Category Archives: Economy

How NOT to finance public works: The Capital Appreciation Bond Saga

Capital appreciation bonds God help school board members. They don’t get paid for their service, and they certainly aren’t compensated for the bombastic late night calls from irate parents when Little Fauntleroy isn’t selected for the lead in the annual 5th grade play.  That said, let’s explore one more reason for them to go gray while doing their civic duty: Swimming with Financial Sharks.

In late 2012 the Los Angeles Times reported that approximately 200 California school districts and community colleges had been talked into Capital Appreciation Bonds which promised to mitigate the problems associated with financing school construction costs. So, what could go wrong?

“CABs, as the bonds are known, allow schools to borrow large sums without violating state or locally imposed caps on property taxes, at least in the short term. But the lengthy delays in repayment increase interest expenses, in some cases to as much as 10 or 20 times the amount borrowed.”

Only, it wasn’t 10 or 20 times the amount borrowed – given the $500 billion borrowed could turn into $2 trillion in future repayments.

“Wall Street exploited the school boards’ lack of business acumen and proposed the bonds as blank checks written against taxpayers’ pocketbooks. One school administrator described a Wall Street meeting to discuss the system as like “swimming with the big sharks.”

Wall Street has preyed on these school boards because of the millions of dollars in commissions. Banks, financial advisers and credit rating firms have billed California public entities almost $400 million since 2007. Lockyer described this as “part of the ‘new’ Wall Street,” which “has done this kind of thing on the private investor side for years, then the housing market and now its public entities.” [SF.com]

This was lucrative business for such firms as Piper Jaffray, which pocketed some  $31.4 million in fees for brokering 165 CAB deals, or for Goldman Sachs which earned $1.6 million for a single deal in San Diego. [SF.com]

The argument in favor of Capital Appreciation Bonds is deceptively simple.  Most bond issues have steady repayment schedules and are limited to 30 years or less.   Capital Appreciation Bonds assume that the asset will appreciate in value or generate revenue for longer than 30 years or less – so, why not spread out the repayment schedule over a longer period? Here’s why, and here are two things to watch as the sharks circle:

(1) Watch for interestingly engineered estimates of future revenues.  If you are looking at property values that are expected to increase exponentially, then imagine the shark grin facing in your direction.  “Gee,” sayeth the Shark, “The recession can’t last forever, and property values will increase. Therefore, why not spread your borrowing costs over a longer period when you’ll be generating larger incomes?”

(2) Watch for the piling up of fees and interest.  Yes, the repayment schedules were such that school districts in California could construct gyms, classrooms, and other facilities that couldn’t get past voter disapproval of bond issues – but as with all loans the longer the repayment schedule the more interest will be paid. For example, the Savanna School District (Anaheim) took on $239,721 in CAB obligations in 2009 on which it will pay approximately $3.6 million by the 2034 maturity date. [Alter]  There are, unfortunately, other examples in Orange County, CA:

“Over the next 40 years, these bonds are projected to cost districts $2 billion as they repay them at rates of 1.1 times to 15 times the principal, according to figures provided by the state treasurer’s office. Conventional bonds typically carry a 2-to-1 or 3-to-1 debt ratio.” [OCR]

It’s entirely possible to call for more infrastructure construction and asset enhancement without having the specter of the Capital Appreciation Bond salesman showing all fifteen rows of teeth in each jaw.  We should also call this kind of dealing what it is – predatory lending.  The Roosevelt Institute provides a summary:

“The financialization of the United States economy has distorted our social, economic, and political priorities. Cities and states across the country are forced to cut essential community services because they are trapped in predatory municipal finance deals that cost them millions of dollars every year. Wall Street and other big corporations engaged in a systematic effort to suppress taxes, making it difficult for cities and states to advance progressive revenue solutions to properly fund public services. Banks take advantage of this crisis that they helped create by targeting state and local governments with predatory municipal finance deals, just like they targeted cash-strapped homeowners with predatory mortgages during the housing boom. Predatory financing deals prey upon the weaknesses of borrowers, are characterized by high costs and high risks, are typically overly complex, and are often designed to fail.” [RooseveltInst]

High cost, high risk, overly complex, and sold to the school boards as a way to finance capital projects without breaking the “no new taxes” pledges.  The thought of paying out at 15:1 when the debt costs should have been no more than 3:1 is possibly worse than the ranting of Fauntleroy’s mother after the 5th grade play cast was announced. And so we come to the camel’s nose into Nevada’s tent with a recommendation for infrastructure funding:

“Along these same lines, there may be instances where changing legislatively imposed requirements relating to bonding may benefit from increased flexibility. For instance, bonds for capital projects are generally limited to terms of less than 30 years. However, in a limited number of cases, such as projects which generate user fees or for which the useful life of the asset extends beyond 30 years, there may be instances where longer financing terms may be useful to accelerating the timeline of a needed capital project.” [Applied Analysis]

What is Applied Analysis (client list includes Chambers of Commerce) recommending?  “More flexibility” in bonding requirements? This sounds ominously like California’s infamous AB 1388 which launched the CAB craze in our western neighbor.  Lengthen the repayment period to the life of the asset? The average functional life of a school building is 40 years. [NCES] So, a capital appreciation bond could be issued for 40 years – go back to the unfortunate example of the Poway School District, wherein borrowing $150 million ended up costing $1 billion.

