Kudos to the SJ Mercury News

The SJ Mercury News has done a great job exposing excessive government spending--see links below:

http://www.mercurynews.com/news/ci_12116499

http://www.mercurynews.com/business/ci_12119850

Old news, but still worth sharing. I just attended a City Hall event where a Councilmember said that average employee salaries have increased from $78,000 to $117,000.

Charlie Munger on NBR

Here's a recent NBR interview with Charlie Munger (Susie Gharib, May 1, 2009):

http://everythingwarrenbuffett.blogspot.com/2009/05/nightly-business-review-susie-gharib.html

We can't have a modern civilization without strong financial companies. But we don't need them as swashbuckling and as crazy and as venal as they've been.

More here from Munger:  http://willworkforjustice.blogspot.com/2010/05/wisdom-from-charlie-munger.html

Update: I replaced the link below, because it no longer worked: http://www.pbs.org/nbr/site/onair/gharib/charlie_munger_of_berkshire_hathaway_090501/

Resources Lifespan

The New Scientist has a great chart showing the finite span of certain resources. See full chart here.

Environmental implications aside, I'm going to check what SLV is selling for these days.

Munger on Economics

In honor of Berkshire Hathaway's recent meeting, here is a 2003 speech Charlie Munger gave in California: [warning: PDF file]

http://www.tilsonfunds.com/MungerUCSBspeech.pdf

Here's a fun snippet:

I think that economists would be way better off if they paid more attention to Einstein and Sharon Stone. Well, Einstein is easy because Einstein is famous for saying, “Everything should be made as simple as possible, but no more simple.” Now, the saying is a tautology, but it’s very useful, and some economist – it may have been Herb Stein – had a similar tautological saying that I dearly love: “If a thing can’t go on forever, it will eventually stop.”

Sharon Stone contributed to the subject because someone once asked her if she was bothered by penis envy. And she said, “absolutely not, I have more trouble than I can handle with what I’ve got.”

Also, Munger saw our financial problems well in advance:

[Question]: …financial destruction from trading of derivative contracts. Buffett said that the genie’s out of the bottle and the hangover may be proportionate to the binge. Would you speculate for us how that scenario can play out? [The question was garbled, but the person asked about derivatives, which Buffett has called “financial weapons of mass destruction.”]

Munger: Well, of course, catastrophe predictions have always been quite difficult to make with success. But I confidently predict that there are big troubles to come. The system is almost insanely irresponsible. And what people think are fixes aren’t really fixes. It’s so complicated I can’t do it justice here – but you can’t believe the trillions of dollars involved. You can’t believe the complexity. You can’t believe how difficult it is to do the accounting. You can’t believe how big the incentives are to have wishful thinking about values, and wishful thinking about ability to clear.

Running off derivative book is agony and takes time. And you saw what happened when they tried to run off the derivative books at Enron. Its certified net worth vanished. In the derivative books of America there are a lot of reported profits that were never earned and assets that never existed.

If you're interested, my review of Munger's 2008 shareholder meeting is here.

Random Thoughts of the Day: Widows and Signs of the Apocalypse

First, a big thank you to federal Judge Christina A. Snyder. The United States government was attempting to deport foreign-born women who married American men and moved to America. In some cases, these widows had U.S.-born children with their husbands. "60 Minutes" did a story on this potential tragedy several months ago. I wrote a letter to Senator Diane Feinstein's office about this issue. Her office sent me an email a few weeks ago. Senator Feinstein supported the widows. Here is her email:

I want to thank you for writing to share your concerns regarding the so-called "widow penalty," which affects the immigration status of legal permanent resident spouses when the sponsoring U.S. citizen spouse dies.

I have great compassion for foreign nationals whose applications for legal permanent status are put into question when the sponsoring American spouse passes away. Under current immigration laws, an individual may only continue to seek adjustment of legal status if he or she was married for at least two years prior to the U.S. sponsor's death. If a couple is married for less than two years prior to the U.S. citizen sponsor's death, a foreign national cannot continue the adjustment of status process and faces the possibility of deportation.

I am an original co-sponsor of S. 815, which Senator Bill Nelson (D-FL) introduced on April 2, 2009 to ensure that surviving spouses of deceased U.S. citizens are not unfairly penalized. This bill would allow spouses who have been married for less than two years at the time of the U.S. citizen's death to continue to petition for status adjustment as an immediate relative, as long as they can prove that they entered into their marriage in good faith and not for the purpose of obtaining immigration benefits. This legislation has been referred to the Senate Judiciary Committee, on which I serve. It is my hope that this legislation will move forward in this Congress.

