Tag Archives: Financialism

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

The Big Catch: Pay Us and We’ll Do The Right Thing

Banker Sorry A small group of ultra-wealthy individuals are getting alarmed by the widening income gap in America. [NYT]  Their cries hit some major news outlets and were analyzed in others. [Salon] [NationalMemo] And, as we might expect there’s a catch:  Corporate Welfare.

“There is a way to start. Government can provide tax incentives to business to pay more to employees making $80,000 or less. The program would exist for three to five years and then be evaluated for effectiveness.

The benefits would be huge. People would have more money to spend, and many would no longer need government help. That would mean a reduction in entitlements.” Peter Georgescu, CEO Young & Rubicam

Yes, you and many others read this correctly – CEO’s like Ken Langone (Home Depot founder) and Georgescu and Paul Tudor Jones are worried about the possibilities of either peasants with pitch forks or declining sales.  And, no, there is nothing new here. Nothing that ventures too far from the business model calling for tax breaks, cuts, incentives, etc. for corporations to locate in beautiful downtown West Buffalo Fart. 

If the suggestion weren’t so demonstrably callous it would be ludicrous and risible.  First, there’s nothing preventing companies from doing this without benefit of yet more tax cuts for the already wealthy corporations – or, is there.  Welcome back to the world of Shareholder Value!

Wal-Mart recently announced plans to increase company-wide minimum wage to $9 per hour, and to increase pay to $10 per hour for many employees by February.  And, then it bowed to the First Law of Staffing:

The company has also increased store staffing at peak hours so shoppers move quickly through checkout lines and see stocked shelves, said executives during the company’s quarterly earnings call earlier in August. [MarketWatch]

The old First Law is that you have enough employees if you can satisfy customer demand and maintain acceptable levels of client or customer service.  This should have been good news all around – except it wasn’t.

Those efforts contributed to a 15% drop in second-quarter net income compared with a year earlier, said executives. [MarketWatch]

What did Wall Street do?  The Street didn’t like that drop and punished Wal-Mart accordingly.

walmart stock

That’s right… it didn’t matter to investors if there were happier employees at the giant retailer; it didn’t matter that customers didn’t have to wait in the cashier’s line so long.  It mattered that the second quarter net income report was down on a YOY basis.

This is one of the more egregious contemporary examples of the Shareholder Value Monster trampling on any corporate plans to do what businesses should do best – meet customer demand with an acceptable level of customer/client service.

As long as the Financialists continue to steer the corporate ships details like customer service and employee retention – which used to inform management policy – will take a back seat to the quarterly earnings reports. So, Wal-Mart caved to the financial side and announced to its +/- 4,600 store managers that it would return to “pre-determined” staffing levels (back to the old levels), and cut employee hours to trim expenses.

CEO’s, of such organizations like Wal-Mart, are now trapped in a device of their own creation. If they attempt to offer higher wages (or improve the quality of customer service), both of which have long term benefits;  they are punished by the Shareholder Value oriented short term investors and their stock prices drop. If the stock prices drop so does executive compensation.  Should the stock prices drop too far in the estimation of investors the CEO can be gliding off on his or her Golden Parachute into the corporate sunset.

Thus, it isn’t surprising that the CEOs are anxious to have some taxpayer assistance “doing the right thing” (increasing wages) in the long term because the short-sightedness of the Shareholder Value Theory of Management has translated into a situation in which long term benefits are sacrificed on the altar of short term profitability.

The paycheck pinch: One of the CEO’s angling for government (read: taxpayer) assistance in decreasing the widening income gap is Ken Langone (Home Depot founder). Sales and revenue for Home Depot in 2011 was $68 billion, increasing to $83.1 billion in 2015. 2011 gross income was reported as $21.69 billion, increasing to $27.3 billion in 2015. Its current domestic income tax liability is $3.26 billion, it has a deferred domestic tax liability of $116 million. [Marketwatch]  And, Mr. Langone agrees that corporations should be given tax breaks in order to pay more to the employees of concerns like Home Depot.

There are some 20 Home Depot stores in Nevada, most in the Las Vegas area, some in Reno/Sparks, and a couple in what is understood as rural Nevada, Elko and Pahrump.  There are plenty earning less than $80,000 per year in these operations.  The wages for a sales associate range from $8.67 to $13.95; cashiers earn from $7.93 to $10.83; department supervisors earn between $12.01 to $18.91; and, retail sales associations can make from $8.68 to $17.16.  (See Payscale.com as information updates)

These salaries have tax implications in Nevada as a result of 2015 legislation:

The Modified Business Tax (MBT) is currently imposed on businesses other than financial institutions in the amount of 1.17 percent of wages paid above an exemption level of $85,000 per quarter. Financial institutions pay a higher rate of 2 percent. The MBT rate had been scheduled to decline to 0.63 percent for nonfinancial institutions beginning July 1, 2015. The MBT base has been narrowed significantly since the tax’s introduction in 2003, with exemption level increases in 2011 and 2013.

After significant debate over whether to expand the MBT or adopt a new gross receipts tax, the final plan includes elements of both options. The MBT will increase from 1.17 percent to 1.475 percent for most businesses, effective July 1, 2015. Mining companies will join financial institutions in paying the higher 2 percent tax rate. The MBT base is broadened by reducing the exemption to $50,000 per quarter, increasing the estimated number of MBT taxpayers to 18,607, up from the 13,492 paying the tax at present.[2] An earlier proposal to remove the MBT exemption for employer-provided health care costs was dropped.

After the first year, taxpayers may deduct up to 50 percent of their Commerce Tax payments over the previous four quarters from their MBT liability. Moreover, should total revenue from all business taxes exceed projections by more than four percent, the MBT rate will be adjusted downward, though to a rate no lower than 1.17 percent. [TaxFoundation]

Note the last paragraph, even with a compromise between larger and smaller corporations in Nevada, there’s still a bit of a tax break allowed on the Commerce Tax depending on the “previous four quarters.”  We’re probably not looking at any massive tax breaks in the 2015 legislation, but we need to add these to the $88 million in breaks given to Apple [MJ]  and the state’s generosity to Tesla in the form of $1.25 billion. [RGJ] In the latter deal the understanding was that Tesla would pay an average of $25/hr.

Not to put too fine a point to it, but corporations are quite used to having government entities, be they Apple in Nevada and North Carolina, Tesla in Nevada, or the bargaining in the 2015 Nevada legislature over how to maintain tax revenues, engage in tax-payer subsidies for corporate operations.  Thus, it’s not the least bit surprising the CEOs would ask for tax-payer subsidization for payroll increases.

It would be a reasonable conjecture to conclude that Home Depot and other Big Box firms like Wal-Mart might be willing to adopt staffing policies which increase employee wages and provide for better customer service –IF and ONLY IF there are further tax breaks associated with those policies which will please the short-term oriented Shareholder Value financialists who pull on the purse strings.

Hanging the Wash? Consider what the CEOs are proposing – it’s all good: “The benefits would be huge. People would have more money to spend, and many would no longer need government help. That would mean a reduction in entitlements.”  But wait, there’s some loaded language herein.  Programs like SNAP, and subsidized housing, or similar assistance to low wage earners are NOT entitlements. These are situational support programs for people in need.  Social Security/Medicare, into which people have paid for decades are entitlements – you get what you paid for.

Loaded language aside,  What happens when the corporations raise wages, projected to reduce the number of people receiving social assistance, but the revenues for that social assistance are reduced by the tax breaks given to the corporations in order to support those very same wage increases? The tax payers are on the hook either way – they either pay for the social assistance programs which subsidize low wages,  or they subsidize the tax breaks to corporations to reduce the need for the social programs?  It’s a win-win for the corporations, and a lose-lose for the average American.