School board members, as well as city and county officials, should approach suggestions that they want “more flexibility” and “longer repayment schedules” with exactly the same trepidation they’d approach the water when the shark alert sign goes up.

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Filed under Economy, education, Infrastructure, Nevada economy, nevada education, Nevada politics, nevada taxation

Home Defects, Budget Shortfalls, and Picking Losers

Jig Saw Puzzle

Interesting items, each worthy of a post, but in the interest of keeping up to date – here are some newsworthy items deserving of a click and read.

Nevada Legislature: Take a moment to read Eli Segall’s piece in the Las Vegas Sun about the interest taken in the Assembled Wisdom about homeowner complaints in regard to construction defects.  Here’s a taste:

“Supporters say the proposal will boost construction jobs, but outside analysts say it will hammer trial lawyers, a political and business foe of builders, and, despite the bill’s name, will make it harder for homeowners to sue for shoddy workmanship.”  Why?

“As proposed, AB 125 would, among other things, strip homeowners’ ability to recover reasonable attorney fees in defect cases; require homeowners to state each problem in “specific detail” rather than in “reasonable” detail as current law allows and to give the defects’ “exact” locations in the house; and change the definition of a constructional defect, eliminating the provision that such flaws are made in violation of law and local codes and ordinances.”

Republicans in Disarray?  There is an effort to recall Assemblyman Hambrick (R-NVAD2).  Hambrick, GOP opponents say, has Strayed From the No New Taxes Pledge. [LVRJ]

School Daze: There’s this from Let’s Talk Nevada:

“8:00 AM: H/T Ralston for this. Pedro Martinez, the man Governor Brian Sandoval (R) hand-picked to run the new “Achievement School District” where he wants to transfer 10% of Nevada public schools into, is so dedicated to improving public education in Nevada… That he’s now running for School Superintendent in Boston. And yes, that’s Boston, Massachusetts.”

Meanwhile in Wisconsin under the Austerity/Trickle Down Hoax regime of Scott Walker – the governor’s solution to the $283 million budget shortfall created by his tax cuts is to skip $108 million in debt paymentsAnd in Kansas, the legislature backed down and decided to allow governor Brownback to sweep $475 million over the next two years from KDOT into the budget hole created by his tax cuts. [Kansas.comGet ready Ohio, governor Kasich is gearing up his 23% cut in the state income taxes over the next two years.

And in Congress, the Republican leadership is operating on the same theme:

“House leaders plan to schedule votes this week on seven bills recently approved by the Ways and Means Committee to make permanent an array of “tax extenders,” a set of primarily corporate tax provisions that policymakers routinely extend for a year or two at a time.  The seven measures, which will likely be packaged into a smaller number of bills for floor consideration, are the first installment in a series of bills that House leaders are expected to move to make many of the largest tax extenders permanent, while offsetting none of the cost.”

I think we’ve seen this before, and labeling it “Credit Card Capitalism,” wherein the Bush Administration turned the Clinton Administration surplus into a massive deficit – and then blamed the Democrats for “tax and spend” policies.  We might get the drift – the Republicans get into control, lower the taxes and revenues, thereby piling up a massive debt. The Democrats take back the control, enact taxes to fill the holes in the state budgets – and the GOP screams about “Tax and Spend?”

About those “economic development” and “job creating” ideas – a report (pdf) from North Carolina documents that 60% of the recipients of their incentive awards were cancelled because the firms failed to live up to their promises. H/T Angry Bear.  The story is about the same in Wisconsin:

“The Wisconsin Economic Development Corporation, a public-private body set up by Walker shortly after he took office in January 2011, was supposed to help the state climb out of recession by shedding bureaucratic rules and drawing on private-sector expertise.

But the WEDC has fallen short of its own goals by tens of thousands of jobs and failed to keep track of millions of dollars it has handed out. One reason for the agency’s disappointing performance: Walker’s overhaul of the state bureaucracy drove away seasoned development workers, economic development experts who work closely with the agency told Reuters.” [CapBlue]

There are other ways to create jobs and improve our economy; take a look at the CAP proposal for the Appalachian region.

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Filed under Economy, Nevada legislature, Nevada politics, tax revenue, Taxation

GOP: Protect the Sharks!

