• Couldn’t agree more with Miranda on physical gold.  The slippage on entering and leaving physical gold is immense.
• Great article by our friend Fred on green savings strategies, for those rare occasions when your pocketbook and your conscience might align.
• Let’s give Poorer Than You a round of applause for netting four dollars and a Plutus Award!
• Online Investing AI discusses finance apps.   Relevant to me as I’m desperately trying to figure out what phone to get.
• Trend technician discusses the black swan in Greece and why I’d be far too scared to chase it.

Post from: Personal Finance And Investing

Wednesday Links — March 3, 2010

The unemployment statistics in America are confusing.  Sometimes you will see unemployment go down without jobs being created.  How can this be?  As it turns out there are many different definitions of unemployment and the number you see is only one of them.  In fact, if you don’t have a job for a certain amount of time, you’re considered to be “out of the workforce,” and no longer counted in the common measure.  As it turns out, long-term joblessness is a danger to societies and this has implications for many of us in our personal life.

Measures of Unemployment

In understanding the impact of long term joblessness, it’s good to understand how unemployment rates are calculated.  In America there are six different unemployment numbers, U1 through U6:

• U1: Percentage of labor force unemployed 15 weeks or longer.
• U2: Percentage of labor force who lost jobs or completed temporary work.
• U3: Official unemployment rate per ILO definition.
• U4: U3 + “discouraged workers”, or those who have stopped looking for work because current economic conditions make them believe that no work is available for them.
• U5: U4 + other “marginally attached workers”, or “loosely attached workers”, or those who “would like” and are able to work, but have not looked for work recently.
• U6: U5 + Part time workers who want to work full time, but cannot due to economic reasons.^[1]

So as you can see, sometimes a job seeker simply “gives up.”  They’re no longer counted in unemployment statistics, but they certainly don’t have a job.  As it turns out, this is actually the worst kind of unemployment, even though we don’t see it measured very often.

Long Term Havoc

A study by the Cologne Institute for the German Economy is one of many supporting the belief that the longer a person is out of a job, the less likely they are to return to the workforce.^[2] Their job skills atrophy and they lose hope.  They basically get locked into a self-reinforcing cycle of poverty.  You may know someone like this, who used to be in the workforce, but now seems unable to return.

Think of all the ways in which this affects people’s lives.  Think about what being in prison for a few years means for your odds of employment, even disregarding the effect the sentence will have on people’s willingness to hire you.  You have whole communities who don’t believe they can find a job and thus make it true in their own mind.  As a society this kind of long-term unemployment can be decimating, but it also has implications for you personally.

What Does this Mean For You

For individuals like you and I this is something to consider as well.  At some point it may make sense to take a job in which you are underemployed, just to keep your frame of mind as a “worker.”  Rather than become chronically unemployed, it may make sense to do some work that helps you keep your professionalism as well as the mindset of a worker.  This can also help with the bills a little bit.  The only concern is to make sure that taking some temporary work doesn’t deter you from finding a job that truly makes use of your skills.

Photo Credit: Hamner Fotos

Post from: Personal Finance And Investing

Long Term Joblessness

1. Wikipedia — Unemployment
2. German Think Tank Says Joblessness Behind Poverty

Photo by: Wildcat Dunny

When the financial crisis was in high gear I argued that the pitchforks and torches being raised against AIG were counter-productive.  I felt like it was a feel-good symbolic gesture that was more for making people feel vengeful than getting at sound economic policy.  I still stand by that idea, however in the face of record profits from companies like Goldman Sachs, one has to reconsider whether the idea of clawbacks don’t have a place in the banking discussion.

A clawback would be some kind of tax levied against the companies that took bailout money, or maybe more broadly to the financial industry as a whole.  While the legality of such a tax may be in question, there are some reasons to consider whether this is a reasonable course of action.  Many of these banks have paid back, or are paying back, the money they borrowed from the government, but that debt doesn’t fully quantify the advantages that financial institutions received from the government.

The first example of this is the asymmetry introduced by preventing various stocks from being shorted during the crisis.  This is obviously beneficial to leveraged companies that are using this stock as an asset to offset their liabilities.  This is on top of the benefits that come from being able to borrow money from the Federal Reserve Bank essentially for free, and the money that is being funneled into the stock market by the low interest rates.

