Author: sgstofka

The Average

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September 15, 2024

by Stephen Stofka

This week’s letter is about two different investing styles, active and passive, and how they are affected by the average. The active vs passive debate in investing began several decades ago when John Bogle founded Vanguard as a way for individual investors to invest in a market basket of stocks. The active investor is like a miner panning for gold in a mountain stream. He (mostly male, I think) carefully studies the residue in the bottom of the pan, looking for the glint of gold in the sunlight. Some miners strike it rich while most barely cover the costs of their tools and time. The index investor, on the other hand, buys a share of the company that buys gold from the individual miners.

The core issue in that debate stretches back to the classical period in ancient Greece and the role of our powers of reason. In the following sections, I will rely on some points my wife, Dr. Beth Davies, made to her class this week. For some background, Aristotle was a Greek philosopher who lived and wrote in the 4th century B.C. Thomas Aquinas was a 13th century Christian theologian who tried to unite the secular reasoning of Aristotle with the Catholic tenets of faith.

Davies writes “Aristotle places all of his confidence in our faculty of reason. No matter the shifts that our fortunes face in life, we can always apply practical reason and therefore pursue our desired end, which is to flourish (be happy).” The active investor believes that research and reasoning can generate what is known as alpha, the extra return that an investing strategy has over an average that serves as a benchmark.

Davies writes “Aquinas loved Aristotle’s philosophy … but the worldview of his time was saturated with the belief that human nature is inherently sinful,” implying that our sinful desires interfere with our reasoning process. How did Aquinas resolve this dilemma? Davies continues, “He did it by adapting the Islamic idea that human intellect is a natural process. Since God created nature, natural processes are not corrupted by sin. Medieval theologians grouped intellect into this category of ‘natural process.’ Medieval theologians, Christian and Islamic, needed a way to preserve some part of the mind from sin, and since reason can be corrupted by appetite, they settled on intellect.” Having less confidence in their intellectual expertise at investing, the passive investor accepts an average market return and saves both the expense of higher trading fees and their own time.

In Thinking Fast and Slow, Daniel Kahneman noted the many cognitive biases that introduce flaws in our reasoning when we make choices. In recognition of these biases, investment managers have developed algorithmic trading models intended to reduce human error and bias. The execution of those strategies can be tainted by faulty reasoning as well, so investment managers are turning toward machine learning. Criteria like minimum returns and acceptable risk ratios are input into programs which run thousands of simulations on trading data and research to find optimal trading strategies (Hansen, 2020). In a medieval interpretation, these programs are the embodiment of the distinction between intellect, created by God, and corruptible human reasoning.

Most individual investors do not have the time, resources or background to develop or maintain such strategies. In the future, investment managers may offer funds or ETFs that employ such strategies but will charge higher fees for the promise of higher risk-adjusted returns. In an analysis of eight years of market data from 2009 -2017, Prondzinski and Miller (2018) wrote “evidence suggests that active funds underperform index funds by approximately the difference in their costs.” If these strategies do deliver higher returns, more investment firms will use them, raising the average market return and reducing alpha to near zero. Even if short-term returns are higher, a passive strategy should produce returns at least as good as many active strategies.

Indexes rely on the power of the mean. There are several ways to compute an average, or mean, but the most common is the arithmetic mean, determined by the sum of the data divided by the number of data points. Few if any data points match the average, yet it is a benchmark concept in statistics, forming the basis for many calculations like variance and standard deviations. Index funds rely on the Law of Large Numbers, creating a sample of a large dataset filtered by some criteria like market capitalization. Unlike machine learning, the filter criteria is not a dynamic optimizing strategy but a characteristic of the market. It is less dynamic but a “good enough” strategy that minimizes costs.

To Aristotle, the virtuous mean was a behavioral phenomenon where an individual used their reason to compromise between extremes of action. On a highway, some drivers are weavers, changing lanes frequently in the belief that an optimizing strategy will get them to their destination sooner. Some drivers keep to one lane, going with the flow and making few changes until they approach their exit. At the exit, they experience a sense of satisfaction upon finding that they are only a few cars behind a weaver. That is index investing.

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Photo by StellrWeb on Unsplash

Keywords: passive investing, active investing, alpha

Hansen, K. B. (2020). The virtue of simplicity: On machine learning models in algorithmic trading. Big Data & Society, 7(1), 205395172092655. doi:10.1177/2053951720926558. Available from: https://journals.sagepub.com/doi/full/10.1177/2053951720926558

Prondzinski, D., & Miller, M. (2018). Active Versus Passive Investing: Evidence From The 2009-2017 Market. Journal of Accounting and Finance, 18(8). https://doi.org/10.33423/jaf.v18i8.114

An Economic Nexus

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September 8, 2024

by Stephen Stofka

This week’s letter is about the labor market, part of a series on investing. Friday’s monthly labor report indicated a job market that is cooling but still growing. Although the market reacted negatively to the news, the Fed will begin reducing interest rates at its meeting next week. The S&P 500 index, the most widely held basket of stocks, is up 15% for the year but the index has twice risen above 5500 before falling back. An index of business activity in the services sectors continues to expand but manufacturing activity is still contracting slightly. When investors get conflicting economic signals, they are responsive to negative data points more than positive ones. The approach of what may be a contentious election creates an environment where investors are more likely to protect their portfolio value and exit short-term positions. Let’s now turn to long-term trends in the labor market.

Economists at the Bureau of Labor Statistics (BLS) refer to workers aged 25 -54 as the core work force. To save some typing, I will refer to this age demographic as the “core.” During those thirty years we accumulate stuff while we build our careers. We buy cars, furniture, homes and vacations. We build retirement savings for ourselves and college funds for our kids. The core is the nexus of a growing economy.

This coming Wednesday we will remember 9-11 and the 3,000 civilian lives lost in the attack on the World Trade Center in lower Manhattan. Since that time, there has been little investment in those workers who form the core of the labor market. From August 2001 to August 2024, the economy has added less than seven million jobs in that age demographic, an annual growth rate of just 0.28% (See FRED Series LNS12000060).

As you can see in the chart above, most of the growth in the core has occurred during the Biden administration. The surge in employment in this age group led to growing incomes and greater purchasing power in an age group that is in the accumulation phase of its lifetime. That rapid growth in employment, coupled with pandemic recovery payments from the government were strong contributors to the rise in inflation in the 2021 – 2023 period. Voter sentiment in this age group focused on the inflation, not the job growth, demonstrating again that we pay more attention to negative rather than positive news.

Several factors contributed to the plateauing of job growth in the core. Demographics played some part. Population analysts have assigned a span of about 18 years to each generation so that the thirty-year span of the core labor force encompasses two and sometimes three generations. The first of the large post-war Boomer generation turned 54 in 2000. As the Boomers aged out of the core, a smaller Generation X, born 1964 to 1982, became the dominant component of this age group. In 2013, the first Millennials, a generation larger than the Boomers, joined the core, and in 2016, the last of the Boomers aged out of the core.

