Friday, July 09, 2010

Art Laffer In The WSJ On Unemployment Insurance

Art Laffer wrote a superb piece in yesterday's Wall Street Journal entitled Unemployment Benefits Aren't Stimulus, exposing the folly of too lavish and long-lived unemployment insurance.

Employing a simple series of thought experiments, Laffer debunked several myths regarding paying high levels of unemployment insurance. For example, he wrote,

On the face of it, the idea that higher unemployment benefits won't lead to more unemployment doesn't make much sense. Imagine what the unemployment rate would look like if unemployment benefits were universally $150,000 per year. My guess is we'd have a heck of a lot more unemployment. Common sense and personal experience indicate higher unemployment benefits will make unemployment less unattractive and thereby increase unemployment even in the Great Recession. As the chart nearby clearly shows, since the 1970s there's been a close correlation between increased unemployment benefits and an increase in the unemployment rate. Those who argue that things are different today don't have the data to back up their claims.

Then he addressed another argument for high and long unemployment benefits,

The second point made by the Obama administration is that unemployment benefits are a great way to stimulate demand. Increased unemployment benefits operate quickly and the recipients spend what they get, which makes these stimulus funds the best bang for the buck.

Here again the facts are in dispute. Studies have shown that previous stimulus spending—much of which was also targeted for the poor and unemployed—was to a large extent saved and not spent. But I'm not going to rest my case on the obvious failure of Washington's prior stimulus packages. Based upon the above logic (as described in the January 2009 white paper co-authored by White House economists Christina Romer and Jared Bernstein) the administration forecast that the unemployment rate would be a little above 7.3% in the third quarter of this year. That isn't going to happen.

The flaw in their logic is that when it comes to higher unemployment benefits or any other stimulus spending, the resources given to the unemployed have to be taken from someone else. There isn't a "tooth fairy," or as my former colleague Milton Friedman repeated time and again, "there ain't no such thing as a free lunch." The government doesn't create resources. It redistributes them. For everyone who is given something there is someone who has that something taken away.

While the unemployed may spend more as a result of higher unemployment benefits, those people from whom the resources are taken will spend less. In an economy, the income effects from a transfer payment always sum to zero. Quite simply, there is no stimulus from higher unemployment benefits.

To see this, imagine an economy that produces 100 apples. If 10 of those apples are given to the unemployed, then people who otherwise would have had those 10 apples now won't. The stimulus of 10 apples for the unemployed is exactly offset by the destimulus of 10 apples for those people from whom the 10 apples were taken.

But wait.....there's more! Laffer then examined the behavioral effects of lavish unemployment benefits.

To see these effects clearly, imagine a two person economy in which one of the two people is paid for being unemployed. From whom do you think the unemployment benefits are taken? The other person obviously. While the one person who is unemployed may "buy" more as a result of unemployment benefits, the other person from whom the unemployment sums are taken will "buy" less. There is no stimulus for the economy.

But it doesn't stop there. While the income effects sum to zero, the substitution effects aggregate. The person from whom the unemployment funds are taken will find work less rewarding and will work less. The person who is given the unemployment benefits will also find work relatively less rewarding and will therefore work less. Both people in this two-person economy will be incentivized to work less. There will be less work and more unemployment.

Not only will increased unemployment benefits not stimulate the economy, they will at the same time lower the incentives for people to work by reducing the amount people are paid for working and increasing the amount people are paid for not working. It's pretty basic economics.

I found this last phenomenon quite interesting. Laffer points out that by implicitly or explicitly taxing workers to transfer their wages to the non-working, the government cuts the value of work and, presumably, reduces the incentive to work. Multiply that over a few hundred million workers, and you have France, I guess. You certainly have less motivated and productive US workers.

Laffer's final point is one which others, including me, have made,

My suggestion would have been to take all $3.6 trillion and declare a federal tax holiday for 18 months. No income tax, no corporate profits tax, no capital gains tax, no estate tax, no payroll tax (FICA) either employee or employer, no Medicare or Medicaid taxes, no federal excise taxes, no tariffs, no federal taxes at all, which would have reduced federal revenues by $2.4 trillion annually. Can you imagine where employment would be today? How does a 2.5% unemployment rate sound?

If this doesn't debunk Nancy Pelosi recent idiotic remarks regarding the best approach to create jobs is to increase unemployment benefits, nothing will.

