Public Policy – Page 8 – The Aleph Blog

See You in Court, Uncle Sam!

Posted on 31 March 2016 by David Merkel

Before I start tonight, I just wanted to mention that I was on South Korean radio a few days ago, on the main English-speaking station, talking about Helicopter Money. ?If you want listen to it or download it as a podcast, you can get it here. ?It’s a little less than 11 minutes long.

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The bravery of Steve Kandarian and the executives at MetLife is a testimony to something I have grown to believe. ?Frequently the government acts without a significant legal basis, and bullies companies into compliance. ?If a company is willing to spend the resources, often the government will lose, when the laws are unduly vague or even wrongheaded.

This was true also in a number of the allegations made by Eliot Spitzer. ?Lots of parties gave in because the press was negative, but those that fought him generally won. ?Another tough-minded man, Maurice Raymond “Hank” Greenberg pushed back and won. ?So did some?others that were unfairly charged.

MetLife won its case against the?Financial Stability Oversight Council [FSOC] in US District Court. ?The government will likely appeal the case, but though I have been a bit of a lone voice here, I continue to believe that MetLife will prevail. ?Here’s my quick summary as to why:

The FSOC’s case largely relies on the false idea that being big is enough to be a systemic risk.
Systemic risk is a mix of liquidity of liabilities, illiquidity of assets, credit risk, leverage, contagion, and lack of diversity of profit sources.
Liquidity of liabilities is the most important factor — in order to get a “run on the bank” there has to be a call on cash. ?Life insurers have long liability structures, and it is very difficult for there to be a run. ?People would have to forfeit a lot of value to run.
Contrast that with banks that use repo markets, and have short liability structures (w/deposit insurance, which is a help). ?Add in margining at the investment banks…
The only life insurers that suffered “runs” in the last 30 years wrote lots of short-term GICs. ?No one does that anymore.
Life insurers invest a lot of their money in relatively liquid corporates, and lesser amounts in illiquid mortgages. ?Banks are the reverse.
Leverage at life insurers is typically lower than that of banks.
Insurers make money off of non-financial factors like mortality & morbidity. ?Banks run a monoculture of purely financial risk. ?(Okay, increasingly many of them make money off of “free” checking, and then kill their sloppy depositors who overdraw their accounts… as I said to one of my kids, “Hey, your best friend “XXX bank” sent you a love note thanking you for the generous gift you gave them.”)
That makes contagion risk larger for banks than life insurers — banks often have more investments across the financial sector than insurers do.
Life insurers tend to be simpler institutions than banks. ?There is less too-clever-for-your-own-good risk.
State regulators are less co-opted than Federal regulators. ?They also employ actuaries to analyze actuaries. ?(At least the better and larger states do.)
Finally, life insurers do more strenuous tests of solvency and risk. ?They test solvency for decades, not years. ?They have actuaries who are bound by an ethics code — the quants at the banks have no such codes, and no responsibility to the regulators. ?The actuaries with regulatory responsibility serve two masters, and though I had my doubts when the appointed actuary statutes came into being, it has worked well. ?The problems of the early ’90s did not recur. ?The insurance industry generally eschewed non-senior RMBS, CMBS and ABS?in the mid-2000s, while the banks loved the yieldy illiquid beasties, and lost as a result.

Anyway, that’s my summary case. ?I haven’t always been a fan of the industry that I was raised in, but the life insurers learned from their past errors, and as a result, made it through the financial crisis very well, unlike the banks.

PS — there are some things I worry about at life insurers, like LTC and secondary guarantees, but I doubt the FSOC could figure out how big those are as an issue. ?A few companies are affected, and I’m not invested in them. ?Also, those risks aren’t systemic.

Full disclosure: long ENH NWLI BRK/B GTS RGA AIZ KCLI and MET

On a Letter from an Expatriate

Posted on 26 March 201627 March 2016 by David Merkel

Photo Credit: Liz West

A friend I haven’t heard from in many years?since he left the USA wrote me. He closed the letter in an unusual way, saying:

PS — USA has gone completely bonkers these days? or what the heck is going on over there? would love to pick your mind over a glass of wine. someday!

I’m not intending on writing on politics as a regular habit at Aleph Blog, and most of what I am going to say is economics-related, so please bear with me. ?Hopefully this will get it out of my system.

To my friend,

There are a lot of frustrated people in the US. ?Though you’ve been gone a long time, you used to know me pretty well; after all, I trained you on economic matters.

Let me give a list of reasons why I think people are frustrated, then explain how that affects their political calculations, and finally explain why they have mostly misdiagnosed the issues, and won’t get what they want regardless of who is elected.

The electorate is frustrated because:

Living standards have declined for the lower 80% of society.
Many people lost jobs, homes, pensions, etc., during the recent financial crisis… those assets are not coming back anytime soon. ?Much of the fault was theirs, but they don’t recognize that, preferring to blame others for their problems.
Many formerly attractive jobs are disappearing either due to technological change or offshoring (whether corporations or subsidiaries).
The economy muddles along, and economic policies that average people don’t understand dominate discussion. ?Many wonder if anyone is seriously trying to improve matters. ?They generally distrust the Fed.
It doesn’t seem to matter who gets elected, Democrat or Republican — the status quo remains because business interests support the Purple Party, which is the consensus of establishment Republicans and Democrats who duopolize politics in the USA.
Nothing good seems to happen in DC, and what few significant pieces of legislation have occurred in the Obama years have turned out to be bad (Obamacare) or useless (Dodd-Frank to the average person who doesn’t get it).
Immigration issues get short shrift, also trade issues.
Moral issues have basically disappeared from the political agenda in any classical form. ?Everything is pragmatic, geared to serve the Purple Party.
In general, the candidates are pretty lousy, and the moral tone of the campaign has been poor. ?That said, negative campaigning works, and the candidates that focus on being negative are doing better.

