Category: insurance

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 In Colorado, the growth of property taxes was held in check by a law called the Gallagher Amendment, which taxpayers repealed in 2020.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 Choices We Steer By

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October 29, 2023

by Stephen Stofka

Last week’s letter explored income and wealth distribution within a framework that involves choice as well  as chance. The emphasis on choice was first presented in a 1953 paper by the Nobel economist Milton Friedman. This week’s letter develops the implications of Friedman’s speculation.

Friedman suggested that a wage implicitly contained an insurance premium charged by employers for reducing an employee’s income risk. Debt instruments involve an ongoing relationship between debtor and creditor and carry a risk premium that is a component of the interest rate on the debt. The employer-employee relationship is an ongoing financial relationship as well. An employee’s desire for a consistent income leads them to accept a lower income, a tradeoff of some income for some certainty about future income. This implies that a worker’s wage is not just the marginal product of their labor, a bedrock assumption of neoclassical economics. A worker who has a tolerance for more risk will demand higher pay from an employer, reducing the insurance premium embedded in a wage.

During economic crises when there is higher unemployment, employers should be able to charge a higher risk premium, i.e. a lower wage, to workers who would have a greater desire for certainty. But wages are slow to decline during these times. In Chapter 17 of the General Theory, Keynes claimed that wages were “sticky.” Economists attributed it to union wage contracts that do not respond to changing circumstances. Today union membership in the U.S. is less than 10% of the workforce, reducing that as a causal factor in this country. So why don’t workers accept much lower wages to obtain work?

Employers and employees bargain over the price of certainty, each of them aware that certainty at any price is in short supply. In times of stress, employees may be concerned that a smaller employer, the implicit insurer of a worker’s wage, cannot provide the degree of income safety that the lower wage would purchase. Because the employer-employee relationship is a persistent one, employees are concerned that working for a much lower wage might set a precedent that is not easily undone. When economic conditions improve, how likely is an employer to restore wages to their former levels? This was a point of contention in ongoing wage negotiations between the UAW – the auto workers’ union – and car manufacturers. During the financial crisis, the union made wage concessions to help the automobile companies stay in business. When business improved, wage increases were based on the reduced wages. Recent hires were paid less than a delivery driver for Amazon.

In the closing decades of the 19th century, neo-classical economists like Stanley Jevons, Francis Edgeworth, Leon Walras and Alfred Marshall cleaved Economics away from Political Economy in an effort to treat economics as a mechanistic science of exchange. They argued that an employee’s wage was just a factor of production like machines and land. They excluded from their analysis the political and legal constructs that protected private property and the social institutions that were a part of the community that surrounded firms and their employees. The wage was a component of the marginal cost to produce one more unit of whatever the company sold. Economists called it the marginal product of labor, or MPL.

There was a moral implication that employees were being paid their “fair share” of the cost to bring the next unit into production. This model suggested that employees who demanded higher wages wanted to be paid more than their marginal product, or more than they deserved. This provided moral justification and political appeal when employers clashed with employees over wages and working conditions. In 1877, railroad owners convinced West Virginia Governor Henry Mathews to provide state militia to end a workers’ strike (White, 2019, 347).

In the late 19th century there were few legal protections and no social insurance programs for workers. Today an employer acts as an insurance broker for a host of mandated government insurance programs. These include Social Security, unemployment insurance and workers’ compensation. An employer does not provide mandated benefits for free. They are included in an employer’s labor costs and deducted from an employee’s wage. Neither employer nor employee have any choice in these government mandated insurances. The choice an employee does have is how much they must pay their employer for income stability. The employer may charge that fee in many ways. These include a lower wage or the expectation that employees will work varying shifts or staggered hours. The employer may include other working conditions in the employment bargain that require compromise from the employee. This is all part of the insurance premium that an employer charges for providing future income certainty.

An employee’s choice whether to pay that insurance premium is bounded by their expectations, personal circumstances and the broader economy. An employee who asks for a higher wage, refuses to work a varying schedule or declines working overtime risks negative consequences. If the job market looks poor, the employee is more likely to comply with employer demands. An employer calculates the degree of difficulty to replace that employee and the “domino effect” of a higher wage on other employees in the company. Employers may stress confidentiality but employees often spread news of a wage increase, or the lack of one, to their coworkers. This is a series of opportunity cost calculations made by both employers and employees.

In the late 19th century, economists devised a mechanistic interpretation of human interaction that is still a component of economic studies today. Bargaining between parties is illustrated by supply-demand diagrams, Edgeworth boxes and other graphical teaching tools. Keynes’ 1936 General Theory is entirely founded on the principle that investors bargain with uncertainty but it wasn’t until the following decade that economists incorporated game theory into their analysis. Friedman’s 1953 paper was an exploration of the choices that underlay the dynamics of economic relationships. Like Keynes, Friedman was fascinated with the interaction between choice and chance in our lives. Chance is like being in a raft on a river. Our choices are like oars that help us navigate the perils of the moving water and the hidden rocks in our way. Throughout his life, Friedman pointed out the hidden aspects of our lives.

