Month: March 2009

Protectionism

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“Punitive” import duties are a classic case of protectionism. The most famous example is the Smoot Hawley act which raised duties to 60% on imports into the U.S. during the depression. This caused other countries to do the same and is regarded by some as the single greatest contributor to the global depression of the 30s.

Any increase in U.S. import duties from their current levels are labeled by “free marketers” as protectionism. What are current levels?

In 2007, the U.S. imported $1.9 trillion. On that amount the U.S. collected $26B in import duties, or 1.3%. What do other countries charge?

U.S. favored trading partners in Europe charge US companies over 5% for imports into their countries. China recently reduced their import duties to 9.8%. Essentially, U.S. import policy makes it more cost efficient for US companies to move their manufacturing base outside of the US, then import the goods back into the US.

Pay As You Go

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For some historical perspective, here are some notes I made January 20th, 2009.

As of early October, Obama’s plan was still pay as you go. Pelosi and the blue dog (economic moderates) Democrats were convinced this was a doable plan even with a recession. However, the economic malaise has since proved to be so systemic both in this country and around the world, that revenues will probably fall short.

WSJ reported today (1/20/09) that, after the increase in the AIG bailout last night, there was talk among Democrats over the weekend that the bailouts are probably going to cost more than $700B even before Obama takes office. Secondly, the promised return of some of the money to the taxpayers from AIG is going to take longer than Paulson and Bernanke predicted.

Lastly, there was a cute little move that Paulson announced in September that went under most people’s radar – a change in Sec 382 of the tax code. It voids the tax that banks pay when they merge. The only ones who did notice this change were the mergers and acquisitions guys at US banks. It may mean as much as $140B in tax revenue gone this year and next. It sweetens the after tax bottom line for banks who want to merge.

I’m sure Paulson did this to encourage banks to buy failing assets and banks instead of the Treasury bailing them out but he made no announcement and the CBO was not notified to change their tax revenue projections because of the change. Corporations pay about $350-$400B in taxes each year so a $140B tax break to merging corporations is huge.

Barney Frank is questioning whether Paulson’s move was even legal, given a law that was passed in 1986. At any rate, tax revenues will be far less than even recently revised projections.

Obama can probably get some savings by drawing down troops in Iraq, which is costing us over $10B a month. General Petraeus is calling for more troops in Afghanistan so it is doubtful that there will be any savings in that combined military theater in the next 6 – 12 months. Iraq currently has a $70+ billion surplus and the U.S. may be able to get a down payment on the amount of money we have put into that country.

There is always cleanup to be done when Presidents like Reagan and Bush champion low taxes and high security. Reagan tripled the U.S. debt in his eight years, Bush has doubled it in his 8 years. Neither of them were very analytical, preferring to trust their guts and “shoot from the hip”. Each of them talked small government but delivered bloated government. Now we have a president who talks big government. Maybe we are living in a “bizarro” backwards universe where events turn out the opposite of presidential promises and projections.

Roth Conversions

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For those of you who have traditional IRAs or 401Ks, the recent sharp decline in stock prices can be a tax boon if you convert the IRA or 401K to a Roth IRA. You will need to pay taxes on the conversion but the tax is based on the value of the account at the time of the conversion.

As an example, let’s say you put $5000 into an IRA stock mutual fund in 2007. Let’s say the account value is $3000 now. If you convert the account to a Roth IRA, you pay taxes only on the $3000 value. All future gains are tax-free. There are no required minimum distributions. Plus there are additional benefits for your heirs.

But wait, there’s more! If you convert in 2010 (that year only), you can pay the taxes on the conversion over two years.

Also, the $100,000 income limit for Roth conversions expires in 2010.

Household Debt

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Thanks to Lydia who sent a link to a Toronto Globe and Mail interview by Heather Scoffield with Laurence A. Tisch, professor of history at Harvard University, and author of The Ascent of Money, A Financial History of the World. Some notable comments:

“This is a very unfair crisis. Here is the world’s biggest economy, which gave us subprime mortgages, rampant securitization, the collateralized debt obligation, Lehmann Brothers, Merrill Lynch. The epicentre is the United States, but the rest of the world, and particularly America’s trading partners, will get hit harder than the U.S. … because the U.S. retains the safe-haven status.” Safe haven is when, in a crisis, the rest of the world buys U.S. Treasury notes and bonds.

