Voice Brokers – Judges on American Idol or The Voice?

Definition: Interdealer brokers for OTC derivatives such as Forex, Commodities, Futures and Swaps

Most of us worry about automated trading - high frequency trading where computer algorithms govern the process, i.e., another flash crash. Would you believe that the US government is more concerned bout the good old-fashioned way of trading?

The term, “voice brokers” conjures up an image from TV shows and movies where brokers mill around on a stock exchange floor waving pieces of paper in the air while shouting out orders. It’s not that chaotic now, but voice brokers indeed use their voices to create orders, usually on a phone or on squawk boxes, an intercom speaker on their desk that they use to communicate with banker clients. They deal with trillions of dollars of OTC (over-the-counter) derivatives every day.

The US government began closely scrutinizing voice brokers this year because it suspects they may be rigging Forex (i.e., currency exchange) deals. This scrutiny was set in motion by the Libor scandal early this year, where brokers from around the world were accused of separately and perhaps jointly trying to rig Libor (London central bank) lending rates. The Financial Times ran an in-depth article, “Libor probe shines light on voice brokers’ on February 17, 2012.

Voice brokers are also called “interdealer brokers”. These brokers used to discuss prices asked by buyers and sellers but now computers can do that. Instead, inderdealer brokers make deals on behalf of clients by matching buyers and sellers for each particular transaction. They have information about all the buyers and sellers in their market.

A conflict of interest arises because interdealer brokers have banks paying them commissions. Even though they serve traders at a lot of banks who want to do swap deals, voice brokers will often alert the bank paying them a commission first or give that bank more details than other clients when a lucrative deal comes across the voice broker’s desk.

Finra (the US Financial industry Regulatory Authority) brought a $2.8 million suit against ICAP, the world’s biggest interdealer, when a former employee attempted to influence fees on credit default swaps in 2009. The Financial Times reports that Finra filed more cases against voice brokers in 2010.

OTC trading could be fully automated and it would be more transparent to traders, but powerful interdealer brokers are raising their voices against that. Voice brokers have lobbied hard against the Dodd-Frank bill, hoping that their privileged jobs and commissions can be saved when the US reforms credit default swaps trading. For how these brokers plan to cope with the coming changes from Dodd-Frank, see  “Can the boutique brokerage survive Dodd-Frank?” (Original headline: Endangered species?”) posted May 3rd at Risk.net.

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Trying to keep up with corporate malfeasance, the SEC (Securities and Exchange Commission) is running around suing bankers and brokers like a homeowner during a typhoon putting out pails underneath a leaky roof. But the scandal at Goldman Sachs this week is one that the SEC itself created.

Back when Robert Kiyosaki first began writing his Rich Dad Poor Dad series in the 1990’s he let readers in on a secret many of us never knew. That secret was that rich people had opportunities available to them to invest in things that the rest of us do not. According to Kiyosaki, the reason for special privileges was that the SEC deemed wealthy investors to be more “sophisticated” than we are.

As I recall, Robert’s examples were things like oil and gas leases and trading stock on the margin (i.e. with borrowed money) , but he hinted at more. Well, now we are all aware of the “more”. More includes things like derivatives and securitized products: CLOs, CDOs, CDSs; MBSs, etc.

OK, so not everyone knows what those investments are, but we all know they exist. We all know they were the investments that became worthless during the crash. We know too that investment banks, and Goldman in particular, were responsible for that because they created and sold those kinds of junk investments.

And so we come to the crux of the matter this week. A Goldman Sachs senior executive mouthed the words that we all suspected were the truth about investment banks, but weren’t really sure of. Goldman’s deliberately took advantage of its wealthy investors, even calling them “muppets” in the process.

Scandals at Goldman Sachs

Goldman’s infamous Abacus mortgage derivative scandal was the tip of the iceberg. Goldman’s sold its clients Abacus while traders at Goldman’s and elsewhere bet against that investment. Goldman’s clients lost their shirts. (For details, see Brucenomics post, “What did Goldman Do Wrong“)

But Goldman’s executives still don’t seem to get it. Their responses to Greg Smith’s resignation letter are typical of what psychologist, Dr. Martha Stout call sociopaths. (See her case study of” Skip” in The Sociopath Next Door.) Goldman’s senior staff tried to paint their star 12-year colleague as a “disgruntled employee” whose remarks shouldn’t be allowed to sully the work of the 30,000 other employees at the company. They’ve whined that they were the only ones to not take bailout funds. They didn’t borrow money so they shouldn’t be attacked. It’s just “politics,” Goldman asserts, and asks why blame poor old us?

Goldman apologists, including New York City Mayor Bloomberg himself, are crawling out of the woodwork to defend the bank, claiming even God couldn’t lead the bank better than its CEO, Lloyd Blankfein. Others are doing damage control by minimizing the event by flooding the Internet with satires on Smith’s resignation from the company or claiming that the Goldman attitude applies only to its derivatives division where Greg Smith worked.

But many others, including Goldman’s own clients, are saying Smith’s point of view is quite accurate. The bank isn’t looking out for the interests of its clients. In addition to its mortgage derivatives scandals, Goldman’s has alienated bank clients with its underwriting practices as well as ticked off a court judge in Texas with “conflicts of interest” involving a merger between two energy groups. (See the details “In need of a brush-up” in Sunday’s Financial Times – March 17/March 18, 2012). Articles have come out about Goldman nasty sovereign debt deals with countries such as Greece and Libya too.

The SEC’s “sophisticated” investors

So why is there no comment from the US government agency that permitted all this happen in the first place? Where is the SEC? The SEC isn’t saying anything about the Goldman flap; it’s just continuing to dump buckets of taxpayer monies into attorney’s pockets to convict other investment advisors who took advantage of gullible rich people that the SEC said were “sophisticated” enough to know what they were doing. What a cruel joke that is!

This year it was reported that even in the shadow banking sector “sophisticated investors” are getting shafted. On average they’ve received from global hedge funds exactly zero returns on their investments. All the SEC can seem to muster in response is a weak attempt to improve “transparency” of these only-the-rich-can-play investments. This kind of patronizing and patriarchal attitude of the SEC towards ordinary American citizens is pure condescending c&$p!

Ask yourself this question. What good is more transparency if rich investors are simpletons in the first place when it comes to investing? The financial crisis wasn’t a result of lack of transparency; it was a result of the hubris of investors who bought into the SEC label “sophisticated”. They actually thought they knew what they were doing and who they could trust to help them.

Why isn’t the SEC trying to protect rich investors from their own ignorance? In fact, why isn’t our government spending one dime on educating every American about what they need to know about investing? Surely that’s of equal if not greater value than learning about chemistry or trigonometry!

I would think that investing would be something we all could agree that our children need to know about — even if only to protect themselves from the foibles of ignorant rich people all over the world, some of whom can’t even bear to admit that, yes, they’ve been “had” by their own bank.

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This week there are a number of stories that relate to recent posts on Brucenomics.

Corporate taxes

My latest post Corporate Taxes: No More Simplistic Solutions!” talked about President Obama’s proposal to raise the tax on dividends. My opinion is that raising the tax on capital gains make more sense. This week a special feature article in the Financial Times, “Tax treatment of private equity: Questions over a quirk” delves into the issue of taxes paid, or rather not paid, by hedge fund managers.

Hedge fund managers have been given a  special deduction for a type of income called carried interest. This is interest that is required to be carried on their books over a multi-year period before it is disbursed and taxed. Hedge funds must carry profits until they reach a minimum level. As a result, the government seems to feel that fund managers can count the gains made each year (until they meet the minimum) as short-term capital gains income. Carried interest enables hedge fund managers to pay the equivalent of a low 15% rate on their huge long-term investments. As a result, many managers of hedge funds have become millionaires and billionaires over the past decade.

Obviously, in an election year where the incumbent President is likely to be running against a hedge fund billionaire, it isn’t surprising that Mr. Obama is floating the idea of removing the tax deduction on carried interest. But carried interest is not just a US concern. Denmark switched to using the personal income tax rate on carried interest years ago. The reasoning for taxing carried income as personal income is that other kinds of “performance bonuses” are taxed as personal income, not capital gains. The UK, on the other hand, just raised its capital gains tax rate from 18% to 28%. Germany too is thinking of removing its tax exemption for 60% of carried interest earned there.

A major issue is the fact that tax exemptions exist to encourage constructive use of money, for example investments in new businesses. However, hedge funds have been charging clients very high fees, yet as a whole paying out on average zero  to their investors over the past year. Meanwhile, hedge fund managers (the active partners in the hedge funds) only risk 2-3% of their money and can take a 20% return out of profits.

Also, in regard to corporate taxes it should be noted that the corporate tax return rate in the US has fallen to its lowest level in a decade, dropping from 35.4 to 31.9 percent over the past year. The reason is that corporations are paying lower taxes abroad, e.g., 26% in London. This has resulted in higher earnings reports for companies doing business abroad. For a proposal about how to tax overseas earnings more constructively, please see my post on Corporate taxes.

A Tobin Tax for the US

Last summer I posted an article in favor of a Tobin tax in the US. A Tobin tax is a miniscule tax on investment transactions. This year we have a bill for Congress calling for a Tobin Tax in the US. The bill, created by Tom Harkin (Senator) and Peter DeFazio (Representative) would produce $350 billion in revenue from a tiny tax of .03% for buying and selling of investments. The expected effect of a Tobin tax is to curtail the activities of financial speculators.

For example, a problem with high-speed trading is that traders are placing multiple orders on exchanges such as NASDAQ which they then instantly cancel. Their purpose in doing this is to confuse their competitors about what prices they are paying for buying or selling financial investments. However, the SEC is concerned that the flurry of rapid-quote-canceling at ultra-high speeds will clog up investment exchanges and disrupt financial markets. A Tobin Tax might be an adjunct or in some cases even be an alternative to regulation to stop bogus trading.

For more reasons why we need a Tobin Tax, please see my article, “Bring Back The Tobin Tax”

The Libor Fraud Investigation

The Libor Fraud may be the first shot across the bow in a global battle against financial crime. In “The First Global Crisis — Coming Soon?  ” I wrote about how investment bankers in countries around the world have been accused of manipulating the Libor and other indexes used to set interest rates for loans among big banks in the world.

On March 7th the Financial Times reported that “Bankers embark on rethink for Libor rate-setting.” Currently a number of bankers around the world send daily estimates to a committee of bankers who set these rates. Insane as such a fox guarding the hen house seems, it seems even crazier when a government bond trader is quoted as saying, “If you want a figure for term interbank rates you have to use the Libor survey because there are no or very few trades.”

It may apply to only a few trades, but the Libor is used for setting interest-rate swaps and other derivatives. These trades aren’t small trades! And perhaps even more relevant to most of us, the Libor rate is what is used by bankers to set the interest rates on our credit cards and home mortgages. According to Canadian regulators, a bank turned over evidence to them showing several conspirators “were able to move yen Libor rates” to benefit themselves.

Moral of this story: like it or not, financial markets do need regulation! Read on for what kind of regulation we need.

The Big Cons Who Didn’t Get Away

An amazing and depressing story this week was the conviction on 13 out of 14 counts of fraud, conspiracy, and obstructing an SEC investigation, of Sir Allan Stanford Texas billionaire for the second largest fraud in US history. As I wrote in February of this year, “Fraud is NOT GOOD for Us! (a response)“. The outlook isn’t very good for Sir Allan’s 20,000 victims. While Stanford will spend “decades” in jail for a multi-country investor fraud involving over 7 billion dollars, the headline on Yahoo finance last week read, “Investors: Stanford verdict won’t restore losses”.

Prosecutors in the US, UK, Switzerland and Canada are seeking $300 million Stanford has in bank accounts around the world. The court-appointed receiver for this case has eked out another $80 million from sales of Stanford’s houses and yachts. However, the receiver has to fight in court with SIPC, the Securities Investment Protection Corporation. SIPC argues that money was held in overseas banks and Stanford’s customers aren’t eligible for the up to $500,000 that SIPC pays for broker fraud. And to add injury to injury, US taxpayers are footing Stanford’s legal bills!

The SEC is being criticized for “concluding as far back 1997″ that Stanford’s business was fraudulent yet the SEC did not bring criminal charges until 2009. (See report of Stanford conviction in the Financial Times, March 7th). Investors hoping for a payout can take a lesson from the Madoff case. The court-appointed receiver for Madoff’s moneys has recovered more than $9 billion, partly by suing some victims to pay others, but only $325 million total has been paid to victims. So far most of the Madoff money is “tied up in legal appeals.”(Financial Times, “Judge sets cap on Mets owners’ Madoff payout” 3/16/12)

Clearly we need better regulatory reform in the US. We need regulators to nip ponzi schemes and financial frauds in the bud, long before they bring massive disaster to hundreds of people around the globe. We need to hire financial experts, not attorneys, to run the SEC. The savings and loan crisis of  the 1980s and the conviction of Charles Keating for the S&L fraud in 1992 clearly shows that no matter what political party is in charge, financial fraud is an area we’ve made almost no progress in combating over the past 30 years!

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I was one of those kids who walked around head bent and looking at the ground – even after they discovered I was totally near-sighted and gave me glasses. The reason? I didn’t start out with a lot of self-esteem, and my peers didn’t help the situation any.

Once I was walking downtown and a couple of older girls passed me on the sidewalk. On called back over her shoulder with a laugh, “You look like a simpleton.”

Now, I had no idea what a simpleton was, but I knew enough about tones of voice to know it wasn’t something good. At home I asked my mother. Knowing I was a bright little girl she told me to look it up in the dictionary. So I did:

“A person who is felt to be deficient in judgment, good sense, or intelligence; a fool.” (The American Heritage® Dictionary of the English Language)

An alternative definition is “a foolish or ignorant person”. OK, now you too know what simpleton means. So, how can we not be the simpletons politicians and pundits seem to take us for?

Simplistic solutions

President Obama recently proposed a higher tax on dividends recently. Did you stop to wonder what a higher tax on corporate dividends would mean?

I certainly did. In particular, I thought about the impact on older retired people. Money market funds have never recovered from the financial crisis. In addition, the Fed has been determined to hold down interest rates. As a result, retirees can’t collect interest from savings accounts or Treasury bills or CDs (certificates of deposit) anymore. That leaves only dividends and interest from stocks or bonds.

But the Fed has used every trick in the book including repeated quantitative easing (buying back government bonds) to make government bonds scarce and thus, force the price of those bonds up and their interest rates down). This has driven nearly everyone into buying stocks. That means a tax on dividends from stocks would hit retirees (and their pension funds) right where it hurts the most.

What I didn’t think about was what effect a tax on dividends might have on the value of corporations. And this is key because it shows how simplistic solutions don’t really solve anything.

Here’s what the Lex column pundit pointed out in the Financial Times this week. If the tax on overseas corporate profits of US companies is lowered, the savings to companies could be canceled out by an increase in the tax on corporate dividends. (That’s assuming the corporations pay the tax rather than passing it on to shareholders).

In other words the value of a company goes up if corporate profits are taxed less but it goes down if its dividend payments are taxed more. This kind of “left hand offsets what the right hand is doing” is very common in DC politics. It’s like driving with one foot on the brake and the other on the gas pedal. It gets us nowhere.

President Obama’s test balloon is floated. You might think this is a corporate tax that will bring the government more revenue to spend on America, but will it? If overseas profits of US corporations are given a “tax amnesty” this year so they can come home with no taxes at all on them, the only new tax revenue from corporations will be from taxes on dividends. Corporations will lose nothing from a dividend tax, and they may even gain at the expense of government revenue because multinational US corporations will gain value from their trillions in tax-free overseas monies when they are repatriated back to the US.

Take a look back in your life! How many times have you been fooled by politicians’ and political newscasters’ “simplistic” solutions to complex economic problems?

Finding real answers

Real answers to thorny problems usually require a lot of thought, and they usually involve changing more than one thing in the end.

This week looking for more ideas about corporate taxes, I ran across an editorial by Robert Pozen, a former investment advisor and lecturer at Harvard Business School, “How to tax foreign profits of US companies” in the Financial Times. What a breath of fresh air on the topic! It looks like it could be the real answer to corporate taxation.

Mr Pozen endorses President Obama’s call for a minimum tax on overseas investments by US companies. Pozen notes that even business lobbyists want the US to follow the lead of other countries and adopt the “territorial” system for taxing foreign profits of US corporations.

In other words, companies should be taxed either here and/or there by another government on their earnings. We shouldn’t encourage a “race to the bottom” by letting our corporations pay no taxes at all on foreign profits (especially not now that “corporations are people”).

But how tax foreign profits?

Mr. Pozen spells out three steps that would need to be taken to set up a territorial tax on US corporate profits overseas.

(1) Congress would exempt US companies from our corporate taxes when they are doing business in countries where they paid at least the minimum US corporate tax rate to that country’s government.

(2) Taxes paid to governments of tax havens would not qualify for this exemption unless the company could prove it actually did business in the tax haven country. Foreign earnings of US companies doing business elsewhere and kept in tax haven countries would be taxed at least at the minimum US corporate tax rate.

(3) If the US company did business in a country with a lower tax rate than ours, the company would have to pay the difference between that rate and the minimum US corporate tax rate, e.g., 12% to the foreign government and 8% to the US government to equal a total of a 20% minimum owed for the US corporate tax.

Finally, rather than declaring a tax holiday for overseas dollars, Pozen suggests a low tax rate, for example 8% on repatriated income earned abroad prior to 2012.

That would encourage companies to bring that money home and still bring the US government needed income while the US transitions to a minimum tax rate on all US corporate earnings no matter where in the world the money is earned.

And what about taxing shareholder dividends?

As I’ve written before, I’m in favor of taxing capital gains at a higher rate to slow down speculation in stock investing.

The companies that pay dividends on their stock tend to be established, larger and more conservative companies. I see no reason to tax them on the dividends they can afford to pay out to pension funds, retirees, and others who want a steady long-term income from their investments.

In my opinion, the last thing we need right now is more uncertainty in the financial markets. Nor should we jeopardize the futures of Americans who depend on interest and dividends on either their present  or future income. But I’d love to hear a good argument for a higher tax on corporate dividends.

How not to be fooled by the simplest solution

At the beginning of junior high school when I was 12, I was again plagued by two girls taunting me as I walked to school each day. One of them was much, much larger than I was.

I was miserable and just tried to ignore them. At the winter holiday season arrived however, my classmates and I wrote our names on pieces of paper and threw them into a bowl. The teacher mixed them up and we each drew a name to get a gift for. Guess which name I got?

At home I complained to my mother about the treatment the biggest of the two girl bullies had given me all fall. I really didn’t want to give that girl a gift, and certainly not a nice one.

My wise mother insisted not only that I give her a gift, but also took me shopping and helped me choose the finest lace handkerchief we could find. It even cost a bit more than what we were supposed to spend, but my mother found the money to pay for it.

I did my best to put a positive face on as I handed over the gift to the bully and then fled. A short while later however she caught up with me. She had tears in her eyes when she thanked me. I was so shocked I didn’t know what to say.

No, of course we didn’t become instant friends. And those two girls continued to follow me every day to school. But whenever anyone came towards me that I clearly didn’t want to talk to, they closed up the gap a bit, and that person left in a big hurry. My tormentors had become my bodyguards.

Every winter I think of them and what I learned that holiday season, and I wonder if they too think of me.

Follow Nancy Humphreys on Twitter @brucenomics

Are you perhaps thinking the biggest financial crisis in the world is the Greek crisis? Well, think again! While Greece is being treated like the “identified patient” of the Eurozone and assaulted with slings and arrows from outraged Germany, France and others, an even bigger tsunami is looming over the world’s banks from Asia to America.

This week more than a dozen investment bank traders have been fired, suspended, or put on leave for possibly colluding in “rigging” the  Libor.

“The what?” you ask. The Libor (London interbank offering rate) is the main global inter-banking loan rate used by big banks here and in the UK. As mind-boggling as this may seem, the Libor rate, used for setting interest rates on over $350 trillion of financial products such as mortgages, car loans, loans to corporations, futures and options contracts, and structured investment bank products and derivatives, is not based on actual trades: it is merely based on daily estimates, estimates sent in by traders and brokers to a committee of global bankers.

Numerous banks are involved in the growing scandal: Barclays (UK); Citigroup (US); Deutsch Bank (Germany); JP Morgan Chase (US); Nomura (Japan); Royal Bank of Scotland, and UBS (Switzerland). There are also three inter-dealer brokers being investigated as part of the possible Libor collusion: Icap, the largest in the world, Tullett Prebon and RP Martin.

Reputedly traders at these institutions did not want the high rates they paid for inter-bank loans to signal their institution was “weak”. Traders also personally earned a golden reputation if they could keep their inter-bank lending rates low. At least one trader at a bank being investigated moved on to a hedge fund, and hedge funds regularly bet on the Libor rates. Investigators now want to know too if hedge funds and traders knew the Libor rate in advance of everyone else.

Citigroup found two employees tweaking the Libor lower because a third employee blew the whistle on them. Citigroup has already written down $50 million in losses after unwinding the two traders’ deals. But here’s the kicker. According to the Financial Times (Libor penalty 2/12-13/12). Should a bank or two be found guilty of manipulating the rate by, say .03 percentage points over 10 years, the theoretical compensation could be $1 trillion.” It’s not just the Libor rate either. Nine enforcement agencies in the US, Europe, and Japan are looking into two smaller interbank loan rates as well. The are the Eurbor for European banking and the Tibor (Tokyo interbank offered rate) for Japanese banking.

The bottom line is that there could be trillions of dollars of losses from this scandal. No governments or institutions in the world will be large enough to bail out these global banks for that sum. While Hollywood is busy entertaining us with visions of the end of the world via natural catastrophes, nuclear destruction, and alien invasions, the real global catastrophe could be as close as our own wallets.

What is the message here?

In just four years we’ve gone from a problem of individual institutions that create havoc when they fail, to a problem with a global banking system that is itself big enough to fail. The investigation of the Libor may or may not reveal the first “international bankers conspiracy”. However, in a lawsuit against the Bank of Scotland, an employee in Singapore who was fired has alleged that all the bankers on the floor knew Libor rates were being falsified. His lawsuit adds that clients of the bank regularly submitted requests to traders to rig rates in order to maximize their profits on derivatives based on the Libor that they owned.

What is the cause of this remarkable global financial crisis? Dr. Susan Pomeroy suggested to me that it was a the lack of global financial regulation which caused the last crisis. Clearly that cause might be even more true in this case.

Why do we need international financial regulation?

I have a friend who is afraid of buying a new car for fear of being “ripped off”. Like many Americans, my friend practices a religion that believes in the notion of “original sin” for mankind. Yet my friend also belongs to a political party that has no problem embracing a philosophy which says the “free market” will take care of everything in the end.

My question is, if we are all possibly sinners, precisely how will the free market prevent fraud?

In Adam Smith’s day, the answer to how the “invisible hand” of the market could regulate fraud was easy. it was an era of small villages. Everyone knew each other. If you ripped off your neighbor, everyone would find out, and no one would patronize your business anymore. Or if they did, they’d be forewarned and on the lookout.

This certainly isn’t the case in a world with a human population that just surpassed seven billion. Yes, the Internet is a great source of information. Sites like Yelp or ConsumerLab can keep a lot of small businesses and large companies in line. But the banking industry is something else entirely.

These people don’t make things; they make up things. Expensive things. And then they sell these made-up (“structured”) products to the richest people and institutions in the world.

Who will pay when the things they make up for their own profit fail? The answer is “no one,” because no one has enough money to fix that kind of problem on the global scale. If governments are not allowed to regulate the banking industry in a way that prevents these kinds of abuses, how else can they be stopped? As far back as 2007, the British Bankers’ Association was being called upon to overhaul how the Libor rate is set, and it simply ignored the Libor’s critics.

The magic of vanishing wealth

The “market” does not create wealth. Neither does money. Both of these entities are merely the mechanism by which wealth changes hands. They are the “medium of exchange,” not the actual wealth itself. This is why trillions of dollars can and sometimes do vanish overnight even in a free market.

True wealth is made by the hands, hearts, and minds of human beings who actually work for a living. While there may be smarter ways of working and earning more, what is happening now is way beyond that. What we see happening now are the biggest pyramid-building schemes since the days of the ancient Egyptians.

Pity the poor Greeks! They lost their beautiful Helen to the Trojans and spent years and many lives in war to get her back, and now they are about to lose their shirts as well. Their government had been ordered pirate pension funds and jettison jobs to pay for the magically-vanishing “wealth” products created by global bankers and sold to foreign institutions.

Who will pay for this outrage? The answer is “no one” and “everyone”. Not only do we have no means of global financial regulation; we have no global system of justice for financial fraud. We barely even have national systems of punishment for financial fraud in place. We will all end up paying for this one way or another.

Governments, including the US government, are frantically suing one bank and brokerage firm after another for the frauds alleged to have occurred in the first financial crisis. The fines exacted in this country by the SEC are ludicrously low, and probably simply go to pay attorneys, bureaucrats, and the courts.

So, who do we imagine will try those international bankers who rigged the Libor, Tibor and Eubor? Will each country punish them differently? Will they be punished at all? So far only the Japanese authorities have placed any sanctions against the banks involved. Will proof be found to convict the rest? One has to ask too, what good will trying them in national courts or even an international court do, if the money is all gone because it was never even there in the first place?

Said one senior financial industry figure to the Financial Times (“Libor probe grows as scale of problem emerges” 2-10-12) “This is just another example of the slow drip of sleaze across the industry. How much more can it take?”

Indeed, and how much more can we take?

Follow Nancy Humphreys on Twitter @brucenomics

This post is a response to “Fraud Is Good For You! (guest post) by “Gus,” publisher of Swindler’s Monthly: The Premier Journal for Cons Everywhere, now on hiatus as Gus serves time in federal prison for something he says he’s “completely and utterly innocent of”. Fraud Is Good For You! was published on Brucenomics on January 20, 2011.

Gus’ arguments for the economic benefits of fraud

Gus makes three main points in this essay. First, he claims “Fraud creates jobs — that’s something the Fed can’t seem to do! Second, Gus reminds us, “Fraud does not create or destroy wealth — it merely redistributes wealth”. And lastly, Gus claims that “Fraud is good — fraud gives people hope.”

Fraud creates jobs – something the Fed can’t seem to do

Yes indeed, fraud employs a whole fleet of attorneys, administrative assistants to attorneys, process servers, court reporters, judges, defense attorneys, expert witnesses, etc. In the end, when cons are caught it also goes to create jobs at federal prisons too. But do these jobs create wealth for anyone but those involved in the legal system? No, and even Gus, you’ll admit that!

Fraud does not create or destroy wealth — it merely redistributes wealth.