When you look at the herculean efforts that were exerted to keep these banks solvent it can be galling to see their bonuses.  Even more galling is the fact that they suggest that by “paying back” certain loans, they’ve paid their dues and are no longer subject to the scrutiny bearing down on them during the meltdown.

While clawbacks are unwieldy and messy, the amount of moral hazard that banks may feel has almost certainly increased since the crash.  Clearly they will be bailed out at any cost and in the rare case when they need it, they simply have to pay back a little cash; then they can return to rewarding themselves handsomely for gambling with taxpayer money.  There is no need to subsidize these companies, and it may be worth considering how to make it known that this approach cannot continue.

Post from: Personal Finance And Investing

Why a Clawback Might Be In Order

Photo by: stephen.moore

When it comes to investing, is America still the most sensible place to keep your money?  This question involves a lot of elements and has no simple answer.  There are however, some pieces of conventional wisdom that may deserve a little extra attention.

Is China the Future?

Listening to the media, you would think the ascendancy of the Chinese is all but assured.  They are one of the few economies to truly start enjoying an alleged rebound from the economic crisis and were already becoming a behemoth before the latest financial woes.  Surely Asia is where the future lies.

What is often forgotten in all of this is that China is not an open society.  In the modern era we assume that the wool can’t be pulled over investors’ eyes.  China however can easily give out misleading numbers to investors.^[1] Moreover, because of the amount of their economy that is centrally planned, they can essentially manipulate their own markets very easily.  Their current stimulus may largely consist of creating unused infrastructure to keep their populace employed.^[2]

Inflation: The Ugly Contest

Another supposed factor in why our money should be fleeing US Dollars is the hyper-inflation that will be driven by all the stimulus spending.  The thinking goes that any kind of recovery in the economy will be coupled with inflation from all the money that’s been printed to finance the stimulus.  While this seems reasonable, at the same time it’s been suggested that as much as 40 percent of the World’s wealth was destroyed by the financial crisis.^[3] With a good deal of that being in America, it seems that we may be able to survive some quantitative easing.

Moreover, those who are looking for another currency into which to move their funds may find it difficult to find another country’s currency that isn’t just as ugly as the Dollar.  Most of the European countries have used debt to finance significant stimulus as well.  Additionally these countries have less business-friendly policies than the US and may be just as slow to recover.  China and much of Asia suffer from the dangers of being net exporters, which is a dangerous position when the rest of the world isn’t buying anything.  While inflation remains a reasonable fear, it may not be quite as dangerous as it appears.

The Dollar as the Reserve Currency

Many nations are suggesting that the time has come to move away from the Dollar as the World’s reserve currency.^[4] Due to the staggering amount of money we’re printing, countries such as China have begun to suggest that banks should begin to use various other instruments as their reserve currencies.  While this is an understandable sentiment, several things impact this position:

• Most of these countries own a lot of US Dollars.  They don’t necessarily want to see the Dollar fall too precipitously.^[5]

• No one is forcing the Dollar to be a reserve currency right now.  Central bankers can hold their reserves in whatever they like; they simply tend to prefer dollars for a variety of reasons.  One of the most important is the openness of American finances versus other countries.

Hedging Your Bets

All of these dangers are real.  However they are far from sure bets.  While it makes good sense to hedge your bets and reduce your exposure to the dollar, it can be very dangerous to bet the farm on the failure of the American Dollar.  While we have certainly taken some lumps lately, it’s not clear who would be the beneficiary of the end of US hegemony.  It may be premature to bet on America’s demise.

Post from: Personal Finance And Investing

Is America Still the Land of Opportunity?

1. Economist: The Art of Chinese Massage
2. The Economist:: China’s Stimulus: Got a Light
3. Telegraph: WEF 2009: Global crisis ‘has destroyed 40pc of World’s wealth’
4. Wall Street Journal: Inevitable End to Dollar’s Reserve Role?
5. Treasury Department: Major Foreign Holders of Treasury Securities

Photo by: whatmegsaid

When it comes to government policy it is rarely acceptable for politicians to do nothing.  Even if it’s only to give the appearance of doing something and instilling confidence, the government actually does have a role to play.   While there is certainly a case for stimulus and crisis management, too much government intervention can completely upset the whole purpose of free markets.  Even worse, the fear of government intervention can inject the same uncertainty in the market that it is supposed to help assuage.

