Photo Credit: Gerard Van der Leun || Personally, I would not have wanted my name on that law

Photo Credit: Gerard Van der Leun || Personally, I would not have wanted my name on that law

 

This should be short.  If you want more, you can read my old piece, “Who Dares Oppose a Boom?

Laws are only as good as those that enforce them.  There was no lack of power in the hands of regulators prior to the financial crisis.  There was a lack of willingness to use the power given, because regulators were discouraged by those above them from using the powers that they could use.  That included both political appointees to high-level positions in the bureaucracy and Congressmen.

The real risk today is not that the laws are inadequate.  Dodd-Frank has its flaws, and I didn’t like handing so many things over to committees, but with respect to banks, it is better than what we had previously.  The risk is that regulators will once again not use the powers that they have, and be lax in enforcement.

I’ve argued before that state regulation of insurance is far superior to federal banking regulation.  There are several reasons for this:

  • Small-mindedness is good in regulation.  Protect the downside, let the regulated suffer.
  • Actuaries have an ethics code.  Their equivalent inside banks do not.  Regulators do not.  (Chartered Financial Analysts also have an ethics code, as an aside…)
  • It’s harder to corrupt 50 states than one federal regulator, particularly if you can choose that federal regulator.

Now, the next big problem may not be in the finance sector… I tend to think that we will see a major developed nation go through a crisis of its finances as the next crisis.  But if there is a significant financial crisis, it will be because the regulators did not do their jobs, whether under outside pressure or not.

Photo Credit: Shiny Things || Apologies, this was the best I could find at Flickr with a Creative Commons License

Photo Credit: Shiny Things || Apologies, this was the best I could find at Flickr with a Creative Commons License

Once I wrote a piece advocating helicopter money, and I called it 2300 Smackers.  For those who were not reading me back during the bailout, you should know that I vociferously opposed it, and wrote a lot to encourage everyone to oppose it.

The 2300 Smackers piece was meant to advocate giving the bailout to the American people, and not the banks.  The piece would have been better if I had advocated limiting the money to debt reduction, but anyway…

Now we are in a situation where helicopter money is once again being advocated — surprising to me, in this Wall Street Journal article, which probably should be an editorial, by Greg Ip, someone I usually respect.  This is what he advocates:

Helicopter money merges QE and fiscal policy while, in theory, getting around limitations on both. The government issues bonds to the central bank, which pays for them with newly created money. The government uses that money to invest, hire, send people checks or cut taxes, virtually guaranteeing that total spending will go up. Because the Fed, not the public, is buying the bonds, private investment isn’t crowded out.

Unlike with QE, the Fed promises never to sell the bonds or withdraw from circulation the money it created. It returns the interest earned on the bonds to the government. That means households won’t expect their taxes to go up to repay the bonds. It also means they should expect prices eventually to rise. As spending and prices rise, nominal GDP goes up, so the debt-to-GDP ratio can remain stable.

If this sounds too good to be true, it’s because usually it is. Throughout history, governments that couldn’t or wouldn’t collect enough taxes to finance their spending resorted to the printing press, from the U.S. Confederacy in the 1860s to Zimbabwe in the 1990s. It’s why so many central banks, including the ECB, are prohibited from financing government deficits.

But just because monetizing the debt can cause hyperinflation doesn’t mean it must. In ordinary times, the Fed is continuously monetizing debt to create enough currency to lubricate the wheels of commerce. Between 1997 and 2007, before QE began, its holdings of government debt rose by $355 billion, and currency in circulation rose by a similar amount. In effect, the government borrowed and spent $355 billion and never has to repay it.

In that instance, the Fed only created as much currency as the public wanted. What if it created more, to finance government spending? Even that isn’t necessarily catastrophic. In his book “Between Debt and the Devil,” which advocates helicopter money, the British economist Adair Turner cites Pennsylvania in the early 1700s, the U.S. Union government in the 1860s and Japan in the early 1930s as examples of governments that used monetary finance without triggering hyperinflation.

An even better example is World War II. The federal government had to borrow heavily to finance the war effort and the Fed helped by buying bonds to keep their yields from rising above 2.5%. Between 1940 and 1945, the Fed’s holdings of debt rose from $2.5 billion to $22 billion, an increase roughly equal to 9% of annual GDP. Though this only financed a fraction of the war, it was still debt monetization: most of those purchases proved to be permanent.

