Bond Ratings Explained

In my February 29, 2008 posting ("Warren Buffett's Letter..."), I mentioned that California's bonds were rated the second-worst in the entire country (single A). Why is this problematic? Two reasons: 1) the relatively low rating shows that the health of the state economy isn't as stable as it could/should be; and 2) low bond ratings mean that future expenses may exceed future revenue, making borrowing for new projects (think schools, tax credits to the poor, new roads and bridges, etc.) prohibitively expensive. In short, Californians may not be able to maximize funds for future generations if bond ratings do not improve.

Let me put this in perspective. California's rating is A. Investment grade bonds are bonds rated in the top four quality categories by either Standard & Poor's (AAA, AA, A, BBB) or Moody's (Aaa, Aa, A, Baa). Some readers might think that the credit risk assessors have rated Californian bonds in the top three, so there is no problem. But, as I stated above, California has the second worst rating in the nation, which means that the accountants who have studied our expected revenue and expenses are saying that our economy is projected to be the second worst place to invest in the entire United States. Moreover, our lower bond rating means that we have to pay a higher interest rate if we want to borrow money, which, over time, could create more liabilities for our children in the form of billions of dollars of interest payments. Other than mis-management and the irresponsibility of our elected representatives, there are no reasons why liberal Oregon, post-Big-3 Michigan, low-growth West Virginia, and high-growth Texas should be able to issue higher-grade investments than California.

Furthermore, California's economy is one of the top ten largest economies in the entire world, so its low bond rating means that the state is not budgeting well at all (i.e., our elected representatives are concealing future costs, or enriching themselves or their lobbyists' pet projects at our expense), and if we enter a recession, the effects would be felt world-wide. As a result, this bond rating exposes a crack in California's economy that could potentially impact not just you, but that 13 year old kid in Thailand who makes clothing to sell to us.

I own a T. Rowe price international bond fund. In my bond fund, 56% of the bonds held have higher ratings than California's bonds. The bond invests primarily in Austria, Malaysia, Italy, Japan, France, Germany, and the United Kingdom. Already, some of T. Rowe Price's investors have basically decided, "Why invest in California if you can get an equivalent, more stable return internationally?" Meanwhile the EU's GDP is now equal to the U.S. It doesn't it take a genius to figure out what will happen if this trend continues. We must take measures to fix these issues lest the price of oil and other major commodity indices become denominated in euros (or some other currency), causing Americans to spend the majority of their days working to pay taxes to Washington, D.C. so that our representatives can use those funds to send payments abroad.

For a more in-depth explanation of bond ratings, see

http://mockingbird.creighton.edu/english/fajardo/teaching/SRP435/junkbond.htm

The Wire, Season 2

I'm only on the second season of The Wire, but David Simon is looking like a genius. The actors in this series are aren't the normal Hollywood contenders--they're gritty and real, and one risk of seeing these characters for six seasons in one role means they will be typecast with the crime genre far more than other actors, limiting their overall exposure.

The Wire's first season seemed long. I know now that Mr. Simon was developing his characters for upcoming seasons, and the first season was like the first 50 pages of a good 400 page book--somewhat tedious, but necessary. The second season was flawless. It deals with the ports and the shipping unions, which we do not normally see or hear from, but are vital hubs of activity nonetheless. One of the best-developed characters, Frank Sobotka, says something poignant about the state of our economy:

"You know what the trouble is? We used to make sh*t in this country, build sh*t. Now we just put our hand in the next guy's pocket."

It's exactly what Warren Buffett is saying about the U.S. economy and the American trade deficit, but it hits home a little harder coming from a non-billionaire.

Warren Buffett's Letter to BRK Shareholders and Government Liabilities

Each year, Warren Buffett publishes a letter to Berkshire shareholders that is both informative and humorous. This year, Buffett discussed an issue that gets far too little press: pension plan liabilities and actual costs of future benefits, which are notoriously difficult to calculate:

"Whatever pension-cost surprises are in store for shareholders down the road, these jolts will be surpassed many times over by those experienced by taxpayers. Public pension promises are huge and, in many cases, funding is woefully inadequate. Because the fuse on this time bomb is long, politicians flinch from inflicting tax pain, given that problems will only become apparent long after these officials have departed. Promises involving very early retirement – sometimes to those in their low 40s – and generous cost-of-living adjustments are easy for these officials to make. In a world where people are living longer and inflation is certain, those promises will be anything but easy to keep."

