A New Minimum Wage

November 20, 2018

by Steve Stofka

Several readers had questions about the minimum wage article a few days ago. Why did I suggest 40% of the average wage? Why not 80%? How much of a difference is there between the average and median wage?

In May 2017, the annual BLS occupational survey found the average wages of all workers was a third higher than the median (Note #1). This survey is conducted only once a year and published six months after completion. I suggested 40% of the average regional wage. That would equal 53% of the median wage. I am not saying that 40% is a livable wage. Only that it might be a practical benchmark that moderates of both parties could support.

In 2015, the BLS estimated that there were 870,000 people making minimum wage. Over one million earned below minimum wage because they were in occupations where tipping is customary, and they have their own lower minimum wage. 870,000 workers out of 150 million is ½ of one percent. So why all the brouhaha about the minimum wage?

Approximately 42% of all workers make less than $15 an hour (Note #2). The percentage is closer to half of workers when adding union workers whose contract wages, particularly starting wages, are pegged to the minimum wage. A 2015 Forbes article quotes the UFCW:
“But the United Food and Commercial Workers International Union says that pegging its wages to the federal minimum is commonplace. On its website, the UFCW notes that ‘oftentimes, union contracts are triggered to implement wage hikes in the case of minimum wage increases.’ ” (Note #3)

I like several aspects of the Raise the Wage Act (Note #4) put forth by Bernie Sanders and Patty Murray. I like the gradual nature of the increases and the indexing of the wage. This is something that economists have been suggesting for decades. The summary published on Bernie’s web site (Note #4) is an embarrassment of errors:

“The Raise the Wage Act is front loaded to provide the biggest impact to workers. Upon enactment, the federal minimum wage would be increased from $7.25 to $9.25. The following increases are: $10.10 (2018); $11 (2019); $12 (2020); $13 (2012); $13.50 (2013); $14.20 (2023); $15.00 (2024).” They can’t even get their date sequence correct. Their calculations of the aggregate raise in wages is half of my estimate using BLS and BEA data (Note #5). Large companies like Wal-Mart are sure to lobby against the 14% cut in profits.

As the Slate op-ed notes, a national minimum wage of $15 is an “economic gamble” in a global economy that beckons business owners with lower cost labor. I am suggesting a compromise between Bernie Sanders’ proposal and the current policy.

1. BLS Occupational Survey
2. Slate article on raising the minimum wage.
3. Forbes article
4. Sumary of the Raise the Wage Act
5. My estimate: The summary of the Raise the Wage Act says “Increasing the federal minimum wage to $15 an hour by 2024 would give workers $144 billion in additional wages by 2024.” The Bureau of Economic Analysis’ current estimate of wages and salaries is almost $9 trillion. Using a low estimate of 2% annual wage growth would equal $10 trillion in 2024. There are currently 150 million workers. Estimating low employment growth of just one million workers a year gives an average of $64,000 per year. Let’s say that the 42% of wage earners who will be affected by a higher minimum wage make only 40% of that average, or $25,600 a year. That averages $12.80 an hour. The total wages that will be affected equals almost $1.7 trillion. The Raise the Wage Act is estimating that the average effect will be 8.5%. Using the estimates above gives us an effect twice that size, or 17.2% – close to $300 billion annually. That only includes the wages. Add in 25% in taxes and mandatory employer insurance costs equals $375 billion. Corporate profits after tax are currently $2 trillion. Estimating that they increase by 5% per year produces an estimate of $2.7 trillion in profits. $370 billion in additional costs is 14% of profits. Large companies like Wal-Mart are sure to lobby against such a bill.

A Real Minimum Wage

November 18, 2018

by Steve Stofka

Near the top of the Democratic agenda in the new Congress is a minimum wage of $15. The bill is unlikely to pass the Senate, but it will signal to the voters that the Democratic House is meeting campaign promises. The states with the most solid Democratic support are those on the west coast and northeast coast where the cost of living is much higher. A single minimum wage for the entire country is not appropriate. Republicans control the Senate and they are from states with much lower costs of living. They will reject an ambitious minimum wage that is one-size fits all.

