Friday, February 20, 2009

A Reader's Rebuttal To Ingrassia & Me

I wrote this post last night and set it to publish automatically at about 5AM this morning. At 5:23AM, I received this email from a reader:

I think that you must think that the auto workers don't deserve the retirement that they are entitled to. How about the veterans of the armed services that get a pension after 20 years? How about the municipal workers that get a pension after 30 years?

You must not have a clue of what it is to work in an auto factory for 30 years. After standing on the factory floor during that amount of time your ankles, knees and hip joints are about ready to give out. I know a lot of hard working people who've had knee replacement surgery because of that. Carpal tunnel is another major problem. You've probably never woke up in the middle of the night with your hands aching.

All you "experts" have no idea about the people who worked in the plants. Paul Ingrassia is another "expert" that doesn't have a clue. I wake up every day with the same sore back, ankles, knees and hips.

Maybe you should rethink what you write. There are a lot of people out there that believe anything that they read.

A Veteran of the U.S. Armed Services and also a Retired Auto Worker

Let me address this post to the reader who sent me this email.

First, as a US armed forces veteran, you have my respect and gratitude.

But that has nothing to do with your choice of employment thereafter. It's obvious even you don't consider your employment history sufficiently convincing to discuss it on its own merits, because you had to drag patriotism into the discussion. Do you know what Samuel Johnson had to say about that?

"Patriotism is the last refuge of a scoundrel."

So, as a favor to you, I'm going to ignore your inappropriate marrying of being a veteran with being a UAW member and retired auto worker.

Did someone put a gun to your head and force you onto an auto assembly line for 30 years? I didn't think so. You probably chose it for the cushy union benefits and wages. Well, welcome to the real world. You make your choice, and you live with the consequences.

I am supposing you are one of those people who equates "hard working" with a lack of education and the requirement that one works in manual labor.

In fact, as a UAW member, I believe that you probably only had to show up for work, sober and not under the influence of drugs, to keep a lifelong job. If your job got cut, you were paid from the infamous "job bank." Your employer could cut your wages only with extreme difficulty, and the risk of a long strike by your union.

I, on the other hand, and many millions like me, chose to purchase more education and work in less physically-taxing careers. We never have unions. We have to manage our own careers, and live with the constant risk of unemployment on the whim of a manager or the result of a bad year in our sector.

It's a tradeoff. We all make them. Nobody is a saint for choosing one path over another. In your case, you decided to spend your physical health in exchange for what you felt was a sweet economic deal.

As for municipal workers, I don't think they deserve 30-and-out, either. Their time will come, and soon, for renegotiation. We cannot, as citizens, afford the lush promises made to these unions by many municipal and state office-holders of both parties.

Veterans of the armed forces are a completely different story. Nothing, in my view, equates with those who have voluntarily chosen the risk of combat as a career.

Finally, I know Paul Ingrassia personally. He has considerably more than a clue.

To be frank, I don't know of many intelligent, highly-motivated people who didn't choose to become better-educated and leave plant floors for more fulfilling work, even if it meant incurring student loan obligations to do so. My brother did that, as did my father. Both have had professional careers of considerable creativity, but both worked in harsh conditions as blue-collar laborers earlier in their lives.

I think that you have an attitude of entitlement that is without merit. You chose a path, made a bargain, and now believe that everyone should feel sorry for your outcome.

I don't. I doubt Ingrassia does, either. Nor most readers of this blog.

You don't have to be vey intelligent to see the folly in a society which allows people to "retire" and earn more in that retirement than they did during their working years. It's simply an unsustainable model. It can't work for long, in very many parts of society, at the same time.

How on earth does anyone really believe that the value created by an employee of any sort, over just 30 years, will pay for both his/her compensation for that 30 years, and then their retirement pay and benefits for up to another 40 years?

It's crazy!

You sound like a whiner with the attitude of a victim, because you are now unhappy with the career choices you made earlier in life.

Quit whining and take responsibility for the choices you have made in life.

