Views on the economic stimulus package: is it effective?

Excerpts from Stimulus Spending Doesn't Work

Wall Street Journal of Oct. 1, 2009, 12:54 P.M. ET by Robert J. Barro and Charles Redlick

"The global recession and financial crisis have refocused attention on government stimulus packages. These packages typically emphasize spending, predicated on the view that the expenditure "multipliers" are greater than one—so that gross domestic product expands by more than government spending itself. Stimulus packages typically also feature tax reductions, designed partly to boost consumer demand (by raising disposable income) and partly to stimulate work effort, production, and investment (by lowering rates)….

The existing empirical evidence on the response of real gross domestic product to added government spending and tax changes is thin. In ongoing research, we use long-term U.S. macroeconomic data to contribute to the evidence. The results mostly favor tax rate reductions over increases in government spending as a means to increase GDP…

The available empirical evidence does not support the idea that spending multipliers typically exceed one, and thus spending stimulus programs will likely raise GDP by less than the increase in government spending. Defense-spending multipliers exceeding one likely apply only at very high unemployment rates, and nondefense multipliers are probably smaller…"

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I would very much like to hear Mr. Barro address the very important question,"So what, what does this mean?"

Many citizens will need help to connect explicitly the dots.  What are the consequences of the massive stimulus package if the multiplier is significantly less than 1? 

The answer is, we fear, a declining standard of living for our children.

Not acting the way we should ... or the way you want? Keep your hands off my kids and the schools.

The administration believes that the American public does not understand energy costs and behaves wrongly. It is now targeting children via the educational system.

Off to the eco re-education camps...?

excerpt from the Wall Street Journal

 Dr. Chu said he didn’t think average folks had the know-how or will to to change their behavior enough to reduce greenhouse-gas emissions.

“The American public…just like your teenage kids, aren’t acting in a way that they should act,” Dr. Chu said. “The American public has to really understand in their core how important this issue is.” (In that case, the Energy Department has a few renegade teens of its own.)

The administration aims to teach them—literally. The Environmental Protection Agency is focusing on real children. Partnering with the Parent Teacher Organization, the agency earlier this month launched a cross-country tour of 6,000 schools to teach students about climate change and energy efficiency.

“We’re showing people across the country how energy efficiency can be part of what they do every day,” said EPA Administrator Lisa Jackson. “Confronting climate change, saving money on our utility bills, and reducing our use of heavily-polluting energy can be as easy as making a few small changes.”

Still, Secretary Chu said he didn’t think that the public would throw the same political temper tantrum over climate legislation has has happened with the healthcare debate.

By what authority do they consume valuable educational resources of classroom and instructional time, not to mention the direct costs?  This has nothing to do with fundamental educational missions of literacy or numeracy.

This is not good...

U.S. to Impose Tariff on Tires From China - "In one of his first major decisions on trade policy, President Obama opted Friday to impose a tariff on tires from China..."

• Raising trade barriers
• Raising US marginal tax rates on capital
• Raising US marginal tax rates on labor
• Raising US energy costs (via cap & trade)
• Raising US health care costs (I don't buy the cost neutral scenario for a minute)
• Increasing ineffective and costly regulatory burdens on large & small US companies
• Reducing global competitiveness of American industry
• Record deficits with no end in sight
• Raising inflation expectations (eg rising gold and falling dollar)
• Increasing % of GDP controlled by government (with consequence of decreasing marginal productivity of those $)

How much more can you push this?

Except that the size of the future liability is not known

"More than banks, life insurers, or predatory loan originators, government sponsored enterprises led the mortgage market into the abyss.  In the second act, we are likely to see the federal government guarantee auto warranties, public and private pensions, municipal bonds, and even home loans.  Federal guarantees encourage risk-taking by the insured at the expense of the taxpayer. Crisis is practically inevitable (italics added).

Guarantees are structurally very similar to debt, except that the size of the future liability is not known...

The systematic risks being created by the Federal Reserve and the Treasury eclipse those created by the private sector by gargantuan proportions."

Steve Francis in letter to WSJ 8/25/09

Sensible health care approaches

John Makey in today's WSJ, The Whole Foods Alternative to ObamaCare ,  has some utterly sensible suggestions for health care reform.

