Category Archives: Economy

Wall Street May Not Be The Enemy: It’s the friends we need to watch

“Wall Street” is an extremely elastic catch phrase, useful for politicians of all stripes.  For example, we have Senator Dean Heller (R-NV) reminding us at every possible moment that he “voted against the bail out.” And, we have politicians from the other side of the aisle excoriating the traders for all the ills of modern America.  Both are off the mark.

Wall Street sign

First, beware the thinly veneered populism of Senator Heller.  Yes, he did vote against the bailout – an extremely safe vote at the time – but, NO he hasn’t stopped being the Bankers’ Boy he’s always been.  Let’s remember that while he was offering himself as the Little Guy’s Candidate he was voting on June 30, 2010 to recommit the Dodd-Frank Act to instruct conferees to expand the exemption for commercial businesses using financial derivatives to hedge their risks from the margin requirements in the bill.  Then, on June 30, 2010, he voted against the conference report of the Dodd-Frank Act.  Heller wasn’t finished.

In 2011 he and then Senator Jim DeMint (R-SC) introduced S. 712 – a bill to repeal the Dodd-Frank Act.

“What S. 712 does is to (1) repeal measures which require banks to have a plan for orderly liquidation (another word for bankruptcy), (2) repeal requirements that banks keep records of transactions which would need to be transparent in case an “orderly liquidation” is in order, (3) repeal the establishment of an oversight committee to determine when a bank is becoming “too big to fail,” and is endangering the financial system — an early warning system if you will.  The new requirements governing (4) Swaps would also be repealed, along with the (5) Consumer Protection bureau.” [DB 2011]

Few could have been more obviously promoting the interests of Wall Street traders than Heller and DeMint. [DB 2012]  Few could have been more readily apparent in their enthusiasm to protect the financialists from the provisions of the Dodd-Frank Act including the Volcker Rule.

Volcker Rule

A word about the Volcker Rule:

“The Volcker Rule included in the Dodd-Frank Act prohibits banks from proprietary trading and restricts investment in hedge funds and private equity by commercial banks and their affiliates. Further, the Act directed the Federal Reserve to impose enhanced prudential requirements on systemically identified non-bank institutions engaged in such activities. Congress did exempt certain permitted activities of banks, their affiliates, and non-bank institutions identified as systemically important, such as market making, hedging, securitization, and underwriting. The Rule also capped bank ownership in hedge funds and private equity funds at three percent. Institutions were given a seven year timeframe to become compliant with the final regulations.” [SIFMA]

Yes, Senator Heller et. al., if the Dodd-Frank Act is repealed then the financialists on Wall Street may go back to gleefully trading all manner of junk in all kinds of packaging with no limits on bank ownership of hedge and private equity funds.  Let’s remind ourselves at this point that capitalism works.  It’s financialism that’s the problem.  Under a capitalist form of finance resources (investments) are moved from areas (funds) with a surplus to areas (businesses) with a scarcity of funds.  Under a financialist system capital (money) is traded for complex financial instruments (paper contracts) the value of which is open to question.  Not to put too fine a point to it, but the “instruments” seems to have whatever value the buyer and seller agree to whether the deal makes any sense or not.  The Dodd-Frank Act doesn’t forbid “financialism” but it does put the brakes on.

Notice, it puts the brakes on, but doesn’t eliminate the old CDOs.  Nor does it prevent the CDO with a new name: The Bespoke Tranche Opportunity.  It works like this:

“The new “bespoke” version of the idea flips that 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. The new products are a symptom of the larger phenomenon of banks taking complex risks in pursuit of higher investment returns, Americans for Financial Reform’s Marcus Stanley said in an email, and BTOs “could be automatically exempt” from some Dodd-Frank rules.” [TP]

Zero Hedge summed this up: “This is the synthetic CDO equivalent of a Build-A-Bear Workshop.” We’re told not to worry our pretty little heads about this because, gee whiz, CDOs got a bad reputation during the Big Recession of 2007-2008, when they were just “hedging credit exposure.”  Yes, and ARMs got a bad reputation when they were just putting people in houses… Spare me.

And, we’d think that after the CDO debacle of 2007-2008, some one might have learned something somehow, but instead we get the Bespoke Tranche Opportunity and a big bubble in really really junky bonds.   That would be really really really junky bonds:

“Junk bonds are living up to their name right now. As we have noted in the past, the lowest-rated junk bonds may have inflated a $1 trillion bubble at the bottom of the debt market. The thing is, it never should have gotten that way.” [BusInsider]

Indeed, back in the bad old days no one could issue CCC bonds.  Now, we have Central Banks supporting Zombie Companies, low yield Treasuries making investors look to more “speculative” debt, and more demand for high yields meant that purveyors of Junk found a market for their garbage. [BusInsider] And, of course, someone out there is hedging all this mess.

Lemmings Here we meet the second problem with financial regulation in this great country.  Not only would the Bankers’ Boys like Senator Heller like to go back to the days of Deregulation, but the Financialists are hell bent on Yield! High Yield!  Even if this means supporting Zombie Companies which should probably just die already; even if this means allowing the sale of Bespoke Tranche Opportunities; and, even if this means selling bonds no one would touch only a few years ago.  The quarterly earnings report demands higher yields (As in: What Have You Done For Me In 90 Days Or Less) and investors jump like lemmings off the cliff.

We’ll probably keep doing this until someone figures out that in these schemes the chances are pretty good that “getting rich fast” more often means going broke even faster.  Thus the financialists package Bespoke Opportunities and C (for Crappy) Bonds.

Said it before, and will say it again:’  What needs to be done is —

  • Continuing to restrict the activity of bankers who want to securitize mortgages, under the terms of existing banking laws and regulations.
  • Continued implementation of the Dodd-Frank Act.

To which we should add, “restrict the creation and sale of artificial “investment” paper products which add nothing to the real economy of this country, and instead soaks up investment funds, and creates Bubbles rather than growth.

