Benjamin Franklin once remarked, “Nothing is certain but death and taxes.”  (The Lamb would add one more certainty — Michigan football will have a weak secondary every season).  We all hate paying taxes, though we realize that it’s a necessary part of life — sort of like having to spit out the seeds when you eat watermelon.

Now along comes Associated Tax Relief.  You may have seen their ads blaring at you on TV.  The company claims to “end your IRS headaches if you qualify.”  On their website, the company boasts of the huge savings provided to some of its clients.  For example, “‘Robert R’ owed $114,625, but settled for $20,688.  Wow!  Great for “Robert R.”  But how about for you?

You get to pay all the taxes that you owe, and your neighbor gets to take the money he owes the government and buy a big-screen television or maybe a speedboat.  The nearly $100,000 that Robert didn’t pay has to come from somewhere.  And that place is your wallet. 

According to Associated’s website, the Robert R situation and others like his are “not necessarily representative of all those who have used our services.”  Thank goodness for that.  Why should other taxpayers subsidize those that don’t pay their bills?  People like “Paula A.”  Paula owed $36,970.20 but, according to Associated Tax Relief, settled for $1,520, barely 4 cents on the dollar.

These are very different situations from those of people who negotiate with credit card companies for lower balances or installment payment plans.  Those are agreements made between two private parties.  And, except for shareholders and bondholders of these credit card companies who may be impacted by these arrangements, Ma and Pa Taxpayer are not forced to subsidize the arrangement.

You may or may not agree with our current tax structure in which, according to an op-ed piece in Monday’s Wall Street Journal:

According to the CBO, those who made less than $44,300 in 2001 — 60% of the country — paid a paltry 3.3% of all income taxes. By 2005, almost all of them were excused from paying any income tax. They paid less than 1% of the income tax burden. Their share shrank even when taking into account the payroll tax. In 2001, the bottom 60% paid 16.3% of all taxes; by 2005 their share was down to 14.3%. All the while, this large group of voters made 25.8% of the nation’s income.

When you make almost 26% of the income and you pay only 0.6% of the income tax, that’s a good deal, courtesy of those who do pay income taxes. For the bottom 40%, the redistribution deal is even better. In 2001, these 43 million Americans, who earn less than $30,500, made 13.5% of the nation’s income but paid no income tax. Instead, they received checks from their taxpaying neighbors worth $16.3 billion. By 2005, those checks totaled $33.3 billion.

However skewed the current tax system may be, each citizen is expected to pay his legally legislated share — no more and no less.  When citizens try to escape this obligation, with the help of outfits like Associated Tax Relief, they are not simply cheating some amorphous entity (the IRS), they are effectively taking money from those that have paid their share.

You likely just went through the joy of filing your tax returns and maybe wrote out a sociable-sized check to Uncle Sam.  If so, just try to watch the following video without getting angry:

The House of Representatives is set to vote today on a measure that would effectively tax MORE than 100% of some Americans’ income.  In an attempt to placate the public’s wrath over bonuses paid to employees at AIG and other TARP recipients, Congress will seek to cut off bankers’ noses to spite America’s face.

As we examine this issue, let’s keep in mind that at many companies, particularly on Wall Street, the term “bonus” is nearly interchangeable with the term “compensation.”  The difference is just semantics.  The rationale for paying the bonus is to have a carrot for employees to strive for during the year (over which time these employees receive comparably less in the form of a salary, or draw).  No performance, no carrot.  While it’s certainly true that some bonuses have been paid for subpar performance, the overwhelming majority are paid as the result of success.

Paying a higher salary and lower (or zero) bonus removes the incentive to perform and increases risk to shareholders, including (now) the government.  The less profitable a given company, the less likely the government is to continue receiving its preferred stock dividend, via the TARP program, and ultimately the return of its original investment.  (Recall that many of these firms were forced, essentially at gun point, to take these government funds whether they wanted them or not — the strings were attached later).

While it is clearly Congress’s intent to strip TARP firm employees of any “excessive” compensation, the effort is misguided.  The vast majority of these “bonus” recipients have generated profits for their respective firms, often far outweighing the losses of their colleagues that Congress is endeavoring to punish.  To paint them all with the same broad brush does a great disservice to the good performing employees as well as to the Treasury’s collective wallet.

