Category: Public Policy

Fannie + Goldman + US Treasury + Tax Credits = Complex Mess

Fannie + Goldman + US Treasury + Tax Credits = Complex Mess

In a prior job, I spent a decent amount of time on Affordable Housing tax credits.? The idea was to reduce my life insurance company client’s taxable income to the point where they would be close to but not subject to the corporate alternative minimum tax.? Occasionally my work would take me on trips to industry conferences on Affordable Housing.? When I would go to these meetings, there would be a panoply of players there — Banks, Insurers, Utilities, perhaps a health insurer or two, and a few other odd tax-focused companies would attend.? In? addition to tax benefits, often banks could get some amount of Community Reinvestment Act [CRA] credits for financing affordable housing.

Oh, there were Fannie and Freddie, also.? They each represented 1/3rd of the investment base, leaving 1/3rd to everyone else.? So at the conferences, there would be a lot of them around.? Throw a rock, hit someone from a GSE.

The tax credits made a lot of sense for Fannie and Freddie back when they were profitable.? The credits/deductions minimized their taxes.? (They had numerous tax reduction schemes, but this was a big one.)? But now Fannie and Freddie are unprofitable, and it is less than certain as to when they will ever be profitable again. It would make a lot of sense for Fannie and Freddie to sell their Affordable Housing deals to some profitable entity that can use the reduction in taxes.

I have gone through a deal like this for a former client back in 2000.? It’s complex but not impossible to do.? The problem for Fannie Mae in this case is that they are now controlled by the US Treasury, and the prospective purchaser is Goldman Sachs.? Very bad optics.? The US Treasury does not want to look like it is favoring Goldman by approving the deal, and it is conflicted in its decision, because allowing the transaction will cause the Treasury to take in less taxes, though it might increase the value of Fannie.

This is what you get for having the Government take stakes in businesses that they regulate, rather than doing a simple liquidation of a very large failed enterprise.? (Stories from NYT, WSJ)? Both business and politics end up worse off when they are not kept as separate as possible, so that the ordinary conflicts between the two stay at the level of business pushing back over regulations and the government attempting to correct business abuses.

I don’t know where this one goes.? Goldman buying the tax credits should have been a moderately complex deal, but the complex interests of the US Treasury make the matter much more difficult.? My intuition says this won’t be the last time we see a conflicted situation like this in the near term.

Seven Recommendations: A Government More Responsive To Its Citizens

Seven Recommendations: A Government More Responsive To Its Citizens

This is not a political blog.? That said, almost all writing on economics and business embeds a political point of view.? I recognize that my view is relatively libertarian with respect to economics/business, but conservative with respect to ethical issues.? There are a few things that I think would get wide agreement from many parties, aside from those entrenched in DC.? That is what tonight’s post is about.? I think that I will not post like this often.

1)? End gerrymandering — all congressional and state districts should follow the following rule: The ratio of the square of the circumference to the area of a district should not exceed 30. This would make representatives less partisan than is common today, because they would have to be elected by groups closer to a random sample of the people in a given area.? Exceptions would be granted for non-negotiable boundaries, like state and national boundaries.

2)? Make them read the bills publicly.? We have a health bill that is 1990 pages long.? Make them read it, and make the legislators listen.? Whip those that fall asleep.? Further, let the bills fully express the changes made in a plain english manner.? Amendments to existing laws must be written out in entire, rather than referencing a code, and saying that it has been deleted, amended, etc.

3)? Limit the length of bills.? The Law of God through Moses was far more comprehensive, and is far shorter than even most narrowly focused bills.

4)? Flesch-test all bills.? Make them simple enough to be understood by ninth-graders.? Hey, they force this on insurance companies!? Do you suppose that laws which should have universal application should be different?

5)? Publish an abstract of all major laws that affect citizens once every five years.? Give a copy to every adult citizen.? Let this be done in every state as well.

6)? Re-emphasize the ninth and tenth amendments to the Constitution.? Those amendments are supposed to maximize liberty for states and individuals.

7) Amend the Constitution to make Federal and State laws superior to treaties.? I know what mischief this would do, but I would rather be ruled by my local peers than by foreigners who have no understanding of what our American system is like.

Would that we would do this.? Our government is less and less understandable to the average citizen.? If we want our government to exist for a long time, we need to put into place reforms that will cause the government to be more responsive to its citizens.

Some Praise and Questions for the US Treasury

Some Praise and Questions for the US Treasury

1) Perhaps the US Treasury is getting a few things right.? Let’s start with lengthening the average maturity of Treasury debt.? I have backed this idea in the past.? It is worthy to note that zero coupon yields peak out around 20 years out, and then start declining.? It is quite possible that debt longer than 30 years might price at a discount to 30-year debt, if for no other reason than there is a demand for longer debt as an asset to fund longer liabilities with seeming certainty.

The US Treasury is finally getting some sense in this matter, and is looking to lengthen their maturity profile.? Good for them; let’s see if foreign investors are willing to take down longer-dated dollar-denominated debt.

