19 July 2011 – The Aleph Blog

Rationality is Overrated

Posted on 19 July 2011 by David Merkel

When I was in school, I was the “class brain.”? (sigh, I had a hard time with it, but after I became a Christian, I won people over by offering homework help for free) I even have this glow-in-the-dark rubber brain that my senior class awarded me.

But it’s not worth that much.? There are many other character attributes desirable to society aside from being smart.? As a little kid, I was a guinea pig for many of the educational theories they tried to test on me, and I survived them.? Not sure what good they got out of it.

In my adulthood, I learned to appreciate the abilities of others who may be less smart, but they have gifts — empathy, mechanic, insightful into people, technical specialties… everyone has something to give, IF they will give.

Economists have a fixation on rationality, and this article is a partial expression of that.? My answer to the article is the people are limitedly rational.? That’s vague, and won’t fit into mathematical theories, but it is accurate.? It explains why people act rationally in some situations, and why they could be more rational in other situations, assuming that economists really know what is rational.? More goods is better is not an adequate explanation of rational.

A view like mine would make it very difficult for economists to create simple mathematical models of reality.? They would rather live in their fake world, where they can publish nonsense to peers, and keep their cushy jobs.

Get the US Government Out of Lending & Insurance Businesses

Posted on 19 July 2011 by David Merkel

I’ve done lots of things in my life in financial businesses.? It’s given me a chance to see a lot of different businesses from different angles.

One thing that surprised me as I learned, was how many places the US Government had lending and insurance programs.? Housing, Agriculture, Veterans, Shipping, Exports, Imports, and more.

But the worst of it was that most of it was non-economic.? I understand giving small subsidies, but not big ones.? Few programs tested the price-sensitivity of borrowers and insurance clients by raising rates until some said, “Ouch! I will do without this insurance.”? To me, not doing that is disrespectful to taxpayers, and promotes borrower dependence on the government, leading to too much debt/ cheap insurance.

Thus, I get annoyed by proposals to continue or expand government lending programs, particularly failures like Fannie Mae and Freddie Mac.? F&F created the conditions for an oversupply of housing.? My view is fold them into Ginnie Mae, and then send Ginnie Mae into runoff.? No more new loans.? Let the private banks fund new loans.? We don’t need more houses at present; past housing policy was a great big fail.? The cumulative losses of F&F prove it.

Let the FDIC raise its guarantee fee until some banks decide to do without it.? Once that starts to happen, drop it a little, and stay there.? If F&F continue to exist, let them raise their guarantee fees until lenders beging to seek other options.

I would much prefer the government exit such businesses, but I am in a minority I suspect.? At a minimum, have them behave like market driven firms, or at least like profit-seeking monopolists.

I write this because I don’t believe that borrowers or insureds deserve to be subsidized by our government.? Subsidizing businessmen has a bad smell.? If they can’t make it on their own, they don’t deserve to make it.

Silent as Night

Posted on 19 July 2011 by David Merkel

When I worked at a life insurer that was in the pension business, we would sometimes get asked to quote on business where termination of the existing plan would result in a surrender charge.? Now no plan sponsor would ever want to deliver a loss to participants — the effect on morale would be huge, so they would approach companies like ours and say something to the effect of, “If you pay our surrender charge off, we will invest with you.”

Not the happiest way to get business, but we reckoned that the fault was on the side of those that accepted the surrender charges in the first place.? We never did surrender charges on new business, but in order to get plan sponsors out of underperforming money managers, we would offer to pay off the surrender charge, at a price of a higher management fee plus a surrender charge.? We didn’t charge anything extra; we left our profit margin the same as with new clients.? We offered plan sponsors longer and shorter surrender charges, with correspondingly lower and higher annual fees.

As my friend Roy said, “We’re the good guys.? We’re out to save the world for 0.25% on assets plus postage and handling.”? But being “good guys” we helped hide the stupidities of plan sponsors, and to some degree, the cupidity of some mutual fund purveyors.

It also taught me a lesson.? When fees are deducted daily, no one notices.

You have read articles about how high mutual fund fees are, and you wonder why people buy them.? They buy them because they don’t look at the fees, and the fees get taken out quietly, night-by-night, imperceptibly.? They might also earn money from securities lending and soft dollar commission arrangements as well.? Their investors might reimburse some expenses also.

Now as for me, my business has just one source of revenue, my management fee as a percentage of assets.? I receive nothing else, and pay all expenses out of those fees.? It comes out once per quarter.? Savvy investors ask for direct billing, which I happily do, rather than deduction from the assets.

But it makes my cost to them very visible.? I am happy to live with that; I hope they are as well.

For those who use mutual funds, I suggest that you review the fees that you are paying. For those with 401(k) and similar plans, I suggest you look at the form 5500 documents behind your plan to see what you are implicitly paying.

Be aware.? In investments, charging through modest changes in the net asset value is the way most fees get siphoned off.? Big firms don’t like to talk about this, because it is their lifeblood.? You are your own best guardian, so review the fees of the firms that you entrust to invest your money.