The war effort massively boosted nominal GDP. Initially, only part of that showed up as higher prices, thanks to wage and price controls. Most of it came through a stunning rise in real output, made possible by the economy’s depressed prewar state, a flood of women into the labor force and business innovation to meet the demands of war and the civilian economy. As wage and price controls ended, prices shot up 34% between 1945 and 1948. But then, inflation reverted to low single digits.

I would encourage Greg Ip, Adair Turner and anyone else who is interested to read the book Monetary Regimes and Inflation by Peter Bernholz.  Even if there have been some times where monetizing debt has not led to inflation, the odds are really low that that happens historically.  Why?

Well, when a government gets a new policy tool, they tend to use it until it stops working or blows something up.  Seeming success leads to more use (think of trying to trade lower employment for higher inflation in the ’60s), and lack of success leads policymakers their economist lackeys to try more because they say it will work when you do enough of it (think of QE, spit, spit).

It’s kind of like knowing that you have a difficult time with self-control issues, and wondering if you should try a drug offered to you at a party (even alcohol).  You shouldn’t want to take the risk.  Upside is low, downside could be very high, and probabilities are tilted the wrong way also.

Now to his credit, Greg Ip ends his piece like this:

Another obstacle is the institutional separation between monetary and fiscal policy. That separation exists for a good reason: Central banks were granted independence so that they would not become the printing press for feckless politicians. The Fed was uncomfortable doing the Treasury’s bidding during World War II and dates its de facto independence to the end of the arrangement in 1951. In 2013, Treasury was advised to sell the Fed a platinum coin to get around the statutory debt ceiling. Treasury dismissed the idea as a dangerous violation of Fed independence.

Tampering with this long-standing separation should not be done lightly. For the U.S., which is at close to full employment and in no imminent danger of deflation, the tradeoff hardly seems worthwhile. But there may be times, and countries, when it is. Monetary finance isn’t riskless, Mr. Turner says, but the alternatives may be worse: stagnation and deflation, or perpetually low interest rates that fuel dangerous bubbles: “The money finance option should not be excluded as taboo.”

No, money finance should be taboo.  Monetary history is replete with examples of where it ended very badly, and with few examples of success.

You know my opinion here.  It would be far better as a society to get the government out of the macroeconomic policy business, except to regulate banks tightly as they are the source of systemic risk, and let the economy endure booms and busts.  We won’t have perpetually low interest rates unless the government interferes, as they have done recently and during the Great Depression.  If anything, government policy has amplified our booms and busts, and makes the present situation worse.

That said, we are going to take some pain from the present economic difficulties, it is just a question of what pain we will get because of too much debt.  It could be inflation or more debt deflation.  There could be defaults on government debt or considerably higher taxes.  I can’t tell what the government will try to do, but whatever it will be, it will be painful.

Thus, diversify and prepare.  You could do worse than the permanent portfolio idea.  Consider it.

Picture Credit: Arturo de Albornoz || "Do unto others, as you would have others do unto you." -- Y'Shua Ha'Mushiach

Picture Credit: Arturo de Albornoz || “Do unto others, as you would have others do unto you.” — Y’shua Ha’Mushiach

This is an extension of a recent piece Decline Free Food.  Things have gotten worse with the mail situation at the Merkel house as I get older.  It’s not enough that AARP keeps sending us offers join.  (I keep a pile of AARP cards next to my work area to snip up if I am feeling blue. 😉 )  Now that I have turned 55, I am getting a flood of invitations from bloodsuckers financial services marketers asking me to come to their free information session.

The three recent ones were:

  • A conference asking “DO YOU HAVE THE COURAGE TO RETIRE RICH?”  The answer is real estate speculation.  Ah, if it were only that easy.  Yes, I know that a tiny amount of flipping has been profitable of late.  The only thing more profitable than flipping and speculating is getting others to pay for your advice and services so that they can go out and lose money speculating and flipping.  As I said to the guy pitching at a “Rich Dad” seminar, “If there’s that much money lying around in mispriced properties, why not go start a REIT and vacuum up all that money yourself?”  His answer, “What’s a REIT?”   I said, “If you don’t know that, you don’t know real estate.”
  • The pitch: “In a moment of decision the best thing you can do is the right thing.  The worst thing you can do is nothing. — Theodore Roosevelt”  A little more classy, but wrong.  Often the right thing to do is nothing, particularly if you don’t know the right answer… better to wait, study and learn.  Don’t be biased toward action, particularly in investing.  Only a salesman wants you biased toward action, and that is for his good, not yours.  In this case, the course offered doesn’t look so bad, and the price is cheap — but they don’t care about the cost of the course aside from the fact that it psychologically commits you to the course, and that you will more likely come, and be more likely to purchase further services from them.  The biggest thing you would learn from the course is that you don’t know much… so buy their services.
  • The next one advertises a dinner.  This one tries to scare you into coming — there’s a crisis around the corner. Boo!  But we can keep your retirement safe.  Inflation is coming.  Boo!  But we will get you an income that keeps up with inflation.  Then, to aid credibility, it mentions that their firm has been mentioned in a variety of local newspapers that no one pays for that cumulatively have less reach than this blog.