Judge Snyder ruled that the Dept of Homeland Security could not reject the foreign-born widows' residency applications merely because the Department failed to process the residency paperwork before the American spouses died. In case America needed more evidence that the Dept of Homeland Security is, in fact, the Dept of Douchebaggery, this story ought to be the nail in the coffin.

I hope Congress passes Senator Nelson's proposed legislation.

Second, did anyone want to slap the homeowners mentioned in this SJ Merc story? ("Sellers of high-end Silicon Valley homes put dreams on hold," 5/2/09)

Basically, a local homeowner is upset that the house she bought decades ago isn't selling for the millions she thinks it's worth. She's lowered the price from $2 million to around $1 million. She wants to move to Puget Sound, and gosh darn it if local homebuyers aren't cooperating with her well-laid plans. So what does she do? She compares her situation with the Great Depression:

"I called my mom and asked her what it was like in the Depression," said Negler, who owns the Victorian. She realized, though, that she "sounded pretty selfish. We stopped looking at ourselves as the center of the universe."

I guess she should get some credit for calling herself "selfish"--it shows she has some self-awareness that her comparison to the Great Depression is off-kilter.

Update on Trading: FXM

I bought FXM last week, believing it had dropped too much. FXM went up 4% today. I sold my shares. The trading took place in a retirement account, so I don't suffer a tax hit. For some reason, my record on short-term price movements is much better than my long-term predictions.

Banks: an Immodest Proposal

Jamie Dimon's shareholder letter inspired me to evaluate ways around another banking crisis. The primary reasons for our current economic crisis are as follows: one, too many banks had lax lending standards; and two, financial and corporate institutions were interlinked to such an extent that conservative behavior was not appropriately rewarded.

In attempting to fix our current problems, we may have sown the seeds for another banking collapse. Currently, too few financial institutions hold too much of consumers' assets. This problem has gotten worse as concerned consumers have withdrawn their assets from smaller entities and placed them in larger institutions. In addition, the government has allowed large banks to take over smaller banks' assets. This has benefited large banks by giving them more assets but has also increased systemic risk. Whenever fewer players exist in any game, power becomes concentrated and competition decreases, which hurts everyone on the outside, i.e. consumers. Right now, Wells Fargo (WFC) currently holds over a trillion dollars in assets. But in 1950, Wells Fargo's combined assets were less than $3 billion. In 1985, the number increased to $50 billion. Prior to the Wachovia acquisition, it held $610 billion, still well short of its current $1.5 trillion. JP Morgan (JPM), after its WaMu acquisition, is now the largest credit card issuer in the nation. There is some good news--after the recent financial turmoil, several investment banks, such as Goldman Sachs (GS), have become mere banks, falling under broad government regulation for the first time. Even so, with fewer financial institutions holding more assets and liabilities, it is unclear whether derivatives and other risky contracts have been sufficiently curtailed, or whether the new assets given to the larger banks have allowed them to maintain the previous system, which led to our current banking collapse.

In 2002, one bank, J.P. Morgan Chase, accounted for $26 trillion of derivatives all by itself. (Again, that's $26 trillion, not $26 billion.) Thus, it's fair to say that JP Morgan knew about the massive risk inherent in its derivatives in 2002--or at least five years before systemic risk spiraled out of control, causing our current economic collapse. Yet, JP Morgan survived through 2009 and appears to be one of the last standing well-managed banks. You can draw two conclusions from this result. One, derivatives or increased financial regulation is unnecessary. JP Morgan being able to extricate itself from derivatives to avoid collapse shows that individual decisions matter, not regulation. Or, two, even though JP Morgan and other banks knew about the massive danger of derivatives in 2002, the system allowed this massive risk to continue unabated for years. As a result, other banks continued to trade derivatives and caused the entire banking sector to suffer, leading to a recession affecting all banks, not just poorly-managed ones. Ergo, we cannot rely upon all banks having excellent CEOs, so we must strictly regulate banks to avoid systemic collapse.

Even if you ascribe to the second conclusion, you must still draft reasonable regulation. To this end, I offer the following:

1. No individual financial institution shall hold more than $75 billion of consumer [non-business individual] assets.

2. No individual financial institution that holds consumer assets shall have liabilities, including derivatives contracts, of more than $1 trillion.