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Photo by Bluewater Sweden on Unsplash

Keywords: marginal product of labor, neoclassical economists, wages, insurance, uncertainty

White, R. (2019). The Republic for which it stands: The United States during reconstruction and the gilded age, 1865-1896. Oxford University Press.

House of Money

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June 12, 2022

By Stephen Stofka

Economics students learn that money is a complex function, a multi-tool that plays three roles in our lives. Lawyers study the role of money in contracts. Psychologists study how our beliefs and personal history shape our distinct attitude to money. Our use of money embodies our expectations of the future and our perceptions of risk. The financial crisis demonstrated that money connects us and separates us. The struggle between cooperation and distrust is the foundation of our experiment in democracy.

Money is the Swiss army knife of most societies. As a medium of exchange, it saves us the cost of matching our needs. We can store our labor in a unit of money, then trade it for the things we want. The law regards an exchange of money as a “consideration” that distinguishes a contract from a gift. Current Supreme Court precedent has held that money is speech. Because we use money to store purchasing power, we want it to be a reliable container that doesn’t leak value. Money’s role as a unit of account requires legal institutions to administer the rules of that accounting.

We buy insurance to mitigate risk but to do so we are herded into risk pools based on age, sex or occupation. Those under age 25 pay higher car insurance premiums but lower health insurance premiums. Because they make less money as a group, they have a higher loan default rate and must pay higher borrowing costs. Roofers pay higher workmen’s compensation premiums than police. Heights are more dangerous than criminals. Before Obamacare, health insurance companies charged women of childbearing age higher premiums for individual policies (Pear, 2008). The premiums reflected the higher expected costs of pregnancy regardless of whether a woman had any intention of getting pregnant. We are Borg.

Companies may classify our risk profile but we have a unique relationship with money, a composite of personal experience and inclination. “Me” and “my” are appropriately contained in the word “money” because our attitude toward money is as unique as our fingerprints. In 1984, British psychologist Adrian Furman (1984) led a study to assess people’s attitudes toward money. The questionnaire included 150 questions grouped into five areas that probed the subjects’ beliefs, their political attitudes and affiliations, their sense of autonomy and personal power. An argument about money can be as complex as that questionnaire.

Many political debates involve money. Each party tries to gain control of the public purse to fund its priorities. After 9-11, the debate over money intensified. The hijackers had attacked a money center as a symbol of American hegemony. While Americans debated the justification for an invasion of Iraq, the budget surplus of the late Clinton years evaporated. For some voters, the choice was a stark one – spend money to blow up people in a foreign land or spend it to strengthen American communities. To calm his critics, Mr. Bush promised that Iraq would repay American war expenses with its oil revenues. This was one of several follies that turned voter sentiment toward Democrats in 2008.

The financial crisis showed us the complex nature of money and tested the values that we attach to money. In the last months of a flailing Bush Presidency, the crisis exposed the corruption, greed and stupidity of the country’s largest financial institutions. Billions of taxpayer money had created and fed a thicket of regulatory agencies that were either corrupt or incompetent. The crisis ignited a strong moral outrage that intensified when Democrats fought to pass Obamacare.

The debate may have ebbed during the decade that followed but the Republican tax cuts of 2017 reignited public disdain and distrust. While many American families struggled to recover from the crisis, the politicians and their rich patrons fattened their fortunes.

Money is the heart of the American experience. The American confederacy of colonies that had won independence from Britain could not pay its debts or borrow money. The writing of the Constitution was sparked by the urgent desire to resolve that crisis or risk becoming subjects again of a colonial power. To reach consensus, the colonies had to overcome their distrust of a central government with the power to levy taxes. The colonies distrusted each other and the regional coalitions that might take the reins of that central government. The founders built their distrust into the Constitution and its governing institutions. In grade school we learn them as “checks and balances,” a euphemistic phrase for distrust.

On social media we argue about the many aspects of money. Our experiment in democracy will be over when Americans stop having spirited discussions about money.

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Photo by Kostiantyn Li on Unsplash

Furnham, A. (1984). Many sides of the coin: The psychology of money usage. Personality and Individual Differences, 5(5), 501–509. https://doi.org/10.1016/0191-8869(84)90025-4

Pear, R. (2008, October 30). Women buying health policies pay a penalty. The New York Times. Retrieved June 7, 2022, from https://www.nytimes.com/2008/10/30/us/30insure.html

Good Hands Government

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January 20, 2022

by Stephen Stofka

Socialist policymaking is founded on an aspirational principle of equal outcomes. Central to that approach is an expanded role for government as an insurance company, the insurer of last resort. Should government be the insurer of first resort? Some would prefer that but others are uncomfortable with the lack of privacy that entails. A characteristic of insurance is what economists call asymmetry of information. The insured knows more about their situation and risks than the insurer. Do we want to give government an incentive to pry into our private lives? Can government protection create a moral hazard? Will people be less careful or less industrious because they trust that government has their back? Student loan debt brings a pointed focus to some of these issues.

