Trying a new format here, I think readers will like it better.  Most things are better after additional effort.  Think of this as a news links by subject post.

Economics

• If you look in the back, it seems that there were 58 respondents. From page 13: Methodology & Panel Selection Invi… http://t.co/p8sVZl9g Feb 06, 2012
• Will the great interest rate gamble pay off? http://t.co/hgj5XSKc People want to believe that you can get something for nothing; ain’t true. Feb 05, 2012
• Central Planning at the Federal Reserve http://t.co/X8qmqU6C Fed: we can create prosperity by holding interest rates down, right? $$ #wishes Feb 05, 2012
• Labor Force Participation Rate: 28-year Low http://t.co/kLgQ61iK Everyone still happy about the lower unemployment rate? $$ Feb 05, 2012
• Bill Gross: Free Money Ain’t Really Free http://t.co/LXWxpxp5 It will lead to stagflation, IMO, depending on what fiscal policy does $$ Feb 05, 2012
• Life & Death Proposition http://t.co/XuZS5Snn Where does credit go when it dies? Back where it came. It delevers, slows & inhibits ec growth Feb 02, 2012
• US unemployment “progress” http://t.co/WoIVZPGp If you add back the discoraged workers, all of the improvement in U-3 goes away $$ Feb 02, 2012
• The Perniciousness of ZIRP http://t.co/dYlFMbLe Gonzalo Lira on how ZIRP loses effectiveness b/c people think it’ll b there a long time $$ Feb 01, 2012
• Why Neoclassical Economics Doesn’t Work In The Age Of Deleveraging http://t.co/D3IAhTyv Steve Keen explains y Krugman & others r wrong $$ Feb 01, 2012
• Warning: Goat Rodeo http://t.co/JQ2FV9LS Hussman makes his case that equities are overvalued and could pull back 25% $$ Feb 01, 2012
• Who Owns World’s Financial Assets? & Why R US Households So Fascinated W/Stocks? http://t.co/5rp52OM4 American Exceptionalism in investing Feb 01, 2012
• As an aside, that is one reason why the US net foreign debt hasn’t spiraled up. We own equities abroad & they own our debt. $$ declines + Feb 01, 2012
• $$ declines reduce the value of our debts, but not the value of r foreign holdings. I think the US will come out of this crisis rel well $$ Feb 01, 2012

Housing

• Home Prices Tumble http://t.co/N1gdNslr No surprise here with all of the dark supply; houses come onto mkt when ppl can bear loss $$ Feb 01, 2012
• Too lazy to be knowns http://t.co/flXRR6fM I know many who understood what would happen if home RE prices fell, but none who got the size $$ Feb 01, 2012
• Freddie Mac’s “inverse floater” allowed more loan origination http://t.co/5devKZ17 Other side to the Propublica story http://t.co/KjXJHU1x Feb 01, 2012
• I’m no fan of the GSEs; I think they should be abolished, but the GSEs have always made a variety of bets on prepayment over time. $$ Feb 01, 2012

International

• On China, Henry Kissinger and Fareed Zakaria see Domestic Tension and Risk of Geopolitical Conflict http://t.co/1bhvrI3U Ferguson is wrong. Feb 05, 2012
• Tightening lending standards vary materially across the Eurozone http://t.co/ciWUK9cm Conditions tight in Italy & France, but not Germany $$ Feb 02, 2012
• Japan Auto Sales Notch Record Jump http://t.co/0VzF4WST Another small bright spot. Of course, bouncing back from a low level $$ Feb 02, 2012
• Socialist Hollande, Who Wants Full European Treaty Renegotiation, Increases Lead Over Sarkozy http://t.co/J3qCpZZ3 Eurozone Wild Card $$ Feb 01, 2012
• Hong Kong Homes Face 25% Drop as Loans Fall in Year of Dragon http://t.co/ifg1146H And this is with wealthy mainlanders fleeing China. $$ Feb 01, 2012

Markets

• RBC Takes On High Frequency Predators http://t.co/MfA5qdxm Where there is offense, there will b defense; nothing goes unanswered in the mkts Feb 05, 2012
• Global Strategists Abandoning Bearish Views http://t.co/dOXCUMA7 Makes me think we r getting close to a turning point. Feb 02, 2012
• Dividend stocks: Buyer beware http://t.co/SvMCHtCj Makes the valid & missed point: high qual div paying stocks r stocks & can lose $$ #yeah Feb 01, 2012

Credit

• 6 High-Yield Canaries-in-the-Coalmine http://t.co/4pz6SSQc 6 reasons y high yield is overheated http://t.co/fKnHmBqD & http://t.co/UPVev0iD Feb 02, 2012
• QOTD: Regulators Watching Aggressive Yield Chasing http://t.co/iWimo3eg FINRA warns of undue risk in income seeking. Advisors take note $$ Feb 02, 2012
• Contra: The Safest 7% Yield in America http://t.co/VrXoLEFH Poor analysis does not take into account the highish leverage on mtge repo $$ Feb 02, 2012
• Shipping Loans Go Bad for European Banks http://t.co/y5Z0wt3R Highly glutted area w/many dead firms walking; how far down will the losses go Feb 02, 2012

Politics

• Group lists top stock investments by members of Congress http://t.co/CarxUCjS Top 50 hldgs -> in top 100 cos by mkt cap. Hard2manipulate $$ Feb 05, 2012
• Obama Re-Election Odds Versus the Stock Market http://t.co/F5EETcve Example of 2 variables that r correlated b/c they anticipate GDP changes Feb 05, 2012
• RE: @abnormalreturns Gold is mostly political philosophy. How much control do you want the government to have over mo… http://t.co/hRxIkaoo Feb 03, 2012
• Getting back to the gold standard http://t.co/pCk8Ij6j Gingrich & Ron Paul have said they would like to appoint James Grant as Fed Chairman Feb 02, 2012

