Author: sgstofka

Fannie Mae Bonuses

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In a 4/5/09 WSJ article, James Hagerty notes that Fannie Mae and Freddie Mac, the two formerly quasi-government mortgage giants that were effectively nationalized last fall, “expect to pay about $210M in retention bonuses to 7600 employees over 18 months.” The maximum bonus that will be paid is $1.5 million. $51M were already paid in 2008 and the remainder are due to be paid this year and next.

Of the 7600 employees receiving bonuses, 4057 are employed by Freddie Mac and constitute a whopping 80% of all the employees at that company. Fannie Mae is rewarding 61% of their employees, 3545 in total, or 61% of their total work force.

The regulator, James Lockhart, is responsible for initiating the retention bonus program. “It is not realistic,” he wrote, “to expect that experienced and highly skilled employees will indefinitely continue to work as hard as they have if we do not provide reasonable incentives to work.” As thousands of people in the financial industry line up at the employment office, why isn’t a paycheck enough “incentive” for most of these workers?

Since Congress has squashed or eliminated many bonuses for those banks receiving bailouts, it is mandatory that Congress follow the same principle with these institutions which have received far more taxpayer money than any of the private banks or investment firms.

Housing Bubble

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In a 4/6/09 WSJ op-ed, a former Nobel Laureate in Economics, Vernon Smith, and a research associate, Steven Gjerstad, examined the several decade long causes of the real estate bubble.

In 1983, the Bureau of Labor Statistics (BLS) changed their methodology for measuring the housing cost portion of the Consumer Price Index (CPI). “They began to use rental equivalence for homeowner-occupied units instead of direct home-ownership costs.”

From 1983 to 1996, home prices were about 20 years worth of rent payments. Between 1996 and 2006, they increased to over 32 years of rent payments. Had this housing inflation been reflected in the CPI, “inflation would have been 6.2%, instead of 3.3%.” Remember that 6% real inflation figure.

The many economists at the Federal Reserve Board (“Fed”) looked at the modest increases in the CPI over the past decade and, concerned as they were about the increasingly heated housing market, didn’t see a direct correlation with the CPI. They attributed this to productivity gains, the lower cost of computers, appliances, etc. The Fed kept interest rates low.

Joe and Mary, average American homeowners, may not have known about the housing component metrics of the CPI. All they knew was what things cost the previous year and what they cost this year. With mortgage money at about 6%, Joe and Mary instinctively knew that they could borrow money on their house at an effective 0% interest rate, the real CPI of 6% minus the 6% mortgage interest rate. It was free money, and “household borrowing took off.” The CPI data model was out of sync with reality, a reality that Joe and Mary knew well.

The authors compare the crash of 2000 – 2002 with this one. That earlier crash wiped out $10T in equity assets yet it caused no damage to the financial system. In this crash, a relatively small $3T decrease in real estate equity has decimated the financial system. How? Like the great depression, it was leverage.

The authors point to a misconception that the market crash of 1929, with 9 to 1 leverages on stock, brought the financial system down. But the banks did not begin their tumble till after the drastic fall in real estate prices beginning in 1930. Mortgage debt during the 1920s had more than tripled.

In the 2000 crash, most owners owned their stock holdings outright. They absorbed the loss of falling equity prices. In this real estate crash, leverages of 9 to 1, or 99 to 1, were common. Lower priced housing was hit hardest, declining by 50% in some cities, and this fall in home equity hit an economic group that could least withstand the impact.

In a WSJ article 3/18/09, Kathy Shwiff reported that delinquencies of Alt-A, or alternative documentation, home loans issued in the past few years have climbed to more than 20%. These loans were issued to people based solely on their credit scores. Often, there was no documentation or verification of income or whether the person’s income would reasonably allow them to make payments on the mortgage.

Medicare

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In a 4/17/09 WSJ oped, Marc Siegel, an internist and associate professor of medicne at the NYU Langone Medical Center, notes a 2005 Community Tracking Physician survey showing that only half of doctors accept Medicaid. He cites a 2008 Medicare Payment Advisory Commission report that “28% of Medicare beneficiaries looking for a primary care physician had trouble finding one, up from 24%” in 2007. A Texas Medical Association survey in 2008 found that only 38% of doctors took new Medicare patients.

My mom’s primary care doctor, who has been in the field for 40+ years, made the comment that many younger doctors specialize because it pays so much more than primary care. As the baby boomers age and need more medical care, there simply will not be enough primary care physicians to handle the load.

