Quick commercial…if you’re in south Florida, I’ll be speaking on Wednesday night in Ft. Lauderdale.  Here’s a link to more information.  (The cost for nonmembers is $55.)

Today’s blog has two short pieces:

1. some thoughts on the EU

2. a few interesting stats

The Eurozone crisis continues.

Here are my thoughts:

1. Imagine that the US, Canada and Mexico had a common currency.  The three individual countries would lose the ability to use monetary policy to respond to their particular economic needs.  They’d also lose the ability to devalue their currency if exports were weak.  That’s what you have in Europe.  It doesn’t work.

2. In order for the common currency to work, countries need to have similar characteristics.  Unit labor costs should be similar, economic cycles should be similar, fiscal policies should be similar.  Greece and Germany…not that similar.

3. Many people argue that the US is very much like the EU – a group of states with a common currency.   Of course, the US is nothing like the EU.  We have a federal government, the states must balance their budgets, we all speak the same language and we have the ability to freely move among states – chasing opportunity.  (We have our own problems, but they’re not caused by a common currency.)

4. Governments like the Greek government (do they have a government now?) are problematic.  They responded to difficult economic times by expanding the government payrolls rather than becoming competitive.  But again, the real problem is that they’re not competitive.

5. You can’t really believe that time will heal these problems, can you?  Gimmicks designed to keep interest rates low in problem countries…will these help?  They delay the inevitable.  Do you really think that a country like Spain, with 25% unemployment, is going to fix their problems by cutting their budget?

6. Germany gets a lot of credit in the press for being much more efficient than other EU countries.  But, an alternative way of looking at the situation is simply to say that they are benefiting from a currency that won’t appreciate.  In other words, the way that they became the world’s largest exporter is by having an undervalued currency.  If the euro breaks apart and they have their own currency, it will appreciate greatly.

7. There is value to the EU situation dragging on.  It allows markets to get ready for the inevitable nature of what has to happen.  It will seem much less significant when Greece stops using the euro than if this had happened two years ago.

8.  With that said, leaving the euro will cause even more pain in Greece.  One of the biggest problems is that when they return to their own currency, it will be worth much less.  For businesses and individuals that have borrowed (in euros) from non-Greek institutions, they’re going to be unable to pay these loans back.  That will lead to a lot of bankruptcies.

A Few Interesting Stats

1. According to a recent MetLife study, nearly half of Americans say they gave money to a family member in the prior year to help pay bills.

2. The Employee Benefit Research Institute predicts that nearly half of Americans ages 36 to 62 may not be able to afford even basic living expenses in retirement.

3. In 2010, nearly one-fifth of 45- to 54-year-olds didn’t have health insurance.

4. The European Commission (the EU’s executive arm) sees unemployment in the euro zone averaging 11% this year, up from 10.2% in 2011. Only six months ago, the commission predicted unemployment would fall slightly this year to 10.1%.

5. Even with Medicare benefits, a 65-year-old couple retiring in 2012 will spend at least $240,000 in health-care costs during their retirement, according to a report from Fidelity Investments released Wednesday. That figure represents a 4% increase from last year, when the study estimated such costs would average at least $230,000.

Have a great week.

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The Fiscal Cliff – Investors are worried about the economic impact of tax increases that could take effect in January 2012.  Most notably, people are worried about the expiration of the Bush tax cuts, the expiration of the payroll tax cuts and automatic spending cuts (from the sequester).  Chairman Bernanke referred to this while testifying before the House Financial Services Committee when he said, “Under current law, on January 1, 2013, there’s going to be a massive fiscal cliff of large spending cuts and tax increases.  I hope that Congress will look at that and figure out ways to achieve the same long-run fiscal improvement without having it all happen at one date.”

This tells me one thing…the Great Recession has been followed by a Horrible Recovery.  If raising the top tax rate back to the levels before President Bush took office (which were still below 40%) and withdrawing 6.2% of employee salaries for payroll taxes (rather than 4.2%) would push us off of a cliff, that should give you an idea of where we are.  In other words, things are so bad that we couldn’t go back to the tax structure of the beginning of this century and survive.  I’m not going to argue with that.  It just tells you the dismal state of our economy.

The Socialist vs. The Conservative – no, I’m not talking about President Obama against Governor Romeny.  (President Obama isn’t a socialist and Governor Romney isn’t a conservative.)  It will be interesting to see what happens in the EU now that France has signaled their discontent with Germany by electing a left-leaning President.  The war against austerity is building.