A few months after 9-11, China was admitted to the World Trade Organization, and within a decade became the world’s factory. Investors poured capital into China, taking advantage of low labor rates and a currency whose exchange rate was maintained at a low level by the Chinese central bank. Investors from outside China got more bank for their buck. As investment moved to China, many production facilities in the U.S. shuttered their doors. In the seven-year span between China’s admittance to the WTO and the start of the financial crisis in September 2008, manufacturing employment (see FRED Series MANEMP) fell by a fifth. By January 2010, employment in the manufacturing sector had declined by a third.

During the 2000s, low interest rates fed a frenzy in home financing and produced a bubble in the U.S. real estate market that imploded in 2008. The resulting financial crisis affected assets and financial institutions around the world. Millions of Americans lost their jobs. From the start of 2008 until the end of 2009, the core work force fell by 6%, about six million jobs. In 2018, an interval of ten years, the level of employment in this age group finally rose above its 2008 level.

Instead of vigorously promoting policies that encouraged job growth, the Obama administration offered policies to support families suffering from the lack of job growth. Democratic politicians eagerly passed ambitious social programs but faltered when implementing policy solutions that embodied their legislative goals. In Recoding America, Jennifer Pahlka (p. 125) recounts the efforts to fix healthcare.gov, the bungled rollout of the health exchanges created under the Affordable Care Act known as Obamacare. In The Rise and Fall of the Neoliberal Order, Gary Gerstle (p. 226) notes that the Obama administration focused more effort and political capital on providing healthcare insurance for poor people rather than supporting the 9 million households in danger of losing their homes to foreclosure.

A sense of betrayal soured voter sentiment and helped to support the emergence of the Tea Party in the 2010 election and the MAGA voters who supported Donald Trump’s candidacy in the 2016 election. In 1976, voters punished President Gerald Ford for pardoning Richard Nixon. In the 2016 election, voters punished Hillary Clinton as a symbol of a set of values disloyal to many Americans. Donald Trump promised to bring manufacturing jobs back to America by taxing Chinese imports and cutting corporate taxes. In the first three years after the 2008-2009 recession, manufacturing employment under Obama grew by more than it did in the first three years of the Trump presidency (see notes for details). No amount of political rhetoric can overcome the power of a supply chain now firmly anchored in Asia.

Biden’s infrastructure policies have actively promoted job growth in the core. Can the economy sustain such growth in this acquisitive age group while keeping inflation at a reasonable level? Should the Fed raises its target interest rate from 2% to 3% to accommodate job growth that supports people when they are raising families and building careers? I think so. Should Harris win November’s election, she should adopt Biden’s pro-growth policies. Should Trump regain office in the coming year, he will try to use tariffs to shift the nexus of the global supply network from Asia back to the U.S. That policy will only increase prices and help maintain a higher level of inflation without promoting the economic growth that supports households in their middle years.

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Photo by Tim Mossholder on Unsplash

Manufacturing employment notes: From January 2010 to December 2012 manufacturing gained 500,000 jobs, an increase of 4.4%. From January 2017 to December 2019, the manufacturing sector gained 432,000 jobs, an increase of 3.5%. In January 2010, manufacturing employment was near a low, continuing to fall after the official end of the recession in July 2009.

Keywords: Obamacare, inflation, labor, financial crisis, China, manufacturing, infrastructure

A Generation of Homes

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September 1, 2024

by Stephen Stofka

This week’s letter is about real estate, part of a series on investing. In the past weeks, I have taken an informal inventory of a half-dozen dumpsters parked in front of vacant houses in the metro Denver area. They are full of earth-toned kitchen and bath cabinets, paneling and other home appointments popular during the 1970s. In that decade, younger Boomers threw out the metal kitchen cabinets of 1950s post-war starter homes and the craftsmen cabinets of pre-war homes. Now the Boomers are aging out of the homes they bought forty years ago, and a new generation takes their place.

Many older homes built in post-war America had smaller rooms to accommodate growing families. Newly remodeled homes for sale often feature open floor plans where a wall has been removed between a kitchen and dining room or living room and dining room to connect kitchens with the primary living space. Removing a bedroom wall to create a bigger living room or family room can have the unfavorable effect of reducing the number of bedrooms a house features.

White, pale gray and dark brown cabinets are  popular color schemes now. In the 1970s, white and dark mahogany were typical of cabinets in apartments. Honey oak cabinets in a house conferred a modest upgrade in status. Now it means old and outdated unless there are glass panel insets in the cabinet doors. Formica is so like last century. When investor groups remodel a home for sale, they install quartz countertops, which are more expensive but less maintenance than Corian or granite countertops. Kitchen and baths get the most attention from potential home buyers, so those rooms receive more investment.

LVP plank flooring can simulate the look of real wood or stone and is a popular choice in newly remodeled homes for sale. In some homes the same style and color LVP is used throughout the home, including the kitchen, baths, laundry, living room and bedrooms. Area rugs in each room could be used to give each room a distinctive theme, I suppose, but the uniformity of that look is not to my taste, particularly when the color is dark mahogany.

There are many steps to buying a home, but the first step is familiar territory. What does my family want? A house is a home in a neighborhood. What amenities does the neighborhood offer and which are important? These include schools, public transportation, housing density, crime statistics and environmental risks like fire, wind, and temperature extremes.

There are several types of homes and ownership. In a single-family home, the owner is responsible for the exterior of the structure and the plot of land where the house sits. A townhome is a residence attached to another residence so there is a shared responsibility for the exterior of the structure. Typically, a homeowner’s association (HOA) manages this communal responsibility and each association spells out common and individual responsibilities in their covenants. These include regular maintenance of the grounds like lawn mowing, tree trimming, repairing or resurfacing paved areas within a townhome development. An HOA might be responsible for siding, brick and roof repairs but hold the townhome owner responsible for damage to the rear concrete patio of their home. A townhome owner is usually responsible for repairs to equipment that services only their unit. Examples include a forced air furnace, an AC unit or a hot water heater.

The owner of a condo is responsible only for the space between the four walls of their home. The inside of an outside wall is the owner’s responsibility. The outside of that wall is a communal responsibility. Equipment systems often serve more than one owner and repairs to these systems are the responsibility of the HOA. The responsibilities are spelled out in the covenant, or CCR (covenant, conditions and restrictions).

Today there are several real estate companies that provide free access to the Multiple Listing Service (MLS) of homes for sale. They offer the ability to filter by location, price, the type of house and the number of bedrooms and bathrooms. A real estate agent can usually provide additional filtering criteria that include the quality of schools, zip codes and square footage. However, the filtered results may not pass additional criteria that a family has. Taking notes in a Word document or other software helps to sort out and remember key details about a property so that the homes do not merge into a blur of pictures and facts. Here is a list of features that you can build on.

Address: the street address first, theninclude a nearby major intersection, for example. The price and whether there has been a price increase or decrease. The square footage, the number of BRs and baths and whether the home is subject to a monthly HOA fee. Natural light is important to me, so I use Google Maps to help me identify which direction the front of the house faces.

Status: Initially leave this blank. If you discard, state that and one or two reasons. Don’t delete the property, but cut and paste it at the end of the document in case you want to revisit it later. This will help you identify “gotta haves.” Low rated primary school might be one or the year the house was built. The master BR is not big enough or there is not enough light.