2) I have also encouraged the concept of liquidating institutions that are “Too Big to Fail;”? I believe they deserve a special chapter in the bankruptcy code.? Well what do you know?? Congress is proposing much the same idea. (Ugh, Barney Frank agrees with me?? But, so does Sheila Bair.? Better company.)? Here are some of the details.? Far better to liquidate such institutions rather than bailing out the holding companies (what idiocy!).? That said, why would we give more money to GMAC?? It is not critical in a systemic sense.? Let it go under.

3) Most stimulus programs waste money.? Better to rebate taxes to everyone equally.? It is fairer than choosing favorite firms or markets.? With that I would argue that it is time for the first time buyer credit to end in residential real estate.? Most of those that bought would have bought anyway, and the credit benefited sellers more than buyers as it pushed prices up for now.

4) The efficient markets hypothesis did not mean that market prices are always right, as if we hit that evanescent neoclassical equilibrium.? No, prices are always wrong to some degree, but that does not mean it is easy to recognize the mistakes.? So I limitedly back Jeremy Siegel, who says that the efficient markets hypothesis was not to blame for this crisis.? That said, common misunderstandings of the EMH did affect the crisis, because markets do self-correct, but over years and decades, not months or days.

5) If you had the ability to ask one question to Tim Geithner, Secretary of the Treasury, what would it be?? I have my list, but maybe I am off base.? As I close for the morning, here are my questions:

  • Haven’t low interest rates boosted speculation and not the real economy?
  • We are looking at big deficits for the next seven years, but what happens when the flows from Social Security begin to reverse seven years out?? What is your long-term plan for the solvency of the United States?
  • We talk about a strong dollar policy, but we flood the rest of the world with dollar claims.? How can we have a strong dollar?
  • None of your policies has moved to reduce the culture of leverage.? How will you reduce total leverage in the US?
  • Why did you sacrifice public trust that the Treasury would be equitable, in order to bail out private entities at the holding company well?? People now believe that in a crisis, the government takes from the prudent to reward the foolish.? Why should the prudent back such a government?
  • If we had to do bailouts, why did we bail out financial holding companies, which are not systemically important, instead of their systemically critical subsidiaries?
  • We are discussing giving tools to regulators for the tighter management of the solvency of financials.? There were tools for managing solvency in the past that went unused.? Why should we believe the new “stronger” tools will be used when the older tools weren’t used to their full capacity?? (The banks push back hard.)

I doubt that I will get a chance to have those questions answered, but who knows?? From Quantcast, I know that some at the US Treasury and the Federal Reserve (I have my own set of questions there) read my blog regularly, so I leave it up to them ponder my questions, whether I ever get answers or not.

Book Review: The Predictioneer’s Game

Book Review: The Predictioneer’s Game

Most of us were kids once.? I think I was a kid once, but my memory is fuzzy.? I do remember playing the card game “War.” Nice game, but suppose if you were dealt a weak deck you had the option to look at the opponent’s deck, and stack yours to meet the challenge.? That would be a sharp example of how game theory could be used to defeat a stronger player.

This book is a little further afield than I usually go, because this is not an economics or finance book in the traditional sense.? The Predictioneer’s Game describes using game theory to solve complex problems, and possibly, affect the results in your favor, or, the favor of your client.

The author, Bruce Bueno de Mesquita is a professor of political science at NYU, and a senior fellow at the Hoover Institution.? Though he uses game theory in his academic work, on the side, he uses game theory in his own firm to analyze tough policy, business, and legal questions.

His methods are simple and complex.? Simple, because the math at first glance isn’t that difficult, but complex, because many different iterations of the simple model must be considered using a computer.? Often the answer that the computer spits out is a surprise that reveals that there is a clever strategy to achieve an unusual result.

There are many elements that go into building such a model.? It begins with designing the question in a way that facilitates sharp opinions from experts.? The experts name all of the parties that have an interest in the outcome, and:

  • What their desired outcome is.
  • How motivated they are to achieve their desired outcome.
  • How influential can they be with other parties in the dispute.
  • How much they want an agreement, even if it is not their favored outcome.

The experts rate all of the parties on those variables on a scale of 0 to 100.? Then the math starts, analyzing what sorts of coalitions can develop to come to an outcome that satisfies those with the most influence and motivation.

Now, I don’t buy in entire his view that everyone is strictly motivated by self-interest.? I have adopted five children, in addition to having three with my wife.? Yes, we wanted a large family, but we would have been happy with fewer.? We saw this as something good for society on the whole, as well as the church, which made us more willing to adopt.? If we are going to argue that a person having love for their culture or for their church is an expression of self-interest, then please tell me what would be self-disinterest.? To use an example from the book, I have mixed feelings about “Mother Teresa,” but I have little doubt that she did what she did out of devotion to the Catholic Church, and not out of self-interest.

That said, until proven otherwise, assuming any party is entirely self-interested is probably correct to a first approximation, which is why game theory is so applicable to complex problems.

Bruno de Mesquita has quite a track record according to the CIA:

Since the early 1980s, C.I.A. officials have hired him to perform more than a thousand predictions; a study by the C.I.A., now declassified, found that Bueno de Mesquita?s predictions ?hit the bull?s-eye? twice as often as its own analysts did.