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Filed under Economy, Nevada economy, Nevada legislature, Nevada politics, nevada taxation, Politics

SLABS: How to make money off someone else’s private student loan

SLABS

SLABs, and no we aren’t talking about the stuff of which patios are made, or the tiles that can be laid on kitchen floors. Nor, are we talking about some Silicon Valley laboratory firm.  Let’s focus on Student Loan Asset Based securities.  Yep, “securitized” assets – like mortgages, auto loans, credit card receivables, etc.  We do remember the mortgage thing? Right?

SLABs were hot in 2013. [WSJ]  In fact, see if you can make sense of the following description:

“Student loans are souring at a growing rate—and investors can’t seem to get enough. SLM Corp., the largest U.S. student lender, last week sold $1.1 billion of securities backed by private student loans. Demand for the riskiest bunch—those that will lose money first if the loans go bad—was 15 times greater than the supply, people familiar with the deal said.” [WSJ]

Why would investors be banging on the doors for those loans which are the most likely to go into default?  I think we’ve seen this movie before, and the ending (2007 – 2008) wasn’t pleasant for anyone.

The Basic Materials

Once upon a time Sallie Mae or SLM, was a government sponsored lending firm specializing in student or educational loans.  That was the case until 2004 when Sallie Mae went private and it’s now a publicly traded private sector corporation. SLM securitizes private education loan by selling them to the SMB Private Education Loan Trusts. The Loan Trusts (2014 and 2015) show “issuance details” online (here’s 2014-A)  There was $382 million in the August 7, 2014 records; divided into five categories with varying rates of return. Scrolling down we find the ‘master servicer’ as Sallie Mae Bank, the sub-servicer as Navient Solutions, Inc., the indentured trustee being Deutsche Bank National Trust Company, and the underwriters Credit Suisse and the Royal Bank of Scotland. [SLM]   Navient Solutions, Inc. is simply the name adopted in 2014 for Sallie Mae’s loan management, servicing, and asset recovery operation. [Bloomberg]  An ‘indentured trustee’ is:

“A financial institution with trust powers, such as a commercial bank or trust company, that is given fiduciary powers by a bond issuer to enforce the terms of a bond indenture. An indenture is a contract between a bond issuer and a bond holder. A trustee sees that bond interest payments are made as scheduled, and protects the interests of the bondholders if the issuer defaults.” [Investopedia]

The underwriters, in this instance Credit Suisse and RBS, are the firms which act as sales personnel for the bonds bases on securitized private student loans.  So, we have SLM issuing the bonds, Deutsche Bank National Trust acting as the agency responsible for bond registration, transfer, and payment of bonds, while Credit Suisse and RBS are the ones selling the bonds.   Sounds impressive, however those private loans comprise only about 8% of the total student loan market – the remaining 92% are Federal Stafford and PLUS program loans.  But – the numbers are still sufficiently high to interest SLM, Deutsche Bank, Credit Suisse and RBS, because there’s about $92 billion involved in the private student loan market. [PSL]

Slabs without much mortar

Recall for the moment what got Wall Street in major trouble during the Housing Bubble.  Investment firms issued bonds, and then played with derivatives based on those mortgage based bonds, without being all that sure the loans were going to be paid off.  Thus, it was extremely difficult, and in some instances impossible, to calculate what the bonds were actually worth. Enter the credit rating agencies who (for a nice fee) stamped AAA+++ on what should have been recognized as piles of garbage; the investors couldn’t get enough of these, so even more garbage piled up as the investment houses bet on whether or not the assets were worth anything.  Enough garbage was included in the piles of paper that the whole pillar of paper crashed.

What’s saving us from the prospect of another bubble of epic proportions is that the market in private student loans is very small – that $92 million is a drop in a very large bucket of corporate and commercial debt. [Atlantic]  Another bit of good news is that because of the Dodd-Frank Act there is more transparency required in dealings in asset based securities.  [SEC]  [WSJ] The bad news is that Republicans in Congress have been wailing for the repeal of the Dodd-Frank Act as “burdensome regulation” of the banking industry.  Or, “make the SEC back off and let us get back to trading asset based securities like we used to in the Good Old Days.”

Who’s holding up the scaffolding?

Another bit of bad news is that while lenders are looking for new customers (students willing to take on private loans) we’re not tracking some important information about those loans.  For example, the default rate for Harvard is less than 2%, while the default rate for the Arizona Automotive Institute is nearly 42%.  [Bloomberg] Interestingly enough, there’s a long list of for-profit educational institutions with default rates higher than 28%. What we don’t need to see are more for-profit training schools encouraging more private student loan debt, debt which someone somewhere hopes will be hedged with private loans more likely to be paid off – because at bottom the funds to pay investors have to come from students paying off the loans.

Don’t panic yet, yes – there’s a hungry market for student loan asset based securities (perhaps in part because some old Federally backed loans were in the pipeline originally) and the market is relatively small albeit subject to some of the valuation mistakes of the Old Investment Houses – the ones who went bust in 2007-2008.   There’s another reason for hope: The Consumer Financial Protection Bureau – the agency the Republicans can’t seem to wait to dismantle. [DB 7/30/14]

One of the provisions of the Dodd-Frank Act was the creation of an ombudsman for student loans which is part of the CFPB.  In the 2014 annual report (pdf)  it’s of interest to note that the biggest problem area was NOT repaying student loans but in getting financial institutions to cooperate with repayment programs and dealing with servicers and lenders (57%). If this sounds like a reprise from the Mortgage Meltdown Days it might be because some of the same actors are involved, at least in terms of complaint volume: JPMorganChase up 56% from 2013; Sallie Mae Navient up 48%; Wells Fargo up 8%.  The annual report indicates problems in the following areas: (1) There is no clear path to avoid default. (2) Proactive outreach from borrowers was too often unsuccessful. (3) When repayment options are made available they are too often too little too late. (4) In some cases repayment options were allowed only after the loan went into default. (5) Short term forbearance options were often associated with processing delays, unclear requirements, and unaffordable fees. (6) Many lenders force a choice between staying in school and repaying the loans.   There is a reason for the Ombudsman’s concern. The Sallie Mae Settlement.

The FDIC announced a settlement with Sallie Mae on May 13, 2014 in which Sallie Mae was charged with (1) inadequately disclosing its payment allocation methodologies to borrowers while allocating borrower payments across multiple loans in a manner that maximizes late fees; (2) misrepresenting and inadequately disclosing in its billing statements how borrowers could avoid late fees; (3) unfairly conditioning receipt of benefits under the SCRA upon requirements not found in the act; (4) improperly advising servicemembers that they must be deployed to receive benefits under the SCRA; and (5) failing to provide complete SCRA relief to servicemembers after having been put on notice of the borrowers’ active duty status.

The Structure

As long as the private student loan market remains a small part of the total structure we can breathe a bit easier about its effect on capital markets. Secondly, the private student loan market has relatively low yields and thus doesn’t get included in most structured derivatives.  Third, the old ‘recourse loans’ (for those with really low credit scores) are a thing of the past, most private loans now take higher scores into consideration. [QuoraWhat will continue to keep investors whole?

  • Continued monitoring of the private student loan market by the CFPB so that loans taken out will continue to be loans paid off, even if this means some reduction in the revenue streams for the bankers.
  • Continued oversight by the SEC and FDIC under the terms of the Dodd-Frank Act so that we don’t return to the Wall Street Casino of old should there be changes in the private student loan market.
  • Improvement in the servicing of private student loans such that there are clear pathways to avoid default; effective and efficient communication between borrower and lender regarding repayment options; and, that this communication happens in a timely manner.
  • Requiring lenders to make all the term of the private student loan clear at the outset including forbearance conditions, and any and all fees associated with deference, late payments or defaults.