 

Read more atSIFMA, “Volcker Rule Resource Center, Overview.” Desert Beacon, “Deregulation Debacle,” 2012.  Desert Beacon, “Full Tilt Boogie,” 2011.  Think Progress, “High Risk Investments,” 2015.  Zero Hedge, “The Bubble is Complete,” 2015.  Bustle, “Is the ‘Big Short’ Right?, 2016.  Bloomberg News, “Goldman Sachs Hawks CDOs,” 2015.  Huffington Post, “Big Short, Big Wake Up Call,” 2016.  Market Mogul, “BTO, Deja Vu” 2016.  Business Insider, “Trillion Dollar Bubble,” 2016.  Business Insider, “Bubble Ready to Burst,” 2016.  Seeking Alpha, “OK, I get it, the junk bond miracle rally is doomed,” 2016.  Wolfstreet, “CCC rated junk bonds blow past Lehman moment,” 2016.

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Filed under Economy, financial regulation, Nevada politics, Politics

Nevada’s Good News, Bad News Economy: Housing, Wages, and Woes

Nevada’s home foreclosure rate is still not a pretty picture.   The state still exceeds the national average.  This is not an argument to slather on the Doom and Gloom economic message with a trowel, but it is a cautionary item in the prolonged narrative of the effect of the housing bubble, and the continued pressure from low wage employment.

Nevada Foreclosure 4 2016One in every 702 properties is in some phase of foreclosure, with one in every 373 in Lyon County, one in every 448 in Nye County, one in every 468 in Churchill County, one in every 643 in Clark County, and one in every 657 in Elko County. [RealtyTrac]  Dismal as this may seem, it does represent an improvement over Nevada’s record breaking performance in 2008-2010. [LVSun] At the end of 2010 Las Vegas saw one in every 9 home receiving some form of default notice. [moneyCNN]

The good news:

“The December surge in foreclosure starts is not a cause for concern, as it comes from a previously existing supply of distressed properties,” said Andres Carbacho-Burgos, Senior Economist at Moody’s Analytics, which analyzes RealtyTrac foreclosure data to forecast foreclosure trends. “The national pool of distressed mortgages has not increased despite the surge in foreclosure filings.” [RealtyTrac]

The astounding appetite of the Wall Street Casino for a supply of home mortgages to slice, dice, tranche, and securitize seems to have mellowed given that the “national pool of distressed mortgages” (of which Nevada contributed more than its share?) hasn’t increased.  National foreclosure statistics illustrate an effort to “clean up” previous backlogs.  So, if housing isn’t the big downer, what might be?

The Not So Good News: Nevada’s wage growth from 2007 to 2012 was a –6.5%.  Yes, that’s a minus sign in front of the percentage.  This is not the sort of chart that warms the hearth:

Nevada wage growth 2012 In short, whatever general wage growth there was between 2002 and 2008 was given back in the wake of the housing bubble collapse. The average weekly earnings of $835 in 2002 dribbled down to the average weekly earnings of $840 in 2012, a $5 increase in five years isn’t much to applaud.

There’s a bit  better news for 2016.  Weekly wages in the 3rd quarter of 2015 were $860, compared to the $840 of a year ago, up 2.6%. [NWF pdf] Even better, the unemployment rate in Nevada is now reported at 5.8%, a significant improvement over the +/- 14% we were looking at during the Recession. [NWF]  And now, another note of caution.  The greatest demand for employees in the state is for wait staff (2,229 openings), retail salespersons (2,113 openings), combined food prep including fast food (1,793 openings), and cashiers (1,420 openings) [NWF pdf] 

More food for thought:  Only two of the jobs listed with more than 500 potential openings offer wages or salaries above the median income in Nevada.  General and Operations Managers (571) has an annual average wage of $104,832, and Registered Nurses (608) can expect an average about $78,811. By contrast, wait staff averages $22,277, retail salespersons about $27,040, food prep about $19,781, and cooks $27,456. [NWF pdf]

Not to put too fine a point to it, but the occupations most in demand in Nevada aren’t the ones which will do much to improve either the housing market or the actual level of wage growth.

Nevada’s current $8.25/$7.25 minimum wage is not helping the situation.  A informative graphic in the Las Vegas Sun illustrates that a studio apartment rental in Clark County is affordable for someone working full time at $12.12 per hour, 1 bedroom requires $15.13, a 2 bedroom $18.63, a 3 bedroom unit $27.46, and 4 bedrooms $32,60.  Want a 2 bedroom apartment in Clark County? It requires 2.25 jobs at $8.25 per hour.

One of the least helpful suggestions made to the last version of the Nevada legislature came from Senator Joe Hardy (R- Boulder City) who offered the following resolution:

The resolution would repeal a constitutional amendment approved by Nevada voters in 2006 setting a standard minimum wage. Hardy said he would also propose legislation giving the Legislature the power to control the state’s minimum wage and tie the wage to the Consumer Price Index. [LVSun]

Republicans offered up a proposal for $9.00 per hour, still well short of what it would take a minimum wage worker to afford a studio apartment. Democrats proposed a $16/$15 minimum wage – which would just about get someone into a single bedroom rental unit.  Hardy’s proposal went nowhere, as did the other two offerings.

Meanwhile, the income inequality gap increased in the state.

“The states in which all income growth between 2009 and 2012 accrued to the top 1 percent include Delaware, Florida, Missouri, South Carolina, North Carolina, Connecticut, Washington, Louisiana, California, Virginia, Pennsylvania, Idaho, Massachusetts, Colorado, New York, Rhode Island, and Nevada.” [EPI]

If there were ever a way to insure that an economy based on consumer demand could stagnate, then it surely must be related to the incongruous notion that if a few rich people get richer then everyone will be better off. Let me suggest a re-reading of the old classic, “Where Are The Customer’s Yachts?

Let me also suggest a review of the Department of Labor’s myth-busting publication on the effects of raising the federal minimum wage.  Conservative sites have their own “myth-busting” reports but their conclusions are highly questionable, and just as highly generalized,  and none effectively challenges the research from Kruger and Card which demonstrates that there’s nothing “job killing” about increasing minimum wages. [HuffPo]

Nevada’s economy could be improved by:

  • Increasing the state’s minimum wage to at least $13.00 per hour.
  • Continuing to restrict the activity of bankers who want to securitize mortgages, under the terms of existing banking laws and regulations.
  • Continued implementation of the Dodd-Frank Act.

Nevada’s politicians might be improved by asking some pointed questions:

  • Do you support an increase in the State’s minimum wage to $13.00 per hour?
  • Do you support the continued implementation of the Dodd-Frank Act

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Filed under Economy, Nevada economy, Nevada politics

Break Up The Bank Bandwagon, or how to be unhelpful?