Tell Me What I Already Believe – with respect to cable news, Fox News is the most watched source.  Now, it seems like MSNBC might be passing CNN.  Maybe people don’t like CNN (and what it’s become).  But, CNN has tried to maintain its position as the nonpartisan news source.  Fox is the source for the right and MSNBC is the source for the left.

So You Want to Know How Divided Our Country Is – I read an article that said that the issue of the so-called “Buffett tax” was raised at Berkshire Hathaway’s annual meeting.  I read that one shareholder said that his 84-year old father didn’t want to hold Berkshire’s stock because of Buffett’s support for this rule.  Apparently, half the audience cheered.  Buffett suggested that the 84-year old should consider owning Murdoch’s company instead.  That led to applause from another portion of the audience.  Buffett also said that running a company didn’t mean that he had to put his citizenship in a blind trust.

Debt Inequality – CNN had an interesting chart showing the 25-year change in “debt-to-income” ratios for the top 5% and the bottom 95%.  Back in 1983, the levels were approximately equal.  But, the bottom 95% have doubled their ratios!  Of course, this doesn’t answer the question of why the debt ratio has increased.  See chart below.

Another Lousy Report Card – the employment report showed that we only created 115K jobs in April.  That’s not going to solve our labor problems any time soon.  Yet, our unemployment rate dropped to 8.1%.  The reason for this seemingly incongruous result is that the participation rate dropped to 63.6%, the lowest rate since 1981.  There are many reasons that the participation rate is so low (and the reality is that we don’t know all the reasons).  Possibilities include discouraged workers (many of whom will return if they believe jobs are returning), retiring baby boomers (people leaving the work force at an increasing rate) and the large number of people joining the ranks of the disabled (see my blog from two weeks ago).

Some Unemployment Rates are More Important Than Others – The Financial Times reports that job growth in the 14 states pivotal to the presidential election has advanced at a slower rate than the rest of the country.

Lower Demand for Employees.  Atlanta Fed President Lockhart said that on the demand side (for employees), many businesses that existed five years ago are gone.  While this is normal, we have fewer start-ups because of the weak economy and difficulty getting financing.  Also, many businesses that weathered the recession made deep and apparently permanent cuts in the workforce.  Many businesses have also made investments in technology that have eliminated the need for certain types of jobs (and the skills that these firms now demand may be quite different than in the past).

Congratulations Jay!  My oldest son Jay had some great success this weekend in the fifth-grade level of a state academic competition in Ft. Worth.  He placed first in two competitions (Math and Maps/Charts/Graphs) and placed third in Number Sense.  Congratulations Jay!

Have a great week.

If you enjoy this blog, please forward it to others who may be interested.

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I guess I haven’t been receiving enough hate mail recently.  There’s no other logical reason why I’d write about the ACA.  So, let me start by disclosing my bias.  I recently spent some time studying the ACA (primarily reading some papers on both sides of the issues).  Ultimately, I’m in favor of the ACA.

I’m not writing in an attempt to convince you to support the ACA.  I believe that most of us have political or personal beliefs that result in us supporting or opposing this law.  (If you don’t believe this, ask why the Supreme Court justices could have different opinions on these issues.)  I think that my support for the ACA comes down to my twelve years of Catholic school that led me to judge issues by how they affect the weak and the poor.   These are my personal beliefs that affect my political beliefs.  I understand that many of you have personal and political beliefs that may lead you to oppose this law.

So then…what is the purpose of today’s blog?  In addition to generating hate mail, I want to give you some basic thoughts and I want to tell you some of the good and bad about the law.  Realize that this is a short piece – it is not intended to be a treatise that covers all of the issues.

The Basics of the ACA

The ACA is premised on three key ideas:

1. Insurers cannot turn anyone down or exclude people with pre-existing conditions.

2. Everyone must have health insurance (“the individual mandate”).

3. The government will subsidize health insurance for people who will struggle to afford it.  People who have income up to 400% of the poverty level will receive partial subsidies.

The Economic Reason for the Individual Mandate

Without the individual mandate, the ACA would likely fail.  Since insurers are not allowed to turn anyone down, healthy people could stay uninsured until they become sick (if there is no individual mandate).  Once they become sick, they would buy insurance (because they can’t be turned down).

If this is what happens, the pool of people who are being insured will be the “sick pool” and will not include the healthy people (who choose to stay uninsured until they actually need insurance).  If an insurer is only selling insurance to the “sick”, the cost will be high.  At that point, many people won’t be able to afford insurance and the system will fail.