The Foundation

From a Wall Street perspective private student loan asset based securities are a niche market, with some revenue potential – enough to keep the big banks interested – however, not with enough total clout to cause major financial displacement should the Quake happen.  And yes, there are some institutions making nice fees for making student loans, selling student loans, securitizing student loans, servicing student loans, and collecting payments on student loans.  Capitalism works, the trick is to keep free market capitalism from becoming casino capitalism and/or financialism.

A more existential question is how to maintain a system in which students are burdened with so much debt (Federal program/Private loan program) that they are deferring consumer purchases which would contribute to the growth of the overall economy.  Deferred student loans can impact mortgage qualifications. [credit.com]  We know this because the  rate of homeownership among those with student debt is 36% below that of unencumbered home buyers, and we’re losing about $6 billion annually in new car buying capacity.  [Forbes]  And, this is not an inconsequential problem:

“Student loan debt is the only form of consumer debt that has grown since the peak of consumer debt in 2008. Balances of student loans have eclipsed both auto loans and credit cards, making student loan debt the largest form of consumer debt outside of mortgages.” [NYFed]

Given some of the trends reported by the NY Federal Reserve’s study of educational loans, how do we make sense of an economic system in which wages and salaries are stagnant while it is taking those from lower and middle income backgrounds longer to repay student loans?  How do we sustain an economy when 29% of borrowers are paying off their loans, while 34% are making regular payments but the balance is increasing, and 20% have reported credit related problems, with another 6% delinquent and 11% in default?

These are not simply economic issues, they are also political as well. Is there the political will to make post secondary education more affordable for more people?  Are we headed toward the privatization of our public institutions of higher education and post secondary training, and is this trend combined with the rising level of student indebtedness creating cracks in our economic foundations?

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Filed under consumers, Economy, education, financial regulation, privatization

Our Thirty Five Years of Mythological Economics

trickle down economics

The only problem with this cartoon version of  Trickle Down economics is that the bird at the top should be getting larger as the years extend.  Likewise, the birds in the middle range should be getting more stressed as they attempt to stay on their middle income perches.  It’s a nice touch that the background is in blue, suggesting we’re about to be washed up in a tide which only serves those who are perched high enough to avoid drowning.

Meanwhile, the  best response to the sentence “A rising tide lifts all boats,” is “Where Are The Customers’ Yachts?”  For those who have not yet read this 75 year old classic – it’s still available, and still germane to American economics.  It was true then, and true now.  The problem is that the financial sector has hijacked significant portions of our economic thinking, in ways that have left us prone to being bedazzled by BS.   Thus, we’d prefer to rail against the Wall Street Casino rather than believe we’ve been following some very foolish advice offered, in turn, by some very foolish, and very self serving,  people. And, there are people challenging the BS rendition of American capitalism.

Those who missed Mrs. Clinton’s speech at the New School (NYC) on our economic challenges can view the C-SPAN broadcast here. (55 minutes)

The initial response from journalists was “Hillary’s bashing Wall Street.” [Reuters] This makes for a convenient headline – Beltway Shorthand for her support for regulation of Wall Street investment bankers’ transactions – however, it doesn’t come close to adequately summarizing what both candidates Clinton and Sanders have been saying about financialism in American economics. The Beltway Media is missing the point, perhaps because it doesn’t fit neatly into a template predetermined by editorial policy, or a simplistic code for easy lead paragraphs.

The point is that we have had 35 years of what President George H.W. Bush called Voodoo Economics (although bless his heart he promoted it like any good Republican), and it doesn’t work in the real world. Why? Because the mythology violates the simple principles of American capitalism:

”So here’s an idea worth spreading. In a capitalist economy, the true job creators are consumers, the middle class. And taxing the rich to make investments that grow the middle class is the single smartest thing we can do for the middle class, the poor and the rich.” [LAT]

With this basis in mind, let’s tackle some of the mythology and deal with a bit more economic reality.  We might as well start with the “job creators” sound bite.

#Job transference is not necessarily job creation.  Yes, Home Depot has about 340,000 employees. [USAT]  However, in order to achieve those numbers, how many local hardware stores went out of business, or had to shave employment numbers, because they were hard pressed to compete with the Big Box Stores?  Of the 340,000 Home Depot employees only 21,000 were salaried, the rest were working on a temporary basis or for hourly wages.  The average hourly wages for employees in the retail sector are $14.36 per hour. [Monster] Further, we know that about 1/3rd of all retail sector employees are working part time. If we take a closer look we find that the median wages for retail employees (full time) in building materials and garden equipment were about $12.21 per hour. [BLS]

So, we have to ask ourselves, if a Big Box Store moves in an puts a local supermarket or hardware store out of business, does that translate into “job creation” or simply the transference of personnel from one job into another – possibly lower paying – job?

#Low wages make stocks attractive and the overall economy weaker.    The largest fast food chain in the U.S. has approximately 440,000 employees. [USAT]  And, what do food service preparation employees earn?  About $19,300 per year, or approximately $9.28 per hour. [BLS]  The average weekly hours for all employees are currently estimated as 25.8 per week, and for nonsupervisory employees at about 24.6 hours per week. [BLS] Significantly, before we fall into the hype-vat argument about the “kid’s first job,” only about 30% of fast food workers are teenagers, another 30% are between the ages of 20 and 24, and the remaining 40% are 25 years of age and older. [CEPR]

From the shareholder perspective it makes perfect sense to keep wages low, employee turnover high, and continue to appeal to those who have a “quarterly value” vision of America.   From the perspective of other business owners in the area, those low wages translate to minimal disposable income, which means fewer customers for their products and services.  In short, the yacht at the top is sailing along while the little boats bounce around the rocks.

#Wealth created from indebtedness doesn’t trickle anywhere.  Median household earnings are slowly, very slowly, emerging from the last Recession.

real median household income If we find more jobs transferred from, say, smaller local firms to larger national ones, or more jobs are being created in sectors like food and beverage service with notoriously low wages, then we might expect to find household incurring debts to maintain a middle income life style.

Consumer indebtedness, which was down to 4.88% of disposable income in the fourth quarter of 2012, is now back up to 5.30%. [Fed]  There are a couple of ways to see this, first as an indication that people are feeling better about assuming credit card or personal debt because their incomes are more stable, or secondly that while they’re feeling a bit better, the credit card has become a way to keep afloat.  However, those debts are the basis for altogether too much of what constitutes Wall Street wealth accumulation.

Household debt Whatever amounts of these debts are securitized means that they’ve gone into the Wall Street Casino to be used as the basis for hybrid financial products.  So, what’s been happening to the securitization of auto loans?  It’s “coming back strong” but not at “pre-crisis levels.” Translation: It’s not a bubble. [FRB ATL]  It’s lovely to know the Federal Reserve doesn’t consider the securitization of auto loans at the Bubble Level, but it’s also a bit worrisome to note that what is gained from that securitization isn’t trickling down anywhere near the automobile product consumer.

Nor is there much happy news about securitization and the student loan business.  ZeroHedge offers this gloomy prospect:

“So just as we have been warning about for sometime now: an underestimation of the impact of deferral and forbearance and weakness in the job market is likely to trigger defaults on billions in student loans and because these loans comprise the collateral pool backing ABS sold to investors, the ripple effect is magnified and we wonder if the July 2007 moment for the student loan-backed ABS market may come sooner rather than later.”