Break Up Big Banks bandwagon  Much of the debate on the Democratic Party side of the primary silly season is related to Wall Street – easy to demonize, more difficult to understand, and altogether more complicated than  sound-byte sized portions of political coverage will allow.  In other words, H.L. Mencken was probably right: “For every complex problem there is an answer that is clear, simple, and wrong.”  Let’s start with the proposition that our economic issues can be resolved by breaking up the large banks.

Yes, 2007-2008 still stings. The Wall Street Casino that created financial market chaos was especially harmful in Nevada, one of the “sand states” in which the real estate bubble was augmented by avarice and the Wall Street appetite for securitization of highly questionable mortgage lending products, and practices.  Certainly, the call to break up the big banks resonates with a significant portion of the national as well as the Nevada population.   However, this “clear and simple” solution may not be the panacea on anybody’s  horizon.  Here’s why:

From a consumer’s prospective, big is not always “badder.”  I, for one, like the idea that my debit card is accepted in convenient locations throughout the country.  I’m technologically challenged so I don’t avail myself of many advances in remote deposits, and other mobile banking services, but I sympathize with those who do.  I also like making my primary banking decisions for myself, and I’m not – as a consumer/customer – particularly happy about the prospect of being dropped by my bank because it is “too big”, i.e. it has too many customers.   And, here we come to a second issue.

How do we define “big” and “too big?”  If we are defining “big” in terms of the amount of deposits then JPMorganChase, Bank of America, Citigroup, Wells Fargo, and USBankcorp  (the top five in total deposits) are targets for the break up.  Thus, if we “break up” any or all of these five based on the “size” – either the total assets or the total value of deposits – then how many customers must deal with the transition costs of moving their bank accounts?

Do we mean breaking up as in reinstituting the old Glass Steagall Act, and separating commercial and investment banking?  This action wouldn’t limit the banks based on assets or deposit values, but instead would constrict their banking activities.  This has some appeal, perhaps more so than just whacking up banks based on the size of their assets and deposits, but this, too, opens some questions.

One set of questions revolve around what we mean by “banking services?”  For example, if a person has an account with Fidelity investments, and one of the services associated with that account is a debit card or a credit card, then does this constitute a “bank-like” service?   There are banks offering brokerage accounts, and insurance services – reinstating the provisions of Glass Steagall would mean a customer would have to give up some services to retain others – or perhaps be dropped as the financial institution made its decision as to the camp it was joining – the commercial or the investment one.  If a person likes the idea of consolidating investment and commercial services, and doesn’t – for one example – have much if any need for things like certified checks, then an investment account with some “bank like” services could be the best option. For others, who like the idea of a “life-line” bank and the notion that some other ancillary services may come with it, then the traditional route would be more enticing.  However much a person may like the sound of “bring back Glass Steagall” there are situations in which this would mean some significant inconvenience and costs for customers and clients.

Another point which ought to be made is that all too often Glass Steagall and the Volcker Rule get mashed together as if they meant the same thing, or something close to it.   Let’s assume for the sake of this piece that what we all really want is a banking system which does not turn deceptive practices into major revenue streams, and which doesn’t allow banks to use deposits to play in the Wall Street Casino.

If this is the case, then it might well do to let the Dodd Frank Act have a chance at more success.  For all the political palaver about this 2010 act, it has been successful.  As Seeking Alpha explains:

“Dodd-Frank did several things that promoted the culture change and reduced the likelihood that a large American bank will fail: (1) annual stress tests that forced a focus on risk management not only among risk managers but at every level of the bank; (2) establishment of the Consumer Finance Protection Board (CFPB), which has primary responsibility for consumer protection in the financial field without the conflicts of interests naturally experience by the banking regulators; (3) the Volcker Rule that removed proprietary trading from bank holding companies, thereby facilitating the cultural reform that I referred to above, and reducing the level of risk in banks’ assets; (4) enhanced capital requirements for large banks, which addressed the major weakness that permitted mortgage losses to turn into a financial debacle in 2008; and (5) living will requirements for large banks, which while perhaps unnecessary, are having the salutary effects of increasing liquidity in stressful situations and decreasing organizational complexity and thereby making big banks more possible to manage.”

In short, if the object is to make banks safer, better managed, and less likely to get themselves into the liquidity swamps of the pre-Dodd Frank era, then the act does, in fact, make the grade.   Those who would like a return to the bad old days, when banks could wheel, deal, and deceive, will find solace in the slogans of many Republican politicians calling for the repeal of the Dodd Frank Act.

Yet another set of questions relate to what breaking up the banks is supposed to accomplish; or to accomplish beyond Dodd Frank.  It’s easy to say that if a bank is too big to fail it is too big to exist. However, we still haven’t dealt with exactly what it means to be “too big.”  Like it or not, we do have a global economy.   Let’s take one example: “Global businesses want global banks. This makes intuitive sense for companies that manufacture, distribute, and sell products globally. 3M, for example, derives a majority of its sales from outside the United States, operates in more than 70 different countries, and sells products in over 200 countries.” [Brookings]

What does 3M do? Operate through a system of regional banks? (and increase costs)  Or, does 3m start using a foreign bank?  What does this do to American market share in global banking? And, we’re not just talking about 3m, what about Intel (82.4% sales overseas), Apple (62.3% sales overseas), General Electric (about 52% sales overseas in Africa, Asia, and Europe), Boeing (58.3% sales overseas), and Johnson & Johnson (53.2% sales in Europe)?  [AmMUSAToday]

At the risk of sounding too nuanced for blog posts of a political bent, I’d offer that the Break Up The Banks bandwagon has been on the road long enough, and has been a distraction from issues that have cost the American middle class (and those trying to achieve that level of financial security) dearly in the last 40 years.

Breaking up the big banks will not assist in the organization of American workers so that the power of the owners is balanced by the power of the workers.   What we DO need are government policies which support the unionization of employees. Policies which increase the minimum wage. Policies which improve wages and working conditions. And, policies which make education and training affordable.

Breaking up the big banks will not assist in establishing fair trade with the rest of the world. What we DO need are policies which promote the interests of American manufacturing, by American workers, in American plants.  We need policies which affirm our support for environmental responsibility.  We need policies implemented which promote modern technology and modern energy sources; with American ingenuity and labor.