“Property ownership is something that our societies, particularly English-speaking societies, seem to be drawn towards. The notion that the majority of people should own their own homes dated from the 30s. It didn’t really become a reality until the 50s. We’ve sort of pushed the home ownership rate up to what seems to be its maximum, and beyond. It will clearly come down. The lesson of the subprime crisis is that you shouldn’t give mortgages to people who can’t afford them.”

“It’s a crisis of excessive debt, the deleveraging process has barely begun, the U.S. consumers are not going to suddenly bounce back and hit the shopping malls just because they get a tax cut. The savings rate is going to continue to rise. These processes have tremendous momentum that quite clearly differentiates them from anything that we’ve seen, including the early 80s, including 73, 74, 75. Those big crises, the ones that we have lived through, were bad. But seems certain to be deeper, and more protracted. “

“August, 2007 was when this crisis began. And if you were really watching the markets carefully, April is when it began, when the various hedge funds started to hemorrhage. The stock markets carried on until October of that year. And in many ways, consumer behaviour in the U.S. did not change until the third quarter of 2008.”

“$2-trillion worth of debt is going to hit the market this year, maybe more. Supply is exploding just when demand is contracting.” “There is still this inertia that prevents the dollar from falling off a cliff, that keeps the Treasury market from falling off a cliff.” “If I were in the market to buy distressed assets, I would wait, I would wait a bit longer until they’re really desperate. And it might even be better to wait until they’re bankrupt.”

“From John Law in 1719 to Alan Greenspan in the late 90s, there’s always a banker, there’s always a central banker making credit too readily available. The second thing is, though, that regulation may not prevent that.”

“Monetary policy evolved in a peculiar way in the 1990s towards de facto or de jure targeting of inflation, an increasingly narrow concept of inflation – core CPI.” “When the central bankers got together at Jackson Hole, the view that emerged from the debate in the late 90s was, we shouldn’t really pay attention to asset prices in the setting of monetary policy.”

“European banks are far more leveraged than American banks.”

“But one of the things that I find troubling about the administration is the degree to which is has ceded power to Congress. It’s almost like it’s a parliamentary system.”

“If you subtract mortgage equity withdrawal from the Bush years, the real underlying rate of growth of the U.S. economy was 1 per cent.”

“If you have a more equitable redistribution through the tax system, which Obama is committed to, it might actually be no discernible downside for middle America and lower-class Americans. So many of the benefits of the boom went to the elites.”

Averages

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Everything is uh, well, normal. That is the point that Jack Hough makes in his Stock Screen article in the April 2009 Smart Money magazine. Well, this economy doesn’t feel normal. But Jack presents some data that may surprise many of us.

House prices are down 25% from their 2006 peak. But Jack quotes a survey by Moody’s, one of the rating companies, that shows the cost of a house today averages about 20 years worth of what they might rent for. “From 1983 to 1999 … most houses cost 13 to 15 years worth of rent.” By 2006, housing prices had gotten so high that they were priced at an average of 25 years worth of rent.

We read that American consumers contribute 70% to the overall economy and alarm bells have been sounding because the American consumer is not spending that 70% now. They are, in fact, spending closer to the 80 year average of 65%. What we are seeing is a return to the average from the abnormally high spending of the past decade. This spending was fueled by abnormally high housing prices.

We’re starting to get the point now. This is not economic Armageddon. It is a return to average. We’ve just gotten used to above average in the past decade.

The S&P500 index is about half of what it was in August 2007. But it trades at the 100 year long historical average of 15 times corporate earnings. Those earnings estimates have sunk 30%. But (we’re getting used to this ‘but’ by now) “in 2006, corporate profits were 26% above their long-term average as a percent of gross domestic income.”

This return to average hurts. The unemployment rate is expected to top 8% when the Bureau of Labor Statistics (BLS) issues their weekly update of new claims. The historical average is 5.6%.

The BLS recently reported a 0.4 percent in productivity in the nonfarm business sector in fourth-quarter 2008, as output fell faster than hours.

Unemployment up + productivity down = not good. Is the mattress the safest place for savings?

The steep decline in stock prices may have caused some to give up on stocks altogether. Jack looked at the twelve worst 10 year rolling periods and found that they are inevitably followed by 10 year periods where the average return is almost 11% per year.

Homeowner Equity

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In a 3/13/09 WSJ report by S. Mitra Kalita: the Federal Reserve announced that Americans had seen their net worth fall by $11 trillion, or 18%, in 2008. However, a historical perspective is still positive for those adults who have been building equity over the past two decades. “Not accounting for inflation, household wealth more than doubled from 1990 to 2000, and then, after a pause, rose nearly 50% before the bust of 2008.”