According to 39 state Attorney Generals, Navient was a predatory servicer of high-interest loans for students attending for-profit colleges (Settlement Administrator, 2022). In the mid-2010s, the Obama administration put its foot down with many  for-profits – if they could not meet minimum graduation rates, they would be cut off from federal funds. Many folded. Recently, 39 states  reached a settlement with Navient that gave relief to many thousands of student borrowers. Who was given no relief? Students who had been paying their loans on time.

In many areas of our lives, we disagree about who is responsible for the risks of unwelcome outcomes. A person who gets an education assumes a certain risk that higher lifetime earnings will be greater than the cost of an education. Such a risk cannot be quantified or insurance companies would sell policies to college students. However, the federal government provides some guarantee for federal student loans. Colleges, including for-profit schools, are usually accredited. That accreditation provides some assurance – but not insurance – to a student that a school’s curriculum has sufficient quality to earn the accreditation. However, conventional non-profit colleges are supervised by regional accrediting organizations that have higher standards than the accrediting bodies of for-profit colleges (The Best Schools, 2022). Without the regional accreditation, for-profit students often discover that they cannot transfer their credits to a 2-year or 4-year college. Employers may doubt the worth of their educational credentials.

Is this a case of buyer beware? How is a college education different than starting a small business? Students have a wealth of research available to them before they enroll in a for-profit college. Should taxpayers pick up the tab for students who may not have done adequate research before committing to a student loan?  Every year hundreds of thousands of small businesses go out of business for the same reason. They did not research the market. They didn’t have adequate management experience. Many people may be stuck with 2nd mortgages used to fund the business. Should taxpayers bail out small business owners? 

Financial and medical risks can be substantial and we may vehemently disagree about government’s responsibility for absorbing these risks. Government now insures us against loss of income due to injury (workmen’s compensation) or permanent inability to work (disability insurance), old age (Social Security), protects our pension funds (ERISA), insures our homes against flooding (Flood Insurance Program). It pays our medical bills if we are poor (Medicaid) and when we are old (Medicare).

Should government have a minimal or expanded role in our lives? If we want government to have our back, what is the limit? What are the boundaries between government and our lives? What is the extent of our personal responsibility? How much risk must we shoulder? There are many strong opinions on the subject.

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Photo by Lina Trochez on Unsplash

Settlement Administrator. (2022, January 13). 39 State Attorneys General Announce $1.85 Billion Settlement with Student Loan Servicer Navient. Home. Retrieved February 20, 2022, from https://navientagsettlement.com/Home/portalid/0

The Best Schools. (2022, January 6). Guide to for-profit colleges: What you need to know. TheBestSchools.org. Retrieved February 19, 2022, from https://thebestschools.org/resources/for-profit-colleges/

Obligate Growth

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This week Goldman Sachs announced that they were raising the starting salaries for entry level analysts to $110,000 from $85,000. When I heard that on the radio, I remembered the bailout of Goldman Sachs a dozen years ago. I thought of the many hospital workers who have risked their lives during the Covid crisis. Most were not making that kind of money. Under capitalism, market transactions direct resources but do they signal a society’s values?

In Sustainable Capitalism, John Ikerd (2005, 4) calls for a balance of our self-interest with our common-interests, citing the classical economists like Adam Smith who recognized that a market system must work within the ethical bounds of society (2005, 4). There is no point to capitalism if the wealth that the system can generate does not improve the general well-being of a society. Capitalism directs resources but only for goods where two parties can agree on a value. It’s hard to find common agreement on the value of many public or common goods. The infrastructure bill being negotiated in Congress this year bears witness to that reality. What is the value of a well-lit street, improved cable systems, safer electrical generation and the many public goods that we take for granted?

Capitalism evolved to assemble and deploy investment for shipping ventures, and to diffuse the extreme risk of shipping goods across oceans. In the 18th century as many as half of all ships returning to England laden with goods from India were lost at sea. Most ventures were launched without insurance. In the 17th century, insurers often went insolvent and could not cover a great loss (Johns 1958, 126). Many did not know how to price risk. In 1720, Lloyds of London and the Royal Exchange were formed to spread the risk. During the American Revolution the British government contracted out the shipping of armaments and British troops to the colonies. In 1780, a series of sea battles between the British, Spanish and French fleets severely damaged the West Indian fleet and caused great losses to underwriters (Johns 1958, 126). Loss is a good teacher of better risk management.

