the OWS protestors world-wide could tell you what the original Glass-Steagall Act did, so somehow I doubt that is driving the train.
The problem with fuzzy concepts like “economic justice” is that they mean something different to almost everyone, which is like saying that they mean nothing at all.
Wednesday, October 12, 2011
Occupy Wall Street vs. Tea Party
Much comparison has been made between the Occupy Wall Street protestors and the tea party movement. The commentary is that even as the tea partiers are a grassroots movement espousing a varied, but generally conservative agenda, so the OWS crew is the left wing equivalent. The laundry list of desired policies from the Occupiers runs the gamut, from calls to intensively regulate the capital markets, to a push for some sort of government jobs program that will put large numbers of the unemployed back to work.
But I see far more structural and philosophical distinctions than similarities between the tea party and OWS, even taking their policy differences into account.
The tea party protests were geographically far flung, and were most effective by working within the democratic system. At literally hundreds of town hall meetings, all across the country, citizens came forward to meet with their elected representatives and express displeasure over government’s increasing reach. The same groups that showed up to protest went on to push for candidates who believed in limited government, and helped get a number elected.
The Occupy Wall Street protests are (so far) an exclusively urban phenomena, and do not seem to be spreading beyond a handful of cities. New York, Washington, Boston, Seattle and Chicago are the one’s I have heard of. No Occupy San Diego, or Occupy Indianapolis has made the news yet.
Also, while both Occupiers and tea partiers are activated by a sense that the government is no longer working for their interests, on the tea party side the theme is generally for a smaller government, and particularly an opposition to tax increases. Of course, many tea partiers are drawing plenty of government benefits already. A more nuanced statement of their position would be that the government is just big enough. Any benefit cuts should come out of programs they don’t use. The real desire is to oppose tax increases.
In a hyper-partisan political environment, saying no to taxes seems to be a strategy that is winning.
The Occupiers want a bigger government, or at least a government that is just enough bigger to give them something. Taken collectively, there would be quite a smorgasbord of increased spending to make all of them happy. To pay for their increased benefits, they want somebody else to foot the bill.
When the Federal government is already running a 40% deficit, expansion doesn’t seem like a good idea, even if you do get to soak the rich to help.
So you’ve got one movement that is geographically diverse, is focused on a primary objective, and is meeting the lawmakers in their districts. You’ve got another movement that is geographically restricted, wants lawmakers to come to them, and has a laundry list of demands.
Advantage, tea party.
But I see far more structural and philosophical distinctions than similarities between the tea party and OWS, even taking their policy differences into account.
The tea party protests were geographically far flung, and were most effective by working within the democratic system. At literally hundreds of town hall meetings, all across the country, citizens came forward to meet with their elected representatives and express displeasure over government’s increasing reach. The same groups that showed up to protest went on to push for candidates who believed in limited government, and helped get a number elected.
The Occupy Wall Street protests are (so far) an exclusively urban phenomena, and do not seem to be spreading beyond a handful of cities. New York, Washington, Boston, Seattle and Chicago are the one’s I have heard of. No Occupy San Diego, or Occupy Indianapolis has made the news yet.
Also, while both Occupiers and tea partiers are activated by a sense that the government is no longer working for their interests, on the tea party side the theme is generally for a smaller government, and particularly an opposition to tax increases. Of course, many tea partiers are drawing plenty of government benefits already. A more nuanced statement of their position would be that the government is just big enough. Any benefit cuts should come out of programs they don’t use. The real desire is to oppose tax increases.
In a hyper-partisan political environment, saying no to taxes seems to be a strategy that is winning.
The Occupiers want a bigger government, or at least a government that is just enough bigger to give them something. Taken collectively, there would be quite a smorgasbord of increased spending to make all of them happy. To pay for their increased benefits, they want somebody else to foot the bill.
When the Federal government is already running a 40% deficit, expansion doesn’t seem like a good idea, even if you do get to soak the rich to help.
So you’ve got one movement that is geographically diverse, is focused on a primary objective, and is meeting the lawmakers in their districts. You’ve got another movement that is geographically restricted, wants lawmakers to come to them, and has a laundry list of demands.
Advantage, tea party.
Wednesday, October 5, 2011
Occupy Wall Street?
I confess I am absolutely mystified by the Occupy Wall Street protests. There doesn’t seem to be any coherent theme or agenda behind the protestors.
Are they advocating specific regulation in the financial industry? I certainly can’t tell that from the news coverage. Are they attempting to disrupt operations on Wall Street? If so, the organizers flunked out of protestor camp, because it is business as usual.