Housing is the largest monthly expense for most families. Below is a graph of home prices in several western metropolitan areas (MSAs) and the national average of twenty large MSAs. Home prices in Dallas and Phoenix are a 1/3 less than Los Angeles and San Francisco. Housing costs in many smaller cities will be below Dallas and Phoenix.


Why isn’t the minimum wage indexed to inflation? Because politicians of both parties, but particularly Democrats, have used it as a wedge issue to gain voter support. If the House Democrats wanted to pass bi-partisan legislation on a minimum wage, they could use a flexible minimum wage that is indexed to the average wages for each region within the country. These are published regularly by the Bureau of Labor Statistics, the same agency that publishes the monthly report of job gains and the unemployment rate. I’ve charted the annual figures for those same cities.


A $15 minimum wage is 40% of the average wage in San Francisco, and a bit more than half of the average wage in Los Angeles. It is almost 60% of the national average. The current minimum of $7.25 is 28% of the national average.

If the House passed a minimum wage bill that set the wage to 40% of the average wage for each region, Senate Republicans might at least consider it. In Denver and L.A., the minimum wage would be about $11.50. In Dallas and Phoenix, it would be about $10.60. Democrats could show that they are in Washington to pass legislation for working families, not pound some ideological stump as Republicans did for eight years with the repeal of Obamacare.


Stocks and Taxes

There is a close correlation between stock prices and corporate tax collections. The tax bill passed last December lowered corporate tax revenues in the hope that businesses would invest more in the U.S. The divergence between prices and collections has to correct. Either tax collections increase because of greater profitability or stock prices come down.

Income Growth

The financial crisis severely undercut income growth. Real, or inflation-adjusted, per capita income after taxes decreased for three years from 2008 through 2010, and again in 2014. It is the longest period of negative growth since the 1930s Depression.


Promises Made and Unpaid

November 11, 2018

by Steve Stofka

A tip of the hat to veterans on this holiday.

The Kaiser Family Foundation (KFF) regularly updates their map of the states that have not expanded Medicaid under Obamacare (Note #1). Here’s a screen shot.

All the non-expansion states except for Wyoming had per capital personal incomes below the national average.


Since these states have less per capita income, it is likely that more of the residents in those states qualify for Medicaid. During the initial phase of Obamacare, the Federal government picked up the tab for the additional costs. That share will gradually decrease to 90% in 2020, when the states will have to foot 10% of the expansion costs.

A ten percent share seems light. Why don’t these states expand their Medicaid eligibility? Let’s look beyond accusations of prejudice, which exists in every state.

The populations in most of these states are older. Poor seniors living in nursing homes qualify for traditional Medicaid, which costs each state much more than expansion Medicaid. The national average of state costs is 38%; the Federal government picks up an average of 62% of traditional Medicaid spending. Wyoming pays almost 50%, far above the average. Texas and South Dakota pay 44% and 41%. Oklahoma and Florida pay the average of 38% and the rest of the non-expansion states pay below average (Note #2).

The financial crisis ten years ago crippled state finances for several years and some have still not recovered. Since 2000, average per capita real income in the U.S. has grown only 1.2% per year. Medicaid spending has grown at more than three times that rate (Note #3). Residents in these poorer states have fared worse than the average. Revenues in those state have barely kept up with obligations. Officials in poorer states with older populations anticipate that funding difficulties will continue now that the first of the Boomer generation has turned 70. Given the political pressure to expand, how much longer will some of these states resist expansion?

Thirteen states that have expanded coverage have adopted new revenue sources to fund the additional costs (Note #4). Most states fund their Medicaid spending, original and expansion, out of general revenues which are falling behind state promises. These include infrastructure repairs – roads, bridges, improvements and repairs to schools and other government buildings – as well as pension obligations. Officials of state and local governments made these promises decades ago, when per capita incomes were growing more than 2%. Annualized growth over a twenty-year period has not been above 2% since 2001.