When I recently went and spoke to the Baltimore chapter of the American Association of Individual Investors, I told them, “I’m not going to market anything to you,” and I didn’t.  I response to a question, I did show them a page from my blog.  Yes, the one that lists all my worst mistakes.  And, I took a fairly extensive Q&A where if I didn’t know an answer, or there wasn’t a good answer, I said so.

My credibility is worth more to me than a little business.  Beyond that, I never want a client to think that I goaded him into working with me, or, that I went overboard to retain him if he wants to leave.  After all, I say to them, “It’s Their Money.”

As I often say:

“Don’t buy what someone else wants to sell you.  Buy what you have researched that you want to buy.”

I would say if someone sends you a slick ad on financial services, ignore them.  Always.  Do your own research.  The best firms don’t advertise, because they don’t have to.  Talk to intelligent friends, and see what they do.  Ask investment managers if they died and their firm went out of business, who would they want their spouse to use?

Don’t respond to retirement, investment management and financial planning ads.  Develop your own proposal, and put it out for bid.  Let multiple providers tell you what they will do for you.  Have smart friends help you review the submissions. Then choose the best one.

Keep the hucksters and charlatans at bay.  Ignore them.

Doing nothing never did more. 😉  Time for the quarterly examination of the composite views of the Federal Open Markets Committee, along with some choice comments on its chief partner-in-crime, the ECB.   Ready?  Let’s go!

GDP graph

Now, I promised a look inside the minds of the FOMC, and hypothetically, that what this will be.  To begin that, you have to recognize the four regularities of FOMC forecasts, as they might think about it:

  1. We overestimate GDP growth
  2. We underestimate labor unemployment
  3. We overestimate PCE inflation
  4. We overestimate the Fed funds rate

You might ask why they think that way, and if you administered the truth serum, they might say: “We believe the neoclassical view of macroeconomic theory.  We know that Fed policy will work, and so we act like we are in control, when we are something in-between being Sorcerer’s apprentices and clinically insane.  We keep doing the same thing and expect a different result.”

Okay, some of that last bit wasn’t fair, at least not fully.  There *are* some processes where until you do a critical amount of effort, the expected result doesn’t happen.  But textbook monetary policy isn’t supposed to be that way.

So, take a look at the above GDP predictions graph.  The “slope of hope” points downhill as the economy does not grow as quickly as they thought it would, given all of their efforts.

Unemp graph

The unemployment was similar, except here, they weren’t optimistic enough.  As it is, they expect unemployment to remain low for a long time, at about the levels that it is now.  Now, how likely is it for unemployment rates to remain stable for three years?  Not that likely.

PCE Inflation

You can almost hear them thinking, “Inflation will come back to 2%.  After all we’ve been so loose for so long.  There’s no way it should remain so low when we are creating credit left, right, up, down, forwards and backwards.”  But then, it doesn’t come — it always stays low.  Their long run view stays stubbornly at 2%, unlike other views where they let it drift, and that’s because 2% inflation is the religion of the Fed!  It is the Holy Received Goal, that proper monetary policy will create.

But sometimes they wonder, when it’s dark at night and quiet, “What would it take to create inflation?  What?”

FF graph

Finally, they all know that the Fed funds rate will rise.  It can’t stay low forever, can it?

Behind it all is the nagging worry: “Why doesn’t economic activity pick up?!  We’re doing everything we can short of doing a helicopter drop of money!  That has to be enough!  We don’t want to go to buying investment grade corporates or negative interest rates like that basket-case, the ECB, at least not yet.  C’mon grow! Grow!”