I am happy to say I sounded the horn on this issue before Mr. Buffett, at least in print. On or around December 2007, The Metro published a letter from me discussing the government's pension plan liabilities. In the letter, I sound quite Ron-Paul-ish, probably more than I actually am, but I have revised the letter and included it below:

America was founded to ensure that private citizens had freedom. To that end, the Constitution provided for a limited federal government, recognizing that large, non-transparent governments and freedom are incompatible. Indeed, any government salary (or new law, for that matter) saps resources from private citizens that could be spent on innovation and other, more productive activities, while also increasing a government official’s power to exert influence and control over private lives. High government salaries are particularly problematic, because they are a form of fraud on the public, i.e. the taking of more funds than necessary from dispersed private citizens to support unionized government members. Here, our local government wanted to hide how much its members were making, which prevents the discovery of corruption and fraud in the form of higher-than-normal salaries. Yet, almost any county position could be filled with qualified individuals even if the county reduced its salaries significantly, recognizing that a pension and the possibility of lifetime medical benefits are more than enough to attract qualified workers. In fact, almost no one in the private sector receives pensions or lifetime medical benefits, and all the private companies that used to offer such benefits, such as General Motors and Ford, are changing their policies. There is a lesson there for private citizens, who may eventually be forced to pay higher taxes to support the unusually generous benefits the government keeps giving itself.

As an attorney, I have litigated against several government agencies and have been shocked at how power individual citizens have granted to unqualified government members. In one case, the DFEH brought an action in a separate tribunal set up exclusively for employment claims, in front of an unelected judge who used to work for the DFEH. The DFEH’s client was awarded no money in the case, but my client had to pay thousands of dollars in attorneys’ fees for a case that almost no one in the private sector would have touched. Yet, we are all paying for a tribunal (the FEHC) with the power to award 150,000 dollars against any small business or individual.

This government excess is not limited to legal tribunals. San Jose’s independent police auditor is having to fight to get a small measure of authority to review taser deaths caused by San Jose police. To get an idea of what happens when government workers are strongly unionized and do not have to fear discipline, read the case of Grassilli v. Barr (2006).

California's own government is so large, I was shocked the first time I saw a list of just the state agencies. Take a look at this link–it does not include city or county governments and yet shows a massive, sprawling government:

http://www.ca.gov/About/Government/agencyindex.html

Someone must pay for all of these employees and their pensions, sabbaticals, and health care. Teachers’ unions usually ask for more money, but the California State Teachers Retirement System is already worth around $125 billion.* It has around 750,000 members and is the third largest public retirement fund in the country. Yet, after health care, education reform remains crucial, and the CTA continues to ask for more money.

As a result of government salaries and benefits spiraling out of control, California’s bond ratings have gone from AAA to single A and are approaching status that is slightly above junk (see http://www.treasurer.ca.gov/ratings/current.asp). The high salaries and unusual benefits of local government workers are just one small part of major fiscal problems that will not get better on their own. The lack of transparency in local government salaries has been remedied somewhat, but many other issues remain. I pray that this country’s citizens will read its history and think harder about current Constitutional issues; otherwise, we will be seeing a great power slowly but inexorably degenerate into a bloated, inefficient police state.

*My figure placed the value of the CTA pension plan at $125 billion. It is actually $131.2 billion, according to the Wall Street Journal's February 28, 2008 article, "Dear Crunch," C1. But what is problematic is that the CTA pension plan is underfunded by 19.6 billion dollars, all of which eventually has to be paid by California taxpayers. This means that the current debt calls for paying retired California teachers 19.6 billion dollars, and the pension plan doesn't have that money now and is hoping to get it in the future (stock market gains, more dues, higher taxes, etc.). To get an overall picture of the financial liabilities we face, the WSJ states that we--that includes you, if you pay taxes in the U.S.--owe our government $440 billion dollars, all of which will be put into the pockets of government workers. In a sign that the purse is already appearing shallow, the WSJ said that the city of Vallejo, CA is considering filing for bankruptcy. Its local government granted itself so much in benefits and salaries that the police and fire department's "salaries and benefits account for 80% of budget costs." Again, if you look at my letter to The Metro, the unstated premise is that without oversight, government will enrich itself at the expense of private citizens, especially in the areas of police power. The City of Vallejo, with almost all the taxpayer revenue going to police/fire union members, proves my point. Yet, even recent front page news stories about how the San Francisco mayor's office increased the salaries of close associates, or how various government departments are paying so much in overtime that correctional guards regularly exceed 100,000 dollars per year in compensation, is not causing any alarm bells to go off (This in a country that now has 1% of its adult population behind bars and will probably need more correctional officers in the future). When front-page news does not shock the public into demanding reform, we need to re-examine how we grant benefits and salaries to government members, perhaps even having referendums or some opt-in voting measure to establish reasonable salaries and benefits. Otherwise, every government employee will be functioning in a pyramid scheme where actual future costs of benefits, especially health care, remain undisclosed and incalculable. Such a situation is not good for taxpayers or our government members. Government, like private industry, benefits when new and highly performing members are attracted to jobs and bring with them fresh ideas. At this rate, government agencies will not be able to hire new employees, and private citizens will not benefit from a fiscally-healthy, secure government.