Companies

• Carlyle’s proposed IPO disaster http://t.co/OqGke8eN So there’s no board. Most boards don’t do much. Mgmt will have no board 2 shield them Feb 05, 2012
• For These Fans, a Day With Buffett Offers Wealth of Photo Opportunities http://t.co/UpcwVKe7 I think Buffett is enjoying life more now. Feb 05, 2012
• Buffett Railroad Boosts Capital Plan to $3.9B http://t.co/9XEw2gyT Buffett changes; organic investment in capital-intensive biz $$ #olddog Feb 01, 2012
• Pep Boys Seen Gaining 27% as Cheapest Value Lures Bids http://t.co/GyfH7qRL Could a bidding war start? Company is undermanaged $$ Feb 01, 2012
• Jefferies Allows Bonus Recipients to Swap Stock 4 Cash With 25% Discount http://t.co/pfGB3Vmc Fair way2 let employees disconnect from $JEF Feb 01, 2012

Financial Services

• I’ve just started “Acts of God and Man,” by Michael Powers. In the intro, he goes through the various meanings of th… http://t.co/tX7uAlWl Feb 05, 2012
• When evaluating Investment Funds, use Dollar-weighted Returns http://t.co/N5g7PI0d This is a neglcted concept that is enjoying a rebirth $$ Feb 02, 2012
• After a Delay, MF Global’s Missing Money Is Traced http://t.co/4s6U8yOe Investigation moves to how to recover the $$ and who is at fault. Feb 01, 2012
• http://t.co/wBbJTe3D FINRA Alert: Do you use complex products? What additional work do you do 2 assure that they are being used properly? $$ Feb 01, 2012
• Banks Need Higher Interest Rates to Start Making Money http://t.co/SneRACCi Flat front end of yield curve squishes bank interest margins $$ Feb 01, 2012
• 401(k) Plans Step Into the Sunshine http://t.co/fvKeup2L But as with DB plans, as costs rise, companies will offer them less. $$ Jan 31, 2012

Value Investing

• The SEC’s “90% Convergence” Fantasy http://t.co/bkWaAS5S US GAAP has many flaws, but we know them. IFRS will introduce abusable flexibility Feb 02, 2012
• But on the bright side, value investors may do relatively better as financials become less trustworthy; the accruals anomaly will sing $$ Feb 02, 2012
• Need to consider (Cost of goods sold)/user $$ RT @ErikSchatzker: Facebook gets $4.39/yr of revenue per user. ESPN gets $4.69/mo. Feb 02, 2012
• Berkowitz: Fund Plunge ‘Makes Little Sense’ http://t.co/pcoPLahW BB, appoint someone in your group 2 seek out opinions contrary 2 yours $$ Feb 01, 2012
• @ADayforRabbit I have argued in the past that BB is not paying attention to the delevering, which is a real headwind for the banks. $$ Feb 02, 2012
• New Fund Hopes to Prove Outspoken Analyst’s Thesis http://t.co/cuVpRzvO I bet @rcwhalen does well like my friends @ Hovde or M3 Partners $$ Feb 01, 2012

Hedge Funds

• Are Hedge Funds Worthwhile Investments? http://t.co/Lw2EhRPr Yet another “Hedge Fund Mirage” citation; the book is having a lot of influence Feb 02, 2012
• Are the hedge fund and private equity boys pulling a fast one? http://t.co/TNXFJo62 Beginning 2c the args of “Hedge Fund Mirage” everywhere Feb 02, 2012
• Did Hedge Funds Trigger the Financial Crisis? http://t.co/lNIb2dgF Secured asset classes can be overlevered; when they collapse, big mess $$ Feb 01, 2012

Miscellaneous

• Do the Job You’re Meant to Do http://t.co/wR3OX20N LIfe is too short to work with people you don’t respect, or tasks unfit for you $$ Feb 02, 2012
• Millionaire adopts girlfriend as daughter http://t.co/zffGCWbu Asset shelter. Does incest rely on consanguinity or on legal relationship? Feb 02, 2012
• Charles Murray Reiterates Willpower http://t.co/smeXZKNh Lack of self-control can destroy relationships, jobs, firms & lives $$ Feb 02, 2012
• I ran into @twitalyzer today. Lots of interesting analytics for tweeting. Here are some for me: http://t.co/HDdcFYaU & http://t.co/8uFFOMuP Feb 01, 2012
• At the first blogger summit at the UST, I recommended to the powers that be that they issue floaters. I also recommen… http://t.co/R3U8OHSi Feb 01, 2012
• California Faces Cash Shortfall by March on Low Receipts, Controller Says http://t.co/QxH1a6Re Could be interesting given the elections $$ Feb 01, 2012

I have long thought that Defined Benefit plans are the best retirement plans for workers.  They are also the worst for employers.  Why?

Employees are incapable of making intelligent investment decisions in aggregate, much as they like the feeling of “control.”  Far better to have professionals choose investments where they don’t give in (as much) to fear and greed, and lose a lot of money in the process.

Defined benefits give retirees a fixed budget, which is good; they are not capable of managing a lump sum over a lifetime.  Indeed that would tax most “professionals.”  The pensions are also judgment-proof, aside from QDROs.

The cost of providing fixed benefits amid low interest rates is tough for most employers, who have seen their liabilities expand dramatically.  It takes a lot more assets to provide a pension if you are investing in safe bond investments.

This is particularly true for public pensions, since they had the greatest tendency to defer making contributions to avoid raising taxes.  Now they are in the soup.  It will be interesting to see what the municipalities do with the pensions.  There may be compromises driven over retirement benefits for future employees, current employees, and even current retirees.  Then again, maybe taxes will be raised to cover the expense.