Financial Metrics: the dollars per square foot (psf) calculated by dividing the list price by the square footage. For no charge, propwire.com will allow you to view median selling prices for homes in that area. Enter the address of the home, then click the Market tab in the results.

Exterior: the listing will have a street view, but these often distort distances from the curb to the house itself. Enter the address in Google maps to see what the property looked like in the past. On a computer, Google maps will display the month and year the photo was taken by their truck camera. In the compilation of photos for the listing, note any features like a recently installed roof, siding, or garage door. The fence may need repair or there is a tree growing close to the foundation of the house. There may be a cozy porch leading up to the front door. Taking notes can help train us to notice and categorize details.

Equipment: the text of the listing will list details like a new roof, hot water heater, furnace or AC. Note them here. Recently installed equipment should reduce your expenses in the first decade of owning the home.

Neighborhood: On Google maps you can see features that might be important to you. A grade school is nearby but on the other side of a major intersection. Is that a problem? Note any nearby parks or other green spaces if those are important to you. Later on, if you do an initial drive through the community, note the general condition of the neighborhood. Single family homes governed by an HOA will usually present a more consistent appearance and maintain their landscaping. In a neighborhood without an HOA, that consistency is lacking.

Shopping, etc: note any commercial or government agencies nearby that are important to you. These might include grocery, drug and hardware stores, restaurants, a movie theater or a library. There is a lot of easily accessible information on your computer screen.

As you browse the photos in the home listing, note any details, positive and negative that catch your attention. Later, these short notes will help jog your memory. An example is below:

Kitchen: gray cabs, pale gray wall color. Lots of cabinets. Swing door to rear deck.

Bedroom: Master is 15’ x 12’ OK. No closet doors in smaller BR?

LR: big window, faces south.

This inspection list can be done in front of a computer screen without any visit to the house itself. If there are several properties in a community, a visit to the neighborhood may help you refine your search further to reduce the number of homes that you physically inspect. There are many checklists when you do a physical inspection of the home. Here is a printable checklist from a blog writer at Orchard, a real estate company. I hope that these tips will make your house hunting a bit more organized and save you some time and effort.

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Photo by Phil Hearing on Unsplash

Keywords: house, homebuying

Stimulus and Response

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August 25, 2024

by Stephen Stofka

This week’s letter continues my look at the dance of our responses to events. In a newsletter a few years ago, Kyla Scanlon coined the term vibecession to describe a general consumer sentiment that is contrary to positive economic data on unemployment, wages, and GDP. Why are consumers ignoring positive data and a rising stock market to direct their focus on rising inflation, interest rates and home prices? Analysts have identified a tangled string of factors that contributed to this negative consumer mood, but identifying a primary cause is difficult.

We assign importance weights to events as we experience them or learn of them. Adam Smith wrote how we can mourn the loss of a tip of our finger more than the deaths of a million Chinese people in an earthquake. Our reaction to even a small tax hike can be out of all proportion to the quantitative change in the tax. State legislators are reluctant to increase a gasoline tax by a few pennies a gallon because they fear the voter backlash. On a ten gallon fill up, the extra tax might be only thirty cents, an amount someone might leave in a tip jar at a coffee shop. To many consumers, that thirty cents is insult added to insult, an example of government sticking its greedy hands into consumer pockets.

The frequency of an event like a sales tax may lead us to consider the entirety, the sum of events, as we react to any one event. Within this perspective, an inappropriate response to a particular event may look entirely appropriate. This can help explain why a person of a minority group reacts in a particular manner in their encounters with police. Their reaction is not to the encounter itself, but a lifetime of more than average encounters because of their skin color.

Sometimes the response is entirely proportional. In Colorado, the growth of property taxes was held in check by a law called the Gallagher Amendment, which taxpayers repealed in 2020. In the past five years, property taxes in Denver have more than doubled. An analysis by the Common Sense Institute determined that many property owners saw an average increase of 27% in their 2023 property taxes. Responding to voter anger, the legislature passed a law in May 2024 that enacted tiny decrease in taxes, from 6.765% to 6.7%. Many voters perceived the paltry tax relief as an insult and have shown strong support for a ballot initiative this November that will curtail the growth of property taxes. Scared that voters will again take more control of state and local revenue growth, the governor has called for a special session this summer, hoping that legislators can craft a measure that will provide substantial tax relief and deflect voter anger this coming November.

Having insurance can lower our reaction to a damaging event like a car accident or a hail storm. By diversifying our portfolio, we act as our own insurance company. However, it is not practical to own multiple homes to diversify the risk of hail damage, so we reduce the impact of such an event by buying a policy from an insurance company. The insurance companies insulate themselves from the impact of large losses, particularly weather-related events, by buying insurance themselves from global reinsurance companies. Because reinsurance companies have a global portfolio, they are able to distribute the risk of local weather phenomenon across all regions.

Unlike animals, most of us monitor and modify our reaction to daily events. Here again, the frequency of an event helps us manage our reaction because we are better able to predict the effect of a particular event. When we first learn to drive, the flow of traffic on a city street can be disconcerting and confusing. Over time we learn to anticipate the movement of the vehicles around us and this expectation reduces our confusion. This reaction management can become a multi-level cognitive process where we modify our management of our reactions. Commercial drivers required to take defensive driving classes are taught not to over-anticipate the actions of others. “Lights do not stop cars. People stop cars.”  “Some drivers use their foot to drive. A safe driver uses their brain.” Per mile of city street, there are many drivers of machines capable of great damage but few lights and signs. We get where we are going because people follow rules both written and unwritten. We pay attention to signs posted and unposted.

In human affairs, event and reaction are not separable like the Newtonian model we are taught in grade school. They may be the two heads of that peculiar animal called a pushmi-pullyu in The Story of Dr. Doolittle by Hugh Lofting. Because of that symbiosis, there may be backward causation. Did x cause y or did y cause x? There may be a factor z that affects both x and y. Event and reaction are a symbiosis that we manage through expectations, diversification and informal rules. Institutions like insurance and laws help us coordinate our individual responses. Somehow we survive in this world of complex causality.

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Photo by Kris-Mikael Krister on Unsplash

Keywords: taxes, event, reaction, quantitative, qualitative.

The Elasticity of Our Spirit

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August 18, 2024

by Stephen Stofka

This week’s letter is about the effect of quantitative phenomena on our quality of life. Why do events impact people of the same socioeconomic circumstances differently? We are part of a group responding to the event, so we interact with the collective responses of the group around us. Our direct response to the event is a small part of the total impact on our quality of life. Imagine we are a rubber duckie in a group of rubber duckies on the ocean’s surface as a wave passes. As we rise with the water that displacement causes a lot of jostling by the duckies around us. Much of the effect we experience is not the wave but the reaction of the others around us to the wave. Yet we attribute the cause of our experience to the wave, not our fellow duckies.

One hundred years ago, Louis de Broglie introduced a wave theory of matter. A few years later Erwin Schrödinger proposed a wave equation of electron motion to explain the quantum world. Those two ideas are cornerstones of quantum mechanics, the most tested theory in physics and the foundation of our current electronic technology. As you read this on a computer or smart phone you are watching quantum mechanics at work. Not all wave are alike. Light and radio waves are electromagnetic waves that don’t need a medium to travel in. Even in the vacuum of space, the electromagnetic field they create acts as a type of medium. Some waves, called transverse waves, cause matter to move in a direction that is partly perpendicular to the force of a wave. A rubber duckie bobbing up and down in the water is an example.