Let’s look at this from another angle.  Take General Motors.  Here is a company that has lost tens of billions of dollars, not for one quarter or one year, but year after year after year.  This company has also received billions of dollars of taxpayer money — money that GM was NOT forced to take, unlike the situation at many banks.

Would it be just as fair for Congress to enact legislation confiscating taxing 90-100% of the wages of UAW workers because the company for which they work was (is) a financial disaster?  Similarly, how about the workers at GM subsidiaries such as OnStar?  Many of these employees (one of which is a close friend of The Lamb) received bonuses for contributing to OnStar’s success despite the fact that GM was hemorrhaging money like a broken Vegas slot machine.  If these employees can escape the Congressional tax assessor, why should bank employees whose units were profitable labor under an exorbitant tax regime?

The illustrious Charlie Rangel, Chairman of the House Ways and Means Committee that is shepherding the bill, in explaining how he arrived at the 90% federal tax rate for TARP bonuses, explained, “we figure the local and state governments will take care of the other 10 percent.”

This reminds The Lamb of (in)famous Ohio State football coach Woody Hayes.  Leading archrival Michigan (Go Blue!) 42-14 late in their annual football death match in 1968, the Buckeyes scored a meaningless touchdown to go up 48-14.  Rather than kick the extra point, Hayes elected to attempt a two-point conversion in order to hang half a hundred on The Lamb’s alma mater.  The attempt was good and tOSU won 50-14.

After the game, a reporter asked Hayes why he had decided to go for two.  The old coach growled, “Because they wouldn’t let me go for three.”

In their vindictive attempt to punish successful employees for the failures of a minor few, Congressman Rangel and his legislative cohorts are demonstrating a poorer sense of fair play than Coach Hayes did over 40 years ago.  If they succeed, The Lamb is one alumnus who won’t be singing Hail to the Victors.

Over fifty years have passed since Ayn Rand penned her classic criticism of government interference in economic matters,  Atlas Shrugged.  For those unfamiliar with this seminal work, it illustrates how government’s proliferation of myriad programs and regulations sabotages the creativity and production of the very economic well-being it desires to improve.

Friday, Congress ratified, and the President is about to sign, the $787 billion economic stimulus bill.  Concealed in the bowels of this 1,000+ pages of legislation is a restriction on executive compensation — thank you, Senator Christopher Dodd of Connecticut.  Proudly announcing his vanquishing of Wall Street gluttony, Dodd crowed:

“The decisions of certain Wall Street executives to enrich themselves at the expense of taxpayers have seriously undermined public confidence in efforts to stabilize the economy.  These tough new rules will help ensure that taxpayer dollars no longer effectively subsidize lavish Wall Street bonuses.”

While at first blush, curtailing pay packages for employees at firms receiving government (taxpayer) funds might make sense, a closer examination reveals more problems than solutions.

James F. Reda, an independent compensation consultant, responded to the new legislation (via The New York Times):

“These rules will not work.  Any smart executive will (a) pay back TARP money ASAP or (b) get another job.”

This highlights just two of the major difficulties with government dictating how companies compensate their employees.  Talented workers will abandon a company shackled by government handcuffs for greener pastures at hedge funds or foreign banks.  This exodus would occur at the very time when their abilities are most needed to help ensure that TARP money is protected and paid back to the government.

Perhaps more importantly, do we really want to incent banks to return TARP money before it is fiscally optimal for them to do so?  Prematurely returning TARP funds carries with it the dual disadvantages of weakening banks’ capital structures and reducing the amount of money available for lending.  The latter cancels out the very purpose of replenishing bank capital — ameliorating the dearth of credit in the system, thereby turning off the lending spigot.

Many of the banks that received TARP funds did not want the funds to begin with.  Back in October when nine bank CEO’s were summoned to Washington, then-Treasury Secretary Paulson stuck a $125 billion gun at their collective heads, ordering them to take the funds.  Furthermore, the money was not given to the banks.  Uncle Sam received preferred stock, paying a 5% dividend (for 3 years, then stepping up to 9% for as long as the firms retained the funds).  Given that the government’s 3-year cost of capital at the time was less than 3%, taxpayers stand to earn more than 2% annually on their money.