Paul Ingrassia On UAW 30-and-Out Retirement

Paul Ingrassia, once of the Wall Street Journal, wrote a very impressive and insightful editorial yesterday entitled "GM's Plan: Subsidize Our 48-Year-Old Retirees."

As usual, with his comprehensive grasp of the American auto industry, Paul debunks the myth that only the UAW is responsible for the mess in which GM, Chrysler and Ford currently find themselves.

There is one line, however, early in his piece, that really says it all,

"That was a couple of years before Detroit agreed to let auto workers retire with full pensions and benefits after 30 years on the job, regardless of their age. In practice, that meant a worker could start at age 18, retire at 48, and spend more years collecting a pension and free health care than he or she actually spent working. It wasn't long before even union officials realized they had created a monster."

Paul blames both auto company executives and UAW chiefs for failing to address and fix this crippling feature of Big 3 employment.

No matter what else you read or hear about the need for a US auto maker bailout, or how badly their filing Chapter 11 bankruptcy might affect the US economy, reread that second sentence.

We are all now paying for a bunch of workers from the auto industry who managed to earn more in retirement than they actually did working.

There are many interesting and important details in Paul's editorial that explain how bad a deal we are all getting for taxpayer funding of GM and Chrysler. GM is waving a $100B price tag around as the cost of Chapter 11, but it's a phony number, because it represents pension guarantees and other obligations that would be trimmed in such a court-supervised reorganization.

Chrysler, as Paul points out, wants continued government funding, in lieu of money that Fiat and Cerebrus won't contribute. How's that for being left holding a very expensive bag?

In his final analysis, Paul concludes that all stakeholders, especially bondholders and the UAW, are unlikely to get serious about facing reality outside of Chapter 11.

For me, however, the most striking element of this whole sorry mess is to be reminded of the sacred, unique "30 and out" deal so many UAW workers managed to connive out of Detroit in the fat years.

Every time I think about that, I find myself not caring at all what larger economic damage could come of forcing GM and Chrysler to file Chapter 11.

Thursday, February 19, 2009

Holman Jenkins On Executive Power vs. Congressional Meddling

Holman Jenkins wrote a very provocative editorial in yesterday's Wall Street Journal, entitled "How Democracy Ruined the Bailout." So provocative is it that CNBC's Rick Santelli declared that 'every viewer should read it.'

The essential point of Jenkins' excellent piece is that Bernanke never needed to go to Congress for the TARP. He had at his disposal sufficient tools and resources to take all necessary actions without subjecting the solutions of the housing, securitization and banking crises, beginning in 2007, to the vagaries of pork-barrel politics by approaching Congress for "help."

Jenkins ticks off a list of actions taken by the Treasury, Fed and FDIC prior to the TARP:

-guarantees of money market funds
-guarantees of liabilities of banks
-liquification of bank assets by expanded repo programs.

By subjecting system repairs to the votes of Congress, Bernanke and Paulson mistakenly introduced legislative excess and grandstanding into what could have remained a well-contained triage process among the technically qualified, empowered components of the administration.

By opening Pandora's Box, the two officials exposed what Jenkins calls "the delicate job of maintaining confidence in the financial system" to 535 political hacks.

My business partner and I discussed this yesterday, and came to the conclusion that Bernanke waffled because he lacked the confidence that his predecessors possessed. Volcker ran the New York Fed, and had been a longtime Federal Reserve heavyweight when he became Fed Chairman. Greenspan, for all his mistakes, was a veteran Washington power player. He had been an economic adviser to Nixon and Ford, an economic consultant, and generally well-respected player on the national economic scene.

Bernanke was a senior Fed official in between academic posts. While unquestionably technically competent and well-prepared for his job as chairman of the Fed, Bernanke seems to lack a strong sense of independence and self-confidence.

As Jenkins notes, we are all paying a terrible, costly price for that now.

Wednesday, February 18, 2009

Stimulus & Resource Allocation- Part Two

Yesterday's post focused on the many, many economists who have reminded us that FDR's New Deal didn't work, and the recently-passed so-called stimulus bill won't, either. I wrote, in part, of Gary Becker's and Kevin Murphy's Wall Street Journal piece,

"In this, they are in agreement with Dick Armey and his harking back to Hayek in noting that Keynes never explained the mechanism whereby a government can make similar, economic-productivity seeking resource allocations that individuals and households make at the microeconomic level."

