Month: May 2009

Age Discrimination

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In a 3/11/09 WSJ article, Jennifer Levitz and Philip Shishkin reported on an Equal Employment Opportunity Commission release showing that “age-discrimination allegations by employees are at a record high, jumping 29%” from year ending Sept 2007 to year ending Sept. 2008.

To avoid these lawsuits, companies have been adopting a tactic they don’t like, one which unions have long endorsed – layoffs by seniority. Last one hired is the first one fired.

In a 5/19/09 WSJ article, Dana Mattioli reports on this new age discrimination against younger workers, who often have little recourse under the law. Seniority based layoffs are easier to defend against age discrimination allegations.

Younger workers usually cost a company less money and can help their case by losing any “high maintenance attitudes typical of younger workers.” Make yourself more valuable to the company by expressing a willingness to crosstrain in another department.

Health Care Tax

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In a 5/19/09 WSJ article, Janet Adamy reviewed various schemes that the Senate Finance Committee is considering to pay for changes to the health care system.

In 2008, the “government gave up $194.2B in revenue due to health care tax breaks.” This tax subsidy was the largest single group of subsidies, 8% of total government revenues of $2.5T. Companies can deduct health insurance premiums for their employees and, in many cases, employees pay their share of the premiums in after-tax dollars. Max Baucus, Committee chairman, said repeal of the exclusion is not being considered.

Several proposals, however, aim to eat away at the exclusion. One proposal eliminates tax breaks for the cost of health plans above a certain value, with the health plan for federal employees serving as a benchmark. A second proposal cuts tax breaks for high income earners making more than $200K, if single, and $400K, for couples. A third proposal is a combination of the first two. Other proposals being considered are various taxes which would promote a healthier lifestyle, including higher alcohol taxes and a new tax on drinks with sugar.

The cost of the rebuilding the health care system has been estimated at $1.2T over ten years. The money has to come from somewhere.

Leveraged ETFs

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In this blog I focus on economic trends and data that will have an impact on our lives, and in a broader way on our investments. As such, I don’t usually go into the particulars of investing in stocks or bonds. However, I will give a word of caution on a particular type of investment – leveraged ETFs. I recently read that some financial advisors are including these in the portfolios of their clients. These products are suitable short term strategies but be cautious before using them as a core holding.

What is a leveraged ETF? For that matter, what is an ETF? It is a basket of stocks, much like a mutual fund, except that it trades like a stock. Typically, one buys an ETF like you would a stock, in whole lot multiples of 100 through a broker. Like stocks, one pays a commission every time one buys or sells.

What is a leveraged ETF? A basket of trading instruments, lets call them, that seeks to either double or triple the return of a particular index of stocks. You can bet with the index or against it. Since ProShares introduced these ETFs a few years ago, they have become quite popular.

The Ultra series of shares seeks to capture 200% of the upward movement of an index. If an index goes up 5%, an Ultra ETF will go up 10%.The UltraShort shares seek to capture 200% of the inverse movement of an index. If an index goes up 5%, an UltraShort ETF will go down 10%.

Sounds simple but, over time, the percentages can work against you. Let’s look at an example. SPY, or Spdr S&P 500, is a popular ETF that is a basket of stocks that closely tracks the movement of the S&P 500, an index that comprises the market weighted prices of the 500 biggest companies in the U.S. I will compare SPY, the PowerShares UltraShort S&P500 (SDS), and the PowerShares Ultra S&P 500 (SSO).

For simplicity sake, I will round to the nearest dollar. On Jan. 5th, 2009, SPY was at $93, SSO was at $28, and SDS was at $67. Fast forward to 3/9/09, a low point in the market not seen in over a decade, when SPY was at $68. That is a 26% decline from the $93 price at the beginning of January. Let’s look at SSO, which should have gone down twice as much as SPY. On that same day, it closed below $15, an approx 48% decline. That is not exactly twice, but close enough. SDS, the short or inverse ETF, should be up twice the 26% loss suffered by SPY, or 52%. On that day, SDS closed at $115, a gain of almost 60%, more than what we expected. If you had bought SDS on Jan. 5th, you would be singing the “greens” on March 9th.

Let’s continue on. The stock market rallied from that low. On this past Friday, SPY was at $89, gaining back all but 2% of what it had lost since Jan. 5th. SSO should be down about twice that, or 4%, but we find that it closed at $24, a 14% decrease from its Jan. 5th price of $28. If SPY has decreased 2% since Jan. 5th, then SDS should be up 4% since then. But SDS closed at $61, a 9% decline from its Jan. 5th price of $67.

What happened? As long as there is a consistent market direction, up or down, these leveraged ETFs work for an investor. If the market seesaws, the percentages work against the investor.

Due to the popularity of 2x leveraged ETFs from PowerShares, a company called Direxion came out with 3x leveraged ETFs late last year.