That will vary by state; some will accept more taxes, and some won’t… beyond that, some will move out of high taxation states, creating a “death spiral” for taxes, or a default/compromise on pension payments.

All that said, I can simply say that in a period of low interest rates and low returns from risk assets, it is unlikely that pension payments will be maintained in many states, unless taxes are raised, and many will oppose that, because their own retirements so not look so promising.

I am a firm believer in “you can’t get something for nothing.”  So it is when a new derivative is proposed.  Either there are natural counterparties to take up the exposure (reducing their risk), or speculators must be encouraged to take the risk (more likely).

So, with longevity derivatives, the risk is people living too long leading to more pension payments in future years.  The proposition is: find a party that is willing to make more payments if mortality is better than expected, and offer him a payment, or series of payments, as an inducement to enter the transaction.

Let’s think for a moment, what entities benefit from a rise in longevity?  I can think of one: life insurers.  But there is a problem: anti-selection.  People who buy life insurance tend to be sicker than those of the general population, who tend to be sicker than annuitants.  Annuitants live the longest, and their lifespans improve the most on average.  Life insurers would find taking on longevity risk to be a dirty hedge at best for their life insurance books.  In general there have been few reinsurance agreements for longevity risk for immediate annuity portfolios, but then, that would be a really small component of the life insurance industry at present.

Even when terminal funding was permitted (back in the 1980s to early 90s) — where plan sponsors could buy annuities from insurers to free themselves from their pension obligations, it typically wasn’t a big business, and what did get done transferred credit risk from the plan sponsor to the participant.  Life insurer insolvency means the pension is at risk, subject to the limits of the state guaranty funds.  An acquaintance of mine, who was an actuary, who partially lost a pension on such an insolvency, said the solution wasn’t that hard — allow a lump sum as an option to those for whom the obligation was being transferred from plan sponsor to insurer.

The terminal funding business ceased because of changes in IRS regulations because a few companies realized gains out of terminating their plans.  That sat ill with Congress, especially past the era of corporate raiders, so an excise tax dramatically reduced the business.

So, even when pension plans were able to use insurers to reduce/eliminate their liabilities, there were issues.  There will be issues for longevity derivatives as well.

A swap agreement could point to a “reference portfolio of lives” chosen from some neutral database, or could point to the actual lives that the plan sponsor is trying to hedge.  The first requires less underwriting, and can be more generic, the second has less basis risk, and solves the actual problem, but requires messy underwriting.

Swap agreements could be long or short, but if I were a plan sponsor, I would have a hard time deciding whether to do a long or short swap.  Long swap: counterparty risk.  Short swap: little risk relief.  And to me, long would be 30 years or more and short would be ten years or less.  On short swaps if I ended up on the winning side of the trade, I would probably find few new takers for swaps when the time period was up.

That leaves me with one idea that might work: use a long (~30 years) cat-bond-type structure, where the principal adjusts down as deaths occur.  But we still have the counterparty issue.  If it is the obligation of a operating corporation, there is credit risk.  If it is its own bankruptcy remote Special Purpose Vehicle (SPV – no recourse to a parent company), then there is the risk that the assets in the SPV might not earn the returns necessary over the long haul to pay the interest and redeem the principal.

Calling Ajit Jain.  This is one of those contingencies that yearns for a Buffett-like investor who has a strong balance sheet and can invest for the long haul with above average returns, and thus absorb the volatility of aging annuitants.

But such balance sheets and investors are few.  So I would submit the idea that if you could not get Berkshire Hathaway to issue longevity bonds through such a structure as I have described, you’ll have a hard time issuing long dated longevity bonds anywhere.

Short-dated structures are cute, but don’t offer the relief that pension plans need.  So, I look at this market and do not expect much from it.  Credit risk and longevity risk are at odds with one another, and can be solved by the “magic man” who can earn returns superior to any excess longevity, or unsolved, leaving a larger problem in his wake, by the charlatan that delivers subpar returns.

That said, if you know the “magic man,” the pension fund should disintermediate and hire him.  Problem solved.  Now, where is this genius?

The genre of personal finance books is crowded.  I have read my share of good and bad books in this area, and the book that I am reviewing this evening falls in the good column.

It covers all of the main areas of personal finance adequately, and makes analogies from the world of martial arts.  Now, personally, to me that is an odd place to source analogies for investing.  I remember being in a meeting when I was a corporate bond manager, and the new head of credit research said to the credit analysts, “Credit analysis is war by another name.”  I rolled my eyes, and said to myself, “Oh, please, this is a business, and no more than a business.  Don’t make my analysts non-economically aggressive.”

This book is long on structuring your finances, and short on how one invests, as is common for most personal finance books.  The advice is simple and practical, and will benefit most individuals/families.

One of the many places where I agree with him is that you don’t have to have a budget.  Save first, and then survive on the remaining cash flow.  This is an excellent way of managing finances, but it takes discipline.  Not everyone can do this because they lack discipline on a month-to-month basis.  Those that don’t have that discipline should craft a budget.

I also found his approach to financial goals useful, because it asks the deeper questions on what the ultimate reasons for living are: not only ways in which we want to be served, but ways in which we want to serve.  Figure out the broad goals for life first, then figure out the financial means to serve those ends.

He also takes a conservative approach to how much money one needs in retirement, using a 4% withdrawal assumption, which in a low interest-rate and mid-to-high P/E environment like today is only reasonable.

It was a breezy read for me, getting through the 180 pages in 90 minutes or so.  Part of that is that it is a very familiar topic to me, but I suspect more of it is good structuring and chapter ends that repeat the main points in summary form, so that the main ideas are difficult to miss.