The Individual Mandate Is a Republican Idea!

In the early-to-mid 1990s, the Republicans were opposed to the Clinton health plan.  One alternative was proposed by a Republican Senator and a Democratic Senator.  It included an individual mandate.  It was supported by 19 Republican senators (including Bob Dole).  If you don’t believe me about this, read this piece by PolitiFact.  Obviously, the Massachusetts plan (signed by then-Governor Romney) also has an individual mandate.

The Single Best Thing About Universal Health Insurance

Regardless of whether you support or are opposed to the ACA, there’s one thing that we should all be able to agree on.  The ability to obtain health insurance (without working for a large employer) will allow a larger number of people to take the risk of an entrepreneurial venture.  In other words, if I can obtain health insurance on my own, I’m more likely to take the risk of starting a business.   Hopefully, we can all agree that we want to support entrepreneurial activity.  We can argue about the cost of this law, but this benefit is great.

Other Reasons That I Like the ACA

1. We will insure approximately 32 million people who don’t currently have insurance.

2. Many of the people who are currently uninsured are still receiving treatment.  Unfortunately, much of this treatment is through emergency rooms – a very expensive way to get treatment.  We’re all paying for this already.  The hospitals and service providers ultimately pass these costs on to us.  We need to find a way to treat these people in a cheaper way.

3. The majority of people who will gain insurance are the working poor.  In other words, these are people who are working in jobs that don’t offer insurance or they are people who have previously made the decision to not participate in insurance.

4. A very similar plan has been successful in Massachusetts.  The “uninsured” rate is 2.6% (lowest in the nation) and they have kept costs low.  (This plan was developed under Governor Romney.)

5. The exchange (think of this as a simple, online market) will make it much easier to compare health plans.  It will also mean that people who are not obtaining insurance through their employer will be able to get affordable insurance that is more than just “catastrophic” insurance.

Reasons to Be Concerned About the ACA

1. Many of the cost assumptions are likely to be wrong.  We assume that we’re going to reduce payments to Medicare providers, that a review board will allow us to reduce costs, that tax laws will remain in place forever, etc.

2. In addition, we have already started collecting some of the ACA tax revenue even though most of the costs start in 2014.  That leads to distrust about the ten-year estimates (to reduce the deficit).  (In other words, as an exaggeration, if we collect revenue for ten years, but offer services for one year, it’s hard to say that this is reducing our deficit.  In the future, we’ll have ten years of revenue and ten years of costs.)  The flip side of this complaint is that estimates are that the second ten years will be more beneficial (to our budget) than the first ten years.

3. Massachusetts is different than the US.  They started with a much lower rate of uninsured people than the U.S. (8% vs. 15%), they have higher income than the U.S. (so more of the bill could be put on the citizens rather than the government), they had resources (from a federal government plan) that were used to fund their insurance law and (most importantly) their law had bipartisan support.

4. This law does a little to “bend the cost curve”, but not a lot.

Conclusion

Again, my goal is not to convince anyone of anything…and this is not intended to be a treatise.  This is a difficult issue and we have no idea of how the numbers will turn out.  But, regardless of how you feel about it, the politics should bother you.  The partisanship is absurd.  We have a problem – we pay more for health care than all other developed countries, we have higher mortality rates than most developed countries and we have less access to healthcare for a larger percentage of our citizens.  The Democrats took a Republican solution and now the Republicans are being forced to argue against it.  This is really “Romneycare” not “Obamacare.”  Maybe we can all get along and call it “Rombamacare.”

Have a great week.

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There continues to be more discussion about student debt.  There was a great article a week ago in in Barron’s, titled “What a Drag!”  Below, I’ve listed some of the key numbers and ideas (taken straight from the article).  The big takeaway seems to be that the amount of debt is large, it’s impacting the lives of graduates, but it’s unlikely to blow up like mortgages did.  It will be a hindrance on our economy and the lives of the debtors – it’s like having a second car loan (and for some people…it’s a really big, fancy car loan).  Here’s what the article said:

SIZE OF DEBT

1. The Fed stated that there is $870 billion of student loans carried by 37 million people.  This is greater than total auto loans.  It’s also greater than credit card debt.
2. The Consumer Financial Protection Bureau asserts that the debt is over $1 trillion when you include interest that has been capitalized (added to the outstanding balance).
3. Two-thirds of the college seniors who graduated in 2010 had student loans averaging $25,250.
4. Student debt borrowing by the 34-to-49 age range has soared by more than 40% over the past three years (the fastest of any age group).  This may be due to bad economic times that prompted many to seek more training.
5. The 30-to-39 age group owes more than any other age decile, with a per-borrower debt load of $28,500.  The 40-to-49 age decile is next with a balance of $26,000.
6. Loans to parents have increased 75% since the 2005-06 school year, to an estimated $100 billion in federally backed loans.
7. Pell grants allow students to borrow up to $5,550 per year.  Federal undergraduate loans are capped at an aggregate of $57,500.