Pension Funds, Risk & Self-Regulation

Last weekend's edition of the Wall Street Journal featured an article in the Money & Investing section entitled Who Needs Risk Rules? Pensions Act On Their Own.

According to the article, several pension funds have begun changing their investment managers well ahead of any definitive FINREG dictates.

One public pension fund in Oklahoma dismissed Bill Gross' PIMCO as a manager because of "the risks of its use of derivatives whose values couldn't be cross-checked in audits."

That's got to sting. Is it really the case that some derivatives are so special that nobody offers the equivalent of the old bond value matrices for illiquid instruments? Apparently so.

Some states are prohibiting public pensions from engaging in derivatives investments, while some other public funds have sworn off swaps because of "counterparty risk."

Now, you're talking. My favorite misunderstood risk of all is counterparty. Accepting a promise to perform by a party that can't is far more risky than mere exposure to the vagaries of market valuations.

The Oklahoma fund was detailed as not even being able to discern, from PIMCO's statements, which side of some swaps they were on.

Looks like some investors are actually learning from the last few years and limiting their exposure to instruments which they either don't understand, on which they can't easily verify valuation, or where counterparties are less than acceptable in terms of risk.

I guess freely-operating markets and agents in them, given time and experience, work after all. On their own.

Thursday, July 08, 2010

Poor Customer Service At FedEx

I had an unfortunate episode of dreadful customer service with FedEx yesterday.

Being a marketing student from way back, I admire companies and businesses that get this right. It's so awesome to watch a good salesperson in action, or see someone deliver superior customer service after the sale.

In my case, it could have been the latter, but it wasn't.

Being a quant investment manager, I buy data. My supplier is S&P. Each week they send a data disc full of equity-related data. It is currently delivered via FedEx.

The FedEx label clearly identifies that the contents of the envelope is a DVD.

Yesterday, the FedEx guy left the envelope laying on the porch in front of my door. I've spoken with whomever the guy has been, in the past, about this. If anyone steps on the envelope, I could be out of luck for a week, as a replacement disc is shipped.

So I called FedEx to request a note be sent to the delivery guy. It wasn't super easy to find a phone number, because there's none on the mailing label or envelope.

When I got to a human, and explained my issue, her response was, to closely paraphrase,

'I can send a note to them, but it's all I can do. Don't know if it will matter.'

Gee, thanks.

I specified, as before in my conversations with prior delivery men, to wedge the envelope behind my mailbox.

To this, the customer service rep replied,

'He can't do that, because the mailman will think it's outgoing mail and take it.'

Wrong, sister. I carefully, but rapidly, explained that the area behind the box is neither in the mailbox, nor USPS property. And what mailman would try to take and deliver a FedEx envelope in the first place?

Stupid. Stupid. Stupid.

Not to mention that she annoyed and disappointed me by not simply saying, while composing the note,

'Thanks for contacting us about this. I'll make sure he gets the note. Call me again if this hasn't solved your problem.'

See how effortless that would have been? She would have appeared to care about my problem and its solution. And even shared my hope and belief that the note would work, instead of essentially warning me it probably was a hopeless task.

Talk about lousy customer service and training.

FedEx need to do much, much better.

The Volcker Rule & Proprietary Trading

Tuesday's Wall Street Journal featured an article concerning the definition of proprietary trading in a Volcker Rule world.

Personally, I think this is much, much ado about nothing. Hairsplitting, if you will.

Consider this passage,

"But does that mean a trader can't buy a bunch of bonds in anticipation investors would want to buy them a week later at a higher price? What if the trader holds the bonds for a month or two? Such scenarios make it difficult to draw a clear line between proprietary trading and the sort of client-centered trades typically handled by separate desks at most firms."

The answers, in the real world, are: yes, too bad, and, no, they don't.

See, only in the self-referential world of professional trading and investment banking could such an otherwise-clear and unconditional rule or concept be twisted like a pretzel to try to get the result the interpreter desires.

For example, if such pre-positioning were legal under the Volcker Rule, who would own the profits of any such pre-positioning? The client who didn't request it?

Not unless you're Red Bone, your client is Hillary Clinton, and you're trading cattle futures.

It's highly unlikely that institutional clients want their execution desk running speculative books on their behalf. For that, they typically invest in hedge funds. Where they expect such activity.

The Volcker Rule is very clear in its intent. Any institution which takes insured deposits must refrain from speculating with their own capital, because those losses are fungible and, if they result in bankruptcy, the taxpayer must foot the bill for deposits which are essentially lost.