Right on the second part, Gus! But to whom does it redistribute the wealth? First it goes to the cons who spend it lavishly and/or hide it in offshore banks. Second, it goes to attorneys and their minions. Lots of it goes to attorneys and their minions. For example, in the Madoff case, almost all of the money has gone into the legal “eagles” or should we just say “birds of prey”?

Take the Madoff case (and please do!). “But because of several appeals and legal challenges only $325 million has been distributed to 1,232 Madoff account holders. Oh, yeah, and another $797 million has been paid out by the Securities and Investor Protection Agency (SIPC), a US government agency…” (bold and italics mine)  Source: “Frustration mounts over Madoff backlog” Financial Times, December 12, 2011.

The Madoff trustee only accepted 2,425 of the more that 16,500 claims submitted. In addition, many of the victims of Madoff’s fraud who actually got money from Madoff are themselves being sued in order to pay off other victims who didn’t. The Madoff Victims Committee complains of being ripped off by not only by Madoff but by the SEC, the IRS, and SIPC. And truly all of us perhaps should be complaining about being ripped off.

Those SIPC millions were an advance from us, US taxpayers, to the Madoff trustee (i.e., the lucky attorney hired by the government to collect money that the con stole from victims and distribute what is left after the “trustee’s expenses” are deducted). Will we ever get that SIPC loan to Madoff’s trustee back? Don’t hold your breath!

The real howler here, Gus, is that Madoff stole at least 67.7 billion dollars of expected income from his victims, ($18 billion in actual funds), and all the Madoff trustee can pay the primary victims is a measly one billion dollars, with most of that borrowed from US taxpayers?  That’s a pretty lousy return on an investment in fraud, don’t you think, Gus?

Fraud is good — fraud give people hope

Now this, Gus, is quite true! Fraud does give good people hope. But it only does so as long as the fraud isn’t discovered by those good people. We can all agree that Bernie Madoff made a lot of people happy while his pyramid scheme paid out. Maybe some of his victims even died happy. But their descendants who inherited their ill-gotten wealth and the rest of Bernie’s victims who are still alive certainly did not have hope after Madoff’s scheme collapsed.

In a way, you could compare fraud to being slipped at “mickey” or “date rape drug” at a bar. You feel great, or maybe think you feel great while it’s lasts, but you feel terrible the next morning. The morning after Bernie Madoff confessed to the feds, a lot of people didn’t feel hope. They felt outrage, grief, anger, and eventually despair. And now what many now feel is utter despair.

The true outcomes of frauds

Most frauds are never prosecuted in court, nor is any money collected on behalf of victims. They are too “small potatoes” for the government to bother with. The true outcome of any fraud is that the victims wind up with peanuts, if anything. And by victims I mean every sheep who gets fleeced.

Those frauds that are prosecuted tend to wind up paying the victims “pennies on the dollar”. That means that all the people who depended on the primary victims of a fraud for payments are themselves fleeced as those victims no longer have the means to pay them for their work or services.

Fraud not only spreads the despair; it makes the victims themselves unwitting perpetrators of fraud on others. Victims of fraud feel guilty that others they promised to pay are not paid. They feel fearful that fraud will happen again, and often it does, because (1) cons have lists of names of victims they sell to each other, (2) victims without money are often at the mercy of other cons for goods and services because the victims can only afford to pay the lowest cost for after they’ve been defrauded.

There is a multiplier effect from fraud, just as there is from unemployment benefits. But while unemployment benefits create more jobs as the unemployed spend their benefits (paid by the employer who enjoyed the fruits of their labor while they were employed by that employer), fraud creates unemployment as more and more people associated with the primary victims do not get paid what they are owed by the victims.

And then there are the “secondary and tertiary victims” of the fraud. Many large frauds involve several layers of fraud involving “feeders”. Feeders are the legit (or semi-legit) brokers, insurance agents, or other financial “professionals” who fail to do their “due diligence” before collecting monies on behalf of the con from even more victims. These clients of the “feeders” are the secondary victims.

The victims of tertiary “feeders” who send money up to the secondary layer of “feeders” who are funding the cons are tertiary victims. These secondary and tertiary victims have no rights to anything the government trustee collects; they have to sue whatever “feeder” fooled them — if they have anything left to sue with and that feeder has anything left to pay them with.

The biggest amount due to the Madoff trustee is $7 billion from the Jeffrey Picower estate. Picower was himself a victim of the fraud, and his this estate is now tied up indefinitely in two lawsuits. When (or if) those cases are ever resolved, the Madoff trustee estimates investors would receive a grand total of 14 cents on every dollar they actually lost.

Nope, Gus, fraud, doesn’t create wealth, it destroys it. Fraud redistributes wealth but not to the real victims of the fraud. And the hope that fraud engenders is nothing but a phantasmagoria, a pretty horrifying one at that.

Follow Nancy Humphreys on Twitter @brucenomics

A Place for Murder by Emma Lathen (NY: Pocket Books, 1963)

Normally I get books at my local library. Given that I live in a poorer city in the Bay Area, the library doesn’t have money to buy new books. The blessing of no funds is that the library doesn’t throw out the old classics to make room for new books. It has a particularly good collection of classic mystery books. However, I didn’t pick up a copy of A Place for Murder by Emma Lathen at my library.

There is a new business in town. It’s a free “lending library,” open only on weekends. You drop off books you don’t want there and take home books you do want. So how can that be a model for a small business you ask? Its a very simple model. I have to admire the entrepreneur who thought it up.

The owner keeps and sells any valuable old books that are donated. The rest can be taken home by anyone else. These books are placed in no order on the shelves, and the staff are there primarily to sort out donations. So, you must browse this bookstore to find what you want. When you “check out” books from the bookstore the staff stamp “NOT FOR RESALE. THIS IS A FREE BOOK” in the front. That encourages people to bring the books back to the store.

I doubt the proprietor spends much on rent. The free books storefront is in a low rent area, and even in high-rent areas in the Bay Area, such as Solano Avenue in Berkeley, commercial properties now have a 20 percent vacancy rate. The only problem with this idea is that it’s a “brick & mortar” store, not an online store. Eventually the local supply of books people don’t want will dwindle. So I’m getting my mystery books now while it’s still in business. A Place for Murder is the second Lathen book I’ve found there.

The place for murder

The place for murder is a town called Shaftesbury in a rich farm area in Connecticut. As you may recall from my review of Lathen’s Green Grow the Dollars the hero of the series is John Thatcher, the senior vice-president of the Sloan Guaranty Trust in New York City. It is Brad Withers, the gadfly President of the bank, who sends Thatcher up to Connecticut to look into a property in dispute in a nasty divorce between Wither’s brother-in-law and his wealthy wife. Both the soon to be ex-wife and the new bride want the property.

Emma Lathen is a pseudonym. The real authors were college friends, Mary Jane Latsis, an attorney, and Martha Henissart, an economist. (The name Lathen comes from LATsis plus HENissart). These books, written in the 1960s and 1970s, are now quaint reminders of a banking industry long gone by now. Thatcher and his associates don’t deal in prop trading desks or derivatives, they deal in businesses, stocks and bonds, and real estate. Nevertheless, the human dramas so wittily captured by Emma Lathen are timeless.

My favorite scene in this book is where Thatcher, annoyed by the interruption in his bucolic plans for the weekend when he is sent to Connecticut, takes it out on a junior subordinate by loading him up with a lot of extra work to do over the weekend too. Miss Corsa, Thatcher’s organized, impeccable, and pragmatic secretary discreetly lets Thatcher know why his junior executive isn’t happy about not having time at home over the weekend.

“She’s expecting,” explains Miss Corsa, eyes modestly downcast, when he demanded enlightenment.

“Expecting what?” asks Thatcher while absorbed with looking at papers on Miss Corsa’s desk.

Miss Corsa was outraged, “A baby!”

Thatcher, however, doesn’t relent. Eventually he, his junior executive, and most of the bank’s top executives wind up in Connecticut to deal with the fallout from a murder discovered during the prenuptial celebrations and involving elk antlers donated for the reception by Brad Withers.

None of the executives is happy about being there. But the President of their bank, as usual, is totally preoccupied with his personal life and utterly incapable of handling any financial transactions of the bank.

A reason for murder

Some things about money don’t change no matter how it is made. The famous divide between and F. Scott Fitzgerald and Ernest Hemingway, two early 20th century novelists, still stands. Are the rich different than the rest of us or do “they just have more money,” as Hemingway retorted?

Emma Lathen throws down the gauntlet in favor of Fitzgerald’s position. In fact, the solution to the murder lies in understanding that the rich are different from you and me. Long before Robert Kiyosaki wrote his first Rich Dad Poor Dad book to teach us how the rich are different, the two women who called themselves “Emma Lathen” created a fictional character, who by virtue of his unique socio-economic status as senior vice-president of a bank, could clearly see the differences that Kiyosaki now writes about.

Robert Kiyosaki, in his books and seminar series, posits a particular mentality that he believes the “rich dad” possesses and the “poor dad” doesn’t. Rich dad owns assets. Poor dad owns only his own labor. That creates the difference in outcomes for each dad. Rich dad’s assets earn money for him even as he does not have to work. Poor dad, on the other hand, must work for a living. When he cannot work, he slides from being middle class downwards into being poor.

In the area of Shaftesbury, Connecticut where Sloan bank president Brad Withers and his rich relatives and friends have houses, the wealthy own farms where they raise livestock. Connecticut, as the New York bankers caustically note, is a lousy place to raise Angus cows. The land is barren and rocky and there is a scarcity of land too, making it quite expensive.

But that’s of no importance to the rich. They aren’t in business to make money. They are in business to lose money. These are wealthy people who inherited immense sums and must manage to hang onto it in the face of an government that has the power to take it away at any time.

The reality of the rich is that taxes are a game rigged in their favor. They’ve spent decades sending lobbyists to Washington and funding candidates in both political parties who will preserve those tax breaks for them. Robert Kiyosaki touches on this fact in his books and Ed Slott, a tax accountant, makes it even more explicit in his books and his PBS specials about taxes.

Two major ways the rich make money now via our tax laws are (1) tax deferral, often until after death, and (2) constant attacks by politicians on progressive taxation in favor of either flat taxes on everyone or regressive taxes that favor the rich over the poor.

The third way, now much discussed in relation to Mr. Romney’s candidacy is the one Lathen focused on. The wealthy in A Place for Murder (copyright 1963) must work and spend diligently to lose money in order to get tax write-offs. These are the “itemized expenses” recorded on IRS Schedule C, such as the full cost of farm equipment, or the “capital losses” recorded on IRS Schedule D for the year end sale of stock at a loss to offset their capital gains. Write-offs enable the rich to pay little or no taxes in proportion to their income.

Why only a Thatcher could solve the mystery

Lathen doesn’t just depict the lives of the wealthy and their tax maneuvers in this book. She also takes us into the lives of those who serve the wealthy. The lifestyles of servants and of the business people in Shaftesbury are also visible and part of the the plot.

In particular, the wealthy people in this area of Connecticut happen to love show dogs. Simultaneously with the divorce dispute the bankers are there to settle and the wedding, there is the famed Housatonic Dog Show taking place. All of these things converge with much ado at the largest hotel-restaurant-bar in the town.

John Thatcher, as senior vice-president of a large bank, is in a unique position to sort it all out and really see what’s going on at the Shaftesbury Inn.

On the one hand, Thatcher is the only executive in the bank who is considered high enough in wealth and social class to be invited into the lives and homes of the Connecticut upper class. On the other hand, Thatcher is an employee of the Sloan Guaranty Trust.

However huge his salary and bonuses may have been, Thatcher is an income-earner, not an investor or business owner. Thatcher is on the wrong side the vertical line in Robert Kiyoaki’s cash-flow diagram. Thatcher’s on the left side and not the right side of that line. As a result he is not classified in Kiyosaki’s books as one of the “rich”.

Thatcher himself understands this distinction. He views himself as an employee. He shares the same problems as any other employee in having his life heavily impacted by those who pay him, those who work under him, and those who are his clients. Thatcher likes his job though. Thatcher likes working for a living. Thatcher also knows the true value of a dollar, whether earned by hard labor and saving, or through investing and owning. Knowing all about money IS Thatcher’s job.

In short, Thatcher, unlike the wealthy people he rubs shoulders with and his boss, Sloan president Brad Withers, understands the ins and outs of how businesses and investments can make money as well as how businesses and investments can be made to lose money. That knowledge is what enables Thatcher to spot the murderer and solve this case.

In the end, being who they are and what they are, Thatcher and his underlings all heave large sighs of relief at finally being able to board the company plan in Shaftesbury, Connecticut and get back to their real work in New York City.

Follow Nancy Humphreys on Twitter @brucenomics

This month I am in the middle of a series about why we need economists return to political science. Well, one economist, a liberal economist at that, has just done this. If you haven’t read my last two posts yet, “Political Economy: An Old System for a New Day” and “Checks and Balances For the Field of Economics” you may want to look at them.

I want to call your attention to an awesome editorial by economist Robert Reich in the Financial Times on January 16, 2012, called “We are all going to hell in a shopping basket”. Professor Reich has returned to the roots of economics, the field of “political economy” to analyze the present malaise in this country. (If the above link doesn’t work, type the full title in Google.)

In this editorial, Reich points to four economic groups in the US, each of whom has economic interests that may conflict with the other. Reich shows how two of these groups are in danger of becoming so powerful that they eradicate the rights of the other two groups. What is enabling this to happen? Reich points squarely to the Internet as the culprit. See if you agree.

Taijitu - diagram of ultimate power

In the spirit of the fourfold thinking the I’ve shown in posts about the Taijitu, the ancient Taoist “diagram of great power” (the Yin Yang symbol), Reich goes even further than merely talking about class conflict. He points out that these four groups of people are interrelated in an essential way – most Americans will belong to each four of these groups at one time or another in their lives. The four groups that we all belong to are: citizen, consumer, investor, and worker.

Reich’s insight is in keeping with the understanding expressed in the I Ching and other Taoist teachings about the interrelationships of all things in existence (the “ten thousand things”) owing to the common source from which they all come.

See my post “Fourfold Problem Solving” from October 30, 2011 for how the fourfold way of thinking works. There are also two practical examples from economics about understanding “How Buyout Funds Work” and the four groups of “Citizens Concerned About Sovereign Debt Crises” here and abroad.

Note: Also this week, Dennis Kucinich, Democratic representative from Ohio, on the second anniversary of the Supreme Court ruling called “Citizens United” which opened the doors to corporate financing of public elections, has introduced a constitutional amendment House Joint Resolution 100 to eliminate corporate spending on elections. See the link below for more on this story.

Last time, in  Political Economy: An Old System for a New Day we looked at how much the world has changed since the times when the United States of America was founded and Adam Smith, the Scottish economists published his classic study of political economy, called The Wealth of Nations.

This time (and in the next couple of posts), we’ll be see how the notion of checks and balances from the US Constitution applied to economics is one way of bridging the gap between politics and economics today.

We’ll start by looking at how economics differs from the study of political economy in the 16th through 19th centuries. We’ll see why the field of political economy changed its name to economics at the end of the 19th century. This was throwing out the baby with the bathwater! We now need to go back and rejoin politics with economics. Read on to see why.

A system of checks and balances for a “political economy”

British economist, Martin Wolf, is fond of saying often in the London Financial Times that the nation of Germany has such a successful economy right now because it is a “surplus” country. The wealth of Germany Wolf thinks, exists only because other countries are poor. There has to be a balance he says. Surplus countries have to lose so debtor and deficit countries can gain.

This kind of “scarcity mentality” was fostered in the mid-20th century by professor Paul Samuelson’s “guns vs. butter” parable of how the economy “works”. Samuelson’s famous dictum resulted from WWII when citizens of the UK and the US literally had to make such an extreme choice between civilian and military goods. But that was over a half century ago. Scarcity mentality now is a bugaboo of a bye-gone age.

It’s also what the field of economics gets for splitting itself in two at the end of the 19th century. i.e., into microeconomics versus macroeconomics.

Alfred Marshall, the “father of microeconomics,” led his colleagues in creating this split after the political economists of that age reacted with fear and rage against an upstart German philosopher who literally laid to rest their field of study, i.e., political economy, with his critique of it in 1887 in his famous book, Das Kapital.

During the great depression of the 1930s, a British economist, Lord Keynes, a student of Alfred Marshall at Cambridge University, founded the field of “macroeconomics”. This is the subfield of economics that aimed to give control of national finance over to the hands of professional “economists”.

This movement too came out of a place of fear and loathing of Karl Marx’s prediction that capitalism would result in too much capital landing in the hands of the rich, while the poor became poorer and poorer, a scenario that was being played out on the streets of England, America, and elsewhere back then.

While the liberal British “neoclassical” economists attempted to remove politics from economics by turning economics into a precise mathematical science, the conservative European “Austrian school” of economists attempted to remove economics from the political arena by replacing Adam Smith’s mystical notion of the invisible hand (of god) with the idea that “prices” set by a “free market” would take care of creating “equilibrium” (balance) in a national economy.

Austrian school libertarians in the US in the 20th century, in contrast to the Keynesians, adopted the 19th century notions of individualism advocated by British philosophers like Jeremy Bentham and John Stuart Mill in England. They combined this individualism with Frenchman, Jean Baptiste Say’s “Law” written in 1800. This “law” of political economy  dictated that “supply creates its own demand”. Say’s Law is the predecessor of both supply-side “Reaganomics” and of the new Republican ‘fixe idea’ about “job creators” as the source of national wealth.

The Austrian School used Say’s Law to bolster its belief that “if you build it they will come”. The Austrian School (Hayek, von Mises, etc) feels that “there can never be sustained “overproduction” [predicted by Karl Marx] or underconsumption [i.e., the neoclassical economists' "lack-of-demand" explanation of recessions] in the free market if prices are allowed to adjust.”

Price is supposedly determined by the intersection of aggregate (total) supply and demand. But we now have “supply-side” Austrian economics in an outright war with “demand-side” Keynesian economics within our national and state governments. In short politics is right back in the thick of economics. We’ve arrived too at a point where Martin Wolf’s lament that surplus must shrink if national deficits to diminish is being applied on the individual level too. Allegations of “class war” show that economics has come full circle. Economics is right smack back into the center of political economy as we argue over whether the pockets of the rich must be emptied via taxation for the pockets of the poor to be refilled.

All this illustrates why throwing out the baby with the bathwater back in the late 19th and early 20th centuries when Professor Marshall and his prize student John Maynard Keynes sought to slough off the label of political economy through splitting modern economics in two wasn’t such a good thing.

The truth about scarcity is that pies may need to be split into a fixed number of pieces in the short-run, but in the long run anyone can bake more pies. Only the limits of our own survival set bounds on the things that human beings are capable of imagining and making reality. As the poet put it:

“Ah, but a man’s reach should exceed his grasp, or what’s a heaven for?” (Robert Browning)

Germany’s successful system of corporate checks and balances

I disagree strongly with Martin Wolf on his way of viewing the crisis in Europe. I believe that Germany is ahead of the other countries in the Eurozone not because it has a trade surplus on the macroeconomic level, but because on the microeconomic level Germany has a system of corporate checks and balances that actually works.

Ever since the industrial revolution began in the mid-1800s those who owned and managed corporations in England and the US have tried to eliminate the ability of their employees to unite. The relationship between unions and management in this country has been completely antagonistic and hostile. At times its been like a civil war.

Germany, the country that the US bailed out because it was in shambles after it lost World War II, took a different path – over time the Germans have given workers more of a say in the management decisions that most affect those employees.

For example, just this week the Volkswagen Corporation and its union agreed to shut off the server that routes phone calls to worker’s Blackberries one-half hour before its employees left work for the day. Workers in Germany are no longer “on call” all hours of the day and night.

Employees in Germany belong to strong unions and they elect representatives who sit on corporate management committees and help to make real decisions of real importance. For example, when a company has to downsize, its workers get to help decide how to handle that – by job sharing, cutting their own hours, or other means.

US law would prohibit this from ever happening here. American workers will have to answer their cellphones 24/7 if that’s what a corporation wants.

Unfortunately, the Anglo-American scholars like Wolf, who dominate the current world of Western economics can’t seem to  see that what happens on the microeconomic (local and regional) level can seriously affect what happens on the macroeconomic (national/global) level. Liberal economists don’t even see the problem with gutting unions and not replacing those unions with any other checks on management. And neither do supply-side Austrian school economists.

Certainly we no longer have the checks and balances that were supposed to keep corporations under control. Government has been usurped by corporate payoffs. Shareholders these days can’t seem to cut down on the obscene bonuses upper management is awarding to itself or even wring more dividends out of big corporations. Consumers have little power over corporations either, since even a consumer protection agency created by the federal government cannot get itself off the ground.

German corporations are by no means democratic – far from it. But they do have the muscle to put a lid on unearned, extravagant, hurtful bonuses paid to corporate executives. That is why we need to bring back word “political” and connect it with the word “economics” again.

We need an overarching narrative that will splice together a splintered economics with a debilitated politics and make the two work together again. That is why we need to think about applying the political principle of “checks and balances” to the sphere of big business. This is why we need to restore the field of “political economy”and start over again.

Next time: Why The “Job Creators” Are Failing

Follow Nancy Humphreys on Twitter @brucenomics

No, this isn’t a post about banks. It isn’t a post about personal finance either. It’s a post about the founders of the United States’ concept of “Checks and Balances” within the US Constitution as it could be applied to the field of economics.

We all know that our government has three branches: the Presidency, Congress and the Judiciary. And we know that those three branches were created to act as a check on each other to ensure a balance of power among themselves.

Within Congress there was a further subdivision to ensure a balance of power between “the masses,”  (represented by the House) and the “propertied interests” (represented by the Senate).

Those propertied interests were mostly plantation owners in the South. Nine of the first twelve US Presidents were southern slave-owners. The tenth President of the US was a northern slave-owner.

The House and Senate were intended to act as checks and balances on each other, but no one anticipated that one branch of Congress would actually try to checkmate the other by use of the the perpetual filibuster! The assumption was that Congress and the Senate would work out their differences to keep the country going.

And now, despite the Founding Fathers’ best intentions, we find ourselves with a Congress that’s as close to “checkmate” as it can get. This stalemate stems not from politics, as so many of us think, but from economics!

The Anglo-American world of 1776

At the same time the Founding Fathers of the United States were promising its citizens a government that would guarantee citizens “safety and happiness,” a scholar over in Edinburgh, Scotland published a book that remains a classic even today. Along with the American Declaration of Independence, Adam Smith’s The Wealth of Nations was published in early 1776.

Adam Smith is called the “Father of Economics,” and his writings are still very visible in the thinking of both liberal and conservative economists in the United Kingdom and here in the United States.

But here’s the thing. There was not such thing as economics in 1776. The field that for at least two centuries before this had talked about the “economy” of nations was called “political economy.” There was no separation of state, i.e., the government, and economy in Adam Smith’s world!

In 1776 in the “New World” there were only 13 states, i.e., nation-states in their own right. The total population of those 13 states was 2.5 million. That’s about the size of of the city of Brooklyn or of Toronto or Rome nowadays.

The “economy” in early America consisted of villages with small shops and stalls. Trade within the states was was conducted on foot or by horseback, wagon or small boat.

Paul Revere with his little silversmith shop in Boston and Ben Franklin with his print shop in Philadelphia were the “tycoons” of those days. Nowadays we’d call these guys “middle class.” or “small businessmen” and lament their demise.

The anglo-american world of 2011

Now our world is dominated by large, multinational corporations. Large corporations now have even more money than most of the nation-states in our world. Only twenty out of 190 countries in the world have a GDP (gross domestic product) that exceeds the revenues earned by giant companies like General Electric, Shell Oil, Exxon Oil, and Toyota. Multinational corporations are clearly able to “buy” politicians’ votes in any democracy they like, including ours. These votes decide whether government revenues from our taxes will be spent to help expand corporate coffers even more!

Given the phenomenal growth of the corporation under legal protection by the US federal and state governments, it’s not surprising to us that one family of six people,  who own the Walmart Corporation have been able to amass as much wealth as the bottom 30 % of the entire US population! Indeed, if they wanted to, the Walton family could purchase a two small countries, e.g., Ethiopia and Uruguay, with the family’s net worth of $69.7 billion dollars!

In fact, corporations are so out of control that they are now flourishing while our governments are not. In our bifurcated economy, large corporations are sitting on billions of dollars while small businesses and governments are struggling to pay their debts each day. It’s gotten so bad that some government’s in Europe are even considering a “transactions tax” to bail other governments out of debt. And that’s ironic.

A transaction tax on financial investments (a “Tobin tax”) is what the The Stamp Act of 1765 did. The Stamp Act tax (a tax on financial documents transported from one place to another) was one of the two famous taxes that started the “American War for Independence” from Britain!

In our world, trade is global, and trust is virtually nonexistent. There is a scandal a day in the financial papers. There is a “big” scandal every few months. We do not live in the world of our Forefathers. We live in the world of Bernie Madoff. We do not live in the world of Adam Smith. We live in a world now where politics is increasingly deadlocked because economists, right and left cannot agree on what to do.

Where is the way out of this? I suggest what we need is a blend of the wisdom of these forebearers in the worlds of politics and government on one hand, and the world of economics on the other hand, that can work for the 21st century. We need to restore the field of “political economy”.

Next time: Checks and Balances: For the Field of Economics

Follow Nancy Humphreys on Twitter @brucenomics

The pain in the pension

Pension plans have been hit hard by the current crisis. The stock market is in a volatile up and down race to nowhere; commercial real estate is still in trouble, and there’s a huge crisis in Europe.

Not only that! World War II baby boomers are now retiring. People are living longer. And the Bush administration was quite successful in helping businesses switch from providing their employees with defined benefit plans (i.e, pensions) to defined contribution plans (i.e., 401Ks, 403Bs etc.).

Unfortunately, defined contribution plans haven’t worked out so well. AARPs newsletter is full of articles about older people unable to retire because they have not made enough money in their 401Ks to do so. Many seniors previously had to take money out of their 401(b)s because of an emergency or illness. And many simply lost money trying to learn how to invest, a skill most Americans aren’t taught in our public schools.

Private pension funds are managed by experts in investing and actuarial statistics. 401(k)s, on the other hand offer products created by investment companies and insurance companies to lure people who know nothing about investing into turning over their money to these companies, companies which define workers’ contributions but not what benefits, if any, those employees will ever receive for their contributions.

In “Insurance Company 401k Mutual Funds; The Poor Man’s Derivatives” I wrote about a major insurance company’s defined contribution plan that my employer at the time the offered years ago. The products offered had the same name as real mutual funds, but when I inquired about why I wasn’t earning the same amount that those mutual funds were paying, I was told the truth. My insurance company’s mutual funds in my 403(b) were “knock-offs”.  The company person claimed they did not take out fees. Clearly their imitation mutual funds simply weren’t as good as the actual products sold on stock exchanges!

Where’s a government when you need it?