If bonuses are limited, companies will be forced to pay higher salaries in order to lure the top professionals to their firms.  This will simultaneously raise banks’ fixed costs, increase their risk, and diminish the incentive for employees to work harder to maximize shareholder value as well as their own remuneration.  Commission-based employees such as loan officers will have little reason to maximize credit availability once their commission compensation approaches the government imposed ceiling.

Dagny Taggart knows how they feel.

As a parent, one would not reward a child with extra dessert for throwing his dinner against the wall.  As a boss, one would not lavishly remunerate an employee who has negligently cost the company money.  Poor behavior should be punished, or at the very least, not encouraged.

Unfortunately, Uncle Sam continuously insists on not only rewarding, but actually encouraging bad behavior on the part of consumer borrowers.  The Lamb has been a vocal critic of the American Mortgagor as the prime suspect in the current financial impasse.  While others certainly share the mantle of culpability, the American homebuyer stands atop the pedestal of guilt.  His inability/unwillingness to repay debts he assumed voluntarily is at the crux of the current crisis.

So, what should be done?  Well, what should NOT be done is what the Treasury is currently considering.  From The Wall Street Journal:

“The plan, which is in the development stages, would use mortgage giants Fannie Mae and Freddie Mac to bring loan rates down as low as 4.5%, a full percentage point lower than the prevailing rates for 30-year fixed mortgages.”

Let’s see.  Easy credit over the past few years encouraged borrowers to take on more debt than they could afford to pay back.  This led to a wave of defaults, causing lenders to go bankrupt, which threatened to destabilize the financial system.  This led to bailout after bailout, which coincided with historic downdrafts in asset prices in everything from equities to commodities, and from high-yield debt to Triple-A asset-backed securities.

Now that asset prices are beginning to show signs of stabilizing, what should the next step be?  Hmmm… that’s a tough question…  Wait!!!  Why don’t we use artificial means to make credit easy again?  Yes, that’s a great idea!  In fact, let’s just go ahead and use taxpayer money (which, by definition, is money paid by those who acted prudently by NOT borrowing over their heads and are still paying taxes) to encourage even further bad behavior (i.e. — more borrowing).

In fact, that is exactly what is being proposed (again, via The WSJ):

“Under the plan, Treasury would buy securities underpinning loans guaranteed by the two mortgage giants, which are temporarily under the control of the government, as well as those guaranteed by the Federal Housing Administration.”

Already, the New York Fed is planning on purchasing Fannie and Freddie (GSE) debt.  The first purchases are slated for this Friday.  From the New York Fed’s website:

“What is the policy objective of the Federal Reserve’s program to purchase direct obligations of the housing-related GSEs?
The goal of these debt purchases, combined with the purchases of mortgage-backed securities (MBS) backed by Fannie Mae, Freddie Mac and Ginnie Mae announced on November 25, 2008, is to reduce the cost and increase the availability of credit for the purchase of houses.”

Sounds like giving your kid more messy food to throw against the wall.

Note:  This post is in no way meant to endorse, oppose, compliment, or impugn any person or political party.

Monday, January 28th, 2013

President Palin sat alone in the Oval Office wondering if the plan she had developed with her financial S.W.A.T. Team would be enough to extricate the country from its latest economic crisis.  She was barely one week into her first 100 days in office, and things were going from bad to worse.  She thought back to her predecessor and the challenges he faced during his four years in her position.

It was late summer 2009 and the previous year’s credit crisis already seemed like a distant memory.  The 0.125% federal funds rate and enormous federal bailout programs appeared to have stabilized the financial markets.  The Dow had clawed and scratched its way back above the 11,000 mark and there had been a nearly one year absence of major corporate failures. 

However, the easy monetary policy masked a deeper dilemma.  With memories of 2008 still fresh in their minds, financial institutions remained fearful of committing capital for longer-term projects.  As many banks began facing maturities on their debt, rollovers became a looming problem.  The 2008 guarantee of bank debt issuance had failed to lower term funding costs significantly as investors had grown leery of just what that U.S. government guarantee was really worth.