The ‘wealth’ produced on Wall Street is based on the loan the students took out to pay for educational expenses, securitized, tranched, sliced, diced, and repackaged for the ‘benefit’ of the investors – those who may very well get burned in this round of Securitization Bingo.

Evidently lost on the Sultans of Securitization is the simple fact that an asset based security requires someone to be able to afford the purchase of educational services or automobiles, or the other stuff on the credit card – the original assets.

It’s one thing to announce that “middle class incomes” are back where they were in 1995 – and another thing entirely to notice that the costs of college tuition are up 61% since ‘95; that home prices are up 13%; that the price of gasoline is up 94%; and that Big Mac is up 28%. [moneyCNN] These numbers aren’t the sort to make anyone comfortable who’s taking out the student loan or buying the house. Eventually, even Wall Street may have to take notice of the fact that no matter how much revenue it can generate in terms of ABS and the hybrids related thereto, if American consumers can’t generate sales – and jobs – then investors are caught trying to ride the bubbles.  Bubbles always pop, that’s why they’re bubbles.

The ‘wealth’ from the sales, and hedges, and bets, on asset based securities, again, trickles down nowhere near the average home owner or car buyer.  However, no one is arguing that ABSs don’t have value.  They are a way to spread the risk around, and that’s positive.  They are negative when we see them mask intrinsic cracks in American capitalism, and negative when we see that the revenue generated never quite manages to trickle back down to the local economies perhaps in the form  of better roads, better schools, better parks, better libraries, and better public services like broadband.

Candidates Clinton and Sanders aren’t “bashing Wall Street,” they are simply trying to point out that the lurch from one bubble to the next isn’t a productive way to run an economy, and lunging from one volatile market to the next isn’t the way to insure that the capacity of the average consumer to purchase the assets on which the securities are based remains steady and profitable for everyone.  If Wall Street can’t divest itself of its 35 Year Investment in imaginary economics, and can’t restrain itself from short term financialist thinking, then someone has to be the adult in the room.  The adult is called reasonable regulation, and that’s all they are asking.

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Sinking the Vasa: A Message for Global Corporations

Vasa 1

The construction of the Vasa took almost two and a half years; her hull built of more than 1,000 oak trees.  She carried 64 bronze cannon, and was to sail with masts over 50 meters high. She was the pride of the Swedish Fleet.  King King Gustav II Adolph was certain she would not only be a tangible reminder of Swedish military power, but a message to other 17th century monarchs of the potential futility of assaulting the Swedish navy.   There may be some modern comparisons, albeit somewhat tenuous, to King Gustav II Adolph and his plans.

79 year old Joseph Sepp Blatter recently won the FIFA election and will head the organization for another four years.  He has crafted a corporate alliance to insure his power, and maintained his control in a manner reminiscent of a feudalism which predates King Gustav II Adolph.   This, in the face of criminal charges against some of his top lieutenants. This, in the face of serious threats to create a new Thirty Years War and break the hold of FIFA on world soccer competition. [DailyMail]

Blatter’s reaction to the possible constriction of his power? He’s a victim, however:

“Between 2010 and 2013, half of FIFA’s 24-strong executive committee was accused of some form of corruption, five were forced to resign, and one was banned for life. In 1999, Blatter reassured the world about his soon-to-be-disgraced cabinet: “I can’t speak about everyone’s sense of morality but, for the 24 members of a committee I have the honor to direct, I can say they have all taken a sort of ethical oath.” [Slate]

By his lights his latest troubles are the result of American and British sour grapes.   There’s another contemporary example of a global mogul who cries “victim” when confronted.

In 2013 JP Morgan tried to spin the tale that it was a “victim” of government interference with the financial markets and therefore could not be held liable for the egregious mortgage/financial results of its actions during the Financial Collapse of 2007-2008.  It was a nice try, but the arguments weren’t constructed of anything so solid as the oaks which went into the construction of the Vasa hull. [Dealbook]   The whining continued into 2015.

CEO Jamie Dimon complained in January 2015 that “banks were under assault!”  A person might think Dimon considered himself analogous to the 1626 Polish-Lithuanian Commonwealth fighting off King Gustav II Adolph to secure the city of Danzig (Gdansk)?  However, there’s more and it brings on another whine. “It’s those lazy investors!” [C&L]

“You might think that the chairman and CEO of a major bank that had just pleaded guilty to a federal felony charge and has paid out more than $20 billion in legal settlements in recent years would show a little humility.  But then you wouldn’t be reckoning with Jamie Dimon, the head of JPMorgan Chase. At an investment conference in New York this week, Dimon lashed out at institutional investors who voted against his pay package and his dual role as the firm’s chairman and chief executive, and otherwise rejected management’s wishes on shareholder resolutions at the annual meeting May 19.” [LATimes]

Dimon’s craft was one of the survivors of the 2007-2008 debacle, Dick Fuld’s Lehman Brothers operation was one of the first casualties, but wait! it wasn’t their fault.  They ignored the 12-1 debt ratio, coming in closer to something like 40-1.  All it took was faulty economic modeling, excessive real estate exposure, over reliance on ratings, and an utter failure to manage their repos. [Bloomberg] One more we find one of the titans of industry and finance whinging as though they aren’t responsible for the systems they set in place.  No more so than King Gustav II Adolph could be blamed for the wreck of the Vasa?

When the King heard the Danes were constructing a ship with two gun decks, he changed the orders and specified the Vasa was to be similarly constructed.  That the original specifications were for a single enclosed gun deck was not taken into serious consideration.  One useless stadium here, another there – no matter.  One purchase of a highly questionable financial enterprise here, another there, no matter? One disregard of the 12-1 rule, so what could go wrong?

Indeed, what could go wrong when keel modifications were not taken into consideration, when no one at the time really knew how to calculate a ship’s stability, stiffness, and sailing characteristics?  Did anyone know the “value” of a hybrid financial product based on the price of a batch of derivatives in 2005?

There was a “lurch test” conducted on the Vasa before her launch, and the instability and ballast problems were noted.  The test consisted of having 30 men run from side to side amidship, and after three of these runs the ship was “rocking so violently it was feared it would heel over.” [FacUPedu pdf] How many more FIFA executives need to be indicted before that organization heels over?

All these ships, physical, financial, and entertaining,  were supposed to sail effortlessly in calm waters of their own choosing.

Vasa 2

The Vasa began her maiden voyage from the Skeppsgarden Shipyard on August 10, 1628; all 1210 tonnes of her, with her 38 ft. beam, her 16 ft. draft, and her 172 ft. height.  Yes, she was indeed top heavy, the ‘lurch test had illustrated that to all who witnessed it.  Hundreds, if not thousands came to see the flagship of the fleet take her first voyage.  The spectacle was not what was intended.

After she sailed about 1300 meters a light wind gust caused her to heel over on her side, the gun ports were open (to allow a salutary salvo to be fired) and water poured in.  The beautifully decorated, heavily armed, ship sank only 390 ft. from shore in waters about 32 ft. deep.

From both historic and modern inquests we know why she sank – there were “Ten Lessons Learned.”

There were excessive schedule pressures.  The scheduling pressures were exacerbated by changing needs, and operational characteristics were modified during the construction process.  There was a lack of technical specifications, compounded by a lack of a documented project plan.  Is any of this beginning to sound familiar?

There was excessive innovation, for example, no one in Sweden at the time had ever constructed a ship with two enclosed gun decks.  Worse still, there were secondary innovations added to accommodate the initial innovations, even though no one knew the implications of the initial ones.  And, there was the inevitable “requirement creep,” during the 2 1/2 years of construction;  we’d recognize this as “mission creep.”

