The real Fiscal Fiasco is the debt per taxpayer

August 30th, 2013

Over at Capital Gains and Games, Stan Collender reports that the FY14 planning in Washington has gone from “Budget Bedlam to Fiscal Fiasco“.

Although he’s right, I’d like to add that the real fiasco here is that our elected leaders persistently fail to address the fundamental problem: the government’s debt cannot continue to increase forever in real, inflation-adjusted, hours-of-workers-pay terms.

Instead, we have over $100,000 in national debt per taxpayer (not counting state debt, underfunded pensions and so on). And we have neither a rational budgeting process nor a rational debt-limitation plan.  Following the methodology of the “Congressional Budget Office” and adding some sanity per Cyniconomics, we can expect in 20 years to have $300,000 in debt per taxpayer (after adjusting for inflation! in 2013 dollars!), and it just gets worse from there. Something’s gotta give. And screwing over Social Security recipients (who are funded by a dedicated tax) isn’t an option. Neither is taking away grandma’s medical care.

The problems is that people want to apply accounting cuts, when what is needed is a deeper rethinking of the structure of the U.S. economy. How can we make America more efficient and more productive?  What can we do to create a stronger tax base, with lower wasted effort, and maintain a carefully prioritized set of vital government functions?

One proposal: It’s entirely possible to have an effective government that is substantially more affordable than what we currently suffer, but it does require goring some sacred cows, primarily in the medical-waste sector. That sector is normally referred to as “healthcare”. But the cost per outcome is at least twice what other nations pay, and arguably as much as 10 times what is reasonable. So most of the expenditure is indeed wasted. Therefore we must indeed call it the medical-waste sector, pending future reforms.

Now, I’m not talking about cutting Medicare outcomes, or destroying the quality of life of senior citizens. We all know from personal experience that healthcare in this country is a bureaucratic and financial disaster. Hospitals, exempt from antitrust laws and often facing no competition, waste money and overcharge everyone. The insurance system creates deluges of time- and money-wasting paperwork for no benefit other than shifting costs in Byzantine ways.  And medications cost far more here than overseas, even for identical quality.  This has all been thoroughly documented (e.g. by Steven Brill in Time). Furthermore, there is a lot of emerging evidence that many medical procedures, with modern technology, can actually be purchased directly by consumers, from competitive providers for a small fraction of the hospital/insurance system’s sticker price. Given all that, it ought to be possible to deliver the same quality of life at much lower cost.

So I’m proposing that we change the laws regulating the medical sector. The medical industry should eliminate the B.S. pricing, live with the same antitrust laws as the rest of the business world (which need to be properly enforced, but that’s another article). We need to eliminate confidential price-fixing agreements. Pills and procedures of equivalent quality should have only one price worldwide (modulo taxes), and be subject to competition among different providers – not arbitrary “chargemasters”. And the whole structure of “insurance” is wrong, leading to endless, needless paperwork that adds no value to anyone’s life.

If we thoroughly restructured that industry, it would enable (over perhaps a decade) millions of workers to gradually shift into new occupations, ones which actually increase human well-being at reasonable cost, and thus add true economic value rather than merely “GDP”. And we’d have both a more-affordable government and greater overall wealth in society.

This isn’t the only sacred cow that ought to be slaughtered, it’s just the largest.  The Giant Squid has many tentacles, and not all of them are on Wall Street.

It’s not as though there’s a choice here. Our alternative as taxpayers and citizens, if we fail to meet the clear need to reform the government and the economy, is to toil away under that ever-increasing federal mortgage, and pray the bill never comes due. But it will. And even in the meantime, we will all suffer a reduced standard of living, because our nation is run with horrifically low efficiency.

“Tornado Warnings” for the stock market? Can we? Should we?

June 5th, 2013

When those with expert knowledge detect that a potentially calamitous event threatens, but they aren’t sure, human nature runs in two directions. We are torn between wanting to issue a warning so that folks can take precautions, versus wanting to keep everyone calm to prevent the damage that could be caused by mass panic.

Meanwhile, those being warned are faced with their own difficult choice. Do they ignore the warning, accept the risks, and go about business as usual? Do they drop everything and take shelter or flee for safety? What level of precaution is appropriate?

Consider first the case of actual tornados. According to Wikipedia, early forecasters were banned from making actual tornado warnings, because of the fear of public panic.

According to NOAA data, tornado warnings have been about 70% accurate since the mid-1990s. Now, we need to be careful when measuring “accuracy”, because even when a tornado warning correctly predicts a tornado touchdown, the tornado doesn’t touch everyone in the warning area. And even if a tornado doesn’t touch down, the severe thunderstorm can still do damage with high winds, hail, and heavy rain leading to flash floods.