I concluded by observing,

"What is missing from Congress' and the administration's calculations is a common sense notion of how one can really effect immediate spending on what our society believes are the most important projects, from an economic and productivity perspective."

Just a week ago, in a Wall Street Journal editorial entitled "Forget About Survival of the 'Fittest,' NYU professor of psychology Gary Marcus noted that it is not the case that we can assume all Americans spend money or make financial decisions equally wisely. Using some examples of the evolution of species, Marcus contends that, in fact, the process results in 'good enough' adaptation far more often than it results in perfection.

Why does this have bearing on the current topic of economics, the stimulus bill, and resource allocation? Because the manner in which money is allocated and used- either saved or spent, and how- affects what happens to the trillion dollars that the current administration and Congress have just put down on the roulette table for all of us American taxpayers.

Perhaps, rather than borrow a trillion dollars, and then dole it out in many politically-motivated ways to many Americans, with the poorest getting the most money, we should just halt tax collections for a year or two. Last year's federal tax take was, conveniently, about a trillion dollars.

Thus, rather than channel this immense pile of money through the very leaky, sticky bucket that is Washington, the states and municipalities, why not just not ask for taxes, instead?

Talk about instant stimulus! It doesn't get more immediate than that! Plus, you avoid the Keynesian problem that government can't replicate the economic resource allocating behavior of the best, most rational and successful citizens.

In an email to my business partner concerning what I took away from Marcus' editorial, I wrote,

"Might the lessons not be these?

If you are fit to amass wealth by earning high incomes, you are probably fairly rational. Thus, your spending of your greater-than-average wealth is fairly sensible, economic and rational.

If, however, you are poor, and underachieve, and the government gives you the equivalent of $10K/household, you may not use it at all rationally, economically, or sensibly.

Thus, extreme transfers of, say, $1T from those who made it, or will have to repay it, to those who would/could never earn it, pretty much insure, as Hayek would expect, less-than-economic use of the money.

Might not poorly-educated, not-so-intelligent young sports and entertainment phenoms be another good example of this? How many of those superstars end up poor and destitute before they turn 40 or 50?"

He replied,

"That’s why tax cuts would likely maximize optimum decision-making at the end points of the system: Specifically, a higher proportion of any overall tax cut would flow to the largest taxpayers, i.e., those “fit to amass wealth by earning high incomes,” and their superior decisions will maximize the productivity."

Furthermore, rather than innumerable local governments asking for federal spending on local projects that they would never bother to pay for locally, now, local and state governments, aware of an extra trillion dollars available in taxpayer pockets, could float their best projects, with the costs properly assumed locally. If the projects were genuinely necessary, economically productive, and worthwhile, communities will undertake the spending to complete them.

If not, then they weren't worthwhile expenditures of our money in the first place.

Clearly, the senseless act of the federal government borrowing a year's worth of tax receipts, just to sprinkle it back onto taxpayers according to its own, politically-driven resource allocation methods, is more wasteful and of dubious value than simply letting each of us keep our tax payments this year.

The more economically successful, rational Americans will thus be in a position to most influence near-term prosperity and growth by exercising their already-proven economic judgments with even more money. The size of the stimulus would actually be greater than that of the so-called stimulus bill, and we would all be comforted knowing that our most productive, economically-driven decision-makers were given the most money with which to make fresh economic decisions.

For the purpose of national survival and growth, we would give the "fittest" members of our society the most resources with which to facilitate those objectives. They have always been the ones to provide jobs for the less fit. Why should we expect it to work differently now? Certainly, nobody believes that the federal government is better at knowing which businesses and jobs to create than our most economically fit citizens are, do they?

Tuesday, February 17, 2009

Stimulus & Resource Allocation- Part One

There has been much ink, electronic and chemical, spilled over the so-called stimulus package that passed Congress last week.