We are hunters of cause. We are interested in the origin of phenomena, thinking that the origin of something will enhance our understanding of that thing. For that reason, some economists like to debate the origin of money. One morning a few weeks ago, our cat woke up, yawned and stretched out a paw on the bed. A claw caught in the quilt and slid it sideways so that it formed a tunnel. Like a wave through water, the direction of the paw was parallel to the quilt, but the quilt reacted in a direction perpendicular to that movement. Kitty pulled her paw back and the tunnel mostly collapsed. She then stretched out her paw again and the quilt rose up. Her hunter reasoning led her to believe that a mouse was the cause of the tunnel under the quilt, so she attacked. She pounced and pawed the quilt to find that imaginary mouse, then lost interest, jumped to the floor and left the room. How often do we search for the cause of a phenomena that is mostly a response to the collective action of a group?

When prices go up, we can look to our side for contributing factors, the decisions of many consumers and businesses. A quantitative change in prices affects the quality of our lives. Like a cat, we often judge quantitative phenomena with an instinctive appraisal. We notice the rise in prices more than we do the rise in our wages because we are more sensitive to loss than gains. The Bureau of Labor Statistics reports that the annual increase in average hourly wages and weekly earnings is now higher than inflation. A rise in the price of the goods we buy has a greater effect than a similar rise in our income because we perceive a rise in prices as a loss of our purchasing power. We are particularly loss averse, according to Daniel Kahneman, the author of Thinking Fast and Slow, who won a Nobel Prize for his research into the less than perfect reasoning we employ in our decision making. He and Amos Tversky proposed a concept called Prospect Theory to describe and model the mechanics of our decision making.

Elasticity is a term that economist John Marshall borrowed from physics to describe the reaction of consumers to changes in the prices of goods. The most common measure is called the Price Elasticity of Demand and businesses pay close attention to this metric. It is the change in the percentage of goods bought in response to a 1% change in price – a ratio of two percentage moves – the zig divided by the zag. If the price of butter goes up 1% and the amount of butter sold declines by 2%, then the ratio of percentages is 2 to 1 and butter is considered to be elastic. If the quantity of butter sold declines only 1%, then butter is said to be unit-elastic. If the quantity of butter barely changes, then it is inelastic. When businesses sense that consumer demand for their good or service is inelastic, they can charge higher prices with less effect on the quantity sold and make a higher profit. Businesses respond to consumer decisions and tastes.

The elasticity of economic goods is not constant because consumer demand responds to a changing economic environment, as well as tastes and culture. In some cases, consumer demand can change abruptly. Such was the case after the pandemic. The airline market is an example of two types of demand elasticities. Business travelers are much less sensitive to changes in price, with an elasticity far below 1, according to research done in the 2010s. Because of that airlines upcharge business customers. Leisure travelers, on the other hand,  have an elasticity of almost 2, meaning that they are sensitive to price hikes. The higher prices that airlines charge business customers effectively subsidizes leisure travelers. However, after the pandemic, the demand for leisure travel surged and airlines responded with higher prices. Average airline fares surged 20% annually in the summer of 2021 then rose sharply by 34% in the summer of 2022. In the first quarter of this year, prices stabilized to pre-pandemic levels. Vacation travel is a luxury good, but it can feel like a necessity when we feel stuck in a grind and stressed at work.

The effect is more frequent for necessities like food, lodging and utilities. That frequency affects the elasticity of our spirit the way a weight on a spring changes the spring’s elasticity over time. The relief checks sent during the pandemic helped some families build a small savings cushion, a relief from the burden of living paycheck to paycheck. In the past two years, families that have dipped into their savings to meet higher housing, grocery and childcare costs feel a sense of loss because their savings are smaller. Even if wage gains have kept up with inflation on average, wage gains are calculated based on gross income before taxes. We buy groceries and pay housing costs with after-tax dollars. The loss is real.

Like water, human society is the medium, transmitting and transmuting the force of thousands of decisions made by people we will never meet. Our circumstances and decisions affect the lives of strangers. There is no single cause because we are part of the cause. Even if we could identify a primary cause like rising prices and remove it with a magic wand, we cannot predict a satisfactory resolution. Yet politicians running for office hold out their magic policy wand and promise to end this or that problem, hoping that enough voters will buy what they are selling. “Here’s the problem,” they say. “I can do something about it.” We want to believe that complex processes have simple causes, and in the final months of this election year, candidates will tailor their message to our belief in that simplicity.

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Photo by Joey Huang on Unsplash

Keywords: prices, inflation, cause, effect, wave

Bond Time

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August 11, 2024

by Stephen Stofka

This week’s letter is about bonds. Many older investors have bond funds in their portfolio because they are told that it adds safety to a portfolio. Like ballast in a ship, bonds reduce volatility when a storm approaches and the water gets choppy. As the Federal Reserve raised rates in the past two years, the bonds in our portfolios acted as a dead weight, producing net negative returns. Why are bond prices so sensitive to changes in interest rates? Why are bonds so weird?

An individual bond is a claim on someone’s debt. A bond fund or ETF is a mixture of individual bonds of various terms to maturity, the length of time to the date when the debt claim ends. These maturities are grouped into three categories: short, medium and long-term. Short-term refers to bonds that mature in less than two years. Bonds with terms of two to ten years are considered intermediate-term and longer than ten years is categorized as long-term.

The length of term is correlated with a bond fund’s sensitivity to interest rate changes. Short-term bonds pay the lowest amount of interest but are the least sensitive to interest rate changes. According to Portfolio Visualizer’s back tester tool, a composite of short-term bonds had an annual return of -0.82% since January 2020. A bond ETF with an intermediate term returned -2.79% annually. Long-term bonds were particularly affected by the rise in interest rates, returning -6.87% annually. I will leave the details in the footnotes.

Why does the price of a debt instrument like a bond react to changes in interest rates? Opportunity cost. If I buy a $1000 mortgage bond paying $50 annually, and shortly after, new mortgage bonds are paying $60 a year, I will have to sell my bond to another buyer for a discount, given the fact that both bonds have the same risk profile and maturity. The income stream on the bond I own cannot compete with the higher income stream from new bonds at the same price.

A bond’s duration is a measure of its price sensitivity to a 1% change in interest rates and is published by financial news outlets like Morningstar, where readers can check the duration of a bond fund or ETF they hold. That number indicates the percentage change in price for each 1% change in interest rates. For readers who want to go deeper into this, Rich Falk-Wallace posted up on X a Bond Math table of forecasted price changes in response to various changes in interest rates.

Using our sailing analogy, the term of a bond is like the height of a mast on a sailboat. A longer-term bond, like a taller mast with more sail exposed to the wind, will get us somewhere faster in calm winds (or pay a higher dividend), but leave us dangerously exposed when wind speed increases. The table mentioned above shows that a 30-year Treasury bond can have suffer a 30% loss in price for a 3% rise in interest rates, a price response of ten times the change in interest rates. Yikes! The leverage effect is even greater when interest rates fall. The table indicates a price rise of 72% for a 30-year Treasury bond when interest rates fall by 3%, an effect that is 24 times the change in rates!

