They Must Be Kidding

So it looks like its going to happen.  The Bush tax cuts for millionaires will be extended.  To get the deal through, the Republicans threw a bone to the democrats in the form of extending unemployment insurance for those that have been out of a job for more than a year.  So we get the worst of both worlds, lower revenue and higher expenses.  We allow the super-rich to keep money that will not be spent or contribute to economic growth in any way.  We continue unemployment benefits that are more generous than many could make by going back to work.

The Republicans think they were elected to extend tax cuts.  This really isn’t the case.  They were elected because instead of focusing on getting people employed the Democrats went on a year long ideological rampage to pass a health care bill that will increase costs and decrease choice.  Americans in general don’t like to be told what to do.  Their tolerance for government is extremely low by world standards.  A center right nation wants the government to provide some security and enough regulation to keep those who would seek to exploit our freedom in check.  

The most stunning fact of the past week is that Chuck Schumer was the voice of reason in the whole debate.  By offering a compromise bill only raising taxes on those making over $1MM per year he offered a bill that should have been a no-brainer for everyone to get behind.  If anything, this compromise offer would have been better for Republicans than the alternative they now look likely to vote for.  

This gross and disgusting bill should be exhibit #1 in just how dysfunctional Washington is.  Its a huge slap in the face to the American public that says were very happy to put totally misguided party ideology first even if everyone knows that bad consequences are sure to follow.  Pelosi, Reid, Boehner, and McConnell will be getting some great sound bites.  But those are awfully expensive sound bites.  The nation simply can’t afford them.

Dear Microsoft: You Suck

I spent the past several days getting Parallels Desktop 6 and Windows 7 set up on my 17in MacBook Pro.  I need a working copy of Windows on a system I own to run SeeYou, a gliding flight viewing software.  I didn’t want an ugly piece of PC hardware sitting around, so I went the virtualization route.  Parallels essentially virtualizes Windows applications so they look and feel just like they do on a native installation.  It’s really, really neat and I’m happy that I have this set up.  I’ll probably be using it for some real world work as well.

Parallels costs $79, a price I find very reasonable.  Windows 7 Home Premium (the least expensive version you can buy in a store, more on that later) non-upgrade costs $199.  Yes you’re reading that correctly.  This is essentially the same OS they sell to OEMs for comparative peanuts.  When I saw the price I nearly choked.  I was ready to spend $49, or even $74, but not $199.  

Apparently Microsoft sells an “inferior” version of Windows 7 to OEMs for their lowest end computers.  That makes 4 Windows 7 versions for sale.  But why should their be more than one version at all.  All Apple computers come with a single fully featured OS.  They don’t try to charge you extra to get the “best” features like Expose.  When they come out with something new that works on my existing hardware, like Facetime, they give it to me for free.

Bill Gates won the PC wars by being ruthless and crushing competitors.  Steve Balmer is a pathetic hack whose only qualification for CEO was that he happened to be around for a long time.  There are just so many reasons to hate the company, and then they find one more way to force you to bend over and take it.  They cripple the Mac Office version in ways that make it not compatible with most serious Excel work.  We’re forced to use their crappy software in the professional workplace because it became the standard two decades ago.  

The company wonders why people pirate their software.  It shouldn’t be that hard to understand.  You’re overcharging for an inferior product.  We’re all sick and tired of it.

Why Warren Buffet Is Right on Taxes

At some point earlier this year I lost count of the number of CNBC/Fox Business specials Warren Buffet had done.  Somewhere in the last 60 years the famously socially awkward Buffet has transformed himself into a gregarious and approachable grandfather figure to the investing class.  One of the major mantra’s running throughout the series is that taxes need to go up on rich people like him.  While lower taxes generally spur economic growth, he probably has a point.  The very rich are getting richer at a rate that we haven’t seen in over a hundred years.  A very small percentage of the population is using the size and complexity of modern capital markets to make fortunes and barely paying for the privilege of doing so.  Celebrities of dubious social value pay tax at the same rate as the small businessmen working hard just keep everyone employed.  