3. Financial institutions may have liabilities of more than $1 trillion only if they meet two conditions: a) they must not hold any consumer assets or consumer loans, such as credit card debt or home mortgages; and b) they must buy insurance covering at least 75% of their liabilities. (This regulatory framework shifts the burden to insurance companies, not the government, to determine appropriate risk pricing. One problem with this framework is that the government must rely on Moody's (MCO) and other ratings agencies to act as ethical middlemen, but the government can more easily regulate ratings agencies than financial institutions. The government can also create its own financial ratings agency, like a "ratings USPS," while Moody's and S&P become FedEx and UPS. You're probably wondering how this framework would prevent another AIG bailout. It wouldn't, but if ratings agencies do their job and evaluate risk properly, an AIG won't ever happen again. The real issue is eliminating conflicts of interest in the ratings agencies, which probably shouldn't be publicly traded companies. Ratings agencies should be focused on prudent accounting, not increasing growth and profits per share.)

4. The FDIC insurance cap on all financial accounts (not investments) shall be raised from $250K to $650K permanently. (On January 1, 2010, FDIC deposit insurance for all deposit accounts—except for certain retirement accounts—will return to at least $100,000 per depositor.) This change may encourage Republican support, because it would help one of their core constituents, the rich. It would also help blunt cries of socialism, because again, this change helps mainly rich people. What rich person wouldn't want the government to insure all of his or her personal accounts up to 650K? This change may also cause the rich themselves to spread their wealth among different banks--increasing overall systemic health--instead of having their money with just one or two financial institutions.

5. Financial institutions that fall under these new regulations shall have five years to comply. The government stresses that there is no single way to comply with these new regulations. For example, financial institutions may spin off new entities to shareholders; they may sell assets to other entities to meet their new threshold; or they may use other methods to fall under the new threshold amount.

6. The Federal Reserve shall, in its sole and independent discretion, have the authority to raise the "trillion dollar" liability threshold once every calendar year, but if it wishes to increase the existing threshold by more than $750 million, it must receive Congressional approval.

Credit unions would benefit from this new legislation, and rightfully so. Did anyone notice that no consumer credit unions have collapsed? (Two corporate ones have collapsed, but these are different from credit unions that serve consumers.) Financial institutions which stayed true to their bread-and-butter business--making conservative loans and paying consistent dividends to shareholders--did well. Why not encourage them instead of the bad banks like Citigroup (C) and Bank of America (BAC)?

As for the inevitable lawsuits, the government would be acting under its anti-trust authority as well as its general welfare powers. No "taking" occurs here. Banks have five years to create a safer framework that maximizes shareholder value in any way they see fit. Most shareholders would end up owning shares in multiples companies and banks, not just one. There is no reason the value of their assets/shares must decrease--in fact, it may increase. As a result of the banks' complete discretion on how to spin off or create other entities and the long time period they have to do so, any "taking" is speculative and financial institutions cannot reasonably make such an argument under the 5th Amendment.

More specifically, the economic impact of the regulation is reasonable because a) the government is not violating or voiding any contracts, and to the extent it is doing so, such contracts may be re-negotiated in three to five years to produce a reasonable result; and b) the government is not taking anyone's property. It is simply ordering financial institutions to modify their own businesses to prevent massive systemic risk--it is not telling them how to do it. This is just like telling a restaurant it cannot have more than 1000 people dining in a certain square footage area. The government isn't taking the restaurant's customers--it's just telling them to modify their practices to prevent a fire hazard. The same principle applies with the proposed banking regulations.

The regulation's impact on investor-backed expectations is also negligible. No investor can reasonably argue he or she is entitled to create massive systemic risk when a) the government is not gaining any money whatsoever; and b) the investor does not necessarily lose any money if the banks handle the transition properly.

The more I think about it, the more I believe that "too big to fail" ought to be "too big to exist." Perhaps the government will come to this conclusion before the next financial crisis happens. I doubt it, though. The main people who would benefit from these new regulations would be average Americans. Unfortunately, Congress stopped listening to them a long time ago.

Bonus: another perspective, from Bob Wilmers:

At the shareholder meeting, Wilmers emphasized the performance of the "good" banks, the more conservative "community banks" that did not become players in the "virtual casino" of our financial markets. He also dissed the bank regulators, including the useless, dim-witted Office of Thrift Supervision. He calls OTS the "place to go ... if management of an institution wanted to be an aggressive player in the banking industry with a minimum of supervision."

Update: I can't believe I missed this Glenn Greenwald post:

Senator Richard Durbin (D-IL): "And the banks -- hard to believe in a time when we're facing a banking crisis that many of the banks created -- are still the most powerful lobby on Capitol Hill. And they frankly own the place."