Medicare’s payment schedule for medical services penalizes doctors who emphasize preventative care. Medical professionals are paid more if a patient has a heart attack than taking steps with the patient to reduce the chances of a heart attack. Because of its size, Medicare’s philosophy and reimbursement approach dominates the entire field of medicine.

The Dough Rises

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Where’s the dough?

The Market Beat column in the WSJ 3/31/09 noted that U.S. Banks traditionally carry about $300B in cash. As of March 18th, they had $976B, more than triple the usual level. The M2 money supply – checking deposits, savings accounts other than IRA saving accounts, money market funds – are up 10% this year.

Americans are saving. The banks just aren’t lending out those deposits as quickly as they are received.

Windbags

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In WSJ article, 3/26/09 Rebecca Smith writes: “The electric-power industry accounts for nearly half of all water withdrawals in the U.S., with agricultural irrigation coming in a distant second at about 35%. Most of the water used by the utilities is returned to the rivers or ground water. In the arid western states, water supply has become an important factor in favor of alternative energy systems. Solar and wind energy require no water.”

Where is the largest wind farm in the world? Texas, of course, the land of the largest. If they installed a wind turbine in front of the speaker’s podium at the House Of Representatives, it would generate enough power to light up all of Washington!

Taxes

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What percentage of your income do you pay in taxes? At the beginning of March, I heard a working class person complain that Obama was “soaking the rich” at 35%. Presumably this person was complaining on principle. By another principle, that of self-interest, a working class person might also cheer that Obama is “soaking the rich.”

What is rich? For 2006, IRS data shows that the top 1% of tax returns had an AGI (Adjusted Gross Income) above $389K. I would say that the top 1% qualifies as rich. Yet, some rich people don’t feel rich.

In the 4/16/09 WSJ weekly “Currents” feature, Gary Fields spoke with several of the rich and near rich, those in the top 1 and 2% income tiers. The owner of a human-resources company in Silicon Valley, California and his wife make about $400K but feel like they are barely getting by. San Jose, CA mayor Chuck Reed calls a family making $250K in Silicon Valley “upper working class,” unable to afford a home in the area.

What did this top 1% pay in Federal income tax? Just under 23%. Wait a second.. what happened to the 35% rate? That is the marginal rate, not the average rate.

If someone is in the 35% tax bracket, that doesn’t mean they pay 35% on all of their income, only on the portion of income that is above the 35% bracket threshold. A person making a $500K salary still only pays 10% tax on the first $16K of that salary. In the 2008 tax year, if someone made $357,701 they paid 27% or $96,770 on the $357,700. They paid 35 cents on the extra dollar.

Warren Buffett once wryly remarked that he paid less in taxes as a percentage of his income than his secretary did. How do the top 1% cut their average tax rate? Many have a significant portion of their income in capital gains, which are taxed at 15%, the rate for middle class taxpayers earning less than $65K.

In a history of the capital gains tax, the Tax Policy Center reports that “The Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA) cut the top tax rate on long-term capital gains from 20 percent to 15 percent, the lowest level since World War II.” Obama’s budget proposes to restore the 20% tax rate on those families making more than $250K. For some historical perspective, this level is more favorable than the recommendations of a 1997 Congressional Joint Economic Committee Study.

There is an old saying: “The poor fight the wars, the rich pay for them.” Former President Bush, together with his party, had a novel idea on this centuries old maxim. Why not have the poor fight the wars in Iraq and Afghanistan and not have the rich pay for it? Instead, the U.S. would charge the war expense on its “credit card”, the U.S. Treasury. It was an interesting idea that didn’t work out so well as the “credit card balance”, the national debt, of the U.S. grew from $6.2T in 2002 to over $10T in 2008.

Defense spending has almost doubled since 2002. To keep our country strong, the rich need to do the noble thing and pay for it. Defense spending is an insurance policy on one’s assets.

President Obama and his wife paid over $700K in taxes last year on $2.7M in income, most of it from the sale of Obama’s books. They didn’t complain about paying that much in taxes and I promise that I will be noble and won’t complain if I make $2.7M next year.

Drug Dealin’

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If I were the head of a large network of illegal drug distribution in the U.S., I would want a political and legal environment that promoted my business.

I would donate to the campaigns of conservative politicians who would vote to continue to keep those drugs illegal. Better that the profits go in my pocket than to state and Federal treasuries in the form of taxes.

I would donate to the campaigns of politicians of a moderately liberal bent who would vote to lessen penalties for small time users. When my customers are in jail, they don’t buy my product. I shun the more liberal politicans who want to legalize any of these drugs and eat into my profits.

I would donate to politicians who favor stricter, but not too strict, security measures at the border because this will make it more difficult for my less sophisticated competitors to get product into the U.S. I would prefer more moderate conservatives for this task.