But despite not being a perfect warning system, we know that the warnings (a) provide people with valuable time to take shelter, (b) do not disrupt activities excessively, and (c) save lives when tornadoes do touch down and wipe out buildings and vehicles. The issue with mass panic has been addressed through decades of careful public education in tornado-prone areas, training people to react appropriately.  People have come to accept and value the warning system, most recently in Oklahoma City where 16 minutes’ advance notice saved thousands of lives as the mile-wide EF5 tornado (an extremely bad one!) wiped out thousands of buildings. The warning didn’t prevent the tornado, but the community will recover much more quickly because they reacted well.

But now consider a warning that might, by itself, trigger human reactions which bring about the calamitous event that it is warning about! What if, whenever it is issued, it causes a certain part of the business community serious damage, while saving others from grave harm? And of course it is going to cause anxiety among those who are warned, and people don’t like that unless it’s really justified.  This is the situation one faces when considering a “Tornado Warning” system for the stock market.

There is a stock market “measurement” (technical indicator) which has a 30-year record of making predictions which have a 77% accuracy in anticipating a market decline of 5% or more. Let’s call any 5% decline a “market tornado”. The measurement does not predict every “market tornado”, but it has triggered before all the really bad tornadoes (with drops in the DOW of 20% or more) and nearly all of the “medium size” ones (10% or more).

Note that in a “market tornado”, as with a real tornado, the damage is far greater in some places than in others. Thanks to inflation and growth, the market as a whole recovers eventually, just as communities repair their damage after real tornadoes. But in a 5% “market tornado” decline, some stocks will fall much farther than the average, just as some homes suffer more damage than others in a real tornado. And if the market tornado is bad enough, some stocks get destroyed (bankruptcy) if the company isn’t in good financial condition, just as weaker houses get destroyed by very bad real tornadoes.

However, unlike in a tornado, a “stock market tornado warning” induces more people to try to sell, which tends to push prices down, and that might exacerbate the market decline that the warning is all about. Businesses involved in the market will be damaged by loss of customers, decline in revenue from remaining customers, and potentially losses on their own trading positions.  We must expect the psychology of market participants to be deeply resistant to warnings which cause them immediate harm, even if the warning provides a prudent opportunity to prevent the harm from being far worse! (For some reason I’m reminded of the scene in Jaws where the shark is spotted and the warning is issued, but the folks running the beaches refuse to spread the word because they don’t want to scare people having fun… and lose profits…)

On the other hand, perhaps when a market has run up too far, a “Market Tornado Warning” might actually mitigate the subsequent inevitable correction?  Perhaps with proper public education, market participants could simply take precautions, rather than panicking?  A warning gives those caught “offsides”, overextended on leverage, a chance to pull in their positions, helping the market to be less overextended and less at risk of a deep crash. Those looking to buy in might hold back a bit, expecting a dip in prices ahead. By slowing the rally and creating a pool of folks willing and able to “buy the dip”, the market tornado might be far smaller than it would otherwise have been. This would stabilize the market, by preventing so many from buying too soon and then becoming sellers at the worst time for all.

In addition, with a reasonable warning system, businesses catering to market participants would have a chance to issue polite warnings that actually help their clients. They would have to accept that some short-term damage to portfolios is very likely, but they would have a critical window of opportunity to work constructively to minimize that damage. And that could also minimize the risk of deep damage to the business.

Perhaps, when the market is due for a correction, the warning actually allows the correction to take place in a less-damaging manner?  That is a tantalizing thought, because the horrific economic damage created by deep market declines affects millions or billions of people…

Oh, and the name of that “Market Tornado Warning” technical indicator?  It’s usually referred to as the Hindenburg Omen.  I believe that’s a poor choice of name, since the name alone induces more panic than it should.  And the indicator itself isn’t perfect and could probably be made better. But more about the Hindenburg later…

Today’s Payrolls Data Worse Than Spinmeisters Say

May 3rd, 2013

The Monthly payrolls data from the BLS shows, over the past year:
* About 1.9 million more jobs, but only a 1.3% increase in jobs
* Job growth is about the same as working-age population growth (not getting ahead)
* Also, 0.4 million (20%) of the new jobs are only part-time. Part-time jobs are increasing at a faster rate than full-time jobs. (Definitely not getting ahead).
* For those working, average weekly earnings are only up 1.6%, only about the same as official inflation. (Most definitely not getting ahead.)