The 2008 Crisis

In retrospect there is a lot of criticism about the TARP-the Troubled Asset Relief Program.^[1] Some politicians complain that the prices paid for the equities were too high.  This criticism is somewhat problematic, since the whole purpose of the TARP was to pay more than the market was willing to pay for distressed banks.^[2] Others claim that it was unnecessary, and that the market would have sorted things out itself.  These criticisms conveniently forget the abject panic that had beset the markets when the idea was put forth.  There was a tremendous amount of uncertainty as to whether the banking system was going to completely collapse and how the world would react.

With all its flaws the TARP may very well have injected some confidence into the market.  The same can be said of Obama’s sweeping stimulus.  Investors and businessmen knew that a large dose of spending was coming and had broad ideas about what it would include.  Economists may argue, but a case can be made for all these changes, particularly when they’re done quickly and in a sweeping fashion.

The Problem

The problem arises when the government becomes a first resort instead of a last resort.  When people expect the government, instead of natural forces, to correct all the ills of the market, uncertainty is sure to follow.  The government can’t do everything, so the economy becomes a guessing game of trying to determine which programs the government will implement.  Even worse it can become a hotbed of cronyism, where the supporters of those in power get bailouts and the rest watch despairingly.

History has taught us that central decision making and governments controlling markets invariably leads to this cronyism.  Free markets, for all their faults, do a better job than any single body of making sure capital is allocated to the best places.  While they are subject to the foibles of the human motivations driving them, they at least have the counterbalance of self-interest.  Even the best intentioned government programs are going to be naturally biased for their own perpetuation and the benefit of their supporters.

Take for example the shares of General Motors leading up the bankruptcy.  People were buying and selling these stocks in a guessing game to see if the company would get a bail out.  This isn’t really market discovery of price, but instead simply a form of gambling based on the speculators read of the government.  The decisions of the government are driving the price of things and that does not have a good historical record.

Conclusion

While many are apt to decry the government’s actions on the current economic crisis, in the face of massive uncertainty the government has a role to play.^[3] During crisis also tends to be when government is the least self-serving and the most just.  While they are tinkering with the market, the idea is to cushion the blow.  It’s important to remember however that you cannot avert the blow; your goal is simply to soften it.  The government can be helpful in a crisis; they just have to know when to stop.

Post from: Personal Finance And Investing

The Problem with Uncertainty

1. Wall Street Journal - Panel Steps Up Criticism of Treasury Over TARP
2. The Economist – Carping about the TARP
3. The Economist – Big government fights back

Photo by: respres

The mortgage crisis was clearly one of the dominating catalysts of the recent economic fiasco.  While many other factors contributed, this was one of the most visible and visceral to most people.  Thus many people, particularly homeowners, are now wondering whether they can breathe a sigh of relief.

How Did We Get Here

By now we’re largely aware of the underpinnings of this crisis.  Demand for securitized debt led to tremendous demand for mortgages.   This demand led to lowered lending standards, which led to tremendous demand for housing.   The demand for housing led to soaring housing prices.   When those with the least capacity to pay their loans, who incidentally had the most onerous terms to their loans, couldn’t make their house payments, the whole house of cards came down.  Foreclosures led to dropping housing prices, which led to more defaults, which continued the cycle.

The Subprime Crisis

During all of this we were told the mortgage crisis and the subprime crisis was one and the same.  Many people equate the end of the subprime problems with the end of our troubles in general.  This leads us to wonder if the subprime crisis is truly over.  Signs suggest that this is the case.^[1] After huge surges, the default rates on these loans have come down sharply, leading many to suggest that the crisis is over.  Of course, that depends on which crisis you’re discussing.

The Real Crisis

Subprime loans may very well be dropping in their defaults, however that statistic neither creates an increase in demand nor says anything about the impending wave of defaults in other types of mortgages. Falling home prices put everyone underwater increasing the chance of defaults across the board.  Although many people who bought houses during the boom bought them with subprime loans, many more did not.

