Friday, July 29, 2011

Rethinking Pension & Benefit Schemes- Part 2

In yesterday's post I discussed my views on the stupidity of every major nation's defined-benefit pension and/or healthcare schemes over the past 120 years, beginning with Germany under Bismarck.

Doug Dachille, a fixed-income maven and occasional guest on CNBC, has articulated several times that overly-indebted governments have a choice between whom they will disappoint/stiff.

They can default on their bonds, being legal debt obligations, in order to favor citizens who vote for members of the government. Or they can pay their bonds and enact combinations of more/higher taxes and benefits cuts for citizens.

A Wall Street Journal editorial in Wednesday's edition echoed Dachille by pointing out that there is no real need for a default, regardless of what happens by August 2nd or, potentially, the date on which Congress recesses for the summer, August 8th.

That is because there is more than sufficient tax revenue every month to pay the nation's debt interest.

Therefore, to Dachille's point, thanks to badly-designed and overly-optimistic social welfare programs passed by less-than-stellar intellects in Congress throughout the last eighty years, the more logical solution to America's spending and debt problems is to cut benefits in these programs.

Yesterday, on CNBC's noontime program, David Stockman was enlisted to push the network's liberal agenda. A perennial favorite of the network's due to his combination of serving in Reagan's administration, but actually being a big-tax-and-spend liberal, Stockman didn't fail his hosts. He immediately decried the current debt limit debate as really about deficits, which, of course, require new and higher taxes to close them.

He then bemoaned, several times, that Senate Democrats had regrettably and inexplicably thrown in the towel on demanding new taxes.

Apparently Stockman isn't familiar with Hauser's Law, or the fact that federal tax revenues as a percentage of US GDP average 18% over the long term, no matter what the composition of tax rates and bases.

Amazing as it may be, Stockman, too, confuses tax rates with tax revenues. He evidently continues to fail to understand that lower rates, which accommodate economic growth and higher GDPs, lead to higher total tax revenues on lower tax rates.

On Greta Van Sustern's Fox News program Wednesday night, GOP House Budget Chairman Paul Ryan discussed the current debt limit debate, noting, in answer to a question from the program's host, that various national debt estimates don't typically include the off-budget programs such as Social Security, Medicare and Medicaid. Further, he explained, those aren't like bonds which have been issued, and must be retired. The terms, conditions and costs of the entitlement programs can be changed and, thus, do not represent formal, fixed claims on the federal Treasury.

While some US states, such as Illinois, California, Michigan and New Jersey, pre-Christie, may flirt with defaults, exhibit government denial of their inability to tax their way out of their fiscal nightmares, and, ultimately, appeal to the federal government to bail them out, the US government has no ultimate guarantor.

It doesn't take a genius to see that fixed debt obligations in the form of bonds will have to be honored and serviced.

Given that tax receipts can't be expected to rise above about 18% of US GDP, the growth of which has been anemic due to recent newly-increased levels of federal spending and regulation, the only remaining variable in the equation to eventually shrink the US federal deficit has to be spending.

Quaint Washington games like automatic 7%-per-year baselines budget increases have to be ended. Eventually, Social Security, Medicare, Medicaid and all other off-budget programs should be brought on-budget, to reflect a consolidated balance sheet of federal liabilities.

Perhaps only then will most voters finally understand that they have allowed their elected federal officials, for some eight decades, to enact promised social benefit programs which will simply never be payable on a sustained basis.

One only has to revisit the Greek situation, with the many stories and jokes about the short working careers, easy work rules and lavish retirement benefits, to understand that much of the developed world's economies have the same tough challenge ahead- to shrink their once-promised federal-provided social benefits back to affordable levels. Probably involving, at some point, individual defined contribution accounts paid annually out of government receipts, so that there will never be generationally-shifted debts for the consumption of social welfare programs.

A chance remark in a recent Wall Street Journal editorial noted that, just now, as many governments need to borrow heavily to plug budget deficits, many of said governments are finding it convenient to excoriate debt rating agencies and dismiss requirements for using their ratings.

Regardless of how badly S&P, Moodys and Fitch mis-rated mortgage-back structured finance instruments earlier in this decade, or how badly they may err in rating sovereign debt, that chance comment caused me to speculate that global economic growth and debt may be about to reach a tipping point together.

Specifically, with so much borrowing occurring for so much deficit spending among so many nations, while growth among the developed economies has slowed, thanks to ill-advised taxation, spending and regulatory policies, we may well see a sustained period of lower global demand as a result.