The horrifying details abound. So many pages that it would have been impossible for a member of Congress to read it completely and intelligibly in the forty eight hours available prior to the vote.

That our President, when campaigning, made all sorts of promises about having the legislation available on a website for five days for citizens to read and on which to comment. Never happened.

The same President, his advisers and cabinet nominees spent no time whatsoever authoring the bill. Rather, he tossed it to liberal House Democrats to write, making it, in effect, a bill with which the President had absolutely nothing to do, save stump for it in the poorest communities he could find.

I will bet you that he hasn't even read the bill himself, in full.

On my desk is a pile of recent Wall Street Journal articles predicting various sorts of doom that will follow from this latest Congressional and administration excess.

On February 2nd, Harold Cole and Lee Ohanian, both professors of economics, the latter known for his work at UCLA on this topic, wrote "How Government Prolonged the Depression." The title is self-explanatory. The details are captivating and scary.

On February 11th, Peter Ferrara, a policy development officer in Reagan's White House, wrote "Reaganomics vs. Obamanomics." Since Reaganomics actually worked, and led to two decades of fairly monotonic rises in GDP and incomes, with low inflation, this would seem to be a very important piece. It is. Ferrara notes that Reagan cut tax rates across the board, controlled government spending so that nondefense discretionary spending actually decreased, deregulated key industry sectors to boost productivity and production, while endorsing tight monetary policy.

Just the opposite of all four of these is now being planned and implemented.

On February 10th, Gary Becker and Kevin Murphy wrote "There's No Stimulus Free Lunch." Becker, an economic Nobel laureate, and Murphy, an economics professor at University of Chicago and a Hoover Institute fellow, explode a number of myths about the stimulus bill being spread by the administration and Congress.

One is Vice-Presidential economics adviser Jared Bernstein's falsehoods that the bill results in a "Keynesian multiplier effect" of 1.5. He and the administration's head of CEA, Christina Romer, allegedly modeled this effect, but they appear to be the only economists in America, with the likely exception of Paul Krugman, who believe it. Murphy and Becker explain why the true multiplier effect is more likely far below 1, but probably above zero.

The authors doubt that the torrent of spending can be controlled and/or shut off when the economy reaches full employment, meaning it will likely lead to significant inflation. They also question the efficacy of spending so much money in such a short period of time. In this, they are in agreement with Dick Armey and his harking back to Hayek in noting that Keynes never explained the mechanism whereby a government can make similar, economic-productivity seeking resource allocations that individuals and households make at the microeconomic level.

Finally, Becker and Murphy note that the longer run impact of taxes and interest on borrowed money, to pay for the stimulus bill, will substantially negate many of the results promised for the bill.

On February 6th, George Melloan wrote an informed piece reviewing the global effects of Treasury borrowing to pay for this stimulus bill. He writes, ominously,

"Even when the economy and the securities markets are sluggish, the Fed's financing of big federal deficits can be inflationary. We learned that in the late 1970's, when the Fed's deficit financing sent the CPI up to an annual rate of almost 15%. That confounded Keynesian theorists who believed then, as now, that federal spending "stimulus" would restore economic health.

Inflation is the product of the demand for money as well as of the supply. And if the Fed finances federal deficits in a moribund economy, it can create more money than the economy can use. The result is "stagflation," a term coined to describe the 1970s experience. As the global economy slows and Congress relies more on the Fed to finance a huge deficit, there is a very real danger of a return to stagflation. I wonder why no one in Congress or the Obama administration has thought of that as a potential consequence of their stimulus package."

I think Melloan is being conservative in his use of the adjective "potential" in his last sentence. There's nothing potential about what is going to happen as a result of this gigantic pork barrel bill.

Then we come to Journal columnist Daniel Henninger's "Exactly How Does Stimulus Work?," on February 12th.

Henninger pokes fun at the President's reference, in Elkhart, Indiana, to the Keynesian multiplier, calling the weatherization of homes,

"an example of where you get a multiplier effect."

Does anyone believe the President could define or give an example of what a Keynesian multipier effect is, and how it works?

