System Disabled

No matter the strength of the economy or the party in power, the Social Security Administration’s (SSA) Disability claim processing has been broken for decades. It is perenially underfunded so that, according to both disability lawyers and people who have worked for the SSA, it manages its caseload by denying 60% or more of claims. Claimants must then go through the lengthy appeals process which can last several years. I know of three people with MS who have experienced this case management nightmare.

This past (we hope) recession, the Great Recession, as some are calling it, has sparked a large increase in the number of people filing disability claims and a growing backlog. For 2010, the SSA is expecting 3.3 million claims, a big jump from the 2.6 million claims in 2007.

In 2007, the SSA started nationwide implementation of its Quick Disability Determination (QDD) process, which enabled them to cut their initial claims processing time by 6 days to – get this – 83 days. For most claimants, it took three months to find out that their initial claim has been denied. What was the average time for processing claims, including appeals? 441 days, or almost 15 months. That was before the recent surge in claims. No doubt that the processing time has climbed as well. Claimants get retroactive benefits once their claims are approved but how many are homeless by the time this process is complete? How many simply give up? How many simply don’t bother?

The stimulus bill contained funds to help address the problem and the SSA was planning to hire an additional 155 administrative law judges to handle the caseload. In the first half of 2009, the SSA employed 1200 judges.

Prescription Drug Managers

A 1/15/10 Wall St. Journal article detailed a Dept of Justice case against Johnson and Johnson (J&J), accusing the company of paying kickbacks to Omnicare, a publicly held company (OCR) and a Medicare and Medicaid Prescription Benefits Manager (PBM). Omnicare is the country’s largest PBM servicing nursing homes. Prosecutors allege that Omnicare’s annual purchases of J&J products almost tripled to more than $280M.

In addition to the kickbacks, J&J paid bonuses to Omnicare for switching patient’s prescriptions from competitor’s drugs to J&J’s medicines.

PBMs typically negotiate prices with drug manufacturers and then add on a markup to their client, whether it be the U.S. government or a large Fortune 500 company. In an earlier blog, I related Caterpillar’s recent negotiations with Wal-Mart and Walgreen’s to lower their drug costs. How much could Medicare/Medicaid save by following a similar path?

Rocky Mountain Low

As expected, Colorado announced this past week that the unemployment fund is broke and the state will borrow money from the Feds to continue paying claims. Colorado joins 25 other states who have had to borrow money from the Federal government. The loans are interest free for this year.

The national picture is grim. In the past two years, the construction industry has shed 1.6 million jobs, more than 20% of the total jobs lost in all industries. The finance sector has lost 548,000 jobs since December 2007, about 7% of it’s workforce. Office and administrative workers have thinned by 10.1%.

After going broke in the 1980s, Colorado instituted some actuarial changes to strengthen its unemployment fund and started the recession with a seemingly fat cushion of almost $700 million. In the middle of this decade, I was one of many employers who grumbled at paying a “solvency tax surcharge” to meet these more stringent guidelines for the unemployment fund’s reserves. In a 2008 report, the National Employment Law Project rated Colorado as one of 20 states with adequate reserves capable of paying at least 24 months of unemployment benefits. Colorado had actually improved since a 2007 assessment that included Colorado as one of eight states that would have financial difficulty in case of moderate or severe recession.

After several extensions of benefits mandated by the Congress, unemployment benefits now exceed a year in many states, more than double the normal 26 week limit. Designed to provide a temporary safety cushion for unemployed workers, they have become a welfare program under a different name.

Knowing that unemployment tax rates will likely double or even triple in the hard hit construction industries, employers are reluctant to take on new employees unless they are very sure of an upturn in business. Already saddled with high workmen’s compensation rates, an increase in unemployment taxes just piles on more of a cost burden on employers in this sector of the economy. Expect a slow job recovery.

Consumer Spending

OK, you’ve just finished your winter book project, War and Peace, and now you’d like something not quite as long. How about a 100 year history of consumer spending? This 69 (PDF) page report has lots of easily understood graphs and brief summaries of the economic household picture at selected periods during the last century.

Most revealing are the 100 year trend graphs near the end of the report. In chart 40 on (PDF) page 64,

we can see the century long rise of consumer spending in real 1901 dollars despite the fact that food, clothing and housing expenses take up far less of our income today. What are we spending our money on? Chart 43 on (PDF) page 67 shows the share of income that the average household spends on non-necessities, from a low of less than 25% in 1900 to 50% today.

While the percentage of income for most categories of spending have changed, there is one expense that has changed little during the past 100 years: entertainment. Those expenses have decreased only slighty, taking up just over 5% of the average household income.

The last page of the report summarizes the century’s changes in discretionary spending: ” households throughout the country have purchased computers, televisions, iPods,DVD players, vacation homes, boats, planes, and recreational vehicles. They have sent their children to summer camps; contributed to retirement and pension funds; attended theatrical and musical performances and sporting events; joined health, country, and yacht clubs; and taken domestic and foreign vacation excursions. These items, which were unknown and undreamt of a century ago, are tangible proof that U.S. households today enjoy a higher standard of living.”