As a result, I tend to believe his claims as he goes through the book.? He has helped solve some tough political and business problems. Most of the examples in the book fall into legal or political categories, though there are a number of examples for the business world: CEO succession (funny), merger negotiations, and how to buy a new car.

The last will pay for the book on its own.? I have used the technique twice before, and it works.? That said, that I have used it twice before means it is not unique to the author.? (For those buying used cars, I have another approach.)

Now, the author offers the opinions of his models on:

  • What will happen in the global warming negotiations?
  • Will Iran develop a nuclear bomb?
  • Will Iraq and Iran develop an alliance?? (Note: there is no explicit mention of the Saudis in this discussion, which I think is a major miss.)
  • Will Pakistan continue to cooperate with the US in the “war on terror?”

Good questions all, but I would ask the following questions:

  • How will the various nations of the world fare through the coming demographic crises?
  • Will the US Government pay off its debts in real terms, or will they inflate the debts away?
  • Will the US Dollar remain the global reserve currency?? If not, then for how long?
  • When will the Communist Party lose control in China?

Perhaps the author could favor us with some answers, but regardless, I recommend the book to all that have interest in predicting the outcomes of complex situations.

Who will benefit from the book?? This is a book that many will benefit from, because the subject area is broad, and the ability to turn the windmills of the mind are considerable.? For those who want to buy it, they can buy it here: The Predictioneer’s Game: Using the Logic of Brazen Self-Interest to See and Shape the Future

Full disclosure: my goal is to have alignment of interests between me and my readers.? I don’t want any of my readers buying something only to benefit me.? But if you want to buy something at Amazon, please enter it through my site — you buy at the prices that you like, and I get a commission.? I like the fact that my readers get what they want at no additional cost as they aid me.? I look for win-win situations, and this is one of them.

Avoid Investment Scams and Bad Advice, Redux

Avoid Investment Scams and Bad Advice, Redux

After the last article on this topic, you would think that they would take me off of the mailing list.? But no.? Wait!? How did GTX Corp do after I wrote my article?

In short, when I wrote, the price went down temporarily, and then rebounded as the flyer advertising GTX circulated among the uneducated masses.? Since that time, the price is down ~90%.

If the advertising group pushing GTX Corp had any self-awareness, you would think they would take me off of their mailing list.? Sad to say, I have a new microcap stock to share with you:? Bonanza Goldfields Corp. [BONZ]

In an era where many fear inflation, an appeal to gold has credibility, and could draw those who think they missed out on the move upward.? The flyer has many evocative images — gold coins, gold bars, etc.? The aura of wealth is palpable.? They appeal to the troubles at present, and suggest that gold is the solution, and that the price of gold will rise as a result.

Because I don’t want to be sued, I am not identifying the researchers — I call them ABC and XYZ.

They give the sense that there are very promising finds of gold to be made from Bonanza Goldfields.? These claims are made in big type, while in small type, the following is written (yes, no paragraphing):

IMPORTANT DISCLAIMER: This paid advertising issue of ABC Research (hereafter “ABC Research”) does not purport to provide an analysis of any company’s financial position and is not in any way to be construed as an offer or solicitation to buy or sell any security. ABC Research is a paid advertiser. OTCBB: BONZ is the featured company. XYZ Inc managed the publishing and distribution of this publication. XYZ Inc is a financial communications media company that disseminates information via paid advertisements. Although the information contained in this advertisement is believed to be reliable, XYZ Inc and its editors make no warranties as to the accuracy of the description of any of the content herein. The information contained herein is being republished from publicly disseminated information issued by third parties regarding BONZ and are presumed to be reliable, but neither XYZ Inc Inc or their editors accept any responsibility for the accuracy of such information. Neither XYZ Inc, nor any of their principals, officers, directors, partners, agents, or affiliates are not, nor do we represent ourselves to be, registered investment advisors, brokers, or dealers in securities. Readers should independently verify all statements made in this advertisement. XYZ Inc, as well as various affiliated companies and vendors have received and managed a total production budget of $1,300,000 for this advertising effort and will retain, over and above the cost of production and publication, any amounts that remain as additional compensation for production services relating to the advertising and publishing efforts. This advertisement was not paid for by BONZ or its management. Please make special note that XYZ Inc, their respective principals, officers, directors, shareholders, stakeholders, creditors, partners, agents, or affiliates own shares of BONZ and intend to sell all of their shares in any company profiled at any time, be that before the date of a profile, during the date of a profile, or at any time after the date of a profile, as has been the practice of XYZ Inc, and their related parties on many previous occasions. Past performance does not guarantee future results. The information contained herein contains forward looking information within the meaning of Section 27 A of the Securities Act of 1933 and Section 21 E of the Securities Exchange Act of 1934, including statements regarding expected continual growth of the featured company. The information contained herein includes forward-looking statements within the meaning of the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995. Reference is made in particular to the description of BONZ’s plans and objectives for future operations, assumptions underlying such plans and objectives and other forward-looking statements included in the information provided. Such statements, which contain terms such as “expect”, “believe”, “anticipate”, “suggest”, “plan”, “indicate” and similar terms of uncertainty, are based on management’s current expectations and beliefs and are subject to a number of factors and uncertainties which could cause actual results to differ materially from those described in the forward-looking statements. All statements relating to operational results are hereby qualified in their entirety by the company’s filings, including its financial statement filings, under the Securities Exchange Act of 1934. Do not base investment decisions on this advertisement. We assume no responsibility for any use or misuse of this material. Consult your investment advisor and do your own due diligence before making any investment in this or any other securities. This report is for INFORMATIONAL PURPOSES ONLY? THIS IS NOT INVESTMENT ADVISE!!!