I can, having taken a boatload of economics courses in my past, and continued to remain abreast of macroeconomics since business school. I have actually read Keynes' "General Theory."

What troubles me now is a sort of denial of our economic experiences of the 1930s on a par with those who, for example, deny that the Holocaust ever occurred.

Surely, if Congress and our President publicly stated that the Holocaust never happened, they'd be the subject of outrage, anger, and calls for retraction of their statements.

But their assertion that FDR's "stimulus" worked is the economic equivalent of claiming that the Holocaust was imaginary. Both are demonstrably false statements.

In the years since my entry into the work force, I have seen at least two crucial developments in global financial markets which would have brought FDR's stimulus program to a grinding, failed halt much sooner than it did.

One, of course, is linked, floating exchange rates. No Treasury Secretary or Finance Minister was ever so disciplined as those who have served after the end of fixed exchange rates. Inflation and interest rates bite much harder and faster now that they cannot be so disguised or manipulated by governments.

The other is global liquidity of private capital at the speed of electrons. Again, government finance officers now must contend with immediate votes on their fiscal and monetary policies by hundreds of billions of dollars of fast-moving private capital.

That's why American equity markets plunged some 5% upon the passage of the stimulus bill and Tim Geithner's ineffectual stumbling over his ever-planned, never-revealed financial sector "plan."

What is missing from Congress' and the administration's calculations is a common sense notion of how one can really effect immediate spending on what our society believes are the most important projects, from an economic and productivity perspective.

I will address that point in part two of this post.

Monday, February 16, 2009

Market Uncertainty, Volatility & Options Valuations

Over the past twenty months, my partner and I have observed a wide range of options performance.

For some time, we have tracked, for each month's portfolio, the same duration and out-of-the-money S&P calls and puts, as well as either actual or theoretically-managed put and call portfolios.

Typically, in a healthy equity market, either the puts are positive and the calls are negative, or vice versa. This has been the case for most of the period during which we have invested in options, rather than the underlying equities.

Because of this sign difference, and the tendency of the positive side, in volatile market conditions, to outperform the negative one, a straddled option portfolio produces returns which a simple equity portfolio strategy cannot. The latter has to be net long or short to have any potential to earn a non-zero return.

However, to our surprise and disappointment, there seems to be a market condition in which both calls and puts sink in value. And the accompanying chart of our November 2008 portfolios demonstrates this.

Both the S&P calls and puts, and our option portfolios of calls and puts, are negative.

What, we asked ourselves, could cause this condition? It seems theoretically impossible that investors would value both calls and puts negatively at the same time for the same equities.

The calls are negative, we reason, because macroeconomic and business conditions are so dismal- now, and looking forward for the duration of the options.

Why, then, are the puts also negative?

Here we believe we see the cost of heavy-handed, unpredictable government intervention.

Back in late March, we saw rising puts suddenly fall after the Bear Stearns rescue. It became clear to investors that the Fed and Treasury would not let money be made by betting on a falling market. The resulting two month period of April and May were good for calls. Then sentiment overwhelmed government intervention, and puts took off once more, as volatility increased to unhealthy levels.

The current mix of badly-designed, pork-laden government programs, including TARP-2, renamed, the spending in the "stimulus" bill, TALF, the looming auto sector bailout, and suspected industry-changing provisions of the stimulus bill, all seem to be leaving investors unsure of where falling business fortunes might be unexpectedly propped up, irrationally, by some government program or cash injection.

With uncertainty regarding governmental actions so high, we reason investors are wary of what would otherwise be reasonable bets on the imminent fall in value of many equities.

Thus, we see a rare event- both puts and calls of the same equities posting a temporary negative return. Since this is an inherently unstable position, we expect that puts will rise in value in the next few months. It seems unlikely that government's unpredictable meddling can last for very long before bringing bad consequences, e.g., inflation, rising interest rates, continuing poor economic results from delayed, not eliminated recessionary forces.