Pay Day Lending Shark Some dots connect.  Dot Number One:

“A bill passed Wednesday by the House would set new limits on, and effectively cut, the amount of money the Consumer Financial Protection Bureau can spend.

The legislation, passed with nearly exclusive Republican support, was originally aimed at placing new limits on agencies writing regulations, requiring them to conduct more analysis on their impact and subjecting them to additional legal review.” [The Hill]

First, the amount cut from the Consumer Financial Protection Bureau would be some $36 million dollars less than the expected expenses for the CFPB in FY 2016.  Secondly, the “more analysis” part translates to “cost/benefit analyses” which have been a crucial part of the Republican litany.  There’s a reason to suspect that this particular dot comes with some major freight.

The “cost/benefit” analysis nearly always comes skewed in favor of the corporations.  The Institute for Policy Integrity found this to be the case in the instance of coal ash regulation in 2010, and while the major impact of the bill would be to the Environmental Protection Agency – a popular whipping boy for the Right – the abuse of the cost/benefit analysis regime could be equally unhelpful for American consumers.  The problem can be summarized as follows:

“Regulatory cost-benefit analyses are inherently vulnerable to challenge. The long-term benefits of regulations are often difficult to quantify, while the costs can be immediate and straightforward. The calculations can be even more complex with public health and safety issues, where the value of human lives must be weighed against corporate costs.” [HuffPo]

In this case we have to ask do the short term losses to the payday lenders outweigh the long term benefits of not having working Americans subject to usurious lending rates?  Evidently, Representatives Heck (R-NV3), Hardy (R-NV Bundy Ranch), and Amodei (R-NV2) [rc 64] believe that the short term losses which might accrue to the payday lenders are of more significance than the long term problems associated with payday lenders in underserved communities?   At the least, they’ve voted in favor of placing more hurdles – in the form of more litigation – in the way of any agency such as the CFPB seeking to curtail some of the more egregious business practices of payday lenders. (For more information on Cost/Benefit Analysis see Better Markets.)

Dot Number Two:

“But a late amendment from the bill’s primary sponsor, Rep. Virginia Foxx (R-N.C.), would also place new limits on the funding for the CFPB.

Foxx’s amendment, added to the bill at the House Rules Committee before it reached the House floor, would cap CFPB funding at $550 million — $36 million less than the Congressional Budget Office estimated the CFPB would spend in fiscal 2016.”  [The Hill]

Now, why would this particular agency be mentioned in this “late amendment?”  If Dot Number One makes it more difficult for an agency, such as the CFPB, to finalize regulations on corporate activity,  Dot Number Two makes it even more difficult for the CFPB to defend its proposed regulations.  Leading us to Dot Number Three.

Dot Number Three: The Consumer Financial Protection Bureau is, in fact,  about to release rules governing payday lending practices [NYT] against which the $46 billion a year industry is lobbying hard and fast.

“The rules are expected to address expensive credit backed by car titles and some installment loans that stretch longer than the traditional two-week payday loan, according to industry lawyers, consumer groups and government authorities briefed on the discussions who all spoke on the condition of anonymity because the deliberations are private. Certain installment loans, for example, with interest rates that exceed 36 percent, the people said, will most likely be covered by the rules.

Behind that decision, the people said, is a stark acknowledgment of just how successfully lenders have adapted to keep offering high-cost products despite state laws meant to rein in the loans.” [NYT]

Translation: Because the payday lenders have been relatively successful thus far in avoiding or mitigating the attempts by the states to rein in some of their more egregious practices, the CFPB has stepped in to assist consumers avoid these financial pitfalls.  And, the Republicans are quite obviously marching in step with payday lending industry lobbyists.  Now, we can see why this was one of the first bills introduced in the 114th Congress, the timing isn’t simply a matter of coincidence.

Dot Number Four: There is a secondary market for payday lender loans. [HoustonSmallBus] [ABA]  And, wouldn’t you know it – AIG and private equity group Fortress Investment Group launched a securitization of sub-prime personal loans (read: payday) in February 2013. [WallStJ]

“The $604 million issue from consumer lender Springleaf Financial, the former American General Finance, will bundle together about $662 million of loans secured by assets such as cars, boats, furniture and jewelry into ABS, according to a term sheet. Some loans have no collateral.” [WSJ]

The last time someone tried this – Conseco Finance Corporation – things did not end well. Conseco ended up in bankruptcy in 2002.  ZeroHedge opined that the Springleaf Financial deal was a resurrection of the worst of the pre-Great Recession credit bubble.   With this in mind, should it come as any surprise that Springleaf Financial partnered with private equity firm Centerbridge Partners LLP in wanting to buy into Citigroup’s One Main Financial – the big banks subprime lender? But wait, there are more suitors.  Citigroup is trying to offload that subprime business, to focus on “the affluent customer,” and Apollo Global Management has joined the potential buyers list as of January 2015.  [BloombergBus]

Let’s muse: If the Consumer Financial Protection Bureau announces regulations that might put a crimp in the profitability of payday loans, particularly those subprime personal loans which have been securitized (ABS) then the bidders from the Springleaf/Fortress operations and Apollo Global Management might not want to pay more for Citigroup’s One Main Financial – which it would very much like to offload onto someone – Lonestar, Springleaf/Fortress, or Apollo Global Management?