The grammatical and other errors in the statement are theirs.? But what do we learn from it?

  • This isn’t a security analysis, much as it would appear to be otherwise.
  • ABC Research paid $1.3 million to distribute this advertising.? BONZ did not pay.
  • XYZ owns shares of BONZ, and may sell them at any time.? They have done so with prior companies advertised in the past.

What we don’t learn is what relationship ABC has to XYZ.? I can find ABC on the web, but I can’t find XYZ.? My guess is that ABC and XYZ are affiliates, but I can’t prove that.? Otherwise, why would ABC pay so that XYZ could benefit from the $1.3 million payment, as well as sell into a rising market for their shares?

The “important disclaimer” was printed in teensy 5 1/2 point type in long lines, making it difficult to read.? They weren’t interested in giving clarity.? Where did they offer clarity?? In the big type, often with special coloration or highlighting:

  • OTCBB: BONZ? This GOLD stock is SET to SKYROCKET!!! BONZ could bring up to 600% to your portfolio in the next two weeks.? PULL UP STOCK QUOTE NOW
  • ABC’s latest stock profile featured OTCBB: BONU? The stock skyrocketed from $0.25 to $3.5 for two weeks in August 2009.? OTCBB: BONZ will be an even bigger winner.
  • OTCBB: BONZ BONANZA GOLDFIELDS CORP.? THE NEXT BIG GOLD STOCK PICK WITH 200-500% UPSIDE POTENTIAL!
  • GOLD IS AT ALL TIME HIGH We believe that gold will hit $2000 per ounce soon and we believe that OTCBB: BONZ will follow the Gold Trend an could hit $2 PER SHARE!!
  • OTCBB: BONZ COULD BE ONE OF THE TOP GOLD PLAYS OF 2009
  • BONZ means $$$$ for your portfolio and HUGE profits!!!
  • Buy OTCBB: BONZ TODAY, IT’S WORTH MORE THAN GOLD!!
  • AGGRESSIVE BUY & HOLD TO $2.90

There’s more, but that’s most of what they wrote in big type to attract the attention of people.? In medium sized-type, the analyst/advertiser spins a tale of how this company has promising land, mainly located in Arizona, where they have done some assays and found some gold, silver, lead, zinc, and copper.? They claim to have an experienced team of people to exploit the resource.

BioNeutral

Before I deal with BONZ, what of the stock BONU that they predicted such gains on — gains that BONZ will exceed?? They included a graph that looked like this for readers:

The company’s name is BioNeutral Group, Inc. Their corporate decription reads as follows:? BioNeutral Group, Inc.manufactures specialty chemicals.? The Company produces chemicals that can neutralize environmental contaminants, toxins, bacteria, viruses, and spores.

But why show such a small graph?? How has BioNeutral Group, Inc. done over the last 12 months?

My, but that was selective.? If I may, it looks like ABC’s report led to a temporary bump in BONU, much as it did for GTXO.? My guess is that better informed people who know the promotion is going on profit at the expense of the rubes who believe their report.? I have not researched BioNeutral, but my guess would be that the stock price would continue to decline, like that of GTXO.

So what of Bonanza Goldfields?

I went and grabbed the 10-K, and the S-1 from their IPO in 2008.? That’s one of the first things anyone should do in a case like this.? What do we learn?

  • Their auditor is not a major auditor, but they still could not issue a “going concern” opinion for the last two years.
  • The firm has negative net worth and negative net working capital.
  • The firm has one asset valued at $99,000, their mining claim, and petty cash.
  • They have no revenues, and have lost money for the past two years.
  • They do not have the resources to explore/exploit their mining claim.
  • From the S-1:? We currently have no employees except the board of directors and officers. We have no employees other than our officer and director as of the date of this prospectus. Our board members currently devotes approximately 5 hours per week to company matters and after receiving funding, they plan to devote as much time as the Board of Directors determines is necessary to manage the affairs of the company. There are no formal employment agreements between the company and our current employees. We conduct our business largely through consultants.
  • From the 10-K: As of fiscal year end June?18, 2009 the Company had 1 employee.
  • From the S-1: During the period ended June 18, 2008, the Company granted to members of the Board of Directors, 6,997,900 shares of common stock valued in the aggregate at $69,979, for service rendered to the Company outside of their responsibilities as members of the Board of Directors and were valued concurrent with maximum price the common stock was sold in a private placement.

