Month: August 2011

One of the proposals that I’ve heard from politicians anxious to stem the tide of red ink in Washington is to adds “means testing” for Social Security payments to those who are currently under 55. Instead of a government-sponsored mandatory pension scheme like what other countries run and like what Social Security has sort of been (except that money wasn’t actually put aside and it was defined benefit rather than defined contribution, so it was done in a way that was most likely to lead to bankruptcy), Social Security would essentially become a Welfare system, providing poverty relief to older Americans who, in the opinion of a new group of government employees, needed it.

I’m wondering why this wouldn’t be subject to a lot of fraud. If the government rewards spenders and punishes savers, wouldn’t there be a large incentive to pretend that one had spent everything? The maximum Social Security benefit of just under $30,000 isn’t lavish, to be sure, but an inflation-adjusted annuity that would return that to a person from age 65 onward (and then continued payments to a surviving spouse) would cost close to $1 million. Plenty of criminal behavior has been motivated by a desire to get hold of $1 million. A person might sell all of his assets at age 65 and stuff the cash in a locker, then tell the government that the money had been spent on an extravagant round-the-world trip including visits to casinos.

Separately, given the high value of the inflation-protected annuity represented by Social Security, I’m surprised that fraud isn’t already common. What stops a family from moving to Mexico, living a middle class life based on the Social Security check, and then neglecting to inform the U.S. government that the beneficiary has died. Does the Social Security Administration have any way to verify that Grandpa Joe is not alive and well at age 107? Wouldn’t it keep direct depositing checks into Grandpa Joe’s bank account?

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Standard and Poors has downgraded U.S. debt, but Treasuries have gone up in value. Another sign of incompetence by one of the ratings agencies that played a critical role in the Collapse of 2008? I don’t think so.

Many of the people buying Treasuries are planning to sell them within the next few years. Believing that the U.S. will default 20 or 30 years from now can be consistent with a belief that the U.S. will not default before today’s buyer wants to sell them and buy assets in one of the world’s fast-growing economies.

The U.S. almost surely will default on some of its currently acknowledged obligations. The only question is whether it will be public employee pensions, Social Security, Medicare, or bonds. (If the U.S. were the world’s only place to do business, in theory a big tax increase would suffice to close the gap, but in a competitive economy where a hedge fund and its managers can move to Singapore or Switzerland and a factory can move to Mexico or China, there probably is no way to raise rates without strangling whatever growth has been forecast.) So the S&P rating makes sense from that basic point of view.

The S&P rating also makes sense from the point of view of arithmetic. Politicians and newspapers talk about “spending cuts”, but they are really talking about cuts to planned spending increases that could not possibly be afforded by the actual U.S. economy. It would be like me saying that I have cut my personal spending by deciding not to buy a $50 million house that I could never have afforded in the first place. After the so-called “cuts”, federal spending will continue to grow and continue to grow at a rate that is faster than the overall GDP.

A deeper reason that the S&P downgrade is justified is that the U.S. political system has proven itself incapable of long-term fiscal management. Although a lot of headlines are consumed by legislation regarding a variety of social issues (gay marriage, medical marijuana, etc.), given that government spending is 40 percent of GDP, the most important function of politicians is deciding how to spend money. At the federal level, the politicians themselves have decided that, after more than 200 years, our Constitutional system of a House and Senate can no longer perform this fundamental function. The important decisions have now been delegated to an unaccountable “supercommittee” of 12 legislators. At the state level, politicians work around state constitutions that require balanced budgets by promising defined benefit pensions to public employees and then not putting aside enough cash even to meet the funding due under “we will earn 8 percent returns” assumptions that are not supported by any market.

The U.S. has some of the world’s most sophisticated politicians who are exquisitely skilled at advancing their personal interests. One of the ways that a U.S. politician can gain personally is to borrow money without regard to who is going to pay it back or whether paying it back is even feasible. This fact combined with the world’s glut of savings has led us to the current pass in which approximately 40 percent of federal spending is of borrowed money. Standard and Poors is right to add a little notch of concern that a future generation of Americans might not be able or interested in paying it back, at least not in dollars that haven’t been greatly inflated.

[One could argue that the supercommittee is accountable because its members could be defeated in the next election. However, it is unclear that individual votes will be recorded from this committee and the committee’s deliberations might be held in secret, unlike with the standard legislative process. For example, one of the 12 will be long-time incumbent Massachusetts Senator John Kerry. Would the predominantly Democrat voters in the state turn against Kerry because of something that he might or might not have done during a secret meeting of the supercommittee? How would a voter know what he had advocated?]

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The stock market has crashed back down to 1998 levels (S&P 500 off 6.6 percent today). The velocity of the collapse has people talking about whether this will be like 2008 all over again. I don’t think that it can be. The Collapse of 2008 was a huge psychological blow to a lot of Americans who’d come to think of themselves as smarter than average, as “winners”, and as savvy and sophisticated. A friend of mine who had made some decent money between the mid-1990s and 2008 said that he had lost his confidence and, though he had not lost his fortune, “did not feel that he could lead a family.” He’s back on his feet now and concentrating 100 percent of his work energy on a startup in China (“our sales in Europe and the U.S. have been disappointing, but strong demand from Chinese consumers has more than made up for it; the dollar and the euro are high, but there just aren’t that many of them left in the U.S. or Europe”).