Defaults lead to a vicious cycle.  The owner of the mortgage immediately wants to sell the property, which increases supply, which lowers prices, which leads to more defaults.^[2]  Given that the subprime section of the crisis seems to be subsiding, the question becomes:  What makes us think this process is not about to repeat itself?

Option-ARM mortgages are currently getting a lot of media attention.^[3]   These are loans that have a low introductory payment, however over time that rate can be adjusted.  While Option-ARM mortgage holders may not be as likely to default during their introductory period, when their rates go up and they’re already underwater default rates are sure to climb.  While many stories are currently in circulation about this segment of the market, it small compared to Alt-A and Prime mortgages.

While the Option-ARMs may further the cycle this cycle seems sure to repeat in Alt-A and Prime mortgages as well.  Even though these loans were made to fairly safe lenders, due to the crash, they frequently owe more than their house is worth, are possibly out of a job and very likely facing a weak housing market.  If we look at Alt-As by vintage, we see soaring rates for those made in later years. ^[4]Prime mortgages with similar vintages see a similar curve, just starting later.  With all of this evidence and the relative size of the markets, it seems highly premature to suggest the worst is over.

Post from: Personal Finance And Investing

Is the Mortgage Crisis Over?

1. Deutsche Bank – Subprime Chart
2. Wall Street Journal - How to Help People Whose Home Values Are Underwater
3. Reuters - Option ARMs, next chapter in U.S. housing crisis
4. Standard and Poor’s - The Spotlight’s On U.S. Alt-A RMBS Issuers As Performance Deteriorates Rapidly

Photo by: Vinay Deep

For decades now the American approach to debt has been to worry about it later.  We’ve essentially kicked the problem down the road.  While some points in our history may have suggested somewhat higher debt levels, we’ve done nothing to reduce them in more booming times.  Ultimately we’ve just turned a blind eye to a growing problem and it may be too late. 

Many people are talking about moral hazard these days, but strangely they all seem to think it’s something that applies to someone else.  Bailouts of millionaire bankers strike us as outrageous, while we personally hold an absurd amount of debt.  Somehow the country got all screwed up without any of us being at fault. 

Our politicians seem to suggest that their opponents are the ones rewarding negative behavior and that they themselves would never commit such an act.  This doesn’t hold up to much scrutiny however.  Throughout the booms of the previous decades, neither Democrat nor Republican has ever used fiscal policy to “cool down” a boom.  Nor have they used any of the booms to reduce our debt to increase our capacity to deal with the next bust.

Clinton was just beginning to talk about reducing the debt when the Internet bubble burst.  Bush managed to go through a massive housing bubble while growing the national debt by over 4 trillion dollars.^[1]  Government has simply never shown any discipline in managing its budgets.  Unfortunately, this is not only true of the government.

Short Term Myopia

Americans and people in general have a tendency to look at a very short sample space and assume that the results they’re seeing are meaningful.  Ten years is a long period of time in a human life, so if something has held true for the last decade, it must be true, the thinking goes.   Unfortunately those ten years are actually quite a short time in the life of an economy.

So many times in history we’ve been told that “things have changed.”  Something has fundamentally shifted and the old rules don’t apply anymore.  For the last decade, people watched their 401(k) accounts grow by double digit figures each year and they just came to assume that this was a sustainable result.  Similarly they’ve leveraged themselves to the hilt and assumed that since they’ve been able to sustain themselves with this massive debt they’d be able to do so in the future.  Sadly, this is an untenable ponzi scheme.

Total Credit Market Debt

Since the introduction of the credit card, Americans have developed a taste for debt.  As the National debt has grown over the past decade, household debt has skyrocketed right in step.  Total credit market debt has gone from roughly 1.5 times GDP in the 80s to over 3 times GDP today^[2].  This means that we essentially owe more than three times in debt what the country makes in a year.  With GDP likely to fall in the near term and massive government spending, this situation is unlikely to be corrected.

As we’ve been growing this debt in the personal sector, the financial sector and the government sector, we’ve been assuming we’ll straighten it out in the future.  And many people haven’t thought about it at all.  Fundamentally we have to know that we’re making bad decisions, but everyone else is doing it and it hasn’t turned out badly for them. 