There were no contemporary scientific methods for “calculating the center of gravity, the stiffness, and the resulting stability relationships of the Vasa.” We’d also recognize the creation of “financial products” the value of which couldn’t be determined at the outset being used as the “ballast” for subsequent iterations and innovations.  And, then there were two more items on the fail-list which we are obviously still dealing with today.

They ignored the obvious. The stability test was a failure – but that quite evidently didn’t deter the launch.  The second item is “possible mendacity,” or, “the results of the stability test were known to some but were not communicated to others.”  [FacUPedu pdf]

Imagine: a modern corporate leader.  A modern global corporate leader so anxious to “win,” to prosper, that in the interest of innovation caution is blown to the winds?  Imagine: a modern corporate leader who is so determined to “succeed” that the lack of specificity, the dearth of calculations, and the inappropriateness of methodology is dismissed? And, imagine a global corporate leader who either ignores or is never informed by the sycophantic warning signs that all is not well?  And so the beautiful Vasa sank.  She is now a museum piece.

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The Wreck of the Penn Central: Conservatives want to replicate another financial debacle?

Rail logos Two days ago Fox News was happily promoting the privatization of Amtrak. [C&L]

“Gasparino went on to promote privatization. He said that the northeast corridor, between Washington and Boston, is a “very profitable service” and “there is no rationale why that service cannot be privatized. …If you put private management in there, it would probably be even more profitable and they could pay for even more upgrades.” “I’m not saying privatize the whole thing, at least not at first,” Gasparino said. But he insisted that privatization would make for “a Jet Blue of rail traffic.”

I admit to having “senior moments,” but I haven’t forgotten the fact that the reason Amtrak was created in 1971 was because of the FAILURE of private corporations to run the railroads.

A Bit of History

Once upon a time there was the Penn Central Transportation Company.

“The Penn Central merger was consummated on February 1, 1968, between the Pennsylvania Railroad and the New York Central Railroad. At the end of 1968, the New York New Haven & Hartford Railroad was merged into PC by order of the Interstate Commerce Commission.

Financial problems plagued the PC during its first couple years. Even though the merger had been planned for 10 years (on and off) before its inception, many problems faced the combined companies, such as incompatible computer systems and signaling systems.

Penn Central also invested in other companies, such as real estate, pipelines, and other ventures. The idea was to create a conglomerate corporation, with the railroad as one part of it. This diversification program, even 20 years later, is a point of debate over the fall of the PC, as some people say funds that were invested in other companies could have been used to run the railroad.” [PCRRHS]

Take a measure of mergers/acquisitions, add “diversification,” and … the world watched as the newly formed company created “dismal numbers.”  Enter the investment bankers. There were warnings.  One warning came before the big merger, in which it was noted that Penn Central had more than $1 billion in debt which would mature by 1982. When Penn Central finally went into bankruptcy it’s long term indebtedness, including obligations due in one year was an eye-popping $2.6 billion. $1 billion was due in five years; $228 million fell due in 1970; $156 million was due in 1971; $172 million came due in 1972; $270 million due in 1973, with another $160 million due in 1974. [Wreck of PCentral]

How this happened should sound eerily familiar:

“…economist Henry Kaufman says of this period in the late 1960s, “I watched with growing alarm as sources of corporate borrowers – in an effort to circumvent regulatory lending constraints – piled into the commercial market as issuers. The trend continued, and culminated in the collapse of the Penn Central Railroad.” [BuyHold]

And collapse it did, into the largest bankruptcy the nation had experienced up to that point, but not before:

“Penn Central’s subsidiaries were stripped of their treasuries in order to prop up PC’s own earnings. For example, New York Central Transport, a trucking subsidiary, had profits of only $4.2 million and yet paid $14.5 million in dividends to the parent. Despite this kind of maneuvering, the dividend on Penn Central common was slashed from $2.40 to $1.80 in 1969. Chairman Saunders vowed to hike it back up, soon. [It was later learned, however, that insiders at PC were unloading their company stock and bonds while all of this was going on.” [BuyHold]

We had a batch of corporate borrowers trying to get around regulations on lending, combined with a company fiddling the books trying to prop up its earnings reports, and taking on massive amounts of debt.  What could possibly go wrong?   The answer, of course, was “everything.”  June 21, 1970 the company declared bankruptcy.  What of the passengers?

“October, 1970, in an attempt to revive passenger rail service, congress passed the Rail Passenger Service Act. That Act created Amtrak, a private company which, on May 1, 1971 began managing a nation-wide rail system dedicated to passenger service.” [Amtrak]

Where was Wall Street?  Again, Wall Street didn’t appear to be all that helpful, except perhaps to themselves.  Goldman Sachs won “the opportunity” to underwrite Penn Central’s commercial paper in 1968.  We can almost guess what happened next:

“For large fees, Goldman sold the paper to its clients, including big companies such as American Express and Disney, and smaller ones such as Welch’s Foods, the grape-juice maker, and Younkers, a Des Moines retailer. Welch’s and Younkers, particularly, counted on the fact that Goldman told them that the Penn Central paper was safe and could be easily redeemed. Welch’s invested $1 million — some of it payroll cash — and Younkers invested $500,000, both at Goldman’s recommendation.” [TribLive]

After the Penn Central’s bankruptcy filing the SEC conducted an investigation.  This, too, is a bit too common for comfort:

After Penn Central filed for bankruptcy, an SEC investigation discovered that Goldman continued to sell the railroad’s debt to its clients at 100 cents on the dollar — even though, by the end of 1969, the firm knew that Penn Central’s finances were deteriorating rapidly.Not only was Goldman privy to Penn Central’s internal numbers, it also heard repeatedly from the railroad’s executives that it was rapidly running out of cash. [TribLive]

By February 1970 Goldman had about $10 million in Penn Central commercial paper on its books.  On February 5, 1970 Goldman Sachs demanded that the railroad buy back that $10 million inventory at 100 cents on the dollar even though it obviously wasn’t worth that much at that point. Goldman Sachs didn’t tell any of its clients about the offer, nor did it tell the customers that it had already taken care of its own interests before theirs.  Plus ca change, plus c’est la meme chose? [see also: WaPo 2102]

It doesn’t take too much imagination to see how (1) a boom in commercial paper – indebtedness; combined with (2) underlying debts incurred in operations, mergers, and acquisitions; abetted by (3) investors seeking ways around regulations; and (4) investment banking more interested in self preservation than best business practices combined to create a blockbuster bankruptcy. 

But yet, we have the Cato Institute, the bastion of conservative economic imagination pontificating:

“Budgetarily, Amtrak has become a runaway train, consuming huge subsidies and providing little or no return. Four decades of subsidies to passenger trains that are many times greater than subsidies to airlines and highways have failed to significantly alter American travel habits. Simple justice to Amtrak’s competitors as well as to taxpayers demands an end to those subsidies. The only real solution for Amtrak is privatization.”

The conservatives are missing several points.  The point may not be to “alter” travel habits – but to maintain services which people were already using for their commute to work, especially in the Northeast Corridor.  The rationale for the act included stabilizing services for passengers, the general public, and shippers. [RRA]

Going to Court

Amtrak is a private corporation, albeit one with some very special features.   If we want to get technical about  it, the official name is the National Railroad Passenger Corporation.  In fact, the point was driven home in a legal case two years ago in which the private nature of the NRP Corporation was pivotal:

“A three-judge panel of the U.S. Court of Appeals in Washington today said Congress had improperly delegated to Amtrak, a private corporation, the power to draft performance standards that affected companies whose tracks the passenger carrier uses. Amtrak trains have legal priority over freight.

