The US House passed a $813 billion dollar stimulus package spending bill yesterday. The vote went along party lines, with the Republicans, in a remarkable show of party unity, voting 100% opposed. It will now proceed on to the Senate.
There has been a steady drumbeat of bad economic news in the last few weeks, with a number of major companies, from Alcoa to Starbucks, announcing major job cuts. Both consumer and business confidence are at low ebbs. So I think a stimulus package is probably a good thing at this point. But I think there hasn’t been much discussion about the purpose behind the stimulus. Put another way, what is the stimulus intended to accomplish?
Most of the rhetoric has been about job creation. The debate has been couched in terms of what puts people back to work faster, spending or tax cuts. My perspective is that the emphasis on job creation is misplaced. As a conservative, I would argue that the purpose of government is not to guarantee everybody a job (an impossible task in any case). The major purpose of government is to safeguard our liberties, with a minor in promote the general welfare.
The purpose of the stimulus should be to create an inflection point in the general trend line of the economy. To do that, we need to break up the current negative feedback loop driving decision making.
I can see my mother now, saying “What the Hell does that mean?”
First, let’s talk about inflection points. Anytime you look at a graph, the line is trending downward over time, or it is trending upwards over time. If you have a graph that shows both, the spot where the trend changes from down to up or up to down is the inflection point. The economy is trending down right now, and from the news, it is trending down pretty steeply. What the stimulus should do is reverse that trend, to get the economy growing again. That will be difficult because the downward trend is being fed by a negative feedback loop.
Here is the mechanism at work: demand is soft, so companies layoff workers. Once they are laid off, those workers cut back on their spending. Since they are not spending, demand for products and services drops further. With lower demand, more companies announce layoffs, leading to another round of reduced spending, lower demand, and more layoffs. The cycle feeds on itself. Another term for a negative feedback loop is a viscous circle.
Adding to the problem are the effects of fear. People who haven’t lost their jobs yet say “I could be next,” and cut back on their spending as well to conserve cash. This is perfectly natural (by which I mean I’m doing it too), but it steepens the decline.
In a growing economy, as demand increases, businesses hire more employees. Those new employees start spending more, increasing demand, leading to more hiring, driving spending higher, and so on. This is a positive feedback loop, also known a virtuous cycle. Once businesses increase in confidence, they start investing in capital. Capital investment both drives the cycle higher and leads to productivity improvement, bringing higher standards of living as well as more jobs.
The emphasis on turning the economy around versus merely creating jobs is critical. A goal of job creation will lead to an expansion of government payrolls. The easiest way to make sure everyone has a job is to keep hiring. But once you add government positions, it is hard to remove them. You end up with higher government costs for the long term.
An emphasis on a short term surge to kick start the private sector leaves the long term heavy lifting to the private sector. And it is the private sector which will develop the productivity improvements that will raise living standards in the long run.
Thursday, January 29, 2009
Tuesday, January 27, 2009
Ski Trip '09
I just got back from my annual ski trip this weekend. Although I live in Tennessee, I still go out with the Ski Club of Sarasota. This marked my nineteenth year of going skiing with the club. This year I went on one of the trips organized by the Florida Ski Council. The Council puts together several trips a year where all of the member clubs send a contingent. This allows the Council to pool the buying power of the various clubs, and negotiate a better deal from the ski area.
This year’s trip was to Snowmass, a resort located near Aspen.
Now, the thing about skiing is that after you schuss down the hill, you have to spend about seven to ten minutes riding the ski lift back up the hill. Since you get on the lift in the order in which you reach the bottom of the run, the people who ride up with you are a pretty random assortment of the people who are skiing that day.
It is very quiet on the lift, so I kill time by yakking with my fellow passengers. It was an interesting cross section of Americans, with more than a few Australians thrown in. A couple of quick impressions were formed:
A ski vacation to a destination resort like Snowmass is an expensive undertaking. With everything in, from airport parking and baggage charges down to the $23 cheeseburger lunch on the mountain, I dropped about $2000 per person for the trip. In tough economic times, you would expect a big ticket discretionary expense like a ski vacation to be dropped by a lot of people. Anecdotally, this appeared to be the case, as a number of my fellow travelers noted the complete lack of lift lines. This was confirmed by one property manager I rode up with, as he told me bookings in the properties he managed were off by over 30%.
Counterintuitively, this same property manager told me that some of the owners he represented were turning down low-ball offers to rent houses. These owners would turn down valid offers at below the listed rental rate, preferring to take themselves out of the market before they cut their price. I can only conclude that represents either A) a failed negotiation: the owners who turned down the offer will wish they had accepted it when no other offers come along; or B) the owners do not care if their property is drawing an income or not.
Since houses in the Aspen area sell for millions of dollars, proposition B supposes that there is a significant population of owners who can afford to park millions of dollars of equity into property that they only use a few weeks out of the year.
I’m in the wrong line of work!
This year’s trip was to Snowmass, a resort located near Aspen.
Now, the thing about skiing is that after you schuss down the hill, you have to spend about seven to ten minutes riding the ski lift back up the hill. Since you get on the lift in the order in which you reach the bottom of the run, the people who ride up with you are a pretty random assortment of the people who are skiing that day.
It is very quiet on the lift, so I kill time by yakking with my fellow passengers. It was an interesting cross section of Americans, with more than a few Australians thrown in. A couple of quick impressions were formed:
A ski vacation to a destination resort like Snowmass is an expensive undertaking. With everything in, from airport parking and baggage charges down to the $23 cheeseburger lunch on the mountain, I dropped about $2000 per person for the trip. In tough economic times, you would expect a big ticket discretionary expense like a ski vacation to be dropped by a lot of people. Anecdotally, this appeared to be the case, as a number of my fellow travelers noted the complete lack of lift lines. This was confirmed by one property manager I rode up with, as he told me bookings in the properties he managed were off by over 30%.
Counterintuitively, this same property manager told me that some of the owners he represented were turning down low-ball offers to rent houses. These owners would turn down valid offers at below the listed rental rate, preferring to take themselves out of the market before they cut their price. I can only conclude that represents either A) a failed negotiation: the owners who turned down the offer will wish they had accepted it when no other offers come along; or B) the owners do not care if their property is drawing an income or not.
Since houses in the Aspen area sell for millions of dollars, proposition B supposes that there is a significant population of owners who can afford to park millions of dollars of equity into property that they only use a few weeks out of the year.
I’m in the wrong line of work!
Thursday, January 15, 2009
"Who is this guy FICA..."
Timothy Geithner, the president of the Federal Reserve Bank of New York, is Barack Obama’s nominee to become the next Treasury Secretary, i.e., the guy who hands out all the fat checks of bailout money. During his confirmation hearings, it has come to light that he filed his taxes improperly for three years running, and had to pay a bunch of back taxes. With interest.
Here’s what happened: In 2001, 2002, and 2003, Geithner was employed by the International Monetary Fund. Because the IMF is an international organization, they do not collect Social Security and Medicare taxes from their US employees (I remember the Friends episode where Rachel got her first paycheck ever: “Who is this guy FICA, and why does he get so much of my money”).
Now, the US employees of international organizations such as the IMF are not exempted from Social Security and Medicare taxes. Instead, even though the employees get a W-2, they also have to pay self employment taxes. That tax rate is about 15%, because the employee pays both halves: the half that is normally withheld from a paycheck, and the half that the employer normally pays without reporting it on the pay stub.
I remember the first time my wife took a foray into owning her own business, and encountered this self employment tax. Wife (in tears): “I worked so hard for that money. Now I have to pay 15%, plus more for income taxes? I don’t think it’s fair for the government to get so much of my money.” Husband: “Welcome to the Republican Party, my love.” But I digress.
Apparently, Mr. Geithner failed to report this self employment tax for those three years (plus a small portion of 2004, but who’s counting?). He did his taxes himself for 2001, and then used an accountant for 2002 and 2003 tax years. This oddity of being an employee, but still having to pay self employment taxes, only hits a few people. So it is perhaps understandable that both he and his accountant missed it. When the IRS caught up with him, he ‘fessed up and paid a settlement. No harm, no foul, right? Anybody can make a mistake, right?
Except that there are a couple of things that stand out in this situation.
First of all, the Treasury Secretary oversees the Internal Revenue Service. Shouldn’t the guy overseeing tax collection be able to, oh, I don’t know, do his own taxes without screwing it up?
Secondly, it turns out that the people who run the payroll at the IMF do know about this self employment tax loophole. For the US employees who have to pay the self employment tax, they add money to your salary to cover the 7.5% that the employer normally pays. The practice is called “grossing up,” as in they increase your gross pay by 7.5%.
Where it gets really interesting is that the gross up pay is paid out quarterly. So this raises the question: what did Geithner think those extra payments were for? Good behavior?
Think back sixteen years. When Bill Clinton was elected, his first pick for Attorney General was Zoe Baird. Ms. Baird, a high powered corporate attorney of considerable experience, was torpedoed when it came to light during the confirmation process that she had used an undocumented immigrant as household staff for several years, and that she had failed to pay the proper taxes for her employee. It was felt that the most senior law enforcement official in the US shouldn’t be someone who had broken the law.
Sixteen years later, a completely different political climate reigns. Mr. Geithner is almost certainly going to sail on to confirmation in the Senate. Still, it makes me wonder. How many other US employees of the IMF have gotten their taxes wrong this way?
Here’s what happened: In 2001, 2002, and 2003, Geithner was employed by the International Monetary Fund. Because the IMF is an international organization, they do not collect Social Security and Medicare taxes from their US employees (I remember the Friends episode where Rachel got her first paycheck ever: “Who is this guy FICA, and why does he get so much of my money”).
Now, the US employees of international organizations such as the IMF are not exempted from Social Security and Medicare taxes. Instead, even though the employees get a W-2, they also have to pay self employment taxes. That tax rate is about 15%, because the employee pays both halves: the half that is normally withheld from a paycheck, and the half that the employer normally pays without reporting it on the pay stub.