Or, to muse and speculate less kindly:  There’s a deal in the works to sell a subprime personal loan unit from a major U.S. bank; there are bidders from private equity firms, and it would be better for the Big Bank if the CFPB would butt out of any activity which would make the subprime personal loan units less attractive.  Further, the subprime personal loan securitization schemes might be less profitable if the CFPB puts the brakes on some of the more “profitable” practices.   If the subprime personal loan lenders aren’t as “profitable” then they might not be able to bid as much as wished for the One Main Financial spin off?

Hence, it’s necessary, nay Vital, that the CFPB be made to back off the subprime personal loan regulations and allow the bankers to continue to securitize those loans and to deal for a bigger share of the subprime personal loan pie?  Would this be part of the reason for the rush to get H.R. 50 through a compliant House of Representatives?

The Republicans have not demonstrated any particular interest in protecting the sharks of the natural variety, but they seem bent on protecting the financial ones.  And, the bigger the shark the better?  Nevada Representatives Amodei, Heck, and Hardy played right along.  Representative Titus (D-NV1), to her credit,  voted “no.”

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Filed under Amodei, banking, Economy, financial regulation, Heck, Nevada politics

From CDO’s to BTO’s: Wall St. tees up the next financial disaster

Wall Street Greed CDO

Think Progress picked up on a piece from Bloomberg News which ought to be raising eyebrows on Main Street.  The banksters are at it again, only this time those pesky Credit Default Obligations which brought down our financial system in 2007-2008 have been repackaged and served up under a new label: Bespoke Tranche Opportunities.

As the Think Progress analysis reports, these derivatives were an extremely important part of the last mess:

“The Financial Crisis Inquiry Commission concluded that derivatives “were at the center of the storm” and “amplified the losses from the collapse of the housing bubble by allowing multiple bets on the same securities.” In 2010, the total on-paper value of every derivative contract worldwide was $1.4 quadrillion, or 23 times the total economic output of the entire planet.”  [TP]

Let’s be careful here, not all of that $1.4 quadrillion is in BTO’s, but the newly labeled derivative has that same capacity to “amplify the losses” when the underlying value of the securities becomes volatile.  For those who would like this explained in really clear diagrams, click over to the Wall Street Law Blog and follow along with the  White Board Wine Glasses Explanation – one of the best I’ve discovered to date.

Now, we can move on to what makes these BTO’s a problem, beginning with their creation:

“The new “bespoke” version of the idea flips that (CDO) business dynamic around. An investor tells a bank what specific mixture of derivatives bets it wants to make, and the bank builds a customized product with just one tranche that meets the investor’s needs. Like a bespoke suit, the products are tailored to fit precisely, and only one copy is ever produced.” [TP]

Now, why would anyone want to buy one of these products, much less order a special one?  In the Bad Old Days  fund managers could choose to purchase some tranched up CDO, those blew up, so why go out and order one tailored to their specifications?  Let’s return to the Bloomberg article:

“Goldman Sachs Group Inc. is joining other banks in peddling something they’re referring to as a “bespoke tranche opportunity.” That’s essentially a CDO backed by single-name credit-default swaps, customized based on investors’ wishes. The pools of derivatives are cut into varying slices of risk that are sold to investors such as hedge funds.

The derivatives are similar to a product that became popular during the last credit boom and exacerbated losses when markets seized up. Demand for this sort of exotica is returning now and there’s no real surprise why. Everyone is searching for yield after more than six years of near-zero interest rates from the Federal Reserve, not to mention stimulus efforts by central banks in Japan and Europe.”  (emphasis added)

Translation: Because interest rates have been kept low by central banks hoping to keep struggling economies moving ahead, banks haven’t been able to make what they deem to be enough profit off corporate and Treasury bonds, and therefore have started playing in the “financial product” game again (not that they ever really stopped for long) and have started making ‘bets’ (derivatives) in the Wall Street Casino – with ‘products’ (BTO’s) which aren’t subject to the reforms put in place by the Dodd Frank Act.

So, what’s the problem? A hedge fund manager wants to buy a structured financial product from a bank which has a higher yield than what he can get by investing in corporate bonds or Treasuries… what could go wrong?  Let us count the ways.