Given the problems of so many seniors, the defects of 401(k) plans, and the current intention in Washington to make cuts to Social Security, wouldn’t you think our national government would be concerned about maintaining private pension plans?

Well, apparently not! AMR, the holding company that owns American Airlines is on its way into bankruptcy court. But this is not your ordinary bankruptcy. This bankruptcy is differs from most bankruptcies in US history. This bankruptcy ranks seventh in terms of the number of employees impacted.

American Airlines’ pension plan owes money to 50,000 retirees plus 80,000 employees. And the company is now talking about jettisoning American Airlines’ pension plan because that plan keeps American Airlines from being ‘competitive’ with other airlines.

In other words, “They don’t have to have pension plans so why should we?”

You can’t blame the executives who think that way. Their job is to cut costs and raise revenues for their company. They run a business.

And there are some think should be the way government does business as well. But if that’s the case, one has to wonder why we should even bother with having a government.

The purpose of have the government we have was pretty well spelled out on July 4, 1776 in the Declaration of Independence.

We hold these truths to be self-evident, that all men are created equal, that they are endowed by their Creator with certain unalienable rights, that among these are life, liberty and the pursuit of happiness. That to secure these rights, governments are instituted among men, deriving their just powers from the consent of the governed. That whenever any form of government becomes destructive to these ends, it is the right of the people to alter or to abolish it, and to institute new government, laying its foundation on such principles and organizing its powers in such form, as to them shall seem most likely to effect their safety and happiness.

The last three words sum up the guarantee promised to the American people by their government: “safety and happiness”.

Except when they are at work?

Most employees of an American corporation have no say at all in how that company is run. A business is not the same as a democratic government. And that is why we have government – as a “check and balance” against business with its narrow focus on making money.

But our government isn’t using its power to check corporations from dumping employee pension plans during bankruptcy.

Here’s how that works. When a company fails, the Pension Benefit Guarantee Corporation (PBGC) covers the the shortfall in the pension obligations of that company. The PBGC is funded by premiums from all the US companies that offer defined benefit plans. At present the PBGC guarantees the pensions of 44 million employees.

American Airlines has only $8.3 billion to cover its employees out of 18.5 billion in obligations it has to the 130,000 participants in its pension plan. But PBCG is $23 billion in the red already. It doesn’t need, and says it may not even be able to handle, another $10 billion for taking care of American Airlines’ employees.

The Pension Benefit Guarantee Corporation is an independent agency of the US government created by the Employee Retirement Income Security Act of 1974 (ERISA). It operates like a mutual insurance corporation. Whenever one company fails, all the other companies in the insured pool of companies with pension plans pick up the tab for the failed company’s plan members.

Well, that’s how it is supposed to work, but you can see clearly that it is not going to.

Moral bankruptcy?

Every time a giant corporation fails, other corporations and businesses have to take up its burden through increases in their premiums. The burden of paying back employees  the pensions they earned while working for their employer can’t be simply dismissed like the way debts owed to the company’s creditors are. By law those pensions have to be paid.

But the camel’s back can’t carry the heavy load that’s being dumped on it. The PBGC is itself on the verge of failure. As each company declares bankruptcy and simply decides it doesn’t want to pay its employees the pensions those employees earned, every other company has an increased incentive to do the same thing.

In economics and finance, this is called “moral hazard“. There has been a lot of concern about fostering moral hazard when it comes to bailing out banks with taxpayer money, but no one seems concerned about “moral hazard” when it comes to allowing employers to dump their employees’ pension plans during bankruptcy. Yet, who will ultimately pick up the tab for private pension funds of corporations that declare bankruptcy if the PBGC can raise enough from its member companies? The taxpayers, of course.

And who will pick up the tab for the massive failure of defined contribution plans to enable employees to take care of themselves when they need to retire? That may well be the question of the century. Today it’s pensions that are going the way of the dinosaur; you can bet that tomorrow it will be 401(k)s.

If you have or hope to get a pension from a private employer, the writing is on the wall. Our government doesn’t care if you ever get that money or not. Our government is too busy arguing with itself about which group of taxpayers ought to pick up the tab for the obligations that corporations don’t want to pay.

Follow Nancy Humphreys on Twitter @brucenomics

Taijitu - diagram of ultimate power

In the last example of Fourfold Problem-Solving we looked at How Buyout Funds Work as an industry on the microeconomics level. Today we’re going to look at national and global examples on the the macroeconomic level.

A national example of fourfold thinking

Macroeconomics is simply the “big picture” economics. At this point in time that usually means on the national or international level. Microeconomics, on the other hand, is anything below the national level, e.g., industry, households, regional and local governments.

The national level is where Americans can clearly see the downside of binary either/or thinking. We think we have two national political parties in this country; Republican and Democratic. The reality is that we have four parties:

conservatives          ultraconservatives

liberals                   progressives

Our ultraconservatives have pulled conservatism one way; now our progressives are pulling liberalism back towards its former place, and even beyond that into more progressive territory. Meanwhile, we have a liberal Democrat President who is trying to moderate the damage of that split, and traditionally conservative Republicans appear to be becoming more and more of a minority in Congress.

A global example of fourfold thinking

Most of the time, economists who use words rather than mathematics to express what they see tend to use twofold models. Foreign trade specialists, for example talk about exports and imports. On the national level macroeconomics specialists, such as Martin Wolf and other writers for the London Financial Times newspaper, talk about surplus and deficit countries, meaning countries with sovereign debt, e.g., Greece, and countries with a surplus, e.g. Germany.

Make no mistake, this is progress. Economists used to use one-good models. They used them in microeconomics for discussing what happens in a manufacturing establishment. And they based ideas of foreign trade on the notion that each of two countries produced only one good. Given the size of multinational companies such as those in the auto industry, and the complexity of international trade, that kind of simplification is no longer useful. The US trades with a myriad of partners, and 0ne-trick-pony manufacturers are now as rare as buffalo in this country. One-good nations are now rare too. And so are one-good economic models.

We’ve progressed, but only to binary models involving two polar opposites . Yet Martin Wolf did use fourfold thinking in one of his recent editorial comments about the crisis in the Eurozone. So let’s look at the basics of the financial crisis in Europe before we see what Martin Wolf says about it.

The Eurozone crisis

The Eurozone is now going through something very similar to the US financial crisis. Global banks overreached. When investment bank deals began to fall through and financial sectors in the Eurozone became shaky, the wrangling began over who was going to pay for the follies of those who bought and sold worthless investments in government bonds.

The holders of those worthless investments in sovereign debt would prefer it be the taxpayers who pay. The taxpayers don’t like that idea. Germany and other surplus countries in Europe, countries who hold a lot of the debt involved in the Greek debt crisis, prefer that Greeks pay the price. Greeks, who are a a strong unionist country have gone on strike. They are protesting in the streets the austerity moves being thrust onto their government and them by other EU countries.

I can’t blame the Greeks. Greece is predominantly a middle-class country. It does not have a preponderance of wealthy people it could even dream of taxing to pay its debts. Many of those debts have been facilitated by Goldman Sachs deals that were made with Greek government officials on an  “off-the-budget” basis. Those deals were invisible to the Greek people until the deals went sour in the global meltdown.

Worse yet, today’s Financial Times reports that a Greek government statistician is accused of altering his accounting method in 2009 to make it appear the Greek government had more of a deficit that it actually did. (“Athens statistics agency chief accused“). Greece is a country that has gone into debt by issuing bonds and by borrowing heavily from other countries. Today’s news threatens to derail a Eurozone-financed bailout loan that Greece needs to pay public sector salaries and pensions in January.

Once Greece got into hot water, a chain reaction began in Europe. Portugal, Italy, Ireland and Spain came under attack for also being deficit countries like Greece. Even France’s banking system has been tarnished by the crisis overseas. And Europe, unlike the United States does not have a strong central bank. The European National Bank does not have the resources to bail out even one of the Eurozone deficit countries.

Also, unlike the United States, the the debt problems within several Eurozone countries, even though different from one another in the details of how they came about, are all very real financial crises. These crises were not self-imposed by polarized political parties within any of the countries. Yes, we are a deficit country too in terms of our national budget, but we are have not yet come close to where our sovereign debt is worthy of being called a immanent crisis. We have time. Europe does not.

The polarization in the Eurozone arose when Greek sovereign debt became dangerously high. The polarization in Europe is between the have and the have nots, i.e., those private investors who “have” and are stuck with the bad sovereign debt (bonds sold by the Greek government along with derivatives sold by banks to “insure” those bonds) versus those taxpayers in Greece and other Eurozone countries who will “have not” if payment for that debt is taken out of their paychecks.

Martin Wolf’s fourfold thinking about the European Union crisis

Martin Wolf has used two pairs of opposites (fourfold thinking) in his editorial for the Financial Times, titled “How to keep the euro on the road“  These two pairs of opposites are: “stocks and flows” and “financing and adjustments”.

“Stocks” refers to the huge debt overhanging some European nations from their past actions. “Flows” represent the need to return to economic growth in the future. “Financing” and “adjustments” relate to ways to deal with the “stocks” (i.e., debt) and/or the need to create sustainable “flows” (i.e., growth) of income and expenditures for the future.

Wolf uses these four interrelated variables to consider how Europe can solve the crisis in the Eurozone as it faces illiquidity and insolvency right now for some of its members.

Unfortunately, toward the end of Wolf’s article where he discusses adjustments to flows, Wolf returns to the binary logic he’s been advocating for the past few years about countries with a trade “surplus” vs. countries with a trade “deficit’. He persists in thinking that “If external deficits are to fall, so must surpluses elsewhere.” In another article he wrote November 2, 2011 for the Financial Times,  “Creditors can huff and puff but they depend on debtors,” he frames international trade this way: “Since the world cannot trade with Mars, creditors are joined at the hip with debtors.”

In this second article Wolf is talking about creditors as countries which have a surplus in terms of their current account balances. Investopedia defines a current account this way: The difference between a nation’s total exports of goods, services and transfers, and its total imports of them. Current account balance calculations exclude transactions in financial assets and liabilities.” But it is financial transactions are precisely what has gotten Greece into trouble.

I really thought this kind of binary, simplistic “comparative trade” model in the field of economics would have left academia around the same time I did! I find myself disappointed it hasn’t.

Getting at the real problem

The real problem in the Eurozone that such dichotomous, binary thinking about current account balances of creditors and debtors glosses over the fact that there is a huge amount of toxic financial debt still floating around everywhere in the world.  Wolf doesn’t seem to notice that investment banks and shadow banks are lurking behind the massive fiscal debt that some sovereign nations have acquired. The real problem in the world right now is: “Who will pay?” Investors? Investment banks? Surplus countries’ governments? Or taxpayers in the deficit countries? That is the battle (literally) going on in Greece right now.

Investment banks who created the crisis have largely dodged the bullet so far, while taxpayers haven’t. Perhaps one reason some of the wealthiest Americans are reluctant to volunteer for the Buffet tax is that they know it could end up being a lot bigger than the current proposal. In addition, some of them are the investors who don’t want to take responsibility for Greece’s toxic debt in the first place.

The interesting thing about the US right now is that those conservatives who pay lip service to Adam Smith are supporting an economic system that would destroy the one Smith espoused. Smith’s world was one where money facilitated commerce and trade among people who had goods and services to offer each other. Our world is dominated by a gigantic gambling consortium that is in business only to make money. This is not what Adam Smith would have called, “The Wealth of Nations.” Yet investment banking is an industry that the US still leads the world in. And it is banks in the Eurozone and the US that hold much of Greece’s sovereign debt and the “insurance” (i.e., credit default swaps against sovereign debt) that are supposed to cover losses from Greece’s debts.

Greece, on the other hand, is a country that does not produce enough goods and services to pay for much of its debts. It has habitually borrowed too much and gone into sovereign default. And like all countries in the Eurozone, Greece gave up its power to control the rate at which its own currency is exchanged with other countries’ currency. Greece cannot devalue its currency in order to foster increased exports of the products it makes or to attract more tourists to the country.

Going towards a solution

The use of one pair of opposites, i.e., only two variables, to think about issues tends to lead to “either/or” thinking. Either/or thinking is polarizing thinking. When people use either/or thinking, they tend to take sides instead of engaging in problem-solving. Either/or thinking, in my opinion, is a trap. And in this case, dividing the Eurozone into surplus vs. deficit countries is too limited. So is talking about creditor and debtor nations solely in terms of foreign trade.

Wolf himself, in his article about keeping the “Euro on the road,” suggests that financing would come mainly from other Eurozone countries raising money from selling bonds for example, to help fund Greece, while adjustments refer to the austerity measures Greece is being arm-twisted to implement. These two variables have to do with cross-border exchange of debt in the Eurozone, while the two variables, creditor and debtor have to do with cross-border trade among Eurozone countries.

Fourfold thinking then can prevent getting to a stalemate; fourfold thinking is one way out of the mental traps we humans build for ourselves.

The Eurozone countries, as well as the rest of the countries in the world, all have at least four interconnected macroeconomic factors in play:

private debt         public debt    (as part of Martin Wolf’s “stocks)

exports                imports        (as part of Martin Wolf’s “flows”)

Rather than focus simply on trade, as Martin Wolf’s twofold thinking about “surplus” and “deficit” countries does, the current global financial crisis can be broken into four interconnected factors — debt, public and private; and foreign trade, exports and imports. Public debt here refers to sovereign debt of the countries in the Eurozone, while private debt refers to the individuals and institutions who hold Greek debt and derivatives.

Looking at an issue from more than two sides can change the way economics works. Looking at an issue from four sides can help break out of a box when two or more sides oppose each other on political issues.

With a fourfold model, we can see how the United States differs from the Eurozone. The US controls the exchange rate for its own currency, and we are now looking at increasing our exports as a way of dealing with our “flows,” i.e., our economic growth, problem. That, from what I can see, was what quantitative easing by the Fed was really all about; by buying back US government debt we sent dollars into the hands of private investors around the world. That kept the exchange value of our dollar low and fosters our exports to other countries. And we are at least attempting to deal with the private vs. public debt problem, our “stocks” problem, via taxation (or “tax reform”) as well.

The biggest question for the US is, can our political polarity be resolved far enough to deal effectively with our both our national debt and our trade deficit.

Follow Nancy Humphreys on Twitter @brucenomics

Normally I don’t write about a the story from a single article in a newspaper, but today there is an article in the London Financial Times that is so outrageous I have to write about it. This article shows the epitome of the craziness going on in the saga of what rich banks and wealthy investors are doing to themselves, this country, and to the world.

Most Americans will never know about this story because it is taking place in Ireland. And that’s unfortunate!

Scylla v. Charybdis

These were my two favorite monsters from Greek literature.  These two sea monsters awaited Odysseus (Ulysses) on his way home from the the battle by the Greeks to retrieve beautiful Helen from her captors in Troy. Scylla was an enormous rock shoal near Sicily. Charybdis was a gigantic whirlpool that was so close to Scylla, ships could not get through the gap. Odysseus had to sail between these two sea monsters in order to get himself and his crew home to Ithaca.

Odysseus was caught “between a rock and a hard place”. He had to choose one. For the “good of the many” as Star Trek puts it, Homer’s story of the ten-year Odyssey back to Greece reveals that Odysseus chose Scylla, the rock. He risked losing a few of his crew, rather than take the “all or nothing” course and risk falling into Charybdis, the whirlpool, and destroying all of his twelve ships and his men.

Today taxpayers are the modern variants of the crew on the Odyssey, and we too are having a hard time surviving. As this Irish tale shows, the reason is that bankers and investors are locked in a destructive battle that threatens to take all of us down underwater.

You might think that situation arose because because corporations have become too big to fail. But I don’t think that is the whole story. The bigger story is that the owners of corporations have become too big to fail.

The original purpose of the small corporation was to insulate its owners’ income from liability if the corporate venture (say, building a new bridge or toll road in early America) failed. Now corporations are giants, employing millions of people (i.e., taxpayers). It is the corporation that needs to be saved, to be insulated, from the actions of its owners, not the other way around.

An Irish tale (a true one!)

Jamie Smyth, in the “Fall of ‘Mighty Quinn’ mirrors Irish collapse” traces the incestuous relationship between the richest man in Ireland and the Anglo Irish Bank. Quinn, worth six billion Euros at his peak, was the owner of The Quinn Group (ROI), a giant privately-owned registered corporation in Derrylin County Fermangh, Northern Ireland.

The Quinn Group owns all kinds of manufacturing businesses, financial services, along with hotels and commercial properties in many countries across Europe and the Middle East. Quinn Energy also owns the biggest electric power station ever built in Ireland.

The Anglo Irish Bank is an investment bank specializing in businesses and commercial properties. The bank developed a shaky reputation. Under The Anglo Irish Bank Corporation Act of 2009, the bank was nationalized. And in a move similar to what the FDIC did with so many American banks, the government of Ireland separated the Bank into two entities: one with loans that could be sold as assets, and the other one held its customer deposits.

The bank was next combined with a second shaky bank, and the new entity was given a new name to neutralize the stigma attached to the old names of both banks. On July 1, 2011, the Irish government officially merged the Anglo Irish Bank with the Irish Nationwide Building Society, and it renamed the integrated two-bank entity, the Anglo Irish Bank Corporation Ltd. This process wasn’t cheap for the Irish taxpayers!

By 2010, a year before the two banks were formally merged, the Irish government had invested Euro 12.3 billion into the Anglo Irish Bank. According to Smyth’s article in the Financial Times this merger cost Irish taxpayers an estimated total of twenty-five and thirty billion Euros.

The epic battle: big bank vs. big investor

Sean Quinn, the “Mighty Quinn,” this week finds himself in bankruptcy court in Belfast. Quinn’s worth has plunged from 6 billion Euros down to 11 thousand Euros in his bank accounts and $563 million (415 million Euros) in debts. Mr. Quinn claims that all he has left is a plot of land worth 35 thousand Euros he owns with his wife, and a 2004 Mercedes.

And the Anglo Irish Bank? It did even worse; it claims Mr Quinn owes it over two billion Euros that it loaned him during the 2000s! That 2 billion+ Euro debt, of course will be more money out of Irish taxpayers’ pockets. Anglo is now suing the Quinn Group in court. The Quinn Group, however, has been largely shattered by Quinn’s debts to the Bank, and it is suing the Bank.

How did this happen? Reading between the lines of Jamie Smyth’s article, it appears that Mr. Quinn became pissed off at his bank when the Bank called in the 2 billion+ Euro loans it had made to him.  Whatever the reason, Quinn seemed to desire getting leverage over his bank. Long after he had transferred title to the corporation he built and still headed, to his five children in 2002, Quinn began gambling away their futures by taking out loans and buying more and more control over the Bank’s shares. Quinn started betting against the Bank in 2007. And Quinn did this in secret!

In Ireland there’s an anonymous form of investment called a CFD or contract for difference. This financial derivative allows a large investor to bet on price movements of a company without buying any shares of the company. In return for betting a mere 750 million Euros, which Sean Quinn borrowed from his own corporation, the Quinn Group, the “Mighty Quinn” ultimately obtained control over 30 percent of Anglo Irish Bank shares. And that was just the beginning.

Deep, deep into the mire

Quinn Group was in trouble financially during the 2000s; and by 2010 the corporation went into receivership. Quinn Group had to sell off its Insurance unit then. And of course, the Anglo Irish Bank too, like all big banks after the 2008 crisis was falling into financial difficulty as too. Its share price was dropping. At that point the Bank, kept Quinn afloat. The Bank loaned the Quinn Group another  750 million Euros, the sum Quinn took out of the Group to anonymously gain control of thirty per cent of the Bank’s own shares!

By then, both corporations, in my opinion, were caught fast in the whirlpool. Like the poem about “the Chatelaine” (i.e., housewife) and “the Beauty” who battle each other as they go up the stairs in a tower, Quinn and his bank too were locked in a do or die battle. Worse yet, Quinn’s family was sucked in too because in 2002 Quinn had transferred ownership of the Quinn Group to his children.

To sum up: the “Mighty Quinn” transferred ownership to his children of a company he ran or would soon run into debt. Then he used a loan from his children’s company to “short” shares in his bank on the margin (i.e., with very little cash involved). Owning a derivative that could profit from a decline in the value of a huge amount of shares, i.e., thirty percent of the bank’s shares, did Quinn tell the bank he would sell the 30% derivative just as the bank’s shares were tanking badly? Is that why The Anglo Irish bank loaned the Quinn’s children’s’ company the money, the 750 million Euros, to pay off Quinn’s bet against it? Or didn’t the Bank know about that anonymous CFD bet?

And wouldn’t you think Mr. Quinn’s five children would be rather angry with their father? No? After all, the bank is suing their company for over 2 billion Euros it loaned to their father. But I guess not! Read on:

The Quinn family itself is suing Anglo. They claim the bank advanced Euro 2.34 billion in loans to fund the CFD margin calls [of their father] to support its [the Anglo Irish Bank's] share price. They allege that Anglo’s former chief executive David Drumm and chairman Sean Fitzpatrick advanced the loans to the Quinn Group in the full knowledge the money was being used to meet the CFD margin calls. They say the loans are “tainted with illegality” because they [the bankers] had an objective of market manipulation and therefore are not enforceable.

And dad, himself? Sean Quinn? What’s become of him?

“My employment has effectively terminated [without compensation],” said Mr. Quinn in the debtor’s petition he filed to the High Court in Belfast.

What a mess! Hopefully the courts can figure out who paid whom and when for what. Meanwhile, as in the story of “the Chatelaine” (i.e., housewife) and “the Beauty” in the tower,  Sean Quinn and his bank have battled it out until their resulting unmasking of each other in court shows that “one face belonged to both” – that’s the face of greed, power, and fear at the top.

The bottom line

Shareholders have given control over corporations to managers who simply give themselves huge bonuses, even when the company has done badly. Consumers, have gotten nowhere with the idea of a consumer agency to protect them from corporate shenanigans. And unions are being busted up regularly. So far taxpayers and the government have largely lost the battle to have a say over what corporations do. And then you have the controlling owners of the corporations and the banks locked in a game of “chicken” with each other.

What group that has an economic interest in corporations is really responsible for controlling what goes on with them? As far as I can see, none! Yet corporations make products and services we all want, and they deeply affect the lives of their employees. Today, a US Congressman has introduced a bill to curb corporate financial involvement in our elections. But I think that is not enough. I think we need to protect the corporation itself and the people who work for it and buy from it, and no longer protect the owners and managers of those corporations from personal and financial liability when they do damage to their own corporations!

Follow Nancy Humphreys on Twitter @brucenomics

Yesterday I drove by the Occupy Berkeley encampment on Martin Luther King Jr. Boulevard. I only had a brief glimpse of the tents and a make-shift cardboard sign as I passed. So my first thought was of a small town somewhere in Oregon.

Long ago, while on a camping trip with my college boyfriend we came into the town as it was getting dark. We asked a pedestrian if there was a place to camp nearby.

“Sure” they answered, “ the city park is right down the street.”

Amazed we drove down to the center of town. Indeed! There were tents, green, tan and orange, beginning to sprout up all over the town square. There were ample bathrooms and water. And it was all free. The only rule was you had to leave in the morning. You couldn’t live there. You couldn’t become a resident.

Our experience that night was a bit exhilarating. True, we’d camped in one of the rest stops on the way out where sleeping overnight was legal, but never had we seen a campground in the middle of a town that was just for travelers.

In a way completely different from any protest we’d ever been at, that peaceful camping area in the middle of a small American town was like suddenly awakening in a whole different country, a country where people really were free.

The commonwealth

I come from Pennsylvania, a state with conflict built into its name. Pennsylvania is a Commonwealth. That means just what the word sounds like, a place of “common well-being” or property owned and enjoyed by all. At the same time, the name Pennsylvania translates into “Penn’s woods”. And woods, or rather timber, was one of the reasons Charles II, king of England in 1681 granted William Penn a land tract of territory for William’s Pennsylvania in the “New World”.

From the beginning, America has been resting on twin pillars: (1) the the promise of a great wealth to be shared in common by those who settled in this land, plus (2) the promise of private ownership being available to all [white males] who worked for it.

The commons

Closely related to the idea of commonwealth is the broader idea of the commons. The Boston Commons in the Commonwealth of New England is the most famous example in the US that ideal. What is a “commons“? Any resources held in common, whether land, natural resources, or intellectual property such as laws are examples of the commons.

Although the idea of commons began long before the US was formed, nothing is more “American” than the town commons, or as city planners called it, the “town square”. Nothing is more American than the public library, the intellectual and entertainment commons that serves all the people of that town. Nothing is more American than the voting booths along with the idea of “one [hu]man, one vote.”

The commons also includes:

• National parks and wilderness areas
• Interstate highways and roads
• Local streets and media strips
• Sidewalks and public plazas
• Public buildings and gardens
• The Internet

And intangibles such as:

• Culture
• Public art
• Political structures
• Shared values such as freedom of speech, religious freedom, and equal justice for all
• Constitutions
• Air and water

But from the beginning there was conflict. Nowhere was that conflict portrayed by mass media more vividly than in movie Westerns. Here the battle was often between the cattle ranchers on one hand and the railroads and farmers on the other.

The cattle ranchers, along with the “outlaws” who were also a symbol of the unfenced commons in the old “wild” West, were portrayed as the “bad guys”. The farmers and law-bringers were the good guys, often good guys without any guns.The American Indians were a sign of troubles fading into the past, while the railroads were the ominous sign of what was to come. In this way we were taught to hate the idea of the commons.

The attack on the American commons

In 2003, David Bollier wrote a book called, Silent Theft: The Private Plunder of Our Common Wealth. Even Newsweek had praise for this book. YES! A Journal of Positive Futures opened its review with this sentence: “When our times finally come to rest in the history texts, I think they will be called the Age of Enclosure—the age of privatization. It is a time when everything has become a commodity, and everything is for sale. (Winter 2003 issue, pp. 55-6 by Jonathan Rowe).

Another concept that Bollier comes up in Silent Theft is the “gift economy”. This is a social space where things are perceived as better because they are given freely instead of being bought and paid for. These kinds of freely given gifts are things like “personal attention, acts of kindness, sacrifices of time”.

Says Bollier:

In the real world, we all know that child-rearing, family life, education, socialization, sexuality, political life, and many other basic human activities require insulation from market forces. We may pay for child care but worry that it is not the same as a parent’s loving personal care. We may pay for college tuition, but real learning requires a voluntary personal commitment. A father cannot buy his son’s affections, our votes should not be sold to the highest bidder, and paid sex is not the same thing as intimacy with a loved one. p 23

Occupy Wall Street (OWS)

Until the Occupy Wall Street movement began, Wall Street was an emblem for the supreme and extreme powers of privatization. The OWS movement called our attention instead to the public streets that Wall Street’s grand buildings sit in the middle of, to the the impoverished commons that surrounds Wall Street’s wealth.