The underlying principle of capitalism is constant growth. In these early centuries the destruction of capital provided a natural constraint. In the 19th century, inflation from government money printing was another natural constraint (Formaini, n.d.). The capital grew but it bought less. The growth of most populations hits the bounds of their environment. Rabbits run out of food and the population periodically crashes. In the last century following World War 2, economists thought that countries who adopted democracy and capitalism would develop into thriving markets for capital. After key losses, capital managers became reluctant to deploy investment into poor countries without infrastructure, institutions and respect for private property.

Decades later, economists and political scientists now question that growth hypothesis. According to that theory, India and some former African colonies should be thriving. They are not. Given the global constraints of growth, the competition between capitals produces a concentration of capital in fewer multi-national corporations. Countries become segregated into two groups: those whose people are still very much engaged in agriculture and those whose people are engaged in services and to a lesser degree industrialization.

Agriculture is an economic trap because it is seasonal. Farmers harvest a particular crop at the same time and their competition drives the prices down. That is good for everyone except the farmers. Weather events can affect an entire region whose economy is dependent on crop production. As more farmers give up or lose their farms, large corporations take over the land. Their size and dispersal across several regions diffuses risk just as the insurance pools brokered through Lloyds of London in the 18th century.

As capital flows become more concentrated, the pool of those who benefit becomes smaller and smaller. Adam Smith’s “invisible hand” no longer spreads a general sense of well-being to the greater community. A few industries, like finance, prosper while many struggle and scrabble for the remains.

Those on Wall Street make a lot of money, but it is highly competitive and stressful. When Goldman Sachs did an internal survey of entry-level analysts at their firm, those analysts reported working an average of 95 hours a week to meet the upswell of client demand as the Covid vaccine led to a lifting of restrictions (McCaffrey 2021). Many reported physical side-effects from the long hours and stress. That $110,000 a year works out to $23 an hour. The median pay for a plumber is $28 an hour. Those entry level analysts suddenly don’t look like titans of industry. Many have student debt. They live in New York City with its high cost of living. Many probably thought that, if they could hang on for a year or two, their load would lighten and all their study and hard work would pay off. They are on capitalism’s hamster wheel. How long can the wheel keep turning?

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Photo by dylan nolte on Unsplash

Bureau of Labor Statistics (2021). U.S. Department of Labor, Occupational Outlook Handbook, Plumbers, Pipefitters, and Steamfitters. Available from https://www.bls.gov/ooh/construction-and-extraction/plumbers-pipefitters-and-steamfitters.htm (visited July 17, 2021).

Formaini, R. L. (n.d.). David Ricardo Theory of Free International Trade (2nd ed., Vol. 9) (Federal Reserve Bank of Dallas). Dallas, TX: Federal Reserve.

Ikerd, J. (2005). Sustainable Capitalism [Scholarly project]. In University of Missouri. Retrieved August 06, 2021, from https://faculty.missouri.edu/ikerdj/papers/WIMadisonSustainCapitalism.pdf

John, A. H. (1958). The London Assurance company and the marine insurance market of the eighteenth century. Economica, 25(98), 126. doi:10.2307/2551021

McCaffrey, O. (2021, August 02). Goldman Sachs Is Giving Entry-Level Bankers a Nearly 30% Raise. Retrieved August 07, 2021, from https://www.wsj.com/articles/goldman-sachs-is-giving-entry-level-bankers-a-nearly-30-raise-11627930285

Pool and Flow

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October 2, 2016

A few weeks ago, I introduced two concepts: stock and flow. I’ll develop that a bit to help the reader analyze their portfolio with a bit more clarity.  To avoid confusion between stocks, as a type of investment, and the concept of a stock as in a reservoir or pool of something, I’ll refer to the concept as a pool and stocks as a type of investment.

Leverage

Each month we might check our investment and bank statements to find that the value has gone up or down.  In any one day only a tiny portion of stocks and bonds trade, yet these transactions determine the value of all the unsold assets, including the ones on our statement.  As I mentioned a few weeks ago, the flow from a reservoir of water determines the value of all the water in the reservoir.  It is like the butterfly effect, the idea that the fluttering of a butterfly’s wings in Mexico can cause a typhoon in southeast Asia.  In financial terms, when a small event has a large influence it is called leverage. A flow, a transaction, is the  catalyst for a transfer of value from one asset to another.

Let’s look at an example.  We buy a 1000 shares of the XYZ biotech firm for $10 a share, for a total investment of $10,000.  The next day the FDA announces that, contrary to expectations, they will allow a drug trial to proceed to Phase 3.  XYZ’s stock price rises 10% in response to the news.  The market price of our investment is now worth $11,000.  Where did the other $1000 come from?

Transfer of Value 

An asset value rose, so the value of another asset pool fell as the value is transferred from one asset to pool to another. Yesterday $10,000 of cash was worth 1000 shares of XYZ.  Today, that $10,000 of cash is worth only 909 shares of XYZ.  This is a different way of looking at cash – not as a liquid medium with  a stable value – but as an asset with an erratic value.