I remember the first time my wife took a foray into owning her own business, and encountered this self employment tax. Wife (in tears): “I worked so hard for that money. Now I have to pay 15%, plus more for income taxes? I don’t think it’s fair for the government to get so much of my money.” Husband: “Welcome to the Republican Party, my love.” But I digress.
Apparently, Mr. Geithner failed to report this self employment tax for those three years (plus a small portion of 2004, but who’s counting?). He did his taxes himself for 2001, and then used an accountant for 2002 and 2003 tax years. This oddity of being an employee, but still having to pay self employment taxes, only hits a few people. So it is perhaps understandable that both he and his accountant missed it. When the IRS caught up with him, he ‘fessed up and paid a settlement. No harm, no foul, right? Anybody can make a mistake, right?
Except that there are a couple of things that stand out in this situation.
First of all, the Treasury Secretary oversees the Internal Revenue Service. Shouldn’t the guy overseeing tax collection be able to, oh, I don’t know, do his own taxes without screwing it up?
Secondly, it turns out that the people who run the payroll at the IMF do know about this self employment tax loophole. For the US employees who have to pay the self employment tax, they add money to your salary to cover the 7.5% that the employer normally pays. The practice is called “grossing up,” as in they increase your gross pay by 7.5%.
Where it gets really interesting is that the gross up pay is paid out quarterly. So this raises the question: what did Geithner think those extra payments were for? Good behavior?
Think back sixteen years. When Bill Clinton was elected, his first pick for Attorney General was Zoe Baird. Ms. Baird, a high powered corporate attorney of considerable experience, was torpedoed when it came to light during the confirmation process that she had used an undocumented immigrant as household staff for several years, and that she had failed to pay the proper taxes for her employee. It was felt that the most senior law enforcement official in the US shouldn’t be someone who had broken the law.
Sixteen years later, a completely different political climate reigns. Mr. Geithner is almost certainly going to sail on to confirmation in the Senate. Still, it makes me wonder. How many other US employees of the IMF have gotten their taxes wrong this way?
Monday, January 12, 2009
Bernie Madoff's Victims
I’ve been reading a lot about Bernie Madoff in the news recently. Bernie is the Wall Street financier who has owned a securities trading firm for four decades. He was one of the pioneers of electronic trading, and was actually president of the NASDAQ organization for a couple of years. As a market maker, he was one of the most respected members of the Wall Street finance community.
He also ran a money management firm, noted for taking cash from wealthy individuals and other money management firms and producing consistent, steady returns of 1% to 2% a month.
Except that it now appears that Bernie wasn’t actually investing the money he was given. He was making up the posted gains, and using the money new investors gave him to pay cash distributions to older investors. A Ponzi scheme. The biggest, longest lasting Ponzi scheme in history.
So now I am reading stories from people who lost everything from a couple of hundred thousand dollars to a couple of million dollars up to institutions that have lost billions of dollars. Estimates of total losses have run as high as $50 billion dollars.
But here’s what I want to know: Can you truly lose money that you never had? For example, I read one account of an investor who put $25,000 into a fund that invested with Madoff in 1992. Even though the investor pulled out cash distributions every year, his investment had grown to $150,000. In his account, the investor said he had lost all $150,000.
The thing is, the investor never had $150,000. He only thought he had that much because Madoff told him he had that much. The most he ever had at risk was the original $25,000, and he had probably gotten most of that back in distributions over the years. So what is the true loss?
A Ponzi scheme is essentially a zero sum game. A zero sum game is one where the winnings of some of the players are offset by the losses of the other players. The individual running the scheme, in this case, Bernie Madoff, takes a cut off the top. Madoff’s skim, however, appears to be miniscule compared with the sums invested. I mean, the guy lived well, but not that well.
When all the forensic accounting is completed, the losses of later investors are going to be balanced with the gains of the earlier investors. And once that accounting is done, the losers are going to hire lawyers and try and get their money back from the winners.
Thousands of plaintiffs and defendants, all using lawyers to fight over money. Now that’s not a zero sum game. That’s a negative sum game.
Except for the lawyers.
He also ran a money management firm, noted for taking cash from wealthy individuals and other money management firms and producing consistent, steady returns of 1% to 2% a month.
Except that it now appears that Bernie wasn’t actually investing the money he was given. He was making up the posted gains, and using the money new investors gave him to pay cash distributions to older investors. A Ponzi scheme. The biggest, longest lasting Ponzi scheme in history.
So now I am reading stories from people who lost everything from a couple of hundred thousand dollars to a couple of million dollars up to institutions that have lost billions of dollars. Estimates of total losses have run as high as $50 billion dollars.
But here’s what I want to know: Can you truly lose money that you never had? For example, I read one account of an investor who put $25,000 into a fund that invested with Madoff in 1992. Even though the investor pulled out cash distributions every year, his investment had grown to $150,000. In his account, the investor said he had lost all $150,000.
The thing is, the investor never had $150,000. He only thought he had that much because Madoff told him he had that much. The most he ever had at risk was the original $25,000, and he had probably gotten most of that back in distributions over the years. So what is the true loss?
A Ponzi scheme is essentially a zero sum game. A zero sum game is one where the winnings of some of the players are offset by the losses of the other players. The individual running the scheme, in this case, Bernie Madoff, takes a cut off the top. Madoff’s skim, however, appears to be miniscule compared with the sums invested. I mean, the guy lived well, but not that well.
When all the forensic accounting is completed, the losses of later investors are going to be balanced with the gains of the earlier investors. And once that accounting is done, the losers are going to hire lawyers and try and get their money back from the winners.
Thousands of plaintiffs and defendants, all using lawyers to fight over money. Now that’s not a zero sum game. That’s a negative sum game.
Except for the lawyers.
Thursday, January 8, 2009
Happy New Year, Part II
In my last post I discussed the theme of deleveraging for 2009. By deleveraging, I mean reducing the ratio of debt to equity on both household and corporate balance sheets.
There are a number of ways an individual household can reduce leverage. Probably the most painful is to have your house foreclosed on. Since a home mortgage is typically the largest source of debt for a family, losing your home means losing most of your debt all at once. Not recommended, but if your mortgage payment is greater than market rent, moving into a rental will free up your cash flow.
A bankruptcy is less effective at reducing leverage than foreclosure. Most states protect your home equity during a bankruptcy filing. You can drop most of your credit card payments, but you still have the debt associated with your mortgage. Foreclosure and bankruptcy have got to be the two most painful ways of deleveraging.
The least painful way to reduce debt is to reduce current consumption and divert more of your cash flow into paying off debt. Whether paying off credit cards or making extra equity payments on a mortgage, either way you are reducing household debt.
Actually, it may be even less painful to increase income and put that extra money into debt retirement. Start up a sideline business or get a part-time second job. But in today’s market, those options may not be as readily available as they were even a year ago.
In the struggle to pay off debt, there are two schools of thought on which debts to pay of first. One school holds that the best idea is to focus most of your effort into paying down the debts with the highest interest rates. That way you lower the burden of finance charges faster. The other school of thought is to pay down the smallest debts first. This technique gives you small victories as you eliminate one debt after another.
Whichever technique you use, I’m more interested in the timing of the payoffs. Unless you are paying truly outrageous interest rates, the best response to an uncertain employment outlook is to build your cash position with additional savings.
Consider: both foreclosure and bankruptcy are not a function of the amount of debt carried. They are a function of cash flow. If you do not have enough cash to make all of your payments every month, you start to fall behind. It is the inability to make payments that drives people into bankruptcy. Exacerbating this is that most lenders pile on late fees and higher finance charges once you have late or missing payments.
Let’s say you are doubling up on the equity payment on your mortgage, and have been for years. The extra equity payments have shortened the term of the mortgage. You will pay it off in 15 years instead of 30. In the meantime, however, you have to keep making your payment every month.
Now you lose your job. If all your extra cash went towards paying down the mortgage, and you don’t have a substantial cushion, you are one month away from being delinquent on your mortgage. The fact that you made all those extra payments won’t cut any ice with the bank. They still want their payment every month.
So my plan is to continue making all my payments every month while I increase my cash reserve. Once I have enough extra money put away to extinguish a debt like a car loan, then I’ll pay it off all at once. It will require more discipline to hold onto the cash, rather than funneling the money directly to the lenders on a month by month basis. I may have to pay more in finance charges. But I’ll sleep better at night knowing I have the ability to ride out any unforeseen financial storms.
In a world of rising unemployment and falling real estate values, cash really is king.
There are a number of ways an individual household can reduce leverage. Probably the most painful is to have your house foreclosed on. Since a home mortgage is typically the largest source of debt for a family, losing your home means losing most of your debt all at once. Not recommended, but if your mortgage payment is greater than market rent, moving into a rental will free up your cash flow.
A bankruptcy is less effective at reducing leverage than foreclosure. Most states protect your home equity during a bankruptcy filing. You can drop most of your credit card payments, but you still have the debt associated with your mortgage. Foreclosure and bankruptcy have got to be the two most painful ways of deleveraging.
The least painful way to reduce debt is to reduce current consumption and divert more of your cash flow into paying off debt. Whether paying off credit cards or making extra equity payments on a mortgage, either way you are reducing household debt.
Actually, it may be even less painful to increase income and put that extra money into debt retirement. Start up a sideline business or get a part-time second job. But in today’s market, those options may not be as readily available as they were even a year ago.
In the struggle to pay off debt, there are two schools of thought on which debts to pay of first. One school holds that the best idea is to focus most of your effort into paying down the debts with the highest interest rates. That way you lower the burden of finance charges faster. The other school of thought is to pay down the smallest debts first. This technique gives you small victories as you eliminate one debt after another.
Whichever technique you use, I’m more interested in the timing of the payoffs. Unless you are paying truly outrageous interest rates, the best response to an uncertain employment outlook is to build your cash position with additional savings.