Now the labor unions are getting involved. Several unions have announced plans to join the Occupy Wall Street protests. The unions appear to be supporting the idea that union members should be getting higher wages and better benefits. What this has to do with credit default swaps and collateralized debt obligations is anybody’s guess.
The most recent stunt was for some of the protestors to wear zombie makeup and pretend to be zombie corporate workers. I’m just not sure what that is supposed to symbolize.
Lots of questions, and not very many answers. I know why the protestors are getting on the news every day. Protests make for great television visuals. But if you cannot articulate what you stand for, don’t be surprised when you don’t get what you want.
Unless you want to be an extra for the TV show The Living Dead. Because the protestors are getting great training for that.
Are they advocating specific regulation in the financial industry? I certainly can’t tell that from the news coverage. Are they attempting to disrupt operations on Wall Street? If so, the organizers flunked out of protestor camp, because it is business as usual.
Now the labor unions are getting involved. Several unions have announced plans to join the Occupy Wall Street protests. The unions appear to be supporting the idea that union members should be getting higher wages and better benefits. What this has to do with credit default swaps and collateralized debt obligations is anybody’s guess.
The most recent stunt was for some of the protestors to wear zombie makeup and pretend to be zombie corporate workers. I’m just not sure what that is supposed to symbolize.
Lots of questions, and not very many answers. I know why the protestors are getting on the news every day. Protests make for great television visuals. But if you cannot articulate what you stand for, don’t be surprised when you don’t get what you want.
Unless you want to be an extra for the TV show The Living Dead. Because the protestors are getting great training for that.
Thursday, September 22, 2011
How Do You Lose $2 Billion, Part II
News has continued to trickle out regarding the UBS rogue trader in London who lost $2 billion of the bank’s money. But not much news. It has dropped completely off the top stories on my Google news feed. There is plenty of speculation out there, however.
One piece of the story that has been out from the beginning is that the trader in question worked at the “Delta 1 trading desk” in UBS’s London office. This is a standard department in all of the big global investment banks. What these trading desks do is engage in trades for securities that are supposed to move up and down in lockstep. A change (or delta) in one stock of 1%, should be matched by a 1% change in other stocks. Of course, with any actively traded security, the correlation is never perfect, which opens up opportunities to make money.
The Delta 1 desk is supposed to engage in arbitrage, not speculation. Speculation involves swinging for the fences. Bigger risks, but correspondingly bigger rewards. Arbitrage, on the other hand, is about engaging in risk-free transactions that still provide a positive return.
Let’s say you are speculating on the price of wheat. Based on your analysis of global weather patterns, you think the harvest will be bad, and wheat prices will be higher a year from now. You can go into the futures markets and contract to buy (a long position) 10,000 bushels of wheat a year from now, with a price of $1.60 per bushel. A year from now, if you are right, the spot price of wheat goes up to $1.90 per bushel. But your contract says you can buy at $1.60. Your contract is now worth 1.90-1.60, 30 cents a bushel. But there is no guarantee. If the price of wheat actually falls, you can lose money. That’s speculation.
Now change the situation. Imagine that someone will sell you 10,000 bushels of wheat today for $1.50 per bushel. They’ll store it for a year for $200. Your cost of capital to buy the wheat is 5%. You buy the wheat, and then you go into the futures market and contract to sell (a short position) the wheat a year from now at the same $1.60 per bushel. Your costs for wheat, storage, and interest are $15000+200+750, for a total of $15950. A year from now you deliver your wheat and collect $16000. You make a small profit of $50. But by buying and selling simultaneously, you have eliminated any risk. The weather can be good, bad, or indifferent. You are insulated from movements in the spot price. That’s arbitrage.
What Delta 1 traders are supposed to be doing is arbitrage. The net total of your buy positions and the net total of your sell positions are always supposed to be close together. That way your bets are hedged. You can’t make much money on any individual trade, but if something unexpected happens, you won’t lose a lot of money either.
What UBS’s rogue trader was doing was faking one half of the equation. He was placing large speculative bets, and then falsifying the paperwork on the offsetting hedges. Eventually, someone noticed that things weren’t lining up properly, and he was caught.
But $2.3 billion is a lot of misalignment.
One piece of the story that has been out from the beginning is that the trader in question worked at the “Delta 1 trading desk” in UBS’s London office. This is a standard department in all of the big global investment banks. What these trading desks do is engage in trades for securities that are supposed to move up and down in lockstep. A change (or delta) in one stock of 1%, should be matched by a 1% change in other stocks. Of course, with any actively traded security, the correlation is never perfect, which opens up opportunities to make money.