But many have not been building equity for two decades. Real estate, primarily their house, accounts for 35 – 40% of the total wealth of most households. Those who invested their house equity in a larger home, or who borrowed against that equity, have watched that equity disappear. The Fed reported that, at the end of 2008, homeowners collectively had only 43% equity in their homes, the lowest level since 1953.

In 1990, Americans had 14% of their wealth in stocks. By 2000, stocks comprised 33% of wealth, slightly more than Americans had in their homes. It was paper wealth. The collapse of the dot.com bubble and the recession after 9/11 “downsized” that stock wealth substantially. In July 2002, the average American retail investor had lost all the stock profits they had made during the 1990s.

The lesson: diversify. As stocks rise, take the money “off the table.” Stocks and houses do not rise in value indefinitely.

Catholic Church

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This blog “follows the money”, which takes us to a a bill introduced in the Connecticut legislature, and withdrawn this week in response to protests, that would amend Section 33-279 of Chapter 598 regarding religious corporations.

The bill is in response to a long standing lack of financial accountability in some Roman Catholic churches. Father Emmett Coyne, a retired priest, notes that “I’ve seen pastors simply take money out of the collection before it was tallied.” in an op-ed today.

Here’s the text of the proposed bill – the red text in brackets would be deleted and the underlined text added. Here’s a summary of the changes.

Here’s the text of section 33-279 before this proposed revision – enter the section in the search box. Connecticut law requires corporations to have “one or more directors”. Previous law required religious corporations to have one lay person as a member of the board. This amendment stipulates that the board be composed of lay members only.

Health Care by Richard Nixon

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In 1974, President Nixon stated that 25 million people, or 11.6% of a population of 214 million, had no health care insurance.

In response to Ted Kennedy’s proposal of a single payer type of national health insurance, Nixon countered with a “National Health Insurance Partnership Act aimed to preserve the private insurance market while requiring employers to either cover their workers or make payments into a government insurance fund.”
“Senator Kennedy’s attempt to fashion a compromise national health insurance bill that preserved a place for private insurers ended up pleasing no one.”
“In his first address to Congress after succeeding Nixon, President Gerald Ford urged lawmakers to approve a national health insurance bill but President Ford’s short tenure was dominated by inflation and other economic woes.” “Critical” by Tom Daschle, Scott Greenberger, Jeanne Lambrew, p.65, 66

In the “Last Lion” Ted Kennedy says he made a mistake by insisting on a single payer type system. 35 years later, President Obama is proposing something similar to what Nixon proposed in 1974.

In this digest of census data:
In 2007, “The Census says the number of uninsured fell from 47.0 million to 45.7 million.” That’s 15.3% of a population of 300 million. That’s bad.

However, “nearly 18 million of the uninsured lived in households with annual incomes above $50,000 and could likely afford health insurance.” Well, maybe. In a previous blog I noted Kaiser’s survey figures showing an average of $12K annually for a family plan. In 2007, CNN Money reported that the median mortgage payment was $1566 a month, or $19K. Add in property taxes, utilities, food, school and other costs for their kids and a family might have enough left over for health insurance if they didn’t have to pay income taxes.

“Up to 14 million uninsured adults and children qualified for government programs in 2004 but had not enrolled, according to the BlueCross BlueShield Association.” Public service messages during commercial breaks for American Idol might help spread the word on the availability of these programs – maybe.

“About 18 million 18-to-34-year olds are uninsured. Most of them are healthy and know they can pay incidental expenses out of pocket. Using hard-earned dollars to pay for health care they don’t expect to need is a low priority for them.” The boomers will outvote them.

Liberal vs. Conservative

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OK, so you are having an identity crisis. Are you a liberal or a conservative?

This article from the National Center for Policy Analysis makes it easy to figure out. “Liberals want government in the boardroom but not in the bedroom. Conservatives want the reverse.”

Now that you have answered that burning question and “found yourself” you can enjoy this 13 page excellent review of liberalism and conservatism, their roots and the distinctions in their ideologies.

To whet your appetite: “In the history of politics, there is only one fundamental, abiding issue: It is individualism vs. collectivism.”

Mark To Market

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You may hear the term “Mark to Market” occasionally. So what the heck is that? This is a long article on the topic but the first two pargraphs summarize the various accounting methods that banks and securities firms use and the issues at stake.

For those of you with short memories, the Enron Scandal (capitalized, as it should be) provoked the controversy of evaluating assets along with a number of lawsuits that brought down Arthur Anderson, one of the big five accounting firms.