Everything important gets covered here for the life of an average person/family.  The reader faces the challenge of executing on the good advice, or finding a good adviser to guide him.

Quibbles

Though I was a wrestler in high school, I sometimes found the analogies to martial arts to be strained.  More importantly, I had a hard time following the logic in the appendix regarding investment performance.  I am no fan of Modern Portfolio Theory, but MPT does not require the concept of buy and hold.  Buy and hold stems from the idea that equities outperform equities and fixed income by a wide margin (the “equity premium”), so one can always win by holding onto equities, and not ever switching into safer asset classes.

The author’s concept of capital preservation investing does not get adequately defined.  Indeed, that could be a book in itself.  The idea  that there are seasons to take more risk and seasons to take less risk is obvious in hindsight, but implementing that idea is tough, and the author leaves us with not enough to do it.  That should not be too much of a surprise though, because if there were an easy solution here, we all would have adopted it years ago, and I would be opining to you from a life of leisure, rather than that of a working stiff.

As such, I don’t penalize the author too much, no one has the holy grail of market timing nailed down yet.

Who would benefit from this book: This is a basic book, and most suited for those that need to get their lives in order.  Personally, I suspect younger males would find the analogies between investing and martial arts most appealing.  I should try it out on my son who wants to be a police officer.

If you want to, you can buy it here: Financial Jiu-Jitsu: A Fighter’s Guide to Conquering Your Finances.

Full disclosure: The author sent this to me after asking me if I wanted it.

If you enter Amazon through my site, and you buy anything, I get a small commission.  This is my main source of blog revenue.  I prefer this to a “tip jar” because I want you to get something you want, rather than merely giving me a tip.  Book reviews take time, particularly with the reading, which most book reviewers don’t do in full, and I typically do. (When I don’t, I mention that I scanned the book.  Also, I never use the data that the PR flacks send out.)

Most people buying at Amazon do not enter via a referring website.  Thus Amazon builds an extra 1-3% into the prices to all buyers to compensate for the commissions given to the minority that come through referring sites.  Whether you buy at Amazon directly or enter via my site, your prices don’t change.

A few notes before I begin for the evening.  First, I have two piles of books sitting next to me — one pile of mediocre books, and one pile of lousy books.  Should I review them, at least in summary form, or should I leave them unreviewed?  It’s ten books in all.  I never know what to do with books that are marginal at best.

Second, with the aid of one of my children, I have completed categorizing my book reviews.  All of my book reviews are ranked within their categories, with links to my reviews, and commentary on who the books might be useful to.

Onto tonight’s thoughts with an email from a reader:

I’m a big fan of your blog and have kept up with it since I started in the investment industry 3 years ago.  I was wondering if you had any advice on standing out in the Defined Benefit world as far as process and investing goes.  I’m on a team that has developed an investment style and philosophy that is highly unique to retirement planning for individuals/families, but it has become very difficult to translate that into the DB world.

I’ve been on both sides of the table here.  I’ve worked with DB plans, Trustee-directed DC plans, 401(k) and similar plans, and individuals.  Personally I would like to work with more DB plans myself, but I will share with you what I know or believe.

The first distinction with DB plans is do they retain a investment consultant or not?  If the answer is not, it means that they might not be slaves to modern portfolio theory, and might think about investment in a more businesslike way.  They would probably be more responsive to the way you do things.

If they have a consultant, then you have to approach them through the consultant.  The consultant is in a tough spot.  Most of them don’t know much about investing, but they have a wide variety of quantitative tools that have been developed by academics that allow the consultants to protect themselves while delivering little-positive-to-large-negative results for clients.

All of the statistics that the fund management consultants calculate assume a world where risk is equivalent to variation, rather than permanent loss of capital.  The consultants would rather see someone that outperforms by a tiny bit each period, than a manager that outperforms by a lot over the same set of periods, but with a lot of variability.  They are the opposite of Buffett’s phrase, “I would rather have a lumpy 15% than a smooth 12%.”

With DB plans, all they care about is investment results versus their benchmark.  They don’t care so much about winning, because they can blame and remove underperforming managers who consistently miss by a little.  What they do care about is those that miss by a lot, because that could cost them their cushy jobs.

This is one area of investing that I would purge if I could; in general, the fund manager consultants do little for the plans they serve.  Far better if the consultants actively analyzed risk, and encouraged plans to take more/less risk when circumstances favored/disfavored it.

Instead, they propagate views that are risk-neutral, as if all styles are equally valid all of the time, and all asset classes are equally valid all of the time.

Now with individuals the game is different, because there are ways to add value through tax-management, and in some cases, ethics management.  With pension plans, those issues are moot.

Now, if you have a good track record of delivering alpha with little variation versus some sector of the market, or the market as a whole, advertise that to the fund management consultants.  Get in the databases.  It’s all a performance game, and one with little tolerance for variability versus their benchmark indexes.

So, part of the reason for your difficulty stems from this: the market to serve individuals is a free market, albeit one where there are a lot of charlatans plying their trade.  The market for DB plans is a bureaucratic market for the most part, one where sponsors who don’t know investing abandon their responsibility to other who have modest math skills, but who also don’t know investing.

That is your problem, and mine as well.  More is the pity for the sponsors of DB plans.  They are the ones who get hurt in the long run.  A pity they never learn, but only terminate.

This is a continuation of an irregular series which you can find here.  Maybe if I were more scientific, I would have called it “All Exponential Growth Processes Run Into Constraints and Threats,” or if I were more poetic, “Nothing Lasts Forever — Nothing Grows to the Sky.”