Consider: both foreclosure and bankruptcy are not a function of the amount of debt carried. They are a function of cash flow. If you do not have enough cash to make all of your payments every month, you start to fall behind. It is the inability to make payments that drives people into bankruptcy. Exacerbating this is that most lenders pile on late fees and higher finance charges once you have late or missing payments.
Let’s say you are doubling up on the equity payment on your mortgage, and have been for years. The extra equity payments have shortened the term of the mortgage. You will pay it off in 15 years instead of 30. In the meantime, however, you have to keep making your payment every month.
Now you lose your job. If all your extra cash went towards paying down the mortgage, and you don’t have a substantial cushion, you are one month away from being delinquent on your mortgage. The fact that you made all those extra payments won’t cut any ice with the bank. They still want their payment every month.
So my plan is to continue making all my payments every month while I increase my cash reserve. Once I have enough extra money put away to extinguish a debt like a car loan, then I’ll pay it off all at once. It will require more discipline to hold onto the cash, rather than funneling the money directly to the lenders on a month by month basis. I may have to pay more in finance charges. But I’ll sleep better at night knowing I have the ability to ride out any unforeseen financial storms.
In a world of rising unemployment and falling real estate values, cash really is king.
Saturday, January 3, 2009
Happy New Year!
At the beginning of the New Year, I like many others, make resolutions for the coming twelve months. Sometimes these resolutions actually come to fruition (2008: start a blog), sometimes the hard realities of December bear no resemblance to the wishful thinking of January (2008: increase the value of my portfolio by 15%). Nonetheless, I find value in the exercise of goal setting. It helps define my priorities for the coming year.
Sometimes as you take stock at the end of one year, and you review progress against your goals, it becomes an exercise in shoulda, woulda, coulda. For example, I sure wish I'd gotten 100% into cash in the first half of 2008. Ah well. I'll just keep telling myself that I'm investing for the long haul. That makes it feel okay. Really, it does.
Anyway, I've decided that my financial theme for 2009 is deleverageing. My spell check doesn't like the term, so maybe deleverageing isn't in the dictionary yet. By the term the current financial crisis is in the history books, it will be.
In financial terms, leverage is a way of expressing the ratio of debt to equity. For example, if you buy a house with a 20% down payment, and take out a mortgage for the other 80%, you have leveraged your equity four to one. As you make your mortgage payments, your reduce the leverage as you build equity. This happens very slowly in the first years of the mortgage, than picks up speed as a larger and larger percentage of your mortgage payment is focused on paying down the principle balance.
The current crisis in the financial markets was brought on by excessive leverage during the housing bubble, both by consumers and institutions. Consumers bought houses with no money down (essentially infinite leverage), or they extracted all of the equity from their houses through home equity lines of credit. After all, if the value of housing had kept going up, they would have created equity out of thin air. Why not borrow against that? It seemed like a good idea at the time.
On the institutional side, banks were dumb enough to make those loans. The investment banks on Wall Street were dumb enough to repackage those loans and resell them, and institutional investors like insurance companies and pension funds were dumb enough to buy them. After all, if the home owners stopped paying their mortgages, the collateral (the houses) would be worth more than the original loans. Why not loan against that? It seemed like a good idea at the time.
It seemed like such a good idea that the Wall Street investment banks borrowed hundreds of billions of dollars to amplify the returns on the firm's capital. After all, bonuses were paid based on returns on capital. These guys were capitalists, says so right on the brochure. So when the housing market started to turn downward, a lot of the banks and investment banks were highly leveraged, 20 to 1 or even 30 to 1.
The upside of leverage is that when you are making gains, those gains are amplified by the amount of leverage. The downside of leverage is that when you are taking losses, the losses hit your capital by the same degree that gains boost it. So if you are leveraged 20 to 1, that means you have 20 dollars of debt for every dollar of equity. A 5% loss on the value of your assets is enough wipe out your equity.
Picture a bank holding most of it's assets in residential mortages. Foreclosure rates have more than doubled since 2007, and housing prices have dropped an average of 18% in the last year. Banks are taking losses of way more than 5% on their loan portfolios. When your debt is greater than the combination of your assets and your equity, that is the technical definition of insolvency, also known as bankruptcy. Ouch.
Financial institutions have spent the last year trying to raise capital, either by selling shares of preferred stock or by selling assets or by raising cash by cutting expenses like dividend payments. If leverage is the ratio of debt to equity, having more capital lowers leverage. For consumers, leverage is also being reduced. When you mail the keys to your house back to the bank, and move into a rental, you have reduced your personal leverage by the amount of your mortgage loan.
The bottom line is that when you reduce debt, you deleverage your financial position. So the process of reducing debt is deleverageing, however you spell it.
The thing about deleverageing is that it is a lot less painful when you do it willingly, before circumstances force you into it. It is a lot easier to tighten one's belt and build your rainy day fund, than it is to deal with foreclosure, or even escalating late payments because you missed a credit card payment.
Having established the theme of deleverageing for 2009, the next question is whether it is better to pay down debt or build up cash. I'll take up that issue in another post.
Sometimes as you take stock at the end of one year, and you review progress against your goals, it becomes an exercise in shoulda, woulda, coulda. For example, I sure wish I'd gotten 100% into cash in the first half of 2008. Ah well. I'll just keep telling myself that I'm investing for the long haul. That makes it feel okay. Really, it does.
Anyway, I've decided that my financial theme for 2009 is deleverageing. My spell check doesn't like the term, so maybe deleverageing isn't in the dictionary yet. By the term the current financial crisis is in the history books, it will be.
In financial terms, leverage is a way of expressing the ratio of debt to equity. For example, if you buy a house with a 20% down payment, and take out a mortgage for the other 80%, you have leveraged your equity four to one. As you make your mortgage payments, your reduce the leverage as you build equity. This happens very slowly in the first years of the mortgage, than picks up speed as a larger and larger percentage of your mortgage payment is focused on paying down the principle balance.
The current crisis in the financial markets was brought on by excessive leverage during the housing bubble, both by consumers and institutions. Consumers bought houses with no money down (essentially infinite leverage), or they extracted all of the equity from their houses through home equity lines of credit. After all, if the value of housing had kept going up, they would have created equity out of thin air. Why not borrow against that? It seemed like a good idea at the time.
On the institutional side, banks were dumb enough to make those loans. The investment banks on Wall Street were dumb enough to repackage those loans and resell them, and institutional investors like insurance companies and pension funds were dumb enough to buy them. After all, if the home owners stopped paying their mortgages, the collateral (the houses) would be worth more than the original loans. Why not loan against that? It seemed like a good idea at the time.
It seemed like such a good idea that the Wall Street investment banks borrowed hundreds of billions of dollars to amplify the returns on the firm's capital. After all, bonuses were paid based on returns on capital. These guys were capitalists, says so right on the brochure. So when the housing market started to turn downward, a lot of the banks and investment banks were highly leveraged, 20 to 1 or even 30 to 1.
The upside of leverage is that when you are making gains, those gains are amplified by the amount of leverage. The downside of leverage is that when you are taking losses, the losses hit your capital by the same degree that gains boost it. So if you are leveraged 20 to 1, that means you have 20 dollars of debt for every dollar of equity. A 5% loss on the value of your assets is enough wipe out your equity.
Picture a bank holding most of it's assets in residential mortages. Foreclosure rates have more than doubled since 2007, and housing prices have dropped an average of 18% in the last year. Banks are taking losses of way more than 5% on their loan portfolios. When your debt is greater than the combination of your assets and your equity, that is the technical definition of insolvency, also known as bankruptcy. Ouch.
Financial institutions have spent the last year trying to raise capital, either by selling shares of preferred stock or by selling assets or by raising cash by cutting expenses like dividend payments. If leverage is the ratio of debt to equity, having more capital lowers leverage. For consumers, leverage is also being reduced. When you mail the keys to your house back to the bank, and move into a rental, you have reduced your personal leverage by the amount of your mortgage loan.
The bottom line is that when you reduce debt, you deleverage your financial position. So the process of reducing debt is deleverageing, however you spell it.
The thing about deleverageing is that it is a lot less painful when you do it willingly, before circumstances force you into it. It is a lot easier to tighten one's belt and build your rainy day fund, than it is to deal with foreclosure, or even escalating late payments because you missed a credit card payment.
Having established the theme of deleverageing for 2009, the next question is whether it is better to pay down debt or build up cash. I'll take up that issue in another post.
Monday, December 29, 2008
The Joy of Christmas Past
You don’t have to be much of a curmudgeon to appreciate the pleasures that come with the end of the Christmas season on December 26. The palpable slowing down of pace after the last minute frenzy of gift buying, wrapping, and delivering. The slackening of traffic on the roads, combined with the ability to get a parking spot at the mall. The chance to rest up after the round of Christmas festivities, and gather strength for the onslaught of New Year’s Eve. But for me, this year, there is one special blessing, post holiday.
They’ve stopped playing “Christmas Shoes” on the radio.
You know the song. It’s the one about the guy who’s in the store when he sees a little kid who needs money to buy a pair of shoes for his dying mother. The poor sap rediscovers the true meaning of Christmas when he forks over the dough for the kid to get the shoes. Just in case you forgot, here are the lyrics to the refrain.
“Sir I wanna buy these shoes for my Momma please
It's Christmas Eve and these shoes are just her size
Could you hurry Sir?
Daddy says there's not much time
You see, she's been sick for quite a while
And I know these shoes will make her smile
And I want her to look beautiful
If Momma meets Jesus, tonight.”
What a batch of hooey! What a load of hogwash! The pathetic absurdities of this song beggar the imagination. Consider the baloney you’re being asked to accept when you listen to this load of rubbish.
First, the kid knows his mother’s shoe size. What? I don’t know my mother’s shoe size, and I’ll bet you don’t either. Hellfire, I was well into my twenties before I could have reliably stated that my mom had feet. It just never entered my consciousness.