Tax the rich is one solution offered, but that is a short-term solution. In the long-term, higher income growth is the sustainable solution. Until Democratic politicians can craft a coherent policy message that promises to promote stronger economic growth in these states, the voters will reject them.


1. KFF’s map of states that have turned down Medicaid expansion.
2. KFF’s breakdown of Medicaid costs per state.
3. A summary of inflation adjusted Medicaid spending from 2000-2012 showed a 4.1% annual growth rate – pg. 4. A state by state breakdown is on page 35. A 49 page report from Pew Charitable Trust.
4. A recent article showing the various sources of funding that expansion states are using.

Voter’s Guide

November 4, 2018

by Steve Stofka

This week – a break from personal finance and economics to bring you a voting guide for Independent voters who make up more than a third of the electorate. Circle which position you favor in each category below. Add up the choices. Vote for whichever party gets the most circles.

Role of Federal Government
If you believe that the Federal government has too much power over individual lives, Vote Republican.
If you believe that the Federal government should have more power to promote an egalitarian society, Vote Democrat.

Political Structure
If you want to change the existing political structure to a democratically elected Parliamentary Republic, Vote Democrat.
If you like the existing system of a Constitutional Republic of democratically elected state legislatures, Vote Republican.

If you think that regulation should be primarily left up to state and local agencies who will be more responsive to the people of that district or state, Vote Republican.
If you prefer federal regulation because you distrust the ability of state and local agencies to apply regulations fairly and evenly, Vote Democrat.

Family Planning
If you think state and local agencies acting as agents of God’s will should control your family planning decisions, Vote Republican.
If you believe in personal autonomy in family planning decisions, Vote Democrat.

Equality of Social Contracts
If you believe that all people should have equal rights to make legal contracts regardless of their social or sexual identity, Vote Democrat.
If you believe that an elected government has a right to restrict access to legal contracts to promote certain moral values and behaviors, Vote Republican.

If you believe that national defense is the primary legitimate function of a Federal government, Vote Republican.
If you believe that the Federal government should provide a safe environment for all citizens, and that defense is just one part of that safety net, vote Democrat.

If you believe that taxes for common benefits should be applied more evenly so that everyone has “skin in the game,” Vote Republican.
If you believe in progressive taxation, that the Federal government has a right to take more from you, so it can give more to someone else, Vote Democrat.

If you believe that we are a nation of laws and that foreigners coming into our country should respect our laws, vote Republican.
If you believe that the administration of immigration law must respond to the plight of human beings seeking a secure home for their family, vote Democrat.

If you believe that there is not yet enough actionable evidence for climate change caused by human activity, Vote Republican.
If you believe that we should pursue policies that limit activities which promote climate change, Vote Democrat.

Social Welfare
If you believe that government has a responsibility for the welfare of all Americans, Vote Democrat.
If you believe that state and local governments have a responsibility to act with charity toward those who cannot care for themselves through no fault of their own, Vote Republican.

There are many particular issues, some of which are sub-genres of these categories, at https://www.isidewith.com/polls.





To Buy Or Not To Buy

October 28, 2018

by Steve Stofka

In ten years, the number of households that own their homes has grown by only 2-1/2%. Renting households have grown by 20%.

Should you buy a home? Home prices are sky high in some cities. Mortgage rates are rising. Is 2018 a repeat of 2006? Many bought homes at high prices only to see the price fall by a third or half over the following years.

Time to discover your inner owner investor who is going to buy the house. You are going to rent the home from your owner investor. Let’s compare the annual Net Operating Income (NOI) to the purchase price of the home. To keep the math simple, let’s say the owner investor can charge the renter $2000 a month in rent for the home. Let’s say that you, the renter, are going to bear the monthly cost of utilities. You, the investor, must pay $2000 in property taxes and other city charges like garbage collection. Your annual net income from the property is $2000 x 12 = $24,000 – $2000 taxes and costs = $22,000. Let’s say that the all-in cost of the home is $360,000. $22,000/$360,000 = 6.1%. That is the cap rate of the property.