• "Remove the legal obstacles that slow the creation of high-deductible health insurance plans and health savings accounts (HSAs). The combination of high-deductible health insurance and HSAs is one solution that could solve many of our health-care problems. For example, Whole Foods Market pays 100% of the premiums for all our team members who work 30 hours or more per week (about 89% of all team members)....Money not spent in one year rolls over to the next and grows over time. Our team members therefore spend their own health-care dollars until the annual deductible is covered (about $2,500) and the insurance plan kicks in. This creates incentives to spend the first $2,500 more carefully. Our plan's costs are much lower than typical health insurance, while providing a very high degree of worker satisfaction for our high-deductible health-insurance plan. We also provide up to $1,800 per year in additional health-care dollars through deposits into employees' Personal Wellness Accounts to spend as they choose on their own health and wellness. .
•  Equalize the tax laws so that employer-provided health insurance and individually owned health insurance have the same tax benefits. Now employer health insurance benefits are fully tax deductible, but individual health insurance is not. This is unfair.
•  Repeal all state laws which prevent insurance companies from competing across state lines. We should all have the legal right to purchase health insurance from any insurance company in any state and we should be able use that insurance wherever we live. Health insurance should be portable.
•  Repeal government mandates regarding what insurance companies must cover. These mandates have increased the cost of health insurance by billions of dollars. What is insured and what is not insured should be determined by individual customer preferences and not through special-interest lobbying.
•  Enact tort reform to end the ruinous lawsuits that force doctors to pay insurance costs of hundreds of thousands of dollars per year. These costs are passed back to us through much higher prices for health care.
•  Make costs transparent so that consumers understand what health-care treatments cost. How many people know the total cost of their last doctor's visit and how that total breaks down? What other goods or services do we buy without knowing how much they will cost us?
•  Enact Medicare reform. We need to face up to the actuarial fact that Medicare is heading towards bankruptcy and enact reforms that create greater patient empowerment, choice and responsibility. "

Many of these basic issues impair the proper functioning & delivery of health care to individuals, families & businesses across the nation, and voters should hold Congress accountable. Why are citizens held hostage to intra state coverage lines? Why is there asymmetrical tax treatment? This is not brain surgery: it smells of market manipulation, the selling of economic dispensation via regulation to the collective disadvantage of our citizens.

Lowering standards to accommodate broker practices?

The vested interest of the brokerage industry is to avoid real fiduciary standards. They can thereby retain the ability to harvest fees for overpriced, under performing product and sell those products to clients under the safe harbor of the "suitability" standard.

This is the same old story: industry participants collude with legislators to tilt the regulatory table for economic advantage.  We've seen this act before... remember the Savings & Loan Crisis? Fannie & Freddie & the Sub Prime mess? 

We don't know the folks at Fund Democracy, but we think they have it exactly right:

“Our concern has always been that if the SEC were to decide what the fiduciary duty is, it would lower the standard in order to accommodate broker business practices,” said Mercer Bullard, founder and chief executive officer of Fund Democracy LLC, an advocacy group based in Oxford, Mississippi.

source: http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aDRJvkh6IQGk

The specific language on "Advance Care Planning" from the current bill

Do you really want Congress to mandate a Post Office like functionary in the ICU meeting room with you and your family?

You can get the full monty here. See SECTION 1233. ADVANCE CARE PLANNING CONSULTATION p424 ff.

‘(5)(A) For purposes of this section, the term ‘order regarding life sustaining treatment’ means, with respect to an individual, an actionable medical order relating to the treatment of that individual that— ‘‘(i) is signed and dated by a physician (as defined in subsection (r)(1)) or another health care  professional (as specified by the Secretary and who is acting within the scope of the professional’s authority under State law in signing such an order, including a nurse practitioner or physician assistant) and is in a form that permits it to stay with the individual and be followed by health care professionals and providers across the continuum of care;‘‘(ii) effectively communicates the individual’s preferences regarding life sustaining treatment, including an indication of the treatment and care desired by the individual; ‘‘(iii) is uniquely identifiable and standardized within a given locality, region, or State (as identified by the Secretary); and (iv) may incorporate any advance directive (as defined in section 1866(f)(3)) if executed by the individual.‘‘(B) The level of treatment indicated under subparagraph (A)(ii) may range from an indication for full treatment to an indication to limit some or all or specified interventions. Such indicated levels of treatment may include indications respecting, among other items— ‘‘(i) the intensity of medical intervention if the patient is pulse less, apneic, or has serious cardiac or pulmonary problems;‘(ii) the individual’s desire regarding transfer to a hospital or remaining at the current care setting;‘‘(iii) the use of antibiotics; and‘(iv) the use of artificially administered nutrition and hydration.’’ 