Second, what kind of shoes are these? Jimmy Choo’s? Manolo Blahnik’s? I mean, seriously, what kind of little kid pays attention to shoe fashion? The only reason I know those names is from watching “Sex and the City” reruns on cable, and I had to Google the names to get the spelling right.
Third, the song posits that what a dying woman wants most before she passes away is a new pair of shoes. Now, you usually can’t go wrong betting on the shallowness and materialism of the American consumer, but the woman is going to die, for cripe’s sake! If I was dying, that sure wouldn’t be the top of my Christmas list. A miracle cure, that’s what I want Santa to drop down my chimney. Or maybe just more morphine to keep the pain pump fully stocked up. But shoes?
What kind of store is this, anyway? Probably a department store, because the narrator isn’t there to buy shoes, he is just there to “pick up a few things.” That raises another question. The kid is described as “dirty from head to toe.” In most upscale stores, the staff wouldn’t let a dirty street urchin wander around, pawing through the merchandise and panhandling from the customers to pay for shoes. The staff would call security, assuming they didn’t just give the kid the bum’s rush on their own. I can picture the response when the kid first walked into the store: “Hey, kid, keep your grubby hands off. That’s cashmere!”
Here’s my theory: the kid and the salesclerk are running a scam. The store overstocked on cheap Chinese knockoffs of designer shoes. The kid spots a mark, turns on the waterworks, and the sucker pays for them. The suddenly overjoyed scamster goes out the front door, and comes around and in through the back door, ready to resell the same pair of shoes with the next mark to walk in. Meanwhile, the clerk cleans up on commissions. Hellfire, the clerk is probably the kid’s real mother! They probably share a good horse laugh over the suckers they rooked when they get home.
Cheating sentimental saps, all in the service of pure commercialism. There’s a Christmas anthem for you. At least we’re all done with that now. That song is off the playlists.
At least until next year.
They’ve stopped playing “Christmas Shoes” on the radio.
You know the song. It’s the one about the guy who’s in the store when he sees a little kid who needs money to buy a pair of shoes for his dying mother. The poor sap rediscovers the true meaning of Christmas when he forks over the dough for the kid to get the shoes. Just in case you forgot, here are the lyrics to the refrain.
“Sir I wanna buy these shoes for my Momma please
It's Christmas Eve and these shoes are just her size
Could you hurry Sir?
Daddy says there's not much time
You see, she's been sick for quite a while
And I know these shoes will make her smile
And I want her to look beautiful
If Momma meets Jesus, tonight.”
What a batch of hooey! What a load of hogwash! The pathetic absurdities of this song beggar the imagination. Consider the baloney you’re being asked to accept when you listen to this load of rubbish.
First, the kid knows his mother’s shoe size. What? I don’t know my mother’s shoe size, and I’ll bet you don’t either. Hellfire, I was well into my twenties before I could have reliably stated that my mom had feet. It just never entered my consciousness.
Second, what kind of shoes are these? Jimmy Choo’s? Manolo Blahnik’s? I mean, seriously, what kind of little kid pays attention to shoe fashion? The only reason I know those names is from watching “Sex and the City” reruns on cable, and I had to Google the names to get the spelling right.
Third, the song posits that what a dying woman wants most before she passes away is a new pair of shoes. Now, you usually can’t go wrong betting on the shallowness and materialism of the American consumer, but the woman is going to die, for cripe’s sake! If I was dying, that sure wouldn’t be the top of my Christmas list. A miracle cure, that’s what I want Santa to drop down my chimney. Or maybe just more morphine to keep the pain pump fully stocked up. But shoes?
What kind of store is this, anyway? Probably a department store, because the narrator isn’t there to buy shoes, he is just there to “pick up a few things.” That raises another question. The kid is described as “dirty from head to toe.” In most upscale stores, the staff wouldn’t let a dirty street urchin wander around, pawing through the merchandise and panhandling from the customers to pay for shoes. The staff would call security, assuming they didn’t just give the kid the bum’s rush on their own. I can picture the response when the kid first walked into the store: “Hey, kid, keep your grubby hands off. That’s cashmere!”
Here’s my theory: the kid and the salesclerk are running a scam. The store overstocked on cheap Chinese knockoffs of designer shoes. The kid spots a mark, turns on the waterworks, and the sucker pays for them. The suddenly overjoyed scamster goes out the front door, and comes around and in through the back door, ready to resell the same pair of shoes with the next mark to walk in. Meanwhile, the clerk cleans up on commissions. Hellfire, the clerk is probably the kid’s real mother! They probably share a good horse laugh over the suckers they rooked when they get home.
Cheating sentimental saps, all in the service of pure commercialism. There’s a Christmas anthem for you. At least we’re all done with that now. That song is off the playlists.
At least until next year.
Wednesday, December 17, 2008
Closing Down
Chrysler has announced that starting tomorrow, they are closing all thirty of their manufacturing sites for a month. This is being billed as a cash conserving move on their part. This is being treated as a major news story, getting coverage on the networks and all the major newspapers. Of course, I have a reaction to this story. Ready? Wait for it.
Big, fat, hairy deal. Do they want us to think that this is a last ditch effort to save the company, because they didn't get their Federal bailout check?
My company shut down operations for the entire week of Thanksgiving. We came back to work on December 1, worked production until December 9, then closed up and sent the production associates home until January 5. Our maintenance crews are going home at the end of this week, and they'll be off for two weeks. So between November and December, we've taken four weeks off, just like Chrysler. We're doing this because orders are down, and you cannot keep building product when your customers aren't buying, just like Chrysler.
The difference is that we didn't issue a press release just because we are closing down for inventory reduction at the end of the year. We would rather be running production, but in today's environment, it is just a sound business decision, to cut production to balance inventories. You don't see us threatening the economy of Tennesse with collapse if we don't get a bailout.
In their campaign to get hold of Federal bailout money, the domestic car companies and the UAW have consistently presented the worst case scenario to support their claim on Federal money. "If you don't give us $30 billion, RIGHT NOW, we are going bankrupt, one out of every five Americans will be unemployed, and a new Great Depression will sweep the country."
It is the industrial equivalent of extortion. And it's getting old.
Big, fat, hairy deal. Do they want us to think that this is a last ditch effort to save the company, because they didn't get their Federal bailout check?
My company shut down operations for the entire week of Thanksgiving. We came back to work on December 1, worked production until December 9, then closed up and sent the production associates home until January 5. Our maintenance crews are going home at the end of this week, and they'll be off for two weeks. So between November and December, we've taken four weeks off, just like Chrysler. We're doing this because orders are down, and you cannot keep building product when your customers aren't buying, just like Chrysler.
The difference is that we didn't issue a press release just because we are closing down for inventory reduction at the end of the year. We would rather be running production, but in today's environment, it is just a sound business decision, to cut production to balance inventories. You don't see us threatening the economy of Tennesse with collapse if we don't get a bailout.
In their campaign to get hold of Federal bailout money, the domestic car companies and the UAW have consistently presented the worst case scenario to support their claim on Federal money. "If you don't give us $30 billion, RIGHT NOW, we are going bankrupt, one out of every five Americans will be unemployed, and a new Great Depression will sweep the country."
It is the industrial equivalent of extortion. And it's getting old.
Monday, December 15, 2008
Investment Scam of the Year
The latest shock to come out of the financial industry on Wall Street is the Bernie Madoff scandal. Mr. Madoff has been involved in Wall Street business for almost fifty years. He was the head of NASDAQ for several years, and his securities firm occupies three floors of a downtown skyscraper.
The primary business of his firm was to act as a market maker, taking orders to buy and sell a number of stocks. However, he also ran an investment advisory firm, taking in money and investing it for people and institutions. At the beginning of the year this arm of his business reported holding $17 billion in other people’s money.
It now appears that the investment advisory part of his business was actually running like a giant Ponzi scheme, where the money that new investors put in was used to pay dividends to older investors. Hit by requests for $7 billion in redemptions by investors this quarter, the house of cards came tumbling down. Mr. Madoff’s own estimate of total losses to investors was $50 billion.
This is an amazing story, and it is only starting to unfold. From what little has been revealed so far, several aspects of the situation boggle the mind.
First, how did one guy pull this off? From all reports, only a couple of dozen people worked on the floor of the building where the investment firm was located. Most of the employees were on the two floors where the legitimate business was located. How did Mr. Madoff handle the mundane details like keeping everyone’s theoretical balance straight, or mailing out statements and dividend checks? Normally, managing billions of dollars takes hundreds of people. Of course, it is a lot easier when you aren’t actually managing the money. Still, the logistical details of a fraud this size must be daunting.
How do we know that Mr. Madoff was acting alone? Because he says so. At this point, if Bernie Madoff said the sun came up this morning, I would have to look out the window to check. I suspect this morality play has more villains than just Mr. Madoff.
The other astonishing part of this story is the victims of the scam. Some of the investors were relatively wealthy individuals who were taken in, and are now ruined. Mr. Madoff’s reputation and longevity, as well as his charm, had to help in duping his victims. But the big money came from other Wall Street investment firms, as well as a slew of international banks. How did these guys fall asleep at the switch?
It apparently never crossed their collective mind that Madoff was scamming them. I can just picture the due diligence meeting. “Bernie? Bernie Madoff? I’ve known the guy for years. We take steam together down at the club. Twice a week, regular as clockwork. He says he needs another billion? So send him a check. Electronic transfer would be even better.”
Then again, these were some of the same sharp guys who were buying subprime mortgages up until a year ago, so I guess we shouldn’t be too surprised that they got taken.
I’m sure that the “Law and Order” screenwriters are already working on a “ripped from the headlines” story.
The primary business of his firm was to act as a market maker, taking orders to buy and sell a number of stocks. However, he also ran an investment advisory firm, taking in money and investing it for people and institutions. At the beginning of the year this arm of his business reported holding $17 billion in other people’s money.