Home pricing, like many assets, behaves in a cyclic manner, as the graph below shows. In the past thirty years, the average annual growth of the Case-Shiller home price index in Los Angeles is 5.6%. The rate of the past three years is slightly above that thirty-year average, meaning that prices in the L.A. area have stabilized relative to the long-term growth average.


Rents have risen almost 5% so the two growth rates are fairly close. Let’s subtract an inflation rate of 2.6% from that to get a real capital gains rate of 3%. Add the two rates together to get a combined rate of 9.1%. For an average home in the L.A. area, this is a pretty good total rate of return.

Let’s look at another area: Denver. The thirty-year average of annual growth in home prices is 4.9%. During the past five years, population growth in the Denver area has been robust. Home prices have risen more than 7.5% during each of the past five years, topping 10% in 2015. In 2017, rents rose an average of 5.33%, not enough to keep pace with the growth in prices. An investor would be buying at an above average price.

In a hot market like Denver, a family might think “I am saving 8% a year by buying now.” They assume that above average price growth will continue. The law of averages indicates the opposite – that price growth is more likely to fall below average, and even turn negative.

In making a decision, understand where current prices are in the cycle (Note #1).  Understand where current rental growth is in the cycle and compare the two (Note #2). Here is a graph comparing the two series in Denver. Note the large divergence between home prices and rents in the late 1980s, 1990s and again in the 2000s. Rental prices were much more stable.


Imagine that the home purchase is a cash investment and estimate a total return on that investment, as I showed above. Some familes pick a home in a price range based on the leverage of their income and down payment. A real estate agent may present home buying choices based on the amount of house a family can qualify for. But – is the house a good deal? These rates of return are an important factor to consider in making a wise decision.



  1. You can search for “FRED home prices [large city name here]” to get the Case-Shiller Home Price Index for that city. Click Edit Graph button in upper right and change the units to “Percent Change From Year Ago”. To get an average, click the Download button above the Edit Graph button to download an Excel spreadsheet.
  2. You can search for “FRED cpi rent residence [large city name here]” to get the index of rental prices for that city. As above, click Edit Graph button and change units to “Percent Change From Year Ago



The recent downturn in the market was overdue. Since the election almost two years ago, the year over year total return of the SP500 has been above the 10% historical average.


The longest above average streak under Obama’s Presidency was almost three years. In the dot-com boom under Clinton, the market had above average returns for almost 3-1/2 years. After a two-month stumble in 1998 due to the Asian Financial Crisis, the streak continued for another twenty months. Such a long period of exuberance was sure to fall hard. During the following three years, the market lost half its value. Reagan and Eisenhower enjoyed the next longest streaks of almost 2-1/2 years. The 1987 crash ended the streak under Reagan.

The Sense and Cents of a College Education

October 21, 2018

by Steve Stofka

Should a young person invest money in a college education? Let’s look at the question from a financial perspective. Building a higher educational degree is as much an asset as building a house. Let me begin with the hard numbers.

Employment: A person is more likely to be employed. Here is a comparison of those with a four-year degree or higher and those with a high school diploma. The difference in rates is 2% – 3% during good times and as much as 6% during bad times.


Is the unemployment rate enough to justify an investment of $50K or more in a four-year degree? Maybe not. During the worst part of the financial crisis, ninety percent of HS graduates were working. Why should a diligent person with good work skills spend time in college? Most college students take six years to complete a four-year degree. They must spend four to six years of study in addition to the loss of work experience and earnings in those years. The unemployment rate is not a decision closer.

Earnings: In 1980, when those of the Boomer generation were taking their place in the workforce, college grads earned 41% more than HS grads. Today, college grads earn 80% more. That gap of $567 per week totals almost $30,000 in a year and is less than the monthly payment on a $50,000 loan (Note #1). Can a person expect to earn that much additional when they first graduate? No, and that’s why many students struggle with their loan payments in the decade after they graduate.