Cash = Investment 

What is cash?  It is an investment of faith in the United States.  We might give it a stock symbol like CASH and I’ll use that stock symbol to distinguish cash when it acts as an asset.  Stockcharts.com allows users to track the relationship between two stocks, or to price one stock in terms of another. We do by typing in the a stock symbol ‘A’ followed by a colon and a second stock symbol ‘B’.  Stockcharts will then show us the value of A priced in B units.  Below is the chart of Google (GOOG) priced in Apple (AAPL) units, or GOOG:AAPL.

On the left side of the chart in early 2014, Google’s stock was worth about 6.25 “Apples.”  By mid-2015, Google’s stock had fallen to 4.25 Apples.  Did Google’s value fall or Apple’s value rise?  Let’s imagine that we live in a world without money, as though we had taken the red pill as in the movie “The Matrix.”  Without a fairly constant measure like cash, we simply don’t know the answer to that question.  Imagine that each investor gets to choose which asset they want their monthly statement priced in and that our choice is Apple.  Over a year and a half, we see that we have lost about a third of the value of our portfolio of Google (6.25 / 4.25 = about 2/3).  We can’t stand the continuing losses anymore and sell our Google stock and get 4.25 units of Apple. It is now September 2016 and we still have 4.25 units of Apple because Apple is our measure of value.  Had we continued to hold the Google stock, we would have 7.29 Apple units.

What is CASH worth?

Now let’s turn to a slightly different example.  We are going to price CASH in Apple units, the inverse or reciprocal of how we normally do things.  When we say that Apple’s stock is $100, for example, we are pricing Apple stock in CASH units, or AAPL:CASH.  Instead we are going to look at the inverse of that relationship: pricing CASH in Apple units.  Remember, we are no longer in the matrix.

We begin with the same portfolio, 6.25 Apple units in early 2014.  We think that this CASH asset is going to do better than Apple, so we sell our Apple units for CASH and get 68 cash units for each Apple unit, a total of 425 cash units.  In mid-2015, we find that our CASH units are now worth only 3.5 Apple units.  We have lost about 45% in a year and a half!  We sell our CASH units and get 3.5 Apple units which is what we still have in this latest statement 15 months later.

Our losses are even worse than that.  Each year, Apple gives the owners of its shares another 2/100ths of a share as a dividend.  The owners of CASH get only 1/100th of a cash share each year.  Apple pays those dividends from its profits.  For owners of CASH, a financial institution pays the dividends from its profits. While the Federal Reserve, a creation of the Federal Government, doesn’t directly “set” interest rates it effectively does so through the purchase of bank securities.  Each dollar bill is equivalent to a share in an entity called the United States and it is ultimately the U.S. government that largely determines the dividend rate that is paid on safe investments like savings accounts.

Stock dividends compete with cash dividends

To remain competitive with safe investments, Apple only has to pay a little more than the very low dividend rate that savings accounts are currently paying.  If interest rates were 5% instead of the current 1%, Apple would have to devote more of its profits to dividends to appeal to income oriented investors.  By keeping interest rates low, the Federal government effectively allows Apple to retain more of its profits.  Where does Apple keep that extra money?  Overseas and out of the reach of the IRS.  That’s only part of the irony.  If Apple had to pay more of its dividends to the share owners, the share owners would pay taxes on the income. So the U.S. government loses twice by keeping rates low (See footnote at end of blog).

So CASH is effectively owning the stock of an entity called the United States, which doesn’t make a profit.  In the long run, owning the stocks of companies that do make a profit generates much more return to the owner.  Let’s look again at the leverage aspect of stocks and cash.  Earlier I noted the huge leverage involved in stock and other non-CASH asset transactions.  A tiny number of transactions affects the value of a large pool of assets.  On the other hand, millions of CASH transactions take place each day and have little effect on the nominal value of CASH.  So we price highly leveraged assets – stocks, bonds, etc. – in terms of an unleveraged asset – cash.

The functions of cash  

Cash plays several roles. First, as a medium of exchange, it acts as a measuring stick of economic flow in a society. This first role has a symbol – $.  Secondly, as an asset pool, CASH acts as a holding pond, a reserve in the waiting, the first in the asset reservoir to be tapped. Lastly, it acts as an insurance on the principal of other assets, like stocks and bonds.  Let’s call that INS.

Insurance

As an insurance, let’s consider a portfolio of $900 in stocks, $100 INS.  A 10% fall in stocks is reduced to a 9% fall because of the INS position.  Let’s consider the exact same portfolio, except that the investor’s intention is that the $100 is a CASH investment, a reservoir of asset buying power.  The same 10% fall in stocks is now a trigger for additional purchases.  In the first case the $100 is an anxiety reduction fee; in the second, a prediction of a market correction.