One of the links in my letter led to bond ratings for all the states. As of today, it shows that California's bond rating is the second worst in the nation, leading to higher borrowing costs and difficulty with improving our infrastructure. Who has the worst bond rating? Louisiana, which was battered by Hurricane Katrina and is still feeling its effects economically. It should be shocking that the sixth or seventh largest economy in the world has the second worst bond rating in the U.S., above only a hurricane-ravaged state, but so far, there are no protests in the streets, no condemnation of government expenditures by citizens, and no cries of unjust takings from our grandchildren. Our founders would be stunned at our utter complacency, but perhaps also proud of the prosperity we have achieved in such a short time. With that in mind, it would be a shame if future generations were unable to see America's promise of prosperity because government members and unions were enriching themselves at our expense or refusing to accept pay cuts, even as tax revenue decreases.

Original letter here: http://www.metroactive.com/metro/12.26.07/letters-0752.html

Update on January 13, 2009: here's a great website on public pensions:

http://www.pensiontsunami.com/

First, Kill All the School Boards

After the Wilson Quarterly, the Atlantic Monthly is my favorite periodical. Its Jan/Feb 2008 issue has a section written by Matt Miller about schools and some memorable quotes:

Mark Twain: In the first place, God made idiots. This was for practice. Then He made School Boards.

Miller jokes, "Things don't appear to have improved since Twain's time."

Also from Matt Miller: The usual explanation for why national [educational] standards won't fly is that the right hates "national" and the left hates "standards."

I read an interesting tidbit about why so many founders of tech companies (e.g. Bill Gates, David Packard, etc.) are focused on changing and improving education. (Many billionaires fund non-profits and various enterprises, but the Gates Foundation, for example, has worked extensively on expanding charter schools.) The theory is that Gates and others in Silicon Valley got their wealth through education rather than inheritance; therefore, they believe that more inventors and entrepreneurs will be created through a better educational system.

Book Review: When the Game Was Ours

(Written January 18, 2011)

When the Game Was Ours is a treat for any basketball fan. Apart from the firsthand commentary from both Magic Johnson and Larry Bird, the book is surprisingly personal.  For example, I had no idea Larry Bird's father committed suicide when he was 16 years old, or that Larry Bird almost decided to stay in his small town and get a "normal" job until his mother reminded him of her expectation that he would be the first in the family to graduate college (which Bird did--even after he was drafted by the Celtics while in college).  I don't want to pontificate my own interpretation of the book, so I'll just share some sections I found interesting:

Larry's teammates were sometimes jealous of the attention he received--back when Magic and Bird played, there were fewer NBA teams, so the talent level was higher across the board.  So-called "sixth men" at that time could have easily started on many NBA teams today.

"Somebody asked me once how I felt about all that [the jealousy from teammates]," Bird said.  "I told them, 'Hell, I'm jealous of them, too.  I'm jealous because I never got to play with a Larry Bird.'" (pp. 47, 2009, hardcover)

On revenues and revenue-sharing: 

"By 1981...60 percent of the gross revenue, which was hovering at $118 million, was being paid out to the players.  The formula had to change or the league was going to be out of business."  "In March 1983...the salary cap...[paid] the players 53 percent of the league's defined gross revenue (television and radio revenues and gate receipts) and a guaranteed $500,000 a year in licensing."  (pp. 99)

"In 1984 the NBA's retail merchandise generated $44 million.  By 2007 that number had jumped to a staggering $3 billion under [David] Stern's watching eye." (pp. 109)

"In 1979, the league's four-year deal with CBS was worth $74 million.  By 2002 the league had inked a six-year deal with ABC, ESPN, and TNT valued at $4.6 billion." (pp. 110)

"[I]n 2002, the league signed a network contract valued at $4.6 billion, a significant upgrade over the four-year, $74 million pact the NBA inked in Magic's and Larry's rookie season." (pp. 312)

