Where I Get Schooled

How are stocks up so much? There's been no serious financial reform; no withdrawal from various wars; no fiscal fix for public employee pensions or private sector pension shortfalls; and still 10%+ unemployment in major cities. The S&P 500 was only 831 when President Obama took office...stocks are up 41% since his inauguration. Are President Obama and the Dems really that good?

In response, one friend mentioned America's 0% interest rates, which help banks but hurt savers. The best answer, however, came from a former high school classmate:

From the corporate side, it seems fairly plain to me. There's been no financial reform to tighten screws on corporations. The government is still spending a lot of money on wars. The debt, while burdensome, hasn't caused any major calamities (so far). High unemployment means lower payroll costs. Add a very low fed rate on top of this and it looks like a very favorable business climate. Even if revenues are sluggish due to low consumer spending, margins are probably up.

Thanks to Andrew N. for schooling me.

Note: when I posted my comment above on Facebook, the S&P 500 was 1171 and the Dow was 10,896.

Chrysler's Promises in December 2000

Automobile companies recently received a bailout from the White House. They promised to restructure, become more efficient, and gave the usual platitudes. These promises aren't new. The only difference seems to be that now, the Big Three are playing with taxpayer money instead of their own. Here are some excerpts from DaimlerChrysler's letter to shareholders, dated December 2000:

Over the last five years, [1995-2000] we have completely restructured and refocused the DaimlerChrysler Group...In the process, we have shed not only a number of loss-making and non-core operations, but we have also considerably improved the cost structure of our automobile operations in Germany... [Great! So things should be fine now...right?]

During the course of the year, we have also taken further important steps to focus our operations on the core automobile business...[But] competitive pressure in the US automobile market increased significantly, as evidenced by the strong rise in sales incentives or discounts which are up by over one third compared with a year ago, and are almost three times what they were in 1997... [Oh, I get it. It's not you--it's your competition. You can't compete on the open market. Got it.]

The management team has a wide-ranging mandate to reposition and restructure the Chrysler business to enable it to regain its strong market position and to become highly profitable again...

In order to restore Chrysler to profitability as soon as possible what is already clear is that we must also restructure the business--this will bring with it a cost. [Sounds like the job of the "car czar" has already been done.] This expenditure however should also ensure DaimlerChyrsler maintains its position at the forefront of the modern automobile industry. [Chrysler was mentioned as the most likely candidate for bankruptcy before the bailout.]

It boggles my mind that our government is using our money to finance companies that can't seem to ever get it together. In a hilarious press release titled, "The $13 Billion Industry Is In No Fear Of Collapse, But Why Take Chances?", Larry Flynt satirized the notion of bailing out troubled industries. Jokes aside, when, if ever, does moral hazard trump "too big to fail"? This question isn't just idle thinking. The bailouts have exposed a core weakness in our political system. Apparently, if you can't compete on the open market, all you need is a bunch of lobbyists to convince your government to give you taxpayer money. Luckily, in this case, the political system actually worked--Congress rejected the auto bailout plan. Even so, the White House, over the objections of the public, provided the bailout money. George W. Bush in bed with the automakers and their unions? Historians will be amused.

Generous Benefits Will Bankrupt California

From the WSJ, 12/18/08, A4:

Calpers, which stands for California Public Employees' Retirement System, is California's pension fund for government workers. It provides retirement and health benefits to more than 1.6 million state and local public employees. From June 2007 to June 2008, the fund declined from $239 billion to $182 billion. Basically, Calpers lost $57 billion of taxpayer monies. Even with this loss, Calpers has almost $113,000 for each California employee's retirement and health benefits. This amount sounds generous, and it's certainly better than what most Americans have, but the pension is still underfunded. As a result, taxpayers will be forced to pay higher taxes to make up the shortfall, or will suffer inflation and a weaker American dollar as the government prints money to give to itself. In this way, public pensions are ticking time bombs, ready to release dangerous inflation unless something is done.