The reason for this would be as follows. As governments realize that promised social benefits must be trimmed, they spark a realization among their citizens that savings must rise to offset diminished future government-provided retirement and healthcare subsidies. With government spending reduced, and private-sector spending among consumers reduced to save for future retirement and medical spending, we may well witness a global shrinkage of demand as the final consequence of the deleveraging which began with the financial crisis of 2008.

To me, it seems obvious that after nearly a century of unaffordable social benefit schemes, many governments are now having to rectify those unsustainable promises, cut them, and trigger heretofore unexpected and unseen changes in savings and consumption patterns among consumers across many developed economies. Such economic behavioral changes among consumers may last for decades, and result in permanent changes in savings and consumption rates and, for years, if not decades, slower national economic growth rates.

For, having realized that promised pension and healthcare benefits simply won't be forthcoming as promised by many governments over past decades, individuals will return to pre-mid-twentieth century habits of high savings rates and markedly lower consumption, to prepare for self-financed medical and retirement needs. I believe that will drive discontinuous changes in individual economic behavior not seen in the lifetimes of most economists currently engaged in modeling, estimating and forecasting such behaviors.

Thursday, July 28, 2011

Rethinking Pension and Benefit Schemes

My July 4th post concerning America's Porkiest Generation was my first organized plunge into the mess that is the modern global entitlement society in any so-called developed nation.

Among the passages I feel most represent the core ideas of that post are these,

"What astounds and confounds me is that, for forty years, from 1935-75, apparently no economist of standing bothered to note that it was a mistake promise defined benefits, over time, from the proceeds of a national economy subject to the vagaries of recessions, depressions, monetary crises, global competition and occasional wars. After 1945, the same economists should have warned Congress not to use a temporary period of US economic hegemony as the baseline from which to forecast the availability of lavish wealth for decades hence, from which to pay ever-growing defined benefits of health insurance, care, and retirement pensions.

My point for today's patriotic post is to highlight how the generation that deserved credit for fighting and dying to win WWII promptly rewarded itself, through unionism and Democratic control of Congress, by promising itself defined levels of health care and old-age pensions which were never going to be affordable. The mistaken belief that a brief period of unrivaled American economic supremacy would endure and fund such lavish promises should have been challenged and crushed before it could become cemented into the American workers' expectations.

Can it really be that nobody was smart and courageous enough throughout the 1930s-1970s to point out this folly? That no society in history had ever managed the trick of working for about 30-40 years, then being paid near-working wages in retirement for another 20-30 years? That the mechanics of actuarial math and compounding wouldn't sustain those promises without economic assumptions never before seen in global economics?

What a Ponzi scheme, eh? You get control of unions and Congress, you pass laws to promise wildly unrealistic and unaffordable benefits to be paid by subsequent generations, then retire and complain when the next generation realizes what the Porkiest had done.

In my opinion, enacting foolish and economically impossible legislation and promises is no defense to simply stripping them away- now- totally- and reverting to defined contribution schemes."

As I understand it, the original social pension concept originated in Bismarck's Germany before 1900. FDR gave the concept a gigantic push with America's own Social Security program.

To be blunt, Michael Spence's recent Wall Street Journal article observing how Germany engaged in "wage and salary restructuring" for the period 2000-05 in order to attempt to regain some measure of global competitiveness, caused me to wonder whether Germany's social pension scheme has ever really worked? And whether America was profoundly misguided to look at Germany and attempt to replicate its program?

Let's admit that the fundamental reason for such so-called social safety nets is that people living in the most economically-advanced societies, with the highest GDPs/capita, are embarrassed to see people in their 60s, 70s and older going hungry, homeless, or suffering debilitating illness due to a lack of medical care. They instinctively think,

'Gee, our society is so wealthy in the aggregate. Surely we can allocate some money to provide for indigent old people, can't we?'

It sounds good in theory. But, as I wrote in that earlier linked post, consider these aspects of that "solution,"

"When you think about it, most of the intent of dedicated health care and old-age pension benefits have more to do with societally-enforced saving for these needs, and necessarily less to do with societal funding of them.

If all Social Security had ever been was a law to mandate workers and employers to dedicate defined percentages of the formers' wages to individual, single-use accounts, it's not clear that federal assistance would have ever been necessary.

After all, using federal funds to augment such accounts is simply a wealth-transfer from those making higher incomes to those making lower incomes. But if actuarially-determined amounts were deducted from compensation, federal funding never would have been required. Besides, society pays, either way. It's just that when the government is involved, it is taking from some to give to others, rather than have those others behave responsibly and live within their means."