#1.  These securities aren’t tied to the performance of the real economy as corporate bonds would be.  In the jargon du jour, the BTO portfolio is a table of reference securities.  Here come the Quants again, there are formulas for determining the ‘value’ of these securities which may or may not be valid, and they certainly weren’t during the Housing Bubble.

#2. The yields are related to the the ratings.  Here we go yet again. One of the major ratings services, Standard & Poor, is ever so sorry (to the tune of a $1.5 billion settlement with the Justice Department) they helped create the Derivatives Debacle of ‘07-‘08, but that hasn’t stopped them from continuing to get involved in evaluating derivatives. [See the FIGSCO mess]

#3. The BTO encourages the same Wall Street Casino behavior we saw in the last Housing Bubble/Derivatives Debacle.  It’s explained this way:

“The trouble with this game is that the value of most structured finance products is opaque and subject to sharp and violent change under conditions of financial stress. So when they are “funded” in carry-trade manner via repo or other prime broker hypothecation arrangements, the hedge-fund gamblers who have loaded up on these newly minted structures are subject to margin calls which can spiral rapidly in a financial crisis. And that, in turn, begets position liquidation, plummeting prices for the “asset” in question, and even more liquidation in a downward spiral.” [WolfStreet]

Sound familiar? Sound a bit like Lehman Brothers?  Remove the jargon and the message is all too familiar – no one really knows the value of the structured product, and if the product is purchased with borrowed funds it’s subject to margin calls (people wanting their money back) which in turn leads to sell offs and the price for the “thing” drops off the financial cliff, and…. down we go. Again.  We’ve seen this movie before, and the ending wasn’t pleasant.

#4. The BTO is a way around financial reform regulations. The offerings, be they FIGSCO or BTO’s are being peddled at the same time the Financialists are trying their dead level best to (a) get Congress to whittle down the regulations put in place under the Dodd Frank Act financial reforms; and (b) figure out ways to get around the Dodd Frank Act provisions – witness the BTO.

The profit motive is perfectly understandable. If I can invest in something that pays more than a Treasury bill or bond, or more than a corporate bond, then why not?  However, at this point, as an investor, I need to make a decision – Am I investing or speculating?  If I’m investing then it would make more sense to take a lower yield on something that has a more credible value. If I’m speculating (gambling) then why not borrow some money and purchase some exotic structured financial product the value of which is far less credible (or even comprehensible) and “make more money?”

It’s speculation that tends to get us into trouble. This new round of creative financial products shows all the elements that got us into financial trouble the last time in recent memory.  Formulaic determination of value which ran head first into the wall of reality. Valuations which were based on “what’s good for business,” rather than on what might be other plausible outcomes.  Emphasis on speculation rather than investment – or on financialism rather than capitalism.  Short term yields as opposed to long term investment.

It was a recipe for trouble in 2007-2008 and it’s still a recipe for trouble in 2015.

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Filed under banking, Economy, financial regulation

Wall Street, Main Street, and Nevada’s Working Families

Average hourly earnings

The Bureau of Labor Statistics released its Jan. 30th report and we get a look at the reason some people aren’t feeling all that Bullish about the economy.  For starters there’s the chart shown above – the average hourly earnings increases or decreases.  Those zeros aren’t all that appealing. Even during the housing bubble period (2005-2008) the increases in hourly earnings weren’t  all that impressive.  The table for average weekly hours for all employees in the private sector isn’t much more delightful – being filled with more zeros as it is.

Average hourly earnings haven’t moved much since 2006, average weekly hours haven’t moved much more, and thus we have a situation in which about the only way to stay in place is to take on more consumer debt.  As illustrated in a 2013 publication from the NY Federal Reserve:

Consumer Debt Trends Chart

There are a couple of ways to look at the chart – for the half-full souls it looks like people are shedding mortgage debt, for the half-empty it looks like fewer people are buying homes and therefore the construction sector is still a bit weak.  The New York Federal Reserve reports on consumer indebtedness on a quarterly basis, the last report told us:

“Aggregate household debt balances increased slightly in the third quarter of 2014. As of September 30, 2014, total household indebtedness was $11.71 trillion, up by 0.7 percent from its level in the second quarter of 2014, an increase of $78 billion. Overall household debt still remains 7.6 percent below its 2008 Q3 peak of $12.68 trillion.”

Overall household debt includes housing debt. We might want to drill down to non-housing debt levels.

non housing debt balance

That large reddish swath is student loan debt, the orange is credit cards, and the green shows auto loans in the last ten years.  Remember, Wall Street has securitized this debt and it’s happily traded in securitized form in the financial markets; betting that Americans can (or can’t) pay off the debts incurred.   We can infer with some confidence that this national chart is representative of what’s been happening in Nevada.  Nevada’s median family income hasn’t exactly stormed up to the top of the charts.