Note that for each quarter the FOMC has given its projections recently, they have thrown a quarter-percent tightening out the window.  That’s how overly optimistic they are in setting estimates of future policy.

Leave aside the fact that various risk assets in fixed income land are now flying.  High-yield isn’t doing badly, but emerging markets debt is taking off — note $EMB which has recently broken its 200-day moving average.

Conclusion

Bad theories beget bad policy tools, which in tern begets bad results.  The FOMC needs an overhaul of its theories, so that it stops creating speculative bubbles, and learns to be happy with an economy that just muddles along.  And who knows?  Give savers a fair rate of return, and maybe the economy will grow faster.

January 2016March 2016Comments
Information received since the Federal Open Market Committee met in December suggests that labor market conditions improved further even as economic growth slowed late last year.Information received since the Federal Open Market Committee met in January suggests that economic activity has been expanding at a moderate pace despite the global economic and financial developments of recent months.FOMC more optimistic than the data would support.
Household spending and business fixed investment have been increasing at moderate rates in recent months, and the housing sector has improved further; however, net exports have been soft and inventory investment slowed.Household spending has been increasing at a moderate rate, and the housing sector has improved further; however, business fixed investment and net exports have been soft.Shades down business fixed investment.
A range of recent labor market indicators, including strong job gains, points to some additional decline in underutilization of labor resources.A range of recent indicators, including strong job gains, points to additional strengthening of the labor market.Shades labor employment up.
Inflation has continued to run below the Committee’s 2 percent longer-run objective, partly reflecting declines in energy prices and in prices of non-energy imports.Inflation picked up in recent months; however, it continued to run below the Committee’s 2 percent longer-run objective, partly reflecting declines in energy prices and in prices of non-energy imports.No change.
Market-based measures of inflation compensation declined further; survey-based measures of longer-term inflation expectations are little changed, on balance, in recent months.Market-based measures of inflation compensation remain low; survey-based measures of longer-term inflation expectations are little changed, on balance, in recent months.No change.  TIPS are showing higher inflation expectations since the last meeting. 5y forward 5y inflation implied from TIPS is near 1.65%, up 0.12% from January.
Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability.Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability.No change. Any time they mention the “statutory mandate,” it is to excuse bad policy.
The Committee currently expects that, with gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace and labor market indicators will continue to strengthen.The Committee currently expects that, with gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace and labor market indicators will continue to strengthen.No change.
 However, global economic and financial developments continue to pose risks.New sentence.  They want wiggle room.
Inflation is expected to remain low in the near term, in part because of the further declines in energy prices, but to rise to 2 percent over the medium term as the transitory effects of declines in energy and import prices dissipate and the labor market strengthens further.Inflation is expected to remain low in the near term, in part because of earlier declines in energy prices, but to rise to 2 percent over the medium term as the transitory effects of declines in energy and import prices dissipate and the labor market strengthens further.No change. CPI is at +1.0% now, yoy.

Shades inflation down in the short run due to energy prices.

The Committee is closely monitoring global economic and financial developments and is assessing their implications for the labor market and inflation, and for the balance of risks to the outlook.The Committee continues to monitor inflation developments closely.No real change, they talked about the global stuff above.
Given the economic outlook, the Committee decided to maintain the target range for the federal funds rate at 1/4 to 1/2 percent.Against this backdrop, the Committee decided to maintain the target range for the federal funds rate at 1/4 to 1/2 percent.No change.
The stance of monetary policy remains accommodative, thereby supporting further improvement in labor market conditions and a return to 2 percent inflation.The stance of monetary policy remains accommodative, thereby supporting further improvement in labor market conditions and a return to 2 percent inflation.No change.  They don’t get that policy direction, not position, is what makes policy accommodative or restrictive.
In determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realized and expected economic conditions relative to its objectives of maximum employment and 2 percent inflation.In determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realized and expected economic conditions relative to its objectives of maximum employment and 2 percent inflation.No change.
This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments.This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments.No change.  Gives the FOMC flexibility in decision-making, because they really don’t know what matters, and whether they can truly do anything with monetary policy.
In light of the current shortfall of inflation from 2 percent, the Committee will carefully monitor actual and expected progress toward its inflation goal. The Committee expects that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run. However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data.In light of the current shortfall of inflation from 2 percent, the Committee will carefully monitor actual and expected progress toward its inflation goal. The Committee expects that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run. However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data.No change.  Says that they will go slowly, and react to new data.  Big surprises, those.
The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction, and it anticipates doing so until normalization of the level of the federal funds rate is well under way. This policy, by keeping the Committee’s holdings of longer-term securities at sizable levels, should help maintain accommodative financial conditions.The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction, and it anticipates doing so until normalization of the level of the federal funds rate is well under way. This policy, by keeping the Committee’s holdings of longer-term securities at sizable levels, should help maintain accommodative financial conditions.Says it will keep reinvesting maturing proceeds of agency debt and MBS, which blunts any tightening.
Voting for the FOMC monetary policy action were: Janet L. Yellen, Chair; William C. Dudley, Vice Chairman; Lael Brainard; James Bullard; Stanley Fischer; Esther L. George; Loretta J. Mester; Jerome H. Powell; Eric Rosengren; and Daniel K. Tarullo.Voting for the FOMC monetary policy action were: Janet L. Yellen, Chair; William C. Dudley, Vice Chairman; Lael Brainard; James Bullard; Stanley Fischer; Loretta J. Mester; Jerome H. Powell; Eric Rosengren; and Daniel K. Tarullo.Not quite unanimous.
 Voting against the action was Esther L. George, who preferred at this meeting to raise the target range for the federal funds rate to 1/2 to 3/4 percent.At last a dissent – maybe the cost of capital can reach normal levels