It now appears that the investment advisory part of his business was actually running like a giant Ponzi scheme, where the money that new investors put in was used to pay dividends to older investors. Hit by requests for $7 billion in redemptions by investors this quarter, the house of cards came tumbling down. Mr. Madoff’s own estimate of total losses to investors was $50 billion.
This is an amazing story, and it is only starting to unfold. From what little has been revealed so far, several aspects of the situation boggle the mind.
First, how did one guy pull this off? From all reports, only a couple of dozen people worked on the floor of the building where the investment firm was located. Most of the employees were on the two floors where the legitimate business was located. How did Mr. Madoff handle the mundane details like keeping everyone’s theoretical balance straight, or mailing out statements and dividend checks? Normally, managing billions of dollars takes hundreds of people. Of course, it is a lot easier when you aren’t actually managing the money. Still, the logistical details of a fraud this size must be daunting.
How do we know that Mr. Madoff was acting alone? Because he says so. At this point, if Bernie Madoff said the sun came up this morning, I would have to look out the window to check. I suspect this morality play has more villains than just Mr. Madoff.
The other astonishing part of this story is the victims of the scam. Some of the investors were relatively wealthy individuals who were taken in, and are now ruined. Mr. Madoff’s reputation and longevity, as well as his charm, had to help in duping his victims. But the big money came from other Wall Street investment firms, as well as a slew of international banks. How did these guys fall asleep at the switch?
It apparently never crossed their collective mind that Madoff was scamming them. I can just picture the due diligence meeting. “Bernie? Bernie Madoff? I’ve known the guy for years. We take steam together down at the club. Twice a week, regular as clockwork. He says he needs another billion? So send him a check. Electronic transfer would be even better.”
Then again, these were some of the same sharp guys who were buying subprime mortgages up until a year ago, so I guess we shouldn’t be too surprised that they got taken.
I’m sure that the “Law and Order” screenwriters are already working on a “ripped from the headlines” story.
Sunday, December 7, 2008
The 5% Solution
As part of the news coverage concerning the Federal bailout of the Big 3 domestic automakers, I have seen stories about how the president of the United Auto Workers, Ron Gettelfinger, has been meeting with other leaders of the union to discuss how labor is going to have to put some cost saving ideas on the table to help the Big 3 avoid bankruptcy. Obviously, it is the union's interest to avoid a Chapter 11 filing, because a bankruptcy trustee could unilaterally make changes to union contracts to preserve the value of the business for the creditors. It's better to volunteer givebacks before they are imposed upon you.
First and foremost should be the Jobs Bank. That is the part of the contract that says laid off UAW workers get to receive 95% of their hourly pay and full benefits while waiting for another job position to open up. Since the domestic manufacturers have been cutting headcount for years, the new job positions never do open up. The UAW members merely collect full wages and benefits, while doing no work for the company. The Jobs Bank has been bleeding the car companies for years now. The union says that the Jobs Bank is not that much of a problem, since there are only about 3500 employees currently in the program.
Only 3500! Wages and benefits for the average Big 3 autoworker are $75 per hour (compared to $45 per hour for Japanese transplants like Toyota and Honda). Simple math tells us that $75/hour times 1800 hours/year time 3500 equals $472 million dollars a year in potential savings. Now I've gotten kind of numb from listening to all the big numbers thrown from all of the different Federal bailouts so far this year, but $472 million sounds like a lot of money to me.
But I've got another idea for changing the UAW contract with the domestic automakers. This won't help stave off bankruptcy in the short term, but in the long run could help them regain some of their lost competitiveness. I call it the 5% solution.
The concept is simple, change the contract to allow management to fire up to 5% of the UAW workers every year, no questions asked. That means no seniority, no grievances filed, no arbitration. Management would have to follow Federal law, which prevents firing people based on their membership in a protected class (race, gender, age, etc.). Other than that, pull whoever you want and give them the boot. Management would not be required to exercise this right, they would merely have the option.
In Right to Work states, employment law features a doctrine known as employment at will. Employment at will assumes that the work relationship is mutually agreed upon, and that either party has reciprical rights to terminate that relationship at any time. Simply put, you can tell the boss to take this job and shove it. The boss can give you the boot. All I'm proposing is to apply this doctrine to the UAW contracts, subject to a limit of 5%.
Consider the effect this change would have. As things stand now, to terminate a union worker requires cause, and proving cause requires evidence that will stand up in a legal proceeding. Being lazy and inefficient doesn't qualify as just cause. But if you could fire 5% without having to show cause, think about the impact that would have on the organization.
You could let the maintenance worker go who has a lot of seniority but can't fix equipment, and keep the newer guy who can actually keep the machines running. Or how about the stock handler who has spent his years finding the best places to hide, and always shows up five minutes after he has been paged. Or the assembler who sends parts with a quality problem down the line instead of raising the flag about the issue. "Not my problem" the assembler says. Think about what it would do to efficiency to get rid of the shirkers and malingerers who drag down the whole team.
Management would not even have to use the option for it to have a salutary effect on the organization. Whe they know they can be fired, almost everyone will hustle harder to impress hte boss. The worst will pick up the pace significantly, and even the best will put out a little extra effort. When they see the bar being raised, employees will be more focused throughout the organization.
Some will complain that my idea will mean the end of job security, and will shift the balance of power away from labor and deciviely towards management. Well, right now the industrial workers with the most contractual rights on job security are the UAW workers. That's what the Jobs Bank was all about. But you have to ask yourself: How much job security do you have if your employer is on the brink of bankruptcy?
The only real job security is when the company is winning in the marketplace. It's time for a change in how the unions do business.
First and foremost should be the Jobs Bank. That is the part of the contract that says laid off UAW workers get to receive 95% of their hourly pay and full benefits while waiting for another job position to open up. Since the domestic manufacturers have been cutting headcount for years, the new job positions never do open up. The UAW members merely collect full wages and benefits, while doing no work for the company. The Jobs Bank has been bleeding the car companies for years now. The union says that the Jobs Bank is not that much of a problem, since there are only about 3500 employees currently in the program.
Only 3500! Wages and benefits for the average Big 3 autoworker are $75 per hour (compared to $45 per hour for Japanese transplants like Toyota and Honda). Simple math tells us that $75/hour times 1800 hours/year time 3500 equals $472 million dollars a year in potential savings. Now I've gotten kind of numb from listening to all the big numbers thrown from all of the different Federal bailouts so far this year, but $472 million sounds like a lot of money to me.
But I've got another idea for changing the UAW contract with the domestic automakers. This won't help stave off bankruptcy in the short term, but in the long run could help them regain some of their lost competitiveness. I call it the 5% solution.
The concept is simple, change the contract to allow management to fire up to 5% of the UAW workers every year, no questions asked. That means no seniority, no grievances filed, no arbitration. Management would have to follow Federal law, which prevents firing people based on their membership in a protected class (race, gender, age, etc.). Other than that, pull whoever you want and give them the boot. Management would not be required to exercise this right, they would merely have the option.
In Right to Work states, employment law features a doctrine known as employment at will. Employment at will assumes that the work relationship is mutually agreed upon, and that either party has reciprical rights to terminate that relationship at any time. Simply put, you can tell the boss to take this job and shove it. The boss can give you the boot. All I'm proposing is to apply this doctrine to the UAW contracts, subject to a limit of 5%.
Consider the effect this change would have. As things stand now, to terminate a union worker requires cause, and proving cause requires evidence that will stand up in a legal proceeding. Being lazy and inefficient doesn't qualify as just cause. But if you could fire 5% without having to show cause, think about the impact that would have on the organization.
You could let the maintenance worker go who has a lot of seniority but can't fix equipment, and keep the newer guy who can actually keep the machines running. Or how about the stock handler who has spent his years finding the best places to hide, and always shows up five minutes after he has been paged. Or the assembler who sends parts with a quality problem down the line instead of raising the flag about the issue. "Not my problem" the assembler says. Think about what it would do to efficiency to get rid of the shirkers and malingerers who drag down the whole team.
Management would not even have to use the option for it to have a salutary effect on the organization. Whe they know they can be fired, almost everyone will hustle harder to impress hte boss. The worst will pick up the pace significantly, and even the best will put out a little extra effort. When they see the bar being raised, employees will be more focused throughout the organization.
Some will complain that my idea will mean the end of job security, and will shift the balance of power away from labor and deciviely towards management. Well, right now the industrial workers with the most contractual rights on job security are the UAW workers. That's what the Jobs Bank was all about. But you have to ask yourself: How much job security do you have if your employer is on the brink of bankruptcy?
The only real job security is when the company is winning in the marketplace. It's time for a change in how the unions do business.
Thursday, December 4, 2008
The gurus have spoken!
Well, it's official.
The National Bureau of Economic Research came out Monday and announced that the US economy was in a recession. Their statement said that the economy had been contracting since December 2007. That means this recession has already gone longer than the post World War II average, which is ten months.
Yup, it's official: the economy has been contracting for a whole year now. This makes me want to channel the late, great "screamer" comedian, Sam Kinnison:
WELL, WHAT WAS YOUR FIRST CLUE?! WAS IT THE 50% COLLAPSE IN HOUSING STARTS? THE TRIPLING IN THE FORECLOSURE RATE? MAYBE IT WAS FACT THAT THE BIG THREE DOMESTIC CARMAKERS ARE ON THE VERGE OF BANKRUPTCY? OR COULD IT BE THE COMBINATION OF HUNDREDS OF BILLIONS IN BANK LOSSES, THE FAILURE OR FORCED MERGER OF MAJOR INVESTMENT BANKS, AND THE TOTAL FREEZE UP IN THE CREDIT MARKETS?
The business I work in has been hunkered down in survival mode all year, but the official announcement is just now being made. It hardly seems worth calling a news conference to announce the finding. What great finding will be announced next? Water is wet? Gravity pulls you down? Oh, I know: The Earth revolves around the Sun!