Nevada Median Family Income 59 to 99

Nevada Median Family Income 2000 to 2013

The ACS reported an annual median income for Nevada families as $56,499 in 2000, and the number has struggled to maintain that general level. The number reported for 2013 is $51,230.

The good news is that Nevada’s unemployment rate is down to 6.8% as of December 2014. More good news is that we’ve seen a 3.7% YOY growth rate. [DETR pdf] Last August the state’s economist was pleased with the wage numbers:

“Wage trends during the first three months of the year in Nevada were a bit more encouraging than in prior quarters,” he said. “Whereas prior gains struggled to keep pace with inflation, this year’s first quarter gain outpaced the overall level of inflation. Specifically, inflation, as measured by the Consumer Price Index, came in at 1.4 percent relative to a year ago during the first three months of the year. Hence, wages grew in real terms.” [DETR pdf]

Before we dance, there’s the usual fly in the floor wax: “However, wage gains have been sluggish, averaging just a bit above one percent annually over the 2011-2013 period.”

Here’s the point at which it’s necessary to talk about the differences between Wall Street and Main Street.  If American consumers, Nevadans included, are taking on more student debt, car debt, mortgage debt, and credit card debt, Wall Street is buoyantly elated. More debt = more securitization = more financial products = more revenue = more bonus payments.  The picture isn’t quite the same for Main Street.

People make decisions about their own personal finances and those decisions create some markets and deplete others. For example, as of August 1913, the New York Federal Reserve was reporting that people holding student loan debt were “retreating from the housing and auto market.”  That would make sense – burdened by student loans? — then a person would be much less likely to take on auto loans or mortgages.  This means, of course, that the local auto dealership or the local developer isn’t going to see increased demand for his or her products – while those burdened with student and other loans or credit obligations decide not to take on yet more debt.  What’s great for Wall Street becomes a drag on Main Street.

There are at least a couple of ways to help people reduce indebtedness and thus enhance their local economies.   For those at the lower end of the economic spectrum we could increase the federal minimum wage.  This will be met with the usual objections, mostly commonly that employers will be forced to cut employees and therefore the people we hope to help will be the ones hurt.  This is a false argument. Hiring isn’t geared to wages, at least it isn’t in a free market economy. Again, and again, and again,  the only rational reason to hire someone, anyone, is that current staffing levels are inadequate to provide an acceptable level of customer service. 

Tax breaks, veterans’ status – those are nice, but if there is no increased demand for service at Ready Auto Dealers Inc. then an additional mechanic will not be hired.  Tax incentives, apprenticeships – those are nice too, but if there is no increase in the demand for single family home construction then Mugwump Brothers Construction won’t need to hire another carpenter. Free market enterprise simply works that way. 

If Nevada (and national) median family income remains stagnant, then the demand for goods and services will remain stalled. If average hourly earnings remain sluggish, and the average weekly hours fall along that line, then there is less demand for goods and services.  If middle income workers take on more debt, Wall Street is delighted, Main Street is on the defensive.

There is one way to finance projects which would help the Great American Middle.  Make some simple tax code reforms.   Wall Street will squawk to the Heavens, but we could (1) close the trust fund loophole which allows the ultra-wealthy to pass along appreciating assets to their offspring – tax free; (2) Raise the capital gains and dividend rates back to what they were when Ronald Reagan was in office – 28%; (3) put the breaks on excessive borrowing by Wall Street financial firms.  What could we buy with this?

For one thing, we could invest some of the revenue in INFRASTRUCTURE which will employ workers across the country in jobs which will create assets for states and municipalities.  Bridges, dams, water works, sewer systems, schools, aren’t counted on the books as liabilities – they are assets.  We might also want to consider investing in education and training facilities and employment.  Want to reduce the burden of student loans?

We could make it easier for states to finance their colleges and universities. Improve the Pell Grant program. Improve the GI Bill. It worked after World War II, it can work again.  We could assist working families by adjusting the child care tax credit, operating on the assumption that it’s more important to have children of working families in adequate day care than it is to protect the inheritance of far fewer trust fund children.  There are far more options available, once we stop protecting the interests of the ultra-wealthy, the friends and allies of Wall Street, and start giving a higher priority to the needs of average families on Elm Street who spend their disposable income on Main Street.