One of the main arguments of supply side economics make is that tax policy can be used to influence private sector behavior.  Just to prove to you that I occasionally read an academic article, an interesting study to bring to point is that of post-WWII Britain.  After six war-swept years where they wondered whether they would control their own country in a few years time, B-Ball Barry’s favorite economist John Maynard Keynes convinced the government to tax capital gains at a higher rate than ordinary income.  A sort of false prosperity ensued.  The rich, who just a few years back wondered whether they were going to be alive, decided not the invest their money under such a confiscatory scheme.  They wanted to spend it.  Every country gentlemen suddenly owned a Rolls-Royce.  But once the money was spent up, demand plummeted and a decade of economic stagnation ensued.  Even nearly ruined Germany managed to get back on her feet.  An important lesson was learned.  People need to be incentivized to take risk.  

Today, we know that all net job creation comes from small business.  The largest businesses in America generally eliminate as many jobs as they create.  Ford and GM have similar revenues today as they did in the middle of the previous decade but have shrunk their workforce by large magnitudes.  Robots have replaced human hands.  The days when every middle manager had a secretary are long gone.  Only small business, where new disruptive ideas are most often nurtured, are jobs being added on the whole.    The capital gains rate has been kept low to encourage investment in these endeavors.  These are the folks we need to reward.  They are the ones that deserve lower tax rates for taking risk with their capital.  

Smart people know a good thing when they see it.  Investment managers convinced Congress that since capital gains are good, and they facilitate capital gains, why shouldn’t their income be taxed that way as well?  The manager receiving income from how well the partnership performs now also gets capital gains treatment, commonly called "carried interest."  Their income comes not from their own capital but for the work they do for the partnerships they control.  The corporate executive builds a company and creates economic value while the hedge fund manager buys a flips a stock with the click of the mouse.  For his hard work, the private equity executive pays about 42% of the taxes.  Fund managers should be taxed just like every other wage earner.

The second potential revenue generating change is to differentiate Joe the Plummer from Jennifer Aniston.  The current top marginal tax rate is 35% on income above .  It doesn’t seem to make sense that a successful Dentist with a family should be paying the same income as Angelina Jolie who can afford to adopt whole African nations.  Their ought to be more tax brackets.  Leave the existing rates where they are but create three more rates at $1MM, $3MM and $10MM of income, perhaps topping off at 50%.  I’m sure Wall Street traders and Hollywood celebrities can afford to let a few more of the Benjamin's back into the government’s hands.  

Raising taxes on the ultra-rich won’t hurt the economy.  Lower capital gains rates will remain for those who truly risk capital, as opposed to being third party fee generators.  New tax brackets won’t deter hard work but would capture revenue from those who can afford to pay it.  Cutting spending alone won’t fix our structural deficit.  The politicians need to be honest with themselves.

For Sale: Education You Can't Afford

University of Phoenix.  Kaplan.  Keiser.  Argosy.  For profit colleges everywhere, branching out like a giant squid sucking in poor souls with no options.  I spent an hour today trolling around their websites, learning about how I could earn a Associate of Science in Interdisciplinary studies which I’m sure will prepare me well for the workforce.  These schools make a living enrolling people who shouldn’t be there and overcharging them for the privilege.  But the main thing they seem to be doing  is to scam Uncle Sam out of all his dollars and sense. 

To get them in the door, “admissions officers” aka “recruiters” read from almost prepared scripts.  From a recent investigation, all 15 colleges visited made false or misleading statements and four committed outright fraud.  Students were encouraged to lie on their FAFSA Student Aid forms in order to be eligible for more loans and grants.  Over 83% of their revenue comes from students receiving Pell grants or taking out Stafford and PLUS Federal Loans.  