It is doubtful that we will enjoy an increase in discretionary spending as dramatic as the last 100 years. Chart 43 on (PDF) page 67 shows the leveling that has happened over the past 25 years.

A comparison of a century’s worth of income data shown in Table 27, (PDF) page 56, reveals that there has been dramatic changes in income for the working person. In 1935, the average manufacturing wage was 58 cents an hour, or $7.62 in 2002 dollars. Real manufacturing wages have doubled in 80 years. Real construction wages ($.49 in 1935 = $6.39 in 2002) have tripled in that same time. In the finance and insurance industry, wages have seen the smallest increase in real terms but even those have swelled by 60%. However, after adjusting the wage data in Table 27 for inflation reveals that real wages have decreased in the past 30 years. The boom happened a long time ago.

Accompanied by that dramatic rise in real discretionary income has come the explosive rise of advertising dollars aimed at enticing us to part with that extra income on new cars, electronics, service contracts for cell phones and internet and cable service that we simply can’t do without. In short, the average American household has been sold the idea that these non-essential items are, in fact, necessary.

As noted earlier, the growth in discretionary income as a percentage of total income has slowed, leveling at about 50%. Wages have declined for more than a generation. Until there is some increase in real wages or the invention of a Star Trek like Replicator machine, the proportion of discretionary income will probably remain stagnant and households will continue to tighten their belts.

Bank Tax

The Obama administration is proposing a tax on the largest banks, based on the amount of leverage they employ. The estimated annual amount of the tax is $10 billion a year. Goldman Sachs estimates that the largest banks made $250 billion last year before taxes and loan-loss provisions. Based on those numbers, the tax amounts to a manageable 2/10th of 1 percent.

Some banks have protested. The 2008 TARP law did require the White House to come up with some system to pay for any losses under the program but a government estimate of $120 billion in losses consists largely of losses in the automotive industry. Jamie Dimon, the CEO of J.P.Morgan says that banks shouldn’t have to pay for another industry’s losses.

That does seem unfair but Dimon overlooks the long term liability of credit default swaps that the government has assumed in the AIG bailout. The Depository Trust and Clearing Corporation estimates the net value of these swaps at $82B. Also overlooked is the full price that AIG paid banks like Goldman Sachs and Societe General on credit default swaps (CDS) totalling $62.1B. In the late part of 2008, many of these swap contracts were selling for as little as 25 cents on the dollar. Let’s conservatively estimate that AIG paid these banks $30B above market price.

Additionally, the Federal Reserve bought $1.45T in Fannie Mae and Freddie Mac mortgage bonds, paying full price for bonds that had fallen 30 – 40% in value. Among these investors were the large investment banks, who took the money from the Fed and re-invested it in Treasury bonds. I have not been able to find estimates of this gift from the U.S. taxpayer but it must be at least $100B for the larger banks as a whole.

In short, the banks will be repaying taxpayers far less than they will have received from taxpayers.

Investment Fees

Let’s put aside our rosy glasses, put on our fine print glasses and look at some percentages regarding investment fees.

I will compare two bond funds holding the same type of bonds. Fund A, an index fund, charges .5% while Fund B, an actively managed fund, charges 1.5% in management and other expenses. The manager or salesperson for Fund B may tell a prospective client that the returns for their fund are superior and will make up for the 1% difference in fees. Many brokers are of the Lake Wobegon mentality, believing that the products they sell are above average.

1% sounds like a small amount so this might seem reasonable to you if you are wearing your rosy glasses. But let’s look at some hard data. Let’s say that the index Fund A averages a 5% return before expenses. The more actively managed fund B would have to earn 6% before fees just to break even with the return on Fund A. Again, that 1% sounds small but what it means is that Fund B has to make a return that is 20% greater than the index. Very few funds are able to do that.

Let’s look at those fees again as a percentage of the return, not the total dollars invested. On a 5% return, index Fund A’s fee of .5% is 10% of the return. Even if Fund B can generate a 6% return, it’s 1.5% fee is a fat 25% of the return, more than what many hedge funds charge.

Let’s say that Fund B has generated these higher returns in the past. How does it do that? Often, by taking more risk than the index fund A. You can check an assessment of a fund’s return vs. risk at any number of stock research sites. Yahoo’s finance site has some good assessment tools. Enter the fund’s symbol and in the resulting summary page, click on “Risk” in the left column. You will be taken to a page which shows 3 year, 5 year and 10 year risk and return ratios.

Alpha measures the amount of return for the degree of risk involved. The average is 0. Less than 0 means that the fund does not get a return commensurate with the risks it takes. More than 0 means that the fund gets a better than average return for the risks it takes. You will be able to compare the fund with other funds in its category.