An investor might blur the distinction between the functions. Retired people who want to preserve the nominal value of their savings may tend to keep the majority of their nest egg in cash without distinguishing the different functions.  Cash = safety and liquidity. Because cash is used as a yardstick, its nominal value is kept constant.  But what that cash can buy, its purchasing power, changes.  When they need some of that CASH ten years from now, the purchasing power of that asset may have fallen by 30% but the nominal value is the same as it was ten years earlier.

Cash Analysis

As noted before, companies must make a profit or go out of business. Not so the U.S. government. Over time, the rate of a company’s profit growth must exceed the inflation rate, so that stocks give the best investment return in the long run.  Investors would benefit by separating their cash position into its functions, $ and CASH and INS, to understand more clearly what their intentions and needs are for the coming year.  This can be as simple as a piece of paper that we review each year.

Analysis Example 

An example – Cash needs:
1) income for the next year including emergency fund – $50K – $ function.
2) stock market seems awfully high and it has been a while since there has been a 10% correction – $100K CASH function.
3) $30K INS function to help me sleep at night in case there is more than a 10% correction.
Total: $180K.

Why write it down?  Believe it or not, we forget things.

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As a footnote:

Offsetting the tax losses to the government is the fact that some of Apple’s cash consists of cash-like equivalents like Treasury bonds which pay a very low dividend.  Apple loses income because of the low dividend and the U.S. government gains by being able to borrow money from Apple at low rates.

Adults Wanted

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The end of another month ending involving billing customers, paying taxes, balancing the bank accounts and closing the books.  Each month it becomes apparent that one of the reasons why there is not more robust job creation is the “invisible” employee costs, both in dollars and in the business owner’s liability.  By invisible, I mean that these costs are typically out of sight and out of mind to most employees.  These costs are quite visible to the owner who, failing to account for them in their business pricing, soon goes out of business.

These costs were designed to be invisible to employees because if most employees knew all the costs, some politicians might lose their jobs.  A paycheck with a gross amount of $1000 might have $200 or more taken out for taxes and health care premiums.  The net amount of the paycheck is $800, which is what we get to spend on bills, rent/mortgage, food, transportation and a movie. We grouse about the $200 in taxes but that $200 pales in comparison to the invisible costs that don’t show on that paycheck stub.  Most of these costs are mandated by either Federal or State law and include Workmen’s Compensation insurance, Unemployment Insurance, Liability Insurance, and Social Security and Medicare taxes (employer’s half).  The cost of these mandates goes into neither your pocket or the employer’s pocket. Benefit costs include health insurance, retirement contributions, education reimbursements, vacation and sick pay.  Mandated costs and benefits can easily add $500 to $1000 in cost to that $1000 gross paycheck amount.  In addition, there are indirect costs which include office and production equipment, rent, utilities, and transportation, as well as the internal costs of accounting, supervision, and training.  After those costs, that $1000 gross paycheck can have a final cost of $2500 or more. 

The indirect costs are simply a part of any business; they are the costs of producing a dollar of revenue to the business.  My chief concern is the invisible insurance and tax mandates whose costs are hidden from employees.  By making the employer, not the employee, responsible for the payment of these costs, politicians could more easily sweep them under the rug.  Some people strongly object to the health insurance mandate but how many protest or are even aware of the Unemployment Insurance mandate or the Workmen’s Compensation Insurance mandate?  Many are not aware simply because the cost is paid by the employer.  While the employer may write the check, the employer “deducts” the cost from the employee by lowering the gross amount that they can pay to an employee.

I am not making a case against these insurances and taxes that add a safety net for workers.  What I do object to is the surreptitious way that lawmakers have enacted them in order to hide the magnitude of the costs of these safety programs.  Because these mandates are structured as a payment from the business and not the employee, Workmen’s Comp, Liability, and Unemployment Insurance are rated based on the company’s industry classification and claims history.  An employee who has worked twenty years without an accident is charged the same amount of money as his/her co-worker who does not pay attention to safety regulations and common sense.  The same holds true for liability insurance; a thoughtful employee and a careless employee pay the same amount.  In some construction industries, Workmen’s Comp and Liability insurance can be 20% or more of gross pay – not a trivial amount.  Should a careless driver and an accident-free driver pay the same amount in auto insurance?  Of course not.  Yet that is how Workmen’s Comp, Liability and Unemployment Insurance are rated.  Since there is no individual worker history, no individual experience rating, there is no direct cost tied to a worker’s actions.  An employee can become naturally divorced from the consequences of their actions.  Often an employer will not add another employee if they are not sure whether he/she will be able to keep them on six months from now.  The reason is that many, if not all, states will increase the unemployment insurance rate for that business when the employee is let go in six months and files for unemployment insurance.  It can be more cost efficient for an employer to pay some overtime to existing employees to make up the extra work till the employer is sure that business volume is on the increase. 