In most previous years this report would have been abysmal, but I guess this month we’re just glad the sky isn’t falling again… yet…

Flash crashes and the gold smash illustrate why stop-loss orders are bad for you

April 24th, 2013

Stimulated by this post at A Dash of Insight by Jeff Miller.

Yesterday’s Twitter-induced “flash crash” and last week’s “gold smash” illustrate why using stop loss orders and trailing buy orders can be a really bad way to play in the markets.

Folks with a “shopping list” and trailing buy orders in the S&P yesterday might have gotten a bonus by getting their orders executed during the dip, but it’s a risky way to trade. Consider those folks with trailing buy orders for gold last week – they were hammered by getting their orders filled at prices which soon proved to be well above the market price! That sudden dip isn’t always buyable…

But there’s a broader conclusion to both the gold-smash bear raid and the flash crashes: any time you send a stop-loss order to your broker, you’re giving Mr. Market a free option to liquidate your shares at a loss to you (and thus a profit for Mr. Market). In the old days a “flash crash” was called a “Bear Raid” or “running stops”, and it was one of the ways the marketeers fleeced the muppets so that the brokers could have their yachts…

Conversely, any time you leave a trailing buy order out there, you’re giving Mr. Market an option to dump his shares on you, at a price which might have been fair when you entered the order, but it very likely won’t be fair when you get your execution!

All options have at least some value. Why give value away for free? Folks shouldn’t be giving those stop-loss and limit-order options away to the market, unless they’re getting good value in return. Maybe the peace of mind is worth it, but it seems like Mr. Market is collecting a lot of rent from those unwilling to hold their positions with conviction. And maybe sometimes those sudden dips prove profitable, but it sure looks a lot like collecting pennies in front of a steamroller.

New Paths to Improved Standards of Living

April 19th, 2013

From a discussion at Economist’s View, I submit the following on the topic of “more exploration of non-wage paths to rising incomes and living standards.”

Another possibility to improve living standards would be to minimize the rentier / interest-earning fraction of the population (who are effectively a tax on the working, indebted population) and help those individuals find more productive (or at least, less-extractive) roles. This issue has both generational-conflict and class-conflict dimensions, but there are non-conflict alternative solutions that no one talks about. A shift in cultural values could lead the seniors to think less in terms of a pure-leisure “retirement” and more in terms of “aging gracefully” while still contributing as much as possible to family and to society. A second shift could lead the “rentier class” to be stigmatized for engaging in consumer lending (a tax on the borrowers) while socially rewarding those who actually engage in investment behavior (formation of true sustainable capital, rather than consumption).

Lowering prices, or at least the rate of increase of prices, would improve living standards (at least in a ceteris paribus world). The inflation goal could be 0%, not 2%, and in fact “stable” is the statutory goal in the Federal Reserve Act. The debt-funded sectors (housing, healthcare and education) all need to become less expensive in order for living standards to rise.

A third way of increasing living standards would be to encourage job growth in sectors that actually improve living standards, while minimizing jobs (and other costs) in sectors that don’t really contribute. I mentioned the broken healthcare sector above. If we could find a new “peace dividend” (improved international diplomacy resulting in a reduction in military and homeland security staff), that would allow perhaps another million potentially-productive members of society to actually produce goods and services (that would improve living standards), rather than defending against harm (which consumes resources that perhaps could be better used elsewhere).

The options exist. We just need to get people thinking about them, instead of wasting their time on divisive non-solutions.

A possible vicious cycle due to flawed CPI measurements?

March 19th, 2013

Some good folks at the Atlanta Fed’s “Macroblog” recently posted a discussion about the imputed rent of being a homeowner and how housing costs are treated in the consumer price index. Owner’s Equivalent Rent is the answer. The Macroblog article describes a trend-vs-cycle decomposition of OER and a comparison of that with actual home prices. The comparison is far from persuasive.

I have long been skeptical of OER, and propose a simpler hypothesis: the CPI determination of OER is flawed. One might then be concerned that this bad OER measurement distorts the CPI, and that this could lead to serious macro consequences due to the widespread use of a bad CPI.