You see, what we're really discussing here is a part of the social compact that nobody wants to, or has, to my knowledge, express simply like this,

'To be part of our society, along with obeying our laws, you must agree to save a socially-mandated amount while you are younger and working, so that the rest of us won't have to support you when you are old and no longer working.'

Instead, that got turned on its head, and became Social Security, Medicare and Medicaid. And now ObamaCare. Rather than force individuals to save from their earnings, in designated individual accounts to fund their post-retirement life, we somehow decided to just promise certain levels of payments to everyone from one big pot, or, really, four big pots now. This had the perverse effect of making people feel wealthy, because the government was going to magically give them defined sums of money when they got old.

How did these people consequently behave from the 1930s onward? Why, they saved less and adopted unhealthier lifestyles, of course, because some disembodied 'government' was going to pay for their older, sicker years. Meanwhile, they bought boats, more cars, second homes, and spent lavishly on themselves while younger.

Now multiply this by several times, to reflect the various economically richer, developed countries in Europe, South and North America and Asia which have followed this model.

See the problem? Actuarially, on a global basis, this concept of government funding defined cash or in-kind benefits for older people, was never going to be sustainable.

By failing to mandate individuals saving sufficiently from their own earnings to fund actuarially-determined amounts, and making clear that no government funds were going to be available to augment these, governments invited hyper-consumption by their populations while working, often including lifestyles leading to higher healthcare costs when retired.

The result is slow-growth, sclerotic European economies overloaded with debt, and America finally reaching its own fiscal tipping point.

Just because Bismarck's concept may have worked for whatever period of time it did, or that it took about 80 years, with periodic fixes along the way, for America's Social Security system to become bankrupt, does not mean those programs "worked."

It simply means that those of us around now to bear the cost of the long term unsustainability of these ill-conceived and -designed programs are the victims of a multi-generational Ponzi scheme.

That's why I see no reason whatsoever why any living American not already on Social Security, Medicare or Medicaid, should be shy about terminating those programs and putting their recipients on defined contribution replacements, funded annually out of tax receipts. With absolutely no time-shifting of funding of any sort.

The whole notion of lavish pensions and benefits appearing magically out of government coffers decades or centuries into the future is just foolish and impossible.

Monday's Wall Street Journal contained an editorial by Arthur Brooks, currently head of the American Enterprise Institute, entitled The Debt Ceiling and The Pursuit of Happiness. In it, Brooks argued that America's current deficit, debt and entitlement woes aren't simply economic in nature- they have have a moral component which involves the erosion and corruption of the Framers' original notions of liberty and freedom in America. Too much guaranteed this and entitlement that have caused people to look to the federal government as the source of their retirement and medical care.

It didn't have to be that way, and never should have been that way. Considering the fraudulent manner in which Social Security, Medicare, Medicaid and ObamaCare have been perpetrated on American voters, there is every reason to simply strip these programs out and move to defined contributions from the federal government's annually fluctuating tax receipts.

Despite various pundits' and politicians' constant claims that Americans currently on these programs "earned" those benefits, they did not. They never paid sufficient amounts of their incomes to fund the lavish benefits they now receive.

We have to redress that fraud now. That's really what the debt limit debate is about. I'll discuss that in tomorrow's post.

Wednesday, July 27, 2011

The Debt Limit & Downgrade- So What?

Occasionally, CNBC co-host Gary Kaminsky will say something simple and insightful when others miss the point. He did so earlier this week on David Faber's noontime program.

When asked about the potential impact of a rating agency downgrade of US debt, Kaminsky said that it didn't really matter, because nobody believed the US is a AAA credit anymore, and the downgrade is already priced in. Not because of the debt limit debate, but because of the nation's profligacy.

I believe Kaminsky is entirely correct and echoes my sentiments in this post from earlier this month,

"Druckenmiller contends that no serious change at all in federal spending and disposition regarding its habits would be the worst outcome. And if the GOP rushes to capitulate after a government shutdown, there won't be such change. Obama will declare political victory, many Tea Party voters will be disgusted with the GOP.

But if Obama faces a GOP House whose members are willing to force a shutdown and, then, after it is clear there won't be capitulation, an ordered payment of federal obligations, while some functions are shuttered, everyone- global investors, voters, onlookers- will understand that things have changed.

In the meantime, the US would have lost its AAA rating. No matter which party gained relatively greater power among Congress and the White House in 2012, a return to borrowing and spending for new programs would no longer be an option. Interest rates would be too high on Treasuries to borrow much more money, if investors would even lend it. Slow economic growth and joblessness would make higher taxes on anyone a non-starter.