The Delta 1 desk is supposed to engage in arbitrage, not speculation. Speculation involves swinging for the fences. Bigger risks, but correspondingly bigger rewards. Arbitrage, on the other hand, is about engaging in risk-free transactions that still provide a positive return.
Let’s say you are speculating on the price of wheat. Based on your analysis of global weather patterns, you think the harvest will be bad, and wheat prices will be higher a year from now. You can go into the futures markets and contract to buy (a long position) 10,000 bushels of wheat a year from now, with a price of $1.60 per bushel. A year from now, if you are right, the spot price of wheat goes up to $1.90 per bushel. But your contract says you can buy at $1.60. Your contract is now worth 1.90-1.60, 30 cents a bushel. But there is no guarantee. If the price of wheat actually falls, you can lose money. That’s speculation.
Now change the situation. Imagine that someone will sell you 10,000 bushels of wheat today for $1.50 per bushel. They’ll store it for a year for $200. Your cost of capital to buy the wheat is 5%. You buy the wheat, and then you go into the futures market and contract to sell (a short position) the wheat a year from now at the same $1.60 per bushel. Your costs for wheat, storage, and interest are $15000+200+750, for a total of $15950. A year from now you deliver your wheat and collect $16000. You make a small profit of $50. But by buying and selling simultaneously, you have eliminated any risk. The weather can be good, bad, or indifferent. You are insulated from movements in the spot price. That’s arbitrage.
What Delta 1 traders are supposed to be doing is arbitrage. The net total of your buy positions and the net total of your sell positions are always supposed to be close together. That way your bets are hedged. You can’t make much money on any individual trade, but if something unexpected happens, you won’t lose a lot of money either.
What UBS’s rogue trader was doing was faking one half of the equation. He was placing large speculative bets, and then falsifying the paperwork on the offsetting hedges. Eventually, someone noticed that things weren’t lining up properly, and he was caught.
But $2.3 billion is a lot of misalignment.
Sunday, September 18, 2011
UBS Loses $2 Billion: Part I
The financial world was rocked by a scandal last week. UBS, the giant Swiss bank, announced losses of over $2 billion in unauthorized trades. The losses were generated by one trader in their London office.
The obvious reaction is "Two billion dollars! How does one guy lose two billion dollars?"
We don't know yet, and the details will only trickle out over the next few weeks. Already this weekend, UBS has revealed that the trades that generated the losses occurred over a period of about three months, and that the total losses came to about $2.3 billion.
"Two point three billion dollars! How does one guy lose two point three billion dollars?"
We have now seen enough of these "rogue trader" cases to make a few predictions about the story that will emerge as the investigation continues.
1. It started out much smaller. These guys don't start out placing $2 billion bets in the giant global casino known as our modern capital markets. Far more likely is that he screwed up some trades, maybe from something as mundane as a keystroke error. "Sell a million euros at the preset price. At most I'll lose a million. Holy crap, how did that extra zero get in there!" You lose a big enough chunk of money, and you will get fired. So now the thought process runs "I can't tell my boss about losing $10 million; I'll get fired. And my swanky bachelor pad costs $10 grand a month in rent. I have to earn that money back."
2. Risk controls were defeated. In the giant global casino known as our modern capital markets, the senior management of the investment banks is aware that it might not be the best idea to hand company credit cards with no limit out to a bunch of testosterone fueled 25-30 year olds who are amped up on Red Bull. So instead, they give them cards with credit limits. Essentially, every bank has systems in place to measure how much the bank could potentially lose from each trader's positions. In every case of a "rogue trader" those systems have been circumvented. Part of the problem here is that the big money is made by trading, and coming up with newer, ever more exotic financials instruments. The small money is made by working in risk management. The best and the brightest aren't clamoring to work in the field.
3. The problem got much bigger quickly. Once you've lost a bunch of money, decided to try and make it back, and figured out how to make bigger and bigger trades without senior management catching on, you start doubling down on your trading positions. Trading positions are what ordinary people would call betting, but we don't work in the giant global casino known as our modern capital markets. Let's say you start by losing $10 million. You place another $10 million bet to get it back. Once you lose that, now you've got to make $20 million back. The losses can grow geometrically at this point. If you double down and lose it all every time, it only takes 8 trades to get to the level of losses experienced by UBS.
The rest of this story will eventually emerge. When it does, I'm going to try and put the details into plain English.