Underwater

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In a 5/6/09 WSJ article, Ruth Simon and James Hagerty report on current housing values after the release of industry results for the first quarter of 2009.

Across the U.S. 19% of mortgage holders are “underwater” or “upside down” – they owe more than their house is worth in today’s market. This is more than a 50% increase in the number of underwater borrowers since the end of 2008. According to one company that tracks this data, “more than one in 10 borrowers … owed 110% or more of their home’s value at the the end of last year.” Las Vegas homeowners have been hit the worst. Zillow.com estimates that over 67% of mortgage holders there are upside down.

Why wouldn’t a bank holding a mortgage agree to write down some of the principal on the mortgage? Let’s say a homeowner with a job is struggling to stay current on a $300K mortage on a house that is now valued at $240K. If the bank forecloses, they will probably sell for closer to $200K and will have expenses for legal fees, maintenance, fix-up and taxes. Wouldn’t it make sense for the bank to at least write down half of the $60K principal difference if that would mean the bank could avoid foreclosure?

The answer is – wait, sit down first. The loss on a foreclosure is a long term loss on the bank’s loan portfolio that can be spread out over several years. A write down in principal on the mortgage is an immediate loss that affects the bank’s bottom line this year. John and Mary Homeowner may have lost their chance to avoid foreclosure because of an accounting rule.

B-School Grade: F

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In a 4/24/09 WSJ op-ed, Michael Jacobs, a business school professor who formerly worked at the Treasury, takes business schools, “B-schools”, to task.

Management compensation should emphasize the long term value of a company. Yet there is no systematic study of the design of management compensation systems at most business schools. A shareholder should be wary when he or she reads assurances from CEOs that their compensation is designed to align management compensation with the interests of the shareholders.

Few business schools cover the topic of board structure – what it does and how it should do it. Citigroup, one of the largest financial companies in the world, had few directors on their board with any experience in financial markets. GE has a large financial division, GE Capital, but has only one board member with experience in a financial instution.

B-Schools offer comprehensive teaching in securitizing assets and diversifying risk. Those skills were well exercised in developing the mortgage backed securities (MBS) and collaterized debt securities (CDS) that crippled the financial world in 2008. In B-Schools, there is little examination of the increase in risk as the providers of capital grow further away from the users of that capital.

Half of Americans have some investment in the stock market but the majority of that investment is through pension and mutual funds. At the financial institutions that handle these investments and own almost 70% of the shares of American corporations, the MBAs have had little training in shareholder rights and duties as owners. Because of this, there is little shareholder input into the governance of America’s corporations.

The author concludes with an assessment: “by not internalizing sound principles of governance and accountability, B-school graduates have matured into executives and investment bankers who have failed American workers and retirees who have witnessed their jobs and savings vanish.”

Bank Stress Tests

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After stressing all of us out, the 19 largest banks had to undergo a stress test of their own. On 5/7/09, the Federal Reserve (Fed) released the results of their several month stress tests on the 19 largest banks in the country. These tests project certain levels of unemployment, loan delinquency, falling asset values and determine whether banks have the capital cushion to withstand the losses.

The stress test used a 9.5% unemployment rate, which some felt was too low. Weekly unemployment figures released 5/8/09 showed an 8.9% rate and it is widely believed that the rate will go over 10%. The U6 unemployment rate, which includes people who have given up looking for a job and those who have taken part time employment because they couldn’t find full time work, is estimated by the Fed at 15.6%. This figure is a more accurate indicator of the true impact of unemployment on the work force and the economy.

In April the Fed released their preliminary stress test results to the affected banks. Some bank executives were furious, claiming that the Fed was being too severe. The final figures released this past Thursday were the negotiated figures.

The capital deficit of Citigroup was originally estimated at $35B. The revised figure was $5B. Heck of a negotiation there.

In a front page WSJ article 5/9/09, an analyst calculated that the capital shortage of the 19 banks would have been $143B if the Fed’s revised results had accounted for unrealized losses. Those revised results required that the banks add only $75B to the capital on their balance sheets to protect themselves against future losses over the next two years.

As long as unemployment doesn’t get too much worse and real estate prices don’t decline much more, the banks should be in adequate shape.

These financial stress tests has been like the treadmill test that a patient undergoes to test the health of their heart. Perhaps we should take an example from the banks and negotiate with our doctors over the condition of the treadmill test. “According to your treadmill test, doc, I gotta lay off steaks and get more exercise. But you tested me while running. Now, how often do I run? Rarely. Your test is unrealistic. What if we did the test with walking fast instead of running?” Good luck with that.

401K

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In a 5/6/09 WSJ “Fund Track” article, Jennifer Levitz reviewed proposed changes to 401K retirement plans, which are the primary savings for 60% of workers.

One proposal is a listing of 401K fees on investors’ statements. A second proposal is a more automatic access to retirement plan participation. Obama’s budget “calls for the future establishment of a program in which all workers would be automatically enrolled in employers’ retirement plans.” There would also be a mandate for those employers without retirement plans to “enroll their employees in a direct-deposit individual retirement account.” Employees will have the choice to opt out of these plans.