Occupy Wall Street can be viewed as the “last stand” by the middle class, working class, and student “outlaws” of this century to preserve the American commons, and indeed, the global commons. Occupy groups are in London, Sydney, Frankfurt, Hong Kong, Toronto and even in cities in Switzerland. In fact, you could say OWS groups were inspired by the uprisings in the Eastern Europe, China, and most recently the Middle East, that also involved famous city squares.

City officials here and abroad are now busy driving the OWS “protesters” out of their commons. With blinders on, they take a narrow view that the rights of private property owners and their employees are being trampled upon. But in reality the reverse is the truth.

Across the globe, private property has ridden roughshod over the commons for centuries. At the rate we’re going even air will be for soon for sale in a world where breathing is no longer a free good.

Public safety is part of the commons. Politicians have every right and duty to be concerned about it, but they can’t be allowed to forget that it is the public who are now occupying the commons that belong to the public.

Officials can’t be allowed to forget that they are merely the representatives of the public who own the political system of this country’s democratic government.

None of us can be allowed to forget that when people are no longer free to walk on the sidewalks of their own towns and cities or campuses; people are no longer free.

Follow Nancy Humphreys on Twitter @brucenomics

Taijitu

Let’s apply the Fourfold Problem-Solving technique of last week to an example in the microeconomics level of the economy. Let’s suppose you are part of the lucky 1%.

You manage  a buyout fund. A good opportunity comes your way. There’s a company in trouble, and you have the funds to buy it. Should you?

Here are four aspects of that question:

Buy                  Hold

Walk away        Flip

Villains and heroes

Many buyout funds buy with the intention of immediately flipping the property belonging to the company they’ve bought out. These are the ones who often get a bad reputation as plundering pirates. Like vultures picking at a corpse, they fire everyone, sell off everything they can, keep the patents, and dump what’s left. They trash companies more efficiently than any street rioters could ever do.

However, there are times buyout funds will hold and restructure a company. They do this in four ways:  (1) by creating direct contact between owners and managers, (2) increasing speed in decision-making, (3) keeping any restructuring of the company out of the public eye, and (4) focusing on the core business problems to get the business back on its feet. Source: “Managers buy in to buy-outs” Andrew Hill, FT 7/28/11 p10

The result of this approach can be a company that is profitable and provides something to the economy, just as the sea captains like Jack Aubrey in the Patrick O’Brien series protected trading ships back in the days of the Barbary coast pirates.

Now, the choice between playing hero vs villain may seem like a matter of morality, but it isn’t.

Some companies just aren’t worth much when the owners get done mismanaging them and/or simply have a run of very bad luck. Sometimes it’s best to tear down an old house that caught fire so a new one can be built.

And keeping some companies afloat may or may not turn out for the best. How many big banks did we keep in business through the Bush/Obama administration bailouts? Are we happy now that we kept them? Are we glad we taxpayers played the reluctant hero?

To buy or not to buy

OK, so back to your problem as a private equity fund manager. Do you buy or not? Obviously if the answer is not, you won’t need to face the the other two decisions. However, you can’t pass up every deal that comes your way. Your job is to buy and convert declining companies.

The thing is that before you buy, it would be a good idea to look and see which hedge fund role, “villain” (sell off and gut) or “hero” (protect and rebuild), you’ll be playing.

If we’re in an “up” economy for hedge funds, you may have more choices – you can flip or hold. In a “down” economy for hedge funds, such as the present, you may wind up having to hold what you bought.

In fact, you may not be able to sell any of the assets of the company you buy, even in order to streamline it. Even in order to make it a better company for someone else to buy. In that case, if you can’t accomplish either mission; you can’t be either pirate or sea captain, you shouldn’t buy the company. To decide, you’ll just have to “run the numbers”.

The current state of hedge funds

Hedge funds are privately-owned pools of investment capital that tend to focus on buying and selling financial investments such as the debt or equity of distressed businesses. Like banks, hedge funds are still far from their glory days of the pre-2008 financial crisis. Some buyout funds are even lowering their fees in response to calls to do so from their large investors.

In an entrepreneurial world like that of the 18th and 19th century sailors or the world of hedge funds in the 20th and 21st centuries, those who aren’t lucky and/or quick enough will certainly pay a hefty price even if they are playing with other people’s money and not their own.

There seems to be an art to running a hedge fund or a buyout fund. Some of the 1% have it and some don’t. And in fact, as a buyout manager, you’d have to make the above fourfold decision, not once, but often as you manage your businesses. Likewise only a few hedge funds and their managers have made it to the very top. The other thousands of private equity funds in the world are much smaller. Those are the ones who are failing just like the banks failed, because doing what they do isn’t easy.

According to The Hedge Fund Implode-O-Meter, “Since late 2006 at least 117 major funds at 71 outfits have imploded”. While this Internet site has clearly been updated to 2011, it was copyrighted in 2007-2008. For some recent stories of “Massive Hedge Fund Failures,” Investopedia is a good source. As it shows, hedge funds, like buyout funds, are sharks who can also be eaten by other sharks.

Who knows? Perhaps someday the person marching next to you in the streets will be someone from a failed hedge fund or buyout fund! Big banks too are laying off droves of employees right now. What happens to them? Do we ever hear? Who exactly is “winning” in the crazy system of gambling with money and lives we’ve evolved in this century?

Investing is a peri-mutuel game. It’s a contest of human knowledge and intelligence. One person pits their wits against another. That means the odds aren’t 50-50, as is the case in probability games that involve physical manipulation of inanimate objects. With peri-mutuel gambling, a “dark horse” can win the race, leaving as many as 99 percent of the gamblers tearing up their totes in its dust.

So I wonder, is this race we’re in right now just an aberration, a fluke, or is it because the winners, the 1 percent, know something the rest of us don’t?

For another practical example of Fourfold Problem-Solving on the macroeconomic level see my post, Citizens Concerned About Sovereign Debt Crises.

Follow Nancy Humphreys on Twitter @brucenomics

You’ve probably seen this symbol somewhere. It’s commonly  called the Yin/Yang symbol. Its name is “Taijitu,” or “diagram of ultimate power”. The Taijitu is the symbol that also expresses the logic of the ancient Chinese Book of Changes – the I Ching.

The logic of the I Ching includes fourfold problem solving, a method for solving problems by using two pairs of opposite ideas to analyze a situation.

Taijitu, diagram of ultimate power

This circle above contains two pairs of opposite concepts that you can easily spot: (1) big and small, and (2) black and white.

The small black and white circles are said to represent the sun and the moon, in the context of night and day. They are part of the eternal cycles of being.

The small black and white circles also are said to be “seeds” of the “other” within the larger black and white halves of the Taijitu. The smaller circles show how all things are interconnected.

They also depict how things change, with each thing ultimately turning into its opposite, say the white dot expanding to turn the black space white, while the black dot expands and turns the white space into black. These kinds of changes are the subject of the I Ching or Book of Changes.

An I Ching example of fourfold thinking

So let’s look at the following two pairs of opposites:

Spending  vs. Saving

Debt vs. Surplus

We tend to think of Spending and Saving as opposite things. We do the same with Debt and Surplus.

In our simplistic, binary, Western way of thinking, we also tend to pair Spending with Debt. We see this as having a direct relationship, almost a causal relationship. We also pair Surplus with Saving. And that too seems almost like a cause and effect. That’s how we come to think of Spending as bad and Saving as good.

Polarization, along with judgments of “inferior” and “superior,” often result from binary Western-style thinking about contradictions.

In contrast, the Taoist way of thinking is to look at each of these four concepts (or in economics, “variables”)  in light of each of the the other three.

Spending

As I pointed out two posts on this site, “Don’t just Save for an Emergency, Spend for an Emergency,” and “Spend for an Emergency, Don’t Just Save for an Emergency,” even though we think of them as opposites, Saving and Spending can be paired simultaneously in a strategy to protect yourself before a financial crisis hits the markets and/or the economy.

Likewise, our tendency to pair Spending with Debt, and only with Debt, leads us straight into to “fear mentality”. If you can see that Spending can sometimes also lead to a Surplus, and Spending can also lead to Saving(s), you are no longer tied to a “knee-jerk’ adverse reaction to a suggestion of “Spending” in hard times.

If you can afford to buy something for half price that you use quite a lot of — wouldn’t you go ahead and Spend on stocking up on that something in order to Save money and build a Surplus?

Saving

Likewise, we pair Saving with Surplus. We believe Saving is always a good thing to do. But now many people find themselves frustrated enough to hit the streets. They’ve “followed the rules,” worked hard and saved, and yet they have little or nothing to show for it and/or they see no future Surplus coming for them. They even stand to lose what they’ve collectively saved.

Saving does not always lead to Surplus. Saving can actually get us further into Debt. This is called this being “penny wise, pound foolish.” When you understand that Saving can sometimes be foolish, you no longer are tied to a “knee-jerk” positive reaction to the suggestion that “Saving” is a good thing.

Debt

Many wealthy people live good lives while they are in Debt. This is because they own or control assets which bring them an income. That income covers the carrying costs of their Debt, i.e, the interest they owe each month on their Debt. That’s what is called being in “Good Debt“.

The more money you have, the easier it becomes to buy these kinds of assets. And some of these assets are available only to the very wealthy. That is the eye-opening message of Robert Kiyosaki’s Rich Dad Poor Dad books and games. Understand this and you aren’t tied to a knee-jerk bad reaction to being in Debt.

Surplus

Saving doesn’t always lead to Surplus. Saving in the face of taxes that rise even faster won’t create a Surplus for you. Saving in the face of a falling value of the dollar (i.e., inflation) will create a loss, not a Surplus. Nor can Saving in the face of declining real wages create a Surplus for you.

Surplus is the result of growth, not decline. Look where the economy is growing and then you may understand better why it is declining elsewhere.

Moreover, Surplus and Debt can coexist in a tight relationship. For example, if you own a hula hoop factory and demand for your hoops declines, you will have a Surplus of hoops along with Debt just as soon as your costs to produce too many hula hoops begin to exceed your revenues.

On the other hand, laying in a Surplus of emergency supplies will mean Saving big time when a natural or man-made disaster actually arrives on your doorstep.

The moral of this Taijitu tale:

As Ecclesiastics so eloquently puts it, there’s a right time and place for everything under the sun (or moon). That applies to Saving, Spending, Being in Debt, and Building a Surplus!

Next time: Practical Examples of Fourfold Problem-Solving: How Buyout Funds Work and Citizens Concerned About Sovereign Debt Crises

I’ve cleared up one concern I’ve had about Warren Buffets call to tax millionaires!

Most of us think that the current recession is largely due to a lack of private spending in our economy. So, what would a millionaires’ income tax do? Would it help or would it set us back?

Ed Hammond, in his Perspective column in the House & Home section of the Financial Times (October 8/9, 2011) wrote a piece called “Measuring the pay gap in square feet.”

European’s proposed taxes on millionaires’ homes

In Europe right now there are proposals to tax the houses of millionaires. So, Mr. Hammond, a property expert, took a look at how much money rich people spend on their houses. In particular, he wondered if rich people spend the same proportion of their income on housing as the rest of us do.

In other words, he asks “what are bosses buying compared to their workers”.

Hammond found that if the rich were to spend the same on housing as others do, their houses should be 145 times better than those of non-millionaires. What would such a house look like? Well if it were 145 times bigger or better furnished, it would be hard to know. Such properties are not widely available in urban or suburban areas of England, (or I suspect, here!)

Taxing millionaires on their personal expenditures

The implication of this is that if we were to tax every homeowner for owning a home, a millionaire would still pay proportionally less, quite a bit less, in proportion to the income they earn than any of the rest of us. This, to me, raises a sticky issue with regard to determining tax “fairness.”

There seems to be an idea that if we charge people the same or similar proportion of income earned, that would be fair. Flat and proportional taxation alike do not take into account the needs of the poorest in society. Many of those who pay no tax do so because they barely have enough or don’t have enough to even support themselves let alone pay taxes. An extra $50 of tax means far more to a family which grosses $5,000 a year than $5,000 does to a family which grosses $500,000 a year.

A study by the non-partisan Congressional Budget Office found that “The after-tax income of the wealthiest 1 per cent of US households increased by 275 per cent over the past three decades, much faster than the average growth of 62 per cent for all Americans…For the poorest 20  per cent [of Americans] growth was 18 percent. Source: “US wealth gap widens further” Financial Times, October 26, 2011 p. 2

And here’s the interesting thing Hammond found out about how much wealthy people spend on residential property compared with others. It isn’t that much more! Hammond found that the rich live differently in scale depending on where they are located. Analysts at a company named Savills figured out that Britain’s wealthy executives do not live in 145 times bigger square footage than workers do – it is closer to four times as much space. In Shanghai bosses only have twice as much space (i.e., 3,000 sq feet) as their workers. In Sydney, Australia, bosses get 10,000 sq feet, eight times as much as workers.

In other words, housing, the biggest expenditure for most other people, doesn’t seem to be what rich people in other countries spend proportionately more money on. What happens here in North America and South America? I don’t know. It would be interesting if some enterprising property company would investigate that.

Still, it doesn’t seem like a tax on houses or personal income of millionaires and billionaires is such an outrageous idea as some like to claim. That’s because the tax is hardly likely to cost the rich very much relative to what they make. In fact, such a millionaires surtax is already collected by at least seven states. In New York State a surcharge on those with incomes over $200,000 is about to expire, and even some Republicans think it should be kept. New York state has taken in $13.8 billion dollars from this tax over the past three years. (“State’s budget dilemma as surcharges on wealthy expire” Financial TImes 10/18/11 p.6)

Millionaires do contribute to growth of an economy via their higher personal spending than others, and that’s good for employment rates. Most of us have no quarrel with such spending. If some people get four houses to live in, we don’t care as long as we get one to live in.

But managing to own even one house is the key problem for a millions of Americans right now!

Given that most millionaires seem to be spending only 2 to 8 times as much as the rest of us in proportion to earning 145% more than us, it looks doubtful that a small tax surcharge on the wealthy would cause the rich to alter their personal expenditures or move to another state or country that lacks such a tax. On the other hand, a tax on the personal consumption of the rich wouldn’t raise as much tax revenue as taxing all the rest of us at the same rate would. We outnumber the rich, and they spend proportionately less on personal consumption than we do.

So, I think we can stop wondering if imposing a proposed surtax on personal income of the rich at a 5.6% rate would harm the economy by making them spend less. But even though the US would benefit from a millionaire tax, we do still need to be concerned about how to create enough growth to reduce our nation’s deficit when so many people have so little disposable income to spend.

Taxing property assets held by the rich

One other thing Hammond finds is that tons of property is being bought by the wealthy as a way to safely park their cash. With financial assets at so much risk right now, real property, like commodities such as gold, seems somehow “even more real” than investments made in stocks and bonds.

But there is a problem with this. In urban and suburban areas, the rich are pricing the middle class out of the housing market. Even renters are having difficulty, as homeowners, forced out of their foreclosed property, try to find rental housing. This struggle has implications for middle class, working class, and poor people, local tax revenues, commuter expenses, air pollution, and a sense of community in cities. And it has implications for companies in these areas looking to hire employees who can afford to live there.

Tax reformers clearly need to look at the taxes paid by the rich on investment in residential homes and commercial residential property like apartment buildings as compared to taxes paid by the wealthy on investments in other types of financial assets they own or control. This is where the wealthy can be taxed “fairly”as far as the rest of us are concerned, and in a way that encourages real growth in the economy.

Flat taxes on income and spending

The earth is not flat, and neither is our economy. Flat taxes may seem “fair” to those with limited imaginations and a lack of patience to uncover and/or explain real answers, but flat taxes aren’t a solution to social problems. One way or another, a flat tax will not have an equal impact on everyone. Before taxes can be reformed, we need to come to agreement on where we want to wind up at.

Rather than begin with simplistic solutions to tax law, and vague notions of “fairness,” we need to look at the social problems we are trying to fix with tax laws. And then make meaningful changes.

Perhaps you recall my first post about Suze Orman, “Broke and Broker: My Week at Suze Orman’s Merrill Lynch“? Well, here I go again.

TV personality, Suze Orman, is fond of advising listeners to keep enough savings in the back to live on for six months.

I think this is about the dumbest advice I have ever heard from such a smart person!

First of all, many American workers simply can’t do it. Why not? Because wages in the US have steadily declined over the past 40 years. Many homeowners are underwater; and some are unemployed or underemployed on top of that!

Small businesses have been dropping like flies over the past three years. Big corporations can get bank loans, but small businesses cannot, even if they had enough demand to dare to expand. Self-employed professionals and entrepreneurs are struggling too. Who can save six months worth of living expenses?

But here’s the thing. Even if you could save up for six months of living expenses and put it in the bank, why would you do that? Once you lived on that money for six months it would be gone! Gone! All gone! And you’d have nothing at all to show for it.

Spend down your savings, and you’d have to start all over from scratch to build up your safety net again. That’s why I think Suze’s advice is the dumbest I’ve ever heard.

I can see a better way that is still available to some of us 99% to build a safety net right now. First of all, calculate your “personal beta”. Second, calculate the size of your existing safety net. If it isn’t high enough, start spending on the right kind of assets to have for a financial emergency. We’ll cover calculating your personal beta today, and calculating your safety net in the next post.

Are you a stock or a bond?

A “personal beta” is the brainchild of  Dr. Moshe A. Milevsky, professor at the Schulich School of Business at York University in Toronto. In his article, “How to Think Smarter About Risk” in the Wall Street Journal last June 14th 2010, Dr. Milevsky advises you to think of youself as an “investment” and calculate your own personal beta.

That novel idea stuck me as funny and intriguing. A beta usually refers to a stock or a bond. A beta is a measure of an investment’s returns in relation to the returns of the market as a whole.

A beta of 1 means that the investment moves in tandem with the market upwards or downwards. A beta of 2 means an investment’s returns will be worse in a downturn or better in an upturn than the market’s returns as a whole. A beta of zero means your investment is totally independent of what goes on in the market. Whatever happens in the market won’t affect anything for you.

Knowing your personal beta is essential for knowing what might happen to you and planning for the kind financial emergency Suze Orman is thinking of when she admonishes us to save six months of salary.

If we think of ourselves as an “investment,” such as a stock, with a particular beta of our own, we can easily see that being independent of the swings in the marketplace is also the end-goal of Suze Orman’s advice – when Suze encourages us to put six months savings in the bank, she wants us to be secure against the vicissitudes of the markets and the economy in general.

The two basic problems with Suze’s approach to security are these. First, downturns (and upturns) affect everyone differently. Secondly, who knows how long a down-trending market cycle will be?

Right now many people are likely to have been unemployed for up to two years or more. We all know it may be awhile before the job market picks up. Likewise, small businesses and solo practitioners always need to be able to ride out a dry spell for an unknown period of time. As we’ve just seen, that dry spell can extend into years. Without government support through dry spells, especially very long ones, most of us are in some kind of trouble.

Here’s what Dr. Moshe A Milevsky wants you to do: he wants you to think about how a stock market plunge would affect not only your portfolio (if you have one), but also to “think about how such a drop would affect your paycheck and your career.” He calls this thinking a form of “personal risk management”.

How to calculate your personal beta

Moshe’s article about calculating your personal beta is both cute and fun. He challenges you to begin by deciding whether you are more like a “stock” or a “bond”. You are to think of yourself as “human capital,” and imagine that your paycheck (or business income) is the dividends on your human capital. To estimate your beta, he suggests you estimate how much your job is likely to change with any change in the markets. Ask yourself, how much is your job affected by what goes on in the marketplace?

He uses US Supreme Court Justices as an example. These government employees have a beta of zero. Nothing that happens in the economy is likely to affect the need for their services or their salaries. But my profession, back-of-the-book indexing, is quite different. Indexing is highly sensitive to what goes on in the stock market.

Holidays and school terms impact book publishing. During downtimes checks from publishers come in way more slowly. Being paid takes months or in rare cases years, rather than days or weeks. Fears at the  millennium about the computer-programming glitch from using two-digit figures instead of four-digit figures for the year in dates, caused publishing to come to a near-halt in autumn of 1999 as book manufacturers held their breath to see what the economy would do if all the dates in computer software could not be re-programmed in time.

Over the past decade, changes in the publishing industry have been phenomenal. There has been a huge amount of consolidation and globalization in the publishing industry, and it has changed the way the book publishing business operates. There have also been major technological changes. (If you’re interested in reading more about this, please download my free, three-part, special report, The State of the Publishing Industry in the 21st Century.)

Long before Dr. Milevsky’s article came out, I was intuitively calculating my personal beta. As a result of seeing what was happening in the traditional book publishing industry, I shifted my business model a few years ago. I decided to focus more on serving self-publishers and independent publishers instead of trying to keep up with the changes at traditional publishing houses. As a writer who was part of the “mimeo revolution” decades ago in the 1970s, I was more than happy to join the new version of “underground publishing” taking place now.

Before we get to thinking about whether your safety net is high enough, I encourage you to read Dr. Milevsky’s article online. Calculate where you and your career are at. We’ll take it from there in my next post about what’s the best way to spend for a possible financial emergency.

Next time: Part 2 of this series: Spend for an Emergency, Don’t Just Save for an Emergency

Follow Nancy Humphreys on Twitter @brucenomics

Part 2 Calculating your financial safety net

In part one, titled, “Don’t Just Save for an Emergency, Spend for an Emergency,” we covered how to find your personal beta. This is an estimate (a ballpark judgment) of how closely your job is related to what happens in the stock and bond markets (or the economy as a whole).

If you have a high beta (over a beta of 1), your financial well-being is in danger of sliding even faster than a down market. If you have a lower beta (under a beta of 1) your well-being will not be so adversely affected by a downturn. A beta of zero means what happens in the economy won’t affect you at all. A beta of 1 means you are likely to experience the same kind of thing financially that is happening to the stock/bond markets.

You can also follow Dr. Moshe A. Milvesky’s advice and figure out whether you, as a form of human capital in the labor market, are more like a stock or a bond. This little game too can help you begin to think about how much of a financial safety net you need to build for yourself. Once you know how likely you are to be impacted, and how heavily, by a downturn, you can estimate how soon and how much money you’ll need to have for your safety net.

Back to Suze Orman’s advice

Suze Orman suggests we all save a total amount equal to  six months of our typical monthly income to live on during a downturn. In my previous post, I pointed out what this is not a sufficient enough action for many of us to take. Many Americans are just now digging out after as much as two-years of unemployment or underemployment. We need a better way to survive future downturns!

What Dr. Milevsky’s approach to building a safety net got me thinking was: the smart thing to do after you identify your personal beta score, is to create a safety net not just through accumulating savings, but also through purchasing assets — against which you can borrow in an emergency.

With these kind of “renewable” assets you can get money for an emergency, and still hang onto your assets too, i.e., you still own the asset you borrow against. I don’t know what the technical name for such assets is, but I’ll call them “renewable assets.” That term means that after you use up some of the value in these assets by borrowing against them, you still have a valuable asset available for you to use while you rebuild it. This means that later on in your life, you can reuse your assets by borrowing against them again.

Putting your savings into renewable assets over a long period of time will provide you with a real safety net when the crunch comes. All you have to do each time is pay back what you borrowed against each of your assets. In other words, your money isn’t completely “gone, baby gone”. You still have something that’s potentially valuable left in your possession. These assets remain valuable because they are “secured” debt. Secured debt is a derivative. It is a bank (or a credit union) loan derived from an underlying asset that you own.

What kinds of renewable assets are best?

Houses and credit cards have been the assets of choice for most working and middle-class Americans who needed to borrow money for short spells of time. During good times (or what some people are now calling “bubbles”) these assets can be used for entrepreneurial projects to “get ahead” a little and build a safety net.

But these days many people cannot borrow against their houses. And at any time, upturn or downturn, the rates of interest on credit cards are sky high. They is because credit cards are “unsecured” debt, meaning there is no asset behind them that you can sell. High interest rates make credit cards dangerous to borrow against for too long a time.

Assets that are usually smaller, but much better to build a safety net with, are things like a new or newer car and life insurance.

The nice thing about a newish car is that you can use it while you borrow against it. All you need to borrow against your car, is  that the car has enough value (or “equity”) over the amount you still owe on it, that it can serve as collateral for your second loan from the bank or credit union. Life insurance too is still in effect while you borrow against it, working on your behalf, (although at a lower payoff if you were to die).

Because these are secured debts, cars and life insurance often have low rates of interest and looser repayment terms — sometimes with no penalties for late payments. For some of us, life insurance can be a better asset than a car because some life insurance policies pay dividends which you can automatically reinvest to buy even more life insurance on yourself. For others, a car can be a better asset because you may not have anyone to leave money to or because you use the car in order to make an income for yourself. With any asset purchase, the decision has to be based on what is best one for you at the time.

The role of your credit rating in spending for an emergency

When it comes to credit ratings, I’m in total agreement with Suze Orman’s advice. In fact, I’m most grateful for all I’ve learned from Suze about this topic as well as for her helpful financial planning and organizing kits. Even though you can’t sell your credit rating, your credit rating remains one of your best assets. That’s because of how much it saves you when you spend with it.

Even when you are not be able to use your credit rating to get a loan from a bank, you can use your good credit rating to buy reusable assets which you can borrow against when you need to. And the better you credit rating is, the less you’ll pay to buy renewable assets such as a house or a car.

Nurture your credit rating. A high credit rating will often enable you to pay lower interest rates on practically everything you buy or rent.

As soon you get equity in a car (i.e., the car is worth more than the amount of the loan left to be repaid on it) you can usually borrow against that car. Some cars retain their value longer than others after being driven off the lot. So shop carefully.

Think too about buying life insurance. You have to get the right kind of life insurance to be allowed to borrow against it. Ask about borrowing terms and conditions before you buy a policy. Often a local public library will be a great source of information for you when shopping for assets you can borrow against.

Then comes the hard part. Make your payments on time! You need to keep your good credit and accumulate enough equity in your renewable assets to borrow against them the next time you need to.

How to calculate your financial safety net

Here’s what I suggest. Sit down right now and calculate your (1) total savings, (2) your total credit card(s) limit left that you could spend, and (3) the total amount from loans you could take out on any assets you own, such as life insurance, investments, your car, and/or your house. Add up the three totals. Your grand total will show you just how long you can hang on if catastrophe hits.

Bear in mind, that as you run up a credit card or home equity loan, your interest rates will probably be raised and/or the bank or credit card company may lower your credit limit. Also, insuring your assets will cost you a bit more money, but you’ll need to to have kept your assets well-insured so they’ll be there when you have to borrow against them. Lastly, diversify your emergency assets to protect yourself somewhat from loss of of any one of them, i.e., buy different types of assets from different companies.

If you’re uncomfortable with the total amount you come up with, just congratulate yourself on being realistic. Then start figuring out how you can find and afford diverse assets that you can borrow against in an emergency!