Comments

  • Policy continues to stall, as the economy muddles along.
  • But policy should be tighter. Savers deserve returns, and that would be good for the economy.
  • The changes for the FOMC’s view is that GDP, inflation, and labor indicators are stronger, and business fixed investment weaker.
  • Equities rise and bonds rise. Commodity prices rise and the dollar falls.
  • The FOMC says that any future change to policy is contingent on almost everything.
  • The key variables on Fed Policy are capacity utilization, labor market indicators, inflation trends, and inflation expectations. As a result, the FOMC ain’t moving rates up much, absent much higher inflation, or a US Dollar crisis.

Photo Credit: Paw Paw

Photo Credit: Paw Paw || The excitement of anticipating our friend’s arrival is overcoming our dignity

While perusing Barron’s on Saturday, I wondered if I had picked up a publication entitled, “Hope for Broken-hearted Value Investors.”  Note the articles, most of which should be behind a paywall:

Two things: First, this could just be a bounce off of the recent run-up in oil prices.  Lots of value investors are hiding there, and I think they are early.  Also, many people are hoping for a bounce in global growth, but there isn’t a lot to commend that in the short run.

Second, there are too many people hoping for this.  Lots of money is flowing out of value strategies, and the stocks are cheap.  I’ve lost several clients, and may lose some more.

Oddly, it is the losing of clients that gives me the most hope.  You need people to leave a strategy when it is down and out for the strategy to bottom.  These are the sorts of people that create the difference between time-weighted and dollar-weighted returns.  They will move to strategies that have outperformed, so they can lose money again.

As for me, I’m not changing.  I like my stocks more than ever, and I think I’ve got good ideas throughout the portfolio.  But I am not depending on value investing as a strategy turning upward now.  I think we still need and will get more pain before it turns.

Photo Credit: Ricardinyo

Photo Credit: Ricardinyo || Secondary Markets are *not* the gears of the capitalist economy

Note to all of my readers before I start on my main topic: on the morning of 3/12 I give a talk to the American Association of Individual Investors in Baltimore.  If you want to see my slide deck, here it is.

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Okay, time for some secular economic and financial heresy, which is always somewhat fun.  Secondary market liquidity isn’t very important to the functioning of the general economy of the capitalist world, including the US.  (That said, my exceptions to this statement are listed here.)

Finance has an important role in the economy, aiding business in financing the assets of the corporation, and most of the value of that comes from the debt and/or equity financing in the primary markets, or from loan granted by a bank or another entity.

After the primary financing is done, the company has the cash to enter into its projects and produce value.  Then the stocks, occasionally bonds, and rarely bank loans issued trade on the secondary markets if they trade at all. That trading is:

The real action of value creation goes on in the companies — occasionally secondary market investing, through activists, M&A, etc., may find ways to realize the value, but the value was already created — the question was who would benefit from it — management or shareholders.