Some industry proposals would limit equity investments in target-date funds. These funds are supposed to change their investment mix to be more conservative as the current date approaches the target date, when an investor presumably needs income from the fund. These funds are used for retirement and for college savings. This bear market revealed that some funds with target dates of 2010 had 60% of the fund in stocks, an inappropriately aggessive mix that prompted large declines in value as the stock market sank.

Other industry proposals are greater tax incentives for workers and employers who participate in 401K plans, and the creation of government insured annuities that would provide a dependable source of income for retired workers.

Health of Health Care

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In a 4/23/09 WSJ article, Vanessa Fuhrmans reports on the health of the country’s health plans.

Wellpoint, the largest insurer, lost 2% of its subscribers since December. It ascribed the larger than expected 1/2 million subscriber loss both to layoffs and workers who are declining coverage under their employer’s plan. United Health Group, the second largest insurer, reported a subscriber loss of 900,000 in the first 3 months of 2009.

The Kaiser Family Foundation estimates that the U.S. Census Bureau figure of 45.7 million uninsured in 2007 has grown to about 50 million uninsured. In a nation of 300 million, that is a 1 in 6 ratio. Of the estimated 9M people who have lost coverage since December 2007, Kaiser calculates that 3.6M have enrolled in Medicaid and other public health programs.

A Kaiser Family Foundation study of Medicaid fees from 2003 – 2008 shows that Medicaid pays physicians only 72% of what Medicare pays. In 2008, the average Medicaid reimbursement for the most commonly billed procedure, a 15 minute office visit with an existing patient, was $38. If you have a stopped up toilet, it costs $75 – $100 for a plumber to run a snake through the toilet bowl.

As the boomer generation nears retirement, swelling the ranks of both Medicare and Medicaid patients, should we be encouraging young people to become plumbers instead of doctors?
The Association of American Medical Colleges reported that the average educational debt of indebted graduates of the class of 2007 was $139,517. The site link is a student doctor network with a message board that you can read, but not post or comment.

Energy Bill Rush

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In a 5/6/09 WSJ article, Stephen Power and Greg Hill report on the progress of the climate bill. Without specifying details, President Obama informed Democrats on the House Energy and Commerce Committee that he “wants a bill that eases costs imposed on consumers and businesses, creates a predicatable set of rules, and addresses concerns that some regions of the country could shoulder disproportionately heavy costs.”

Obama plans to auction off CO2 permits and use the proceeds to fund middle class tax cuts. Representatives from the Rust Belt and the coal states are pushing for free permits for some industries in their districts. Texas lawmakers want free permits for oil and gas refiners.

Democrats and Republicans are arguing with each other and among themselves over the provisions of this bill. Henry Waxman, the Chairman of the Committee, may bypass what will probably be a contentious subcommitte vote in order to meet the President’s request that the bill get to him by Memorial Day.

Part of the bill will be a “cash for clunkers” provision, offering up to a $4500 rebate for people who buy cars that get at least 10 mpg more than the older car they are driving now. Car dealerships, particularly GM dealerships, could use a big stimulus.

A 1/27/09 US News article reported that “General Motors has 6,375 dealerships in the United States. Its closest rival, Ford, boasts less than 3,800. Toyota, the world’s largest automaker, claims less than 2,000.”

In a 4/27/09 article, Bob Golfen at SpeedTV reports that “General Motors will close half its dealerships nationwide by 2014 and cease Pontiac production next year, according to an “undated viability plan” offered Monday by GM to the U.S. Treasury Department. “

If you are planning on using that rebate to get a new GM car this summer, call first to make sure the dealership is still in business.

Bird Cage Bedding

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USA Today, the most popular daily newspaper in the U.S., reported a 7.5% decline in paid circulation in the past 6 months. Only the Wall St. Journal (WSJ) has reported a subscriber increase, although it was a slight 0.6%. This put the WSJ at over 2M subscribers, just 30K less than USA today. The New York Post and the Atlanta Journal-Constitution both fell about 20%.

“The [New York] Post, like many newspapers, has increased newstand prices as publishers come under increasing pressure to ratchet up revenue as their ad sales drop.” This process, a cyclic self-destructive market mechanism, is contributing to the steep decline in the number of newspapers. Until the newspaper industry can construct a viable model for profitability, newspapers will continue to close.

Does the world need newspapers? No. Does the world need more opinion articles? No. Does the world need professional reporters? Yes. They are our watchdogs, our synthesizers of current events. They sit through interminable state and federal hearings and give us, the readers, the short version. They read pages of budget projections and state and federal agency rulings and give us the “Cliff Notes” version. They ferret out scandals brewing in government and industry and raise red flags. How will those reporters get paid if there are no newspapers?