Maybe that earnings difference is a temporary trend. The debt is permanent. Should a young person take on a lot of debt only to find out the earnings difference between college and high school graduates was temporary? Unfortunately, that’s not the case. The big shift came in the 1980s when the gap in earnings grew from 41% to 72% in twelve years.


There were several reasons for the explosive growth in that earnuings gap. Many Boomers had gone to college to avoid the Vietnam War draft. As they crowded into the workforce in the late 1970s and 1980s, they wanted more money for that education.

During the 1980s, the composition of jobs changed. Steel manufacturing went overseas to smaller and more nimble plants which could adjust their outputs more economically than the behemoth steel plants that dominated the U.S.

Automobile companies in Michigan closed their old plants. Chrysler needed a government bailout. The manufacturing capacity of Asia and Europe that had been crippled by World War 2 took several decades to recover. The U.S. began to import these cheaper products from overseas. As high-paying blue-collar jobs diminished, the advantage of white-collar workers grew.

As more companies turned to computers and the processing of information, they wanted a more educated workforce that could understand and execute the growing complexity of information. Manufacturing today relies on computer programs that require a set of skills that are more technical than the manufacturing jobs of the past.

A oft-repeated story is that the signing of NAFTA in 1993 and the admittance of China into the World Trade Organization were chiefly responsible for the growing gap between white collar and blue collar workers. I have told that story as well, but it is incorrect and incomplete. As the graph above shows, that gap has grown modestly in the past twenty-five years. The big shift happened in the 1980s when the first of today’s Millennials were in diapers and grade school.

When we adjust weekly earnings for inflation, we can better understand the evolution of this earnings gap. In the past forty years, high school graduates have seen no change in median weekly earnings. From 1980 to 2000, their earnings declined. The 25% growth in the earnings of college graduates came in two spurts: in the mid to late 1980s, and during the dot-com boom of the late 1990s.


Since this trend has been in place for decades, college students can assume that it will likely stay in place for the following few decades. Like the mortgage on a home, the balance on a student loan doesn’t increase every year with inflation, but the earnings from that education do and they have increased more than inflation. The payoff to a four-year degree is the difference in earnings. That is the decision closer.


  1. Using $50,000 loan for ten years at 6% interest rate at Bank Rate.

Changing Dance Partners

October 14, 2018

by Steve Stofka

This week’s stock market activity helps us remember some simple rules of investing. Many of us confuse mass and weight. Mass is the resistance of an object to a change in speed or direction. Weight is the force of gravity on that object. Using this model, let’s compare the masses of stocks and bonds. On Wednesday, when stocks fell over 3%, the price of a broad bond composite barely moved.

Bonds act like a big cruise ship, more resistant to changes in wind and wave than a sailboat. The cruise ship’s progress is ponderous but predictable. Stocks behave like a sailboat which moves in a zig-zag fashion, changing directions to cope with wind and wave. Sometimes, the sailboat makes a lot of progress in calm waves with a favorable wind. November 2016 through January 2018 was one such period when stocks made steady progress.

On the previous Wednesday, October 3rd, a “rout” – a half-percent drop – in the bond market indicated a global unease. A half-percent move in the stock market occurs weekly. The last half-percent drop in the bond market was on March 1st 2017, eighteen months ago. Let’s look at that incident to help us understand the pattern.


Post-election, the stock market rose for three months, then plateaued for two weeks following that bond rout. Bonds drifted slightly lower and then, on March 15, 2017, charged higher by .6%. Within a few days, stocks lost 2-1/2%. On May 17th, bonds again surged, and stocks fell 2%.

The gigantic size of the bond market dwarfs the stock market. An infrequent daily shift in the pricing of the bond market signals a long-term recalculation of future risks and profits in both the bond and stock markets. When large shifts in the bond market happen frequently, stock investors should pay attention. Between Thanksgiving 2007 and the end of that year, the bond market experienced ten days of greater than 1/2% price swings! It signaled confusion and was a warning to stock investors that rough times were coming.