What if you don’t have any money at all? You might look around and see if there’s anything in the clutter in your home or office that you can sell in order to start buying assets for an emergency. Also, see if Kim and Robert Kiyosaki’s advice about paying down credit cards in the quickest amount of time possible can work for you. At the very least, even if you are out protesting in the financial districts of the US, create a plan for when you’re able to make and spend a little more money again.

Once you begin spending on assets for an economic emergency, periodically recalculate your financial safety net. Things change. Interest rates go up. Your living expenses may increase or decrease. Your health may be different than it was. Make sure your safety net hasn’t developed holes in it while you haven’t needed to use it.

Building a safety net that won’t be depleted in just a few days or weeks will take time and patience, and you’ll be glad you have that net when you need it!

Follow Nancy Humphreys on Twitter @brucenomics

As Warren Buffett pointed out, the rich are paying more money in taxes because they are richer than the rest of us, but the rich are not paying as high a proportion of their income for taxes. Even their secretaries pay a higher proportional rate of income tax on what they earn than the rich do. Why is that?

Because, as F. Scott Fitzgerald once wrote, “Let me tell you about the very rich. They are different from you and me.”

For one thing, the rich can always move.

Oh, they may not want to, but the fact is they can and do move, if not themselves personally, they move the companies or parts of the companies that they make their money from owning. Workers can only be in one place at a time. Not so investors!

It’s great to be free to invest anywhere in the world. You can make lots of money abroad and never have it be taxed as long as you don’t bring it home. That’s a small price to pay for having the leverage that “owning” all that money gives you for borrowing even more money at home and spending it to own even more assets so you can grow ever richer.

Legal tax evasion via deductions and loopholes

The rich also benefit from incredible tax loopholes where not only do they not pay taxes, they even get money back from the government. Take the gas companies, for example. Or General Electric.

Or take charitable deductions. Why is giving the rich a tax deduction for giving to charity really a function of government? Why should those who can’t afford to give to charity pay taxes to the government so that the government can turn around and give a tax break to those who can afford to give to charity? Does paying taxes for this kind of wealth transfer make sense?

In the name of charity for the poor, tax breaks for charitable donations and non-profit enterprises simply transfer money from the poorest to the wealthiest. These transfers assuage the guilt of those with wealth who give to charity and leave them feeling righteous and superior to others who don’t give.

The rich can afford to hire lobbyists to get them these tax breaks and subsidies from the federal and state governments. The rich can afford high-priced tax advisers too to tell them how to take advantage of those tax breaks and loopholes.

Legal tax evasion by not earning income

Unlike the rest of Americans, the rich have an easy way to get out of paying taxes. All they have to do is work less. Of course, most of the rich don’t do that. They work hard. But they purposefully don’t work hard in order to earn money. Earned income is anathema to the rich.

And there’s no reason why the rich have to earn money from the purposes they pursue. They can afford to choose, as some CEOs have done, to work for a mere $1 annual salary.

And why not? These CEOs get millions in stock options. If they leave the money in the company for over a year and then sell their shares, they’ll pay a much lower proportion of their income in tax than than the people who work for them will pay on the income they’ve earned by working. That’s because the US government taxes profit made on the sale of investments and other assets such as property, held for a year or more, at the the low capital gains tax rate of 15%.

Capital gains taxation essentially sets a flat tax on the money made by the wealthy. The more the rich make by owning assets, the more they get to keep as compared to higher-paid workers who move into higher income tax brackets as they get more earned income for their jobs. Why should we keep the capital gains tax?  It simply transfers money from the working class and the middle class to the rich.

Legal tax evasion by earning portfolio and passive income

Why do those of us who don’t invest or own real property and/or business assets have to pay taxes so that the government can use that money to give a tax beak to those of us who do invest or own other assets?

The low capital gains tax rate on sales of owned assets is said to be an incentive for the rich to not speculate on short-term investments. That’s because short-term investments held less than a year are taxed at the higher ordinary income tax rate. The ordinary income tax rate is the very same tax rate that applies to earned income in the US.

In contrast, income from sale of passive-investment assets, such as businesses or properties, and portfolio income assets, such as stocks, is taxed at a flat rate of 15%. The capital gains tax rate simply provides an incentive for the rich to speculate on long-term investments.

Favorable capital gains tax rate on sales of long-term investments certainly did nothing to keep many of the rich from getting stiffed after they speculated in new-fangled long-term investments in the 2000s.

Nor did it keep our pension funds safe as they too got partially wiped out by investment and land speculation in the last decade. Even foreigners got burned by the politics behind US taxation.

The politics of US taxes

Taxes are a creation of politics. The rich can afford gigantic political donations to candidates and office holders who will campaign and work hard for that money by putting a lid on “excessive budget deficits.”

The rich know such budget deficits will ultimately have to be paid for by themselves. They count on being about to run up high budget deficits while their people are in office doing things on their behalf, such as lowering taxes on the wealthy. Then they turn around and focus on bringing down government spending when the opposition gets in power.

That’s why they pay good money for politicians.

Right now, that objective is very important to them. Why? Because, who knows if the US will ever be able to run up a huge deficit again? And if it can’t? What if high unemployment now has a “structural” cause? What if the US never gets its unemployment rate down below 10% again? What if poverty in the US just gets worse and worse?

Well, as I said at the beginning, the rich can always move wherever they want. And wherever they live, they can and always will invest in companies that take advantage of a much cheaper labor market in the US. What’s good for GM will just have to do for the rest of US!

For a discussion of taxation of the rich in Europe as well as America, see  John Plender, “Underestimate the revolting rich at your peril” Financial Times,  Sept. 10-11, 2011, p 7.

Follow Nancy Humphreys on Twitter @brucenomics

Last week, the Commission on Wartime Contracting released a report to Congress about military contractors. The report, cited by California senator, Dianne Feinstein, in a hearing about it, alleges military contractors cost the taxpayers of this country 30 to 60 billion dollars. As mentioned in the Commission’s four bullet points in its 8-page abstract of the report, “CWC-NR-49,” that money disappeared through waste and fraud:

• Pegs waste, fraud in Iraq, Afghanistan at >$30 billion
• Sees threat of more waste in unsustainable projects
• Faults both government officials and contractors
• Offers 15 recommendations for contracting reform

Contractors were ostensibly hired because the US military was not ready to fight the wars in Iraq and Afghanistan that President George W. Bush led us into. About half of the “military” forces fighting for the Americans  in those wars have been foreign mercenaries. Talk about outsourcing American jobs! With taxpayer funding, no less!

While the  IRS is busy going after domestic employers who evade their tax responsibilities by hiring independent contractors in place of employees, no government agency appeared to be going after our federal and state governments for doing exactly the same thing! In the name of “national security” for a war based on a lie, the federal government was allowed, often without even requiring competitive bidding,  to hire fake “employees”, and turned its head while they defrauded taxpayers out of billions of dollars. And it won’t stop. Senator Feinstein complained that a 2009 agreement with the Defense Department to cut the number of independent contractors used by 5% a year wasn’t being honored.

This is not just a federal government problem. State governments also have been hiring contractors to do the same jobs that state employees do, but with more expensive results for those of us who rely on our local governments to protect American citizens. And there are those in power in some our states who would like to use our taxpayer monies to hire nothing but private contractors! Before going along with that idea, take a look at the abstract of the Commission’s report from August 31, 2011 and the following article I posted about independent contractors in government a little over two years ago on Brucenomics.

Independent Contractors: This Gun’s For Hire

August 2nd, 2009 | Government

Recently an acquaintance of mine at a California state agency complained about independent contractors at his workplace.

“They come in when they please, sit around, don’t do anything, and I get stuck with all the work. AND they’re falsifying their results to look bad when in fact things aren’t that bad. They’re getting federal monies they shouldn’t so they can keep getting their fat salaries. Oh, did I mention they make a lot more than I do even though I’ve been there for years. What do you think Nan, should I blow the whistle?”

I pointed out to my acquaintance that in spite of so-called protections, most whistleblowers get fired, and if they appeal, they wind up losing. But I missed the real reason why he should be wary of complaining.

Traditionally, independent contractors were white-collar women and blue-collar men hired by private employment agencies such as Manpower or Kelly Girls rather than state employment agencies. These “temps” were hired on a short-term basis to fill-in for regular staff at other companies. Companies paid a lot for these “temporary employees,” but the temps earned below market rates and received no benefits.

With the rise of “Silicon Valley” type companies this changed. These companies needed technical specialists, innovators, and management experts. The independent contractor of the 1990s was often a computer or scientific research consultant with special expertise. These experts weren’t temporary replacements for existing workers. They were brought into a company to solve problems the regular managers and employees of the company couldn’t. Some were even brought in to “reorganize” companies, i.e., layoff employees.

The jig was up at the end of the last century after Microsoft Corporation created “dummy employment agencies” and hired droves of “independent contractors” in lieu of computer-savvy employees at its headquarters in the state of Washington. This put Microsoft in violation of federal employment laws that protected employees. After that, the IRS cracked down hard on private employers who hired independent contractors as a way to avoid paying employee benefits.

During the Bush administration of the past eight years, the use of independent contractors by government agencies escalated dramatically. Often these independent contractors were retired workers on pensions, and the government had the same motives as Microsoft—to save money on salaries by not having to pay worker benefits. In other cases, outsourcing of government jobs was seen as an effective way to bring innovation into the bureaucratic government workplace. More than that, many politicians assumed uncritically that any effort to replace civil servants with private labor would be beneficial. Even your mail deliverer could now be an independent contractor.

Recent scandals at the federal government level have created some doubts about this practice. First, it was revealed that contract workers in Washington, DC had released private records of celebrities and politicians. But the government could not discipline these workers. They could only be fired after the fact. Doubts arose too in cases where private soldiers, not punishable under military law, were accused of killing civilians in foreign countries.

But the biggest issue for everyone, regardless of political philosophy, is why some of these “private civil servants” are being paid more than their government counterparts. How is this reducing the size of government bureaucracy or government costs? And when charges of indiscriminate killing or unethical research falsification are raised, doesn’t it make you wonder what is going on?

My acquaintance went awry when he assumed independent contractors were additional help brought in by his state agency to do the same job as he was at a higher salary. Clearly the “hired guns” were given a different mandate by his managers than he was. Those temporary contract scientists were probably hired because they were willing to “bend their statistics” so the government agency they were at could get more funding. Civil servants with scientific credentials couldn’t have been persuaded to do that at any price.

Highly paid independent contractors are paid more because they have some form of “expertise” that an agency or organization believes its own managers cannot or will not provide. Because of their special talents they have to be compensated for their special abilities at a higher level of salary, and they get additional perks, such as the right to come to work whenever they feel like it.

The main problem with independent contractors is that they allow management to bring in personnel to easily circumvent the publicly accepted goals and rules of an agency or organization for some particular individual or group’s private benefit. This can result in a tremendous, and even dangerous, waste of resources. We all, as taxpayers and donors to charitable organizations, deserve better when we pool our resources so that our government and nonprofit agencies can bring about some kind of “public good.”

And as far as my friend’s dilemma goes, unless he goes to the news media, whistle blowing will rarely be effective while higher management is involved and covering up.

Copyright © 2009 Nancy K. Humphreys

Follow Nancy Humphreys on Twitter @brucenomics

Several years ago I cam across a book by a Harvard Medical School psychologist, Martha Stout, called The Sociopath Next Door. This book really opened my eyes.

I’ve been fascinated by psychopaths (now called “sociopaths”) ever since I met one of them when I was in my twenties. He was the kind you read about and see in the movies.

He was a short, balding guy around thirty who owned a tobacco-store near the University of Pennsylvania in Philadelphia. He lured lonely students into his back room, drugged them, and then dumped chests full of their chopped-up bodies into the Schuylkill River.

When I went in his store late one night to buy something, he tried to befriend me. The instant he parted the bead curtain over his back room and came out to serve me, I was terrified of an unseen evil I sensed but couldn’t understand. I fled after buying what I came for, running in panic, and I never went back. The police arrested him two months later.

Like you, I’d grown up learning from Hollywood movies like Alfred Hitchcock’s Psycho and Frenzy and Peter Sellers’ portrayal of Dr. Strangelove that psychopaths were crazed killers. But, as Dr. Stout says, that is rarely the case.

According to Stout, sociopaths are not “crazy”. Psychologists classify them as people who have a “anti-social personality disorder”. (See the Psychodynamic Diagnostic Manual, PCA103.) One out of every 25 people is a sociopath. A sociopath could be your coworker, a member of your church or club, or even your neighbor next door.

The Sociopath Next Door

And indeed, I met one of those later on in my life. A neighbor of mine quite knowingly destroyed my home and damaged others nearby. Like most of my neighbors, I was stunned by this man’s power-tripping, obstructiveness, and gratuitous acts of meanness towards anyone who wasn’t in his little circle of minions willing to support the irresponsible things he did.

He and his cohorts seemed fixated in getting into my home. They used legal, and, I believe, illegal means, e.g., breaking my front door look, to do that. When he did go into my home, ostensibly to have a crew fix it, he saw that they tore apart and destroyed nearly every single thing in it, right down to each and every lightbulb.

At one point in my battle to to save my home from this man’s glee in its destruction, he and I encountered each other outside the building. It was midday. No one else in the neighborhood was around. He came around the side of my house. He stopped short when he saw me.

I was just getting in my car across the street from him. I stopped too when I saw him. The look on his face was chilling. He clearly wanted to kill me.

I stood my ground and gave him a look back. My look said, No, you will not kill me.”

After what seemed like several minutes, I won the battle. He turned and skulked back the way he came. Shaking, I got in my car and sat until my heart stopped racing. Still, it didn’t occur to me that I’d been in a contest with a sociopath until years later I read Stout’s descriptions of the sociopath’s odd eyes and their “stare”.

Behavioral economics

When I was in graduate school in economics at the University of Wisconsin, behavioral economics was just beginning, mainly in the field of microeconomics, the study of companies and households.

My advisor at the time, Dr. Martin David, was writing a book on how young newlywed couples choose new furniture. That kind of microeconomic research was cutting edge back then when economists believed in the theory of rational choice-making. I doubt that even now, years later, economists are yet studying the impact of irrational choice-making by sociopaths on the American economy.

Stout’s view of sociopaths, after years of counseling their victims, is this. Very few sociopaths are killers – or even convicted criminals. They are simply people who feel no empathy with others. They are people who have no “conscience” and feel no remorse.

After I read Stout’s book, I started thinking maybe some of those responsible for the doings on Wall Street before the financial crisis of 2008 were sociopaths. Stout even included a case study in her book about a very successful sociopathic financial wizard. Since then, I’ve seen scattered references to this idea, originally in regard to the character, “Gordon Gekko,” played by Michael Douglas, in the movie Wall Street: Money Never Sleeps.

Just recently the Financial Times; Wealth section carried a commentary that explored this idea. Published in Summer 2011, the essay by FT’s investment editor, James MacKintosh, was titled, “Hitchcock’s ‘ The Bankers’”. In it MacIntosh mentions two professors of psychology, Robert Hare and Paul Babiak, who began studying psychopaths in the workplace back in the days after the dotcom bust.

If economists ever do open themselves to the idea that some people are sociopaths, these professors will need to make huge changes in the way they study economic choice behavior. Sociopaths are very different from the rest of us when it comes to making choices. In the end, their choices often get them into trouble at work or in regard to their families.

Here is the passage from Stout’s book that resonated most with me about the one I met who destroyed so much property where I once lived.

“And yet when such a person is around us in our lives, even on a daily basis, we are often oblivious to [his or] her activities. We do not expect to see a person direct a dangerous, vicious vendetta against someone who in most cases has done nothing to hurt or offend [him or] her. We do not expect it, and so we do not see it, even when it happens to someone we know—or to us personally. The actions taken by the…sociopath are often so outlandish, and so gratuitously mean, that we refuse to believe they were intentional, or even that they happened at all.” (p. 77)

The most telling comment from the “sociopath next door” that I met came when he had clearly succeeded in frustrating yet another homeowner at one of our neighborhood meetings. He said archly, “Oh, I understand your position. You just don’t get mine.”

Indeed we didn’t. This too is what Stout points out. Sociopaths study us in order to figure out how to pass as one of us in order to have their way with us. All the while they do this, we don’t even realize that we know a sociopath. We have no clue why they do what they do, and we are often at a loss for any explanation at all for their inconceivable anti-social behaviors.

Sociopaths in the House

It is the passage from Stout’s book I quoted above that I go back to in my mind when I watch on TV what is happening in Washington DC right now.

I understand the principles of the Republican party. In the past, I’ve supported some of them. But what I also see is that a few of the players, both nationally and in some states, are displaying the same kind of lack of empathy and conscience my sociopathic neighbor exhibited. I see leaders who are rigid, but not out of conviction or principle. Instead, they contradict things they themselves previously stood for in order to take advantage of each new opportunity to thwart the victims of their hostility.

I suspect those whom Stout calls “covetous” sociopaths have gotten themselves into politics as well as other workplaces. They’ve done this by using the guise of a conservative, libertarian agenda but for their own twisted purposes. From the strikingly unusual amount of consensus within the Republican party, I suspect a handful of sociopaths are coercing, charming, and/or manipulating loyal, traditional, Republicans to go along with their hidden agendas no matter what the cost to their party.

If smart sociopaths are indeed in control of our country’s House, I can guarantee the economic damage they do will be something that frustrated economists will be grappling with for the rest of this century.

Sociopaths are masters at manipulating and bullying weaker people to get them to do both petty and outrageously cruel things to others. Sociopath’s rewards are not just the “economic” rewards most of us seek; their biggest reward is the adrenaline-filled high and pleasure that come from deceiving, one-upping, and “gaslighting,” other people.(Stout, pp. 94-98)

When I see my country happily going after “madmen” elsewhere, i.e., sociopathic dictators in the Middle East, a kind of “cognitive dissonance” makes me uneasy. It seems the ultimate irony that the US thinks it is helping to cleanse the world of those same kinds of self-serving, irresponsible risk-taking, lying, bullying, and sometimes very charming and callous manipulators whom psychologists label sociopaths.

Because right now, the same types of men (and women) appear to be right here. They can be found all across the US, at the state and federal levels, running for office and doing their best to ruin our own democratic government.

Follow Nancy Humphreys on Twitter @brucenomics 

The mere suggestion of a tax on the wealthy was one of the factors that caused last week’s dire slump in global markets. But this suggestion wasn’t made in the USA and it had nothing to do with earned income. (“EU Tobin tax” Financial Times Lex column 8/18/11 p10.)

Much as I appreciate Warren Buffet’s offer, as one of the wealthiest Americans, to pay a higher rate of  income tax, I can’t help but suspect that the wealthy are not eager to have us look at the other types of taxes they pay or don’t pay; taxes they could be asked to pay, i.e., the capital gains tax or the Tobin tax.

The capital gains tax rewards long-term (over a year) investors for saving and earning money. Money invested for the long-term earns the investor income (called “portfolio income”). This portfolio income is taxed at a rate that is about equal to the second lowest of the six income tax brackets in the US. The capital gains tax favors those who make their money long-term by buying (and selling) capital over those who earn their money by selling their own labor and those who make money by hiring workers in their small businesses.

The Tobin tax is the opposite of a capital gains tax. It is a transaction tax, i.e., a sales tax, on the financial transactions of investors. Money invested, including money invested repeatedly for the short-term is taxed at a minuscule percentage (such as .005 to .05 of a percent) every time a financial transaction (i.e., the buying and selling of investments) takes place. The Tobin tax obviously promotes the spending of money for hiring labor or buying property rather spending that cash solely on financial investments.

According to Representative Peter DeFazio who sponsored a 2009 bill to implement a Tobin tax in the US, the country previously instituted an even larger Tobin-type tax after the Great Depression, and this tax lasted with no ill-effects until the 1960s. The US Tobin tax was levied in order to dampen the type of financial speculation that led to the Wall Street crash in 1929.

However, it was a mere suggestion of a global Tobin tax in talks between France and Germany last week that sent European financial markets into a panic this week. “Deutsche Börse and the London Stock Exchange were down by 5 and 3 percent respectively.” (“EU Tobin tax,” Financial Times Lex column, 8/18/100 p10)

The history of the Tobin Tax

The Wall Street Journal in its article, “Lawmakers Weigh a Wall Street Tax,” reported at the end of 2009 that “Lawmakers are considering a financial-transactions tax that takes aim at Wall Street to help Main Street.” “But,” objected the article, “the tax could wind up striking others, too, including pension funds, commodity-dependent business, and even ordinary investors.”

Reporting on the same topic at the same time, the Financial Times said, “US lawmakers working on ways to pay for legislation to reduce unemployment are considering taxes on [investment] banks as a way to raise revenues.” Mr. Geithner, head of the US Federal Reserve, however was opposed to such a tax. Nancy Pelosi, speaker of the House, wanted the tax on the table, but said it must be a global tax. (“US lawmakers consider taxing banks to tackle unemployment” Tom Braithwaite, FT, 11/20/09 p 7.)

This is the sticking point about a Tobin Tax. Capital is a global phenomenon. So is investment banking. Wealthy investors can afford to take their money elsewhere if one nation, acting alone, imposes a Tobin tax. Gordon Brown prime minister of  Britain jumped on the global Tobin tax bandwagon and floated the Tobin tax idea at the meeting of G20 in 2009. The Financial Times wrote that Brown got a hostile response from the finance ministers from other countries who belong to G20. Discussion at this point shifted to the bank capital reserves that are now the popular solution for most governments in advanced economies to address the problem of “too big to fail.” (“Focus shifts on options for regulation” Beattie and Masters, FT 11/10/09 p2)

At the time Brown tossed the Tobin tax on the table, there were those who wanted to use proceeds from a .005 percent Tobin tax to foster economic development in the world through foreign aid programs to eradicate poverty. But the Tobin tax itself, does not include notions of how the funds collected will be used. The Tobin tax was originally created by a nobel laureate economist named James Tobin in 1972. Tobin suggested his tax as be used as a forex (foreign exchange) transaction tax to stop global currency speculation.

In the summer of 2009, along with US bankers protesting the idea of the tax in the US, the British Bank’s Association opposed Lord Turner’s proposal for a Tobin tax in Britain. Germany’s BDB banking association reportedly said at that time,  “it was ‘unrealistic’ to think that a Tobin tax could be applied in practice to ‘undesirable’ speculative capital movements.” German businesses considered this idea to be an extreme leftist view. One European bank official said, “Global taxes don’t happen.” (“Business hostile to ‘Tobin tax’ proposal, Jenkins et al, Financial Times 8/28/09 p 3)

Flash forward two years and we see Nicolas Sarkozy, the French President suggesting a Tobin Tax to Angela Merkel, the German chancellor this week. However, a study by The Austrian Institute of Economic Research estimated a .05 percent Tobin tax could provide Europe with Euro 215 billion dollars annually, certainly a start towards addressing the sovereign debt crises in the EU.

The Financial Times Lex column op ed on the EU Tobin tax last week concluded that the risks for Europe would come from “geographical arbitrage” if every part of Europe didn’t sign on to collecting the Tobin tax, a dampening of non-speculative risk-taking (non-speculative risk-taking was not defined by the article), and a possible further consolidation of the banking industry.

In my opinion, the latter “unintended consequence” is a current trend already, and it appears to be taking place without any need for help from a Tobin tax! In fact, a Tobin tax might help the banking industry by making it focus more on lending rather than investing.

Contrary opinions about the Tobin tax

Back in September of 2009, Willem Buiter, a professor at the London School of Economics argued against the Tobin tax, saying that instead, the unsecured creditors of institutions too big to fail should pay the price if they fail.  Professor Buiter was concerned about the “moral hazard” involved with the government removing the risk from risky investments of the private sector. This idea doesn’t seem very popular today. In hindsight most people believe the American financial system would have toppled without government intervention in 2008. (“Forget the Tobin tax: there is a better way to curb finance” Willem Buiter, Financial Times 9/2/09 p9)

Writing about the Tobin tax a few months later in December of 2009 Professsor Luigi Zingales said the European Union had urged the IMF (International Monetary Fund) to consider the Tobin tax on financial transactions. Zingales, a professor at the University of Chicago Booth Business School, urged instead that the Tobin tax be targeted specifically toward short-term trading, especially trading that is based on borrowing. He is not the first or only one who has urged that mutual funds and other ordinary long-term investments be exempt from a Tobin tax.

Professor Zingales argued that while individual short-term traders can get out of the market quickly in the case of a crisis, all short-term traders cannot exit the market at once. Hence, the need to discourage short-term traders who bet on the margin with highly-leveraged borrowed funds or pension funds that gamble with other people’s money. But short-term trading on the margin has been fostered for quite awhile by the Fed’s low interest rates on borrowing over the past few years. In particular, Zingales wanted the US to take aim at financial institutions who are engaging in short-term trading. (“A tax on short-term debt would stablise the system.” Luigi Zingales, Financial Times 12/16/09 p 13)

Pros of a targeted Tobin tax

Looked at in another light, Mitt Romney’s remark that corporations are people isn’t quite as utterly ridiculous as it sounded to his audience last week. Corporations offer the ability to “pass through” their expenses as well as earnings. A sales tax on the transactions of any corporate entity offering investments means that as long as the market permits, the cost of a Tobin tax would be “passed on” to the buyer of the investment. In the case of the exotic investments that froze up in 2008, the buyers are corporations, institutions that invest, and/or wealthy individuals. This is why a Tobin tax can be thought to dampen the particular kind of financial market speculation we all worry about happening again.

In essence a Tobin tax is a sales tax that is levied mainly on the rich. It impacts individuals and corporations who can better afford to pay a minuscule tax of .005 to .05 of a percent than can the unemployed and workers who now pay as much as 10% sales tax on any goods they purchase. Without these basic goods workers could not enable themselves to go on offering their labor skills and knowledge for sale.

When those who earn a living by employment and self-employment are paying almost the same amount, or even more, for sales taxes as they are for income taxes, the fruit doesn’t have much juice left in it to squeeze out. That’s why an speedy economic recovery without the participation of everyone involved right now seems a dubious prospect.

Given the huge amounts of money that global corporations are gaining, paying proportionately little actual tax on, and hanging onto out of fear of another Great Depression; while the ordinary worker is steadily losing ground in terms of employment, wages, and benefits; a Tobin tax, however unlikely, still seems like a proposal well worth putting back on the global table right now.

Follow Nancy Humphreys on Twitter @brucenomics

My last book review for The Library Journal was about the original edition of Bruce R. Barlett’s Reaganomics: Supply Side Economics in Action, with introduction by Jack Kemp, published in 1981. Library Journal reviews are specifically written by librarians for librarians, so they are exceedingly economical -  they run 25 lines or less of a narrow column. Normally the editors of LJ didn’t change my reviews, but this editor did. She took my assessment that Mr. Bartlett was an was “articulate” spokesman for his group’s views. She turned that into a notion that Mr. Bartlett’s presentation about supply-side economics were “accurate”.