How hard is this to understand? Really?

So, if trading is done on behalf of a client, but not in their custodial account, with their money, that would be------ proprietary trading!

See how easy that is?

The Journal ends with a paragraph containing this passage,

"Goldman President and Chief Operating Officer Gary D. Cohn has said that he expect the firm will be required to get out of "pure prop trading businesses," but he wouldn't rule out ditching the firm's bank-holding company status to gain more trading flexibility."

Amazing. Is this the same Goldman Sachs that came crawling to the Fed in late 2008, begging for a commercial bank charter, so it could borrow at the Fed window and stave off insolvency?

If such a move by Cohn isn't illegal, it's certainly immoral.

This is why Goldman is so hated. And should be, with this attitude.

Wednesday, July 07, 2010

Mediocrity At The Top: BofA's Brian Moynihan

Yesterday's Wall Street Journal's Money & Investing section carried a feature article discussing how BofA's CEO Brian Moynihan got his current job.

The details should bring shame and humiliation to everyone involved, but most especially the board.

That Moynihan should have joined the ranks of overpaid, mediocre large US bank CEOs is not, by itself, all that surprising. At least not to me. None of the CEOs of the few remaining large, authentic commercial banks are at all noteworthy for their outstanding skills or accomplishments. Moynihan is no exception to that.

But the details of Moynihan's career left me shaking my head. The guy literally hopscotched luckily from a general counsel job at Fleet through various unremarkable stints in business units at BofA. Soon after the Merrill acquisition, he refused a transfer to a credit card unit, and was told he was finished.

Little more than a year later, he was named CEO to replace Ken Lewis, the guy who promised to sack him for refusing the earlier job offer.

Go figure.

If this story, just by itself, doesn't tell you why there is so much ineptitude and mediocrity among US commercial banks, nothing else will.

But wait, as they say in the infomercials....there's more!

One BofA board member held out against Moynihan, encouraging fellow board members to seek an outside replacement. Nothing doing. The rest of the incompetent firm's board railroaded the improbably named William Boardman by forcing a vote on a unanimous decision. Boardman was reported as believing that his dissent on Moynihan's election would hurt the bank, so he caved.

He must be so proud.

Moynihan, too, I suppose.

Together, Lewis, Moynihan and BofA's board all contributed to the naming as CEO a rather unaccomplished, generic businessman with no outstanding instance of ingenuity, creativity or other quality involving unusual excellence.

Instead, Moynihan is a return to banking's Organization Man era. Very much according to this post, which I wrote upon Moynihan's being named CEO at BofA last December.

It took a while, but the Journal's piece yesterday, which filled in the blanks on Moynihan's career and the BofA board's actions, have pretty much validated my initial sentiments.
The nearby five-year price chart for the S&P500 Index, BofA and its major large US commercial bank competitors does, as well. BofA is still the worse than all but Citigroup.
Way to go, Ken and Brian...and your board.

Tuesday, July 06, 2010

Auto Insurance Wars

If you have noticed the clever Progressive and GEICO television ads for vehicle insurance, then you may find this post of interest.
Judging by recent advertising activity, those two startups have triggered strong reactions from two long-lived giants in the sector, All State and State Farm.
GEICO is a subsidiary of Berkshire Hathaway, while State Farm is still a mutual insurance company, with no outstanding equity. Policyholders are, essentially, owners.
GEICO has made 'The Gekko' famous from years of ads. Playing on the similar sounding names, the firm has commissioned a very memorable series of ads featuring the talking gekko. While separate, complete financials are obviously not available, recent advertising by State Farm and All State suggest GEICO has made inroads into their market share.
The same appears to be true for Progressive, whose ads feature the bubbly saleswoman with an attitude. She wields the 'pricing gun,' and emphasizes Progressive's do-it-yourself assembly of policy features and great service.
Now, All State is airing commercials observing that if you chose your own policy features, you might not be covered by commonly-occurring car damage such as falling tree limbs.
State Farm, on the other hand, is pushing its special discounts and market share, citing the relatively small customer bases for both GEICO and Progressive.
The five year price chart above for All State and Progressive does show the latter outperforming the former, but both trailing the index.
Still, just on the basis of competitive reactions alone, it's a good bet that Progressive and GEICO are making serious dents in the pricing structures and market shares of fellow vehicle P&C firms All State and State Farm.