And indeed, if one takes time to read how OER is actually determined, one is not heartened. The quote is below. The bottom line is that some owners are SURVEYED and asked their OPINION about what their house WOULD rent for, if they rented it! I am flabbergasted by this, because in my experience owners’ responses are horribly biased, and not at all reflective of actual rental market conditions. Owners are usually not market participants. Many owners haven’t even looked at renting for years, decades, etc. Why would someone who emphatically chooses not to participate in the rental market have any expertise on what their home might rent for?  THERE HAS TO BE A BETTER WAY TO MEASURE 24% of the CPI! (The fact that this isn’t being done, despite the weight and importance of this part of CPI, is a significant “tell” that no one in a position to make a difference genuinely cares about getting anything factually right in economics…)

Here is the quote, from the link given in the article cited above:

” ‘ … Owners’ equivalent rent of primary residence (OER) is based on the following question that the Consumer Expenditure Survey asks of consumers who own their primary residence:

“If someone were to rent your home today, how much do you think it would rent for monthly, unfurnished and without utilities?”

… From the responses to these questions, the CPI estimates the total shelter cost to all consumers living in each index area of the urban United States. ‘ “

Now, what happens when a flawed OER distorts the CPI?  Consider the present… There is widespread evidence of ongoing declines in actual housing rental prices right now, in multiple markets nationwide but especially those in the Southwest. The mechanism appears to be this:

  1. Investors seeking higher yields send credit to firms investing in rental real estate.
  2. Firms purchase foreclosed housing (depressing inventory while inflating sales rates and prices and creating “housing boom” headlines).
  3. Firms convert housing to rental property in hopes of earning cash flow from rent and capital appreciation from future price increases.
  4. Rental market is glutted as a result of this reaching for yield, and much of the rental inventory goes unrented.
  5. Investor-driven glut of homes-for-rent depresses rents, even though purchase prices are rising.
  6. Homebuilding firms see rising sale prices and start building even more homes.

However, since median wages are not increasing and total full-time-equivalent employment is lagging badly, the sustainable household formation rate does not appear sufficient to absorb large amounts of additional housing. The current low-interest-rate environment appears to be distorting investment into housing in an unsustainable way.

So we’ve got a lot of poorly invested credit, a glut of rental homes, and another unsustainable building “boom” which is likely to lead to another “bust”.

And of course the OER metric currently being reported fails to capture this effect. (Similarly, during the housing bubble, OER badly lagged the market bubble and held the CPI artificially low, preventing policymakers from raising interest rates early enough to stop the bubble before it became a disaster.)  Even worse, if OER did capture the current “rental bubble” effect, it would appear deflationary (falling rents lower the CPI), suggesting that the “cure” would be to push credit even harder…

The CPI and other consumer-price inflation metrics are supposed to serve as crucial counter-cyclical signals to the Federal Reserve that interest rates need to change.  But the OER portion of CPI was in fact pro-cyclical (or at least neutral) for both the original housing bubble and the new emerging “rental housing bubble”!  Since OER makes up such a large fraction of CPI, this effect is a huge distortion on U.S. monetary policy.

But I suppose, if we carry on down this path for a decade or so, the U.S. can eventually end up with Chinese-style vacant cities of our own! (Or at least vacant neighborhoods… or just millions more vacant structures…)

“Beating Buffett” Blog is full of B.S.

October 31st, 2012

I know it’s better to ignore it when “someone is WRONG on the Internet”, but I can’t help myself this time:

I recently ran across a new blog called “Beating Buffett”.  I think Beating Buffett is a great concept, and it’s among my own personal benchmarks as an investor.  However, BeatingBuffett.com is definitetly not a great blog and will not go into my bookmarks unless its performance improves significantly.

Case in point: Among the posts visible today (though posted on October 10) is one about Annaly Capital Management.  The article claims that “Annaly Capital significantly underperformed the S & P 500 over the past 3 years in the best possible macro-environment. What will it do when things turn ugly?”

The article then plots a chart of NLY’s stock price, using a cherry-picked time period to show a net loss over 3 years, and totally ignoring the huge dividend payouts from Annaly.

In point of fact, a more assessment of NLY vs. the S&P 500 ($SPX) must include the total return of both. The chart below does this and shows that NLY has held its own and at times done better than the S&P 500. This chart correctly captures the reality that NLY pays out around $0.50/share quarterly, a much higher dividend yield that the S&P 500.

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Disclaimer: I don’t own NLY directly, though I may have some through a mutual fund, but even I know that to assess an investment over a 3-year horizon what matters is total return, not share price.

If you want to “Beat Buffett”, you’d better do so on a total return basis over time, and after taxes!

So, do you have a fixed-rate mortage…

July 9th, 2012

… or one with “adjustable” rates that have been “fixed”?  Eh, Barclays?  And how do YOU plead, Team LIBOR?

Barclays “Fixed” Rates, eh?