If you are investing, choosing assets to buy is the most important aspect of risk control.  Measure twice, cut once.  Yes, secondary trading may help you do better or worse, but only if the rest of the world takes up the slack, doing worse or better.  There is no net gain to the economy as a whole from trading.

I grew up as a portfolio manager for a life insurance company.  Many assets were totally illiquid — I could not sell them without extreme effort, and only interested parties might want to try, who knew as much or more than me.  Ordinary bonds were still largely illiquid — you *could* trade them, but it would cost you unless you were patient and clever.  In such an environment you made sure that all of your purchases were good from the start, because there was no guarantee that you could ever make a change at an attractive price.

My contention is that most if not all financial institutions could exist the same way, rarely trading, if they paid attention to their initial purchases, matched assets and liabilities, and did not buy marginal securities.  Now some trading will always be needed because individuals and institutions need to deploy new cash and raise new cash to meet expenditures.

But I would not give a lot of credence to those in the banks who complain that a lack of liquidity in the financial markets is harming the economy as a whole, and as such, we should loosen regulations on the banks.  After all, liquidity used to be a lot lower in the middle of the 20th century, and the economy was a lot more perky then.

Don’t let finance exaggerate its role in the economy.  Is it important?  Yes, but not as important as the financial needs of the clients that they serve.  Don’t let the tail wag the dog.

Photo Credit: Tori Barratt Crane || "When is the next pension check coming, dear?"

Photo Credit: Tori Barratt Crane || “When is the next pension check coming, dear?”

I’ve seen a small group of pension articles in the recent past, none happy:

  1. Europe Faces Pension Predicament
  2. More Companies Freezing Corporate Pension Plans
  3. The Tragedy Of California’s Public Pensions
  4. Retirement Is Looking Even Worse for Americans

A defined benefit pension is a stream of payments that continues until the beneficiaries die, mainly.  It is funded from the assets set aside by the sponsor, and the earnings that flow from them, as well as additional contributions, should the assets not be enough.  With municipal pensions that means taxes.

Pension benefits are like debt, and sometimes more so.  What I mean is this — pension benefits earned can’t be reduced, except in bankruptcy.  Many states give municipal pension payments preferential treatment, so troubled municipalities can’t compromise pension payments easily, even in bankruptcy, if allowed.  (The main point of the third article is that underfunded pension plans in California will lead to taxes rising further, or, some sort of compromise, with a huge political fight either way.)

In principle, if defined benefit pensions had been funded properly, there wouldn’t be a lot of furor over them.  From inception, funding rules were not conservative enough, particularly in what plans could assume they would earn off investments.

Thus the second article is no surprise.  From my start in investment writing over 20 years ago, I predicted that more corporate pensions would get frozen, terminated, and replaced with defined contribution plans.  Plans assumed too much in the way of investment earnings. Sponsors contributed too little, encouraged by the IRS, that wanted more tax revenue, and thus limited the amount sponsors could contribute.

Things could always be worse, though… many nations in Europe will undergo a lot of strain trying to pay all of the benefits that were promised.  Here’s a quotation from the first article:

“Western European governments are close to bankruptcy because of the pension time bomb,” said Roy Stockell, head of asset management at Ernst & Young. “We have so many baby boomers moving into retirement [with] the expectation that the government will provide.”

Even the U.S., with a Social Security trust fund of $2.8 trillion, faces criticism for promising more than it can afford. That is because the fund—which is mostly in the form of IOUs from the Treasury—is projected to fall short of the sums needed to cover all benefits in a dozen years or so, and run out in 2035. Europe’s situation is much worse.

When taxes are already high, and because of demographics, the ratio of workers to pensioners is falling, it gets difficult to figure out what many European governments will do.  It will be a political fight.  Think Greece — but more widespread.

And from the article, one thing that all should expect is that older people will work to supplement their economic needs — the homey example was the lady raising berries to sell, and rabbits for her personal consumption.

The fourth article had a lot of pension factoids:

  • New York is the worst state to retire in, by one survey.  (But no state is that well off.)  Wyoming, South Dakota, Colorado, Utah, and Virginia are supposedly the five best states for retirement.
  • The odds for a woman of being in poverty after age 65 are high.  Part of that is that women live longer.  Also, the private pensions of most women are smaller.  Another part is that joint pensions for the often higher-earning husband drop in amount paid after he dies.  Two *do* live more cheaply than one, so that *is* a loss.
  • Most people think they won’t have as comfortable a retirement as their parents. (Probably true.)