For decades now we’ve been growing the problem and pushing the problem into the future; each time we postpone a solution, the eventual bill to pay becomes more and more grim.  We continue rewarding the people who make bad decisions and punishing those who don’t.  We never want to take the short term pain, so we reinforce the moral hazard and hope that sometime in the future we’ll come up with a magic solution to the monster we’ve grown over the past decades. 

Ultimately all we’ve been doing is saving up pain.  For a while it looked like we’d finally have to take our medicine when the credit crisis hit.  But through stimulus and unprecedented government action it seems like there is a possibility we’ve pushed off the reckoning a little longer, making it all the worse in the process.  The only question is: have we already run out of rope with which to hang ourselves.

Post from: Personal Finance And Investing

Debt and Moral Hazard

1. CBS News - Bush Administration Adds $4 Trillion To National Debt
2. Comstock Funds – Total Credit Market Debt

Photo by:  futureatlas.com

I am a fervent believer in free markets.  More specifically I believe that they, much like Democracy, are flawed but vastly superior to any alternative.  As various elements in the world decry the current financial crisis as an indictment of the flaws of capitalism, I wait patiently for them to suggest the proven alternative.  Despite this, I am left wondering if the financial sector is an exception to the wisdom of free markets.

Does Regulation Even Work?

If I’m defending free financial markets, my first piece of evidence is the Office of Federal Housing Enterprise Oversight.   This organization was 225 people as of 2006, tasked solely with regulating and overseeing Freddie Mac and Fannie Mae.^[1] With both of those organizations now being operated by the government after becoming tremendously over-leveraged, the efficacy of regulation is certainly in doubt.  If an organization of 225 people cannot regulate a large financial entity, what good does adding more regulation to the system do?

Is Financial Destruction Creative? 

One of the great arguments for free markets is the idea of creative destruction.  An oversimplification of the idea is that when you have an asset bubble burst its capital is reallocated more effectively.  In the end the death of these asset bubbles is good for your economy.^[2]  Hyman Minsky would argue that this is not equally true of a financial bubble.  He suggests that a financial boom and bust cycle differs from a normal market, in that the bursting of the bubble does not result in creative destruction, but instead simply a deflationary cycle.  Capital is actually destroyed instead of reallocated.^[3] This suggests that unbridled booms may not have the same benefits in the financial sector that they have in other markets.

Who’s Really At Risk?

We have empirical evidence to suggest that more politicians side with Minsky and believe that this deflationary cycle is something that must be avoided.  Namely they believe that they need to counter this deflationary cycle with government spending and bailouts.  If they support this idea then this inherently leads to an asymmetric risk profile.  During the booms, bankers and investors are rewarded handsomely because they’re allegedly taking a lot of risk, however during the bust, they are bailed out because society doesn’t want to deal with the “destructive destruction” that the bubble bursting brings.  They get rewarded for risk they aren’t actually taking.

What We Already Know

All of this sounds very theoretical and doesn’t necessarily suggest that if the government were to allow the banks to simply go bankrupt that it wouldn’t wind up being for the best.  However there is also empirical and practical evidence to suggest that some industries are inherently better served with some government interference. 

The most obvious example is FDIC insurance.  By putting the full faith and credit of the US government behind our banking institutions, we bring stability to the banking industry that was simply not there before.  Without this kind of insurance, people would literally have to analyze the balance sheets of banks to decide whether they wanted to keep their money there.  They’d also have to keep doing this due to fear of losing their life’s savings.  Ultimately this would deter many people from putting their money in banks at all.  This is not good for the flow of capital.

 A more glaring example is the insurance industry.  Imagine if insurance companies were not heavily regulated.  People could start insurance companies, charge unduly low premiums and when they didn’t pay off, they could simply declare bankruptcy and then insurance claims would go unpaid.  Once again it’s not necessarily good for the economy for insurance purchasers to have to do a tremendous amount of research before they can buy simple insurance.  Thus we regulate insurance companies to make sure that their claims will not go unpaid.  As AIG and the Credit Default Swap outcomes have shown us, insurance and banking are very closely related industries.

Utility Regulation

While all these arguments are compelling, it seems likely that the best outcome is somewhere in the middle.  Pro-regulation pundits are of course calling for blood and suggesting that the banking industry is out of control and needs tremendous reform.  One fears however that if the pendulum swings too far you will have the same kind of slow growth and poor allocation of capital that you see in other heavily regulated industries like utilities. 