With small and large banks alike experiencing growing funding difficulties, President Obama called on Treasury Secretary Lawrence Summers to find a solution.  Working with Fed Chairman Robert Rubin, who had reluctantly assumed his position after Ben Bernanke had been “asked” to leave by the President, Summers embarked on a bold solution. 

Loathe to face the specter of another large bank failure, the duo ordered (the official stance was “strongly encouraged”) the marriages of the country’s few remaining “super” banks.  Goldman Sachs was sent kicking and screaming into the arms of Citigroup, and Morgan Stanley was reunited with its ex-spouse JP Morgan.  The restriction on any institution holding more than 10% of total U.S. deposits was conveniently repealed.

Unfortunately, this failed to stem the rising tide of consumer bankruptcies.  Credit card debt was now crippling the country.  By late 2010, credit card debt in the United States had skyrocketed from $27 billion in 2007, past the 2009 level of $96 billion (estimated by NBC News), to a staggering $200 billion, as households tapped any possible source to pay for day-to-day living expenses.

Faced with a public outcry and using the 2008 bank bailout as precedent, President Obama ordered Secretary Summers and Chairman Rubin to enact a freeze on all credit card interest charges effective as of December 1st, 2010.  To mollify the credit card companies, the Treasury would begin making the interest payments on all balances as of this date, though at a rate of just 9%.  Though this was below what they were currently slated to earn from consumer balances, the credit card companies acceded to the plan as it dramatically reduced their allowances for bad debts and strengthened their deteriorating balance sheets.

Financial blows continued to batter the global economy.  South American nations, borrowing more and more money in an effort to grow their own economies out of the three year recession, faced spiraling inflation.  Playing their trump card, they threatened an oil embargo against the U.S.  With oil already having soared above $350 per barrel after the June 2011 Israel-Iran War and the American public demanding a reprieve from crippling gas prices, the United States approved low-interest loans to Brazil, Venezuela, and Argentina in exchange for their promise to maintain the flow of oil.

The dire financial straits of consumers and declining property values culminated in much lower tax receipts for municipalities, just when this money was most badly needed.  California, already buckling under huge fiscal strains and unwilling/unable to repeal Proposition 13, in early 2012 became the largest municipal bankruptcy on record, easily eclipsing Orange County in 1994, Alabama’s Jefferson County in 2009, and even the 2011 State of Arizona filing.

In an effort to forestall cascading municipal failures which threatened to paralyze essential state and local services from education to police and fire departments, in the summer of 2012 Congress passed the Municipal Assistance Rescue Program (MARP).  The MARP allowed state and local governments to borrow money interest free from Uncle Sam for up to three years.

However, as the conga line of municipalities lining up to take MARP funds grew, the national debt soared, as did interest rates on everything from U.S. Treasury securities to home mortgages.  Inflation, that scourge not seen since the late 1970s, skyrocketed past 12% and the U.S. Dollar, already battered by the proliferation of government bailouts the past four years, sank like a stone. 

Many banks were now unwilling to make loans in dollars, fearful of the currency’s continued depreciation and unable to effectively hedge themselves in the increasingly illiquid foreign exchange markets.

As summer turned to fall with the economic and financial landscape looking increasingly bleak, the nation elected its first female president — Senator Sarah Palin of Texas.

Sitting in the Oval Office, President Palin greeted newly appointed Fed Chairman Timothy Geithner.  The President wanted reassurance that her campaign pledge of lowering inflation and crippling interest rates could be accomplished.  The Chairman, taking a page from one of his predecessors, Paul Volcker (who had raised the federal funds rate to as high as 20%), reiterated faith in their plan to raise the funds rate from the current 10% all the way to 18%.

In response to the President’s hesitancy to increase rates, Chairman Geithner explained its necessity in wringing inflation out of the system.  The Chairman admitted that he had learned his lessons from the ill-planned bailout binge that he had helped orchestrate and sustain as President of the Federal Reserve Bank of New York during the presidencies of George Bush and Barack Obama.  He said that the country now needed to take its financial medicine, no matter how bad the taste, in order to cure the disease of inflation.