The bond market’s YTD price loss of 4% marks the probable end of a multi-decade bull market in bonds. The bond market is so stable that a small loss of 4% can mark the largest loss in decades.

We are seeing a change in dance partners. As an example, the stocks of high growth companies rose 20% from February lows. That was almost twice the gains of the SP500 broader market. Many of these are small and medium size companies whose growth is hampered by the greater cost of borrowing money in an environment of rising interest rates. The owners of growth stocks wanted to take some profits this past week but could not find buyers at those high prices. In the past week, prices of those stocks fell 8%. Cushioning the fall of some stocks is the large stockpile of cash – $350 billion – that U.S. companies have stockpiled for buybacks of their own stock. Some of that money was put to work in Friday’s recovery.

The U.S. stock market has been the one of the few bright spots in a global marketplace that has turned down this year. This week begins the reporting for the 3rd quarter earnings season so we may see more price swings in the days to come.

Consumer Credit

It is very iniquitous to make me pay my debts; you have no idea of the pain it gives one. – Lord Byron

October 7, 2018

by Steve Stofka

The total of all consumer loans, excluding mortgages, is almost $4 trillion. The Federal government owns $1.5 trillion of that total, most of which is student loans, which have tripled in the past decade. According to the Dept. of Education, 11% of student loans are in default, three times the credit card default rate and more than ten times the auto loan default rate (Note #1).

Over a five-decade period, the stock market has risen when consumer credit rose. Below is a chart of consumer debt outstanding as a percent of GDP (Note #2).


This a decade long indicator, not a timing tool. Notice that the ratio of credit to GDP (blue line) rises during recessions (shaded gray) when GDP, the bottom number in the fraction, falls. When the recession is over, credit falls as people fall behind in their payments, loans are written off, etc. Now GDP starts rising again while the top number, credit, is falling.

Auto loans make up 28% of outstanding consumer credit and currently have less than a 1% default rate. If we adjust the total of consumer credit by the extraordinary growth in student loans, auto loans make up 39% of total consumer credit (Note #3). We saw a similar percentage in the mid to late 1980s when savings and loans aggressively extended auto loans and mortgages. In the late 1980s and early 1990s, a third of all S&Ls failed.

Typically, people do not count vehicle depreciation in their budget, but they should, just as businesses do. Example: the average yearly take-home pay is $52K. Let’s say the average car, new and used, is $24K and depreciates $2400 a year (Note #4). Let’s say that the average person saves about $2400 a year to make the math easy. The $2400 that goes in the savings bank is simply offsetting the $2400 in depreciation. There is no savings.

In addition to depreciation, many of us don’t include the cost of inflation in our budget. Six years from now, a replacement car, new or old, could cost an additional 15%. Without adjusting for these “hidden” costs, we may think we are getting by. Over time, however, we add these hidden costs to our credit balances. We put less down on the next car and get longer auto loans. The average loan length is now 5-1/2 years. As soon as we are done paying off one car, it is time to get another (Note #5).

The economy is strong, and it needs to stay strong so that households can pay back their loans. The ultra-low interest rates of the past decade have reduced the monthly debt payments for many. For the past two years they have leveled at 5.6% of disposable personal income, the mid-point of the past forty years. For every $20 that a person takes home, they are paying $1 to service their consumer debt. The average yearly debt service payment would be about $3000 on a $52K take-home pay.

In response to the strong economy, the Federal Reserve has been raising interest rates to a more normal range. The 30-year mortgage rate just hit 5% this past week. Rising interest rates raise the monthly payments and reduce the loan amounts that borrowers can qualify for.  Many younger workers are unfamiliar with a world of normal interest rates.  They will have to learn a new math.



1. Student default rates . Default rates reported by the credit agency Experian .
2. More detail on consumer credit here at the Federal Reserve ()
3. I made the adjustment by subtracting $1 trillion in Federal student loans from the current total of credit. This pretends that Federal loans grew 15% in the past decade, not 300%.
4. The average amount financed on a used car is $17,500 (FRED series DTCTLVEUANQ). New car loans average $29,800 (FRED series DTCTLVENANM).
5. A buyer of a new car holds it for 71 months according to Auto Trader.