Relative to stocks, price changes in bonds are tame. In 2022, a broad composite of bonds like Vanguard’s BND ETF experienced a 10% decrease in price, and it was historic. A similar decrease in the price of the SP500 stock index is a “correction,” a cause for concern. A 50% decrease in stock prices is historic. The stock market is like riding on a dirt road in a 4×4 jeep. The bond market is like riding in a car on a paved road. We react strongly to any rough patches or potholes.

There is a positive aspect. Depending on your financial situation, it may be prudent for an investor to convert a regular IRA invested in bonds to a Roth IRA. The investor will have to pay income taxes on the capital gains, but those gains have been reduced in the past two years. Once converted to a Roth, any subsequent gains will be tax-free. A Roth IRA has no required annual withdrawal, so an investor has more control over their funds in retirement. Some investors may have what are called unrealized losses in a taxable account that holds bonds, and these could be used to offset gains this year if sold. These are options that some readers may consider and discuss with their financial or tax advisor.

For several decades, interest rates on savings were so low that investors used index funds as a way to earn a higher return on their savings. In the years following the financial crisis, the lack of inflation was more a risk than inflation. In such an environment, investors may have not fully appreciated the difference in risk between bond funds and money market funds. In the decade following the financial crisis, 2008 through 2017, a broad composite of bonds earned 3% or more when savings accounts were paying almost 0% and money market accounts were barely paying 1%. In the last seven years, the return on bond funds has been 1% or so. Investors who piled into longer-term bonds with higher returns were hit hard when the Fed raised interest rates in 2022 and 2023.

A bond’s term to maturity indicates price sensitivity to interest rate changes. An investor’s term to retirement indicates portfolio sensitivity to market conditions and mistakes in judgment. Someone in their thirties can be more aggressive and recover from judgment errors more ably than someone in their sixties. That reality underlies the conventional advice that people should devote a greater portion of their portfolio to bonds when they are older. However, bond investors may have felt like unlucky victims when bond market prices sank in 2022-23. Dramatic market shifts reinforce the rewards of diversification. At the heart of the math on bond duration and risk diversification is an aphorism we learned as kids: don’t put all your eggs in one basket.

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Photo by Christophe Ferron on Unsplash

Bond Notes: Short-term bond ETF: Vanguard’s BSV. Intermediate-term: BIV; long-term: BLV.

Keywords: investing, bonds

Claims to Truth

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August 4, 2024

by Stephen Stofka

In this week’s letter I will clean up my notes on the judiciary before I start a series on investing next week. For several millennia, human societies have struggled to figure out the how and the who of lawmaking. How to construct a rule whose language is clear enough to be understood but flexible enough to apply to varying circumstances? Who will enforce the rules? How will they be enforced?

Let me start with a real story from my childhood. My younger brother and I were only one and a half years apart in age and were quite competitive. Tired of listening to my brother and I argue over the rules of various card games we played, our dad bought us a book called Hoyle’s Official Book of Games. This resolved some of our disputes, but still we argued over the interpretation of the rules. If a rule in Rummy requires a player to play a card once they have touched it, how to interpret the word “touch?” If a gust of wind threatens to toss a few cards from the deck, can a player reach out to prevent that without having to take that card? What if a player grazes the card with their elbow while reaching for a drink?

Former Supreme Court Justice Stephen Breyer (2024) wrote that many cases the court decides can hinge on the interpretation of one or two words in a law. In the Heller decision on the Second Amendment, the majority and dissenting justices wrote 80 pages of argument over the meaning of “bear arms” in the Second Amendment. He quotes the example of a railroad that required passengers to pay full fare for each animal they brought on board. When a biology teacher brought a number of snails on the train for a class, the conductor charged the teacher a fare for the snails. When the teacher complained that the rule was meant for pets, the conductor explained that the rule used the word “animals,” not “pets.” Snails are animals.

If you were a judge, how would you rule? Breyer’s story raises the question: what if the rule said, “domestic animals?” What does the term “domestic” specify regarding animals? An animal related to a person’s home or family. Snails can be kept at home so even this change in the rule could be interpreted to include snails. The most important symbol in mathematics is the equals sign. There are specific rules of valid operations on either side of an equals sign. Plain language has no equals sign. For centuries, French was the language of diplomacy. The language has fewer words, which conveniently left agreements between diplomats open to interpretation.

If the truth were an island, it would be stained with the blood of millions. Throughout history, kings, philosophers and countries have laid claim to and fought over the truth. In 17th century Britain, a civil war erupted between monarchists, those loyal to the king and the power of the king, and Parliamentarians, those loyal to the Parliament as representatives of the people’s will. Robert Filmer, a noted monarchist, argued that the right to property comes from God through the King. John Locke argued that the right to property comes directly from God. When God drove Adam and Eve out of the garden, He told the couple they would have to work the land for their survival. Therefore, those who cultivate the land add value to the land and “thereby makes it his property” (PDF link, p. 116). The state merely recognizes that title. In later centuries, the American colonists would use this reasoning to deny that Indians had any right to the land because they did not cultivate it.

Journalists often make claims on the truth. Matthew Yglesias wrote on his Substack “this is journalism, and we owe a duty of truth to our audience.” He referred to “journalists’ obligations of candor,” but truth and candor, or honesty, are different. In its 1964 decision New York Times v. Sullivan, the Supreme Court ruled that statements about public officials were not subject to claims of libel unless they were shown to be made with “actual malice” and a disregard for the truth. That is a standard of candor, not truth.

The American Bar Association states that lawyers “must be honest, but they don’t have to be truthful.” They distinguish between being honest and being truthful. “A defense lawyer has no obligation to actively present the truth.” Being honest requires only that “Counsel may not deliberately mislead the court.” A lawyer who serves their client’s interest by making a false representation to the court risks disbarment. Rudy Guiliani was recently disbarred for making deliberate misrepresentations to further Trump’s claims of a stolen election.

A witness, on the other hand, must vow to “tell the whole truth” to the court. Politicians take no such vow, nor do they pledge a vow of candor, to be honest with the public. They take an oath of office to “support and defend the Constitution against all enemies,” a vague statement open to wide interpretation. It is up to the public to judge their lies, and to assess the importance of those lies. Abraham Lincoln supposedly claimed that all the people could not be fooled all the time, but a politician does not have to meet that high bar. They only need to fool enough of their constituents to get re-elected.

Should Congress set minimum years of service as a judge for Supreme Court nominees? Chief Justice John Roberts, and Justices Kagan and Thomas had the fewest years on the bench before joining the Court. I will leave the details and links in the footnotes. I have many more notes after reading Breyer’s recent book, but I will close this for now. Next week, I hope to present some perspective on investing in plain language without equations.

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Photo by John Cameron on Unsplash

Keywords: rules, honesty

Breyer, S. G. (2024). Reading the constitution: Why I chose pragmatism, not textualism. Simon & Schuster.