“Though the federal government’s involvement in Amtrak is considerable, Congress has both designated it a private corporation and instructed that it be managed so as to maximize profit,” U.S. Circuit Judge Janice Rogers Brown said in the ruling.” [Skift]

The case got the attention of the U.S. Supreme Court. [FRAdvisor] Enter the “fish or fowl” phase.  Roger’s decision was “vacated and remanded” on a 9-0 decision.  Could Amtrak “metrics and standards” be set aside because the Congress unconstitutionally delegated power to a private corporation? And the Court said:

“No. Justice Anthony M. Kennedy delivered the opinion for the majority. The Court held that, for purposes of determining the validity of the metrics and standards, Amtrak is a governmental entity. The members of Amtrak’s Board of Directors are appointed by the President and confirmed by the Senate, and Amtrak is required by statute to pursue broad public objectives. Because of Amtrak’s significant ties to the government, Amtrak is not a private enterprise, and therefore, treating Amtrak as a governmental entity is consistent with the constitutional separation of powers.” [Oyez]

Therefore, what the Cato Institute and its allies are arguing is that the decision in DOT vs. Association of American Railroads (49 USC 24301) should be overturned and the railways should exist without any “regulations” imposed by Amtrak which would be applicable to freight haulers.   Extrapolating the Cato’s position to absurdity, under their reasoning we could revert to the wonderful old days of differing track gauges. 

Riding the Thin Rail

However, perhaps the most crucial point the conservatives are missing isn’t about the legislative and legal nature of the National Railroad Passenger Corporation, but why this entity was established in the first place.  Although a person might think we’d have learned something from the financial debacle of 2007-2008, the calls to privatize Amtrak have a remarkably familiar ring.

In a financial atmosphere in which commercial debt is treated as fodder for the creation of derivative financial products, and trading is barely regulated in the face of financialist opposition, and mergers and acquisitions generate incentives for corporate mismanagement, and there isn’t an old school investment bank left on the American landscape because of the casino mentality of Wall Street during the Housing Bubble, are we truly going to believe that privatization is the panacea for all that ails the passenger rail system in the United States?

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Filed under Economy, financial regulation, Infrastructure, public transportation

Shady Lender Protection Act heard in Nevada Legislature Committee

AB 282

Perhaps this was a good week to revisit “Margin Call?”  Why? Because Fiore and Friends are promoting AB 282 in the Nevada state Legislature.

“AB 282: AN ACT relating to real property; revising provisions governing mediation of a judicial foreclosure action; revising provisions requiring certain actions related to the foreclosure of owner-occupied property securing a residential mortgage loan to be rescinded after a certain period; revising provisions governing civil actions brought by a borrower for certain violations of law governing the foreclosure of owner-occupied property securing a residential mortgage loan…”

This bill is on today’s agenda in the Assembly Judiciary Committee.  Might it be suggested that the informal title of the bill be “The Shady Lender Protection Act of 2015?”  Here’s why:

“Existing law provides that in a judicial foreclosure action concerning owner- occupied property, the mortgagor may elect to participate in the program of foreclosure mediation. (NRS 40.437) Section 1 of this bill removes provisions governing the process of such mediation and the documents required to be brought to the mediation. Section 1 instead requires the Nevada Supreme Court to adopt rules governing the mediation.” (emphasis added)

Let’s start with the part wherein the Nevada foreclosure mediation process has been successful.  It’s been especially beneficial for borrowers in owner occupied homes who want to avoid foreclosure. [nolo] Perhaps this is why Fiore and Friends and so dead set against it?  So, what are those documents required in the process?

“Nevada’s mediation program requires that borrowers and the lender provide the mediator and each other with certain documents prior to the mediation. The borrower must provide appropriate documentation, such as financial information, so that the lender can make a determination about whether the borrower is eligible for a loan workout. The lender must provide documents such as the original note, deed of trust, and assignments (or certified copies).” [nolo]

Remember those bad old days, the ones in the wake of the housing bubble debacle?  Those were the days during which lenders were seeking to foreclose properties on which they didn’t have the paperwork necessary to prove who held the mortgage.  And at this point we return to the messy problem of MERS.

MERS was an ‘electronic’ recording of mortgages which was supposed to facilitate the assignment of mortgages etc. at high speed – speed high enough to sate the demand from Wall Street for more and more and more mortgages to slice, dice, tranche, and otherwise divide into financial products for marketing.  The idea was that county recorders weren’t fast enough to keep pace with the Wall Street demand for mortgages in the secondary market.  The fall out from the MERS mess is still being felt in parts of the country. [Harpers]

Thus, what AB 282 does is to (1) eliminate a mediation process which has been successful in Nevada, and (2) eliminates the documentation requirements now on the books according to which the borrowers must provide their financial information and the lenders must prove they own the paperwork on the property.  We can guess who’s having problems with the paperwork, but an article in the Reno Gazette Journal in 2012 provides some interesting details:

“Data from the same report (on program effectiveness) , however, have some questioning what the program’s definition of good faith is. Out of the 3,183 total cases from the same time period, banks did not bring all the required documents in 1,149 cases — a rate of 36 percent.

JPMorgan Chase topped the list, failing to bring all necessary documents in 52 percent of its cases. Ally/GMAC was second at 50 percent, followed by Bank of America at 41 percent, US Bank at 32 percent and Wells Fargo at 31 percent. Citigroup posted the lowest rate of the six banks mentioned at 12 percent.”

And, why did the banks have problems with the paperwork?  They didn’t have it. The Great Wall Street Mortgage Mill had shredded the mortgages into sliced and diced financial products in which nobody knew who really owned what – much less what the paper was really worth.

“They want the original paperwork and not a certified copy, which becomes an issue for mortgages that have been securitized (into investments),” Uffelman said. “Once a mortgage gets securitized, the paperwork ends up in a different place and can be tough for a servicer to track down and pull back together. The more you securitize stuff, the easier it is to screw things up.” [RGJ 2012]

And screw things up they did. Since Wall Street was in such a glorious rush to manufacture asset based securities on offer in the Casino, the recording and other record keeping practices were lost in the great paper shuffle.  Only in the imagination of Wall Street sycophants does this create a problem to be borne solely by the homeowner.

If we look at the latest report (pdf) from the program we see the nature of the continuing documentation problem:

“Of the 1,894 mediations held during FY 2014, 73 percent resulted in the homeowner and the lender not coming to an agreement to retain or relinquish the property. In 28 percent of these cases, no resolution was reached because the lender failed to prove it had the authority to foreclose, or the lender failed to prove ownership of the deed of trust or the mortgage note.”  

“For example, in 319 cases, the beneficiary failed to bring the required certifications for each endorsement of the mortgage note. By statute, the lender must provide a certified deed of trust, a certification of each assignment of the deed of trust, a certified mortgage note, and a certification of each endorsement and/or assignment of the mortgage note.”

And just so borrowers aren’t inclined to take on the banks in a questionable foreclosure, AB 282 limits the time line for the mediation process, drops awards from $50,000 to $5,000, and eliminates the recovery of attorney fees by a prevailing borrower.

The Legislature already has AB 360 The Annuities Saleman’s Friend Bill in the hopper, and now the financialists must be rubbing their palms at the prospect of the Ultra-Big-Bank-Friendly AB 282!