In short, a default now will bring forward what I believe would be the eventual outcome of political business as usual in Washington, which will continue without a default.

Whether it's this group of Republicans, or another, after a brief return to Democratic control of the House, Senate, and Oval Office, and the final orgy of unaffordable deficit spending, it will likely now take some catastrophic event such as a credit rating downgrade and default to wake up Washington politicians to what is understood by many American voters and most global investors, to wit, no small change in American federal government fiscal policy will suffice any longer."

Just this morning, I heard a fund manager from Loomis Sayles say essentially the same thing.

What seems to escape the grasp of many pundits, and certainly Congress and the president, is that America doesn't have an inalienable right to a AAA credit rating, even as it debauches its currency and has spent, for most of 80 years, more each year than it receives in tax receipts.

Ironically, sophisticated capital markets combined with a dearth of investment alternatives post-WWII to leave the dollar and US Treasuries in the position of becoming the world's reserve currency.

Much like Rome after the fall of Carthage, the US has been, in the long run, ill-served by the absence of competitors to it as a reserve currency and general free world economic superpower. We've gradually picked up momentum, post-WWII, spending and promising to spend, on entitlements, consistently more than tax receipts were funding. It took about three-quarters of a century, but we've finally exhausted the investment appetites of the rest of the world for our securities.

On recent fiscal policy course, the US has become a discredited government. If the Fed weren't artificially pegging rates so low, and monetizing Treasuries' borrowings to the great extent that it is, does anyone really believe interest rates on Treasuries would be so low, or that the dollar wouldn't be even cheaper?

An official rating cut from AAA for America is warranted, debt limit agreement, or not.

One pundit predicted a partisan 'blame game' among federal elected officials.

Well, American voters need only look in the mirror for whom to blame. They consciously elected and re-elected generally inept spendthrifts since 1932, then wonder why the country has amassed so much net external debt.

It's time for Americans to wake up to the consequences of their poor political choices for the last eight decades.

And when the rating downgrade happens, the resulting increased funding costs will help put a stop to excessive spending and bad tax policies, only from outside, uncontrollable forces, rather than internal, political ones.

BofA, Merrill Lynch & Counterparty Risk

I saw an unbelievable story on Monday's CNBC noontime program.

Merrill Lynch is offering a 4-year bond which pays, if I remember correctly, according to the following conditions:

S&P500 down 16% or more:  99% of principal

S&P500 down 0-16% : 100% of principal

S&P500 up 0-15% : 100% of principal plus 15%

S&P500 up 16%+ : 100% of principal plus S&P gain

A quick look at the structured payoffs reveals that an investor appears to get all the S&P upside and virtually no downside, thus competing with simply buying the S&P.

However, Gary Kaminski asked the correct question, which is, if a herd of investors bought this offering and the S&P rose, say, 50% in four years, how will Merrill Lynch, a unit of the too-big-to-fail BofA, hedge its exposure? What if it doesn't or can't?

Isn't an investor assuming a large amount of counterparty risk of the sort that counterparties to AIG effectively assumed? Yes, an investor is assuming an immense counterparty risk on the part of a firm which imploded in 2008 due to risk mismanagement.

How can our new, souped-up, fancy, so-called-smarter Dodd-Frank regulators be allowing this to occur at the subsidiary of one of the nation's four largest commercial banks? One currently viewed probably as third weakest, in front of Citi, but behind Chase and WellsFargo?

Isn't this the sort of risk-taking that isn't supposed to be funded or subsidized by taxpayers anymore?

Tuesday, July 26, 2011

Will The UAW Never Learn?

Yesterday's Wall Street Journal carried this headline for its Marketplace section's lead article,

For UAW, Jobs Trump Pay

Will this union never learn?

The article begins with comments from a Flat Rock, Michigan Ford employee who asserts,

"We know that we need more product in the contract because that will mean more jobs and job protection for the rest of us."

Job protection. What a quaint notion, eh? Especially in a company in a sector, which had to be rescued by the federal government, so badly was it mismanaged due to management's ineptitude in dealing with the UAW's egregious demands.

The article goes on to list some comparative hourly wage rates:

$58 for Ford
$58 for GM
$49 for Chrysler
$27 @ Volkswagen in Chattanooga, TN & Hyundai in Montgomery, AL

Those Ford and GM numbers equate to a rough gross annual cash compensation of $111,360. Chrysler is paying about $94K/year. Obviously, the right-to-work Tennessee and Alabama compensations are about half that, or just under $52K.