Altogether, many are worried about retirement.  That is a rational fear.  I have older friends who have thought ahead, and retrained for lower-impact occupations.  If you don’t have assets, you will probably end up working.  Best to think about that sooner, rather than later.  After all, many Americans get to age 65 with less than $100,000 saved.  In this low interest rate environment, getting less than $4,000/year from your savings won’t do much to pad old age, but maybe working in a nice place could.

This isn’t the advice that many want to hear, but for 75% of Americans reaching 65, it is realistic.  Be grateful if you get to retire.  Be more grateful if you don’t get bored.

Caption from the WSJ: Regulators don’t think it is the place of Congress to second guess how they size up securities. Fed Chairwoman Janet Yellen said recently that legislation would “interfere with our supervisory judgments.” PHOTO: BAO DANDAN/ZUMA PRESS

Caption from the WSJ: Regulators don’t think it is the place of Congress to second guess how they size up securities. Fed Chairwoman Janet Yellen said recently that legislation would “interfere with our supervisory judgments.” PHOTO: BAO DANDAN/ZUMA PRESS

Catch the caption from the WSJ for the above picture:

Regulators don’t think it is the place of Congress to second guess how they size up securities. Fed Chairwoman Janet Yellen said recently that legislation would “interfere with our supervisory judgments.”

Regulators are not required by the Constitution, but Congress, perverse as it is, is the body closest to the people, getting put up for election regularly.   Of course Congress should oversee financial regulation and monetary policy from an unelected Federal Reserve.  That’s their job.

I’m not saying that the Congressmen themselves understand these things well enough to do anything — but that’s true of most laws, etc.  If the Federal Reserve says they are experts on these matters, past bad results notwithstanding, Congress can get people who are experts as well to aid them in their decisions on laws and regulations.

The above is not my main point, though.  I have a specific example to draw on: municipal bonds.  As the Wall Street Journal headline says, are they “Safe or Hard to Sell?”  For financial regulation, that’s the wrong question, because this should be an asset-liability management problem.  Banks should be buying assets and making loans that fit the structure of their liabilities.  How long are the CDs?  How sticky are the deposits and the savings accounts?

If the maturities of the munis match the liabilities of the bank, they will pay out at the time that the bank needs liquidity to pay those who place money with them.  This is the same as it would be for any bond or loan.

If a bank, insurance company, or any financial institution relies on secondary market liquidity in order to protect its solvency, it has a flawed strategy.  That means any market panic can ruin them.  They need table stability, not bicycle stability.  A table will stand, while a bicycle has to keep moving to stay upright.

What’s that you say?  We need banks to do maturity transformation so that long dated projects can be cheaply funded by short-term savers.  Sorry, that’s what leads to financial crises, and creates the run on liquidity when the value of long dated assets falls, and savers want their money back.  Let long dated assets that want debt financing be financed by REITs, pension plans, endowments, long-tail casualty insurers, and life insurers.  Banks should invest short, and use the swap market t aid their asset liability needs.

Thus, there is no need for the Fed to be worrying about muni market liquidity.  The problem is one of asset-liability matching.  Once that is settled, banks can make intelligent decisions about what credit risk to take versus their liabilities.

In many ways, our regulators learned the wrong lessons in the recent crisis, and as such, they meddle where they don’t need to, while neglecting the real problems.

But given the strength of the banking lobby, is that any surprise?

Before I start this evening, I want to add one follow-up to last night’s piece on Berkshire Hathaway.  My summary was that it wasn’t a great year, and the profit margins are likely to shrink in insurance, because BRK is being conservative there.  So why do I still own it for my clients and me?

BRK is trading maybe 8% over the level at which it would begin buying back stock.  Even in a pessimistic year, I expect BRK’s book value to rise to the level that triggers the buyback.  Thus, I think the floor for the stock is pretty close below me, and there is a decent possibility that Buffett could do some things with the cash that are even better than buybacks, especially if the market falls into bear territory.

It is positioned well for most market environments, even one where insurance gets hit hard.  BRK is “the last man standing” in any insurance crisis — they have the ability to prosper when other companies will have their capital impaired, and can’t write as much business as they want.

That’s why I own it.