    During the period ended June 18, 2008, the Company issued 3,302,100 shares of its common stock for $85,000. The shares were issued to third parties in a private placement of the Company?s common stock. ?The shares were sold throughout the period ended June 18, 2008, at a range between $.01 – .02 per share. (DM: giving them a small gain.)

  • The risk factors are voluminous, consistent with a company that doesn’t have much going on.
  • None of the Board of Directors have any experience in mining listed; the advertisement suggests extensive management experience (over 120 years), though it is silent about mining management experience.
  • Officers own 66% of the firm, as of the date of the 10-K.
  • There are three entities that have provided the financing: Gold Exploration LLC, who sold them the parcel, and gets some royalties.? Taylor Invest & Finance and Venture Capital International have provided financing, and were sellers of shares at the IPO (look at page 11 — also note that there are multiple entities selling stock controlled by the same people.? Odd.)
  • Bonanza Goldfields raised no proceeds in the IPO.
  • I’m not sure I am reading it right, but it looks like Taylor Invest & Finance and Venture Capital International would end up with a large amount of the company if they converted their financing to shares.? The wording is vague.
  • I also can’t explain why “In June?2008 a total of 3,302,100 common shares were sold?to public non-U.S. investors, for an average price of $0.026 per share.”? These same shareholders sold it all for the same price in April of 2009.? The only possible benefit I can see is that it somehow cements relationships with Taylor Invest & Finance and Venture Capital International.
  • They entered into more financing arrangements with Taylor Invest & Finance, and Advantage Systems Enterprises Limited (another seller at the IPO).
  • They split the stock 7 for 1.
  • From the 10-K: At June?18, 2009, there were 72,100,000 shares of common stock of Bonanza outstanding and there were approximately 21 shareholders of record of the Company?s common stock. That is a small number for just having done an offering, particularly when the S-1 said there were just 19 shareholders then.

This filing may connect Mr. Vippach of Venture Capital International and a Mr. Soullier, who might be related to the 40% owner Rose Marie Soullier.? That’s just a curiosity, though; I have no idea if it means something.

The stock did not start trading until May 5th, 2009, long after the IPO in September 2008. It traded around 65 cents a share, a considerable amount above the IPO price.? The current price of 30-33 cents gives the firm a market cap of around $18 million.? Off of the recent financings, they are looking to explore their mining interests.? They have also bought two more interests.? They have enlisted Gold Exploration LLC to help them analyze the property.? (Why should Gold Exploration LLC sell property to them, and then help them analyze it?? Weird.)? Also odd is the cancellation of shares of the #2 shareholder, seemingly for no compensation.? Gold Exploration, LLC, or at least Steve Karolyi, a co-founder, has had dealings with three other microcap miners, Mariposa Resources, Firstar Exploration Corporation, and Zone Mining (now delisted).? I don’t have enough data to say whether it seems fishy or not.

Summary:

There’s a lot of weird stuff here, and a lot of stuff that I don’t know:

  • How does a company with practically no assets, no revenues, and a negative net worth support a $18 million market cap?
  • How are ABC and XYZ related?? What does ABC Research get out of this?
  • Do they have any relationship with BONZ, or those with economic interests in BONZ?
  • How much of BONZ does XYZ own?
  • How are the various financiers related?
  • Is Gold Exploration LLC just a service provider?
  • The advertisement offers no justification for its target prices.
  • The advertisement uses gold as a hook, because it is hot now.

Note: here is a penny stock feed complete with twitter: they think it is going up.? I would, too, looking at the charts, and looking at the advertisement.? But I can’t speculate on stuff like this; it’s unethical.? Stay away — do not go long or short.

As I closed the prior piece — Buyer beware, and don?t listen to strangers giving you advice.? Cultivate networks of knowledgeable friends who are trustworthy, and avoid getting taken for a ride by slick-talking (writing) hucksters who pitch clever ideas to you.? Do your work, and buy cheap, boring ideas like I do.

-=-==-=-=-=–==-=-=-

One note in passing: shouldn’t the SEC have some interest in this sort of advertising?? I mean, at least have a rule that says that legal disclaimers must be in type larger than the largest font size otherwise in the document, and with no other alterations to affect readability.? Then perhaps it would be harder to fool people through advertising that pretends to be research.

Full disclosure:? No positions in any securities mentioned.? This is my opinion only, and not that of my employer.? I’m only interested in honesty in the markets.

OTCBB: BONZ BONANZA GOLDFIELDS CORP.? THE NEXT BIG GOLD STOCK PICK WITH 200-500% UPSIDE POTENTIAL!
Book Review: Think Twice

Book Review: Think Twice

Since I met him at a Baltimore CFA Society meeting in 2001, I have? appreciated the intelligence of Mike Mauboussin.? (My old boss was his roommate in college, so I was told, the name is pronounced “MOE-bus-son.”)? He was early to pick up on the value of behavioral economics and nonlinear dynamics (“chaos theory”).