This might sound like good social policy, helping students to afford an education that should lead to better things.  But first over 30% of revenue is often spent on advertising.  Your Federal tax dollars are paying for you to watch “I’m a Phoenix” ads.  Next, few students are graduating. the University of Phoenix has a 16% graduation rate.  The other 84% rack up debt that they are not in a position to repay.  The Washington Post, which owns Kaplan, reports that only 24% of Kaplan’s students are repaying their debt.  I am on the only one that sees the irony there?  These students might as well have taken out a credit card and enjoyed themselves.  They’d probably be better off as you can discharge credit card debt in bankruptcy.  Once you have them, student loans join death and taxes as things you will always be certain of for the rest of your life, at least until paid.

For profit schools also seem to account for the lowest income segment of the population.  For-profit schools account for 6% of students and 20% of Pell recipients or those with the least resources.  This group likely have a lower educational level to begin with.  Remember all those folks who took out $500k mortgages with $25 incomes?  Well they can often take out PLUS loans to help pay their "cost of living."  Yup, you and I are both sure there are a lot of repeat offenders.

So what about those hearty souls that have made it through the rigor of of for profit education?  Then the final problem arrises.  The "college" has turned out a newly minted graduate who is looking to enter the workforce or find a position of increased responsibility.  What are the job prospects from the good old U of P?  The colleges put out relatively high job placement rates, but they count someone as “placed” if they have a job available.  An accounting major working in sales at Wal-Mart was employed in his field.  I certainly haven’t heard someone say they’d want an accounting graduate from a for profit college over say a Buffalo State where they would have paid a lot less.  

A college education shouldn't be a business or even worse a factory.  Schools should be putting all of their resources into improving their educational quality, not paying dividends to their shareholders from Federal loans that will never be repaid, sticking the taxpayer with the bill.  We have great public and private educational institutions for people at all levels all over the country.  We don't need to subsidize marketing companies.

Free Rider Free Rider and the Market Based Healthcare Solution

I received an interesting comment to my last post for which I would like to provide more than a brief reply.  The health care free rider problem is when an individual does not have any health insurance and uses healthcare services they can’t pay for.  The costs of these services must be written off by the healthcare provider who must in turn charge higher costs to patients with insurance to cover their losses.  One major example of these costs is that uninsured individuals go to the emergency room with an “emergency” that really isn’t serious but they know they will get treated for free.

Much has been made about the fact that such costs push up the cost of insurance to those with coverage and its absolutely true.  However, the total amount of healthcare spending would not go down if all people had insurance.  Someone still has to pay for the new insurance that pays the service providers.  In fact when we insure more people the total amount of healthcare spending may actually increase.  All the newly insured individuals could demand services they previously would have gone without because they would not have been willing to shoulder the costs themselves.  And therein lies the major problem with health insurance as we know it today.

When individuals are separated from the cost of the choices they make they are not in a position to make educated choices.  Medical technology is advancing in sophistication at an ever expanding rate, but the costs of the new technology is growing exponentially.  While a suggestion of ice and rest might have sufficied for an upper ankle sprain twenty years ago, today such an event requires a 3D MRI followed by multiple followup visits.  Of course the result is pretty much the same - the body is wonderful healing machine.  Since the unfortunate athlete is separated from the thousands of dollars of expenses he just ran up he will continue to return to the doctor who is happy to collect for each visit.

Another point the commenter makes is the uproar over so called “death panels.”  Here I have to find some agreement with him but perhaps for different reasons.  Their is a clause in the healthcare law highly suggests that doctors have discussions with their patients about end of life decisions.  Furthermore there are new medical review panels to determine the efficacy of treatments.  As outlined above, individuals are currently separated from cost of the healthcare choices they make.  There are cancer treatments on the market that cost tens of thousands of dollars a month and might extend someones life expectancy a few months.  Should the public fisc bear the burden of such expenses?  Or do such expenses actually represent a resource misallocation?  Could the funds so used be redirected to extend the overall populations life quality and expectancy?  These are some of the questions we must address however difficult.

Today we have an insurance model that I would call the dirty patchwork model.  Most working age adults and families receive their health insurance through their employer.  Many lower income individuals are eligible for Medicaid and those over 65 are covered by Medicare.  Those on the left have proposed that the only way to get healthcare spending under control is a single payer model.  In a single payer model the government becomes everyones health insurer.  Its a giant version of Medicaid/Medicare.  However, this solution still insulates the health care consumer from the cost of their health care decisions and can only address out of control costs by medical panels and resource rationing.