The link to the justices’ bios is here. Chief Justice John Roberts served as an Appeals Court judge for only 2 years before becoming Chief Justice. Justice Clarence Thomas – one year. Justice Samuel Alito – 16 years. Justice Elena Kagan had no prior judge experience. Justice Sonia Sotomayor – 16 years. Justice Neil Gorsuch – 10 years on an appeals court.. Justice Brett Kavanaugh – 12 years. Justice Amy Coney Barrett – 3 years. Justice Ketanji Brown Jackson – 9 years.

The Black Robes

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July 28, 2024

by Stephen Stofka

This week’s letter continues my look at a method of judicial interpretation called textualism. For fifteen years, I have been writing regularly, trying to understand systems of power and thought that are bigger than my readers or myself. We are often unaware how much our daily lives are shaped by some ethical philosophy that guides the institutions that determine the rules we live by. Over the past two decades, the Roberts’ Court has increasingly used textualist interpretation to upend decades of precedent. The Court has overturned Roe, and several justices have same sex marriage protections in their sights as the next precedent to fall. They have redefined the Second Amendment as an individual right and set severe restrictions on affirmative action considerations used in college admissions.

The economist John Maynard Keynes once commented that we were slaves to the ideas of some defunct economist. The same can be said about judicial interpretation. Justice Scalia, the leading proponent of textualism on the Supreme Court, died several months before the 2016 election. Fellow Justice Alito indicated the reverence that conservative justices had for Scalia’s reasoning when he commented that they would ask “What would Scalia do?”

Stephen Breyer, another Associate Justice on the Court who retired in 2022, often held public debates with Scalia. In his book Reading the Constitution: Why I Chose Pragmatism, Not Textualism, Breyer recalls the irresolvable issues between the two justices. Breyer placed greater weight on the purpose of a law. Scalia emphasized the statutory text of a law and the “text’s original public meaning” (p. 28), a sub-branch of textualism called originalism. Sometimes a strict textualist approach conflicts with or contradicts an originalist approach. Richard Epstein (2014, p. 54) cautioned, “it is a dangerous mistake to conflate any form of originalism which asks how texts were understood when written, with strict textualism, which ignores those necessary but implied exceptions.”

Breyer (p. 25) writes that Scalia thought the textualist approach would create what Scalia himself called a “science of statutory interpretation.” In the 19th century, Jeremy Bentham, a founder of an influential philosophy called utilitarianism, wanted to become the “Newton of morals.” Bentham invented a “felicific calculus” to bring scientific and objective analysis to moral and ethical controversies. The calculus focused on the effect of an action, not its nature or the parties involved. Bentham’s goal was to design a system of moral reasoning that would make judicial sentences proportionate to the effect of a crime. A stolen chicken was a stolen chicken. It didn’t matter who was the owner of the chicken. Novel in its approach at the time, it has become the foundation of law, ethics and economics but the calculus itself seems rather quaint to students who are introduced to it in an ethics class. Like Bentham, Scalia wanted to develop a set of rules of judicial interpretation that would guide the drafting of statutes in Congress. Unfortunately, the Court’s textualist reasoning has created confusion in the lower courts.

Some of the confusion arises from the inconsistent application of textualist methods by the conservative justices. In the District of Columbia v Heller majority opinion authored by Scalia, he disregarded the first half of the text of the Second Amendment. The Amendment had been written to assure the state legislatures that the new federal government could not call up state militias, then collect their muskets and disband the militia, leaving states powerless against an autocratic federal government. In his majority opinion, Scalia dismissed the first half of the text as a prefatory clause imposing no limit on the meaning of the second half of the amendment’s text. That decision highlights the difficulty, if not impossibility, of being objective in legal or moral reasoning.

Ethicists have long grappled with a grounding problem, establishing a moral foundation for ethical evaluation. The folks at Crash Course Philosophy have an informative video. (I set the  playback speed to .75 to digest all the points they present). In ancient Greece, Socrates asked Euthyphro if the gods loved the pious because it was pious, or was something pious simply because the gods loved it. Twenty-five hundred years later, ethicists and jurists have not resolved this question, known as the Euthyphro dilemma. Is something inherently just or right, or do we simply make it so? Neither Scalia nor Bentham could escape the inherent self-centeredness of our perceptions. In Einstein’s terms of space-time, we are like the sun that bends the space around it. We bend the information that we receive so that it is difficult to find any objective agreement among human beings that will persist across time and culture.

The subjectivity of our perceptions can defeat any methodology in search of an unambiguous objectivity. I will pick a case from the Court’s current term to illustrate how textualist analysis can reach very different conclusions. Snyder v United States was a case testing the distinction between bribery and gratuity. James Snyder was a former mayor of Portage, Indiana who was charged and convicted of violating a federal law for a payment he received following the award of a contract for the purchase of some garbage trucks. Snyder was charged under §666 (the curlicue symbol denotes “paragraph”) of Title 18 of the U.S. Code:

“corruptly solicits or demands for the benefit of any person, or accepts or agrees to accept, anything of value from any person, intending to be influenced or rewarded in connection with any business, transaction, or series of transactions of such organization, government, or agency involving any thing of value of $5,000or more.” §666(a)(1)(B).

Snyder argued that he did agree to any payment before the transaction and that   §666 applied only to bribes. Writing for the majority opinion of six conservative justices, Justice Kavanaugh distinguished between bribery, a payment before an act, and a gratuity, a payment after an act:

either (i) a reward given after the act with no agreement beforehand (gratuity)

or (ii) a reward given after the act pursuant to an agreement beforehand (bribe).

Although Kavanaugh distinguishes the two, why did Congress expand the scope of the law by including “or rewarded?” If they meant that §666 of the statute to apply only to bribery, they could have left the text unmodified. The addition to the text indicated to the dissenting three justices that Congress intended the amended text to apply to payments before and after the fact. However, a strict textualist approach ignores legislative history. Kavanaugh justified his reasoning because of the placement of an adverb “corruptly” in the statute. Kavanaugh looked to §201(b) covering bribery and §201(c) of the statute governing gratuities and found that only §201(b) used the word. Therefore, Kavanaugh reasoned, the use of “corruptly” in  §666 limits its application only to bribery.

The bribery statute for federal officials, §201(b), uses

the term “corruptly.” But the gratuities statute for federal

officials, §201(c), does not. The term “corruptly” therefore

signals that [18 U.S.C.] §666 is a bribery statute. And statutory

history, statutory structure, statutory punishments,

federalism, and fair notice strongly reinforce that textual

signal and together establish that §666 is a bribery statute.

Writing the dissenting opinion, Justice Jackson wrote, “To reach the right conclusion we need not march through various auxiliary analyses: We can begin—and end—with only the text.” Justice Jackson referred to a separate §215 that targeted bank employees who accepted bribes and gratuities. That  section of the text was used as a model for the language in §666, according to the House Reports of Congress at the time, and §666 duplicates the wording of §215. The majority opinion disregarded that salient fact.

At the heart of this controversy and others is the conservative dislike of federal interference in state affairs, a breach of federalism, mentioned twelve times in Kavanaugh’s opinion. Here is one example: “Interpreting §666 as a gratuities statute would significantly infringe on bedrock federalism principles.”