Think Twice is an effort to get all decisionmakers to take a step back and ask whether they are making decisions from shorthand rules, or from carefully analyzed data.? The book is full of examples of how people are easily fooled by irrelevant data.? Most of the examples I was aware of, becauseI have studied this stuff intensively.? There were a few surprises for me, though.

Did you know that at the craps tables in Las Vegas, on average, when someone wants a higher number, they throw the dice hard, and when they want a low number, they give it a gentle toss?? I found that to be an amusing example of the illusion of control in? a case where humans have no control.

This book helps answer a number of tough questions:

  • When are crowds better than experts, and vice-versa?
  • Why don’t we go get data, rather than listening to anecdotes?
  • Why does an initial estimate play such a large role in estimating the final value?? (Why don’t people ignore the estimates, and start from scratch?? It’s too much work!? Never underestimate the power of laziness.)
  • Can subliminal cues lead people to make different decisions?
  • Do I have to understand the whole system to understand the piece of the system that I am interested in?
  • When can you outsource production, and when does it not make sense?
  • When do catastrophic events occur, and why?
  • How does one sort out happenstance (so-called “luck”) versus skill?

The clear message of the book is don’t be lazy; do your homework on any task.? Try to be objective as possible, ignoring the opinions of others, and using as much data and cold logic as one possesses to confront the problem.? Be aware of the mental shortcuts that hinder good decisonmaking.

I recommend this book, but with a quibble.? It is not written in a truly user-friendly way.? There are technical terms used and not defined that many average people will blink at, and maybe get part of the meaning through context, but not get it in full.? If we Flesch-tested the book, it would come up at “college level” for reading.? (As for me, I am to be understood at a high school level.)

Who can benefit from this book?? Anyone who makes economic decisions could benefit.? It would help them be more self aware of the pitfalls involved in decisionmaking.? I found it to be a breezy read at 143 pages of main text, and the writing style is entertaining.

You can buy the book here: Think Twice: Harnessing the Power of Counterintuition.

Full Disclosure: Anyone entering Amazon through a link on my site, and buying something — I get a small commission.? Your costs remain the same.

To my readers, if you want me to review Mauboussin’s other book, Expectations Investing, I would be more than happy to, because I read it five years ago.? If you have other books you would like me to review, let me know… my time is limited, but if I get a lot of people asking for the same book, I will give it a shot.

PS — look at the book cover — what is the hidden message? (which never gets mentioned once in the book…)

Pension Apprehension

Pension Apprehension

I have a bunch of pieces “ganged up” to go on real estate, international economics, government policies, market risks, and a book review on “Think Twice,” but tonight the topic is pensions, with a side order of Bill Miller.? Hopefully I will get to the other topics next week.

Defined benefit [DB] pension plans have run into the perfect storm: lousy equity returns and low high-grade bond yields.? It makes the last great pension crisis in the late ’70s look good — at least they had higher yields back then.? Thus this article from the Washington Post.? Many pension plans face almost impossible odds of catching up, raising the odds significantly of more plan terminations, where the two main losers are healthy defined benefit plans, who will have to pay higher amounts for PBGC coverage, and pensioners with high benefits, because those benefits will be cut.

That places pension plan sponsors in a bind.? What to do?? Take more risk, contribute more assets to bridge the funding gap, terminate the plan, or declare bankruptcy?? It is worse for US states, who can’t declare bankruptcy.? And municipalities don’t have the PBGC behind them; the pension liabilities are difficult to shake.

Why are there these problems?? Three reasons:

  • Actuarial funding methods were too optimistic for sponsors, and led them to underfund.
  • Investment assumptions were too generous, which also led to underfunding.
  • We have a cultural problem where we hide deficits/profit shortfalls through adjusting pension assumptions, or trading lower salary increases for pension benefit increases, which don’t hit the bottom line immediately, but increase funding needs for years to come.

With life insurance reserving, we use assumptions that are conservative for reserves and capital.? Pension reserving is best estimate.? If a life insurance reserve is inadequate, it must be raised to adequacy.? Pensions have a lot more flexibility, even with the recent legal changes.? It should not have been that way — pension reserving should have required pre-funding and conservative reserving.

We had boom years in the ’90s, and most DB pension plans were overfunded for a while, but the boom gave the illusion that returns would be stupendous for a long time, and companies stopped contributing as much or at all to their DB plans.? Some of that was IRS policy; the IRS did not want companies hiding income by contributing to the employees’ DB plans.? Thus the IRS capped the degree of overfunding at the time when overfunding was needed.

The states have their own issues in that it was always easier to defer making payments to the DB plans, because no one wanted to raise taxes, or defer spending plans.? Now the true costs have come home to roost because of the financial crisis.? Not only are interest rates and asset values lower, but tax revenues are down significantly, and unlike the US government, the states can’t print their way out of it; there are no foreign buyers that think they have to buy the states’ debts.

I have said before that it is foolish to take more risk in order to try to get ahead of the pension promises.? Periods of debt deflation are not kind to those taking risks.