While you don’t want to see the kind of insane risk, backed up by an asymmetric risk profile that we’ve all just witnessed, you also don’t want overly cautious banks.  In fact right now you’re seeing the pain of a “credit crunch” caused by banks that are afraid or unwilling to lend money.   Further diminishing banks’ willingness to lend doesn’t seem like a wise idea in the long term. 

Governments almost never run things efficiently, so you probably don’t want them taking too much control over our country’s capital allocation.  Central planning does not have a good track record for efficient capital flow.  While lawmakers are rarely reasoned, or contemplative, one can hope that this would be a case where they would invest the time in striking the right balance of regulation and market forces.

Post from: Personal Finance And Investing

Is the Financial Sector a Utility?

1. OFHEO 2006 Performance and Accountability Report
2. Joseph A. Schumpeter – Capitalism, Socialism and Democracy
3. The Economist – Minsky’s Moment

Photo by: Gene Hunt

Populist rage is all the…well…rage.  Everyone right now is outraged over how much people get paid to do their job poorly, or how much more some people have than everyone else.  Now of course you can make arguments that the income distribution of modern society is counter-productive, but one key question is:

Why Do We Care RIGHT NOW?

As of now Congress is considering passing a tax to basically recoup 100% of any bonuses paid to AIG employees.^[1]  Everyone is incensed that people get paid these bonuses despite their companies doing poorly.  It seems that the public will not be satisfied until they get their pound of flesh.  This leads one to question why we stop at bonuses?  If the American government is willing to institute taxes to recoup money from the employees of this company, why not garnish their wages too?  

They did a bad job, so lets punish them, regardless of whether they were instructed to do what they did, and more importantly:  They have contracts stating they get this pay.^[2] These employees signed contracts indicating that if certain events happened they would get these bonuses.  We now want to invalidate them, simply because we don’t like what they are getting paid.  Imagine if you were guaranteed a signing bonus after one year of employment and then because the company did poorly, they decided to simply not honor that obligation.

“Yes But They’re Taking Our Bailout”

The justification for this 100% tax is that AIG took our bailout money so all their obligations are moot.  They want our money, they have to do whatever we say.  In theory that sounds fine, but then you have to question why we bailed out AIG in the first place.  The reason we bailed out AIG was so that the people to whom they had obligations would not be wiped out.  AIG had obligations to foreign banks and other institutions and investors that we didn’t want to see destroyed, so we bailed out AIG so they could meet those obligations.  Now we want to essentially pick and choose which obligations we’re willing to meet.

What’s interestingly lost in all of this is the release of AIG counterparties and where all your tax payer money has been going.  Among the recipients of these funds are foreign banks.^[3]  In that same populist vein, had the bonus story not overshadowed this story, would the same people be advocating that we not pay back European banks?  Or other Wall Street firms?  Ultimately all of this bailout money is going to people who helped create the crisis, because if it wasn’t there wouldn’t be a crisis.  It is interesting that in all of this mess, alleged “populists” are getting outraged by individuals having their obligations met, but not institutions.

None Of This Is Fair

One thing you have to remember in all of this is that none of this is fair.  It’s not fair that poorly mismanaged companies get bailed out at all, while people who made much less egregious mistakes go without aid.  However the sum of these bonuses, $170 million dollars in a bailout in the trillions of dollars, seems like too little of a price to compromise the law.  Ultimately when it comes to the law we all like to have a certainty that if we have a contract to receive something, we will receive it.  I personally don’t think it’s wise to discard the law simply because of one of the smaller injustices in a story rife with injustice.  I’d rather not set the precident that in times of crisis, the law goes out the window.  My sharpest criticisms of the Bush administration were that when our principles were challenged we threw them all out the window in the pursuit of revenge, I have no desire to see us repeat that mistake.

Post from: Personal Finance And Investing

AIG and Populist Rage

1. AIG Bonus Checks May Be Taxed At Up to 100%, Says Sen. Chuck Schumer – U.S. News and World Report
2. The Case for Payout Out Bonuses at AIG – New York Times
3. AIG Outs Counterparties – Forbes.com