Unlike the other insurance mandates, the health care mandate at least makes individuals personally responsible for their own insurance.  With no direct responsibility for their own Workmen’s Comp, Liability and Unemployment insurance, employees are effectively treated, in the eyes of lawmakers, like teenage children.  A host of state and federal employment regulations only confirms that status.  In the eyes of our laws,  employees are not quite adults.  Employers are treated by state employment agencies as though they were the parents of not quite fully responsible teenagers and the burden of proof is on the employer to show that the employer complied fully with regulations.

How did we get here?  During the second World War, the Federal Government was running up extremely large war costs and experiencing severe cash flow problems.  One problem the government had was that tax payments were not due till March 15th of each year (in 1954 the date was changed to the current April 15th), which meant the government had to borrow a lot of money each month.  Many people were not paying all of their taxes, either income or the Social Security tax enacted several years prior.  The problem of collecting delinquent taxes presented yet another costly headache for the government.  A noted economist of the time, John Kenneth Galbraith, suggested a solution last used eighty years earlier during the Civil War:  make employers withdraw the taxes before they paid their employees.  This would both solve the problem of timely collection of taxes and curb much of the delinquency.  It would be much easier for the government to go after the far fewer businesses in the country than millions of individual taxpayers.  Thus the withholding system was born again. (A history of taxes)

Once the mechanism of withholding was in place, politicians realized what a boon this was.  Taxpayers dislike taxes and the politicians who enact them. Politicians could now increase existing insurance costs and mandate new ones without the taxpayers – the voters – constantly being reminded of these now invisible costs.  Politicians simply had to change the law, then notify a relatively small number of businesses to pay more.  That created a new problem for business owners.  Politicians had effectively deflected the disapproval of voters onto employers.  When an insurance cost goes up, it is difficult for an employer to say to an existing employee that the employer will have to reduce an employee’s hourly wage or salary to make up for this increased cost.  For subsequent hires, an employer can reduce the hourly wage or salary that they will offer to a new employee.  The employer has two alternatives:  raise the price it sells its product or service; or eat the increased cost.  Employers complain about this state of affairs long and loud. They form trade groups and lobby their state legislatures.  The politicians get the better of a bad situation:  listen to loud protests from a lot of voters and possibly get thrown out of office or have to listen to a relatively few employer lobbyists.

I am not advocating the abandonment of the withholding system, which does solve the problem of timely tax payments.  I am advocating for a system that directly charges those who are going to benefit from the safety net that exists – the employees.  This is no longer the paper and pencil age of World War 2.  Digitized records would enable most state and federal agencies to assign individual ratings to employees based on their history.  A new or existing employee presents their individual rating for various types of insurance to the employer and the employer deducts the amounts and sends to the appropriate agency, just as they do now.  The difference is that the employee gets to see what he/she is being charged for and might in some cases be able to control some of those costs.  Instead of being paid $20 an hour, an employee might be paid $34 an hour.  The cost to the employer is the same.  For many of these mandated costs, the tax write offs to the employer are the same; it is a cost of producing business income.

What can we do about it?  Press your elected representatives for individual ratings for these insurances.  An employee who has never filed for unemployment insurance pays the same as a person who has collected six months of unemployment insurance last year.  Does that seem fair?  Why have an employee half and an employer half of the Social Security and Medicare tax?  It all comes out of the employee’s pocket in the long run.  Why the game of hiding the costs?

Imagine a world where an employer can have a bit more sales volume, hire an employee and let them go if sales subsequently fall off.  An employee who is let go would then make the choice of whether to collect unemployment.  They might absolutely need the unemployment insurance and that would affect their individual unemployment rating the same as it does when we file an auto insurance claim.  They might try harder to get another job or switch to a different job in order to keep their individual unemployment rating pristine.  It would be the employee’s choice.

Imagine a world where the employee controls what they put away for retirement.  If you want to put away $6,000 a year tax free into a 401K retirement plan, why shouldn’t you?  Why have the charade of the employer matching your contribution by some percentage?  How did we get to the point where employee compensation is a haunted house of smoke and mirrors?  

Imagine a world where an employee is not bound to an employer for insurances and benefits and tax benefits.  Imagine a world where the employee has choices.  Imagine a world where the employer pays the total of the employee cost to the  employee and the employee then sees the true scope of deductions.  In fact, we do have that world now.  Employers are increasingly using subcontractors and temporary agencies as a way to sidestep the burdens of employment.  From the BLS July Labor Report: “Temporary help services has recovered 98 percent of the jobs lost during the most recent downturn.” (Source).  Tell your state and federal representatives that you would like a different world – one in which you are treated like an adult.

Health Care Right

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For some Americans, there is a question fundamental to the debate on health care insurance reform: is health care insurance a right or a privilege? Taking apart the question, the central debate is whether health care itself is a right or privilege.

In 1986, Congress passed the Emergency Medical Treatment and Active Labor Act (EMTALA), requiring hospitals to treat those in need of emergency care. The law, and subsequent amendments, established some universal access for urgent health care. What the law left out was any provision for paying for the care received and about half of emergency room care goes unpaid. The debate over reform involves two issues.