Breaking up the big banks will not reform a financial system which too often rewards its components for short term gambling as contrasted with long term financial vision.  It will not replace the transformed and corrupted Shareholder Theory of Value among managers.  What we DO need is a system which rewards investment and replaces the fantasy of “Trickle Down” economics.

Perhaps it’s time to find a new bandwagon?  One that’s going in the desired direction, and not merely headed toward a successful election day performance?

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Filed under banking, Economy, financial regulation

Local Water, the EPA: Beyond Goodsprings

Water Faucet EPA

The Reno Gazette Journal reports that there are 23 local water systems in Nevada which are not in compliance with drinking water standards (there are currently 22, but more on that later).  Three local systems listed in the article have lead contamination levels exceeding the lead standard, 15 ppb (parts per billion) as the “action level.”  The public needs this information. However, the agency responsible for establishing the maximum contaminant level (MCL) standards is the whipping boy of choice for the Republican Party.  In short – it really doesn’t do to get up in arms about water or air pollution levels and then call for the abolition of the Environmental Protection Agency.

The regulatory system isn’t all that complicated. The EPA establishes the standards and then it’s up to the states to devise the implementation.  There’s a reason for this. Setting national standards means that states can’t compete in a ‘race to the bottom’ in which some states seek to attract industry by lowering standards until they are in competition to achieve the status of “Worse Than Any Pig Would Ever Consider in a Sty.”  And, potentially damaging everyone else’s air and water in the process.  However, this hasn’t stopped Over-Hyped Demagogue Donald Trump from calling for handing over environmental regulation to the individual states.  [WaPo]

Nor has this made much of an impression on Seven Mountain Dominionist Ted Cruz; “Cruz has called the EPA a “radical” agency that has imposed “illegal” limits on greenhouse gases from power plants. “I think states should press back using every tool they have available,” the Texas senator has said. “We’ve got to rein in a lawless executive that is abusing its power.” [WaPo]

Ohio Governor John Kasich has been critical of the Michigan attempts to address its man-made, GOP inspired, water quality issues in Flint, MI, but hasn’t been on top of the situation with the Sebring, OH water contamination. [TP]

The 2008 Republican national platform was exceptionally mealy-mouthed about environmental protection:

“Our national progress toward cleaner air and water has been a major accomplishment of the American people. By balancing environmental goals with economic growth and job creation, our diverse economy has made possible the investment needed to safeguard natural resources, protect endangered species, and create healthier living conditions. State and local initiatives to clean up contaminated sites — brownfields — have exceeded efforts directed by Washington. That progress can continue if grounded in sound science, long-term planning, and a multiuse approach to resources.”

It’s not likely that much more will come from a 2016 version.   Nor should we expect much in the way of support for addressing the national problems associated with our drinking water systems.  Remember the ASCE’s Report Card on American Infrastructure (2013)?

“At dawn of the 21st century, much of our drinking water infrastructure is nearing the end of its useful life. There are an estimated 240,000 water main breaks per year in the United States. Assuming every pipe would need to be replaced, the cost over the coming decades could reach more than $1 trillion, according to the American Water Works Association (AWWA). The quality of drinking water in the United States remains universally high, however. Even though pipes and mains are frequently more than 100 years old and in need of replacement, outbreaks of disease attributable to drinking water are rare.”

Not to put too fine a point to it, but as a nation we’re running on a Run-to-Ruin system in which local water distributors are functioning with outdated infrastructure while trying to maintain acceptable levels of quality.  Goodsprings Elementary School offers us an example of what can happen given a 1913 building and 21st century water quality standards. [RGJ]  If Goodsprings was an isolated example, then we could address the aging pipes and move on, but it’s not that isolated, nor that uncommon.  Current EPA estimates indicate we are having to replace between 4,000 and 5,000 miles of drinking water mains in this country on an annual basis, and that the annual replacement rate will peak sometime around 2035 with 16,000 and 20,000 miles of aging pipe needing to be replaced each year. [ASCE]

Putting The Public Back In Public Utility

I am going to start with some basic assumptions. First, that a family or person should be able to move to any part of this great land and expect to find clean water running from the faucet.  Secondly, that it is not a good idea to allow individual states to set drinking water standards, since some might find it inconvenient or inexpedient to set scientifically reliable standards in the interest of “development” or “industrialization.”  Such a piece meal approach would put paid to the first basic assumption.   So, if we’re agreed that any person in this country should have a reasonable expectation of clean drinking water then we need national standards.

Some of the standards are easier than others.  Arsenic contamination levels offer an example of a complex problem with some nuanced related issues.  The MCL (maximum contaminant level) for arsenic was lowered in 2001 from 50 ppb to 10 ppb. Public water systems were to be in compliance by January 23, 2006. [EPA] [More information at FAS pdf] The Reno Gazette Journal reports ten Nevada water systems not in compliance.  One, the McDermitt GID has recently been declared in compliance with a current projected annual running average below 10 ppb after the system put in a new central well.

Arsenic enters the drinking water systems one of two ways, either through industrial activity or as a naturally occurring contaminant.  If the system is west of the Rocky Mountains it’s a reasonably good bet that the arsenic is naturally occurring.  It’s probably not too far off the mark to say that if the standard were set at 15 ppb most Nevada water systems would be in compliance, but the standard is 10 and that’s ultimately what matters.