I propose the individual market model.  In this model, everyone is responsible for purchasing their own insurance.  When you are negotiating with an employer for a job or a raise, one part of the negotiation would be for the employer to contribute a certain amount to a "Medical Benefit Account."  Each individual would then take their MBA funds and go into a market place to choose an insurance policy that best fits their needs.  If the policy they purchase costs less than the MBA contribution, the remaining funds would stay in the account and could be used to fund out of pocket health care costs or roll over to the next year.  Carriers would be required to cover everyone and at the beginning of each year you could change your policy.  Medicaid and Medicare recipients would get similar contributions to an MBA account from the government.  MBA funds could also be used to purchase other forms of insurance such a life, disability, vision, and dental.  Individuals could accumulate MBA funds over the course of their life that would help cover end of life expenses or they could choose to use some of their MBA funds to purchase long term care insurance.  Any MBA funds left over at the end of life could be willed to another's MBA account whether it be child, grandchild, or sibling.

Employers would love to be able to use this model.  First off it would help provide employers with some cost certainty.  Secondly it would eliminate certain disparities that currently exist.  For example if you have a married employee with a family one spouse or the other would choose to be covered by their employers health insurance.  The "unlucky" employer who has to cover the whole family runs up expenses while the other spouses employer has no expense.  In the MBA model families would combine their MBA funds to insurance for the family.

When every individual is exposed to the cost of their insurance they are likely to make better use decisions.  Do I really need that $2,000 MRI, or is my upper ankle sprain likely to heal itself?  Millions of Americans being exposed to the true costs of what they consume is the only way to drive down long term health care costs.  The ability to change carriers will create a completive marketplace that will offer policies that individuals desire.  Lets create a true marketplace where each person can get the health care coverage and services they want and need.  Let's liberate the healthcare market.

Fooling Some of the People All of the Time

I recently finished reading hedge fund manager David Einhorn’s book “Fooling Some of the People All of the Time.”  Einhorn recounts his five year battle against American Capital Strategies, a company that systematically manipulated its financial statements to smooth earnings and make itself a Wall Street darling.  Despite Einhorn providing substantive evidence of the fraud to the Securities and Exchange Commission no investigation is even opened.  The company is eventually forced to acknowledge its manipulations when it declares bankruptcy during the financial crisis.  Einhorn’s book points out an interesting fact of human nature: if you repeat things often enough to a large enough group of people at least some of that group will believe it.  Right after I went on to read Bill Ackman’s “Confidence Game.”  Ackman fights the bond insurers who use mark to make believe accounting tricks in an attempt to prove they are solvent.  The consequences of the bond insurers insolvency would undermine investor confidence in the entire municipal market.  Indeed, in late 2008 in the municipal market was one of the hardest hit bond sectors.

The government has gotten into the “fooling some of the people all of the time” game with health care reform.  “We can cover more people, provide more services for those who already have coverage, and it will cost less.”  Most intelligent American’s recognized this as bullshit the moment it came out of B-Ball Barry’s mouth, but a lot of them didn’t care because it advanced their ideological agenda and they would have no problem raising taxes to pay for it later.  I have to give B-Ball Barry credit for one thing.  He was totally honest when he was running for office.  He told people exactly what he was going to do, they knew fundamentally they disagreed with him, but he offered “hope and change” so why not give the nice guy a chance?  I digress.

In order to fool some of the people all of the time, you have to have someone with authority and gravitas repeat your lie.  The biggest thing B-Ball Barry ran before the country was a "community organizer" whatever that menas.  So someone had to be co-opted.  Enter Paul Krugman.  It is arguable whether the Beard won the 2008 Nobel Prize in Economics for his contribution of academia or for his high-profile post as a partisan New York Times columnist.  Krugman has never really done any groundbreaking work.  But the Swedish voters love to stick it to America in any way possible.  When B-Ball Barry picked up the 2009 Peace Prize it was a jab in the eye for America's past hubristic sins.  In two years the Nobel went from the highest prestige award in the world to a joke.  But the award gave Krugman new ammunition.  He could say whatever he wanted, and people would believe him.  If enough people believed him his diatribe would gain a life of its own.  