Amy Finkelstein is a MacArthur genius award recipient who studies trends in health care. Proponents of Medicaid expansion projected that lower income families would better control and plan their medical care under Medicaid. Instead they have used the ER even more.  She found that people visit the ER more, not less. Although families report better health and more confidence in their financial security because of Medicaid expansion, measureable health outcomes have shown no change. WSJ article (paywall) is here. Her citations on Google Scholar.


Inflation Measures

“Everyone is entitled to his own opinion but not to his own facts.” – Sen. Daniel Patrick Moynihan

September 30, 2018

by Steve Stofka

The above quote has been attributed to the former Senate Majority Leader. People repeat the quote when discussing a contentious subject. We are often convinced that we have the facts when our facts may indeed be arbitrary. Let’s take the case of real or inflation-adjusted income. Has the average real wage declined or risen in the past decades? The calculation depends on which measure of inflation we choose.

There are two measures of inflation, the Consumer Price Index (CPI) and the Personal Consumption Expenditure Price Index (PCE). The CPI relies on surveys of what consumers buy. The PCE is based on surveys of what businesses sell (Note #1). The CPI uses a fixed basket of goods, regardless of changes in the prices of items in a basket. If the weekly basket of goods includes two pounds of ground beef, that two pounds never changes in response to lower prices. It is static. The PCE does adjust for price changes. If the price of a pound of ground beef went down thirty cents, the PCE calculates that a family bought a bit more ground beef and a little bit less chicken, for example. It is a dynamic measure.

People drive fewer miles and buy more fuel-efficient cars as the price of gas increases BUT only after a certain dollar amount. Our purchasing patterns are both static and dynamic. Because we are creatures of habit, our buying patterns are resistant to change. Within a certain price range, we will continue to buy the same items. Outside of that range, we do make changes because we want to optimize our choices.

In the past forty years the CPI has calculated an annual rate of inflation that is over ½% higher than the PCE rate. That small difference compounded over forty years amounts to 23%. That large difference tells two very different stories. Using the CPI, the average worker has lost a few percent in inflation adjusted hourly wages. Using the PCE, on the other hand, the average worker has enjoyed real gains of 20% in the past forty years (Note #2).

Our most volatile disagreements are in areas where facts are difficult to observe. The household survey data that underlies the CPI is unreliable because people living busy lives are not accurate journal keepers of their daily purchases. On the other hand, surveys based on business sales are inaccurate because people stock up on items whose prices decline.

Even when facts are readily verifiable, the interpretation of those facts varies with context. In arriving at our version of the meaning of those facts and their context, we subtract a lot of observable data.  We must filter reality because we cannot manage such a large amount of information. Because we filter our perceptions, eyewitness testimony is unreliable. Although our perceptions are inaccurate, we must act on those perceptions and hope that they are accurate enough. That same reasoning guides economists, politicians, and those in the social and physical sciences. We would all have more constructive discussions if we understood the imperfection of our perceptions.



1. The Difference between CPI and PCE {Federal Reserve}

2. Using the average hourly wage for production and non-supervisory employees.

The Crack in the World

Ignorance has one virtue: persistence. – John Kramer, Blythe

September 23, 2018

by Steve Stofka

Ten years ago, the financial world cracked. Job losses during the first eight months of 2008 were definite signs of recession, but this correction to an overheated housing market had been expected for two years. In July 2008 came the news that June’s job losses had eased. The average duration of a post-WW2 recession was eight months, so the correction was nearing an end. More worrying were the high gas prices, which had topped $4 per gallon. Beginning in mid-July, the stock market rose more than 5% and traded in a consolidation level through August.

In early September, the market lost 3% when August job losses worsened. Within a week, the market recovered those losses and closed on Friday, September 12th at the consolidation level it had been at during August. Over that weekend, the Federal Reserve, U.S. Treasury and other banking agencies tried to arrange a rescue of the investment firm Lehman Brothers.