Besides, he elaborated, raising short-term rates might be enough to reverse the outflow of foreign capital that had been occurring for most of the past year.  China and Japan, for example, had sold nearly $1.5 trillion of dollar-denominated debt, mostly U.S. Treasury and Agency securities.  America’s runaway inflation had shaken their faith in its ability to service its debt, now owned predominantly by foreign governments.

If this did not work, Geithner worried, the country might be forced to return to some version of the gold standard, not seen in the United States since President Nixon abandoned it in 1971.

As February turned to March and March to April, the economic climate began to improve.  Data showed that foreign capital was returning to the U.S., taking advantage of higher short-term yields.  As inflation fears abated, fixed-rate mortgage rates dropped precipitously, falling below the psychologically important 10% level.  Even the Dow had closed above the 5,000 mark for the first time since late 2011.

The country was learning (forced?) to live within its means after an arduous period of stagflation.  Long-gone were the days of easy credit and government safety nets.  But a more disciplined and realistic debtor-creditor relationship had emerged, one which held the promise of stable prices and moderate long-term growth.

For nearly 75 years, Americans have relied on Social Security and other “retirement” plans to assist them financially after they stop working.  The Lamb was going to write in this post about the looming crisis in government entitlement programs like Social Security, Medicare, and Medicaid, but he will let that keep for another time.

For now, The Lamb wishes to discuss pensions.  Ahh, pensions — that little (or not so little, as the case may be) nest egg sitting quietly in the corner of our grand retirement plans.  Pension plans fall into two general categories:  defined contribution plans (IRAs and 401(k)s) and defined benefit plans.  With defined contribution plans, the participant makes investment decisions and essentially bears responsibility for the risks and returns of the plan.

However, with defined benefit plans (DBPs), the participant is promised a fixed or formulaic payout from her employer at set times in the future.  Sounds great, right?  Well, it’s great unless the employer can’t make good on its promises.  In many DBPs, the employer has made fairly optimistic and ambitious assumptions about its plan’s returns, usually 8-10%.  The employer does this for a very simple reason — it is the only way the employer can arrive at figures that will produce the requisite amount of income.

8-10%, huh?  Well, equities sometimes reach that threshold.  However, cash and bonds rarely come close to 10% annual returns.  And what about the years in which returns not only fall short of this bogey, but are actually negative?  Like, hmmm, this year.  To wit:  The Lehman Brothers Global Aggregate Corporate Bond Index is roughly down 16% in the past year; and the S&P 500 Stock Index is down over 30%, even after yesterday’s 10% rally!

Many private and public retirement plans are fully funded, some are even overfunded.  However, some of the largest plans are in dire straits.  From boston.com:

The California Public Employees’ Retirement System, the largest pension system in the United States, said it might have to require the agencies and schools that participate in the plan to increase payments after watching its investment fund shrink by 20 percent, or $50 billion, this year.

And as more and more DBPs find themselves underwater, they decide to take on more risk in a Sisyphean effort to increase returns and get their plans fully funded.  They shift a greater percentage of their portfolio away from stable cash flow instruments like bonds and into more volatile assets like stocks.  Given what has happened over the past year, it seems likely that many of these funds are in even worse shape now than what is shown here:

Given the trend and what has happened in the capital markets this year, it’s safe to assume that nearly half of state and local government pension plans (DBPs for teachers, police officers, sanitation workers, city/state employees, etc.) are significantly underfunded.

But it’s not just municipalities that are having problems.  From bloomberg.com:

The value of so-called defined benefit plans fell to $1.1 trillion by Oct. 24 from $1.3 trillion at the end of September, according to Mercer, a pension consulting unit of Marsh & McLennan Cos.

But wait!  What about the backstop of the Pension Benefit Guarantee Corporation, that bastion of government safety and security?   Well, not surprisingly, things haven’t been going exactly swimmingly for them either.  From a Wall Street Journal article last week:

PBGC reported earlier this week a $3.12 billion loss in equity investment during the 11 months ended August 2008. Those losses increased by roughly $1.7 billion in September alone, bringing the fiscal year 2008 total stock investment loss to $4.79 billion, according to documents released by the agency.