The smaller public water systems have more trouble meeting the standards than the larger ones, as described by the BSDW:  “The smaller systems are the ones that tend to struggle with regaining compliance because they typically have limited financial resources so we have to collectively figure out ways to help that community get back to compliance,” said Jennifer Carr, NDEP deputy administrator. “Larger systems such as TMWA also have more personnel to tackle projects whereas some of our smaller water systems are operated by one person who might be doing another side job.” [RGJ]

And, now we’re down to the gritty part: Where does the money come from to resolve contaminant problems with arsenic? Or, for that matter, other water infrastructure issues?    The State Revolving Fund provides low interest loans for water infrastructure projects in the state; and can in some circumstances offer “forgiven” loans to small public water services.  The “bottom line” is that in 2016 there will be a need for approximately $279 million for arsenic treatment, groundwater treatment, storage tank replacements, metering systems, and distribution lines in Nevada.  And, the worse news, “Not all will be funded.” [KTVN]

The Drinking Water State Revolving Fund was created in 1996 to support water systems and state safe water programs.  “The 51 DWSRF programs function like infrastructure banks by providing low interest loans to eligible recipients for drinking water infrastructure projects. As money is paid back into the state’s revolving loan fund, the state makes new loans to other recipients. These recycled repayments of loan principal and interest earnings allow the state’s DWSRF to “revolve” over time.”  [EPA]   As of 2014 this system had provided $27.9 billion to water suppliers to improve drinking water treatment, improve sources of drinking water, providing safe storage tanks, fixing leaking or aging distribution pipe, and other projects to protect public health. [EPA] The EPA estimates that small public water systems nationwide, those serving populations less than 3,330,  will need approximately $64.5 billion for infrastructure needs. [EPA 5th report pdf]

What was the Republican controlled Congress’s response? They may have avoided a shutdown, but the waters weren’t exactly flowing:

The bill provides $863.2 million for the DWSRF  well below President Obama’s request of $1.186 billion and more than $40 million below the programs FY2015 appropriation.While the figure represents the lowest DWSRF appropriation in several years, it is significantly above the FY16 funding levels originally proposed by the House and Senate Appropriations Committees, each of which would have cut DWSRF funding to below $780 million. [UIM]

What have we learned?

  • The Republican candidates for the presidency show little to no enthusiasm for infrastructure investments in general, and beyond bemoaning the state of Flint’s water system which must be someone’s fault “just not ours,” even less enthusiasm for funding local drinking water improvement projects.
  • The Republicans in Congress were only too happy to cut funding for the best source for local public water companies projects, in the name of “fiscal responsibility” – meaning, one could think, that preserving tax cuts for the rich is preferable to providing clean drinking water to everyone.
  • The infrastructure needs in this country are serious and go well beyond fixing bridges and filling pot-holes.  This, and we’ve not yet reached the peak of distribution line replacement needs coming up in the next 20 years.
  • “Austerity” is a lovely buzz word, and “We’d love to do it but we just can’t afford to” is a fine campaign trail stump speech phrase, but these won’t keep the water coming from the tap clean and safe.  We need to stop thinking of our infrastructure as an expense and begin to consider it for what it is – an investment; an investment in the capacity of our cities and towns to provide basic services so that economic activity can take place.
  • And, NO it isn’t a good idea to abolish the EPA.

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Filed under Appropriations, Congress, conservatism, Economy, EPA, Infrastructure, nevada health, Politics, public health, Water

Fiorina, Lucent, and Lucidity

Fiorina 1 Nevada Republican Party Chair, Michael McDonald, was pleased to post that Carly Fiorina won the National Federation of Republican Women’s straw poll at their convention in Phoenix, AZ last month. [NVGOP]  Gathering 27% to the Hair-Do’s 20% – if that’s to be called a ‘win’ in the sorting of the occupants in the GOP 2016 Clown Car.  There’s another way to sort the candidates, especially those who claim that business acumen is an automatic qualifier for political office. 

Those pundits who have labeled Fiorina “Snarly Failure-ina” are usually referring to her unfortunate tenure – and subsequent Golden Parachuted Escape therefrom – at Hewlett Packard.  However, it’s instructive to go back a bit and start with AT&T.

Twenty years ago AT&T began the process of selling off one of its core assets, the equipment manufacturing division, including Bell Labs the originator of the transistor and a ‘preeminent research outfit.’  The idea was that as a separate entity the equipment division could compete with AT&T competitors and sell its products to flashy outfits like Sprint, Winstar, and PathNet telecom networks.   Fiorina’s star ascended as the head of the group selling gear to “service provider networks.” [Fortune]

The Big Deal in which AT&T spun off Lucent was not without some chickens which would come home to roost later.  There were several clues at the time which projected problems: (1) Lucent was valued at $15 billion at the time of the IPO, but a $21 billion value had been bruited about only a week earlier; (2) its major competitors were Siemens (Germany), Alcatel (France), and Motorola. (3) AT&T loaded the company with $3.8 billion in debt; (4) there were restructuring costs tied to planned major layoffs and Lucent reported a loss of $867 million for 1995 on revenue of $21.4 billion, down from a profit of $482 million and revenue of $19.7 billion for the year before. [LATimes]  And then there was this warning:

Lucent also faces a maturing U.S. market for telecommunications switches. It is making an aggressive push into faster-growing markets in Asia and elsewhere, but it faces tough competition from companies like Alcatel that have long had a powerful international presence. [LATimes]

A bit of history is in order:

“At that time, telecommunications equipment companies had entered a period of unprecedented — and as it would later emerge, unsustainable — growth. Congress had passed a law making it easier for new companies to compete with local phone companies, which had long been de facto monopolies. Households and businesses first connecting to the new-fangled Internet added phone lines and equipment and services, creating a gold rush to build up new network capacity around the world.” [Recode]

For “gold rush” read “financing” for the Qwests and WorldComs and other providers  which had laid far more fiber optic cable and installed way too much capacity, well beyond the needs of the potential customers.  What to do in the service of selling telecommunication switches in a “mature” market – one which was at least saturated if not in the flood zone?

Fiorina administered the practice of “vendor financing” to keep revenues up. There’s nothing necessarily nefarious about this – it was a standard business practice in which Lucent required suppliers to arrange or provide “long term financing for them as a condition to obtaining or bidding on infrastructure projects.” [recode]  When the deals were good, such as the $2.3 billion extended to Sprint, they were very good. But then… there were others of much more questionable obligations. 

It was reported in October 1998 that Lucent and WinStar entered into a $2 billion five year “network pact.” That $2 billion from Lucent was supposed to allow WinStar to expand on an international basis. [IntNews]  The deal didn’t last any five years, it only lasted until WinStar declared bankruptcy in 2001, and sued Lucent for $10 billion claiming that the firm broke its vendor financing agreement. [CompW]  By the time WinStar went under, Fiorina was ensconced at Hewlett-Packard.  WinStar wasn’t the only disaster.