As soon as I saw her mistake I contacted her. We debated the issue. “Articulate,” I said meant “well-said”, but not necessarily “correct”. She insisted that “logical” equalled “right.”  With no promise that my meaning wouldn’t be edited again in the future, I resigned as reviewer.

I respected Jack Kemp and Bruce Bartlett, but I sure didn’t agree with their views. And now I’m dismayed to see how their views are being even rendered into something even more “wrong” for the US. Here is why the US Government is at an economic impasse.

Keynesian (demand-side) economics

Supply side economics was the 1980s alternative to liberal Keynesian economics. Keynesian theory was  born during the Great Depression of the 1930s. Lord Keynes, a British economist, suggested a government should spend the country’s way out of trouble when its economy slumps badly. This is basically what’s called “demand-side” theory of economic recovery.

Keynesian economics believes a slump in demand for goods and services from consumers is what is causes our unemployment and debt problems. Low demand for consumer goods means loss of jobs which means even lower demand for consumer goods. It’s a downward spiral. To stop the spiral, Keynesians rely on low interest rates and government spending to jump-start a stagnant economy.

Their opponents at this point in time argue that our government has kept interest rates low, and it has spent money (the “stimulus”), but the economy hasn’t been jump-started. It’s a fact that right now that US companies are sitting on trillions of dollars at home and abroad that they are not spending on production and job creation. But what, other than just plain use of force by the US government, will motivate corporations to spend that money on the American economy? Does supply-side economics have an answer?

Supply side economics

Supply-side theory, a term coined in the mid-1960s by Herbert Stein, advisor to President Nixon, and  later promoted by a Wall Street Journal editor and a couple of economists named Arthur Laffer and Bruce Bartlett, was adopted by Ronald Reagan during his presidency in the 1980s. Supply-side economics was also referred to as “trickle-down” economics.

While Keynesian economics as a long-run strategy or a short-run strategy for all seasons can certainly be questioned, supply-side economics clearly didn’t work at all. the Reagan government in the 1980s began a precipitous march into more and more US government debt to fund the wealthy, but that wealth never trickled down or created prosperity. In more recent times, not only did the Obama stimulus not work well, but the Bush II tax-breaks didn’t work at all! We extended those tax-breaks for the wealthy and the middle classes, and nothing improved. Things have just gotten worse since Bush II left us with a mess.

It seems really iffy that either a huge new government spending-spree or any more tax-subsidies for the wealthy are going to do much of anything to jump-start our economy. We’re stuck while the US government goes in circles like a rowboat trying to get someplace with two paddles that are fighting each other.

Many liberals thought that supply-side economics had died along with Ronald Reagan. Even George H.W. Bush called it “voodoo” economics. But…Here we go again…! One side of the debate in DC is now advocating supply-side economics with their calls for “job-creators” to be given even more tax breaks subsidies while the working classes do without even more, even though working class (middle class) income has declined steadily for the past four decades.

What is the reasoning behind supply-side thinking? Here’s one pundit’s comment that puts it in a nutshell. “The Supply-Sider’s Hoax: Bush-I called it voodoo economics (but he got stuck with it). Their “theory” is that cutting taxes for the super rich will encourage them to work so much harder and make so much more money that they will pay more taxes, even though their tax rate went down. Well the voodoo didn’t work in 20 out of 20 years. And now they want to try it again. And they’ve scared America again about the debt. It’s easier now that they’ve run it through the roof.”

Even Bruce R. Bartlett does not see the present-day supply-side argument as tenable. He wrote in a New York Times op ed piece April 4, 2007, “Today, supply-side economics has become associated with an obsession for cutting taxes under any and all circumstances.”

Trickle-down economics

Where did the trickle-down idea associated with supply-side economics come from?  It came from the belief that as the rich got richer (and paid in a higher percentage of aggregate or total taxes) some of their wealth would trickle down to the workers who were hired with that tax money.  So tell me, is that what’s happening now? Did the Bush tax cuts for the rich create more jobs during the 8 years of his presidency? Have taxes on the exploding new wealth of the rich gone to hire more American workers? You know the answer to that.

These tax break revenues have been going straight back into the pockets of the job creators, not the workers. Meanwhile unemployment has skyrocketed to nearly 10 percent. Corporations are sitting on trillions of dollars in cash. They aren’t spending it on jobs, at least not on American jobs.

What we have now is supply-side economics with no trickle-down allowed. Yes, the percentage the rich pay of total taxes has increased. And no, the government sure isn’t going to be allowed to spend that money to increase jobs for Americans given the current Republican quest to pare down the size of government. But nor are corporations likely to do so either.

Gush-away economics

I suggest the present form of economics should be called “gush away” economics. Gush-away is where the US bleeds out more and more money to foreigners each year, the foreigners who hold a claim to its debt, the foreigners who are getting American jobs.

There are all kinds of scary figures floating around right now. Speakers constantly confuse the debt and the deficit as the same thing, and they throw around a lot of different big numbers with no explanation of what they mean.

Those of us who don’t deal in trillions, billions, or even millions of dollars have no idea how to interpret these figures or guess what the changes in them over time might actually mean. We are just left feeling afraid and disbelieving at the same time. No wonder! Any way we look at it, we foresee only loss in our futures.

I don’t believe the US is in as much trouble as the fear mongers would claim. But how far down the slope of gush-away economics do we have to slide before someone comes up with an economic theory based on aiming for a balanced growth and fair-share taxation, rather than the binge (Keynesian) or purge (supply-side) mentality of our two competing traditional theories about economic recovery?

I just have to wonder, where is the wise economist who can make us a sail for our “rowboat,” before both of its “paddles” manage to smash each other and our boat to smithereens.

Follow Nancy Humphreys on Twitter @brucenomics

“These jobs are goin’ boys and they ain’t comin’ back” (Bruce Springsteen, “My Hometown”)

Where have all the jobs gone?

At a picnic recently, someone asked why all the wars the US is in aren’t creating jobs like they did during World War II.

“Hey! Why go back to World War II?” asked someone else, “Every job I held as an adult in my 20s was connected in some way to the Vietnam war.”

Why, we all wondered, aren’t the wars we are in now creating more jobs?

Well, maybe these wars are creating jobs. But here’s the thing – a body that creates 100 new cells every time it loses 1,000 cells is not going to look as good it did as time goes by. Here’s an example of what I’m tailing about.

A message from my bank

Recently I received an email from HSBC, the British bank, announcing closures of US branches in New York.

Being in California, I didn’t pay much attention. But a couple days later, on August 2, 2011, an item on the front page of the London Financial Times caught my eye:

Hiring and Firing

HSBC is planning to hire up to 15,000 people in fast-growing Asian and Latin American markets in the next three years while culling jobs elsewhere. Stuart Gulliver, chief executive, confirmed plans to cut up to 30,000 jobs by 2013, amid stronger-than-expected first-half results. Mr. Gulliver plans to strip up to $3.5bn from the bank’s cost base by 2013.

WOW! That word “elsewhere” in the phrase “culling jobs” above sure doesn’t tell the whole story does it! But HSBC’s email to this “valued customer” tells part of the story:

Subject: HSBC Announces Sale of Upstate New York Retail Branch Network

As you may be aware HSBC Bank USA N.A. (HSBC) has been undergoing a review of the markets in which we operate globally to reposition our businesses around our vision to become the leading international bank. Consistent with HSBC’s global strategy, HSBC Bank USA has been conducting an analysis of its retail branch network to align the size and locations of our U.S. branches with those markets with strong international connectivity.

I am writing to you today to let you know that HSBC has reached an agreement to sell all retail branches in Upstate New York along with 4 branches in Westchester County and 2 branches in Putnam County New York, and 6 branches in Connecticut to First Niagara Group, Inc., subject to regulatory approval. Please click here for a list of impacted branches.

In addition, and also subject to regulatory approval, we will be consolidating approximately 13 branches in Connecticut and New Jersey into nearby branches…

If you would like further details on this announcement, please visit our website www.us.hsbc.com.

I take this opportunity to thank you for your ongoing business and loyalty, and look forward to continuing to meet your financial needs.

Sincerely,

Kevin Martin
Senior Executive Vice President
Head of Retail Banking and Wealth Management
HSBC Bank USA N.A.

All of our hometowns are goin’ boys

When Bruce Springsteen released “My Hometown” in 1984, he was singing about the loss of jobs from the northern states to the southern states in the United States. Don’t we all wish that were still the case!!!

You can see where our jobs going now, right? Why can’t our politicians in Washington?

Follow Nancy Humphreys on Twitter @brucenomics

Where is the discussion of risk in the current debt ceiling debates? Why isn’t anyone talking about the risks of the deficit reduction proposals being put on the table?

Only today, two days before the deadline, did I clearly hear one side talking about risk. That was progressive economist Paul Krugman on the This Week show. Krugman, clearly in despair, finally predicted “a lost decade” worse than Japan’s  for the United States if any cuts were made without revenue increases. Clive Crook too, considers that “America flirts with a fate like Japan’s” (Financial Times, June 20, 2011) and expounds on Krugman and Eggertsson’s theory of the “paradox of toil” where if everyone tries to save, aggregate (total) savings actually decline.

Is the choice either cuts or revenue (tax) increases? Personally I detest either/or thinking. It always gets me into trouble, and I think it is getting our economy into trouble right now too.

The privileges of inheritance

It’s so easy for some people I’ve met to say they’ve risked all for what they got from life. These are usually people who started out with an inheritance of some kind. In my book they (and myself)  have not risked as much as other Americans to get where they are.

By inheritance, I mean not just money, but skills. Look at Donald Trump, for example. Mr. Trump’s father was a developer in the New York City area. Donald can certainly be proud of how much further he has taken his real estate development business in New York. But how many of us had a father (or mother) who gave us precisely the skills we needed to get ahead of them?

By inheritance I also mean the social structures that support us – the “entitlements” that our parents, our governments (state, local and federal), or our employers paid for, some of which we will be expected to pay for when we are older. That includes the promise of social security for old age, student loans and grants, unemployment compensation, worker’s comp, subsidized downpayment and mortage tax breaks for homeowners, medicare, medicaid, and many other entitlements.

In fact, even being an American is a kind of inheritance in a world where the vast majority of people are far poorer than any of us are.

Weighing risk vs. reward

When we make a decision to go into debt, we all weigh the risk vs. the reward. The risk level of a decision is actually the most important element of the decision, not the debt level of a decision. When we make a decision to go into more debt than ever before, it leads to huge anxiety, usually the middle-of-the-night kind! We may wish we hadn’t ever made the decision that got us to this level of debt.

That is exactly why there has to be an understanding (and discussion!) about the risks involved before making a decision to go into debt, or indeed even to get near to the point of going into debt.

So here’s how that process works. If you have an inheritance of some kind: money, skills, and/or social support, you are more willing to assume risk. You will assume risk even though you may not fully understand the consequences, e.g., you later realize that the student debt you incurred for college won’t be able to be paid back before you’re a grandparent!

On the other hand, if you don’t have an inheritance, the risk required goes way, way up, but you may feel you have to take it. At the poorest levels of our society, the choices are few. The drug trade and the military are two of those choices. Both can be extremely dangerous.

Those with no inheritance who want to get ahead literally put their lives on the line in order to get the skills the military promises, skills that those with an inheritance do not have to risk their lives for. As a certain singer from the working class put it, “You want it, you take it, you pay the price.”

Either/or choices

It is a privilege of the wealthy and the middle class that we don’t often have to make either/or choices. We have alternatives. That is what is so troubling about the debt ceiling debates. There is an either/or atmosphere around the issue of money that is not common to those who are, or have been at one time at least, better off. That in itself leads to a huge feeling of crisis.

We’re in crisis. How did we get here? We got here because Congress, the House of Representatives in particular, and the previous two administrations in the White House, went deeply into debt. The very same entity that got us into this debt, the House, is now the one freaking out. Congress realizes the consequences of its actions and is obviously feeling a huge anxiety.  As a result, we have a government that is being driven into reflexive withdrawal due to fear of consequences for its own actions.

Anxiety about debt isn’t wrong, but making decisions based on anxiety is. Decisions involving risk should be made ahead of time with a clear understanding about what the probable consequences are. It isn’t how we spend money or how much money we spend that matters, it is where we are going.

For example, during an expanding economy a person with an inheritance (savings and/or good credit) might decide to quit a dead-end job, buy a house with the intention of turning it into a rental after fixing it up, and go into debt for their own living expenses.

There is risk involved, and the person must be willing to accept that. If they don’t get renters, they will have to get a job and spend years paying back the debt. A person without an inheritance knows they might lose their life if they fail. Soldiers and sailors do know that, and they do take the responsibility for that risk when they enlist.

This is why investors, entrepreneurs, workers, and business owners alike all know what politicians don’t seem to be aware of. There is always risk involved when you go for rewards. There is no such thing as rewards without risk; at least some risk has to be borne to get what you want.

The Congress of 2000 to 2008 and President Bush do not seem to have ever taken into account the risk of the massive spending they did. The Congress of 2008 to 2010 and President Obama acknowledged that the spending they did involved risks, but they have never come out and said, as Mr. Krugman has consistently done, that it would not solve the problem they were facing. And now we have panic.

Questions about risk that aren’t being asked

We, the American people, are being asked to sit by while scared and defiant politicians refuse to discuss with each other or us the exact nature of the risk that is being taken in our names. And there are risks, huge risks. We have a right to know those risks and get some answers about how to minimize them.

How exactly will our children be “protected” if our and their entitlements are taken away? How will they take care of themselves without any inheritance? How will poor Americans be protected if we keep on spending massive amounts for wars that are their children’s only real alternative for getting out of debt in the long run? How will children of wealthy Americans keep prospering if other Americans are out of work and not buying anything?

And my biggest question listening to all this is -  how will making cuts that are equal to every revenue increase get us anywhere? Isn’t that just like driving with the gas and the brake on at the same time? Cut, cut cut is the voice of fear. Cut cut cut is the voice of those who didn’t think before they took the leap and spent too much without considering the risk.

I don’t live my life that way, and I resent being expected to clean up the mess of those who do! There’s a time to save, and there’s a time to spend. Wise people figure out the difference and when they fail, take responsibility for taking on debt.

The false distinction between private and public debt

I personally vote that the richest country in the world takes a further risk of spending more right now in order to put Americans back to work for the short-run. I’ll pay the higher taxes if we fail, because that will most certainly be the consequence.

But in return for taking that risk, I want the assurance that my government officials will start talking calmly about how to shift resources in this country to making more money for all of us.

Taxes are not the only form of revenues! GDP goes up because a country as a whole begins earning more than it’s spending. GDP (gross domestic product)  goes up when debt is incurred for things that ultimately bring us rewards. (And what exactly are the “rewards” from any of the wars we’ve begun?)

As liberal British economist Martin Wolf pointed out recently – the line between public and private spending is a thin one. Said Wolf n his article “The eurozone after Strauss-Kahn” (Financial Times May 17, 2011): “Indeed, we now know that the distinction between private deficits and debt and public deficits and debt is far less absolute than the fiscal priesthood understands: private debt becomes public debt and private deficits become public deficits very swiftly.

Thanks to the financial crisis of 2008, private debt has been shifted onto the shoulders of the government. It has become public debt. Now, the public is being asked to pay for what the private sector did.

I don’t want to penalize the private sector or the public sector – as a small business person, I’m a part of both sectors. I know too that we all make mistakes; but I do want the private sector and its advocates in the public sector to begin to take some responsibility for what is happening in the public sector. Maybe if anything good comes out of the debt ceiling crisis it will finally be the recognition by Wall Street and Washington that neither can eat its cake and have it too – at least not for much longer!

Scenario One

A man named George comes home from work one night. He’s tired. All he wants to do is slip into something more comfortable and sit in front of the TV watching the news for awhile. George’s spouse, however is upset. The spouse has just read that you shouldn’t spend more than a third of your credit limit for your credit card. George’s credit card is at 40% of its limit.

The spouse insists that George take his card, put it in a plastic bag with water and store it in the freezer. George objects. He points out that they really need a few things around the house. He wonders how they’ll pay for the party they have scheduled for next week for their youngest child. The two argue. They argue on into the night.

The spouse, who has control of the checkbook for the family, finally says, “No more. No more credit!”

George asks, “What about the bills?” The spouse doesn’t care. The spouse has taken his card from his wallet and now refuses to pay the bills until George stops wasting their money.

The utility company is first to not be paid. It tacks on a charge and sends more bills. After all, it’s a utility company. It has to work with them. They miss a car payment. Their credit union calls and asks for its money. George says sorry, next month. He had to pay for the insurance policy on the car instead.

Then they miss their mortgage payment. After a month, they receive a call from the bank that holds their mortgage. The couple is warned that their stellar credit rating is about to slide downwards. The couple argue – long into the night. George insists what they are doing is crazy. The spouse insists that they cannot go into bankruptcy by using their credit card any more. They must start saving money.

The spouse says they will only pay minimum interest on the card and they should start cutting down on their expenses. George, stymied, tunes out the spouse and stops caring.

Cable TV goes first, then the second phone. The heat gets turned off, the car repossessed, an eviction notice arrives. The spouse is happy. At least they don’t have pay insurance on the car and house anymore. George has just been spending too much money.

But now they’ll have to find the money to move to a smaller place. They do move, but their credit rating is in the toilet along with the credit card. Nasty creditors begin calling at 6 am. and on weekends. The word bankruptcy hangs in the air.

Oh yes, each of the kids do get their birthday party, but there’s no cake and they don’t get a gift – just a greeting card from the spouse saying they can’t afford a gift this year.

Scenario Two

A man named Fred comes home from work. He’s tired. All he wants to do is sit and watch the weather channel for a spell. But his spouse says she has something urgent to discuss. The spouse has just read that using a credit card in excess of 33% of its limit can lower their credit rating. They now have 40% of their card tied up in debt. They have a debt problem.

Fred groans and sits at the table while they go over their expenses. They disagree about what debts to cut. But both agree they want to keep their good credit rating. Without it they will have to pay higher interest on the card, and that will eventually put them into bankruptcy.

Fred has a sudden inspiration. They’ll put the kids to work picking and delivering fruit from their trees in their yard and the neighbors’ trees too (if the neighbors agree.) The kids in return will have to pay for the gas and insurance on the car. But they can use it for fun as well as delivering the fruit.

Everyone pitches in. The family raises money from picking the fruit. The kids are happy. They get to use the car now, as long as they work to pay for the gas and insurance. George gets to watch the weather channel, while his relieved spouse takes care of paying down their credit card. Soon they are under the 33% mark.

The couple can now actually make and save money while paying down their credit card a little more than the interest owed each month. The couple finally celebrates with an magical evening out together.

NOTES: I used 40% as the figure because that is the amount the US government pays on servicing its current debt – 40 cents out of every dollar. And I did not make up scenario one – it actually happened in my home when I was a teen.

This weekend we’ve seen the results of “my way or the highway” ideological thinking in Norway. We’ve also seen it closer to home. The FAA (Federal Aviation Authority) was de-funded on Friday, leading to the furlough of 4,000 FAA workers and transfer of taxes on passengers’ tickets into airline pockets. Airport shutdowns are immanent, as well.

Is this how the debt crisis will go? Just like the financial crisis — in slow motion, with one agency after another folding its wings? Until the whole house of government threatens to collapse on all our heads? Could the damage done ever be undone?

Well, of course not! Because there is no debt crisis. The debt crisis is a hoax, manufactured by politicians to make us all amenable to changes they know we won’t like. Paul Ryan’s “budget” proposal was the bugaboo that will make us think anything less that that is a relief.

Time and time again we are warned that we will have to make sacrifices and give up things we don’t like. But no one ever tells us exactly what is in any of those budget proposals. When the fake “settlement” happens as we are right on the brink of the fake “crisis,” we’ll have no time to look at the details. We’ll just have to swallow things we don’t like. Again. How nice! Are you fuming? I am.

The deficit problem

All we really have in the US is a distant “deficit” problem. We’re overspending at a rate that — in the future — could take us to a point where we couldn’t pay the interest on money we’ve borrowed (i.e., US Government debt) There’s no huge problem with overspending as long as you can pay the bills you owe along with your the interest costs on your debts each period they all come due.

And there’s no reason a government shouldn’t be in debt for things that are good for the nation. Good debt for a nation includes things that bring in more revenue: support for exports, support for business expansion; support for education, health, and well-being of its workers; and support for the infrastructure business needs to function.

The United States has created its own “crisis.” We do not need to have a debt ceiling. Other countries don’t have one, and they do just fine. And we aren’t the country with the most debt-to-GNP (gross national product)! Not by a long shot. The United Kingdom, France, and Germany all have higher debt-to-GNP ratios than we do. And those countries also have lower (negative!) per capita debt-to-income (or the effective net worth per citizen) than we do. [Note: "effective" means "actual]  We actually have a positive debt-to-income ratio. Interest on our government’s debt hovers around 40%.

Yet these European countries aren’t having a crisis, well, at least not in direct relation to themselves, only through their connection in the European Union with Greece. And what is Greece’s debt-to-GNP ratio? In June of this year, a blogger wrote, “Greek debt is now at a staggering 150% of its GNP.”  Pundits are predicting it might even rise to over 400% Ireland, Portugal and Spain are in similar straits. Now THAT Is a real debt crisis.

The US debt crisis is a bunch of BS (and I don’t mean Bruce Springsteen!)

How to Get Out of Debt

Debt is the big issue for America right now. Let’s look at how we should go about getting out of it. Any of us can face a time when we have a need for going into debt. Borrowing could be an option to pay for school, a child, or for living while unemployed, or for starting up a new business. For government, debt can come from the expenses of using a military force, offering new services to citizens, and/or dealing with a recession in the private sector.

Robert Kiyosaki and Kim Kiyosaki, his wife of many years are authors of a series of books called Rich Dad Poor Dad. The purpose of their books is to show people how to achieve financial security and ultimately get out of “the rat race” of employment as one gets older

The vision they offer is one where each generation of workers, as they age, can create enough financial know-how to become business owners or real property investors who are able to live independently on residual income or cashflow. This is done by offering products or services others. In other words it’s a utopia of entrepreneurs.

Whether or not this vision is possible for everyone, I can’t judge. But I can judge that some of what the Kiyosakis teach is most useful to anyone who wants to use their money to live well. And one of the the things they talk about is how to get out of debt.

As part of the free “$800 value gift” promotion for their coaching services, the Kiyosaki’s have a new audio program. It’s about 45 minutes long. In it, Robert and Kim tell how Robert got into debt and how he and Kim got out of debt. Kim Kiyosaki lists their ten steps to getting out of debt, beginning with a complete inventory of what is owed. All of these steps are important, but one step is key for understanding the government debt crisis we are all in right now.

As I’ve written, I don’t believe our national, state or local governments even have a complete inventory of government assets or liabilities, let alone make those inventories readily accessible in condensed form for citizens to see and discuss! We’re not even at step one of getting out of debt! No wonder we’re deadlocked.

The Kiyosaki get-out-of-debt strategy

Here’s the Kiyosaki’s key strategy for getting out of personal debt. You first freeze your credit card. OK, you think, that means having a debt ceiling. No! A debt ceiling is the point at which your credit card maxes out, and you can’t borrow anymore. A debt ceiling is like a credit card company’s credit limit. You don’t even want to get to the point of reaching your credit limit in the first place!

Long before that, you freeze the bills you are paying, and you decide not to spend more until you can catch up with what you already owe. Do we see our government discussing where to draw the line at not spending more? No, we don’t. We see a government that is acting like it has maxed out its credit when it has not, and like it is teetering on bankruptcy when it isn’t. This is simply insane. Why do we need all this storm and drama? I believe it’s so the “dupes” in the audience will swallow the hoax — hook, line, and sinker.

So how does anyone pay down their debt? You focus on paying off one debt at a time, beginning with the debt that can be paid off the quickest. Once you pay that debt, you take the money and interest that you are no longer paying on that debt and use that money for your next biggest creditor. After you pay the next creditor, you move on to a bigger creditor. In this way your debts get paid as quickly as possible.

How do you pay off your first debt?

But how do you pay the very first creditor? You’re broke! That’s the rub. And this is key for solving sovereign debt too. Here’s the Kiyosaki’s answer. YOU DON’T CUT ANYTHING OUT OF YOUR BUDGET – YOU FIND A WAY TO SCRAPE UP A FEW MORE DOLLARS A MONTH. That’s what you use to begin paying down your debt in an orderly way until you get out of debt.

Yes, that’s right! You get out of debt by finding an additional way to raise money. The Kiyosakis suggest that for individuals that means coming up with an extra $100 a month. That can be from finding extra work, selling something you don’t need, planting a garden, or making something others can use.

No matter how deeply you are in debt, and as I pointed out above, the US is not nearly in debt as other developed countries in the world, you don’t start getting out of debt by cutting out some big massive program, such as Medicare or the military! You start by figuring out how you can bring in just a small amount of extra money each month so you can start paying off the bad debts you already owe. What is bad debt? Bad debt is debt for things that do not make our nation more prosperous.

If you’re serious about managing debt, you begin with a plan you all agree on. Then you make a commitment to get out of debt one step at a time. And while you work on bringing down your debt, you make sure you hold down your expenditures. Just as soon as you can cover your bills again, you pay off your creditors, one by one.

Meanwhile, you find ways to bring good debt into your lives! For more on what good debt it is, see my previous post “Good and Bad Debt: Why We Need to Know About Them”.

Does the Kiyosaki’s system work? You bet it does! It isn’t easy, but I’ve done it more than once in my life, and so can you. And so could our government – IF it ever tried.

Right now debt is a four letter word in America. With the advent of the recession, Americans cannot bring themselves to believe again that owing money could ever be a good thing. But the fact is, good debt is what made this country great. In our attempt to lower the debt ceiling (how much we can owe) and the deficit (gap between what we can pay and what we actually owe), we may very well be throwing out the baby with the bathwater.

Personal debt has become an enormous problem in this country too. Recently I was inspired by a video by Robert and Kim Kiyosaki about how they got out of debt. So, a look at how to get out of debt for individuals was my original intent in blogging today. But I found that before I could get to that topic or to the issue of our national debt, some clarifications are necessary and unavoidable. Before we can even start to “get out of debt” we have to first understand what debt actually is.

Dictionary definitions of debt refer to anything owed. Anything owed by one person to another is called debt. But financial definitions of debt are different. Debt in the financial sense is usually is limited to contractual debt. This is borrowing money on which you usually have to pay back the principle with interest. There often is confusion because people switch back and forth between these two meanings of the word, “debt.”

One kind of debt we think of most often as “bad” debt are incidental expenses, frivolous things which we didn’t really need to buy. We may owe money for these things, but they are not what is meant by Robert and Kim Kiyosaki when they talk about “bad” and “good” debt. Financial debt generally pertains to serious debt, debt which is intended to bring in income.