Clearly, the pension problem is exacerbated exponentially when the “insurer of last resort” is investing its reserves in the same volatile assets that it is effectively insuring!

And this from The Washington Post:

With workers retiring earlier and living longer, governments have been struggling to keep up with the promises they made. Many are taking out loans to restock their pension funds, which is akin to using a credit card to cover monthly mortgage payments. Others are passing the bill to future generations by using sunny projections of what their investments will return, claiming they do not need to dedicate more money now to their pensions.

Such “accounting nonsense” has been “pushing the envelope — or worse — in its attempt to report the highest number possible” for their investment returns, wrote billionaire investor Warren E. Buffett in a recent letter analyzing pensions for shareholders of his company. Taxpayers ultimately will pay the price when these forecasts prove wrong.

“Because the fuse on this time bomb is long, politicians flinch from inflicting tax pain, given that problems will only become apparent long after these officials have departed,” he wrote. “In a world where people are living longer and inflation is certain, those promises will be anything but easy to keep.”

So, what does this mean?  Well, unlike Uncle Sam, these entities can’t just turn on the printing press.  They have two choices:  raise taxes or cut benefits.  Either choice will infuriate a large group of people.  Is it fair to raise taxes for the majority of citizens to pay for benefits for a minority of the citizenry?  Is it fair to renege on promises made to government employees whose labors benefitted the aforementioned majority?

Susan Urahn of the Pew Center on the States perhaps says it best:

“The age of retirement was set when people did not live that long. It’s very hard to change that now,” she said. “People feel these pension obligations were a promise. And changing them feels like you are breaking a contractual promise, that you are changing the rules of the game. But the game has changed.”

While it comes in a distant second place in general popularity to The Terminator, Conan the Barbarian has always been The Lamb’s favorite Ahhhhhnold Schwarzenegger movie.  For those of us who were teenagers when Conan came out, we’ll never forget the famous scene when the Mongol general asks, “Conan, what is best in life?”  The response:

Now, what’s best in life for Governor Conan and California may be entirely different from what’s best in life for those of us that live in the other 49 states.  Governor Conan has petitioned Uncle Sam (effectively, the other 49 states) for a loan.  He says that the credit markets have made it all but impossible for California to borrow in the debt markets.  Bloomberg.com says that California will run out of money by the end of October without $7 billion in additional funding.

Next week, California will try to help itself by selling even more debt.  The state is already the largest borrower in the entire municipal market.

Clearly, there is another very basic way that Governor Conan can generate badly needed funds:  he (and the legislature) can raise taxes, specifically property taxes.  The Lamb realizes that property taxes are a live wire in California politics.  His in-laws live there and they are adamant that their property taxes should not be raised.

What you may not know, dear reader and likely property tax payer, is that California has enacted a law known as Proposition 13, now in effect for nearly three decades.  Among other things, this law restricts property tax assessments to:  1) a cap of 1% of assessed value and 2) an increase of no more than 2% annually (increases which themselves are capped by the annual cost of living increase if it is less than 2%).

What practical ramifications does this wonderful law have?  First, two homeowners with nearly identical houses can often pay radically different amounts in taxes.  Second, this law fomented one of the greatest housing bubbles in history.  This simultaneously exacerbated the risk of homeownership and made its attainment all but impossible for many in our nation’s most populous state.

Additionally, as the website wealthandwant.com points out, “California’s schools have gone from being highly respected to being well below the middle of the pack.”  It should be duly noted, however, that The Lamb’s beautiful and brilliant wife is a proud graduate of a California public school.

For years, Californians have enjoyed some of the lowest property tax rates in the nation.  In fact, as of 2007 the state was tied with Delaware for the third lowest rate (barely ahead of Alabama and Hawaii) at just 0.68%, less than half the national average of 1.38%.  Before Californians, who have been the beneficiaries of low property taxes for so long, hit the rest of us up for a loan, perhaps they should try pitching in a bit more themselves.

Although The Lamb is not part of the 10% of Rule #3 — 90% of the world doesn’t care about your problems; the other 10% is glad you have them — he can nevertheless assure Governor Conan of one thing:  if California does decide to borrow money from the rest of us and doesn’t return it, “We’ll Be Back!”