On Isiah Thomas, who ends up looking like the least classy player in the book: 

"Isiah [Thomas] kept questioning people about it [Magic's sexuality]," Magic said.  "I couldn't believe that.  Everyone else--Byron [Scott], Arsenio [Hall], Michael [Jordan], Larry [Bird]--they were all supporting me.  And the one guy I thought I could count on had all these doubts.  It was like he kicked me in the stomach." [pp. 241]

"I'm sad for Isiah [Thomas].  He has alienated so many people in his life, and he still doesn't get it.  He doesn't understand why he wasn't chosen for that Olympic team, and that's really too bad.  You should be aware when you have ticked off more than half the NBA." [pp. 263]

Dennis Rodman's reaction to playing with Magic after the HIV announcement: 

Rodman eliminated the awkwardness on his very first trip down the floor, when he elbowed Magic in the back, then bodied up on him and bumped him in the post. "C'mon now," Rodman said to Magic. "Show me what you got." ... After a few minutes, the players seemed to relax." [pp. 249]

Bird on tipping and frugality: 

In his rookie season, the first time Bird went to New York with the Celtics, he and Rick Robey popped into a bar to have a brew. When he saw the prices on the tavern's menu, Larry abruptly stood up and walked out.  Years later, while dining with his teammates in a trendy New York eatery, the players began collecting money for the bill.  Told they were going to give the waiter a 20 percent tip, Bird said, "What for? All he did was deliver the food."  He stood up, grabbed the tip money, and strode unannounced into the kitchen.  He handed the astonished cook a fistful of bills, then walked out. [pp. 270]

Bird's politeness: 

"Bird...insisted on calling the commissioner Mr. Stern." (pp. 107) 

Chuck Thompson's Smile When You're Lying

Thompson's Smile When You're Lying is the funniest book I've read since Sedaris' Me Talk Pretty One Day. Thompson writes travel stories you don't often hear about in the sanitized media, which include paintbrushing with unorthodox body parts, possibly being robbed by seemingly demure religious women, and writing love letters for food--and that's just the first chapter. Thompson knows how to write, is opinionated, and interesting, which usually produces a great book filled with unusual insights:

"[Bruce Lee's] kitty-cat squealing and falsetto yelping always conveyed to me an understanding of just how laughable all that in-your-face showboating is. I'm not sure what sound the koala makes in anger, but if I ever get back into kendo, that's the one I'm going to adopt as my battle cry." (p. 82, Holt Paperback)

Thompson's rants will become legendary in time--here's one on public school teachers:

"And, yes, poor unappreciated teachers. I did say sweet deal. American public school teachers have the world's best PR operation going. Whining every chance they get about how demanding their jobs are, how many 'extra hours' they put in, how little they make, how much of their own money they have to spend just to do their jobs, how noble they are working this job that nobody ever asked them to do--welcome to the f*cking world...

You think you got it tough? You don't got it tough. American teachers would crumble if they ever had to work the real hours of a cabbie, doctor, bartender, fisherman, truck driver, small-business owner, hotel clerk, mechanic, architect, janitor, musician, surveyor, accountant, or the million other jobs that don't observe weekends, much less every city, county, state, and federal holiday on the docket, almost three months' paid vacation a year, and pension programs funded out of the public trough. How is it we go through school painfully aware that half our teachers are lazy or incompetent or pathological control freaks, then turn around and let them convince us what a bunch of saints they are as soon as we become taxpayers?" (p. 100)

Thompson's views on Americans' general fear of traveling to South America are just as pellucid as his other opinions:

"Despite being home to Angel Falls, the Gran Sabana wilderness, and parts of the the Andes, Amazon River, and Carribbean coastline, fewer than half a million international visitors venture into the majestic Venezuelan countryside... This is in large part due to the fact that, fear being the lietmotif of all good propaganda, about 75 percent of Americans are convinced that any trip south of Texas will involve some combination of bribery, kidnapping, armed revolt, the most toxic GI diseases this side of the Congo, knives pulled in macho bar duels, and a probable colonoscopy at the border." (p. 118)

Thompson's ability to use sharp humor to defuse common misconceptions about travel and the world is unparalleled. One gets the feeling that he's kept all of his non-politically-correct secrets hidden to appease the gods of corporate fealty and finally decided to unleash his wisdom on all of us, decorum be damned. For example, we've all seen the alcohol ads go from Swedish bikini team to "drink responsibly" slogans. But after Thompson writes, "When the beer companies start running ads lecturing the public about responsible behavior, you sense a civilization in decline" (p. 129), you realize beer companies advocating responsibility does appear, on second glance, to be a strange combination. Those "a-ha" moments come regularly and wrapped in laugh-out-loud lines throughout the book. You owe it to yourself to read Smile When You're Lying, especially if you're looking for a good laugh.