Krugman was one of the most vocal supporters of health care reform.  He repeated the some of the people all of the time lie over, and over, and over again.  And how did he get away with it?  Bogus accounting.  For example, if you raise taxes in Y1 and start providing a service in Y4, you might make enough revenue in the first ten years to pay for the six years of the service.  So whats the take away.  If you manipulate your accounting, and repeat it often enough, a lot of people are bound to be fooled.  To use real accounting, that would show how insolvent the government truely is, would ruin the confidence game necessary to prop up the treasury market.  The government has every reason to perpetuate the lie.  They can't fund themselves if they don't.  We've seen this all before.  The people who were supposed to protect us were complicit then.  They are once again.  The end game will be no different.

The New Subprime Security

Markets just seem to love bubbles.  One of the first recorded financial bubbles was the Dutch Tulip bubble.  At its peak in January 1637 particularly desirable tulip bulbs traded for ten times the annual average wage of a day laborer.  For one bulb.  The best (stupidest) part of the tulip bubble is that properly cultivated, the number of tulip bulbs in existence will continue to grow.  Unless the demand for bulbs grows faster than supply over a long period of time, the price is bound to fall.  

The long dated Treasury market is today is like the tulip market in January 1637.  It seems great, people have made a lot of money, but its only straight down from here.  The 30 year bond is currently closing right around a 4.0% yield.  To put this in perspective twenty years ago in the 30 year cost of borrowing was 8.61%.  At its peak in 1981 the cost borrowing was over 13%.  Can the United States Government really be a more creditworthy borrower today than in 1990?

Yesterday the Fed announced that it will purchase $600BB of long-dated Treasuries.  The market in the 30 year promptly reacted by dropping over 150 basis points.  In a normal market, when a buyer announces that they are purchasing ~4.4% of all outstanding assets in a market ($600BB purchases divided by $13.6TT of debt total US sovereign debt), the price of the asset rises.  However, the market is starting to question the creditworthiness of the government.

The creditworthiness of a sovereign with debt denominated in its own currency is not based on whether it will pay interest and principal.  The ability of central banks to print money assures that.  The creditworthiness of that sovereign is based on whether the coupon and principal payments deliver a return that allows the holder of the bonds to purchase more goods and services when received than when the investment was made.  Because the government can print money it can debase that money and what is received from the bond can lose much of its purchasing power.

The market’s reaction suggests the Fed has lost the ability to move the market.  Expectations of increasing inflation spurred by the Fed funding the Federal Government  have decreased investors view of the government’s creditworthiness.  The only way the government can repay its debt is by increasing the price level.  In 1981 inflation ran 8.05% while the 30 year bond yielded in excess of 13%.  The coupon of the 30 year bond therefore returned over 5% in real after inflation returns.  Today, inflation is running right around 2%.  The 30 year bond is returning around 2% in real, inflation adjusted returns.  While it is likely that investors will demand a far higher real return "premium" in a volatile environment, let us assume that they will continue to accept a 2% real return and that inflation will run a moderate but stable 5%.  Yields on the 30 year will increase to 7%.

What will happen to the price of the bond that was issued with a 4% yield?  Prices of bonds move inversely to yield.  If you have a $1000 that pays $40 a year and investors demand a return of 7% they will pay less than $1000 for the bond.  They will pay a price where the $40 coupon plus the appreciation of the investment when principal is paid at maturity returns 7% on invested capital.  In this case the value of a just issued 30 year bond would fall from $1000 to $622 - a 38% decline.

Based on projections of future budget deficits the supply of Treasury securities will grow indefinitely.  Meanwhile its highly likely their purchasing power will fall reducing demand.  Today it might not be such a bad idea to buy some Tulips.  At least you'll have something pretty to look at when your savings are worthless.