Now, if somebody knew when the recession would end, and the economy start growing again, that would be news you could use.
The National Bureau of Economic Research came out Monday and announced that the US economy was in a recession. Their statement said that the economy had been contracting since December 2007. That means this recession has already gone longer than the post World War II average, which is ten months.
Yup, it's official: the economy has been contracting for a whole year now. This makes me want to channel the late, great "screamer" comedian, Sam Kinnison:
WELL, WHAT WAS YOUR FIRST CLUE?! WAS IT THE 50% COLLAPSE IN HOUSING STARTS? THE TRIPLING IN THE FORECLOSURE RATE? MAYBE IT WAS FACT THAT THE BIG THREE DOMESTIC CARMAKERS ARE ON THE VERGE OF BANKRUPTCY? OR COULD IT BE THE COMBINATION OF HUNDREDS OF BILLIONS IN BANK LOSSES, THE FAILURE OR FORCED MERGER OF MAJOR INVESTMENT BANKS, AND THE TOTAL FREEZE UP IN THE CREDIT MARKETS?
The business I work in has been hunkered down in survival mode all year, but the official announcement is just now being made. It hardly seems worth calling a news conference to announce the finding. What great finding will be announced next? Water is wet? Gravity pulls you down? Oh, I know: The Earth revolves around the Sun!
Now, if somebody knew when the recession would end, and the economy start growing again, that would be news you could use.
Monday, November 24, 2008
Throw the bums out. Just not yet.
In my last post I mentioned that Gail Collins, a New York Times columnist, had advocated George Bush resign the Presidency so that Barack Obama could start his term early. Today, Thomas Friedman, the Times' foreign affairs correspondent seconded that desire. I just found out that Lou Dobbs, the CNN anchor, had made the same suggestion, that George Bush resign.
These are supposed to be thoughtful, intelligent, well-educated people. What possesses them to say such silly things?
One of the great things about the American political system is the peaceful transfer of power. On the appointed day, the outgoing guy packs up his momentos and rides off into the sunset. No riots in the street. No power sharing deals. No cabals of senior military officers throwing their support behind one candidate or another. No flight into exile, financed by a secret Swiss bank account. On Inauguration Day, the ex-President and his team leave quietly, and the new President and his team move into the White House.
What the pundits listed above have proposed is to interfere with that process. There is a crisis, so throw the rulebook out the window. No one's in charge, and we need a strong hand at the helm to steer us through this storm!
This just another version of the end justifies the means. If, by some miricle, they did manage to hound Bush out of office prematurely, do they not realize that would set a precedent? A precedent that can cut both ways. Suppose Bush was to announce that due to the crisis in the financial markets, he was going to have to stay in office until the crisis was resolved. That would create a constitutional crisis, but no more so than trying to install Obama before Bushes term in office is over.
Once you start playing games like that, you are starting to erode away one of the supports of our democracy.
Whether they like it or not, Obama is just going to have to wait his turn.
These are supposed to be thoughtful, intelligent, well-educated people. What possesses them to say such silly things?
One of the great things about the American political system is the peaceful transfer of power. On the appointed day, the outgoing guy packs up his momentos and rides off into the sunset. No riots in the street. No power sharing deals. No cabals of senior military officers throwing their support behind one candidate or another. No flight into exile, financed by a secret Swiss bank account. On Inauguration Day, the ex-President and his team leave quietly, and the new President and his team move into the White House.
What the pundits listed above have proposed is to interfere with that process. There is a crisis, so throw the rulebook out the window. No one's in charge, and we need a strong hand at the helm to steer us through this storm!
This just another version of the end justifies the means. If, by some miricle, they did manage to hound Bush out of office prematurely, do they not realize that would set a precedent? A precedent that can cut both ways. Suppose Bush was to announce that due to the crisis in the financial markets, he was going to have to stay in office until the crisis was resolved. That would create a constitutional crisis, but no more so than trying to install Obama before Bushes term in office is over.
Once you start playing games like that, you are starting to erode away one of the supports of our democracy.
Whether they like it or not, Obama is just going to have to wait his turn.
Saturday, November 22, 2008
Be Calm
From all indications, the US economy is in bad shape. Unemployment is rising, as more companies announce layoffs. The fall in stock prices has gotten to the level that many of us have stopped looking at our 401K balances. The credit markets are still largely frozen up, making it difficult for even profitable companies to get financing for their operations. It is clear that we are in a recession, and by all indications it will be a bad one.
In the face of all this bad news, the cries for a new stimulus package from Washington have become louder and more insistent. Paul Krugman, the Nobel winning economist and New York Times columnist, is calling for an immediate fiscal stimulus of $300 to $600 billion. Gail Collins, another New York Times columnist, is calling on President Bush to resign as the only way to save the country. "Orderly transfer of power be damned! Save us, Obama, save us!" Any impediment to handing out the fat envelopes of government cash, such as the Constitution, is considered as perilous in this time of crisis.
Two things are being missed in the panicked rush to increase the national debt in the name of keeping the economy going.
First, it's not that bad out there. The unemployment rate has risen, that's true. But 93% of us still have jobs. Banks have had to write off hundreds of billions of dollars worth of bad mortgages, and a number of banks have failed, that's true. But not a single depositor has lost his savings. Credit has gotten scarcer and more expensive, that's true. But my credit card still works and I expect it to keep working, as long as I keep paying off the bill. Standards may be a bit higher, but banks are still making loans to individuals with good credit ratings. Corporate profits are down, but aside from financial services and the domestic auto makers, companies in most sectors are not losing money.
Perform a little thought experiment: when you drive past Wal-Mart, is the parking lot still full of cars? If you go out to eat at a restaurant, is the place half empty, or do you have to wait for a table? My experience has been that the economy is still functioning. It may be harder to make a buck, but rumors of a new Great Depression are greatly exaggerated.
The other factor that has been missed by the pundits is that gas prices have dropped in half over the last couple of months. Gasoline that was at $4 a gallon over the summer now costs under $2 at the pump. For the average household, this frees up between $50 and $100 a week. Between now and the end of the year that could be worth up to $500, with another chunk of budgetary relief in January. And another in February, and so on. Over the next few months, lower gas prices will but as much money back into the economy as any proposed stimulus package.
Money that isn't literally burned is availible for keeping mortgages current, and paying down credit card debt, and shopping for Christmas presents. All activities that will reduce the level of financial panic. We just have to be patient.
In the face of all this bad news, the cries for a new stimulus package from Washington have become louder and more insistent. Paul Krugman, the Nobel winning economist and New York Times columnist, is calling for an immediate fiscal stimulus of $300 to $600 billion. Gail Collins, another New York Times columnist, is calling on President Bush to resign as the only way to save the country. "Orderly transfer of power be damned! Save us, Obama, save us!" Any impediment to handing out the fat envelopes of government cash, such as the Constitution, is considered as perilous in this time of crisis.
Two things are being missed in the panicked rush to increase the national debt in the name of keeping the economy going.
First, it's not that bad out there. The unemployment rate has risen, that's true. But 93% of us still have jobs. Banks have had to write off hundreds of billions of dollars worth of bad mortgages, and a number of banks have failed, that's true. But not a single depositor has lost his savings. Credit has gotten scarcer and more expensive, that's true. But my credit card still works and I expect it to keep working, as long as I keep paying off the bill. Standards may be a bit higher, but banks are still making loans to individuals with good credit ratings. Corporate profits are down, but aside from financial services and the domestic auto makers, companies in most sectors are not losing money.
Perform a little thought experiment: when you drive past Wal-Mart, is the parking lot still full of cars? If you go out to eat at a restaurant, is the place half empty, or do you have to wait for a table? My experience has been that the economy is still functioning. It may be harder to make a buck, but rumors of a new Great Depression are greatly exaggerated.
The other factor that has been missed by the pundits is that gas prices have dropped in half over the last couple of months. Gasoline that was at $4 a gallon over the summer now costs under $2 at the pump. For the average household, this frees up between $50 and $100 a week. Between now and the end of the year that could be worth up to $500, with another chunk of budgetary relief in January. And another in February, and so on. Over the next few months, lower gas prices will but as much money back into the economy as any proposed stimulus package.
Money that isn't literally burned is availible for keeping mortgages current, and paying down credit card debt, and shopping for Christmas presents. All activities that will reduce the level of financial panic. We just have to be patient.
Monday, November 17, 2008
Buzzing with Excitement
Since Congress passed the $700 billion bailout authorization called TARP (Troubled Asset Relief Program) in October, the predictable rush to the trough has occurred. What I didn't anticipate, however, was how fast other players than banks would get their hands out for a share of Federal largesse.
Originally sold as a plan to buy up illiquid mortgages and mortgage backed securities, TARP quickly morphed into direct equity injections into major banks. Seeing how easy it was, insurance company AIG bellied up to the bar for a second round, having already received an $80 billion Federal loan.
Not to be outdone, the cities of Philidelphia, Atlanta, and Phoenix sent a letter to Treasury Secretary Paulson, asserting their rightful claim to a Federal handout. San Jose, the home of Silicon Valley, is waiting to see how that is handled before submitting their request for $15 billion.
This was closely followed by the domestic automotive manufacturers. Not satisfied with the first $25 billion in loan guarantees they got as a separate line item in the TARP authorization, Ford, Chysler, GM are threatening economic armageddon if they do not get at least another $25 billion.
This morning a group of automotive supplier companies applied for their fair share of the bailout money. In a strange way, this latest request almost makes sense. The big 3 car companies are threatening to take their supplier base down with them if they have to declare bankruptcy. The auto suppliers are just trying to cut out the middleman, getting the money directly from the Treasury instead of getting it from the car companies.
I guess I shouldn't be surprised with how fast players far removed from the financial industry are rushing in to get a chunk of the $700 billion TARP bailout fund. When you've got that big a honeypot, you're going to pull in a lot of flies.