Congress and state legislatures talk about regulation, but they don't pass laws forcing cities and states to fully fund their pensions and/or to prevent borrowing money from pension funds. I remember Al Gore talking about putting Social Security funds into a "lock box," i.e. a box that is untouchable. Too often, when cities, counties, and states need money to finance a project or to cover a revenue shortfall, they dip into the retirement funds of police officers, firefighters, and other government employees. Eventually, the monies will have to be paid because a) the government employees have paid into the system; and b) the political will to reduce or deny retirement funds is non-existent. Just witness the auto bailout--if we cannot avoid printing money to give to GM and Chrysler, which lost billions of dollars annually, we surely cannot avoid printing money to give to retirees).

In addition to creating a lock box, the government needs to pare down benefits. Every dollar paid to a government employee means another dollar coming out of non-government employee pockets. Here is a quote from the WSJ story:

Like many residents who work for private employers, Ms. Nolan-Stewart, an AT&T manager, says she is astounded at the generosity of public-employee pensions. "If I were to retire, my retirement would be one-quarter of what I make today for the rest of my life," she says. By contrast, city firefighters and police who retire at age 50 with 30 years of service may retire with 90% or more of their final salary.

The WSJ (12/17/08, A1) also reported that Calpers used leverage (borrowed money) to boost returns; however, using leverage also means that losses are magnified, which may explain the fund's recent poor performance.

So Calpers engaged in a risky investment strategy with taxpayer money, and few Californians seem to care. Americans seem to have been so distracted with Iraq, they forgot about domestic surveillance and protecting our finances from government ineptitude. That's too bad, because history shows that every major empire has collapsed from within, not from an outside threat.

To Aspiring Lawyers

Many lawyers who cannot find permanent work do temp work. Most of these temporary jobs are projects involving document review. It's not exciting work, but some projects pay well, and the work is a necessary part of litigation. There are so many temp attorneys, there is even a website dedicated to them at temporaryattorney.blogspot.com.

With the number of lawyers increasing with every annual law school graduation and more work being outsourced to capable Indian attorneys, law is no longer a stable profession where most entrants earn a steady paycheck:

http://temporaryattorney.blogspot.com/2008/08/we-should-have-become-plumbers.html

The Temp Attorney post links to a WSJ article that shows that a degree isn't what it used to be. On the bright side, the chart above shows that at some point--many years later--a college degree finally pays off. Still, I can't help but think that the American education system is broken.

First, the paper-pushing jobs--bankers, lawyers, etc.--make more than engineers and doctors, people who provide vital services or who spearhead innovation. As a result, many intelligent young people go into law--which produces no innovation--rather than nursing, engineering, or science. On some level, that's a wise decision--it's easy for companies to hire engineers in other countries for much less. At the same time, it seems strange that America's job market incentivizes students to go into non-innovative professions rather than innovative ones.

Second, many high schools do not teach their students useful subjects, or they encourage too many students to go to college. Not all students need to go to college, and some students are better off spending four years in an internship program or an apprenticeship program. Also, many subjects taught in high schools will have no future application for students. For example, I still know how to take the derivative of x-squared (it's 2x), but I have no idea what that signifies, and I've never used it in my law practice. Yet, I was able to sit through calculus because I knew it made me a more competitive college applicant. Despite calculus's uselessness to me, I had an incentive linked to a long term goal--a college and graduate degree--which made the class and high school tolerable.

I empathize with students who have no interest in math, second languages, science, or any other required core classes. These students have good cause to be disenchanted with school--they know they will most likely never use physics or even algebra. Their disenchantment or disinterest in their classes may actually be a sign of high intelligence. After all, which is a smarter choice: refusing to spend time on a subject that has no utility, or dedicating hours to it?

In addition, if the under-performing students' family lacks the money to send them to college, the students intuitively realize the system isn't designed with them in mind. Common sense tells them--and should tell us--that their first order of business should be getting useful skills that will lead to a non-minimum wage job. To accomplish that end, high schools ought to join forces with local businesses to teach students the skills they need to get a job immediately upon graduation. When a law degree--which takes four years of high school, four years of college, and three years of law school, plus an exam--doesn't lead to stable employment or useful skills, families should realize their property taxes and other taxes are being spent unwisely. There must be a better way to educate students than a system that encourages eight to eleven years of school and the prospect of paying off student loans by the age of 40.