Congress awards federal money to states for various purposes, but local officials complete the transactions with national and local companies. It is perfectly understandable that Congress did not want local officials to profit from the disbursement of federal funds. However, Congress effectively made all jurisdictions subject to the law, expanding the scope of federal regulatory power. The federalism principle is nowhere in either the Constitution or the relevant statute but captures the idea of boundaries and separation of powers implied in the Constitution. Given that aversion to an expansion of power, a skilled jurist can use textualist analysis to serve whatever purpose they want.

A recurring theme in former Justice Breyer’s book is that textual analysis is as arbitrary as the traditional analysis it was meant to replace, an analysis guided by the purpose of a piece of legislation. Scalia thought that textualist interpretation would produce a set of rules that would guide legislators as they wrote the law. Out of all the justices on the Court, only Stephen Breyer had worked for a time in a legislative function, serving as counsel on Senator Edward Kennedy’s staff. Scalia knew little of the negotiations and deliberate obfuscations that legislators employ to build a consensus to pass a law. The ambiguity in statutory text is deliberate in some cases. Just as with the executive and legislative branches, justices have points of view, and they use their talents and experience to reinforce their perspective. Don’t be fooled by the black robes. There are human beings beneath the cloth.

These past weeks I have explored some aspects of the law as they relate to expectations. Because I am not a lawyer or a constitutional scholar, the research for these topics requires more time. I hope that readers have learned a bit as I expanded my own knowledge of these topics. I apologize in advance for any faults or omissions. Next week, I intend to turn to several topics on investment, the tradeoff between our current self and our future self when we delay consumption and save money.

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Photo by Gene Gallin on Unsplash

Keywords: ethics, utilitarianism, bribery, gratuity, textualism, originalism

Breyer, S. G. (2024). Reading the constitution: Why I chose pragmatism, not textualism. Simon & Schuster.

Epstein, Richard Allen. (2014). The classical liberal constitution: The uncertain quest for limited government. Harvard University Press.

The Reins of Judicial Power

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July 21, 2024

by Stephen Stofka

This week’s letter is about an alliance of business interests and libertarians alarmed by the growing power of the federal government that emerged during the 1930s Depression and enabled by a shift in judicial interpretation on the Supreme Court. In the following decades, executive agencies expanded their authority by assuming powers held by each of the three branches (Epstein, 2014). The agencies wrote rules like a legislature, administered the rules with or without the assent of the President, and resolved controversies in legal interpretation like the judiciary. When the Court’s decisions challenged the traditions of religious groups, social conservatives joined the coalition.

Social unrest in the 1960s followed by political turmoil and economic stress in the 1970s accompanied a generational shift in power in the Congress. A coalition of civil rights advocates  and environmental activists helped pass legislation in both areas. In the southern states where resistance to federal control was still active a century after the Civil War, voter sentiment began to shift from the Democrat Party to the Republican Party. Extractive industry groups increased their lobbying efforts to check environmental laws that increased their costs or delayed their projects (Kraft, 2022). In the 1970s, environmental activist groups turned to the courts to block industrial developments (Smith, 2022). Many of these controversies occurred in federal district courts where 860 justices with life tenure decided the application of the rules. Business groups recognized the need for judges sympathetic to any judicial philosophy that promoted a diffusion of government power to the states and individual business interests. Large corporations, enjoying many of the legal rights of individual persons since the 19th century, had revenues greater than those of many state governments, allowing big businesses the power to steer state and local policy toward maximizing profits.

A hybrid form of judicial interpretation called textualism/originalism was an effort to develop objective rules of jurisprudence to guide decisions in the lower courts. Textualism focuses on the legislative text while originalism focuses on the history of statutes and the Constitution (Eyer, 2022). Together the rules encourage justices to stay faithful to the text, history and tradition of the law. Six justices on today’s current Supreme Court hold the reins of this team of horses, which sometimes pull in opposite directions. Four decades in development, textualism and originalism have not brought the sought after clarity. Lower courts have sometimes responded with contradictory decisions to recent Supreme Court precedents, resulting in a judicial recycling of controversies in which the Court clarifies an earlier precedent.

As executive agency power expanded in the decades following World War 2, the Supreme Court expanded individual rights in its interpretation of the 14th Amendment. Richard Epstein (2014, p. 121) voices the conservative sentiment when he called this period a “veritable explosion of new rights.” The 1973 Roe v. Wade decision overruled state laws that prohibited abortions at various stages in a pregnancy, determining a right to privacy in the 14th Amendment. Social conservatives, business interests and libertarians formed an alliance of think tanks to limit the expansion of judicial and executive power.

Conservatives decried the Court’s Roe v. Wade decision upon its publication. In an interview late in her life, liberal Justice Ginsburg faulted the reasoning the court gave in that decision. She explained that the decision should have been based on a principle of gender equality clearly stated in the 14th Amendment. The Court’s ruling, based on a presumption of privacy, left the decision vulnerable to repeated attacks by groups of social conservatives. A coalition of religious groups, still angry over the Court’s 1962 decisions banning prayer in schools, now found common cause with business interests angry about the expansion of executive agency power.

For some foundational understanding of this revolution in judicial interpretation, readers will remember that the Bill of Rights was a package of ten amendments submitted to the states for ratification in conjunction with the Constitution. They applied to the federal government and were meant to assuage any concerns that this newly created federal government would impinge on the rights and power of state legislatures and the small number of individual citizens allowed to vote in each colony (Klarman, 2016). The enumerated powers stated in the Constitution was designed to define and contain the powers of the federal government but left unsettled or undefined powers to the states. In the century following ratification, the Court’s rulings gave preferential treatment to state autonomy in controversies over Bill of Rights protections. The Supremacy Clause of the Constitution gave the federal government priority if a federal law contradicted state law, but if there was no federal law resolving a controversy, state law took precedence. Separation of powers included the three branches within the federal government and between the federal government and the states.

For an evolving history of jurisprudence, I will turn to the National Constitution Center, a bipartisan independent organization authorized by Congress to educate the public on the history, text and meaning of the Constitution. They offer a free curriculum of classes on the Constitution for readers who want to expand their knowledge of the controversies related to the Constitution and its Amendments. What follows is a synthesis of a class section on selective incorporation, the Court’s application of protections for individuals to the states law.

Following the passage of the 14th Amendment, several Supreme Court decisions limited its protections against state abuses. In the 1925 Gitlow v. New York decision, the Court held that a state could not violate an individual’s First Amendment rights. In the 1960s the Supreme Court, headed by Chief Justice Earl Warren, further expanded individual rights, reasoning that the due process and equal protections guaranteed by the 14th Amendment made Bill of Rights protections applicable to the states as well as the federal government.

Before the rulings of the Warren Court, individuals had few protections against abuses by state governments. States routinely violated protections against search and seizure contained in the Fourth Amendment, the right to counsel stated in the Sixth Amendment, the protection against self-incrimination in the Fifth Amendment, and the right to free speech in the First Amendment. As I noted last week, a minority of rural voters in some states controlled the legislature through clever districting rules that magnified their representation and interests in the state legislature.