Sunday, February 15, 2009

CNBC's "House of Cards" Program On Financial Excess- Part 2

Friday's post on David Faber's CNBC special program dealing with the global effects of securitization of subprime mortgages drew record views- over 300. And almost 200 more yesterday. As I watched the first half of the program this morning, I noticed that Faber was credited with 'reporting' on the story, but someone else wrote and directed the piece.

The names of two key figures appearing in the program are Kyle Bass, the Texas-based hedge fund manager whose fund earned approximately 600% in 18 months by betting against the mortgage/housing industry, and Ira Wagner, the head of structured product development at Bear Stearns.

Bass bought credit default swaps on various companies involved in the mortgage industry, which, of course, turned out to be a highly profitable bet. He related chilling conversations with various executives at financial houses and rating agencies involved in the evolving mess.

For me, as, I'm sure, for other viewers and observers of the industry in the past few years, two particular exchanges stood out.

First, Bass learned from rating agency personnel that their ratings were based on assumptions of constant 6-8% rising home values in perpetuity. This, of course, is totally unreasonable and unsustainable. Thus, Bass realized that the CDOs were literally overrated. And somehow shorting or betting on a decline in their value would be a reasonably safe move.

Second, Bass reported that a managing director at one of the investment banks involved in mortgage-backed security origination, and head of whole loan trading, was so young that he had been in graduate business school during the last financial market downturn. I believe Bass was referring to the 2001-03 bear market, so he implied that the MD had only about five years' experience. This MD stated, in reply to a question from Bass about the nature of cyclicality in the volumes of CDOs being originated, that the volumes would not end, and the company was pumping out questionably-valued, unseasoned CDOs with AAA ratings to European and Asian investors as fast as possible, leaving none on the investment bank's balance sheet.

Again, Bass knew this, too, would end sooner or later.

But, in re-viewing the program, perhaps the most interesting scene, for me, was Faber's questioning of former Fed Chief Alan Greenspan on his ability to have halted this merry-go-round of securitization of subprime mortgages.

When I first saw the program, I felt that Greenspan was covering his ass by alleging that there was nothing he could have done.

However, upon a second viewing, I feel differently, as I mentioned to my business partner this morning while discussing the interview.

What Greenspan implied by his answer was that his independence as Fed Chairman and, in fact, of the Fed in general, would have been at risk, had he stepped in to halt the origination of subprime mortgage origination.

To fully understand this, one has to go back to Paul Volcker's tenure to understand that Congress routinely has threatened the independence of the Federal Reserve System, which it created as a populist alternative to a single central bank, when and if it does not seem to be sufficiently lubricating national finance with the growth of the money supply.

Thanks to William Jennings Bryant's advocacy of American farmers' cry for coinage of silver, to devalue dollar-denominated debts by inflating the money supply at the turn of the century, the Fed system was designed to give each of the country's regions a Reserve bank, and, thus, a say in money supply management. It was a populist solution which would lessen the chances of another J. Pierpont Morgan-led rescue of the US financial system as occurred in the Panic of 1907.

Much later, in the waning days of Hubert Humphrey's life, the hapless liberal Democrat's misguided Humphrey-Hawkins Full Employment Bill was passed, mandating that the Fed maintain equal focus on two objectives: appropriate money supply growth consistent with low inflation, and full employment. The former, of course, is often at odds with the latter.

And it was this issue to which Greenspan was referring, by implication. If he had tried to rein in subprime lending by more vigorous bank examination and quashing of these activities, Congress would have hauled him up before some committee to explain his actions, which would have dampened economic growth, particularly at the expense of home ownership by lower-income groups.

This Greenspan was unwilling to do.

One only has to read this post to see why.

Thus, while many of the actors in this sorry saga were guilty of knowingly doing inappropriate things, they were allowed to do so by the complicit consent of the Fed, bowing to Congress' desire for more homeownership among the poor.

Congress wanted this mess, and now, they look for scapegoats among the businesses they asked to execute it.

In retrospect, I think Greenspan was pretty brave being as near to explicit as he was in explaining his actions during the boom in unseasoned, unwise, low-downpayment mortgage lending and securitization.