Regardless, simple modeling is the bane of long-duration financial calculations.  I remember talking with some friends who served on a charitable board with me, about some investment grade long bonds (11-30 years) that I had purchased for a life insurance client that yielded 7-9% in late 1999.  They said to me that it was foolish to lock up money for so long in bonds, when you could earn so much more in stocks.  My three comments to them were:

• Prohibitive for life insurers to hold equities
• At current levels of the market, the yield of these bonds more than compensates for the possibility of capital growth in equities (valuations are stretched)
• The risk in the bonds is a lot lower.

And, I said we ought to shift shift our charity’s asset allocation to more bonds, as we were invested past the maximum of our guidelines in equities.  They looked in the rearview mirror and said that we were doing fabulous.  Why change success?

I was outvoted; I was a one-man minority.  There are a lot of people who would have loved to make that change in hindsight, but done is done.  I ended up leaving the board a year later over a related issue.

Now, don’t think that I am advising the same in 2011.  We may be headed for significant inflation or deflation; it is difficult to tell which.  Bonds offer little competition to equities here.  Commodities and cash may be better, but I am reluctant to be too dogmatic.  If the economy turns down again, long Treasuries would be best.

Here’s the difficulty: most people have been trained to think at least one of a few things that are wrong:

• That we can use simple models to forecast future outcomes.
• That average people are capable of avoiding fear and greed when it comes to investing.
• That financial markets are random in the sense that last period’s return has no effect on the returns of future periods.
• Over long periods of time, average investors can beat long Treasuries by more than 2%/year.  (Corollary to the idea that the equity premium is 4-6% versus 0-2%/year over high quality bonds.)
• That financial markets are expressions of what is going on in the real economy.
• That the real economy tends toward stability
• That government actions make the real economy more stable

I’m prompted to write this because of two articles that I ran across in the last day: Retiring Boomers Find 401(k) Plans Fall Short, and Stay Out of the ROOM (registration required).

I’ve written about this before in many places, including Ancient and Modern: The Retirement Tripod.  And yet, when I wrote about these issues 20 years ago, one of the things that I tried to point out was that as the demographic bulge retired, it would be difficult for homes and asset markets to throw off the returns necessary, because there would not be enough buyers for the assets/homes.  If a large portion of the population wants to convert assets into a stream of income — guess what?  They are forced sellers, and yields that they will get will be compressed as a result.

In a situation like that, those that are better off, and can delay turning all of their assets into an earnings stream should be disproportionately better off.  As with corporations, so with individuals/families: those with slack assets and flexibility are able to deal with volatility better than those for whom the environment must be stable/favorable for the plan to succeed.

Now, the Wall Street Journal article points at the problems of 401(k) plans.  What they say is true, but the same is true of other types of defined contribution and defined benefit plans.  When assets underperform, and/or investors make bad choices, guess what?  The pain has to be compensated for somehow:

• 401(k): They will work longer, maybe all of the rest of their lives, and cut back on expenses and dreams.
• Non-contributory DC: maybe the employer will ask them to kick in voluntarily, or he might give more.  Also same as 401(k)…
• Private sector DB plans: employers may contribute more, or they may terminate them.
• Public sector DB plans: Taxes may rise, spending cuts enacted, forced contributions to retiree plans negotiated, plans terminated for a 457 plan, partial plan termination, job cuts, funny accounting practices (worse than the private sphere), brinksmanship over debts, etc.

Note that one of the answers is not “take more risk.”  First, risk and return are virtually uncorrelated in practice.  Only when enough people realize that might risk and return become positively correlated.  Second, there are times to increase and decrease risk exposure.  Typical people won’t want to do that, because of euphoria (the example of my friends above) and panic.  The time to add to high risk assets is when no one wants to touch a high yield bond.  More broadly, always look for asset classes that throw off the best cash flow yields, conservatively estimated, over the next ten-plus years.  Be sure and factor in the likelihood for economic regime changes and capital loss, inflation, deflation, etc.

Good asset allocation marries the time horizon of an investor to the forecasts for future returns, conservatively stated, and considers what could go wrong.  At present, investment opportunities are average-ish.  I would be wary of stretching for yield here, or raising my risk exposure in equities.  Stick with high quality.

And, for those that are retired, I would be wary of taking too much into income.  I have a simple formula for how much one could take from an endowment at maximum:

• 10 Year Treasury Yield
• Plus a credit spread — 2% if spreads are sky-high, 1% if they are good, 0.5% if they are tight.
• less losses and fees of 0.5% — higher if investment expenses are over 0.25%.

Not very scientific, but I think it is realistic.  At a 3.5% 10-yr T-note yield, that puts me at a 4% maximum withdrawal rate, given a 1% credit spread.  This attempts to marry withdrawals to alternative uses for capital in the market.  You may withdraw more when opportunities are high, and less when they are low.  (But who can be flexible enough to have a maximum spending policy that varies over time?)

Now some of the advanced models that calculate odds of retiring successfully are a step in the right direction, but they also need to reflect demographics, time-correlation of returns, regime-shifting returns/economics, etc.  Things don’t move randomly in markets; that doesn’t mean I know which way things are going, but it does mean I should be cautious unless the market is offering me a fat pitch to hit.

These statements apply to governments as well, and their financial security programs.  In aggregate, investments can’t outgrow growth in GDP by much, unless labor takes a progressively lower share of national income.  (And who knows, but that the pressure on union DB plans to earn high returns might lead to takeovers/layoffs in private firms…)  The real economy and the financial economy are one over the long haul, but can drift apart considerably in the intermediate-term.

In summary, any long promise/analysis/plan made must reflect the realities that I mention here.  We’ve spent years on the illusions generated by assuming high returns off of financial assets.  Now with the first Baby Boomers trying to retire, the reality has arrived — sorry, not everyone in a large birth cohort can retire comfortably.  Wish it could be otherwise, but the economy as a whole can’t generate enough to make that proposition work.

I don’t intend that this series have more parts, but if one strikes me, I will write again.