Another thing we think about in terms of debt is really lack of revenue. We don’t make enough money, so we are in debt. This isn’t “bad” debt either, it is just plain old debt. If debt that you can’t pay were bad debt, then there would never be such a thing as “good” debt. How could there be good debt? Ever? If debt had to be payable to be “good,” there wouldn’t be any good debt or for that matter, any debt at all! You’d just pay your debts.

It may feel bad to be unable to pay a debt you owe, but the debt itself isn’t bad or good. Yet, there ARE things called good and bad debt! You’ll find them in Robert Kiyosaki’s world, the world of his “Rich Dad“. And it’s really important to understand what the thing called good debt is if (1) you want to get out of personal debt, and/or (2) you are concerned about how we’re going to solve our national debt problem.

Assets and liabilities that underlie both good and bad debt

Good and bad debt come from owning or controlling assets and liabilities that bring you positive or negative income. Good debt is money owed on things that bring you positive income (profits). Bad debt is money owed on things that give you negative income (losses)

Assets which you are paying to own or control include things like rental property, stocks and bonds; businesses; franchises; intellectual property (such as copyrights and patents); whole life insurance policies; and leases.

Liabilities related to income-producing assets include things like mortgages, bank loans, stocks and bonds bought “on account”; IOUs or any kind of investments based on debt instruments; and debt maintenance costs (i.e., interest owed on borrowed money).

Assets you are still paying on

If you are granted legal control of assets that you are still paying off, the assets involve liabilities for which you owe money. For example, let’s say you owe mortgage on a house you rent to others. The mortgage is a liability. Because you have control over a rental house, the house is an asset. You can make a regular income from it.

When you make a regular income from a rental property that you are paying the mortgage on, you have “good debt.” But if you are losing money from rental property that you are paying on, your good debt just turned into bad debt. You have bad debt when you are losing money on unpaid assets that you still owe money on.

You also have bad debt if you have control over a house that you live in while you pay the bank for it. As is the case with a loser rental property, your mortgage is simply taking money out of your pocket each month. You are losing money on your home. Your mortgage is a liability. The money you owe on your mortgage is simply ”bad debt”.

Assets you have paid off

If you bought the rental house outright, you own an asset rather than control the asset. You do not have bad debt because you do not have debt. Period!

But if you can’t cover the expenses of owning and renting your rental house, then you have an asset that becomes a bigger liability. its expenses are taking money out of your pocket. Your asset is then going to cause you to have bad debt (perhaps on your credit card). Your paid-up asset is supposed to bring you income and it doesn’t. The same goes for a business that runs in the red. So, paid-off assets can still bring you bad debt from paying their expenses.

If you’ve paid off the mortgage on the house you live in, your house is no longer a liability; nor do you owe bad debt your house, But neither do you receive income from your house. In fact you will still owe expenses for it, such as utilities and taxes. Your house does not provide you with any money to pay off its expenses. For this reason, in Kiyosaki’s system, only rental property or property used for a business can be defined as an asset that can have both “good” or “bad” debt attached to it.

A personal mortgage is simply a liability, and it’s a bad debt until it is paid off. After that, your house has expenses that can put you into bad debt, if you don’t have enough cash-flow to cover them. (But as we’ll see later, bad debt doesn’t mean you have to pay it off to be successful. What counts isn’t the amount of your bad debt; it is the amount of your cash-flow i.e., your residual income after your expenses are paid.. Cashflow, or “residual income,” comes from paid-off assets and good debt.)

Asset- and liability- windfalls through arbitrage (buying and selling)

What happens when assets are paid for fully? They are not debts any longer. They are simply assets. If assets don’t produce any income, they are either potential assets, e.g., land or a house you might sell for a profit in the future, or they are just plain old things which may or may not cost you money (i.e., expenses) to keep and enjoy. And here we come to the need to sort assets into two kinds.

One kind of asset produces money “periodically” or at intervals; the other kind of asset provides only a one-time payment. For example, your house can only be sold once. That is when you will make or lose money on it. This kind of one-time income from buying low and selling high is called arbitrage. Arbitrage is the difference between the buying and selling prices (usually within a short period of time). Arbitrage is the reason a house you live in is sometimes called an asset. You can make (or lose!) money on your house, but this only happens once – when you sell it.

Through arbitrage, you have one-time income (or loss) from a liability and/or an asset. For example, if you borrow money to “flip” a house, you are in debt for your liability (the mortgage), but you intend to make money from the house (your asset) when you sell it. You don’t own the house; the bank owns it, but you control it, and you have the right to fix it up and sell it to another buyer. You can make a one-time income from this kind of arbitrage on a debt you sell.

You can make or lose money when you sell previously-paid-for assets like stocks or bonds too. The same thing goes for stock you buy with money your borrow from your broker. This stock is a liability that you can sell for a profit on a one-time basis, But these kinds of assets and liabilities are not called “good” debt in Kiyosaki’s system either. They are more like windfalls. Windfalls (in the form of capital gains or losses) are important in terms of making money, but you can’t count on them. They can’t be included in your good and bad debt calculations because windfalls are not regular income coming in a periodic intervals.

The importance of understanding good and bad debt

Why is it important to know about good and bad debt? Because the object of the “game” in Kiyosaki’s world is for you to make enough income from “good debt” to get out of the “rat race” of working at a job or in self-employment. Good debt, like outright ownership of an asset that pays a steady income, is a good thing!

Bad debt, however, is not intrinsically bad. A thing which is a liability, e.g., a car, can be turned into an asset by simply adorning it with advertising for a business. A yard can be used to grow produce for sale. This kind of use brings in money. A thing which is a “non-productive” asset over the long-term can still be sold for a one-time windfall. A thing that is a liability can also be useful as a way to lower necessary personal or business operating expenses.

For example, if a home mortgage is cheaper than a rental, a mortgage may be your best choice. When it comes to getting out of the rat race, sometimes you need to lower your necessary expenses (including paying down bad debt) in order to get out: but other times it doesn’t matter if you have bad debt as long as you are taking the right steps to increase your good debt and create cash-flow; your cashflow will get you out of the race.

This is a way of thinking that is utterly foreign to most Americans. If you don’t “get it”, don’t worry, I’ll be writing about it further, and you can also read the Rich Dad Poor Dad series, play the cash-flow games, or listen to the Kiyosaki videos and audios online. Or write a comment in the box below!

Related terms: assets and liabilities

The head of a family was laid off from a high-paying manufacturing job that technology was making obsolete. The family called in a counselor to talk about what to do. The family’s expenses had been unusually high over the past few years with a lot of unexpected bills. The family was deeply in debt.

The spouse of the head of the family lived on a trust fund left by a parent. The spouse did not want to spend the trust fund on family expenses. The fund was for the spouse, not the family.

Now, with no job for the head, and the spouse unwilling to draw on reserves, the family was in crisis.

The kindly counselor, Mr. Keynes, settled down on their couch and listened to their story. He told them that he was sure the head of the family could get work again, but the head of the family would have to get training for a new kind of job.

The head’s previous experience and skills indicated the head could pass that training and get the new job. All the head needed, said Mr. Keynes, would be the fees for the classes along with some new clothes and travel expenses for job-seeking when the head got done with the training program.

The head of the household thought that was a great idea. The spouse however, saw things another way. “If we’re going to have to live on less in the future, we should start doing that. We can’t burden our children with our problems. We’ve got to cut expenses starting right now.”

The counselor pointed out that the head needed a new job if they were going to pay for the remaining expenses. The spouse replied they were broke. They couldn’t spend any more money. They’d spent too much already.

The counselor turned to the head of the family and asked if the head could come up with money needed. The head said yes, by borrowing the money.

“Borrowing” shrieked the spouse. That’s all we’ve been doing! And look where it’s gotten us. We’re in debt! We’ve got to get out of debt!

“How will we pay our bills?” asked the head of the family.

“We’ll just pay interest on the debt. Other people will just have to wait until we can pay them.” answered the spouse.

“That’s insane,” the head said, turing red in the face. “We owe them. They already provided us with credit, heat and electricity, and cable. They’ll expect payment, not interest. What about the bank? It will repossess the house and car if we don’t pay.”

“Screw that,” replied the spouse, “you should’ve thought of that before.” The two glared at each other.

Mr. Keynes stepped in. “Well, I do have a solution here. Just spend a bit now for getting the new job and save a lot later.”

He continued, “After all, it will run you legal fees and impound costs if they take your house and car. And you’ll have to pay to get the gas and electric and cable turned back on. The interest rates on your accounts will all go up, and you’ll probably lose some of your credit. I suggest you spend money now and save it in the future.”

“SPEND MORE NOW!” screamed the spouse. ARE YOU CRAZY? WE’RE IN DEBT!  We have to cut costs or WE’RE GOING TO BE BANKRUPT. Even my trust fund won’t be able to pay all we’ll owe if we do that. Short-term spending got us into this mess. WE HAVE TO STOP SPENDING NOW!”

The children who were sitting playing in the corner froze, fear on all the little faces. What, they wondered, was wrong with their parents? Did this mean no more bubble gum? What was happening? Why was it happening? Would they all wind up out on the street?

Mr. Keynes tried one more time. Clearing his throat he said, “I don’t think you’ll go bankrupt if one of you gets a job. Do you?”

The spouse’s reply to Mr. Keynes was “F^#k off, a-hole.”

Mr. Keynes picked up his briefcase, and left the house.

The children sat wide-eyed and frightened.

The head of the family and the spouse both were now in agreement. They each wanted only one thing now, the same thing – a divorce.
 
 

Good Debt – Debt that it pays to keep

Definition – debt based on income-producing assets

Discussion – There are actually two steps to amassing good debt. The first component of good debt is that the liability incurred is based on an income-producing asset. This income can be earned income (i.e., the asset being your labor), or it can be passive income or portfolio income (i.e., the asset being your investments). These different ways of “making a living,” although taxed at different rates, are all based on owning an asset or assets that provide income to pay debts.

The second component of good debt is satisfied when one has a residual income or cashflow greater than the sum of one’s total periodic liabilities, (e.g., one’s monthly bills). In other words, one’s debt payment is sustainable over time. There is enough income left after the bills are paid to pay for the interest owed on the debt. Also, you own an asset or assets that, if necessary, can pay off the entire debt by some point in time.

For example, If employed — you know you have paycheck, although a layoff, injury, or loss of benefits could change things. If self-employed – you know you have a business plan even though things may not go according to plan. If an investor, you know you have investments, although the market price could drop, or those investments could go bad. The only difference is that employed and self-employed individuals are severely limited by the value of their asset (the income earned) and its duration. That’s why employed and self-employed people also need investments to live independently upon retirement.

Accumulating good debt is usually a two-step process: (1) development, followed by (2) success in accumulating assets. This is how individuals, households, businesses and governments can sleep well at night while still owing debt.

Here’s an example of good sovereign debt. A country borrows from other countries at an interest rate of X%. The country uses that money to develop an export industry using its natural resources and labor. During the development phase, the country has a potential for good debt because it is building an asset for itself. If it succeeds, then the the exports created enable it to pay the X% interest each year and have another 2-5% “residual income, i.e., cash-flow left over, after expenses. The country will still be in debt for the loan, but it now has the means to pay the interest for each period over time. And it now owns a new income-producing asset.

Individuals, families, businesses, and nations all need to acquire good debt to survive and live well over the long term. In regard to debt, including sovereign debt, the question isn’t just the amount of debt involved, but rather how will that debt be able to be sustained! What assets does a a individual, a group, or a nation have that will enable it to meet its periodic expenses over the long term.

Related terms:  Capital; Assets; Liabilities

Copyright © 2011 Nancy K. Humphreys

Many years ago I decided to go to Athens and Crete. Why? Because in my textbook for art history (Janson) there was what was clearly a toilet and a bathtub at the ruins at Knossos on Crete. In fact, that 3,000 year old town even had a sewage system!

Back entrance to Knossos, Crete

Odd, I reflected, that people in 19th century London threw their “slops” out the windows, and that even my parents grew up with an outhouse. Greece must be terribly civilized I thought.

To prepare for my trip, I decided to learn Greek. I found a class over in San Francisco and enrolled. My teacher was a married woman who came from Crete. Many of my classmates had been to Greece as well. Two in particular I noticed.

She was a waitress at a restaurant, the kind of attractive woman that you know who has “been around”. He was a bartender looking slightly dissipated at age thirty who worked in the same place she did. They joked constantly about Greece, but with an ironic affection. Both intended to go back for a visit. So did my teacher, and it turned out we were going at the same time. So we arranged to meet on Crete

“Modern” Greece

Arriving in Athens, I found that Europe and America were not the only places that slid backwards in terms of bathroom technology. Unlike Spain, where the airport had beautiful marble sinks and gold-plated faucets in the airport women’s room, but no water, Greece didn’t even pretend to be modern.

Toilets in the hotels were flushed by pulling a chain that released water downward from a ceramic box above the toilet. Showers were simply a shower head and handles extending from the wall with a nearby drain in the floor. Public restrooms consisted of a concrete platform containing a toilet-sized hole. Luckily my classmates had warned me to wear a skirt and washable shoes!

The nice thing about the public restrooms was they had something you’d see here only in an exclusive restaurant — a woman handing out towels, whom one tipped. I realized how true what my classmates had said. Greece was a place that catered to tourists, most of whom came from Europe on their one-month summer vacations.

Crete

Samaria Gorge near Chania

A worker’s strike had shut down the Acropolis, so, after a few days in Athens, I traveled early to Crete.

On arrival in Heraklion by a Greek ship, I began walking around a charming, somewhat sleepy, Mediterranean city. Passing a whitewashed tavern in the morning, I heard a familiar refrain. It was an old hit by Leonard Cohen – “First we take Manhattan, then we take Berlin,” Inside, the whole crowd lustily sang along.

I wasn’t really surprised. In Athens I’d seen the navy blue buses cruising around, full of young men picked up at political rallies for some offense or other. There were multiple political parties in Greece, very antagonistic to each other, and even an NGO for women that aimed, regardless of party, to get 50% of office-holders to be female.Greece is indeed, the cradle of democracy, especially after surviving the cruel dictatorship of its military junta in the 1960s.

Crete, invaded by the Germans, was deeply affected by World War II as well. On Crete I took my clothes to a laundry run by a stolid, stocky, scowling German woman with a nasty-looking dog. On my return to pick up the laundry I asked her how living on Crete was. She loudly complained that Cretans were unfriendly and she hated it. How long had she been there, I asked? “Twenty years,” was the snarled reply.

I’d arranged to meet my Greek teacher in her hometown to visit an off-the-beaten-track ruin near Sitia and meet her family. At the family’s home, the women told me about keeping chickens under the houses and silkworms on their breasts during the War. Puzzled I asked why. The chickens were hidden because the German soldiers took their food. The worms warmed because electricity was scarce. Silk, I learned, was once the great pride of Crete.

After a dinner of the most amazing chicken (“Tasted like beef,” I observed), and a discussion of politics among the family, the father announced that “The show is almost over.” We arose and went into the living room, arranging ourselves around the small black and white TV. A comedy ended and commercials began to play. The commercials, much like the live ones I saw when a child, went on for half an hour!

“The commercials are the best part, said the old man. Everyone else nodded.

Back in Athens, the cradle of civilization

My two jaded classmates in San Francisco had joked that they’d like to take a limousine and drive it around Athens so they could watch the amazement on the faces of the Greeks. Athens was indeed a totally middle class city with a large number of unemployed young men. There were no ostentatious rich people. Nor were there any panhandlers. Greek families take care of their own. And more importantly, the streets of Athens were far too small for a limo to pass through them!

Ruins of city on Thera (Santorini)

Back in Athens I breathed in the mix of ancient and modern air and headed up to the Acropolis before packing to go home. Coming down the hill again, I walked into the park below the fabled hill. There, columns from an ancient temple lay in pieces in front of a partial wall of the temple left standing. In a postmodern collage, the columns and temple wall were utterly dwarfed by the modern glass and steel skyscrapers surrounding the park.

I thought of the things I’d noticed on my trip: the kindness of the Greek people, the wads of colorful Greek money that was too large for the men to fit into wallets, the statues at the museum in Delphi that seemed alive, the wild goats with vertical cat eyes munching grass at the foot of the Samaria Gorge trail near Chania the freedom-fighters used to fight the Germans, the ancient town of Akrotiri on Santorini with its two story stucco houses that looked just like those in the Bay Area of San Francisco, and the food, wonderful food served by bored, male waiters, who never brought the check.

http://goeurope.about.com/od/greece/ss/crete-map-travel-guide_5.htm (gorge)
http://travelingclassroom.org/?p=210 Akrotiri

And then I spotted it! There at the edge of the park in Athens was an ancient Cretan-style bathtub, complete with drain hole, lying among the other ruins.

It was big. When I reached it, It was nearly as high as my waist. I peered down into it, recalling again my amazement with what the ancients in that country had devised. Instantly I was struck dumb by another contrast with modernity in that park. For there at the bottom of the ancient bathtub lay a used condom.

So why the danger of default?

Greece, joked my two jaded classmates, was a country whose economy was based entirely on tourism, kind of like the area of San Francisco (North Beach) they lived and worked in. “If tourism ever goes, so will Greece,” they proclaimed.

Well, tourism has gone. We’ve seen it here in the Bay Area as the busloads of Japanese tourists vanished, and I can imagine it there. Taking a long view of the financial crisis, as if one could see it all from a spaceship, it seems like all those people who didn’t “got the faith to stand their ground” were shaken loose by this crisis in a way like almost never before.

Fraudsters, successful at front-running, ponzi schemes, and other scams were outed by the drying-up of money they could no longer get their hands on. Those who bought and those who didn’t sell houses at the beginning of the slump slid underwater. Storefronts became vacant everywhere, even in the upscale malls. Those whose jobs were based on consumer demand were handed pink slips. Even the illegal immigrants from Mexico left the West Coast in droves.

All of us will have to remake ourselves to survive in this century. Greece will survive. I have no doubt of that. But when I think of poor Greece paying the price again, I cry. The only consolation I can see is that perhaps, if dropped from the European Union, the Greeks will bring back their lovely money again.

Sustainable Growth -  Looking towards the horizon rather than the next pothole in the road

Definition – The Sustainable Growth Rate (SGR) is the “maximum growth rate that a firm can sustain without having to increase financial leverage“. (Source:  Investopedia )

Discussion: Jack Welch, former CEO of the General Electric Company (GE) which got billions in bailout funds from the US government in 2008,  launched this idea with his famous quote in 2009 – “Shareholder value is the dumbest idea in the world. It [the value of shareholders' stocks] is a result, not a strategy.”

Welch added, “Your main constituencies are your employees, your customers and your products.” (Source “Sustainable growth is the new incarnation of capitalism” Financial Times Mastering growth supplement 5/18/11 p 2) In his new book, The New Capitalist Manifesto,” Umair Haque refers to new incarnation as “constructive capitalism”.

Sustainable growth is a radical notion in a world where the bottom line governs all!

The idea of a sustainable growth rate for corporations suggests that fraud, financial speculation, environmental and economic damage, and all kinds of other social ills can spring from the effort of large companies to hit their growth targets each quarter.

The alternative to the bottom line is “creating shared value” with the other communities besides shareholders, that as Mr. Welch points out, a corporation also serves.

Related terms: Constructive Capitalism; Dividend Payout Ratio: Thin Value; Thick Value

Copyright © 2011 Nancy K. Humphreys

Trapped Cash – Cash that can’t escape corporate pockets and come home

Definition: Overseas earnings of corporations that are taxable on return to the US

Discussion: American multinational investment banks and other corporations who do business overseas make trillions of dollars abroad, and of course, they pay no taxes on it.

Currently these companies are “going native”. They no longer send American executives on long plane trips. In the age of the Internet, decisions can be made instantly. That means having people familiar with a foreign country working in that country advising the company on it’s decisions and helping facilitate things it wants to happen overseas.

As a result of corporate expansion overseas rather than at home, cash is being kept abroad so that it can be used there. American multinationals are now engaging in “cross-border transactions.” They are looking to make all-cash buyouts and mergers with or takeovers of foreign companies. Observers of the surge in international deals by American multinationals are worried that, as a result of trapped cash, “tax issues are distorting business decisions”. (Source: “Tax fears prompt M&A rush” Financial Times 5/16/11 p 15)

If they need money to use at home, American multinational corporations can simply borrow money cheaply by issuing bonds. Given the recession, they don’t need to obtain more money from abroad right now. However, these corporations are still asking for a “tax holiday” on any overseas earnings they bring them home. The proposed tax would be only 5.25%, roughly the same amount as it costs them to issue bonds. (Source: “US tax holiday proposed for overseas corporate profits” Financial Times 5/18/11 p4)

Those opposed argue that giving corporations a  tax break on foreign earnings would not increase American jobs. They fear that that jobs would continue to be shifted overseas while money shipped home would be spent on share buyback sand higher dividends paid on the remaining shares. That is what happened during the last tax holiday in 2004. One could argue though, that shareholders would eventually pay a tax at ordinary income tax rates (of at least 15 %) on most of the increase in dividends, thus helping to diminish the US debt at some point in time.

Copyright © 2011 Nancy K. Humphreys

Like Greece, the US is currently facing the issue of “who will pay” for our sovereign debt crisis. So far, I haven’t come across the suggestion to put the capital gains tax on the table. Here are three reasons I feel capital gains taxes should be increased right now to be at parity with ordinary income taxes.

(1) Capital gains were saved by the bailout

The stock market is not the only wealth-building game in town, but through IRS tax breaks, it has become the biggest one! In addition to individual investors, the stock market also serves institutional investors such as mutual funds, banks, insurance companies, hedge funds, and pension funds. These are the institutions that benefited most from the taxpayer funds spent on the bailouts and the stimulus during the recent financial crisis. Those who are better off financially in this country have the most to be thankful for. Their comfort would have diminished greatly if these big institutions hadn’t been saved!

Here is an example of disparate results of the financial crisis. Older people who depended on interest from government bonds and dividends form holding stocks were out of luck. Interest rates declined to near zero. Older people on fixed incomes made no income on interest and dividends, and hence the government collected no ordinary income taxes those kinds of investments.

For example, Wall Street Journal’s “Rejuvenated Banks Raise Dividends,“ quotes an investment bank, Keefe, Bruyett and Woods, Inc. “Nearly 300 banks had reduced or discontinued their dividends since 2008, saving the industry nearly $100 billion in shareholder payouts…” It has been both working people and less-well-off older people who have lost their income during the recession. Meanwhile, those who are continuing to enjoy betting in the stock and bond markets still get profits and tax breaks on their capital gains.

Is it too much to ask for the wealthy to put their (15% maximum) capital gains tax rates on the table as we face a huge budget deficit that, in large part, was caused by the stimulus and bailout monies needed to save their Wall Street banks?

(2) Capitals-gains-tax breaks skew entrepreneurship

If you’ve ever played Robert Kiyosaki’s Rich Dad Poor Dad Cashflow board games, you’ve seen that investments in stocks and bonds are part of the sustainable wealth chain. A player amasses a certain amount of cash flow, or residual income, i.e., income that exceeds monthly expenses, from these investments. But the real wealth in the game comes from the “big deals” section of the deck where you can become an owner of real property and/or businesses.

If you’ve read Kiyosaki’s recent books such as The Conspiracy of the Rich, you’ll note he now discusses “derivatives” in the form of intellectual property, licensing, and leasing. These legal vehicles are major wealth builders for the Kiyosaki family. All of these kinds of derivatives that offer ways of accumulating enough money to sustain oneself without a job are heavily favored by the US tax code. That is why speculation is such an effective wealth-building technique.

The thing is, there is another way to build wealth. That is by building a small business that offers some kind of service or product that others need or want. And here the tax code is not only not helpful; it is perfectly antagonistic.

The federal government drives US small businesses with one foot on the gas while the other is on the brakes. The work of the US Small Business Administration (SBA) is admirable. But it a drop in the bucket compared to the draconian taxes collected by the IRS on solo and small (non-incorporated) businesses. Especially onerous is the double SE tax (similar to the FICA tax paid for employed people, half of which is paid by the employee and the other half by the employer.)

Sole proprietors, who work in their business as well as own it, are not two people; their tax rate should not be 100% higher than that paid by an employee. Furthermore, sole proprietors who hire others should have the employer portion of their payment of the SE taxes for their employees prorated until they reach a size where they gain enough efficiency through division of labor and increasing returns to scale to be able to afford to pay full SE taxes for their employees and ultimately, for themselves too.

Taxes are a major reason so many small businesses fail within the first three years. Yet while sole proprietors and small (micro) business owners struggle to pay taxes each year, large corporations and those who buy and sell their stock and bonds are growing fat off of the capital gains tax break.

Capital gains tax rates are dampening job creation

Large corporations are growing profits like crazy. But they are not doing this by hiring more workers! Rather they are increasing the “efficiency” of the workers they have. They are also rushing to to find mergers and acquisitions opportunities abroad so that they do not have to bring home their cash earned overseas and pay US taxes on it! (Source: Financial Times, Tax fears prompt M&A Rush, May 15, 2011 p. 15)

Sole proprietors and small (micro) businesses are the ones who create the most jobs in this country, but without the incentive of customers who can afford to pay for their products and services, job creation has stalled. This is why the current cuts in unemployment benefits in many states for the workers laid off in the recession will have such a large impact on the economic recovery. Unemployment checks go directly towards funding local services and businesses.

It is a myth that large corporations are “job creators”. Large corporations are exporting American jobs abroad in droves. They are diminishing the wages of American workers by pushing for union-busting legislation. And they are using their large cash reserves to buy each other out (and thus, lay off more Americans!), to buy back their own shares (profiting their large shareholders), and speculate in the new financial derivatives that are making a comeback at the investment banks on Wall Street and elsewhere in the world.

Small, local entrepreneurship is being stifled in favor of investment in the financial markets. Large amounts of capital is accumulating in the hands of those who create nothing of necessity for society. And clearly they have had and still have too much capital to play with. Witness some of the risky derivatives that are making a comeback right now.

The bottom line

American workers in unions have generously offered to share the burden that the financial crisis left. But this just isn’t right. Our government, that is we taxpayers, “socialized” the private debt of large corporations during the financial crisis to prevent the markets from collapsing. And now our governments have huge amounts of debt. Surely those who benefited the most from the bailout and stimulus programs should pay the most for restoring the economy. It will be years before we even know how much their actions will cost the federal government agencies who bailed them out.

Here’s why I suggest we put capital gains tax rates on the table. It’s way past time to (1) stimulate real economic growth and employment instead of gambling on corporate stock and bond market gains and losses (2) encourage sole proprietors and small business owners to create more jobs for others, and (3) make taxes fairer to all Americans.