AB 282 is a bill for the Banks, for the Wall Street Casino Players, for the Speculators, for the Financialists – and it is NOT a bill which does anything for average Nevada families.   As the session progresses it’s becoming ever more clear who the Nevada Republicans are supporting – and it’s definitely not Nevada homeowners.

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Filed under Economy, financial regulation, Foreclosures, Nevada economy, Nevada legislature, Nevada politics

The Great Annuity Bundle Bungle: AB 360

banker 2 The Financialists are at play in the current session of the Nevada Assembled Wisdom, with the support of Assemblyman David Gardner (R-NV9) and his AB 360 which will be heard in the Assembly Government Affairs committee today.  Here’s the summary:

“This bill: (1) requires a program for deferred compensation that is made available by the State or the Board of Regents to offer an employee at least five investment options to choose from; (2) provides that any plan authorized by 26 U.S.C. § 403(b) or 457 must offer at least two investment options consisting of fixed or fixed index annuities and at least two securities investment options offered by different investment management companies; and (3) provides that a third-party administrator of a program for deferred compensation must use an open and competitive request for proposals process when selecting investment options for the program.”

Sounds techy?  This link will take you to the UNS page explaining the supplementary (and voluntary) retirement programs currently offered by the institutions of higher education in Nevada.  There are two “record keepers” for voluntary retirement programs: ING and Hartford; and, there are also plans separated from these two offered by TIAA CREF, Valic, and Fidelity.  So, why would the University System have to offer five, including “fixed or fixed index annuities?

First, what’s a fixed index annuity?  The SEC explains the forms currently available:

“There are generally three types of annuities — fixed, indexed, and variable. In a fixed annuity, the insurance company agrees to pay you no less than a specified rate of interest during the time that your account is growing. The insurance company also agrees that the periodic payments will be a specified amount per dollar in your account. These periodic payments may last for a definite period, such as 20 years, or an indefinite period, such as your lifetime or the lifetime of you and your spouse.

In an indexed annuity, the insurance company credits you with a return that is based on changes in an index, such as the S&P 500 Composite Stock Price Index. Indexed annuity contracts also provide that the contract value will be no less than a specified minimum, regardless of index performance.

In a variable annuity, you can choose to invest your purchase payments from among a range of different investment options, typically mutual funds. The rate of return on your purchase payments, and the amount of the periodic payments you eventually receive, will vary depending on the performance of the investment options you have selected.”

So, what could possibly go wrong?  There are several reasons why annuities aren’t all they are cracked up to be.   First, we ought to remember that annuities are forms of insurance, and are regulated as insurance policies and NOT like securities.  For example, with fixed or fixed index annuities there aren’t the disclosure requirements which are in place for investments in securities.  The individual purchasing the annuity is on his or her own to figure out the fees, the comparative performance, and even how the money is being invested. [Kiplinger]   Thinking about fixed index securities? Think again.

FINRA issued an “alert” regarding those “Fixed Index,” or sometimes called “Equity Indexed” annuities (pdf)

“Sales of equity-indexed annuities (EIAs) have grown considerably in recent years. Although one insurance company at one time included the word “simple” in the name of their product, EIAs are anything but easy to understand. One of the most confusing features of an EIA is the method used to calculate the gain in the index to which the annuity is linked. To make matters worse, there is not one, but several different indexing methods. Because of the variety and complexity of the methods used to credit interest, investors will find it difficult to compare one EIA to another.” (emphasis added)

If a person isn’t knowledgeable and comfortable with terms like “ratchet” indexing, or “high water mark,” or “point to point” indexing methods, then the session with the salesperson will be (a) quite long or (b) really confusing.  The salesmanship is an important element, and leads us to the second thing that could go wrong.  Did we explain that because annuities are lightly regulated, unlike equities, that the commissions for selling and managing annuities are in the really high range – like around 6%? [Orman

So, with an almost unregulated product, the opacity of which is nearly legendary, and the fees are some of the highest in the business, why require the University System to offer them?

Because the whole business in annuities goes back to the Romans, but the recent interest has more to do with insurance companies trying to shave off a bit of the money that was going toward money market accounts  in the late 1980s and early 1990s.  And, what the salesman is telling the potential buyer doesn’t usually include: (1) The high costs and fees; (2) The illiquidity (for ‘premature’ distribution; (3) The complexity of the product – remember it’s really hard to compare products; and (4) The taxes, “All withdrawals received from an annuity contract that are not considered to be a return of principal are taxed as ordinary income, regardless of the holding period of the contract (see below). There is no chance to qualify for capital gains treatment.” [Investopedia]

Why AB 360? Perhaps because somewhere out there in Nevada there are insurance companies still seeking to pick off investors who might otherwise sign up for retirement plans associated with the equities or money market sectors – who are ripe for the picking.

If a reader still isn’t sure why DB is opposed to this bit of legislation designed to enhance the bottoms (and bottom lines) of the insurance business, then I’d recommend “Beware the pitch for indexed annuities,” Reuters 2010; and,  “Annuities are not bought, they are sold,” from Forbes 2012; and, “The low down on equity indexed annuities, “ Bankrate.

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Filed under financial regulation, Nevada economy, Nevada legislature, Nevada politics, public employees

Legislative Headaches: The Tax Man Cometh

Take Two Aspirin

If the three major tax plans in the Nevada Legislature, and their varied explications, are giving you a head ache, the Las Vegas Sun offers a good comparison of them.  There’s a major problem with the Assembly GOP plan which:

“Would change modified business tax rate from 1.17 percent for general business and 2 percent for financial sector businesses to 1.56 percent for all businesses. Exempts companies with payrolls less than $50,000 per quarter and removes a deduction for health care premiums.”

This is a form of “flat tax.” And, there’s one group of businesses which benefit most from a “flat tax,” – the big ones. I know, it sounds counter-intuitive, but what gives the appearance of equity (the flat tax) actually ends up being one of the most inequitable forms of revenue raising.

Beloved by such think tanks as the ultra-conservative Cato Institute, flattening taxes works against middle income groups, both domestic and business.  Let’s assume that the 1.56% tax were to apply to all businesses in the state with payrolls more than $50,000 per quarter ($200,000 per year.) This would apply to all forms of enterprises except those in the financial sector.  For clarity, the financial sector includes commercial banks, investment banks, insurance companies, investment companies, unit investment trusts, face amount certificate companies, management investment companies (closed/open), and three types of non-bank investment companies: (1) savings & loans, (2) credit unions, and (3) shadow banks. [Investopedia]

Current law and the Sandoval Plan keep the tax on those financial sector enterprises at 2%.  The Assembly Republicans would provide them with a 0.44% tax break. At this point, it ought to be asked – Why is a bank like Wells Fargo with a reported revenue of $21.4 billion (up 4% YOY) getting a tax break when a supermarket is running on a 6% margin?  Or, why is a hedge fund, and those similar firms which operated in the shadows in the run up to the crash of 2007-2008, getting a break?

One conclusion is that the Banking Lobby and associated financialists are running full bore at the tax proposals.  Hedge fund managers already have one of the sweetest tax breaks imaginable in the form of the Carried Interest Loophole, and now the Assembled Wisdom is proposing they get a nice break from the state. [See also: TO.org, BusinessInsider]  If nothing else, the Assembly proposal indicates that Financialism is alive and well in the Legislature’s bailiwick.

In short, what looks superficially “equitable” actually makes it easier on the financial sector firms, and places more of the revenue raising responsibility on those businesses which operate on a local level – retailers, wholesalers, and the like.  “Shadow” financial institutions, already the beneficiary of copious tax avoidance strategies, are paying the same “freight” as the supermarket chain and the retailers.