Since the mid-1980s, when a number of cranks argued that the balance sheet of the US needed to be laid bare, including off balance sheet items like Social Security and Medicare, there came a statutory requirement that there would be a Financial Report of the US Government.

Here is fiscal 2010′s report.  Page with more options here.

Now let me give you my summary of the 2010 report.

Note the large drops in net liability for Medicare parts A & B.  This is the effect of the “Affordable Care Act.” (My, what an Orwellian name.)  Yes, Obamacare, in order to get the bill passed, said that there would be reductions made to reimbursements for Medicare.

The benefits from Medicare are statutory, and are not rights, per se.  Yet there are human needs that prompt the estimates, at least on average.

That is why I don’t think that the 2010 report is accurate, and they agree with me in their verbiage:

The extent to which actual future Part A and Part B costs exceed the projected current-law amounts due to changes to the productivity adjustments and physician payments depends on both the specific changes that might be legislated and on whether Congress would pass further provisions to help offset such costs. As noted, these examples only reflect hypothetical changes to provider payment rates.

It is likely that in the coming years Congress will consider, and pass, numerous other legislative proposals affecting Medicare. Many of these will likely be designed to reduce costs in an effort to make the program more affordable. In practice, it is not possible to anticipate what actions Congress might take, either in the near term or over longer periods.

The Medicare Board of Trustees, in their annual report to Congress, references an alternative scenario to illustrate the potential understatement of costs under current law. This alternative scenario assumes that the productivity adjustments are gradually phased out over the 15 years starting in 2020 and that the physician fee reductions are overridden. These examples were developed by management for illustrative purposes only; the calculations have not been audited; and the examples do not attempt to portray likely or recommended future outcomes. Thus, the illustrations are useful only as general indicators of the substantial impacts that could result from future legislation affecting the productivity adjustments and physician payments under Medicare and of the broad range of uncertainty associated with such impacts. The table below contains a comparison of the Medicare 75-year present values of income and expenditures under current law with those under the alternative scenario illustration.

ObamaCare assumes/demands that it can pass through cost reductions to Medicare recipients.  The difficulty is whether doctors and other healthcare providers will accept reduced payments.  What is a reduction in payment may become a reduction in service.  Who cares if you have Medicare, if few doctors are willing to accept it?

Public Statement

I would be much happier if we placed healthcare to be an ordinary matter, not something where the government intervenes to assure coverage.  When Medicare was created in the ’60s, the costs of assuring coverage was low, but the government did not accrue the assets to pay for the future coverage.  Then again, neither did the budding health insurance business, which relied on estimates of uninsured health care usage to price products, and was surprised to find that usage rises when one is insured.  (Just as many health insurers in the present day underpriced high deductible policies for HSAs, assuming that utilization would go down a lot.  Instead, it went down a little.

Today, we face a shortfall in most municipalities, where there is not enough to pay benefits, absent an increase in taxes from the municipalities.  The taxes will be a continuing burden for municipalities.

Beyond Municipalities

The government can assume that there will be less cost from Medicare.  That bogus concept allowed the “Affordable Care Act” to pass.  But will Congress have the guts to stand behind their actions when oldsters complain?  I doubt it, so I think costs will be considerably higher here.

How much higher?  Well, deep in the report on pages 129-131 they suggest an alternative scenario:

This alternative scenario assumes that the productivity adjustments are gradually phased out over the 15 years starting in 2020 and that the physician fee reductions are overridden.

The result is a $12.3 trillion increase in the net present value.  Now it would have been nice, and the actuaries could have done it, if they would have broken out separately:

• The effect of the productivity phase-out
• The effect of overriding the physician fee reductions.
• And even, just showing what the difference would have been if they had run the calculation using last year’s assumptions.

That last one is the key omission.  As it is, I can’t tell but can only guess at how much higher the liabilities of the government are, going from 2009 to 2010.  Compared to using the 2009 assumptions, the 2010 liability figure is understated by $12.3 trillion minimum.  My guess on the 2010 liability has the present value of expenses for Medicare parts A & B running ahead at 7% from 2009 to 2010, which is similar to many prior years in the recent decade, if not on the low side.

To see the total liabilities rise by $4.5 trillion in fiscal 2010 isn’t unreasonable, when one sees that the net debt has gone up by $2.0 trillion, and add in the natural drift of underfunded entitlement plans in a slow economy, where unemployment is high.  Not counted in the estimate is the payroll tax holiday, which is a ridiculous policy because employers do not respond to temporary measures, and Social Security is already in bad shape.

So, there is little reason for cheer in this financial report.  In closing, here are a few charts using my estimate for 2010:

Until next time, fare well, good readers.

This is a post about economics, but it will probably sound more political than most.  Part of being mature is learning to live within boundaries.  No, not everything is possible.  Immature people like Bush II, Obama, JFK, and FDR tell us that we can have our cake and eat it too.  It is not an uncommon positions for assume, particularly when they can use a particularly large cohort of workers as a tool to sap revenue from, while not retaining the funds for retirement benefits.

That said, I can look at the past and be a critic.  That’s easy, there have been real jerks that have milked our society, and retained a good name, though they robbed the future to pay the past.  It is criminal what municipal politicians have done, hiding behind high assumed investment assumptions, supported by brain-dead consultants who assumed markets are magic, and always provide high returns.

But there are enough targets in the present.  The evil party, the Democrats, ignore the long run effects of their deficits, and ignore the entitlements crisis that will engulf the nation.  The stupid party, the Republicans, rolled over for the idiocies of Bush II, and ignored the long term effects of debts and entitlements.