Originally sold as a plan to buy up illiquid mortgages and mortgage backed securities, TARP quickly morphed into direct equity injections into major banks. Seeing how easy it was, insurance company AIG bellied up to the bar for a second round, having already received an $80 billion Federal loan.
Not to be outdone, the cities of Philidelphia, Atlanta, and Phoenix sent a letter to Treasury Secretary Paulson, asserting their rightful claim to a Federal handout. San Jose, the home of Silicon Valley, is waiting to see how that is handled before submitting their request for $15 billion.
This was closely followed by the domestic automotive manufacturers. Not satisfied with the first $25 billion in loan guarantees they got as a separate line item in the TARP authorization, Ford, Chysler, GM are threatening economic armageddon if they do not get at least another $25 billion.
This morning a group of automotive supplier companies applied for their fair share of the bailout money. In a strange way, this latest request almost makes sense. The big 3 car companies are threatening to take their supplier base down with them if they have to declare bankruptcy. The auto suppliers are just trying to cut out the middleman, getting the money directly from the Treasury instead of getting it from the car companies.
I guess I shouldn't be surprised with how fast players far removed from the financial industry are rushing in to get a chunk of the $700 billion TARP bailout fund. When you've got that big a honeypot, you're going to pull in a lot of flies.
Sunday, November 9, 2008
Bailout Nation
Ford and General Motors are looking for $50 billion in loans from the Federal government to keep their operations going. I should say another $50 billion, because they already got $25 billion earmarked for them when the $700 billion financial bailout package passed.
Speaker of the House Nancy Pelosi and Senate Majority leader Harry Reid issued a joint statement last week in favor of handing more taxpayer cash to the domestic carmakers. Rahm Emmanuel, chief of staff designee for President-elect Barack Obama, weighed in on the side of the increased bailout this weekend. I guess that this means the fix is in.
Still, I’m not convinced that a good case has been made for bailing out the domestic car companies. Not that I do not believe that bankruptcy is a real possibility for the car companies. GM alone burned through $6 billion in cash during the last three months. If they continue at that rate, they will run out of cash sometime next year.
But bankruptcy isn’t the end of the road. They can use Chapter 11 of the bankruptcy code to continue to operate while they reorganize. This is what all of the major airlines except Southwest and American have done, and they all managed to stay in the air while going through the process. If the airlines can do it, why can’t the auto makers?
A Chapter 11 filing would give them a chance to get out from under their UAW contracts. These are the contracts that require the car companies to pay laid off workers 95% of their base wage (and 100% of their benefits), even though those workers and actually doing any work.
My concern is that, even with the government loans they are seeking, GM and Ford are only staving off the inevitable. Without structural changes to how they do business, like dropping the UAW contracts, what’s to keep them from coming back to the taxpayers in another year or two, asking for good money to be thrown after bad?
Speaker of the House Nancy Pelosi and Senate Majority leader Harry Reid issued a joint statement last week in favor of handing more taxpayer cash to the domestic carmakers. Rahm Emmanuel, chief of staff designee for President-elect Barack Obama, weighed in on the side of the increased bailout this weekend. I guess that this means the fix is in.
Still, I’m not convinced that a good case has been made for bailing out the domestic car companies. Not that I do not believe that bankruptcy is a real possibility for the car companies. GM alone burned through $6 billion in cash during the last three months. If they continue at that rate, they will run out of cash sometime next year.
But bankruptcy isn’t the end of the road. They can use Chapter 11 of the bankruptcy code to continue to operate while they reorganize. This is what all of the major airlines except Southwest and American have done, and they all managed to stay in the air while going through the process. If the airlines can do it, why can’t the auto makers?
A Chapter 11 filing would give them a chance to get out from under their UAW contracts. These are the contracts that require the car companies to pay laid off workers 95% of their base wage (and 100% of their benefits), even though those workers and actually doing any work.
My concern is that, even with the government loans they are seeking, GM and Ford are only staving off the inevitable. Without structural changes to how they do business, like dropping the UAW contracts, what’s to keep them from coming back to the taxpayers in another year or two, asking for good money to be thrown after bad?
Thursday, November 6, 2008
Where is the Center?
As Team Obama shifts from the campaign to the transition team, the analysis coming out of the media has also shifted. Some have suggested that the Obama administration will shift to the right once in office, attempting to find centrist positions to the tough issues. Looking at Obama's policy positions, I'm not holding out a lot of hope.
Governing from the center is raising taxes to pay for infrastructure spending. Governing from the left is raising taxes on some people to give transfer payments (excuse me, tax credits) to others.
Governing from the center is making an argument for expediting new nuclear power plants, to replace carbon dioxide emitting coal fired power plants. Governing from the left is placing a massive tax on energy (excuse me, a cap and trade system), while telling people that wind mills will replace the industries that you bankrupt.
Governing from the center is announcing that you will put your administration's political capital into redefining Federal law to recognize gay marriage. Governing from the left is declaring you will appoint judges who will rule based on their compassion for the downtrodden.
Governing from the center is coming out in favor of unionization, staffing the NLRB with pro-union partisans, and ramping up Justice Department investigations of companies accused of illegal antiunion activities. Governing from the left is tossing out 70 years of law backing secret ballot elections, and replacing it with card check legislation allowing for covert intimidation and coercion to determine the nature of the workplace.
Governing from the center is to propose raising the minimum wage to $9.25/ hour. Governing from the left is to propose raising the minimum wage to $9.25/hour, extend the FMLA in terms of employers affected, reasons for claiming leave, and amount of leave, and require employers to give employees 5 days of paid leave.
Governing from the center is to require health insurance plans to provide unlimited mental health benefits. Governing from the left is to require health insurance plans to provide unlimited mental health benefits, and then go on to require employers to health insurance to all employees as a mandatory benefit.
The Obama administration has the potential to make conservatives nostalgic for traditional tax and spend liberalism. Between unfunded mandates on business and tax and give policies, I'm gearing up for four years in loyal opposition.
Governing from the center is raising taxes to pay for infrastructure spending. Governing from the left is raising taxes on some people to give transfer payments (excuse me, tax credits) to others.
Governing from the center is making an argument for expediting new nuclear power plants, to replace carbon dioxide emitting coal fired power plants. Governing from the left is placing a massive tax on energy (excuse me, a cap and trade system), while telling people that wind mills will replace the industries that you bankrupt.
Governing from the center is announcing that you will put your administration's political capital into redefining Federal law to recognize gay marriage. Governing from the left is declaring you will appoint judges who will rule based on their compassion for the downtrodden.
Governing from the center is coming out in favor of unionization, staffing the NLRB with pro-union partisans, and ramping up Justice Department investigations of companies accused of illegal antiunion activities. Governing from the left is tossing out 70 years of law backing secret ballot elections, and replacing it with card check legislation allowing for covert intimidation and coercion to determine the nature of the workplace.
Governing from the center is to propose raising the minimum wage to $9.25/ hour. Governing from the left is to propose raising the minimum wage to $9.25/hour, extend the FMLA in terms of employers affected, reasons for claiming leave, and amount of leave, and require employers to give employees 5 days of paid leave.
Governing from the center is to require health insurance plans to provide unlimited mental health benefits. Governing from the left is to require health insurance plans to provide unlimited mental health benefits, and then go on to require employers to health insurance to all employees as a mandatory benefit.
The Obama administration has the potential to make conservatives nostalgic for traditional tax and spend liberalism. Between unfunded mandates on business and tax and give policies, I'm gearing up for four years in loyal opposition.
Wednesday, November 5, 2008
How to Create Jobs, Not!
Part of an interview Barack Obama gave in San Francisco last January came to light over the weekend. In the interview with the San Francisco Chronicle, President-elect Obama made the following comments regarding coal-fired power plants:
“If somebody wants to build a coal plant, they can — it’s just that it will bankrupt them, because they are going to be charged a huge sum for all that greenhouse gas that’s being emitted.”
This comment was made in the context of explaining a cap and trade system for reducing greenhouse gas emissions. Since coal burning power plants emit more carbon per kilowatt than any other type of electrical generation, the penalties on those plants will be higher. The idea behind a cap and trade system is that, over time, the penalties for emitting carbon increase, until they become ruinous, and the carbon emitting power plants are shut down.
The goal of a cap and trade system is to drive carbon emitters out of business, while rewarding businesses that produce the same products in a carbon neutral way. In the context of power generation, coal-fired power plants are bad, solar and wind farms are good.
I bring this up by way of introducing the topic I really want to write about: the myth of the “green job.” The way this myth is presented is that by developing nonpolluting energy sources, all kinds of jobs with high pay and great benefits will be created. Since entirely new industries will be created in the field of clean energy, lots and lots of new “green jobs” will be added to the economy.
Yesirree, plenty of demand for windmill mechanics out there on the horizon. Sky’s the limit. Speaking of the sky, we’ll also need a bunch of solar mirror focusers. Step right up and get your job application here.
Now the problem I have with this line of argument is that job creation is being sold as one of the benefits of changing our energy infrastructure over to a less carbon intensive model. Try telling that to the guy who works in the coal-fired power plant that’s going to be taxed out of existence to pay for all those shiny new windmills. That poor schmoe is going to lose his job. So will the coal miners supplying him with fuel.
As I see it, employment in the energy industry is at best a zero sum game. For every job you create building or servicing windmills, or installing solar panels, you lose a job building mining equipment or transporting coal. There are going to be winners in new energy technologies, but there will be just as many losers in the old, reliable, proven technologies.
If we have to make this transition, if the survival of civilization requires it, than so be it. But don’t try and pitch it as a good way to create jobs.
We should pay more respect to the people who are going to lose their livelihoods after the companies they work for are bankrupted.
“If somebody wants to build a coal plant, they can — it’s just that it will bankrupt them, because they are going to be charged a huge sum for all that greenhouse gas that’s being emitted.”