The first is does a person have a right to health care? Legislation and both state and federal court cases ensure that prisoners have a right to adequate medical care. In 2002, a heart transplant for a California inmate prompted a contentious debate over the meaning of “adequate.” If you are a taxpayer who pays to maintain the prisoner, however, you may or may not have a right to health care. It depends on your condition, which has to be assessed by a doctor using a number of guidelines, both local and federal, to determine if you have an EMC, or Emergency Medical Condition. If you do have an EMC, you have a right to health care. That doesn’t mean you have a right to free health care. You’ll have to figure that one out on your own or with the help of a counselor at the hospital.

Among Americans who are not lawyers, the debate often turns on this constitutional and philosophical debate: does a person have a right to health care? Some say that the Declaration of Independence clause citing a right to life and the 5th Amendment protection of life gives one a right to health care. Some argue that these constitutional provisions include only life or death care. People see it one way or another and there is a tall fence between the two camps.

The second debate is partially founded on the first. If someone has a right to health care, does that imply that the government then has an obligation to provide that care at no cost? Some argue yes, some argue no and there is a big wall between these opposing groups.

As a comparison, let’s review a few other rights. The citizens of this country have a right to the protection of life and liberty. Government, then, has an obligation to provide for armies, police and courts to sustain that right of its citizens. Likewise, if health care is a right, shouldn’t that also be provided by government? Some who argue that health care is a right, could also argue that there is a differentiation of rights. Defense is provided to all citizens whether they pay taxes or not. The 2nd amendment gives one the right to own a gun but the government has no obligation to buy any citizen a gun. If health care is a right, is it a right similar to that of owning a gun?

Some argue that there is no right to health care, be it life or death. For those people, the case is closed on both the health care and health care insurance debate. I heard one older man say that when he was growing up, if you didn’t have money for a doctor, you died and that was how it was and everyone got along the way it was.

For some pragmatic Americans, the debate over rights to health care is stupid. There are two camps here as well, some arguing that unhealthy people spread disease and inevitably are a burden to those around them so we, as a community, have to find a way to provide health care to everyone. Some object that simply paying the additional taxes required to provide that health care will make us all more unhealthy, thereby exacerbating the condition we hoped to cure.

In this debate, which camp are you in?

For a look at some of the gripes about the existing health care insurance situation, read a few
real life stories

United States of Insurance

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The United States government has become the largest insurance company in the world.
Its citizens are among the most heavily insured people in the world. We are insured for many aspects of our lives, from our life itself to other people’s mistakes.

Some insurance fees we pay directly. These include insurance against getting old, Social Security and Disability Insurance, insurance on our health, home, car and mortgage. Some insurance fees are indirect in that the cost of that insurance is passed on to us in the price of a product we buy or income to us is reduced by these fees.

Examples of the first type of indirect insurance are “mistake” insurance, malpractice and liability. A business pays a fee to protect themselves in case they make a mistake. Those fees are passed on to us in higher prices.

Unemployment and FDIC insurance are examples of the second type of indirect insurance.
Unemployment insurance is a based on a percentage of the wages paid by an employer to an employee. An employer typically reduces the wages that it can pay an employee by that amount. FDIC insurance is a fee charged to banks to protect savings against bank failure. The bank reduces the interest it can pay on a savings account to offset the fee. Like individuals, businesses pay for many types of insurance, passing the cost on to their customers in the form of higher prices.

There is another indirect form of insurance in the form of taxes paid into a general fund.
We are insured against poverty in the form of SSI and food stamp programs, whose payments come out of general Federal and State tax revenues.

How have Federal and State governments become so heavily involved in the insurance business? With the passage of the Social Security Act during the 1930s Depression, the Federal government entered the annuity insurance business – sort of. Annuities are a type of insurance where a person pays premiums over a period of time and, at the end of that period, begins collecting payments from the insurance company. Insurance companies invest the premiums paid in order to make the payments at a later time. The Federal government, on the other hand, spends the premiums received each year, relying on future premiums to make payments. If our Federal government did not spend the premiums each year, Social Security would be more like an annuity program. Since the premiums are spent, it is a Ponzi scheme.

With the introduction of the Medicare and Medicaid programs in the 1960s, the Federal government stepped into the health insurance business. Unlike private health insurers who charge higher premiums for those with higher risks, the government charges higher premiums based on a person’s ability to pay higher premiums. This premium pricing system is most often used by those in the protection racket.

Ponzi schemes and protection rackets eventually collapse. What can we do? Elect representatives who are willing to make a transition to a valid business model. Elect representatives who will support a new law giving them a legal fiduciary duty to the voters and taxpayers. Without that duty, our elected reps have no responsibility to the public or liability for their actions other than the prospect of losing their jobs. They can enact laws and make promises with impunity. We, the voters and taxpayers, pay the price.