There’s another point which ought to be addressed:  Who is at greater general risk during an economic downturn?  In case we hadn’t noticed – the financial sector is no longer directly connected to the commercial sector. The advent of the Shareholder Value theory of corporate management is what drives stock prices – it doesn’t matter if employment is dropping, if the cuts in payroll are assumed to be part of the management plan to boost the value of the shares.  However, in the real economy it matters very much if employment is reduced because that in turn yields lower demand for goods and services.

In this instance, “sharing the load fairly” actually means that the businesses most likely to be hurt by any economic downturn, and those businesses which are dependent on local economic conditions, are to “share” an equal burden in terms of revenue raising with those which are all too often the perpetrators of commercial difficulties in the “real economy.”

Putting it less diplomatically, the Assembly proposal really isn’t very fair at all.

*And by the way – doesn’t eliminating the deductions for health care insurance make it less likely employers will sponsor such plans, making it all the more necessary that the health insurance exchange markets under the Affordable Care Act be sustained?

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Filed under banking, Economy, Nevada economy, Nevada legislature, Nevada politics, nevada taxation

ALEC assault on Nevada PERS: AB 190

AB 190 AB 190 is hitting the light of day [ltn] – and for those advocates of middle class financial security and adequate pensions for former public employees this bill needs to go back down into its pit.  This bill is a bit of ALEC dreamland:

“…relating to public employees’ retirement; providing for the establishment of a hybrid retirement program for certain public employees; requiring the program to include a defined benefit plan and a defined contribution plan; setting forth the required provisions of each plan; requiring certain public employers under certain circumstances to make additional contributions to the Public Employees’ Retirement System to reduce the unfunded liability of the System;…[ NVLeg]

The Hybrid From Hell

This portion of the bill would create a system similar to the one enacted in Utah, and promoted by ALEC in its “State Solutions for Government Pension Reform.” [ALEC pdf] *See Utah Reform, page 18.

There are a couple of crucial point embedded in the ALEC publication.  First is the notion that defined benefit plans are a “problem.”  It doesn’t matter the fiscal state of the pension benefits program – if it isn’t about to send the state into bankruptcy, there are ways to massage the statistics in order to make it appear the state has a monstrous unfunded liability.   Funding from the Koch Brothers partially funds the NPRI’s conclusion that there is a $41 billion current liability.  And, gee whiz – wouldn’t you have guessed it? – they recommend a Utah style hybrid public pension program. *See DB 12/9/14.

Before grabbing the children and heading for the hills in a panic – consider the possibility that we can make the unfunded liability number really big by reducing the advance funding factors.  Translation, if I were to total up the liability for every public employee, working and retired,  and treat it as if it were all going to be paid out tomorrow morning, the number would be really  big – and really misleading and  inaccurate.

What we need to focus on is how well the program deals with liabilities over time.  So, when AonHewitt did an independent review of the NV PERS system what did it find?

“AonHewitt found that NV PERS “funding levels and the discount rates were not uncommon, where NV PERS differs from others is in its Funding Policy and contribution rules which provide much better than average protection, when compared to similar systems. Continued review and comparisons of costs and benefits with other large plans, actuarial audits, and consistent updating of the Funding Policy facilitates NVPERS ability to remain among the best run large public systems.”  [AonHewitt pdf]

Sorry, privatizers and financialists, there really is no reason to adopt any major changes in the current define benefit plan in Nevada because, as the independent comparative review discerned, Nevada doesn’t have the problems associated with other large pension systems in some other states.

There’s Gold In Those Hills (for Someone)

Thus far, ultra-right organizations such as ALEC and associated think tanks like the NPRI have been beating their drums and issuing reports to friendly news outlets about the Problem – which doesn’t exist in Nevada, in the hopes of promoting ALEC’s agenda that brings us to the second major point of the issue:

ALEC, et. al., want to promote defined contribution plans because there’s money to be made.

“On the private side – Continue to tell workers that they’ll be better off with their “economic freedom” (in a defined contribution plan) to finance their own retirement plans with “flexibility,” and they can use their money as they want – just make the management fee structure so complicated it takes a degree in Finance to figure it out, and then operate on the happy assumption that the financial professional’s first duty is to his own firm’s bottom line not with a specific obligation to cover the future retiree’s bottom.   Give us your money, pay us the fees, and just trust us!  Go quietly, and no one will get hurt?” [DB]

AB 190 is a classic assault on a perfectly good public retirement system which is NOT generating an unwieldy unfunded liability.  If the ultimate purpose isn’t to retain the best features of the current system, but to replace it with defined contributions in the future, then the other motive which springs to mind is that the financialists among us have been ogling the coffers of public employee retirement systems and want very much to dip into them up to at least their elbows, if not their shoulders.

What the advocates of AB 190 want to do is fairly easy to see – ultimately hand over wads of money from the public employees retirement funds to wealth management firms who will exact their fees and transactional costs with less public scrutiny than is required in a publicly managed retirement system.  What could possibly go wrong?

Golden Years or Fleeced Sheep?

Not sure this is the case? Then look at the provision in the bill in which individual trust accounts are inserted. [NV Leg pdf Section 4]  Let’s review two problems associated with the individual trust accounts.  First, how many people have the financial training, experience, or acumen to manage their own trust accounts?   The obvious answer is – not many.

In this instance a newly hired heavy equipment operator for NDOT might be given his “freedom” to establish an individual retirement trust account.  This freedom has a price tag.  There will be transactional and management fees associated with this account. There will be transactional decisions made about the portfolio and contents of the account.  If the basis for the transactional decisions is “proprietary” information within the wealth management firm handling the account, then how is the NDOT employee to determine if the transactions were made in his or her best interests?

This brings us to the second problem, not only do many public employees (or other regular folks for that matter) lack the financial expertise to track their own individual retirement trust accounts, but if the system isn’t very carefully structured, and the contracts exceedingly open – the employee may not be able to find out how and why investment decisions were made on his or her behalf.  However, the wealth management firms will be delighted.

Half of the Research is false, ergo Half the Products are false

If these two problems aren’t enough to may a person queasy, there’s one more issue to explore.  Financial firms are happy to inform investors that their investment decisions are based on empirical research.  Sounds nice, doesn’t it?  Wait.  Evaluating trading strategies has proven to be a mare’s nest of research forms, leading the Journal of Portfolio Management to report that,  “Most of the empirical research in finance, whether published in academic journals or put into production as an active trading strategy by an investment manager, is likely false. This implies that half the financial products (promising outperformance) that companies are selling to clients are false.” [Economist]

Do the advocates of AB 190 comprehend what the JPM author’s are saying when they conclude that:

“In summary, the message of our research is simple. Researchers in finance, whether practitioners or academics, need to realize that they will find seemingly successful trading strategies by chance. We can no longer use the traditional tools of statistical analysis that assume that no one has looked at the data before and there is only a single strategy tried. A multiple-testing framework offers help in reducing the number of false strategies adapted by firms. Two sigma is no longer an appropriate benchmark for evaluating trading strategies.” [JPM]

Let’s translate:  If there is a 50-50 chance that the research is wrong, then there’s a 50-50 chance the financial product sold on the basis of that research will be falsely assumed to be a good product to put in a retirement portfolio.   How is our NDOT equipment operator, our public school teacher, our firefighter, our police officer, our assistant county administrator, our receptionist in the Department of Education, supposed to track his or her retirement account IF the research isn’t made available, and if it is, it might very well be inaccurate?

We might revert to the previous advice from the management firm – give us your money, don’t ask too many questions, go quietly, and no one will get hurt – in this firm. You, might be another matter.

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Filed under privatization, public employees