This comment was made in the context of explaining a cap and trade system for reducing greenhouse gas emissions. Since coal burning power plants emit more carbon per kilowatt than any other type of electrical generation, the penalties on those plants will be higher. The idea behind a cap and trade system is that, over time, the penalties for emitting carbon increase, until they become ruinous, and the carbon emitting power plants are shut down.
The goal of a cap and trade system is to drive carbon emitters out of business, while rewarding businesses that produce the same products in a carbon neutral way. In the context of power generation, coal-fired power plants are bad, solar and wind farms are good.
I bring this up by way of introducing the topic I really want to write about: the myth of the “green job.” The way this myth is presented is that by developing nonpolluting energy sources, all kinds of jobs with high pay and great benefits will be created. Since entirely new industries will be created in the field of clean energy, lots and lots of new “green jobs” will be added to the economy.
Yesirree, plenty of demand for windmill mechanics out there on the horizon. Sky’s the limit. Speaking of the sky, we’ll also need a bunch of solar mirror focusers. Step right up and get your job application here.
Now the problem I have with this line of argument is that job creation is being sold as one of the benefits of changing our energy infrastructure over to a less carbon intensive model. Try telling that to the guy who works in the coal-fired power plant that’s going to be taxed out of existence to pay for all those shiny new windmills. That poor schmoe is going to lose his job. So will the coal miners supplying him with fuel.
As I see it, employment in the energy industry is at best a zero sum game. For every job you create building or servicing windmills, or installing solar panels, you lose a job building mining equipment or transporting coal. There are going to be winners in new energy technologies, but there will be just as many losers in the old, reliable, proven technologies.
If we have to make this transition, if the survival of civilization requires it, than so be it. But don’t try and pitch it as a good way to create jobs.
We should pay more respect to the people who are going to lose their livelihoods after the companies they work for are bankrupted.
Tuesday, October 28, 2008
Hail to the King!
I don’t know if this is a function of the media coverage or a real phenomena, but it looks like a lot of the people at risk for losing their houses in the next wave of foreclosures will be the newly unemployed. Whenever I read an article about foreclosures, the stories feature people who just lost their job.
Now, as far as recessions go, this is not my first rodeo. We had spikes in the unemployment rate in 2001 and in 1991 when the economy contracted. But from my admittedly foggy recollection of news coverage from those days, I do not remember a lot of foreclosures being associated with the downturn.
To the extent that this is a real phenomena, I wonder if this is a function of increasing household leverage. During previous recessions, did folks have more savings that could tide them over a rough patch? Or is it that these days, the mortgages are so large that making the payments exhausts one’s savings more rapidly than in years past?
In an uncertain environment, you want to have more stored fat to carry you through the lean times. Whether because we’re leaner (financially, not physically) or because our burdens are heavier, it seems like people who lose their jobs in this recession are at much higher risk of a financial upset turning catastrophic.
I wonder if some people thought they were “storing fat” though their home equity. Either by making extra equity payments, or rising housing prices, maybe some thought they were storing up equity. The simultaneous drops in housing prices and credit availability have given the lie to that theory.
Cash is king right now, and cash is the only truly liquid investment. Times like these demonstrate the critical importance of keeping an emergency fund available.
Now, as far as recessions go, this is not my first rodeo. We had spikes in the unemployment rate in 2001 and in 1991 when the economy contracted. But from my admittedly foggy recollection of news coverage from those days, I do not remember a lot of foreclosures being associated with the downturn.
To the extent that this is a real phenomena, I wonder if this is a function of increasing household leverage. During previous recessions, did folks have more savings that could tide them over a rough patch? Or is it that these days, the mortgages are so large that making the payments exhausts one’s savings more rapidly than in years past?
In an uncertain environment, you want to have more stored fat to carry you through the lean times. Whether because we’re leaner (financially, not physically) or because our burdens are heavier, it seems like people who lose their jobs in this recession are at much higher risk of a financial upset turning catastrophic.
I wonder if some people thought they were “storing fat” though their home equity. Either by making extra equity payments, or rising housing prices, maybe some thought they were storing up equity. The simultaneous drops in housing prices and credit availability have given the lie to that theory.
Cash is king right now, and cash is the only truly liquid investment. Times like these demonstrate the critical importance of keeping an emergency fund available.
Wednesday, October 22, 2008
Give the guy a break!
Sometimes the media coverage amazes me.
Take Joe the Plumber. The guy questions Barack Obama's tax plans at a campaign stop in Ohio. Based on Obama's answer to his question, the interaction gets posted to the internet, and is picked up by the McCain campaign, who used it in the last debate between McCain and Obama.
So apparently editors around the country start asking who is this Joe the Plumber, and what is his story. What seems like a hundred reporters sift through every public record on this guy, and report the following scoops:
His name isn't really Joe.
He doesn't hold a plumbing license.
At one point he was in arrears on his taxes.
The business he works for probably doesn't generate over $250,000 in earnings for the owner.
Who gives a crap.
What made the exchange newsworthy wasn't the question, or the questioner. It was the candidate's response. Barack Obama said "I think things go better when you share the wealth." What he meant was "I think things go better when I share your wealth." Barack Obama's tax plan proposes to use the government as the intermediary to transfer money from people who have it to people who don't.
Take from the rich and give to the poor.
As I have said before, Barack Obama will be the Robin Hood President.
And focusing on Joe, or Sam, or whatever his name is, distracts us from focusing on the candidate's proposals, and the implications of those proposals.
Take Joe the Plumber. The guy questions Barack Obama's tax plans at a campaign stop in Ohio. Based on Obama's answer to his question, the interaction gets posted to the internet, and is picked up by the McCain campaign, who used it in the last debate between McCain and Obama.
So apparently editors around the country start asking who is this Joe the Plumber, and what is his story. What seems like a hundred reporters sift through every public record on this guy, and report the following scoops:
His name isn't really Joe.
He doesn't hold a plumbing license.
At one point he was in arrears on his taxes.
The business he works for probably doesn't generate over $250,000 in earnings for the owner.
Who gives a crap.
What made the exchange newsworthy wasn't the question, or the questioner. It was the candidate's response. Barack Obama said "I think things go better when you share the wealth." What he meant was "I think things go better when I share your wealth." Barack Obama's tax plan proposes to use the government as the intermediary to transfer money from people who have it to people who don't.
Take from the rich and give to the poor.
As I have said before, Barack Obama will be the Robin Hood President.
And focusing on Joe, or Sam, or whatever his name is, distracts us from focusing on the candidate's proposals, and the implications of those proposals.
Monday, October 20, 2008
Tax Cut Semantics
When is a tax cut not a tax cut? Barack Obama claims that his economic proposals include tax cuts for 95% of Americans. But to do so would require redefining what it means to cut someone’s taxes. To understand what I mean, it’s necessary to illustrate the differences between tax deductions, nonrefundable tax credits, and refundable tax credits.
The basic concept behind income taxation is pretty simple. You take your income and subtract out deductions to come up with adjusted gross income (AGI). Then you multiply AGI by a percentage to figure how much tax you have to pay. The US tax is progressive. That is, the more money you make, the bigger the percentage you hand over to the Federal government.
Tax deductions are things like paying home mortgage interest, or saving for retirement by putting money into an IRA. You deduct the money you put into those things from your income. So if you are in a 15% tax bracket, for every dollar you put toward your IRA, your taxes are reduced by fifteen cents.
Your deductions can only drop your income down to zero. You can’t have negative income and get any kind of rebate from the IRS.
Then there are the tax credits, nonrefundable and refundable. After calculating how much tax you owe, based on your adjusted income, tax credits reduce the final sum of taxes paid. For every dollar of tax credit, your taxes are reduced by a dollar. For nonrefundable credits, you can reduce your tax liability down to zero, but then the game stops. With nonrefundable credits, you can’t have a negative liability and get any kind of a rebate from the IRS.
This brings us to refundable tax credits. With this type of tax credit, after your tax liability is reduced to zero, any credit left over is yours to keep. Which means the government sends you a check.
Tax deductions, nonrefundable tax credits, and refundable tax credits: guess which type the Barack Obama plan calls for when he says he’ll cut taxes for 95% of Americans? Now here’s the thing about this tax “cut.” After deductions from income, and existing tax credits, about 40% of American households don’t pay any income tax. But under the Obama plan, they would be getting money from the government.
So, getting back to our original question, when is a tax cut not a tax cut? When it’s welfare.
The basic concept behind income taxation is pretty simple. You take your income and subtract out deductions to come up with adjusted gross income (AGI). Then you multiply AGI by a percentage to figure how much tax you have to pay. The US tax is progressive. That is, the more money you make, the bigger the percentage you hand over to the Federal government.
Tax deductions are things like paying home mortgage interest, or saving for retirement by putting money into an IRA. You deduct the money you put into those things from your income. So if you are in a 15% tax bracket, for every dollar you put toward your IRA, your taxes are reduced by fifteen cents.
Your deductions can only drop your income down to zero. You can’t have negative income and get any kind of rebate from the IRS.
Then there are the tax credits, nonrefundable and refundable. After calculating how much tax you owe, based on your adjusted income, tax credits reduce the final sum of taxes paid. For every dollar of tax credit, your taxes are reduced by a dollar. For nonrefundable credits, you can reduce your tax liability down to zero, but then the game stops. With nonrefundable credits, you can’t have a negative liability and get any kind of a rebate from the IRS.
This brings us to refundable tax credits. With this type of tax credit, after your tax liability is reduced to zero, any credit left over is yours to keep. Which means the government sends you a check.
Tax deductions, nonrefundable tax credits, and refundable tax credits: guess which type the Barack Obama plan calls for when he says he’ll cut taxes for 95% of Americans? Now here’s the thing about this tax “cut.” After deductions from income, and existing tax credits, about 40% of American households don’t pay any income tax. But under the Obama plan, they would be getting money from the government.
So, getting back to our original question, when is a tax cut not a tax cut? When it’s welfare.
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