As the court has applied combinations of textualist and originalist interpretation, it has satisfied the wishes of the coalition of social conservatives, business interests and libertarians. Its Dobbs decision overruled the 50-year-old precedent set by Roe v. Wade, pleasing social conservatives. It overruled previous precedent set by the Bakke decision in 1978 that established affirmative action, pleasing business interests and libertarians. In 2008, its Heller decision established an individual right to own a gun, satisfying libertarians. It 2010 Citizens United decision overrules McCain-Feingold limits on corporate political contributions, giving business interests a greater opportunity to influence policy. Social conservatives are hoping that the court’s next term will overturn a right to same sex marriage established by the 2015 Obergefell decision.

Next week I will look at the conflicting priorities in textualist/originalist analysis and how its methodology differs from the more traditional analysis that focuses on the purpose of a law.

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Photo by Jim Strasma on Unsplash

Keywords: civil rights, environmentalism, amendments, Bill of Rights, Supreme Court, textualism, originalism

Epstein, Richard Allen. (2014). The classical liberal constitution: The uncertain quest for limited government. Harvard University Press.

Eyer, K. R. (2022). Disentangling textualism and originalism. SSRN Electronic Journal. https://doi.org/10.2139/ssrn.4090893

Klarman, M. J. (2016). The Framers’ Coup: The Making of the United States Constitution. Oxford University Press.

Kraft, Michael E. 2022. Environmental Policy and Politics. New York: Routledge, Taylor & Francis Group.

Smith, Kimberly. 2022. “Environmental Policy In the Courts.” In Environmental Policy: New Directions for the Twenty-First Century, eds. Norman J. Vig, Michael E. Kraft, and Barry George Rabe. Thousand Oaks, CA: SAGE. essay, 137–54.

Alliances of Reasoning

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July 14, 2024

by Stephen Stofka

This week’s letter is about expectations and alliances of judicial reasoning and power. I will begin with some background on the judiciary, then follow up next week with a closer look at the rationales that various schools of judicial reasoning employ to reach their desired conclusion.

The legislature has 535 individual opinions of what is fair and just, as many interpretations of statutory and Constitutional text, and many prescriptions of what should be done to address a problem. Party leaders must collapse those many dimensions into a singularity, a sheet of paper that becomes law. As laws emerge from the halls of Congress, they become a multi-faceted work of collaborative reasoning. Businesses hire lawyers to reinterpret a piece of legislation in their favor, or to defend against regulatory action. The executive agency responsible for administering or enforcing the law has its own opinions of what the law says and how it should be executed. Judges in federal district courts weigh in with their opinions as they rule on cases and controversies brought before them.

Those opinions may be challenged in federal appellate courts then submitted to the Supreme Court asking them to take the case for review, a petition  called a “writ of certiorari.” Of the many cases submitted, the Court accepts only a small number – 62 in the 2023-24 session, according to Ballotpedia. Lawyers for the plaintiff and respondent argue their opinions to the Court, which reviews those arguments as well as amicus briefs submitted by advocate groups on either side of an issue. Again, many opinions collapse into a judgment won by a majority of the Court’s justices. In some cases, they simply refer the case back to a lower court with a clarifying interpretation of a legal area that the lower court should include in its consideration of the case.

The Constitution contains three articles that establish the Legislature, Executive and Judiciary. Article 3 authorizing the Judiciary is only 373 words, less than the word count required of a fourth-grade essay. Article 2 establishing the Executive branch is three times longer. Article 1 instituted the Legislative branch and is almost eight times as long. The principle of judicial review, that the courts can decide whether portions of laws passed by the legislature conflict with the Constitution, is not cited in Article 3. How did the Judiciary assume that plenary power?

The ruling in an 1803 case titled Marbury v. Madison decided that Marbury, the plaintiff, did not have standing to sue Madison, the Secretary of State under Thomas Jefferson. The decision was less noteworthy than the reasoning supporting the decision. The Court, headed by Chief Justice John Marshall, ruled that a portion of the Judicial Act passed in 1789 conflicted with Article 3, Section 2 of the Constitution. In that decision, Marshall assumed the right of the Court to have the final word on the meaning of statute and Constitutional text. A strict textualist interpretation of the Constitution would argue that the Marshall court had found a clever way to amend the Constitution. In recent decades textualist interpretations of the law have gained popularity among conservative justices. This branch of analysis emerged as a reaction to the purpose-oriented jurisprudence typical of the Court’s opinions in the sixties and seventies.

After WW2, voters gave Democrats an average 81 seat advantage in the House (Kraft & Furlong, 2021, p. 345), an effective mandate. In the current House, Republicans have only a 7-seat advantage. Many House members were World War 2 veterans, determined that the sacrifice of their military brothers in the fight for freedom would not be subjugated to racial practices that suppressed the freedoms of Black people, including those soldiers who had fought in the war. In 1962, Rachel Carson’s book Silent Spring focused popular attention on the sewage and dangerous chemicals that contaminated the nation’s air and water. As veterans gained seniority in Congress, they were able to pass civil and environmental reforms. In a surge of anti-Republican sentiment following the Watergate scandal, voters in the 1976 election handed Democrats a 150-seat advantage in the House.

A Constitution should thwart the human inclination to shape laws to suit to one’s advantage. The Supreme Court, headed by Chief Justice Earl Warren, established, or re-established depending on one’s perspective, several Constitutional principles of equality that upset relationships of power at the state and local levels. Shortly after President Eisenhower appointed Warren to head the Court, it issued its Brown v. Board of Education decision that established the principle that segregated schools in southern states were not equal. George Wallace, the Governor of Alabama, defied federal efforts to desegregate the state’s schools. In his campaign for President a decade later, he rallied his followers with the cry “segregation today…segregation tomorrow…segregation forever.”

The Court’s reliance on the equal protections of the 14th Amendment provided the rationale for other reforms, including Reynolds v. Sims (164), the “one person, one vote” decision. In several states, a dwindling population of rural voters maintained control of the state legislature through imaginative schemes. In Kentucky, districts were apportioned according to the mileage of the roads in the county, not the number of voters. In Tennessee, the legislature had not changed district apportionment since 1901, a move that disadvantaged the growing urban population of that state. In Vermont, 49 people in one district had equal representation with 33,000 in another state district. Other individual protections included the Miranda warning upon arrest, the protection from search and seizure by state and local officials without a warrant,  and the freedom to buy contraceptives in the Griswold ruling.

Some considered these rulings an intrusion on state and local autonomy and antithetical to the conservative principle of limited government. In the final year of the Warren Court and the close of the 1960s decade, Nixon encouraged a “silent majority” of traditionalists to reject the reforms and societal upheavals of the past decade. Nixon sought to wake the sense of grievance in a coalition of conservative minorities. In 1973, a volatile combination of events – the Watergate hearings, an oil embargo touched off by America’s role in the Arab-Israeli war, an 8.8% inflation rate, and the Court’s Roe v Wade decision – stirred up a backlash of traditionalist fervor that would gain momentum over the next two decades. Next week I will examine those alliances of power.

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Photo by Wesley Tingey on Unsplash

Keywords: silent majority, Watergate, Roe v. Wade, segregation, Supreme Court

Kraft, Michael E., and Scott R. Furlong. 2021. Public Policy: Politics, Analysis, and Alternatives. Thousand Oaks, CA: CQ Press.