There are so many index funds and low cost index ETFs in the market for an investor to choose from. If you are willing to take more risk in bonds, for example, you can probably find an index product that invests in a riskier class of bonds. Over the long run, expense fees do matter. The lower the return, the more they matter. Over 10 years, that additional 1% in fees will cost you $1400 on a $10,000 investment in a fund averaging a 5% return.

In short, play the percentages.


A few tidbits of info sitting around on my desk:

WSJ tidbit 12/31/09 – Families USA reports that Cobra family coverage averages 83% of the average unemployment insurance check, up from 61% in 2001. The stimulus bill provides a subsidy to unemployed individuals averaging $325 a month, $715 for families.

According to a Congressional Research report – after dropping dramatically from 1950 to 1980, death from diabetes has increased to above the levels of 1950, a 33% increase from mortality rates in 1980. Unintentional injuries, including automobile accidents, has dropped by half from 1950. Cancer rates are about the same as 1950. Death from heart disease are at 40% of 1950 levels. (pg 4)

Many of us do not like government interference and mandates, yet we see the results of several decades of seat belt and product safety laws.
Despite all the money invested in cancer research over the past fifty years, the rates have not improved. Of course, more people are living longer, naturally driving up the cancer incidence rate, which disproportionately afflicts older people.
Despite the dislike that some people have for “Big Pharma”, it is thanks to the pharmaceutical industry that heart disease has become a manageable problem for many older Americans.
While many like to blame the soft drink and fast food industry for the increase in diabetes, no one is forcing anyone to drink and eat sugar laden foods. Of course, it is easier to blame the big food companies than take personal responsibility for one’s food choices.

On Oct. 16, 2009, the Bureau of Labor Statistics reported that the median (not average) weekly earnings of the nation’s 100.1 million full-time wage and salary workers was $738 in the third quarter of 2009. This was 2.5 percent higher than a year earlier. The Consumer Price Index for All Urban Consumers (CPI-U) fell by 1.6 percent over the same period.

Social Security income accounts for about 40% of retirement income.

A retired person spends, on average, about 80% of what they spent before retirement.

WSJ tidbit 12/28/09 – The Institute for Justice cites that 50 years ago, 3% of American workers were regulated or licensed by government agencies. It is 35% today.

Food, energy, housing and health care consume the same share of American spending today (55%) that they did in 1960 (53%).

Revolving credit, primarily credit cards, declined at a steep 18.5% annual rate last year.

Smaller businesses are a dying breed in the U.S. Companies with less than 250 workers comprise 70% of the private-sector work force in the European Union, compared with 49% in the U.S., according to EU figures.

In 2009, 804 companies cut dividends, up sharply from 110 two years earlier and the highest level since S&P started to collect such data in 1955. Conversely, the number of dividend increases dropped 36.4% to a record low.

More than 6% of commercial-mortgage borrowers in the U.S. have fallen behind in their payments, a sign of potential troubles ahead as nearly $40 billion of commercial-mortgage-backed bonds come due this year. Moody’s reported a 4.9% actual delinquency rate. It is projected to go above 8% by the end of 2010.

The Mortgage Bankers Association reported that almost 6.2% of mortgages in Arizona and 9.4% of mortgages in Nevada were in foreclosure by the end of the third quarter of 2009. In California, 5.8% of mortgages are in foreclosure and personal bankruptcy filings rose almost 60% last year.

Forecast: Clearing

In forecasting future company profits, there are two Ouija boards and each board comes up with different results.

On the first Ouija board, equity analysts put their hands on the triangular platen and divine the future profits of each company they cover. All the results are then added up for a total “bottom up” forecast for earnings of the S&P 500. For 2010, the analyst Ouija board spelled out $77.54 in profits, a 30% increase over 2009.

On the other Ouija board, a bunch of economists put their fingers on the platen and foretell future profits. This is termed a “top-down” forecast. The economist board says $72.52. This small $5 difference in the two forecasts – a year ago the difference was $40 – is a good indicator of greater clarity looking forward, and a more stable market.

The Dump

Recycling has become popular in China.

In 1999, Chinese state owned banks dumped $200B (U.S.) of bad loans made during the 1990s into Asset Mgmt Companies (AMC) or “bad banks”, banks set up to hold “toxic assets” and non-performing loans. Six years later, they dumped another $170B into these AMCs. Many of these loans are carried on the books at face value, far above their true market value. When the loans came due this year, most were rolled over for another ten years. Here is a brief summary from the Gerson Lehman Group.

Large private companies have been accused of managing, or massaging, earnings in order to sustain a higher stock price for the company’s stock. Tempting as this practice is for private executives, public officials are under even greater pressure to put their best foot forward by manipulating asset values. China’s strong, rapid move to urbanize is bound to incur casualties along the way. The commercial real estate market is beset with vacancies, while newly constructed factories stand ready to supply a world whose demands have slowed. When state owned banks defer the recognition of bad real estate loans, it becomes difficult to honestly evaluate their financial status.

FXI is an ETF that tracks China’s top banks. A word of caution.