12 Notes on the Economic Scene

1) I may as well start out with some predictions. I’m not an expert on this, but Chapter 9 of the bankruptcy code applies to municipalities, but not states. Given the problems with state & municipal pensions, we will probably see chapter 9 modified over the next two decades to allows states to default. There will also be some modification to retirement funding laws as applied to municipalities, states, and maybe the US Government, to allow for retroactive negotiation of pensions and healthcare benefits for an insolvent government.

2) California will lead the parade of states in trouble. They want the US to guarantee their municipal debt. Schwartzenegger did all he could to try to pass the referenda that might partially close the budget gap, but from what I see now, it looks like most of the important ones have failed. Having been a California resident for seven years, I went though my share of referenda; the referendum process makes the politicians of California lazy… they pass the tough stuff off to the electorate, who then get to decide off of voters’ guides and soundbites.

3) California is an exaggerated version of the troubles that other states are having. Social program spending rises, while taxes on wages, corporate profits, real estate, real estate transfers, etc., all fall. If you can’t print your own money, and must balance your budget, life is tough, kind of like it is for most Americans.

4) Another municipal issue — can financial guarantors split in two? I have argued “no,” but who cares what I think? We do care about those that use the courts, and banks are suing to prevent the MBIA split. It is a simple issue of fraudulent conveyance.

5) One last municipal issue: pension placement agents. This is very similar to what I experienced in Pennsylvania regarding municipal pensions there. Pension consultants would gain business through campaign contributions, and the Democratic and Republican consultants would collaborate and share to control the profits jointly. Insurance companies providing pension services would pay compensation to the consultants in exchange for business. It’s a dirty business, and when I raised ethical objections to it, I was told that I was naive. Perhaps I have more company now.

Anytime you have opaqueness of compensation, politics, and uncertainty of results (investing), there is always room for corruption.

6) Asset allocation. The belief in a large equity premium led many to overweight stocks. I have argued against that. Now there are many who are finding the they have to start over, after bad equity returns. There is no magic in any asset class. Yes, equities do better than bonds in the long run, but only by 1-2%/yr, not 5-7%.

As for the arguments of Ayres and Nalebuff, only the most emotionally dead investors can live with levering up 1.9 times perpetually. Most people panic. They can barely deal with the volatility of the S&P 500, much less double that.

7) Mmmm… is it time to take on Bill Miller again? Yeh. Overweighting financial stocks? That is quite a bet, and probably irresponsible again. Here is my free advice — analyze your estimates of intrinsic value with commercial real estate prices 30% lower than today. Aside from short-tail insurers, I don’t think you want to be overweight financials.

8 ) On the same note, many small and intermediate-sized banks face troubles under stress, particularly from commercial real estate lending.

9) I think we are in the second inning for declines in prices for commercial real estate, but perhaps the seventh inning for residential real estate. So long as residential properties sell for less than their mortgages there is downward pressure on prices, because negative events lead to foreclosures, not sales.

10) How will derivatives be regulated? That is the question. Will it be as transparent as TRACE? I doubt it. The market is not that liquid.

11) Will the US Government likely get full value back on TARP buyouts? No, because they lack expertise at analyzing these situations. They don’t know what a warrant is worth.

12) Will low-rate mortgages rescue the economy? No, but many middle class people with equity will breathe easier after they refinance. Also, some will buy homes, but who will have the downpayment necessary to qualify now that underwriting has tightened? Not many.

Comments

[TheSnail:]

Very insightful. Thanks.

May 20 11:37 AM

[thiazole:]

I don't know why any organisations offer pensions. They are so destructive in every case that I've ever seen. Are people really so blind to this? Give people the option to contribute to retirement accounts - the organization can contribute to it as well, and if things don't work out, the entire organization isn't sunk as a result. How complicated is this? Too many neurotic people in our society that want a guarantee in life, I guess. There are no guarentees in life - any one of us could die tomorrow. That is just nature. There is nothing we can or should do about it.

May 20 12:06 PM

[Thomas J. G...:]

thiazonle, good comments. another question I have is how did we ever afford pensions? 30 yrs ago 1/2 the s&p 500 offered full pensions to long term employees. california is falling apart now but 30 yrs ago they had all the public colleges and public pension plans and no problems. what changed? mabye through the end of 2000 the u.s. was an economic superpower that could guarantee pensions and company provided company health care for 70% of the population. Maybe now the world caught up and things are more competetive?

May 20 12:43 PM

[Alan Young:]

Once upon a time, there was a concept that experienced, skilled and loyal workers were an important asset to a company. I find it sad that this concept is now thought so quaint that people can't even imagine why pensions were ever thought of as a good idea.

On May 20 12:06 PM thiazole wrote:

> I don't know why any organisations offer pensions. They are so destructive
> in every case that I've ever seen.

May 20 03:10 PM

[Bob 123:]

Amen Alan.
Lots of Union bashers too on this site, oblivious to the fact that the workplace they enjoy now, the rights and protections from unscrupulous and ruthless employers, safe air to breathe, clean water to drink, etc -- that was paid for in blood not that long ago.
They do forget and history taught in school now too often skips over the rise and importance of the labor movement -- and what it did for the working man and the expansion of the middle class.