In short, the political and legal environment in the U.S. is pretty close to optimal for a well run illegal drug distribution network.

What A Fool Believes

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Thirty years ago, in April 1979, the top song on the Billboard charts was “What a Fool Believes” by the Doobie Brothers.

On April 16th, 1979 the Dow Jones average was 857. In 2009 dollars that was 2502, using this handy inflation calculator. Today, April 14, 2009 the Dow closed at 7920. That is a 7.7% annual return. The yield on a 30 year U.S. Treasury bond in April 1979 was 9.08%.

Do bonds have consistently better returns than stocks over the long run? Not according to Jeremy Siegel who researched owning stocks versus bonds for various periods in his book “Stocks for the Long Run.” Mike Piper, who has written several introductory books on accounting and taxes, reviews some of the details on his Oblivious Investor blog.

As convincing as Siegel’s case for stocks may be, should a person put all their savings in stocks? No. Only a fool believes that the next 30 years will be like the last 30 years. For most of us, the safest answer is to diversify among a range of investments.

Mark To Market Debate

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The tribe needs meat. The antelope, gazelle and wildebeest have already passed through your area on their annual migration so the easier game is gone. Off in the distance you and your buddies see a lone bull elephant, whose meat would feed the tribe abundantly well. The problem is that all you have for weapons are some sharpened sticks, some rocks, and some rock flakes tied to sticks. Big problem, and a big payoff if you can solve it.

Mark to market accounting is like that.

At a recent Future of Finance Initiative seminar sponsored by the WSJ, Stephen Schwarzman, head of the investment firm Blackstone Group, said “If [a bank] made a loan in the old world . . And you didn’t think it was impaired, you kept it on your books at par. Now, if loans are trading at $70 [per $100 and] you make that loan, you lose $30 just for making the loan.”

He concluded, “Even though there is a lot to be said for complete mark-to-market in a system that can take it, I don’t believe that the financial system, as currently organized with its current rules, can really take the full hit of it.”

Robert Shiller, professor of Economics at Yale U., countered with “The first thing is to make sure that we preserve the integrity of our accounting. People know that this country stands for high integrity, and so anything that looks like we’re allowing people to doctor the books, I think we shouldn’t do that.”

Social Security Decrease?

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Social Security recipients saw almost a 6% increase in their monthly checks in 2009.

The Consumer Price Index (CPI) is calculated from October to September every year. In 2008, the spike in gas prices during the summer overinflated the CPI. If the Social Security Administration had calculated the CPI on a calendar basis in 2008, the swift decline in gas prices in the fall and winter would have resulted in a truer CPI index and a lesser increase in monthly check amounts to retirees.

Because of the overinflation in the preceeding period, the current period Oct 2008 to Sept 2009 will probably show a decrease in the CPI. So, will SS recipients see their monthly checks decrease? No. By law, the SS benefit portion can not decrease from year to year.

In her weekly WSJ “Ask Encore” feature, Kelly Greene notes that “the Bureau of Labor Statistics has developed an experimental consumer-price index for Americans age 62 and older, referred to as the CPI-E.” This is weighted more heavily toward medical care and housing than the currently used CPI-W index for urban consumers. In the 25 years ending 2007, this CPI-E index has risen faster than the CPI-W.

Estimates are that Social Security recipients, including children and the disabled, will increase from 51 million today to 89 million by 2035. At the end of 2004, it was about 48 million. For the next 20 years, 10,000 people a day will become eligible for SS benefits as the baby boomers retire. According the U.S. census clock, there are an estimated 306 million people living in the U.S. The population rose by 8 while I wrote this paragraph.

In Jan. 2009, the Bureau of Labor Statistics counts a bit over 140 million working. That’s a ratio of a little under 3 contributing workers to 1 SS recipient, who also may be working at least part time.

It is a ratio of approximately one worker to one non-worker in this country. If someone, a hundred years ago, had predicted that over half of the population would not be working, everyone would have laughed. The productivity gains of the past century have been a remarkable synthesis of individual and community ingenuity and spirit.

Robert Ball was commissioner of Social Security under Presidents Kennedy, Johnson and Nixon. In a 2005 brief he made the case for returning the Social Security “cap” to the original design of 90% of the maximum annual earnings base: “over the past twenty years the earnings of the higher paid have been rising much more than average wages—so an increasing proportion of earnings exceeds the maximum earnings base and thus escapes Social Security taxation. Today [2005], only about 83 percent of earnings is being taxed.”

Ball recommended that the cap be raised slightly more than inflation, gradually getting back to the 90% target goal.