Cities and the Recession

ABC has a story on how the recession is affecting various cities:

http://abcnews.go.com/Business/Economy/story?id=6259063&page=1

Instituting hiring freezes and eliminating after-school programs doesn't sound like financial Armageddon to me. It appears the government is cutting non-essential services until tax revenues increase. This isn't news to most people who have to live on a budget. I try not to spend more than I make. Why shouldn't the government have to do the same thing, too?

An Auto Bailout is Unjust

Here's an audacious question: How is an auto bailout not preferential corporate welfare?

There is no contention that America suffers from an automobile shortage. Honda and Toyota are perfectly capable of increasing production to fill in any gap caused by a GM and Chrysler bankruptcy (I don't mention Ford, because it appears to be the healthiest of the Big Three). Meanwhile, Japanese car companies have created thousands of jobs in the South and are schooling Americans in how to run an efficient, profitable auto manufacturing operation.

To its credit, the UAW has responded to charges that it is asking American taxpayers to subsidize the Big Three's inefficiency. Unfortunately, its arguments are misleading. For example, the UAW has mentioned state incentives given to Japanese car companies as support for a federal bailout (See Autonews Article).

First, states like Alabama provided incentives to Japanese companies because the UAW was opposed to relocating to the deep South. (Southern states generally favor "right-to-work" laws, which are code for anti-union laws.) The UAW's refusal to support American production in the deep South allowed the Japanese to enter those states without competition. The UAW and the Big Three could have requested Southern state incentives, but they failed to do so on reasonable terms. As a result, any tax incentive given to other companies was due to the UAW's own unwillingness to be flexible. It's akin to losing a war because you refused to go to the most advantageous territory to fight--and then calling the other side dirty for going where you wouldn't.

Second, speaking of the Japanese, we criticized them for years because they bailed out their banks after their speculative bubble. Indeed, almost every American economics study found that bailing out inefficient companies exacerbated the Japanese recession. Just google "Japan's lost decade" for more. (Here's one particularly relevant link from a google search result: http://www.guardian.co.uk/business/2008/sep/30/japan.japan)

Third, the Japanese car companies received only $3 billion since 1992--far below the UAW's request for $25 billion (see penultimate paragraph of Autonews article). The disparate amounts of incentives requested indicate that subsidies aren't the reason for the Big Three's woes. In addition, while it's easy to forget now, the Japanese took a major risk in coming to the South to do business. Just fifteen years ago, no major entity was considering investing billions of dollars in the deep South because of its less-than-cosmopolitan reputation. This reputation required the Japanese to take major risks, such as opening manufacturing plants in places where some residents had never met a Japanese person and where pro-white groups still exist.

There's a happy ending to the Japanese and their risk-taking. Although various Americans continue to refer to Southerners as uneducated and backwards, it is now apparent that these so-called "backward" Southerners have outworked the Midwestern UAW. (It will be interesting to see if Southerners will return the favor and call non-Southern workers lazy and handout-prone). In short, the Japanese should be lauded for taking a risk when the Big Three and UAW refused to consider the South as a viable business destination. Moreover, $3 billion is not what the UAW is demanding, making their reference to the South irrelevant.

The UAW's remaining argument is based on emotion. It talks about the loss of thousands of jobs, implying that without taxpayer monies, the Big Three's employees will be in breadlines and bankruptcy courts. By resorting to this argument, the UAW has taken a page out of Naomi Klein's Shock Doctrine. The UAW fails to mention any other option except demanding billions of dollars in taxpayer monies. For example, it fails to advocate increasing the length of time and amount of payments given to unemployed workers nationwide. Yet, the $15 to $25 billion requested could be used to extend unemployment benefits for all Americans, and at higher amounts. Using this method, no industry receives preference, and taxpayer money benefits Americans nationwide. After all, it's not just the auto workers being affected by this recession, but engineers, accountants, and food service workers. Don't these workers have families to support, too? By demanding money only for auto employees so they can continue in an inefficient business, the UAW is essentially admitting it wants preferential treatment over every single American worker who has been laid off and those who will be laid off. Its attitude is unacceptable if you believe that government should consider the welfare of all its people, not just one particular group.