On May 20 03:10 PM Alan Young wrote:

> Once upon a time, there was a concept that experienced, skilled and
> loyal workers were an important asset to a company. I find it sad
> that this concept is now thought so quaint that people can't even
> imagine why pensions were ever thought of as a good idea.
>
> On May 20 12:06 PM thiazole wrote:

May 20 04:00 PM

[thiazole:]

I don't have any evidence to back it up, so take my explanation with a grain of salt, but I suspect that 30 years ago, it was just an empty promise. As workers "began" to retire, the companies could handle it, but after too many people retired, (more modern times) the pensions just couldn't support the weight. I don't believe that pensions were ever designed to work.

One could also argue that people just live too long now and it just isn't affordable. It probably isn't reasonable to pay for 20 years of retirement just because you worked at the same place for 30 years. 5 years, for sure, 10 maybe, but when you are retired almost as many years as you worked for the company, then it really doesn't add up.


On May 20 12:43 PM Thomas J. Gordon wrote:

> thiazonle, good comments. another question I have is how did we ever
> afford pensions? 30 yrs ago 1/2 the s&p 500 offered full pensions
> to long term employees. california is falling apart now but 30 yrs
> ago they had all the public colleges and public pension plans and
> no problems. what changed? mabye through the end of 2000 the u.s.
> was an economic superpower that could guarantee pensions and company
> provided company health care for 70% of the population. Maybe now
> the world caught up and things are more competetive?

May 20 04:02 PM

[thiazole:]

My industry was never unionized and we do pretty well (pharmaceutical industry). Some would say industries that employ mostly more educated people aren't unionized because they don't need it, but others would suggest that educated people are just more privvy to the reality that unions usually do more harm than good in modern society.
Consider how much the UAW demanded in recent times even though the big 3 were clearly in trouble and losing money. You can't be too intelligent if you are demanding more benefits when your employer is just trying to survive. There is a good reason unionized industries don't do very well.


On May 20 04:00 PM Bob 123 wrote:

> Amen Alan.
> Lots of Union bashers too on this site, oblivious to the fact that
> the workplace they enjoy now, the rights and protections from unscrupulous
> and ruthless employers, safe air to breathe, clean water to drink,
> etc -- that was paid for in blood not that long ago.
> They do forget and history taught in school now too often skips over
> the rise and importance of the labor movement -- and what it did
> for the working man and the expansion of the middle class.

May 20 04:09 PM

[Socialism c...:]

Re. #s 2 & 3 -- CA is sunk not because people don't understand and pass the correct referenda, but because the state has become a huge welfare state. Kill the "everything in English and Spanish" thing. End free healthcare and schooling for illegals -- you don't have ID? Sorry -- no services. End the entitlement programs. Downsize the government. Do these things, and the budget is fine. The bottom line is THERE HAS BEEN NO SERIOUS ATTEMPT to perform any real spending cuts in CA during this crisis. NONE.

May 20 06:05 PM

[matt...:]

thiazole,

I would disagree. The purpose of a union is to represent their constituents, which is the labor force. Why wouldn't they ask for the moon, knowing full well that it's a negotiation; management is expected to counter-offer. The fact that management didn't have a backbone and wouldn't risk a strike isn't their problem.

May 20 10:41 PM

[thiazole:]

It IS their problem, because now they are all losing their jobs because their employers are going under. That is what those of us who would refuse to join a union understand. 1. They are terrible for the economy when they when they are constantly wiping out every good industry in the US. 2. It does no good - when you calculate the union fees and the lost wages striking, not only do the companies they work for lose a lot of money, but all the gains the employees got in the negotiation are lost to the strike. It is a lose-lose proposition.

This day and age when the unemployment rate is usually less than 5% (except during recessions, of course), there is no reason to have unions. If the conditions at your job are unacceptible, then you can just as easily find another job. If it isn't worth finding another job, then things must not be that bad. Let the market determine the value of labor, and the whole economy will improve VERY significantly. If you are worth your salary as an employee, someone will pay for you.


On May 20 10:41 PM matt... wrote:

> thiazole,
>
> I would disagree. The purpose of a union is to represent their constituents,
> which is the labor force. Why wouldn't they ask for the moon, knowing
> full well that it's a negotiation; management is expected to counter-offer.
> The fact that management didn't have a backbone and wouldn't risk
> a strike isn't their problem.

May 21 10:22 AM

[pigdog67:]

The article and the responses are very interesting.
1) Unions failed. Well yes because management failed.
2) Pharmas make lots of money. Thank Medicare (look at it from the beginning). The free lunch is going away for the pharmas. This ties in with (1). Pfizer has been down, down down.
3) American management is totally incompetent. Look at George Bush. Harvard and Yale and the president. GM, Ford, Chrysler, GE. American universities are incompetent/corrupt. American healthcare is incompetent. 18K in 2009 to deliver a baby in America and $25 in India. Women have had babies for millions of years. With no 18K dollars.
I believe all of this corruption comes from the American elite. So America is finished. They cannot compete with China's elite. George Bush vs Putin. George Bush vs Hu Jing Tao. Hmmm.
It is not the fault of the middle class. They are just getting shafted.
4) How did GE make there money really? By raiding the pensions of the companies they bought up. By raiding the wealth accumulated by America's "Greatest Generation". Where do you think Wall Street got the idea? From the conglomerates. Now there are no pensions left to raid (only unfunded liabilities). So Wall Street, GE and Tyco are dead. And all the jobs that create additional wealth instead of draining accumulated wealth have been offshored, or soon will be.
Healthcare - drains wealth away
Pharmas - drain wealth away
Government - drains wealth away
Education (in America) - drains wealth away

May 24 06:57 AM