There was also PathNet, a vendor financing deal which made even less sense.  PathNet at least had the sense to notice that first tier cities were all but awash in telecommunications equipment in 1999, so they were going to focus on second and third tier cities for their networks. To this end they secured $2.1 billion from Lucent in vendor financing in February 1999.  [FOonline]  This amount to a company which reported less than $2 million in annual revenue. [recode]  Even using the most generous estimates the company had barely $100 million in equity; it was juggling $385 million in junk bonds at 12.25% interest, and the added $440 million in loans from Lucent only served to jack up the company’s leverage to 8:1. Even higher as they drew more of the loan? [Fortune]

Fiorina has pushed back on the notion she was happy with these short term, dubious deals, however, there’s another side: Lucent at one point predicted annual growth of 17%-22% annually. (1997) [Fortune]  Now, what’s not for Wall Street to love about a 17% annual growth rate? Fiorina may not have been over the moon about the vendor financing deals, but she was determined to rack up big sales. [Fortune]  PathNet filed for bankruptcy in April 2001.

An SEC filing just after Fiorina left Lucent revealed a $7 billion in loan commitments to customers, Lucent dispensing some $1.6 billion. [Fortune]  Why would this be important?  For starters, think Bubble. What the highly questionable home mortgages were to the Housing Bubble, those vendor loans were to the Tech Bubble.  At one point Lucent shares dropped to >$1, and in 2006 the company merged with Alcatel. [Fortune]

So, what do we know?  Fiorina’s tenure at AT&T/Lucent wasn’t much more than that of the Super-Saleswoman who predicted high growth rates and revenues based on vendor financing deals, deals which collapsed as the saturated market finally emerged from behind the curtain of financial manipulation. This isn’t business vision, it isn’t even lucidity – it is merely chasing a fast buck.

References and Recommended Reading:  Linda Rosencrance, “Winstar files for bankruptcy, sues Lucent for $10 billion, Computerworld, April 18, 2001. Staff Report, “AT&T Spinoff Lucent Makes Historic IPO,” Los Angeles Times, April 4, 1996. Scott Woolley, “Carly Fiorina’s troubling telecom past,” Fortune, October 15, 2010. Arik Hesseldahl, “Time to revisit Carly Fiorina’s business record before HP?…” Recode, August 30, 2015.  Jeffrey Sonnenfeld, “Why I still think Fiorina was a terrible CEO,” Politico, September 20, 2015.  Glenn Kessler, “Carly Fiorina’s misleading claims about her business record, Washington Post, May 8, 2015.  Andrew Ross Sorkin, “The influence of Fiorina at Lucent, in hindsight,” New York Times, September 21, 2015. Julie Bort, “Yale Professor on Carly Fiorina’s business record: She destroyed half the wealth of her investors yet still earned almost $100 million,” Business Insider, September 16, 2015.

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No Free Lunch No Free Market

“The market is a human creation. It is based on rules that humans devise. The central question is who shapes those rules and for what purpose,” Reich concludes. “The coming challenge is not to technology or to economics. It is a challenge to democracy. The critical debate for the future is not about he size of government; it is about whom government is for.” [Robert Reich]

Bingo!  Adam Smith, in Wealth of Nations, offered the Invisible Hand – and economists have been grabbing it ever since. IF, they mused, if all buyers and sellers were truly free then markets would achieve equilibrium and all will be well.  Everyone will act in their own self-interest, and the competition induced will benefit all.  There will be an equilibrium price – for anything – when the demand and the supply are equal.  However, there’s always been a flaw in this argument.

The cracks begin showing when it’s noted that “price” and “value” are not the same thing.  Truly, there is a “market value,” i.e. the price at which an asset would trade in a competitive auction setting, but this isn’t a definition of value.  Value is a qualifier we assign to things that are beneficial, significant, advantageous, or useful. Let’s digress a moment and review why this differentiation between price (even market price) and value is important.

Finance works best when it acts as the conduit for moving capital from places of surplus to places of scarcity.  In the simplest possible terms, finance allows the money in someone’s savings account to be invested in someone else’s business enterprise.   The owner of the savings account benefits from the earnings; the owner of the business enterprise benefits from the extra cash to expand his operations.   Not to put too fine a point to it, but when finance doesn’t move capital from surplus to scarcity then it’s not finance – all too often it’s merely gambling.

Additionally we should note that the the system itself is a gamble.  If I put in a $1000 investment in Widgets International Inc. then I’m betting my shares will either pay dividends, gain in price, or preferably both.  And now to return to “value.”  I’m taking a risk with my money, but I’m also hoping to invest in something of value – perhaps WI Inc. manufactures the best product on offer which helps nurses prevent bed sores from afflicting their patients.  I have $1000 on hand (surplus), Widgets International Inc. needs to expand to meet the demand for its product (scarcity) and finance allows the conduit to work toward mutual benefit.

However, what if I behave as though my $1000 really isn’t surplus? What if I make a side bet that the price of Widget International will go down?  In this instance I am buying a “financial product” which has precious little to do with the product the company is manufacturing, a bit more to do with how the company is managed, and a great deal to do with how a hedge fund can be used to “manage wealth.”   Or, to put it another way – to reduce risk.  Money (capital) slathered about in an effort to reduce risk isn’t part of that conduit for moving capital from surplus to scarcity, and it (as we’ve seen) is fraught with consequences.  The word “behave” is the key term.

If the concepts of price and value are problematic in a discussion of American economics, then our Economic Man as described by Adam Smith is also at issue:

“Economic Man makes logical, rational, self-interested decisions that weigh costs against benefits and maximize value and profit to himself. Economic Man is an intelligent, analytic, selfish creature who has perfect self-regulation in pursuit of his future goals and is unswayed by bodily states and feelings. And Economic Man is a marvelously convenient pawn for building academic theories. But Economic Man has one fatal flaw: he does not exist.” [Harvard]

The “convenient pawn” became the cornerstone of neoclassical economic theory.  The theory elevated the pawn, and the pawn returned the compliment by rationalizing everything from child labor to global out-sourcing.   The Magic Market would “equalize” everything, and all would be well.  In fact, there is no such thing as a free lunch, and there is no such thing as a free market.