Now take a moment and think about what people do when they are desperate. ?In short, they take longer-shot chances than they would ordinarily take. ?They think:

“This person couldn’t be that much worse than what we have going now, and he sounds a lot different than the politicians that I have been hearing for so many years, ad nauseam. ?He talks about issues that affect my situation, and is not willing to mince words. ?He could be a LOT better than the status quo, which stinks. ?

So, the downside is limited, and the upside could be significant. ?I don’t care about the rough edges of this guy; the media always blows things out of proportion anyway, and helps foster the consensus candidates that never solve anything. ?So, I’m just going to hold my nose and vote for (fill in the blank).”

In my opinion, that’s why politics is nuts over here right now. ?Given the relative inability of the electorate to digest complex explanations, there are a lot of matters that they can’t understand, and as a result, regardless of who they elect, they won’t be happy.

Most of the economic and political problems stem from:

Technological change
Increasing returns to those that are smart versus those that are not
Not enough productive children being born
Attempts to improve the economy that don’t work
Gerrymandering
A diminishing consensus on what is right and wrong, and the proper role of government

The technological change is the most important factor, and explains why attempts to limit immigration or limit free trade won’t help. ?As a result of the internet, businesses can set up in many areas and benefit from the different aspects of each area — labor here, capital there, taxes way over there. ?Unless governments are willing to work together to limit this, and they?compete, they don’t cooperate here, this can’t be solved.

Information technology can make lower skilled workers far more productive, leading to a diminution of jobs in many sectors. ?This can happen anywhere — in banks, investment shops, factories, and restaurants. ?It works anyplace where you can turn 80%+ of a job into a set of rules. ?That can move jobs away from where they currently are to places where inexpensive labor can do the work.

In the short-run, this is a problem for many. ?In the long run, it will release labor to more valuable pursuits. ?That said, many older people will not be capable of retraining, and younger people will gain the opportunities if they are smart. ?the “know nots” are becoming “have nots.”

Part of this is payback for not studying enough in school, and/or studying topics that would eventually valuable in college. ?As I have said before, “Follow your bliss” is selfish and dumb. ?Real value comes, and society improves, from facilitating the bliss of others. ?The more people you make happy, the greater the rewards are.

Now, demographics are getting worse for most developing economies. ?Most economies do better when the fertility rate is over 2.1 — i.e., that population is growing. ?Typically that means that opportunities are growing. ?When working populations shrink, social benefit plans begin to collapse, and when populations shrink, countries lose vitality and creativity. ?We need youth to replenish its ranks to keep our societies healthy.

Note that efforts to fix fertility by offering tax incentives do not work. ?Once women are convinced it is not valuable to have kids, no reasonable amount of effort will change that.

As for economic policy, we are still running policy off of a model that assumes that debts are not high on order for policy to work. ?That is why continued deficit spending and abnormal monetary policy (QE & Zero or Negative Interest Rates) aren’t helping. ?Helicopter money?has its own issues.

Regardless of what happens to the presidency, Congress will remain the same because of gerrymandering. ?There’s only so much that even a good President can do if Congress is occupied by ideologues from both sides of the political spectrum.

Finally, the sides of the political spectrum are further apart because there is less consensus?on what is right and wrong, and the proper role of government. ?In some ways the internet facilitates this because you can filter out the arguments of those who disagree with you more easily. ?I set up my news sources so that I am always reading liberals and conservatives, as well as those that don’t fit well on the political map, but few others do.

And that, my friend, is why the political scene is nuts in the US now. ?There are a lot of disappointed and desperate people who are willing to try anything to get their prosperity back, even though none of the politicians can do anything that will genuinely help the situation.

It is a recipe for disaster, and absent an act of God, I don’t see anything that will change the attitudes rapidly. ?People across?the political spectrum are happily believing their own myths; it will take a lot of pain to puncture them all.

PS — I’ve given up alcohol. ?We’ll have to figure something else out if?we get together.

Laws are Only as Good as Enforcement

Posted on 25 March 201625 March 2016 by David Merkel

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.

Fly Away From Helicopter Money

Posted on 23 March 2016 by David Merkel

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.

A Look Inside the Minds of the FOMC

Posted on 17 March 2016 by David Merkel

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!

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:

We overestimate GDP growth
We underestimate labor unemployment
We overestimate PCE inflation
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.

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.

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?”

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.

Redacted Version of the March 2016 FOMC Statement

Posted on 16 March 2016 by David Merkel

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.

Financial Market Liquidity Isn’t That Important for the Economy as a Whole

Posted on 12 March 2016 by David Merkel

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:

A lot of noise
A zero-sum or negative sum game
sometimes important for future capital raising
and we pay too much attention to it

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.

Picturing Pensions

Posted on 11 March 2016 by David Merkel

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:

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.

Trying to Cure the Wrong Disease

Posted on 5 March 2016 by David Merkel

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?

They Can’t Help You

Posted on 4 March 2016 by David Merkel

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?