(One point I feel compelled to make, in an act of true lawyer-ly nitpicking: Thompson bemoans traveolcity.com's attempt to increase sales using sexy women on its magazine cover, but his own book features a picture of a blonde woman in a bikini holding a margarita, beckoning readers with her pneumatic charms.)

Bonus (added on August 31, 2015): "If there were a fundamental principle that once separated America from the rest of the world, I'd nominate institutional integrity.  More simply, public honesty.  I'm not suggesting that dishonesty isn't readily found in every civilization, that a Golden Age of American honor ever existed...Nor am I parading myself as a paragon of virtue.  We all lie, to some degree, usually in petty ways, for the sake of discretion or keeping the peace or perhaps on occasion simply because it's the most expedient means available to get what we want.  Still, lying and cheating--perhaps other than to avoid hurting someone's feelings--has never been openly accepted or condoned in the United States, much less celebrated as a 'genius' operational tactic (when done with Rovian finesse) from the boardroom to the courtroom.  At least, not until recently....Worse, Americans seem to be reveling the descent...American society is no accident; it didn't evolve by providential decree; its success wasn't inevitable...Americans have historically understood that to create a country in which half the world aspires to live, the first prerequisite is the integrity of its public and private institutions.  That's the foundation upon which the country was assembled and its illustrious future once determined...What's being overlooked in the rush to save the planet, however, is that we're also pissing away a social gift as great as any people in history have been bequeathed.  And if we don't resist the seduction of the seemingly inevitable road in front of us, it won't matter how much fossil fuel we stop burning, we'll fail to preserve the part of us that mattered most in the first place." -- Chuck Thompson, To HellHoles and Back, pp. 309 et al, paperback, Henry Holt and Company. 

The Age of Turbulence, by Alan Greenspan

Greenspan's new book is the opposite of his opaque speeches to Congress; here, he's remarkably human and clear. There are several funny tidbits about his life, including a very obtuse, meandering dedication to him in his father's book when he was young, which may have influenced Greenspan more than he may want to admit. His love for his wife comes through loud and clear, and the book includes a delightful picture of him at the piano with her.

However, Greenspan offers nothing new or insightful in his book other than a life-changing interaction with Ayn Rand, which led him inexorably down the path of libertarianism. (And yes, that's a contradiction for a government economist, if you're keeping score.) His comments on over-dependence on foreign oil, "creative destruction" causing U.S. citizens to become concerned about their quality of life, corn-based ethanol being a boondoggle, warnings against protectionism and economic populism, etc.--this has all been said before, by someone else, somewhere else. Greenspan does advocate a higher tax on gasoline to reduce consumption, which is surprising for a libertarian, but again, not a new idea.

Greenspan also compares the U.S.'s main competitors, especially the U.K., Russia, Japan, France, Italy, and India. He concludes that India needs to overthrow its labyrinth bureaucracy to be competitive, France needs to reform its union-based employment system, Italy made a wise decision to join the EU, and Japan's emphasis on saving face may harm its future growth. He also contends, without saying so directly, that Russia may be the next rising power due to its natural resources and military strength.

Greenspan mentions that the currency markets are more difficult to manipulate than one might think, and points out that Japan bought 20 billion U.S. dollars in one day in 2004, and the dollar-yen exchange rate barely moved. On the other side of the currency divide is Argentina, and Greenspan briefly discusses Argentina's pegging of its currency to the dollar, which led to a financial restructuring. Again, nothing new is said, but Greenspan did have access to many high level politicians and economists, so he is able to discuss, for example, Gerald Ford's "ordinary Joe" persona with more credibility. (For the record, Greenspan did not like Nixon, but found him to be very intelligent, and mentions later in the book that until Clinton, he did not meet anyone as intelligent as Nixon in the White House.)

Although he offers nothing profoundly new (except for perhaps the role liquified natural gas might play in our future energy plans), Greenspan's book is pleasant to read and gives the reader an insight into his sense of humor and tastes. Greenspan's overall message seems to be that the U.S. owes the Constitution much credit as its backbone of stability; citizens should be careful not to revert to the old ideas of centralized government; and the Federal Reserve should maintain an environment of controlled optimism.