Thursday, September 8, 2011
Unemployment: We're On Our Own
The President is scheduled to make a major address on jobs and job creation this evening. He is going to unveil his plan for reducing the unemployment rate below the 9% level where it seems to be stuck. I plan to be doing something else during the speech, maintaining my near unbroken, bipartisan record of skipping presidential addresses.
President Obama will probably propose a bold new program of infrastructure rebuilding. This will be combined with tax credits for companies that hire new employees and maybe a request for money to retrain displaced workers. This will be combined with lines like “let’s get this country moving again.”
The problem is that almost none of what he proposes is going to work. Tax credits have been tried before, and failed miserably, during the Carter administration. A $500 credit, or even a $1000 credit, simply is not enough incentive to convince employers to add on employees they don’t need. Conversely, if you do need to hire someone, you are going to do it whether tax credits are available or not.
Retraining sounds like a good idea, but community colleges are set up to produce entry level employees with no experience. Taking a couple of classes for six months to a year will not lead to a new career.
As for a massive Federal jobs program, that is going to run into fiscal realities. The government is spending 40% more than it is taking in tax revenue. A bipartisan super committee of Congressmen and Senators is currently doing the planning for a major round of spending cuts.
Besides, what does an infrastructure rebuilding program really consist of? A bunch of work crews filling potholes and painting bridges. Does anybody really think that an unemployed office worker who’s a hundred pounds overweight is going to take a job on a road crew? Those positions would probably be filled by illegal immigrants with fake social security numbers.
Nope, a big jobs program is an idea that would be dead on arrival. All that’s left is a bunch of high sounding phrases about how the government is no going to abandon the people who need help in this crisis.
Now, it is easy for me to be blasé about the unemployment rate. After all, I still have a job. But it seems to me that the best thing the President can do about jobs in this country is tell the truth: we’re on our own. It is not the Federal government’s responsibility to provide jobs. Even if it was, deficit spending has reached its limit and beyond.
Anybody who is waiting for the Feds to ride in like the cavalry and create a bunch of jobs is going to be sorely disappointed. The first step to solving a problem is to admit that the problem exists. Everybody agrees that high unemployment is a problem. But the second step towards solving a problem is taking ownership of the problem. As long as we think it is the President’s, or Congress’s, or the Federal government problem to solve unemployment, people will not take whatever necessary steps to reinvent themselves and find work.
You see, it is up to us, to get this country moving again.
President Obama will probably propose a bold new program of infrastructure rebuilding. This will be combined with tax credits for companies that hire new employees and maybe a request for money to retrain displaced workers. This will be combined with lines like “let’s get this country moving again.”
The problem is that almost none of what he proposes is going to work. Tax credits have been tried before, and failed miserably, during the Carter administration. A $500 credit, or even a $1000 credit, simply is not enough incentive to convince employers to add on employees they don’t need. Conversely, if you do need to hire someone, you are going to do it whether tax credits are available or not.
Retraining sounds like a good idea, but community colleges are set up to produce entry level employees with no experience. Taking a couple of classes for six months to a year will not lead to a new career.
As for a massive Federal jobs program, that is going to run into fiscal realities. The government is spending 40% more than it is taking in tax revenue. A bipartisan super committee of Congressmen and Senators is currently doing the planning for a major round of spending cuts.
Besides, what does an infrastructure rebuilding program really consist of? A bunch of work crews filling potholes and painting bridges. Does anybody really think that an unemployed office worker who’s a hundred pounds overweight is going to take a job on a road crew? Those positions would probably be filled by illegal immigrants with fake social security numbers.
Nope, a big jobs program is an idea that would be dead on arrival. All that’s left is a bunch of high sounding phrases about how the government is no going to abandon the people who need help in this crisis.
Now, it is easy for me to be blasé about the unemployment rate. After all, I still have a job. But it seems to me that the best thing the President can do about jobs in this country is tell the truth: we’re on our own. It is not the Federal government’s responsibility to provide jobs. Even if it was, deficit spending has reached its limit and beyond.
Anybody who is waiting for the Feds to ride in like the cavalry and create a bunch of jobs is going to be sorely disappointed. The first step to solving a problem is to admit that the problem exists. Everybody agrees that high unemployment is a problem. But the second step towards solving a problem is taking ownership of the problem. As long as we think it is the President’s, or Congress’s, or the Federal government problem to solve unemployment, people will not take whatever necessary steps to reinvent themselves and find work.
You see, it is up to us, to get this country moving again.
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