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Filed under Economy, education, Infrastructure, Taxation

It’s The Income Inequality Gap, and it’s stupid

Nevada Income Gap Map We’ve had the following information in hand since last February:

“The average income in Nevada rose just 8.6% between 1979 and 2007, among the lowest increases in the nation. However, most of the state’s residents actually lost money during that time, as average real income dropped by 11.6% for the bottom 99% of earners. For the remaining top percentile of earners, average incomes rose by 164% between 1979 and 2007. As of 2007, the top 1% accounted for 28% of state residents’ total income, the fifth highest percentage in the United States. The gap between the top percentile and other earners has further increased in recent years. Incomes for the top 1% rose by 4% between 2009 and 2011, while incomes for the bottom 99% of earners slipped by a nation-leading 6.7%. Nevada has struggled with high unemployment in recent years, including an average unemployment rate of 11.1% in 2012, the highest in the nation that year.” [24/7WallSt]

Need more? The share of growth captured by the top 1% = 218.5%. The real income growth from 1979 to 2007 was the second lowest in the nation, at 8.6%  The income growth for the bottom 99% of Nevada residents was –11.6%, the 2nd least in the country, and the income growth for the top 1% was 164%, the 24th highest in the country. [24/7WallSt]

If this were a “one off” situation we might dismiss it more causally, but it isn’t.  The change in Nevada household income from the late 1970s to the mid 2000’s shows a 16.8% increase for the bottom 20%, a 19.7% increase for the middle 20%, and the top 20% saw income growth of approximately 58.6%. [CBPP pdf]  So, how much annual income does it take to make it into the top 1% of Nevada’s income earners?

Nevada top 1% From the map shown above, it takes about $306,000 per year to be in the top 1% of Nevada income earners.  And, what is the income inequality ratio in Nevada?

Nevada Income Inquality ratio map The answer is 44.1%, one of the highest in the United States.  The next obvious question is: Why does a widening gap in income by households create a problem?  Hint: You don’t need a degree in finance or economics to figure this one out.  What tends to happen is that in the long run the lower income families tend to stay in the lower income brackets, the top 1% move steadily upward, and it’s the middle class that gets caught in the squeeze.  Economists Saez and Zucman explain:

“Among the fascinating findings of Saez and Zucman is how thoroughly the top 0.1% have shouldered their way past all other households. While their wealth share was soaring, that of the next 0.9% was barely growing, while that of the “merely rich” — those ranking in the top 10% but below the top 1% — actually shrank.

But the real victims of the trend are in the middle class. Saez and Zucman show that the wealth share of the bottom 90% grew from the 1920s through the mid-1980s, from 15% to 36%. Mostly the gain was due to the growth of pensions and of homeownership. Since the mid-1980s, however, middle-class wealth has evaporated, falling to 23% in 2012, about the same level as 1940.” [LATimes]

So what? What if middle income range families are getting the squeeze? To demonstrate that they ARE getting shouldered out of their share of increasing wealth doesn’t necessarily prove the situation is essentially economically negative?  Or does it? The answer is “yes, it does” if we’re talking about the real economy and not the shadow economy of the investment bankers and financialist allies.  For what now may be a record number of times in a single blog, let’s review the calculation of the Gross Domestic Product:

Gross Domestic Product Formula

Once More! The C is for consumer spending. The I is for investment. The G is for government spending. The (X-M) part is the difference between imports and exports. Who has disposable income to spend on goods and services? Who has income to save or invest?  If you guessed that there are more lower and middle income households you’d be right.

As of the 2012 IRS report, there were 144,928,472 household income tax filings. Of these filings 705,029 came from homes in which the annual adjusted gross income was between $500,000 and $1 million. Incomes between $1.5 million and $2  million accounted for 71,874 households, and there were 106,711 filings from households reporting income between $2 million and $5 million. 27,167 homes reported AGI of between $5 million and $10 million, and 17,685 reported AGI over $10 million. [IRS download]

Those 2012 filings of AGI ($500K-$1M) were 4.68% of the total; the next category up were 1.68% of the total filings; the next category composed 0.49% of the total; and the next 0.74%; at the very top the AGI ($5M-10M) comprised o.0187%, and the over $10 million were 0.0122% of the total filings. Now for the practical question: Who is buying more washing machines, television sets, and automobiles?  Who is buying more clothing, gasoline, and groceries?

We can narrow this down to Nevada’s statistics. [IRS download]   There were a total of 1,289,360 filings in 2012. Of these 4,420 were for adjusted gross incomes over $500,000 and 3,300 came from households with over $1 million.  The top bracket filings constituted 0.34% of the total and 0.25% respectively.  Again, who is purchasing consumer goods and services in Nevada?  Facing reality – a household could own one home in Las Vegas, one at Lake Tahoe, and another in Elko County – that’s still only three washing machines, three dryers – we could even toss in a car elevator and the total consumer spending wouldn’t create the DEMAND for goods and services which might be generated from the remaining 99% of Nevada income earners.

This is precisely WHY the Supply Side “Trickle Down” hoax is so pernicious. Continuing to monkey with the tax code by giving tax breaks, tax ‘incentives,’ and tax avoidance tactics to the upper 1% simply means we’ve skewed the numbers by which we measure our own economic growth. It has been, and continues to be, nothing less than a recipe for disaster.