Long BRK/B for my clients and me

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Onto tonight’s topic.  This is partially spurred by an article at Bloomberg.com entitled Angry Americans: How the 2008 Crash Fueled a Political Rebellion.  There was one graph that crystallized the article.  Here it is:

Incomes have not improved for the bottom 80% of Americans over the last decade.  Before I go on, recognize that the income distribution is not static.  The same people are not in each decile today, as were in 2006.  Examples:

  • Highly skilled students in a field that is in demand graduate and get jobs that pay well.
  • Highly skilled immigrants in a field that is in demand come to the US and get jobs that pay well.
  • Less skilled people who relied on the private debt culture to keep getting larger no longer have jobs that pay well in finance, construction, real estate, etc.
  • Workers and businessman who expected the commodities and crude oil boom to go on forever have seen their prospects diminish.
  • Some people have retired and their income has fallen as a result.
  • Layoffs have come in some industries because many people did not realize that they were lower skilled workers, and as such the work that they did could be automated or transferred to other countries.
  • Manufacturing continues to get more efficient, and we need fewer jobs in manufacturing to produce the same output (or more).  This is true globally; manufacturing jobs are being reduced globally.
  • Technology firms that apply the advantages of the internet gain value, while legacy firms lose value.  Whole classes of goods go away because they are replaced, and in other cases, some firms find that they can’t price their products to make a decent profit, while other firms can.
  • Some effects are demographic, like mothers ceasing work to raise children, or industries with a lot of older workers becoming uncompetitive because their pension plans are too expensive to fund.
  • Divorce usually ruins the prospects of the wife, if not the husband.
  • Throw in death, disability, substance abuse, and serious diseases.
  • And more…

Thus there is a lot of reason to look at the graph and not say, “The rich are getting richer,” but, “Those who are getting rich today are doing so faster than those who were getting rich back in 2006.”

My life is even an example of that… I make less than 30% of what I was making in 2006.  On an income basis, I’ve gone from the top of the graph to the middle.  I’m not upset, because I’m debt free, and manage my finances well.  I’m grateful to have my own little firm, and every client that I have.

Resentment

That said, many feel that the comfortable life that was theirs has been denied to them by forces beyond their control. They think that shadowy elites want to turn previously well-off people into modern serfs.

It’s a tempting thought, because most of us don’t like to blame ourselves.  Myself included, we all make mistakes.  Here is a sampling:

  • Did we make a bad decision in the industry in which we chose to work?  The particular firm?
  • Did we choose a bad field of study in college?  Rack up too much student loan debt?
  • Did we borrow too much money at the wrong time?  (Remember, debt is always a risk.  If you don’t know that, you shouldn’t borrow money.)
  • Did you make bad decisions regarding your assets, and get too greedy or fearful at the wrong times?
  • Did you spend too much during your good years, and not save enough for the future?
  • Did you not buy the insurance that would have protected you from the disaster that hit you?
  • Throw in relationship errors, etc.

The truth is, changes in technology, and to a lesser extent demography, affect the entities that we work in, and affect our personal economics as a result.  There are some politicians blaming immigrants for our problems, and that’s not a major source of our difficulties.  Most people don’t want to do the work that unskilled immigrants do, and skilled immigrants get hired when there aren’t enough people seeking those positions.

There is a need for retraining, but even that has its difficulties, as technology is changing rapidly enough that more areas may face job reductions.  Again, this is a global thing.  Those that think that making trade less free will help matters are wrong.  It’s not trade; it’s technology.

Some think that matters can be fixed by changing government taxes and spending.  That would only help limitedly, if at all.  Businesses and people can move to other countries.  In an era of the internet, many more things can move than ever did previously.

Now, if the developed  countries collaborated to unify tax policies, some of that would end.  But cheating under such a regime is too tempting, just as Indiana and Wisconsin try to attract businesses to move out of Illinois.  The relatively healthy governmental entities have advantages that allow them to prosper at the expense of the sick ones.

You’re Going to be Disappointed

Politicians live to promise.  I can tell you right now that not one of the surviving candidates for President has a realistic proposal that could be voted up by the next Congress or the buyers in the US Treasury market.  It’s all airy-fairy… just as most politicians have been since we stopped running balanced budgets.

I would encourage you therefore to look at your own situation and resources soberly, and assume that the next government will do nothing better for you than the current one.  All of the main drivers of what could improve matters for the middle class are outside the power of any individual government, so plan your own situation accordingly and adjust your economic expectations down.  After all, there is no place in the world that can promise its people prosperity.  Why should the USA be any different in this matter?