Auction rate securities: two noteworthy stories

TD Ameritrade Settles Securities Case

"TD Ameritrade Inc. agreed to buy back $456 million of auction-rate securities from its clients as part of a settlement with New York Attorney General Andrew Cuomo, the Securities and Exchange Commission and Pennsylvania securities regulators.

The online brokerage intends to return the money to customers across the country -- including individuals, charities, nonprofit entities and businesses by March 2010 but could need until June 30 to complete the buybacks.

Auction-rate securities, short-term debt instruments whose prices reset in periodic auctions, caused billions in losses for investors after the $330 billion market collapsed in early 2008.

Over the past year, regulators have reached settlement agreements with several Wall Street firms and brokerage houses, which have agreed to buy back over $60 billion of the securities from investors..."

source: 7/20/09 Wall Street Journal

Cuomo Says Schwab Faces Fraud Suit

" In an official notice sent to Charles Schwab & Co. Friday, Attorney General Andrew Cuomo warned that his office plans to sue the largest online brokerage firm for civil fraud over its marketing and sales of auction-rate securities to clients. Emails and testimony cited in the letter show Schwab's brokers had little idea of what they were selling and later failed to tell clients that the market was collapsing...Charles Schwab executives received daily reports showing in the fall of 2007 that demand for the instruments was declining rapidly, but it didn't make that information available to clients, said the letter."

source: 7/20/09 Wall Street Journal

Free alpha or expensive beta? Either way costs matter.

This is a picture about a wealth transfer from an investor to a broker dealer done under color of 'incidental' advisory service.

It's a real story, unfortunately, and in many ways has come to represent the state of the financial services industry where the interests of the client are subordinate to the revenue preferences of a firm operating on a 'suitability' standard.  An unsophisticated investor will get harvested.

By the way, the difference in the picture is just fees. It is the 'wealth transfer' of your money to the financial services industry. Ever wonder who's paying for the mahogany offices?

It's old fashioned, but costs matter and compound over time. More often they're hidden to some extent, certainly not transparent.  In this case the investor was paying a private banking group (of a broker dealer affiliated with a major US global bank) 3% p.a. for separately managed accounts.  The result was about 1,000 trade confirmations a year and unfathomable account statements some 60+ pages long. What to do?

Analysis revealed it would be possible to 'clone' the performance characteristics of the managed portfolio with a diversified portfolio low cost indexed product comprising some nine distinct asset classes. The comparative analysis above assumes an alternative total cost structure of .80% pa, and the results over 15 years increase the wealth of the portfolio by more than 30%. 

For another perspective, think of it this way: if you expect

• an 7% equity return (on the S&P 500 or the Wiltshire 5000) and
• the 10 year Treasury is paying 3% and
• you have a 50/50 debt/equity portfolio, then
• you have an expected return of 5% before fees on the portfolio

Let's pretend this is your Roth, so there are no taxes (taxes, of course, make everything worse). 3% pa fees consume 60% of your expected pre-tax return.

Some friends came to us, and this is their story. Unfortunately, it is true.  The private banking group was charging excessive fees for under performing product. As you can see it has significant adverse long term implications for wealth creation. 

It is your money. Make your story end well.  It's too important.

How long do you need to recover the loss of real value in your equity portfolio?

This is a picture about the destruction of American savings, the difficulty and timing pertaining to the recovery of those values, and the punitive impact that taxes impose on that process.

This is likely your story if you had any investment in equities via:

• savings for your retirement, or
• your kids' educations or
• eldercare,
• a pension, SEP, Roth or regular IRA; or
• are a business or institutional portfolio manager or
• if you simply own a house (the numbers change a bit, but it’s generally the same story)

You likely won’t recover the real value of the portfolio value until 2039 and that seems to be a reasonably favorable scenario. It is clear that the increases of long term capital gains and dividend income taxes as proposed by the administration won't be helpful. Of course, if income and capital gains taxes are eliminated, it shortens the recovery from 2039 to about 2024.  You can make your own call on that one.