Meanwhile, the UAW is pushing hard, with German labor officials, to unionize Volkswagen's Tennessee operation. Interviews reported in the Journal with employees at the plant aren't particularly enthused and, at best, are open to hearing why they should join the UAW.

Not so promising for the union guys, is it?

Let's consider what's really going on here. Foreign auto makers locate their plants in Southern, right-to-work US states so they can be competitive with cars and trucks which they hope to sell to Americans.

Unfortunately for GM, Ford and Chrysler, their legacy plants leave them stuck in closed shop states in which they are forced to pay about twice as much per employee. Those cars and trucks, too, are destined for US consumers. With Boeing's recent attempt to open a second Dreamliner assembly plant in South Carolina under union attack, the Big 3 can't ever hope to simply move production south of the Mason-Dixon Line.

I'm guessing Ford, GM and Chrysler build as few vehicles as possible in Michigan and other northern plants. In an ideal world, they'd shut them and locate near their competitors' plants in the South. But that's obviously impossible.

From that perspective, what could the UAW possibly offer to get any of those assemblers to commit to more jobs, in a contract, at those sky-high wage rates? No wonder Ford, GM and Chrysler all want to move to more profit-sharing for union workers, and, I'm sure, in time, health care premiums more in line with their white-collar workers.

Is it really possible that rank and file UAW workers at Ford, GM or Chrysler, having witnessed the carnage in their sector in the past three years, really believe any of those managements can offer 'more jobs,' let alone 'job protection?' Hell, they're lucky that the Democratic administration repaid the UAW's election efforts by stiffing legitimate bondholders, short-circuiting a conventional Chapter 11 bankruptcy for GM and Chrysler, and handing over significant chunks of the companies to the UAW.

If a reorganization had put the profitable parts of those two companies up for bid, it's not even clear any of the buyers would have retained the Michigan plants. They may have just bought machinery, licenses to IP and various trademarks and patents, and re-opened production somewhere in the South.

It's truly comical that UAW members think that, global trade and competition notwithstanding, they should earn north of $100K/year for fastening subassemblies together for commodity cars and trucks selling in a hotly-competitive US market.

When will they learn?

Monday, July 25, 2011

Another Slant On The AMR-Boeing-Airbus Deal

Holman Jenkins, Jr., wrote an informative column in this past weekend's edition of the Wall Street Journal.

There's considerably more behind AMR's mega-order than was reported by either CNBC or Bloomberg, at least when I was watching.

Specifically, Jenkins portrays the deal as not so much AMR making a bold bid to acquire new jets and lessen the average age of its fleet, than Boeing and Airbus to fend off coming competition from new entrants into their industry from Canada, Brazil, China and Japan.

I recall Boeing dismissing the re-engining of the 737 a year or so ago. Well, that's exactly what the 737s they are selling to AMR will be. According to Jenkins, Boeing's salespeople sold a jet which the board hasn't even approved for development as yet.

Then Jenkins explored the financing end of the deal, in which a large part of each vendor's order is seller-financed, essentially giving AMR leases rather than forcing them to further weaken their balance sheet.

So let's review what appears to have really occurred.

Boeing and Airbus want to foreclose competition from new entrants into the large commercial jet segment from vendors such as Embraer and Bombardier. So they rushed out retooled existing jets to sell,with lavish financing and pricing that, in Boeing's case, can't even yet be costed on the still non-existent 737 variant.

So Boeing and Airbus are taking the financial risks for the deal. And, as Jenkins notes, essentially stuffing the airline industry with several hundreds of new jets whose sale will soon reduce the value of other jets on order but not yet delivered. Thus, global consumption of new airliners is being pumped by existing plane manufacturers.

Someone has to fund these planes. And, like it or not, the flying public will be using/consuming more expensive, newer jets. And other airlines may now rush to replace more of their fleets, too, creating more demand.

One would like to believe this will all stimulate production in a healthy manner, leading to more or longer-lasting jobs, various national economic growth, etc.

But will it, when the massive deal is more aptly seen as two entrenched manufacturers underpricing their new wares and pushing such expensive equipment onto their customers, and the customers of those airlines?

Jenkins thinks it's a new bubble, and I'm inclined to agree with him.

What financing institutions are at the bottom of this new mess? Who's holding the paper on these questionably-needed new jets?

Will the federal government in the US, and the EU in Europe, soon be bailing out Boeing and Airbus for this deal? As well as the associated financing entities?