The UAW's selfishness exposes another issue with an auto company bailout--the slippery slope. What will Congress do when other industries come knocking? Will taxpayers be forced to support all affected industries that happen to have highly paid lobbyists? Once Americans understand that Congress probably wouldn't take seriously a bailout request from restaurants waiters and waitresses, they have to ask why their government is focusing on the Big Three to the exclusion of other industries.

The only reason to provide an automobile bailout is because of the Big Three's legacy costs, which may be shifted onto taxpayers anyway through the PBGC. Unfortunately for taxpayers, it seems that all roads lead to pillaging of their wallets.

Update on December 21, 2008: a 12/20/08 WSJ letter pointed out that the Southern states didn't get loans--they received tax deductions, which are useless, unless the companies actually invest in a particular state and expect to make a profit. In other words, without the tax breaks, a state like Kentucky would get 0 dollars for its residents. But with the tax deductions, a company might come to Kentucky and bring jobs and other positive benefits--none of which would have happened without the tax incentives. So Kentucky and its residents received a net gain because of the tax incentives. GM and Chrysler, on the other hand, are asking for loans directly from taxpayers, which force Americans to own a stake in American car companies and which do not create new jobs. The loans are high-risk and it remains to be seen whether American taxpayers will come out ahead.

Update on 12/23/08: Madoff's investors are already asking for a taxpayer bailout:

"There's no doubt that hearings will be held on this, and some government aid is a very logical request," said Robert Schachter, an attorney with New York-based Zwerling, Schachter & Zwerling, which is representing several Madoff victims. "If we're bailing out Wall Street and the auto industry, maybe these individuals should be bailed out too."

Can you say, "slippery slope"?

Brits and Americans Going Down Same Path

Looks like the Brits are in as much trouble as the Americans:

http://www.telegraph.co.uk/finance/jobs/3492912/Bonanza-for-jobs-but-only-in-public-sector.html

Mark Wallace, of the TaxPayers' Alliance, said: "It is unsustainable to have fewer and fewer private sector workers paying for more and more public sector workers. "The state wage bill, not to mention the future pension cost, is putting a crippling burden on the economy."

Didn't the Americans sail away and fight a war to be free from an overbearing government that was taxing them too much?

Oh, the irony.

Foot Locker Affirms its Financial Strength

Things have gotten so bad, Foot Locker is sending emails to individual customers assuring them it is still a viable business:

As you are a valued member of the Foot Locker family, I would like to take a few moments to address the misleading information regarding our Company that has been circulating the Web and covered by the general media. Much of this information is being used to encourage consumers to avoid purchasing gift cards this holiday season.

We can assure you that our financial position remains strong and we continue to be a leader within the athletic retail industry. From time to time, we do close underperforming stores, in the course of normal business, in order to concentrate our efforts on those stronger-performing stores that ultimately allow us to better serve our customers.

During this holiday season and beyond, we will continue to offer an extensive selection of the most sought-after products at our more than 2,000 U.S. stores and on-line at footlocker.com, ladyfootlocker.com and kidsfootlocker.com. And, of course, our gift cards will continue to be another great gift idea and are redeemable at all of our stores and on-line.

Thank you for your support.

Best regards,

Stacy Cunningham
Corporate Vice President
Foot Locker, Inc.

Oh, the paranoia.

Small Business Stats

These are some facts I received from the SBA's Office of Advocacy, which is sort of a BLS for small businesses, gathering lots of useful statistics:

http://www.sba.gov/advo/stats/sbfaq.pdf [PDF file]

1. "Since the mid-1990s, small businesses have created 60 to 80% of the net new jobs."

For more, go to http://www.sba.gov/advo/research/data.html#us

2. "Small businesses employ about half of U.S. workers."

3. "Two-thirds of new employer establishments survive at least two years, 44 percent survive at least four years, and 31 percent survive at least seven years, according to a recent study."

Well, so far, I'm in the top 44% so far.

4. "Very small firms with fewer than 20 employees annually spend 45 percent more per employee than larger firms to comply with federal regulations."