Americans have made whatever psychological and financial adjustments they needed to make for a world in which U.S. stocks might be volatile and trending down, at least in real terms. Even if the market continues its downward trajectory, I am not expecting the same scale of problems with the real economy that we had in 2008-2009.

 

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I didn’t pay a lot of attention to the debt ceiling debate in Congress or its ultimate resolution, which was to borrow more money and promise that a group of future politicians would raise taxes and/or cut spending at some point between the year 2013 and never.

A more thorough analysis was the cover story of Business Week for July 27: “Why the Debt Crisis Is Even Worse Than You Think”.

There is a comforting story about the debt ceiling that goes like this: Back in the 1990s, the U.S. was shrinking its national debt at a rapid pace. Serious people actually worried about dislocations from having too little government debt. If it hadn’t been for two wars, the tax cuts of 2001 and 2003, the housing meltdown, and the subsequent financial crisis and recession, the nation’s finances would be in fine condition today. And the only obstacle to getting there again, this narrative goes, is political dysfunction in Washington. If the Republicans and Democrats would just split their differences on spending and taxes and raise the debt ceiling, we could all get back to our real lives. Problem solved.

Except it’s not that way at all. For all our obsessing about it, the national debt is a singularly bad way of measuring the nation’s financial condition. It includes only a small portion of the nation’s total liabilities. And it’s focused on the past. An honest assessment of the country’s projected revenue and expenses over the next generation would show a reality different from the apocalyptic visions conjured by both Democrats and Republicans during the debt-ceiling debate. It would be much worse.

…

Even in the late 1990s, when official Washington was jubilant because the national debt briefly shrank, fiscal-gap calculations showed that the government was quietly getting into deeper trouble. It was paying out generous benefits to the elderly while incurring big obligations to boomers, whose leading edge was then 15 years from retirement.

Mostly using numbers from the Congressional Budget Office, an analysis shows that the U.S. government is about $211 trillion short (i.e., the $14 trillion headline debt is the least of our worries). The article doesn’t link to the analyses that it cites, so it is tough to know what assumptions went into them [this article by Kotlikoff is the closest that I’ve found]. It seems reasonable to conclude, however, that the shortfall would be much larger than $211 trillion if our economy doesn’t grow as expected and/or if Americans begin to live longer than expected.

The debate worth having is how we are going to divide America’s income between the working and the non-working and how much of America’s income we want to put into health care, military adventures, and other overhead areas that will not produce a return on investment. Our Congress, at any rate, is not having this debate so it probably isn’t worth anyone’s time to pay attention.

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http://economix.blogs.nytimes.com/2011/08/05/length-of-unemployment-continues-to-break-records/ says that the average length of unemployment is the longest ever recorded, up to more than 40 weeks (compared to less than 15 weeks in the downturn of the late 1940s). According to http://www.census.gov/hhes/www/housing/census/historic/ownrate.html , home ownership rates have been growing gradually since 195o, as has the duration of unemployment.

Let’s look at a couple of reasons that increased homeownership could lengthen unemployment periods. Let’s consider mobility. There is a large variation in demand for labor across states and regions. Homeowners are crippled in terms of mobility compared to renters. The homeowner, especially in a state with a shrinking number of jobs, may need months or years to sell a house and move. He may delay the move for months in hopes of landing a local job that will spare him the pain of paying a 6 percent real estate commission. A renter can pack up, tow a U-Haul, and be on the other side of the country within a month.

A renter may feel more urgency about earning enough money to make monthly payments. A landlord can get a non-paying tenant evicted, in most states, in a matter of weeks. Now that the mortgage industry has combined 21st Century financial engineering with 19th Century methods of handling paperwork, and therefore nobody can say who owns anything (we’ve turned the U.S. into the kind of informal economy that we once derided), it might take years to foreclose on a homeowner after he or she stops making payments.

So it may be that the more we encourage homeownership the more we engender long-term unemployment. Perhaps therefore the trillions of dollars that we’ve poured into subsidizing homeownership (mortgage interest deduction, propping up Fannie Mae, etc.) were ill-considered. In a fast-growing global economy, maybe a big competitive advantage for a nation is a mobile workforce of renters.

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Folks might enjoy this New Yorker article on Bridgewater Associates, supposedly the world’s biggest hedge fund. The founder has an unusual management style, e.g., “One rule of radical transparency is that Bridgewater employees refrain from saying behind a person’s back anything that they wouldn’t say to his face” leads to inviting a worker into a conference room where top managers discuss whether or not he is qualified for a promotion.

The founder, Ray Dalio, has some interesting ideas about investing, e.g., “One says that, over the long run, the price of gold approximates the total amount of money in circulation divided by the size of the gold stock.” (i.e., since the world keeps getting richer, gold will keep going up, up, up (though at any moment it might be mispriced))

The article doesn’t have a lot of practical advice except maybe to avoid holding assets in U.S. dollars:

Dalio believes that some heavily indebted countries, including the United States, will eventually opt for printing money as a way to deal with their debts, which will lead to a collapse in their currency and in their bond markets. “There hasn’t been a case in history where they haven’t eventually printed money and devalued their currency,” he said. … “I think late 2012 or early 2013 is going to be another very difficult period”

 

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