Photo found at Gary Kaltbaum’s Site

Why we will not “build our way to prosperity”

December 23rd, 2011

There have been some comments on analyses that “We’re going to need a LOT more houses” lately.

The analysis presents a plot of housing starts vs population, since 1960, showing that current starts are at a series low.

Using the ratio of starts to population is not the correct metric for understanding the likely future path of housing starts.  It’s true that housing starts are currently historically low, and population remains high, but there are reasons why the Flow (housing construction) could remain low for some time, if there’s too much durable Stock (existing housing units) and persistent low demand for said stock (due to demographic changes).

The construction need is determined primarily by two flows: changes in household size, and population growth — not by population. 100% of population growth needs housing, whereas only 1% of population stock needs to be rebuilt each year, assuming a given home lasts 100 years.  Assuming stable househould size, if population growth previously averaged 2-3% of population, but today averages only 0-1% due to declining birthrate and reduced immigration, that cuts the need for new housing and reduces the required number of starts by 2/3 to 3/4.

Furthermore, in recessionary conditions, household formation drops and household size increases.  With median household size in the range 2 to 3 persons, a change of just +0.1 person per household results in a -3 to -5% change in the required housing stock, equivalent to 3-5 years of replacement production.  This effect can therefore be even larger than the population growth effect.

Household size and population growth were both quite high in the 1960s (when the available data series started, the Baby Boom was peaking).  The decline in household size since the 1960s drove much of the demand for housing but is not sustainable.  If we previously ran a population growth of 2%/year and it is now 0%/year or even slightly negative (as in Japan, Russia, China, Europe…), and if household size is trending back up, we might not need any new homes at all for as long as household size trends upward.

So to me, it’s not at all clear when we’ll need to build more houses.  (If it were clear, investors would flock to homebuilder stocks, would they not?)

Why we cannot “borrow our way to prosperity”

December 2nd, 2011

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Only in the past few decades have we brainwashed ourselves into thinking that debt levels of 40-80% of GDP were normal, or that there could be such a thing as a “sustainable deficit”.  Our forebears were demonstrably wiser than most Boomers today, and I believe we’re about to relearn some very painful historical lessons.

Historically the US, like other nations, has sought very hard to stay out of debt, not to add to it with allegedly “sustainable” deficits.  This is illustrated very dramatically with the historical debt charts.  The ones on Wikipedia are particularly accessible:

US Federal Public Debt, 1800-1999

U.S. pubic debt was only 20% of GDP in the early 1800s, and the debt was all but extinguished from 1830-1860.  The Civil War led to a debt burden of 30-40%, which was again extinguished by 1910.  World War I led to another 30% burden, which had been cut to 20% when the Great Depression hit.  Even in the GD, the debt only went up to 40%.  It was only World War 2 which pushed the debt to 110% of GDP, and once again as soon as the war ended we sensibly reduced the debt burden, reaching about 25% of GDP in 1970-1980.

Throughout all of these periods, rising national prosperity has led to a reduction in debt relative to GDP.  We have never been able to “borrow our way to prosperity”!

As the more recent data below shows, since 1980 we have gone on a debt binge.  We are not alone. The European PIIGS “canaries” are screaming that we now live in an unsafe “coal mine”, a debt trap!

US Debt to GDP, 1940-2010

If we don’t get our debts back into balance, we face horrific declines in our national standard of living, because if we don’t pay the debt off, the alternatives are either default or inflation.  And when debt exceeds 100% of GDP, it’s very hard to pay the debt off.

It is time to bring the Debt-to-GDP ratio back down.  Any incremental debt must therefore have a strong impact on GDP growth.  The current Administration and Congress are unable to deliver.  We need to change, if we are to have hope!

However, I do not currently see, nor do I expect to see, public attitudes shifting quickly enough.  Too many think that we can live with “sustainable deficits”, despite the fact that unexpected events happen every year which force debtors into defaults.  Those who try to “sustain” their deficits find, almost inevitably, that sooner or later they are “unexpectedly” bankrupt.

Unfortunately,  our government (and many others) has accumulated a debt burden which is only sustainable if the bond market chooses to sustain it. The bond market has voted otherwise in Europe, and could easily do so here. These governments, rather than being led by their people’s votes, are now at the mercy of their financiers.

The pattern of accumulating more debt than you can pay off (without rolling or refinancing) needs to be tamed. Because if a nation can pay off its debt without depending on bankers, it has far more freedom. As it is, we have fallen into debt serfdom.  I don’t think the American people will want to stay in that position, so I think we are in for a painful awakening, and a return to more historical attitudes towards debt.