In fact, if we skip the jargon (such as a trader saying “I make markets”) what we understand is that traders in the financial sector are sales personnel who have products to sell to prospective buyers.   Last time we looked those sales personnel, the buyers, and the sellers were all human beings – or human beings managing various and sundry enterprises.  Even if  trading is  computerized, someone – some human being – had to program those computers, which still have no innate capacity to count beyond 0 to 1.  There are some benighted souls who believe that if we have just enough “self monitoring,” and more elegant algorithms those messy, inconsistent human beings will no longer screw up the financial markets.  Again, we’d have to ask, “Who is writing those algorithms?” And,  how much “self-monitoring” is good enough?   There are markets, but they are certainly not free of human beings – humans being the brokers, the agents, the buyers, and the sellers.

“Who shapes the rules, and for what purpose?”

We have rules for all manner of human transactions.   When sharing a meal we don’t eat the mashed potatoes with our hands. When getting an invitation with an “RSVP” we don’t wait until after the event to respond.  A soccer match is played with only 11 on each side.  The FAA has rules for take offs and landings to minimize the risk of collisions.   And we have rules for financial markets.   Why? Because a market is simply a transaction between two human agents – buyer and seller – no matter how computerized.

One thing we did learn during the debacle of 2007-2008 was that some investment houses were selling products on which they could calculate a price but they were incapable of determining the product’s value. In some instances the artificiality of the product and its distance from anything tangible, such as a home mortgage, made it impossible to determine what the product was actually worth.  All too much of the Stuff had a “market price” but turned out to have no value in the last analysis.  Thus the demise of Lehman Brothers.

There are some questions at the intersection of economics and politics in 2016:

  • Do we want an unfettered market for financial products? Do we want rules advantageous to the sellers of products in the financial markets? Do we want rules advantageous to the buyers in financial markets? Do we want rules which protect the general public from irresponsible or anti-social behavior on the part of the buyers and sellers?
  • Do we want those who write the rules for the transactions in the financial markets to have the interests of the general public in mind?
  • Do we support agencies which enforce rules designed to restrain the behavior of buyers and sellers in the financial markets?
  • Do we encourage investment or speculation?
  • Should our system of taxation reward work or wealth?

We can focus down on a single issue illustrative of the general regulatory environment – this past July a Senate Committee was taking testimony on a proposed rule that investment advisers place the client’s interest first when deciding upon investments in retirement accounts. One member of the panel offered that the rule would “cost” the investors some $80 billion because financial firms would simply raise fees to make up the profit differential if they couldn’t put their own interests before the interests of their retirement account clients. [Litan pdf]  However, what didn’t go unchallenged was that the study cited by the panel member was financed by the Capital Group, a corporation which definitely stands to benefit if the proposed rule from the Department of Labor is not implemented. [BostonGlobe]

The question highlights the element of freedom:  Is the investment adviser free to purchase elements in a portfolio which enhance the profitability of his firm, or must the adviser give first priority to those investments which will best serve the clients’ interests?  Is the client free to assume his agent (investment adviser) is acting in his or her best interests?  Is the client free to know how investment portfolio decisions are made?  It isn’t a question of whether or not the “market” is “free,” it’s a question of who is free to do what.

Consider for a moment a situation in which a large employer has selected a financial advisor to manage its retirement program.  There are three human agencies at play: the employer, the employees, and the financial advisors.  And, because there are human beings involved we should assume that these relationships are contractual. If the financial advisors are placing their own interests above those of the retirees, then must the employer seek to break the contract? Under what conditions and at what expense?  Are the employees free to take their contribution elsewhere? But, what of the employer’s contributions?   In the rarefied theoretical academic version of a Free Market this would never happen – all the pawn would march neatly across the board. However, this isn’t a theoretical academic version – this is real life – and if the financial advisor is “free” to act in his or her firm’s interest, what happens to the contributions of the employer and the employee? If they act in their self interest then they must cut ties with the advisors.  If the adviser is “free” to act in his or her self interest the employer and the employees lose value in their retirement investments; if the employer and employees are “free” to act in their own self interest the adviser loses the account.   We are left asking: Who is going to write the rules of our economic game? Or to put it in economic-political terms:

“The most important political competition over the next decades will not be between the right and left, or between Republicans and Democrats. It will be between a majority of Americans who have been losing ground, and an economic elite that refuses to recognize or respond to its growing distress.”  [Reich]

References/Recommended Reading:  John Lanchester, “Money Talks: Learning the Language of Finance,” New Yorker, 8/4/2014.  Craig Lambert, “The Marketplace of Perceptions.” Harvard Magazine, March-April 2006.  Michael Blanding, “The Business of Behavioral Economics,” Forbes, August 2014.  Adam Ozimek, “The Future  Irrelevancy of Behavioral Economics,” Forbes, September 2015.  Dan Ariely, “The End of Rational Economics,” Harvard Business Review, July-August 2009.  Paul Krugman, “How did economists get it so wrong?” New York Times Magazine, September 2009.  Noah Smith, “Finance has caught on to behavioral economics, Bloomberg View, June 2015.  Robert Litan, Senate Subcommittee on Employment and Workplace Safety, Senate HELP, July 21, 2015. (pdf) Annie Linsky, “Warren…Brookings Institution,” Boston Globe, September 29, 2015.  Robert Reich, “How the pro-corporate elite has rigged the system against the rest of us,” Alternet, September 29, 2015.

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Filed under Economy, financial regulation

VW Bugs

VW “With three Volkswagen and two Audi dealerships in Las Vegas told to stop the sale order of its four-cylinder diesel vehicles, Volkswagen AG said Tuesday that a scandal over falsified U.S. vehicle emission tests could affect 11 million cars worldwide as investigations of its diesel models multiply.” [LVRJ]

There are some interesting layers to this story.  Let’s call layer one the “regulations” layer.  We do want to set standards for the emission of nitrous oxide, which accounts for about 5% of greenhouse gas created by human activity. And, the stuff tends to stick around:

“Nitrous oxide molecules stay in the atmosphere for an average of 114 years before being removed by a sink or destroyed through chemical reactions. The impact of 1 pound of N2O on warming the atmosphere is almost 300 times that of 1 pound of carbon dioxide.” [EPA]

Therefore, it sounds like a good idea to set some standards for light duty vehicle emissions. [GPO.gov pdf]  Volkswagen, desirous of selling its products – in this case four cylinder diesel powered cars – was subject to those vehicle emission standards, just like other diesel vehicles manufactured by Ford, Mercedes Benz, and BMW. [AutoTrader]  So, why would the corporation cheat? One important reason is that the company could not manufacture a car with the three legs of the stool: Performance, Fuel Economy, and Low Pollution – and maintain its profits. [Vox]

As everyone knows by now, the corporation decided to install defeat software which fudged the numbers when the cars were being tested for emissions. In short, they could get the performance levels they wanted, at profitability levels they wanted, and this done by sacrificing the pollution part of the equation.  This explains the wide difference between the results of the road tests and the lab tests.