I have advocated that small businesses with fewer than five employees and a gross income of less than $550,000 annually should have no regulations other than those guaranteeing payment of wages to workers. (I still haven't figured out what the best number is for the gross annual income cutoff and chose 550K because if a company hired five employees and paid them 50K each and had gross receipts of 550K, it would probably net around $200K-$250K, which is not unreasonable.) Criminal laws are sufficient to keep small businesses in check. Beyond that, onerous civil regulations are a form of corporate welfare to larger corporations, who have the capital to hire in-house counsel to advise them, to keep up with ever-changing laws, and to have a litigation defense budget. Small businesses, on the other hand, sometimes don't even know a law until they get sued, because they've been too busy trying to survive in the real world instead of reading regulations and cases.

5. "Commercial banks and other depository institutions are the largest lenders of debt capital to small businesses. They accounted for almost 65 percent of total traditional credit to small businesses in 2003. (This includes credit lines and loans for nonresidential mortgages, vehicles, equipment, and leases.) Credit cards account for much of the growth in small business lending over the past few years."

This might be one factor in the credit crunch--the more small businesses fail, the more bad loans on the banks' books.

Recession Hits Law Firms

Two major SF law firms have shut down:

http://www.sfgate.com/cgi-bin/article.cgi?f=/c/a/2008/10/31/MNA113S07P.DTL

You know the economy's bad when lawyers can't find work. On the other hand, like most professions, certain subgroups do well even when an overall industry doesn't. For example, bankruptcy lawyers, especially those who can handle Chapter 11s, will have plenty of work. Family lawyers probably aren't worrying too much, either. As for me, a labor and employment attorney, I'm not sure how everything will shake out, but I'm not overly concerned.

Economy

Great article from Ron Scherer (www.csmonitor.com) about Americans finally shifting their attitudes towards finances:

http://www.csmonitor.com/2008/1010/p01s04-usec.html

Since last October, household net worth has fallen more than $6 trillion...That calculates to roughly $55,000 per household.

This is one time where I am happy to be below the average. Americans, for the first time, are realizing that having too much debt is unwise, which should cause a short-term bump in our savings rate.

What the Japanese Stock Market Tells Us

Remember the Japanese and their banking problems? Japan is much different from the U.S., but this chart does not bode well for the U.S. stock market. Japan currently has the world's third largest GDP (on a purchasing power parity basis). Check out this article:

http://news.bbc.co.uk/1/hi/special_report/1997/asian_economic_woes/34500.stm

The Japanese economy was growing at a headlong rate, and companies were expanding and investing as never before.

The trouble was that much of this investment was being financed by an extraordinary boom in property and share prices. Property and shares were used as security for huge bank loans - and when the property markets and stock markets suddenly crashed at the beginning of the nineties the whole spiral of borrowing, asset price inflation and investment came to a full stop.

And despite many government initiatives to kick start demand, Japan's economy has remained fairly stagnant for the last six years. The stock market has been flat too, making it difficult for companies...to make profits.

Sound familiar? Defensive investors know that consumers will always need health care and consumer staples (e.g., Unilever products); however, investors looking for more than a 5 to 7% annual return are evaluating other options. After all, the key to getting high returns is determining the next high growth economic area and/or product.

U.S. companies realized earlier than most Americans that their growth would rely on non-U.S. countries. As a result, most major companies have shifted their emphasis overseas while lobbying for fewer trade restrictions. Now that the American consumer appears to be down and out, the question is whether the world economy can finally gain traction without the U.S. The most obvious way this decoupling will occur is if the American dollar is devalued, creating incentives for other countries to buy American products. If a Chinese yuan buys quite a bit of American goods, the Chinese consumer will feel flush and may start spending more, allowing the world economy to have more than one major source of income. A similar scenario can also play out with the Indian and Brazilian consumers. In fact, non-U.S. citizens must spend more in order to maintain economic stability.

Once you realize how small the American population is--only 5% of the world population--it's fairly easy to see that the most growth will come from abroad. As a result, trade restrictions will harm U.S. companies and their ability to expand and get their products into the hands of other countries' consumers. American companies that fail to achieve high growth rates will lay off workers in order to become more efficient. Thus, improving the job market means helping American companies gain more consumers, which means giving them more access to non-U.S. consumers. To achieve easy access to the international market, we have to negotiate with other countries and have fewer restrictions to encourage a free flow of ideas, money, and traffic. As much as we may hate to admit it, reducing trade restrictions and devaluing the American dollar may actually stabilize the world economy in the long run.