That applies to defined contribution [DC] plans as well.? This article in Time suggests that 401(k) plans be scrapped, which are a type of DC plan.? A few notes:

  • 401(k) plans were an accident that got shoved into a piece of legislation for providing supplemental savings benefits.? It was probably design for a special interest, but was discovered by an then-obscure Ted Benna, who started a practice around it.
  • Whoulda thunk that it would get bigger than DB plans?? Few thought it possible until the early ’90s.
  • During the boom years, few questioned the abilities of plan participants to direct their own investing.? The bust years have made that inadequacy plain.? Average people don’t know how to allocate assets.? They are either too conservative or aggressive.? Few choose the middle ground of a Ben Graham 50/50, or a DB plan 60/40 (stocks/bonds).
  • Participants are also not well equipped for receiving and managing a lump sum of assets at retirement.? Few will buy an immediate annuity for part of their funding needs, smart as that is.? They also will not limit themselves to withdrawing only 4% of assets per year at most.

As for the Time article, I take issue with this phrase: “This isn’t how retirement was supposed to be.”

Oh please, retirement is a modern innovation that only the developed world achieved, and only because they had more than enough children (with technological development) to fund the economic growth of the entire system.? Now that developed countries are down to replacement rate or less, the only way these systems hold together is through tax subsidies or optimistic assumptions.

The world is not so bountiful that everyone can have an easy time after age 62, without taxing others to make it happen.

Now, the 401(k) was not a bad idea, but there were limitations:

  • People did not contribute enough.? They should have contributed to the max, but many only did it to the degree of the match, and and some did little to nothing.
  • They were too aggressive or too conservative, which led to greed, panic, and underperformance.? A middling allocation would have served most well, and could have been maintained through good times and bad.
  • Perhaps it would have been better to have had trustee-directed plans, where participants could have chosen the amount to save, but trustees would have invested for them.? One can’t easily tell when bad markets will come, thus it pays to have dispassionate advisors do he investoing for those that will give in to fear and panic.
  • People were poor at choosing how to distribute their 401(k) assets — few chose immediate annuities, for two reasons: it means the forfeiture of assets for a stream of cash for life, and insurance agents don’t want the money locked up; they want to earn multiple commissions.

Some of the large insurance companies are offering deferred income benefits, i.e., pay so much today, and we will give you an income of such and so at age 65, if you are still alive then.? They are not yet common, and will say that it is a tough benefit for insurers to fund.? Not many fixed income assets are not long enough to fund such a risk.

Regarding the termination of DB plans, and their replacement with DC plans, I predicted that 15+ years ago.? Why?? As the Baby Boomers got older, there would be no way that a corporation could afford the huge benefits, because the pension funding methods were back-end loaded, as I said before.? Corporations had to pony up a lot more to fund the retirement of a 60-year old than a 25-year old.? Corporations that did not terminate their DB plans would lose investors to those that did terminate, becausetheir profits would be a lot lower.

And, If the IRS had not made it tough to overfund DB plans, perhaps we would have more of them today.? Alas, it is not so.

So, what can I say?? Don’t blame 401(k) plans for broader societal trends.? Corporations would have had to terminate their DB plans simply due to demographics.? Also, understand that the economy is limited, and stocks are not magic.? Stock don’t guarantee a good return or even a positive return.? Also, don’t blame 401(k)s and other DC plans for people not investing enough.

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Okay, time for the side dish.? So Bill Miller has had a comeback over the year to date.? Big whoop.? He is still behind the S&P 500 over the last 10 years, though over the last 19 years, he is still ahead by 1-2%/year.? This is not as impressive as John Neff, by any means.

What has fueled the returns of Mr. Miller?? Low quality companies bouncing back from a crisis that the Government/Fed bailed them out of.? What Bill Miller does not do is value investing.? Value investing is not “buying them cheap,” but buying with a margin of safety.? Financials have not had a margin of safety for a long while.

Given that I think that companies with a lot of debt will underperform in the future, so do I think the Bill Miller will underperform as well.? That is an area where he he been sloppy in the past; given the weakness in the current economy, it will bite him again.

US Dollar: “I’m Not Dead Yet!”

US Dollar: “I’m Not Dead Yet!”

Analyzing currencies is weird, and most people don’t get it.? Sometimes, I think I don’t get it.? There is nothing fixed in our economic world, no fixed measure of value.? Everything trades against everything else.? Currencies exist to make the trading easier.? Imagine a matrix that is millions by millions, with trillions of exchange rates for one good or asset against another.? With currencies, it simplifies.? Each nation prices out goods and assets in their own currency, and then currencies trade against each other, subject to arbitrage with commodities, and commodity-like assets.

Anyone who has read me for a while knows that I am not a bull on the US Dollar.? But where I part ways with the grizzly bears (call me a teddy bear 🙂 ), is that the fundamental accounting identities must be maintained.? Whatever country of our world has the status of reserve currency must issue debt, and a lot of it, that other countries can invest in to park their idle cash balances.

It does not matter what currency crude oil trading, or any other trading, is denominated in; it does matter in what currency the proceeds from the sale of crude oil is invested in.? So long as the US runs current account deficits, foreigners must acquire US assets in order to fill in the gap.? In the past that has mainly been bonds — agency, mortgage, corporate, but increasingly Treasury notes.