But there is a new force of anger, the t-party.  And that is about all they have, is anger.  They want their taxes reduced, but don’t want large entitlement programs reduced, or defense.  They represent small-minded libertarianism.  I am an economic libertarian, but I recognize that my views mean real pain for many in the short run, though I think those policies will be best for all in the long run.

There was a real loss in our nation when we abandoned the idea that national budgets needed to be balanced.  It brings out the worst in politicians when they think money is free, and they can engage in the basest demagoguery with no cost.  As it is today, we would probably be better off electing our politicians via random selection.

I have no sympathy for the t-party.  If you only have economic interests, and aren’t willing to take stands on broader ethical questions, you do not deserve to be our rulers.  Government is ethical as a rule, and the most important questions are what behaviors we encourage and discourage in our society.

I have a further concerns.  Leaders should not be merely facile rhetoricians, but should be genuinely mature.  I cringe listening to the t-party endorsed politicians, because they aren’t mature enough to rule.  If you can’t control what you say, and how you say it, you don’t have enough control over yourself to be one who promotes order in society.

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I wrote the above three weeks ago and sat on it.  After writing it, I said to myself, “This is not one of your better works, are you going to say that?”  After review, I am saying this with full conviction.  Most t-party candidates are not ready for prime time.

Take Sarah Palin as an example. Sarah Palin is a bad joke.  If she is such a good Evangelical Christian woman, why is she not at home taking care of her young children, particularly the one with Down Syndrome.  Or, why was she occupied with Alaska politics at a time when she should have been there for her daughter Bristol, who was about to make some very bad decisions.

Feminism has no place in Christianity.  Men are to lead, not women.  Go home, Sarah.  Homeschool your children, if you can. I would not say this to a woman outside the Church, but since you claim to be one of the disciples of Christ, I say it to you.

I say this as a leader in the Church, ordained by the elders of my presbytery, in a Bible-believing church.  There is no good that comes from neglecting your own home to address the problems of the nation.  Sarah Palin is no Deborah.  Deborah was wise, and Sarah Palin is not.

I fear God more than I care about the political direction of this country.  As the Apostle Paul said, “Shall we do evil, that good may come?”  Paul spoke rhetorically, saying that we should do what is right, regardless of the results.  There is no good that comes from trying to save society, when our own house is not in order.

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I could talk about the other t-party candidates and their idiocies.  Time would fail me.  I am in favor of a brainy libertarianism and Biblical morality, rather than a brain-dead libertarianism, and appeals to general morality.

The most pressing and immediate economic problem is this: we are facing a funding crisis for all of the promises made by governments and corporations regarding retiree employee benefits.  Every day I see more articles about the pain municipalities are going through over funding pensions, with occasional pension strengthening from corporations.

The sins of past governments, making promises that could not easily be fulfilled, or, at least fairly funded in the short run, are coming home to roost.  Funding issues for all levels of government are rising.  It doesn’t matter if you have met the budget this year, however you have done it.  Next year will be worse, because the assets will not throw off enough income to satisfy the liabilities over the intermediate-term, across the whole nation.

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We go to the polls in the US today, but no one dares talk about the funding crisis.  They talk of tax cuts or protecting benefits, while at the same time the economic decay continues, where debt grows, and ability to repay it declines.

It is a sad state of affairs, and indeed, I despair over it.  I love my nation, though I do not support its wars or its economic foolishness.  Unlike what Reagan said, America is not the last best hope of man on Earth, rather it is the God-man Jesus Christ, to whom we must all eventually answer.

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If I have a fault economically, it is that I look to the long-term.  For me, it is Heaven, though on Earth it is what will happen to my great-grandchildren and beyond.  Our policies are slanted to the present, and will force those who are younger to pay far more than they ought to pay, because they will be carrying the profligacy of the Baby Boomers.

No party is seriously looking at the future funding crisis.  There are little hints among the municipalities that are the worst running into problems now.  Those problems will only grow, and spread.  The problems in the unfunded Federal plans will be a plague in their time.

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This is an unusual post for me, prompted partly by the elections, because I don’t think anyone from an economic standpoint is addressing the real problems that we are facing.  Mere politics prevails for now, with fine-sounding but empty words telling the electorate that they will be restored to prosperity.

There are bigger forces in play here.  Consider my old piece, Rethinking Comparable Worth; as it stands, less skilled labor in the US should see wage declines as the rest of the world becomes more competitive.  Unskilled labor is not scarce. Skilled labor is somewhat scarce. Good ideas are scarce.  Real capital is scarce, but financial capital is not scarce.  Commodities vary in scarcity.

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I see this as a time for the US to “grow up,” and see that there are no easy solutions, but that it will take shared sacrifice to preserve our nation.  Taxes will have to rise while benefits are cut.  Keynesians will scream, but the average person in the US will see it as fair, because they know that everything must be paid for; there is no free lunch.

Do you have a lotta money?  Lotsa, lotsa money?  And is it liquid?  More than $5 million?  If so, I have a book that could help you, The Insured Portfolio: Your Gateway to Stress-Free Global Investments (Agora Series).

There are risks that the rich want to avoid, or at least minimize:

• Losses from lawsuits
• Estate taxes
• Income taxes
• Lack of flight capital, if things go really bad
• Inflation, or loss of purchasing power
• Fear of US degeneration: Do you want leave the US, renounce your citizenship, and minimize/eliminate your tax liability in the process?  It can be done, at least at present.

The first chapter describes the rise and decline of America.  It is a bit harsh, but for one following demographic trends, it is accurate.  So, why should you keep money in America, if things are so bad?  (Uh, stable politics, relative freedom…)

The second chapter introduces international investing, because diversifying internationally offers greater possibilities for profit and capital preservation, given the greater tendency of the US to inflate the currency.  To the authors, it is a panacea, and I find it somewhat unrealistic.

The third chapter goes into wills and trusts. How do you want to distribute your money after you die?  How much control do you want until then?