At the end of the day, what choice do we have, really? The American consumer is tapped out. Other countries' consumers must step up to the plate, and we need to encourage them to do so. In an era where the world economy requires more trust between countries, the latest failure of the Doha Development Round is an ominous portent. Thankfully, the failure of governments is not determinative.

The American corporations that succeed will be the ones who understand that the American consumer is but one small slice of a very large worldwide pie. In an era of cynicism, skepticism, and security fears, we must regain our confidence and look to maximize our international footprint through trade and superior products. The "Post-American world" can no longer be an amorphous, distant concept if we are to succeed--Americans must begin to see the world as one large marketplace in which they have the advantage because of their greater access to technology (Google, Yahoo, eBay, Intel, etc. all made in the U.S.A.); the world's common language (English); an above average health care system (better health means more productivity); and entrepreneurship (it can take less than a week to set up a small business in California--for fun, compare that time with India and its small business rules/red tape).

I never thought I would advocate a weaker domestic currency, but sad times create sad consequences. The time has come to work harder and re-gain our stature in the world. When the non-U.S. buyers come, America must welcome them with open arms and the American attitude formerly known as optimistic. America is down, but as long as we have immigrants arriving and hoping for a better future, you cannot count America out. For better or worse, we are still the world's major repository for dreams. That's why I don't see a Japan-style economic morass happening in America--Japan is getting older and has never liked immigration. As long as we stay away from protectionism and encourage responsible immigration, we will do just fine.

WSJ on Turkey's Islamic Capitalism

Singaporean 2006 Collectible Coin

Today's WSJ ("Muslim Land Joins Ranks of Tigers") profiles how Islam has benefited Turkey's economy. Despite the tug-of-war between the secularists and the Muslims, there is no question that the pro-Islam party has brought better economic prosperity to Turkey. This adds more evidence to my overriding theme that economics is destiny. A country could believe in Wicca, and as long as it was also successful, we'd all be analyzing how Wicca makes people rich. Any religious or political system that allows people to work hard, feel appreciated, feel safe, and gain material prosperity will be considered successful and progressive. 

Here are some interesting lines from the article, written by Andrew Higgins and Farnaz Fassihi: 

Islam itself has nothing against business. The Islamic prophet Muhammad [peace be upon him] started out as a merchant, and his first wife was a successful businesswoman. Asked to fix prices in the bazaar by followers who wanted to buy goods more cheaply, Muhammad [peace be upon him] is said to have refused: "Only Allah governs the market." 

Now there's one interpretation of the "invisible hand" in action. Of course, Dubai has been successful more consistently than Turkey. Turkey's bonds were paying in excess of 20% until recently (still around 13% from my last memory--these numbers have not been cite-checked). 10 year U.S. bonds now sell for around 4.05%. 

The lower the interest rate on a country's bonds, the more stable the country usually is, because the country has to increase rates to whatever point makes sense to investors after a risk-reward analysis. The higher an interest rate on government bonds, the more risky the country is perceived. Even with higher interest rates and potential inflation problems, Dubai and Turkey should be cited as economic and yes, Islamic, successes. 

Malaysia, at least today, has done the best job in terms of creating both an Islamic and an economically successful state. With its increasing diversity, Malaysia must now find ways to integrate its entire population or risk losing its most successful workers to neighboring countries. It's a problem all rich countries, including America, have and it can be an opportunity to re-affirm nationalism in a peaceful way. Singapore, for example, had a great idea in making an independence day coin displaying different races. See links below:

http://www.singaporemint.com/product_info.php?products_id=966

http://www.singaporemint.com/product_info.php?products_id=810 

Back to Turkey. I own Turkish bonds in my T. Rowe Price Emerging Markets Bond fund (PREMX) and am happy thus far. PREMX also has Iraqi bonds with a 5.8% interest rate. Apparently, the market thinks Iraqi bonds are only a moderately less safe bet than U.S. bonds. I wonder what the interest rates on proferred Iraqi bonds will be when American troops leave. It may not make much of a difference, as long as some troops remain to protect the oil pipelines, or if Iraqi security forces are strong enough to protect their own pipelines. Interesting note: the Iraqi bond held by PREMX matures, or ends, on December 28, 2025. Yup, the year 2025--over 17 years from now.