It is not that easy to abandon the US Dollar.? Where do you go?? The yen will suffer for years as Japan heads into demographic decline and large structural budget deficits. The Euro is still an experiment; there are many pressures on it; its survival is mot assured. Nothing else is large enough or stable enough, or mature enough to run the deficits necessary to have the debt markets, to be the global reserve currency.? As an example, China does not want to run deficits, nor is its financial system strong enough to bear the wear and tear of global use of its currency.

So, when reporters write pieces indicating the imminent demise of the US Dollar, I don’t buy their arguments:

Other parties disagree with the worry:

If the money is not invested in US Dollar investments, where will they invest? That is the question.

Now, there are other issues. China? could queer global trade by asserting that entities in China could default on obligations from derivative contracts and not worry about it.? Why is this big?? If a major country does not respect contract law, that country will not be respected in global trade.? Granted, China is a creditor, not a debtor on net, but the ability to transfer capital is paramount in the global economy, and if China will not honor contracts, that will bite them.

Away from that, I was fascinated by Australia’s interest rate hike.? It makes me bullish on the Australian Dollar, even after its significant rise.? That said, don’t move too aggressively, because eventually US Dollar rates will rise.

My view is that the US is in a Japan-like funk, which it will not rise out of for years.? I don’t think the Fed will move aggressively — they will be timid.? It is easier to argue to Congress that they did their best but conditions were severe, than to argue that they headed off inflation, but many people were unemployed.

Unless Europe moves to a full political union, or China frees its economy, there is no real competitor to the US Dollar.? Yes, the dollar will likely decline over the next decade, but it will not be likely to lose its reserve status, unless a commodity standard currency comes into being.

At Last, Death!

At Last, Death!

Alas, but all good things in the human sphere come to an end.? Penn Treaty is the biggest insurer failure since 2004.? Now, don’t cry too much.? The state guaranty funds will pick up the slack.? The banks are jealous of an industry that has so few insolvencies.? Conservative state regulation works better than federal regulation.

Or does it?? In this case, no.? The state insurance regulator allowed a reinsurance treaty to give reserve credit where no risk was passed.? The GAAP auditor flagged the treaty and did not allow credit on a GAAP basis, because no risk was passed.? No risk passed? No additional surplus; instead it is a loan.? I do not get how the state regulators in Pennsylvania could have done this.? Yes, they want companies to survive, but it is better to take losses early, than let them develop and fester.

A prior employer asked me about this company as a long idea, because it was trading at a significant discount to book.? I told him, “Gun to the head: I would short this.? Long-term care is not an underwritable contingency.? Those insured have more knowledge over their situation than the insurance company does.”? He did nothing.? He could not see shorting a company that was less than 50% of book value.

It was not as if I did not have some trust in the management team.? I knew the CEO and the Chief Actuary from my days at Provident Mutual.? Working against that was when I called each of them, they did not return my calls.? That made me more skeptical.? It is one thing not to return the call of a buyside analyst, but another thing not to return the call of one who was once a friend.

Aside from Penn Treaty, the only other company that I can think of as being at risk in the long term care arena is Genworth.? Be wary there.? What is worse is that they also underwrite mortgage insurance.? I can’t think of a worse combo: long term care and mortgage insurance.

The troubles at Penn Treaty are indicative of the future for those who fund long term care.? Be wary, because the troubles of the graying of the Baby Boomers will overwhelm those that try to provide long term care.? That includes government institutions.

Financial Versus Real

Financial Versus Real

I wrote the following this morning for Finacorp clients:

“One of the keys to understanding the current environment is that there is a lot of financial liquidity, which obscures a lack of demand for products that are not staples. With unemployment so high, and perhaps worsening, it is difficult to invest in new plant and equipment, but easy to build up excess liquid assets as protection against further decay. It is also then easier to refinance debts, or buy high yielding debt, and clip a spread, hoping things don?t blow up again.”

Let me phrase it another way.? So the Fed comes in and offers cheap liquidity to financial institutions.? Does that mean the financial institutions will now offer loans to industrial corporations?? More of the loans will go to those that are buying “cheap” high yield debt, until the yields make no sense versus the bad default climate for companies that have issued high yield debt.

Most of what the Fed has done has been to raise? the prices of financial assets for now.? Unfortunately, the the Fed is not big enough to do that for most residential housing in America.? For those that have mortgages, sorry, half of you are under water, where under water is defined as higher than a 90% LTV.? Once sale costs are counted in, a 90% LTV is a close to a breakeven.

For the US government, together with the semi-independent Fed, it is relatively easy to lower interest rates, which percolates through the lowest risk sectors of the economy, so long as the dollar does not fall apart.

The Fed can manufacture financial speculation easily, but has a harder time encouraging investment in plant and equipment.? Much of that depends on the rest of the world.? There are no strong economies now, and most countries need to pay down debts.? Debt-based financial systems are more fragile than equity based systems.? Things may be weak for a while as we head back to an equity-based system.

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