The fourth chapter describes insurance policies that minimize taxation, while allowing for limited asset diversification. The strategies are pretty basic, I have seen better.

The fifth chapter goes into tax havens.  Where can you minimize taxes and other costs best? I found this to be pretty boilerplate; if you pay attention, the tax havens are well-known, with their relative liabilities.

The final chapter tries to tie it all together, but it is all generalities, with little additional substance.

This book would be useful to someone who has prospered dramatically and has never considered wealth preservation.  It gives a taste of all of the tools, but does not give enough to execute the tools on their own.  You will have to hire bright  experts to protect your wealth, but at least you will know what they are  doing, and will be able to spot phonies.

Quibbles

I dislike Agora because of the doom-and-gloom outlook that they possess, but this book does not share in that flaw to any large degree.  All of that said, all strategies that use insurance products are very expensive, and there is no proof that you can obtain above average returns on the assets.  The authors talk a good same, but they offer little proof of superior performance.

Who would benefit from this book:

Only the very wealthy could benefit from this book, and many of them have wealth advisers already, who can help them with tax avoidance and estate protection.  But this gives a good introduction to the topic so that a person could be wiser in hiring an adviser.  He would know what the issues are.

If you want to, you can buy it here: The Insured Portfolio: Your Gateway to Stress-Free Global Investments (Agora Series).

Full disclosure: I asked the publisher for a copy, and they sent one to me.

If you enter Amazon through my site, and you buy anything, I get a small commission.  This is my main source of blog revenue.  I prefer this to a “tip jar” because I want you to get something you want, rather than merely giving me a tip.  Book reviews take time, particularly with the reading, which most book reviewers don’t do in full, and I typically do. (When I don’t, I mention that I scanned the book.  Also, I never use the data that the PR flacks send out.)

Most people buying at Amazon do not enter via a referring website.  Thus Amazon builds an extra 1-3% into the prices to all buyers to compensate for the commissions given to the minority that come through referring sites.  Whether you buy at Amazon directly or enter via my site, your prices don’t change.

Two notes before I begin: I will be in New York City next Wednesday, and maybe Tuesday or Thursday.  I will be meeting with potential investors.  If you would like to hear what I am up to, e-mail me, and maybe we can get together.

Also, if you have a moment, have a look at my friend Cody’s website that deals with applications for mobile devices.  He seems to have found an interesting new niche.

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When I was a kid, I remember reading a story about a business that started a letter delivery service in a major American city, I think it was Philadelphia.  They undercut the US Postal Service by about 20% or so, and they began to attract a decent amount of volume, such that government came and shut them down, because USPS has a monopoly on delivering non-urgent mail.

Unfortunately for USPS, it has a much larger lower cost competitor: the Internet, which is eating into its high margin businesses, forcing prices up as it tries to maintain its subsidy to activities that lose money.

The Internet improves and destroys.  The economics of newspapers has been destroyed by the internet.  Should we be surprised that the economics of a similar business, the Post Office, is suffering similar troubles?  Delivering paper mailings to addresses seems to be populated by junk mailers and a variety of businesses that could deliver via e-mail.  I get few personal letters for my family, and many of those could go via e-mail.

This is a system that is looking for a kick to get it to move from an unstable equilibrium, perpetually asking for price increases, and service decreases, to a stable equilibrium where people receive almost all mail traffic over the internet.  So, what if we replaced the postal service two years from now?

If there were two years of lead time, older folks would be forced to adapt to e-mail, and advertisers would find new means contacting clients.  Some clever businesses would buy up post office sites, perhaps UPS and Fedex, and augment their businesses.

It would be likely that the cost of purely local mail delivery would go down in densely populated areas, but that delivery outside of major urban areas would be considerably more expensive, and would depend on the location of both the sender and the receiver.

The price differences would become similar to the price of a person traveling from one place to another.  Is it hard and costly for you to go from point A to point B?  It would be the same for mail.  Sending a piece of mail from one low density area to another would be expensive.

Now, I don’t think the postal service will go away in two years.  But ten years down the road the answer might be different.  Here are two alternative visions of the future:

• Post Office Shows Where U.S. Is Headed: Kevin Hassett
• Testimony of the current Postmaster General

Now, I think Hassett is mistaken when he says, “We need only write regulations that require firms that compete for postal business to provide universal service.”  The US is a big place, with a lot of sparsely populated areas.  The countries that have privatized are typically more compact, making it possible to have netorks that deliver everywhere at a reasonable cost.  Universal service will come with astronomical pricing for low density deliveries.

But I think the Postmaster General is mistaken when he estimates the total amount of demand over the next ten years.  I think that more and more will go online, with many businesses making people pay extra to receive paper bills, statements, etc.  Paper mail is not only costly to deliver, but costly to create.

People will also evaluate the postal service on convenience as well.  As the number of days for delivery declines to five, and local post offices and local delivery diminish in rural areas, people will begin asking for more to be delivered via e-mail.

One final note: I find it tragic/comical that USPS does with its employee benefit plans what all companies and governments should do: fully fund them.  But now they are looking to raid the funds to support current services, and push back on the  Federal government to absorb more of certain shared costs.  I think it is amazing to call funding 30% of retiree healthcare and 80% of pensions to be “fully funded,” because those are the average levels of many corporations.  Raiding the funds may help today, but ten years out, as postal workers age and retire, this will place even more expense pressure on postage rates.

Eventually the economics of a situation prevails.  The proposed move with the employee benefit plan is desperate.  Eventually a significant change will have to be made to the US Postal Service.  It would probably be better to think about an integrated plan today, than let ten years elapse, and face a larger crisis.

Given the nature of the US, and the short-termism that plagues us today, I suspect that we get the crisis.