“The Environmental Protection Agency alleges the automaker had designed software to let its diesel cars detect when they were being tested for emissions. The software, known as a “defeat device,” was installed in some 482,000 cars, spanning model years 2009 through 2015, regulators say.” [LVRJ]

Again, as everyone knows by now, this was patently illegal.  Patently illegal behavior by a company with sales revenues of $202.46 billion in 2014; gross income of $33.88 billion; and, a net income of $10.85 billion. [MktWtch] Prior to this debacle, VW’s ROE (return on equity) was at 11.84%, Ford reported 14.33%, and BMW’s ROE was 15.61% [YCharts]

Investors like watching the ROE because:

“Return on equity (ROE) measures the rate of return on the money invested by common stock owners and retained by the company thanks to previous profitable years. It demonstrates a company’s ability to generate profits from shareholders’ equity (also known as net assets or assets minus liabilities). ROE shows how well a company uses investment funds to generate growth. Return on equity is useful for comparing the profitability of companies within a sector or industry.” [YCharts]

VW’s earnings for 2015 were estimated as about $234 billion. Ford, by contrast, was expected to see about $150 billion for 2015.  On June 24, 2015 VW was selling at $218.40/share; things started to go south quickly after VW hit $162.40/share on September 18, 2015, and the stock is reported at $111.50 September 23, 2015.   We are now sliding into the second layer of the story.  It’s not just that VW stock took a dive after the cheating was reported – nor that the cheating caused investors to sell – it may very well be that the very thing the corporate management feared, which caused the cheating, was the proximate reason for the Big Slide.

The Management Layer.   VW’s annual report to investors opens with a general description of board operations, “We also receive a detailed monthly report from the Board of Management on the current business position and the forecast for the current year. Any variance in performance as against the plans and targets previously drawn were explained by the Board of Management in detail, either orally or in writing. We analyzed the reasons for the variances together with the Board of Management so as to enable countermeasures to be derived.” [VW pdf]

What we appear to have at this point is Management Speak for Shareholder Value management.  It’s probably safe to assume that the discussions of “current business position” included the old standbys sales, revenues, expenses, liabilities, and analyst expectations.  We can base this conjecture on the reference to the “forecast for the current year.”  Remove the gilding on “variance,” and “targets,” and we’re most likely talking about share prices predicated on earnings expectations. 

So, in order to keep the earnings expectations nice and high, and thereby secure higher share prices – the management decided to roll the dice and hope that no one caught on to the Defeat Device.  More simply stated: Shot. Into. Own. Feet.

If there were a better reason to chuck the Share Holder Theory of Management – or at least to modify it such that it doesn’t drive the decision making process into the nearest convenient ditch – this just might be the appropriate occasion.

Note that it is not that Volkswagen wasn’t a profitable company.  It had a perfectly acceptable RoE (11.84%) with earnings expected to be in the $230B range for 2015.  Nor did the 4 cylinder diesel engine cars constitute a major portion of its sales.  While the total number of cars involved isn’t clear yet, VW has shut down sales of the 2015 and 2016 “clean diesel” models, noting that 23% (7,400) of new cars sold in August were diesel. [NYT]  Volkswagen Group manufactured some 10.2 million vehicles in 2014. [Stat]  The North American production for 2015 was estimated at 0.64 million. [Stat]

It almost defies common sense to perceive how cheating on the emissions testing for a group of products which were not a major part of the American market was really supposed to enhance the bottom line.  Unless, we revert to the “every penny counts” mindset in maintaining a certain targeted profit level.  Let’s take an educated guess that it was more important for VW management to maintain profit (and thus share value) than it was for them to develop and produce cars with legal levels of emissions, acceptable standards for performance, and reasonable fuel efficiency.  They were more interested in making money than in making cars? More interested in short term profits and rolling those dice against long term losses?

It wasn’t that long ago that Volkswagen wanted to be the global leader in unit sales, but as a CNBC commentator put it: “Volkswagen is learning that getting ahead at all costs eventually catches up with you. So much for being the leader on a global basis on auto sales.”

The international layer.  Diesel powered cars are much more popular in Europe than in the U.S.  Thus, economists are trying to sort out what the impact will be on the Eurozone economy [Express]  The company is now facing litigation in Italy over fuel economy related issues. [Telegraph]  And, there are reports that the EU is looking at stricter rules to close the gap between laboratory and road test results. [EuObs]  Ironically, a company that didn’t want to play by the rules may find itself facing a more rigid regulatory regime in the very part of the planet where it had 25% of the market.  As of yesterday, there were calls for greater scrutiny of all automobile manufactures in Europe. [MrktWtch

Perhaps even more ironically, a company that wanted to increase its value managed to cause a 30 billion Euro drop in market cap in two days. [MrktWtch]  The CEO has resigned, the Chancellor of Germany is calling for a prompt investigation, [Telegraph] and the UK is entering the lists for a probe of what went so ridiculously wrong. [Guardian]

What went wrong?  What’s been going wrong for a while now – the story sounds entirely too familiar?  Financial institutions which sold and then bet on the value of financial products on which they could not place a value (Lehman Brothers et al.) in the U.S. in 2007-2008? Subprime CDOs?   Bankers colluded to fiddle with the LIBOR rate?  Does it sound like the same motivation as seen in the Worldcom and Enron?  It’s founded in the same swamp land all the other egregious examples have inhabited – greed.

Perhaps it’s too easy to forget that money isn’t the root of all evil; it’s the LOVE of money, or  that “For the love of money is the root of all evil: which while some coveted after, they have erred from the faith, and pierced themselves through with many sorrows.” [1T 6:10]  There will be sorrows aplenty – in the regulation layer, the management layer, and on the international scene.  There is a relatively fine line between seeking economic growth and downright avarice, and when it’s crossed the results can be catastrophic.  The question becomes: How many more times do we have to see this play before we get the point?

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Filed under ecology, Economy