The chart shows the decline of VTI, Vanguard's Total Stock Market Index ETF, from peak value on $78.26 on October 12, 2007 to $45.32 on July 7, 2009.  VTI basically represents the entire US stock market, and the peak to trough decline you see is real.  Thereafter, we assume a 7% nominal, pre-tax return on US equities.  We may have over or under estimated future returns, but many managers would have been happy with 7% for the last few years and perhaps would be for the next few as well.  We stipulate the forecast is primitive, but people can see and understand it.  Monte Carlo simulation would be better, but it's harder to understand, and the zip code of the results won't change.

We assume a series of 366 day holding periods to simplify taxes. We also assume our initial basis to equal the proceeds of our first periodic sale, so all subsequent long term capital gains are taxed at the proposed federal rate of 28%.  Dividends are taxed at the 28% proposed federal tax rate, and we added a 6% state income tax for the home team. 

Play around with the assumptions if you like, but it won’t change fundamental and very sobering nature of the out outcomes: we’ve sacrificed the savings of several generations. In a steady state scenario, anyone over the age of about 27- 28 will likely run out of time and earnings capacity to catch up.

"So? I already knew I had a problem." Ok, in our next posting we'll talk about what this means for investment (and life) strategy going forward.

Assumptions:

2.64% dividend yield (ticker: VTI)

4.36% + expected price appreciation

7.00% = expected nominal pre tax equity return

0.90% less income tax on dividend

1.22% less LT cap gain (366 day holds)

4.88% = after tax equity return

3.00% less inflation

1.88% = real after tax equity return

3%   inflation

34% fed dividend income tax as proposed at 28%+ 6% state

28% fed LT capital gains taxes proposed, no state

Should you buy municipal bonds individually or in a fund?

J. Hunter Brown's comment on the municipal bond market

"Individual investors that are unfamiliar with indentures and some of the embedded risks - interest rate, credit, or liquidity, many of which are appropriately noted here - should stick to reputable mutual funds or ETFs. And there aren't a lot of them around...A major problem for individuals with the muni market is that there is little to no price transparency. The inefficient structure and informational risk of the market can put the individual investor at the mercy of a dealer trying to monetize an informational monopoly or unload a risk position."

is cited in WSJ: Should You Buy Municpal Bonds Individually or in a Fund? (Wall Street Journal, The Wallet, Feb. 3, 2009)

"A 2004 investigation by the National Association of Securities Dealers — now known as FINRA – assessed a total of more than $610,000 in fines and restitution on Charles Schwab, Edward Jones, First Trust Portfolios, Merrill Lynch, Morgan Stanley, Prudential Equity Group, UBS Financial Services and Wachovia Securities for buying municipal bonds from clients at unfairly low prices....According to the NASD, the fair market value of the bonds was 97.02, but a UBS broker executed the trade at 40.00 – meaning that more than half of the bonds’ total value ended up in the broker’s pocket. (All the firms settled the case without admitting or denying the charges.) That’s an extreme case of the problem that reader J. Hunter Brown points to in his comment: How can you know whether you get a fair price when you buy or sell an individual muni?"

Why not double down?

"Mr. Geithner, who was closely involved with the AIG bailout, offers no change ... His latest scheme is called the Public-Private Partnership Investment Program. But there is actually very little private skin in this game: It gives a handful of wealthy financiers huge nonrecourse loans to enable them to purchase toxic assets that the market supposedly won't buy at a "fair" price. As the housing crisis has shown, providing subsidized nonrecourse loans creates asset bubbles, not true price discovery. And bribing buyers to ramp up prices smacks of market manipulation." Amar Bhide

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The new program offers non-recourse debt financing at ~20x leverage to the hedge fund crowd. It is a free option of unprecedented macro scale: a massive call option on the taxpayer wallet at a 5% premium.   'Heads they win, tails the taxpayer losses again'.

So, form a hedge fund, buy the maximum you can. If it works, you're rich. If it doesn't, just walk away. You only have 5% down.  It's your best shot.

"a little song, a little dance, a little seltzer in the pants..." - Chuckles the Clown

If the hedge fund isn't working for you, consider buying TIPS & selling long dated treasuries.

What the large print giveth, the small print taketh away

From the H-15 schedule published by the Fed:

"Trade data insufficient to support calculation of the 90-day A2/P2 nonfinancial rate for April 6, 2009. "

There is a hole in the bucket: this market is closed.