CDFs – Convenient Full-Service Derivatives

Definition: Contracts for Difference (CFDs) are popular derivatives in many other countries. The SEC has banned them in the US.

Discussion: Contracts for Difference “allow investors to speculate on price movements of stocks without owning the underlying assets.”

“Contracts for difference (aka CFDs) mirror the performance of a share or an index. A CFD is in essence an agreement between the buyer and seller to exchange the difference in the current value of a share, currency, commodity or index and its value at the end of the contract. If the difference is positive, the seller pays the buyer. If it is negative, the buyer is the one who loses money.” Source of above quotes

CFDs are one-stop shopping derivatives that make life “simpler for fund managers and wealthy retail buyers alike – CFDs “allow the buyer to hedge an existing exposure, leverage a position, or make an outright short [bet]“. Source: Article, “First central clearing for CFDs” in Financial Times FTfm section, May 9, 2011.

For a comparison of CFDs with options, futures, covered warrants, ETFs, FX (currency) products, and margin buying, see Wikipedia’s article on contract for difference.

Related terms: naked shorts; bucket shops

Copyright © 2011 Nancy K. Humphreys

Dividends – an extra slice of the pie

Definition: a periodic reward one gets for holding stock in a corporation

Discussion: Stock in a company represents ownership of a piece of the pie. Whenever a company grows or has an inflow of cash, the pie gets bigger. The company has money to spend. This money can be used for expansion, buyouts of other companies, buyback of the company’s stock, or to reward its shareholders.

Buybacks of stock can offset stock options issued as part of employee salary packages and/or boost a company’s earnings per share (EPS). Stockholders give each company a “home court advantage” in the playoffs against competing companies. When a company expands or buys out other companies, more stockholders may come to the game, i.e., buy that company’s stock. Stockholders like to see EPS rise. They also like to receive dividends. Company CEOs and boards operate their companies with an eye on stockholder approval of their actions.

During times such as the present when corporations experience growth in profits coupled with a lack of strong consumer demand for their products, corporations will boost spending on dividends. Unlike money shareholders make from buying and selling stocks and bonds that is taxed at capital gains tax rates, money shareholders make from holding onto stocks is taxed at higher ordinary income tax rates – just like the interest made on holding bonds to maturity. Capital gains are treated differently than dividends and interest by the IRS.

The bottom line is that the IRS’ differential tax treatment of buying and selling stock and bonds versus holding onto these two types of investments favors speculation in stocks and bonds.

Related terms: stock, bonds, capital gains tax

Stock – a derivative based on the perceived value of a company

Definition: a share of stock is a specific percentage of the total ownership of a corporation, e.g., one share out of 100,000 shares = .00001 percent ownership

Discussion: Bonds are loans made to a corporate or government entity. Bonds are IOUs that must be repaid. Stocks, on the other hand, are ownership of “a piece of the pie.” The problem with that metaphor is that the “pie,” i.e., the corporation, does not stay the same size; it can contract or expand, literally in an instant.

Any number of things at the company, in its industry, and in the world, can affect a stock’s perceived value and hence, its price, at any moment.

A number of financial indicators are used to estimate a company’s “real” value over time, but in the end, each buyer and seller of the company’s stock sets their own perceived value on that stock, just as each bettor at the track helps determine the overall odds of any horse winning in the next race.

Betting on stock prices to rise or fall is a form of gambling called pari-mutuel betting. Stock prices are basically the “odds” set by investors in a company on the likelihood that company will do better or worse than it has in the past. One can place odds on groups of companies as well by buying and selling exchange traded funds (ETFs) and mutual funds.

Federal government tax law strongly favors this kind of pari-mutuel gambling over other kinds of legalized gambling by the IRS’s treatment of capital gains and losses. Other kinds of winnings from gambling games such as horse races and state lotteries, are taxed at ordinary income tax rates, rates that tend to be much higher than capital gains tax rates.

Related terms: bonds; capital gains taxes

Copyright © 2011 Nancy K. Humphreys

At the end of the last century, Robert Kiyosaki, author of the Rich Dad Poor Dad book series and cash-flow games, declared that the Age of Manufacturing is dead; we are now in the Age of Information. Recently he was interviewed in a video, “Industrial Age vs. Information Age” posted on the Web.

Looking at the emphasis in the media about job creation in the manufacturing sector, you’d never know it was the Age of Information. And looking at the US government, you’d never even dream it was the Age of Information.

If you were asked if the we have a Bureau of Information in the US, you’d probably think about it and say, well, isn’t that what Homeland Security is about? Its budget has risen dramatically since its inception ten years ago. But this secret data collection on behalf of our national security is not the kind of information I’m talking about.

There are other kinds of information that are desperately needed by both the government and the public. Government and public Information is not a luxury. We need other databases for issues that are just as important to our economic welfare and survival as those national security databases we spend so much money on.

A database to curb fraud

For example, at the same time September 11th happened, so did the biggest health insurance scam ever. Employers Mutual scammed patients and doctors in every state of the union. At the pharmacy, HIV and cancer patients were denied expensive prescription drugs they had paid premiums for. Others were denied operations; at least one lost partial sight as a result.

How could this happen? Because the federal government and the states had no database of frauds. Nor did states communicate with each other. States began issuing “cease and desist business” orders to Employers Mutual, but it paid no attention. At one point, Employers Mutual claimed it had the total endorsement of a state insurance commissioner who had just called its owners a “pack of scoundrels” on his state web site. The problem was laypeople and even state commissioners in other states did not know about this.

And we all know about Bernard Madoff’s even bigger scam. Con men and women flourish when no light is shined on their  activities. A national database (with public and private information sections) about past and possible current fraud schemes is missing in this country.

A database to track life insurance policies

A few years ago, a friend found a longstanding series of payments for a life insurance policy in her parent’s effects, but the insurance company claimed it had no record of any policy at all, not even a canceled one. That’s when I learned there is no database of life insurance policies in this country.

The Wall Street Journal has reported that state insurance commissioners in California and Florida s are now looking into allegations that “Life Insurers Skimp on Payouts”. It’s being alleged that insurers are using their databases to cut off annuity payments when their clients are deceased, but ignoring those same databases when it comes to notifying heirs or the state governments who process unclaimed property.

John Hancock Financial Services has settled with the state of California and promised to do a better job of monitoring itself when it comes to researching the deaths of its clients. This week the Wall Street Journal says “MetLife Is Probed on Death Benefits”.

It’s chilling to think that large insurers have been slicing and dicing tranches of life insurance policies for resale in the derivatives market. These companies have no records for what they are selling in the way of life insurance derivatives.

And apparently they have no way of even keeping track of whether the policies underlying a life insurance derivative are covering a living person or one who is dead and whose heirs or the states should have received a payout!

A database  to ensure regulation of the financial sector

Right now the government is almost completely dependent on the companies it regulates to provide it with the documents it needs to regulate those companies. A keep problem with this is that it prevents government from reacting to a crisis in any kind of timely way.

Instead, data has to be collected from a variety of sources in order to assess what’s going on. In an age of algorithms and high-speed trading that can wipe out savings and pensions in an instant, that just isn’t good enough.

Also, there is a problem that companies themselves do not really know what other companies are doing. It’s easy for one company to feel it isn’t doing anything wrong. Only when the effects of all companies choices descend, as in a freeze-up of lending, does one company see what its practices have led to.

And that doesn’t begin to cover the damage done by people who knowingly do the wrong thing with no concern for who gets hurt.  When it comes to protecting our financial security, can we really afford to keep letting the wolves guard the hen house?

The Age of Information

I could go on. There are many other areas, such as health care costs that the public could benefit from having more information available about. For an intriguing look at the “liberation” of non-copyrightable government data, such as SEC filings and state law, into the public domain see the video and booklet, 10 Rules For Radicals by Carl Malamud. At issue is which kinds of government information should be available to the public as well as to government agencies. And there is the key question too of how much private sector information should remain private.

I can’t answer those questions. All I can say is that it’s high time we start discussing them. And I mean discuss them not as abstract academic exercises, but discuss them as an important part of our political process during election times.

Copyright © 2011 Nancy K. Humphreys

Bonds — securities that aren’t always secure

Definition:  IOUs issued by a company or a government

Discussion: A bond is a formal contract to repay borrowed money with interest at fixed intervals for a finite period of time. That contract can be contravened under a process we call bankruptcy.

When bankruptcies happen, bondholders are supposed to be more assured of repayment than holders of a kind of securities called “stock”. However, that isn’t always the case. Washington Mutual bondholders, like its stockholders, received virtually nothing when the bank went bankrupt.

The thing about bonds is that they are fixed debt securities. This means that they pay a fixed rate of interest over a certain amount of time. Interest on bonds, like dividends paid on stocks, is taxed at ordinary income rates, rather than at the lower tax rates for capital gains.

However, if the holder sells a corporate bond before its “maturity date,” the seller can incur capital gains  or capital losses. Capital gains taxes are levied on money made when buying and selling securities, (i.e., stocks or bonds).

Related terms: capital gains taxes; stocks

Copyright © 2011 Nancy K. Humphreys

Green Grow The Dollars by Emma Lathen (NY: Pocket Books, 1982)

Previously I reviewed a book by two male economists, called Murder at the Margin. Well, they weren’t the only economists who wrote mystery books! A much more famous mystery series was written by a dynamic female duo who met as students at Harvard University. Martha Henissart went on to become an economist.  Mary Jane Latsis went on to become an attorney. Together they wrote twenty-four books under the pseudonym of “Emma Lathen”. (from LATsis plus HENissart)

Emma Lathen is vastly underrated. It’s difficult to find her books these days. But they’re even more timely than ever. Lathen’s hero is John Putnam Thatcher, head of The Sloan Guaranty and Trust in New York City. Lathen’s heroine is Thatcher’s ever-reliable secretary Miss Corsa, who often catches small details her boss overlooks. And frequently, those small details launch her boss, Thatcher, right into the throes of a mystery involving financial shenanigans.

When I read these books years ago, I knew nothing about investment banks. Now, however, we all know a lot more about those institutions than we did. Recently I came across Lathen’s Green Grow the Dollars at a free book exchange nearby. Re-reading this story of the patent battle between two genetically-altered tomato researchers at seed companies in Wisconsin and Puerto Rico, I enjoyed it twice as much as the first time.

Since the first time I’d read it, I’ve been to professional conferences of the type the book describes in such sardonic detail. I understand the terms Thatcher tosses around with Charlie Trinkham, Walter Bowman, and Everett Gabler, his subordinates at the bank. And I appreciate even more than before Rose Corsa’s discretion and wisdom, having met so many women AA’s who were so much more clued in than their bosses during my career as an employee.

The only thing that seems dated now is the fecklessness of the bank’s President. Heads of financial institutions these days have to be much more savvy about what’s going on in their banks than the Sloan’s Bradford Withers, who in this book was preoccupied mainly with his sailing trip to Nicaragua. Thatcher, as usual, deftly avoided his boss’ invitation to lunch, preferring to ask a client to dine out with him instead.

Lathen’s mysteries are well-plotted and teach a lot about the world of high finance and the world of human fallibility. But what isn’t acknowledged is her brilliant writing and her wit. She can be as literary and biting as the best mystery writers today. Here’s a prime example of her drollness as she introduces the reader to Howard Pendleton, a biological researcher who claims fame for creating a tomato that grows year round:

“Ditchdiggers enjoy less prestige, and less take-home pay, than brain surgeons. Asking why, economists have come up with more explanations than you can shake a stick at. All of them are wrong. The differential exists because mankind esteems what it does not understand. As history proves, incomprehension always informs the prevailing standard of value. Keepers of the people’s secrets–Zulu indunas, kings imbued with Divine Right, Mahdis who saw what others did not–were yesterday’s top dogs. Today we have scientists.

So long as they are the only ones who see precisely why E equals MC2 , scientists have us where they want us.

But contrary to widespread superstition, they are not all Albert Einsteins. They are actually a representative cross section of the general population, with the important reservation that whatever they are doing is totally baffling to the rest of us.

Until of course, it cures us, blows us up, or lands us on the moon.”

Copyright © 2011 Nancy K. Humphreys

OCR – Optical Cheating Recognition agency

Definition: OCR is the Office of Credit Ratings, a new unit of the SEC that oversees credit-rating agencies.

Discussion: The government believes that optimistic ratings of mortgage derivatives and other bank investments by credit-rating agencies promoted the financial crisis. So, the Dodd-Frank reform law has set up an overseer for the big credit rating agencies.

No, these are not the personal credit-rating bureaus you may be familiar with: Equifax, Experian and TransUnion. These credit-rating agencies rate sizable organizational debt. They include Moody’s, McGraw Hill’s Standard & Poor’s, and Fimalac SA’s Fitch.

But here’s the rub – credit raters rate government debt too.

In fact, this week Standard and Poor’s threatened to downgrade our US government debt. So, here’s the dilemma: what if the watchee watches the watcher?

If the government is watching S&P, and S&P is watching the government, and they disagree about the safety of our sovereign debt, which one can you trust? And then again, if the government regulates the raters, can you trust them if they agree?

Related term: credit rating agencies

Copyright © 2011 Nancy K. Humphreys

Capital gains tax – welfare for the wealthy

Definition: Capital gains tax is tax on profits from sales of investments

Discussion: “Income” from profits on sales of financial investments, e.g. stocks or bonds, held for less than one year is taxed at a maximum rate of 15%. The financial investments invested in are called “assets”. To owe taxes on capital gains you make from investments you must buy financial assets low and sell them high. Income you make on buying and selling investments is called portfolio income.

Non-investment assets that you make money on while holding onto them for a longer term produce a type of income called “passive income“, e.g., rents and royalties. This income too has an effective rate (after deductions) of around 15%. However, the IRS lumps together passive income along with “earned income,” into a category called “ordinary income“. Ordinary income is the opposite of capital gains income, and it is a graduated tax where you pay more tax the more you earn.

For earned income, a rate of 15% tax in 2011 puts you at the bottom of the income tax schedule, e.g., earnings of up to $34,500 if single or 69,000 if married, filing jointly. Earned income above those amounts winds up being taxed at higher rates than investment income. That’s because the capital gains tax is always 15% or less. In other words, earned income that falls between the 15% and 38% marginal tax brackets is taxed more heavily than the same amounts of income made from sale of investments held for a short time (less than one year).

In addition, if you have a loss rather than gain on your portfolio income, you can take that loss as a deduction. This is called a “capital loss”. No such deduction is allowed for a loss on earned income.

What would a loss on earned income look like? It would be a loss on the value of your wages through inflation. It could also be a loss from cutbacks in wage rates for your job, such as the cuts in pay and benefits that public employees are taking right now. If you worked the same job and same hours, but earned less during the year, you’d have a deductible loss against your taxes on earned income for that year.

“It’s not how much you make; it’s how much you keep that counts.” Ed Slott, 2010 PBS special “Lower Your Taxes Now and Forever”

Broader term: income tax

Antonym: ordinary income tax

Synonyms:  portfolio income tax; investment income tax

Related terms: earned income tax; passive income tax

Copyright © 2011 Nancy K. Humphreys

Private property – the illusion that property is not part of nature

Definition:  Land that is not owned by the government or dedicated to public use. (Nolo’s Plain-English Law Dictionary)

How shocking it is to drive through a part of a country that’s been devastated by catastrophes and see the weeds growing three feet tall through cracks in buildings that once were filled with people!

Examples

(1) Ghost towns of the American West

(2) The upper peninsula of Michigan in the 1980s

(3) Chernobyl

Private property is erroneously contrasted with state, community, and government property. State, community and government property is a form of stewardship over the commons on behalf of the people who occupy the commons. Private property (as well as “personal” property) should actually be contrasted with the commons.

Because private property is deemed separate from nature, it is frequently the cause of negative externalities.  Usually it is the commons, i.e., nature and/or taxpayers, that bear the costs of dealing with those externalities.

Antonymns: nature; commons

Copyright © 2011 Nancy K. Humphreys

Commons – wealth enjoyed by all, common wealth

Definition: Property that the people of a nation own

Examples:

(1) Our laws. Until 1998, West Publishing Company claimed it owned the “rights” to publish all federal American laws because it claimed it had copyright over the pagination of federal law. (Copyrights are legal rights that go back into the public domain after a certain number of years)

Because attorneys needed to include the location (i.e., page reference) of laws they they cited in legal proceedings, West had a defacto monopoly over federal law.  In 1998 a court ruled that American law belongs to everyone. It is again part of the public domain or commons. (Silent Theft: The Private Plunder of Our Common Wealth) by David Bollier, 2003)

(2) Community gardens – treasures  owned by a local communities

(3) Parks, including our national parks and the oldest park in the nation, the Boston Common.

Common wealth is the glue that binds a nation and makes it strong; it is the commons that frequently bears the cost of externalities from private enterprises.

Related terms: public domain; parks; nature;  leasing; copyrights; externalities; privatization

Copyright © 2011 Nancy K. Humphreys

Nature – a double edged sword by which we humans slay ourselves

Definition:  “Nature means the sum of all phenomena, together with the causes which produce them…”
(John Stuart Mill, “On Nature” p. 1)

Explanation: John Stuart Mill, British philosopher and political economist, points out in this essay the confusion we fall into when using the word, “nature”. Nature is viewed as a powerful force outside of us, and nature is viewed as an equally uncontrollable force within us. Are we part of nature or separate from nature? Can human nature be unnatural? The word, “nature” has become an utter paradox.

Wars can result when the definition of “nature” shifts from one meaning to the other.

Example: “It is human nature to want more than we can have; but Nature will not allow us to have all that we desire.”

This confused thinking underlies the chief principle of “scarcity economics” named the “guns and butter” tradeoff” by Paul Samuelson in his classic econ 101 textbook. Let’s sort it out:

Does the above sentence mean that (Mother) Nature has made us want more than we can have, and (Mother) Nature will not allow us to have all of it?

Or does it mean that human nature makes us want more than we can have, and human nature (our own negativity perhaps) will not allow us to have all of it?

Is it Nature or is it nature? What’s the difference?

Note on guns and butter: In 1948 Paul Samuelson started with the idea of a society that produces two goods: guns and butter. Writing in the shadow of World War II with its rationing of tires, stockings, sugar, gas, and other scarce items in the US, Samuelson made his two-good economy one torn between producing military goods or civilian goods. Then he ramped up his guns and butter “metaphor” to stand for public and private spending:  “Thus the more resources the government uses to spend on public highways, the less will be left to produce private goods like houses.” [or vice versa].

And so, from the humble beginnings of two simple words, “guns” and “butter,” we get to the present battle of the budget in Washington DC tonight.

Copyright © 2011 Nancy K. Humphreys

CHIMPS – budget cuts that improve government efficiency

Defintion: CHIMPS is the acronym for “changes in mandatory program spending”

Explanation: Currently Congress is only discussing “domestic discretionary spending,” a very small slice of the federal budget. Democratic Senator Charles E. Schumer of New York, suggests that CHIMPS be included in the discussion.

Mandatory spending on programs is not discretionary; it is mandatory. However mandatory spending does not dictate how program goals should be achieved. Schumer argues that jobs and money could both be saved by CHIMPS. Mandatory programs are found in different sectors of the economy than discretionary programs.

Related term: discretionary program spending

Copyright © 2011 Nancy K. Humphreys

If you have a yard full of orange trees, lemon trees, and lime trees, and the lemons and limes had all been picked, which fruit would be left?

Thanks to whatever group you care to name and blame, the “limes” and “lemons,” i.e., the middle classes and the poor, are fast losing ground in this century. Their demise began in the last century when capitalism began to take a global turn in earnest.

In this century we can expect to see continuing unemployment, cuts in programs for the poor, and wage decreases due to union-busting, the coming inflation, and pressure from the unemployed who increasingly will be cut off from unemployment compensation.

And there is an imminent threat to the rich too.

This week Columbia University economist Jeffrey Sachs wrote an article for the Financial Times titled, “Stop this race to the bottom on corporate tax“. Sachs points out that the dominance and mobility of global capitalism is pushing the US and other countries into a race for the bottom when it comes to corporate taxes and loopholes for taxes on the rich.

Says Sachs, “The problem [with this race to the bottom] is that both the US and UK are aiming to do the impossible: run a modern, high-technology, prosperous 21st-century knowledge economy without the requisite tax base…”

The race to the bottom

Have you noticed those tax cuts for the rich now being proposed? A maximum US federal tax of 25% for all? For years I’ve thought the reason behind tax cuts for the rich is that rich people are assumed to fund corporate production. This week I see my error. Rich people are needed for their consumption, not for their production!

It seems “conspicuous consumption” is a necessary byproduct of capitalism when government is used to transfer large amounts of wealth from the poor and middle class to the rich through taxation of wages, erosion of wages via inflation, stimulus funds for large corporations, and tax cuts and loopholes for corporations and the rich.

According to Kelly Evans in the Wall Street Journal article “Gains in Income Aren’t Lifting All Boats,” incomes of the working and middle classes are steadily being eroded. “Roughly 40% of consumer spending these days is generated by the the upper fifth of households.”

Evans adds, “UniCredit economist Harm Bandholz notes the share of U.S. consumption financed by labor income [i.e., "earned" income as opposed to "passive" income made form investments] has declined to abut 61% today from 85% in 1970.”

According to a Financial Times report  “Credit card Firms Target Rich Not Poor,” credit card corporations  are now wooing “wealthy customers” to offset the dangers from the card companies’ “exposure to increasingly indebted low-income borrowers.”

Says the FT, “The average wealthy borrower carries about $3,124 in credit card debt a month, $326 less than last month. By contrast, the average low-income borrower’s debt has risen by 100 over the same period to $2,464 a month…”

So when the income of working and middle classes is gone, who’s next? Who pays when it comes to raising taxes after the “lemons” and “limes” have all been picked clean? Obviously it will be the rich.

But how could taxes on the rich be raised?

No doubt you think the rich in this country have all the power?  Not so! We have a superrich class in this country too.

See the following income charts from Mother Jones for a pictorial description of the rich in America. Note that the title of the article, “How Rich Are The Superrich” is totally misleading. These charts describe the rich, not the superrich.

According to these charts, the top one percent of Americans in terms of income are merely millionaires, and the top ten percent of Americans families have an average income of only $164,647.

The real superrich are the billionaires, headed towards becoming trillionaires, who control the largest of the US corporations. Large corporations are a tiny minority of existing corporations. 95% of American corporations have five employees or fewer. Only 5 % of US corporations are what you’d call large.

The superrich are not limited to America either. The richest man in the world lives in Mexico, not the US. The man who is the fourth richest in the world lives in Indiia. The superrich are a global class. Their power and interests stretch around the world.

The superrich are the ones who own the corporations that are competing internationally for corporate tax cuts everywhere. It is not just states within the US who are cutting taxes for corporations; it is states all over the world.

The demise of rich Americans

Here’s what I see coming for the rich. When the superrich are done squeezing out every dollar they can from middle class and the poor, the superrich only have one place left to go. They can’t raise corporate taxes – that would hurt their own pocketbooks. They have go after the rich to pay for the public goods and services that the poor and middle classes now pay taxes for.

The rich, who currently find their interests allied with those of the superrich at the pleasure of whom they have high paying jobs will find that is no longer the case. When the superrich need more money, they will have to get it from the ten percent of American families who earn an average income of $164,647.

What we’ll be likely to see then is that a disgruntled upper middle class will be cleverly, through the media owned by the superrich, pitted against the rich in democracies, which by then will be prevalent around the world.

On this path, we are not headed toward the utopia Star Trek portrays with its 23rd century United Federation of Planets. The prime directive of this world is make profit, not seek out new life.

The failure of economic systems based on greed

And here we get down to the unsolved problem of global capitalism. Just as with the mercantilist (i.e., “colonial “) system that came before global capitalism in the 17th and 18th centuries with the rise of nation states, trade between countries, and navies, capitalism too will be unsustainable.

Eli Heckscher shows in his economic and psychological analysis in his multi-volume book, Mercantilism, colonialism failed because the mother countries in Europe relied on using cheap imports from their colonies to manufacture expensive finished goods to sell back to those colonies.

Mercantilism was the opposite of free trade. Colonials, by law, were banned from competing with the mother country in producing and/or selling finished goods themselves. Nor could a colony buy goods from a European power that competed with their own mother country. On top of that, colonials were taxed by their mother countries.

Colonies had to import manufactured goods, at a cost which, over time, increasingly became onerous. In the end, colonials just didn’t have the money to keep on buying expensive imports from their mother countries from Europe. The rest is history, our history in particular.

Capitalism that spews out globally-produced cheap goods made by corporations owned by the superrich will be similarly in trouble. Global capitalism is also based on a massive imbalance of one-way wealth.

With most of the rich taxed almost as heavily as the middle classes and the poor, who will be left to buy things that the superrich produce? After all, there is only so much this very tiny class at the top of the world can use for itself! And credit cards can only go so far to provide for the rest of us! This raises the question…

How far do we have to go before the insanity of this becomes clear to everyone?

Cat Bond – a bond that purrs loudly when things are good and scratches like hell when they aren’t

Definition:  A “cat” bond is an extremely risky, high-interest, long-term bond that is paid back only if a pre-specified catastrophe does not occur

Explanation:

Normally insurance companies (and their insurers, who are called “reinsurers”) assume all the risk for calamities that befall their clients. In the case of cat bonds however, the insurance company (or an investment bank) sells bonds that pay off investors only if a catastrophe doesn’t happen.

If a pre-designated disaster doesn’t happen, the bondholder (usually a hedge fund or other type of large investor) cleans up from payments of high yields and repayment of their total principle by the insurance company that created the cat bond.

If a catastrophe does happen, the principle on the cat bond is not paid back; it is used by the insurance company to pay its clients’ claims from the disaster.

This is literally a bond that lets you “bet your shirt on the weather”.

Broader terms: securitization; diversification; cat models

Copyright © 2011 Nancy K. Humphreys

Bezel – a metal band that binds a precious gem – a thing we don’t notice until the gem is gone

Definition: “The bezzle” is the total value of “undiscovered embezzlement” at the nation’s businesses and banks.

Famed economist, John Kenneth Galbraith, in his book, The Great Crash of 1929, points out the ebb and flow of “the bezzle” during times of boom and bust.

Examples:

Retail businesses often write off 10% in losses each year to “shrinkage,” i.e., pilfering by employees.

The Association of Certified Fraud Examiners has found that “Organisations worldwide lose 5% of their annual revenues to fraud…”

“Frauds committed by owners and executives are more than three times as costly as those committed by managers and more than nine times as costly as employee frauds. Executive-level frauds also take much longer to detect.” (Source: Ian Wylie, Financial Times, March 7, 2011)

Synonyms: white collar crime; shrinkage; fraud

Related Posts: Bernie Madoff’s Wealth Redistribution and Fraud is Good for You! (guest post)

Copyright © 2011 Nancy K. Humphreys