On September 15th, the world learned of the firm’s collapse. Within hours, the market lost almost 5% of its value, more than the market may gain or lose in a year. In busy urban areas, people stopped to stare at the market’s extraordinary volatility displayed on storefront TV screens. There were more such days to come. Over the next two weeks of turbulent price swings, the market stabilized at its mid-July low, closing September just below 11,000.

What stabilized the market in those closing days of September? On September 30th, the N.Y. Times reported that the Securities and Exchange Commission (SEC) might suspend a newly implemented FASB international accounting standard SFAS 157 (Note #1 and #2). This accounting rule required financial institutions to value loans and other assets on their books at market value, not by the present value of future cash flows (Note #3). In turbulent markets, when raw fear is the auctioneer, market prices do not reflect the future value of assets.

After a TARP bill (Note #4) failed to pass Congress on the first go, there would be another attempt by the end of the first week in October. Neither the Congress or the administration could summon the political will to temporarily suspend the accounting rule. The TARP bill that President Bush signed on Saturday, October 3rd, required only that the SEC study the accounting rule.

Investors ran for the exits. The financial carnage may have happened in September, but the market implosion happened in October. In seven consecutive days in early October, the Dow Jones Industrial Average lost almost 23% of its value (Note #5). Did an accounting standard cause the financial crisis? No, but it did intensify negative investor reaction to the financial crisis, which exacerbated the crisis in a negative feedback loop.

In early March 2009, after the market had lost 40% of the value it had in early October 2008, the FASB announced that they would modify the standard a month later (Note #6). By the time that modification was implemented on April 9, 2009, the SP500 had risen 20%.

Could the Bush administration have eased the response to the crisis? Yes. Did accounting standards cause the financial crisis? No. Can we expect another crisis sooner rather than later? Yes. Central bankers and Federal agencies that supervise the banking system cannot fully monitor modern credit markets in real time. When the horses are spooked, regulators sitting in the driver’s seat may hold the reins but have little control of the panicked animals.

Investors who maintain some balance in their savings portfolio can weather these market catastrophes. 50% market falls have occurred only three times in the past fifty years (Note #7). Investors with long time horizons can afford to take a less balanced approach.


1. The FASB is a privately held international organization that sets accounting standards. Fair Value Accounting standard SFAS157 (“mark to market”) is one of their standards, implemented in 2006. An explanation of the standard from FASB in May 2008, before the crisis.

2. Suspension of the SFAS 157 standard would have allowed banks to report higher profits and relieve some of the capital pressures on bank balance sheets. Sept. 30th NY Times article.

3. FDR suspended mark-to-market accounting in 1938. See this March 2009 article for a  review of the issue.

4. TARP – The Troubled Asset Relief Program was a compilation of many programs designed to support the automotive, housing and financial industries. On page 11, a reminder of the corruption of Wall Street and the incompetence in Washington. “In March 2009, after receiving $170 billion in federal bailout money with another $30 billion pending, AIG announced a $165 million bonus payout to executives. Despite the bailout and the U.S. government having ownership control, AIG management thought it was prudent to pay executive bonuses in a financially struggling company. The U.S. government lacked the oversight to assure efficient use of taxpayer bailout funds.”

5. The sharp fall in October was the second sharpest decline since World War 2. The leader is the October 1987 crash, when the market lost 28% in four days.  What about the dot-com bust? Over 2-1/2 years, the market lost half its value but there wasn’t a decline of more than 20% during that market fall. The strongest decline began in February 2001 and took 34 trading days to lose 18%.

6. An article from the Harvard Business Review in November 2009.

7. 50% market falls: The gas crisis of 1973-74, the dot-com bust of 2000 – 2003, and the mortgage and financial crisis of 2007-2009. Less severe falls came in 1966, 1969-70, 1977-78, 1982, 1987, 1990, and 2011. These were all more than 20% drops in market value.



In mid-2016, the inflation-adjusted price of the SP500 index finally rose above its price at the start of the century. The price has risen 25% since then.