Now, let’s take a look at the I part of the equation. Where is the investment going?  In good old fashioned garden variety capitalism, the “savings” or excess income is Invested in stocks or bonds which corporations can use to expand production, add employees, and use to build facilities or put into research and development – so, what are investment advisors telling their clients in the upper income brackets now?

The “hottest” investments for 2014 were in non-wrap mutual funds (82%) and exchange traded funds (79%). [OnePA]  “The exchange traded funds are like index funds but they can be bought and sold just like shares of common stock.  Whenever an investor purchases an ETF, he or she is basically investing in the performance of an underlying bundle of securities — usually those representing a particular index or sector. Unit Investment Trusts (UITs) are often organized in the same manner. However, the unusual legal structure of an ETF makes the product somewhat unique.” [Invest]  They can be bought and sold like common stocks but the crucial part is that they are NOT common stocks, and the “somewhat unique” structure comes with some tax advantages.  Who could have guessed?  A non-wrap mutual fund is one in which there isn’t a mutual fund advisory program giving the investor access to a big pool at a set annual fee.   Not to put too fine a point to it, but what we have here is a Financialists Day Dream – lots of ‘financial products’ to trade based on “an underlying bundle of securities.” Not reality.  If you were thinking that the I stood for the good old capitalistic categories of fixed investment and changes in business inventories – think again?

And this is the way the income gap expands.  Wage and salary workers face issues of globalization, technological changes, educational and training gaps, and increasing levels of indebtedness, while the top 1% bets on the capacity of the 99% to pay off the debts which have been warehoused, sliced, diced, slung into the Wall Street version of the financial Cuisinart, and traded in the financial markets.

There are no Silver Bullets but there are some things that might help.

  • Tax capital gains at the same rate as any other form of income. People work and get taxed, if ‘money works’ then tax it as well.
  • Close the special tax advantage loopholes which allow ‘investors’ to play with Dark Pools, exotic funds, and other Wall Street creations which serve to minimize Wall Street risk and place the general economy in a volatile financial environment.
  • Don’t fall for simplistic solutions like the Flat Tax, which is simply one more way for the top 1% to get a break while the wage and salary owners continue to pay the freight.
  • Increase the federal and state minimum wages.
  • Increase investment in education and training programs.
  • Encourage union and worker organizations.
  • Encourage American manufacturing with a long term national plan to improve U.S. manufacturing, including the government procurement of items made in America.
  • Avoid trade treaties which impinge on U.S. production, labor, environment, and U.S. sovereignty.

Nor can we assume that any one of these elements will bring Peace and Prosperity – there must be a conscious desire to return to that good old garden variety Capitalism – with an acknowledgement that “financial products” are here to stay – coupled with the encouragement of investment in infrastructure (public and private), production improvements, and research and development.  It’s possible if we can get our noses out of our checkbooks long enough to get a better view of our economic horizons.

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Filed under Economy, Nevada economy

Heads Up Items: Infrastructure, ALEC, Social Security, Financial Reform

Jig Saw Puzzle

There are items which don’t lend themselves to a full blog post, but are of immediate interest. Here’s a sampling:

#1. ALEC may be down to nine big corporate sponsors, but that doesn’t mean it doesn’t have a full agenda for its 2015 legislative season.  Watch for bills, often crafted from ALEC ‘models,’ on pre-empting efforts to increase the minimum wage. depriving low wage workers of health insurance, deregulating electronic cigarettes, protesting global taxes on tobacco, regulating ride share companies, lowering certification standards for dental practitioners, limiting the ability of individuals or businesses to dispute a denied property insurance claim, and school privatization.

#2. We’d probably ought to be watching the state of pipeline infrastructure in this country.  The current pipelines are aging, and some were constructed during the 1950s when low frequency electric resistance welds were popular – these welds are failing.  There’s more information from Inside Climate News, and from the Department of Transportation’s Pipeline and Hazardous Materials Safety Administration reports.

#3.  There are inklings that the Republicans in Congress are planning to turn discussions of Social Security into an Annual Crisis – such as they’ve done with debates about the budget deficit and the national debt.  The process is almost an art form: Declare a CRISIS; mount a full-on publicity campaign complete with constant press releases, comments from members of Congress, and pundits on television; ignore factual refutation and information; then use the CRISIS to leverage concessions from the Democrats.

#4. Expect the Republicans in Congress to step up their attacks on the financial reform regulations enacted in the Dodd-Frank Act.  For some excellent background information see the conversation between Bill Moyers and Simon JohnsonSalon also has a piece on the same subject, and the New York Times weighs in as well.  If you missed these, it might be a good idea to have a click and read.

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Filed under Economy, financial regulation, Infrastructure, Social Security