RISING TUITION

1. There is research that argues that tuition has increased as a result of the availability of these loans.
2. Private four-year college tuition and fees have increased 181% over the past 30 years.  Public four-year college tuitions have risen by 268%.
3. In-state tuition at public universities averages $8,244.  Private tuition averages $28,500.
4. Ivy League schools led the increase in prices during the 1980s.  They knew that there was demand for a limited number of seats.  There was also a signaling effect.
5. State governments know that there is a large gap between private and public tuition.  This may mean that state governments will continue to cut appropriations to schools.
6. For-profit schools derive 90% of there revenues from government loans (and the GI bill).
7. For-profit schools account for 40% – 50% of all student-loan defaults.
8. Schools often lack cost controls and have to pay for high-salaried professors, expensive presidents and provosts, huge administrative bureaucracies and lavish physical plants.

OTHER PROBLEMS

1. Delinquencies are reported at 10% but may be double that when you properly account for things like loan-payment deferrals.
2. Tuition is rising and income is stagnant.  That means that people need to borrow more (and that it’s harder to pay back).  Tuition and fees at four-year schools increased 300% from 1990 – 2011.  Over the same period, overall inflation was 75% and health care costs increase 150%.
3. High debt levels (and weak job prospects) make graduates reluctant to buy cars, homes or spouses.  Weak family formation is not a promising sign for the housing market.

THIS IS NOT THE MORTGAGE MARKET

1. Student loans are just one-tenth of the size of the home-mortgage market.  Subprime mortgages (including alt-A and option ARMs) were bundled into $2.5 trillion worth of securitizations at their peak.  In addition, all of this was amplified by credit default swaps.
2. The bulk of the student debt is guaranteed by the federal government.
3. The government has particularly strong collection powers.  They can garnish wages, take income-tax refunds or Social Security payments.
4.  Student debt is generally not dischargeable in bankruptcy.
5. The government claims to recover 85 cents on the dollar from defaulters.  Contrast this with credit card recoveries that tend to be closer to ten cents on the dollar.

Have a great week.

If you enjoy this blog, please forward it to others who may be interested.

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I frequently talk about Social Security and we always think about the Social Security retirement payments.  But Social Security is actually OASDI – “Old Age, Survivors and Disability Insurance.”  Today, it’s time to talk about disability.

Here are some quick background facts about disability insurance:

1. You are eligible for disability insurance if you have paid payroll tax for five of the ten most recent years.  The payroll tax is 1.8% (the employee pays .9% and the employer pays .9%).
2. You are entitled to disability if you have a medical condition that has lasted or is expected to last at least one year or will result in death.  You must be unable to engage in previous work or adjust to a different type of work.
3. The benefits are equivalent to the Social Security payments that you would receive if you retired at full retirement age.  (FRA used to be 65 but is in the process of gradually being changed to 67.)
4. After you’ve been disabled for two years, you are entitled to Medicare.  This is a very attractive feature for recipients.

Ten Things You Should Know About Disability

There are so many outrageous things to tell you about the disability program.  Here are ten.

1. Almost 5% of working age people (25 – 64) are receiving disability payments.  Do you believe one-in-twenty people are disabled?
2. Disability has become a safety net.  Two percent of working age people applied for disability in 2010.  Do you believe that 2% of all working people became disabled in 2010 or do you believe a weak job market had something to do with this?
3. Disability has become the program of choice after 99 weeks of unemployment insurance lapse.  Look at the chart below (from Krueger and Mueller, cited at bottom of today’s blog).  You can see that people who do not have access to $5,000 claim disability at a much higher rate when their unemployment insurance lapses.  Think about this – there’s no reason that this group should have a higher disability rate than people who have access to $5,000.
4. Once someone goes on disability, there is little chance that they will ever return to work.  There are three ways to leave disability: you can die, you can reach full retirement age and shift to the Social Security payroll or you can return to work.  Less than 1% leave the disability roll by returning to work.  See chart below from Autor’s paper (cited at bottom of today’s blog).
5. If your initial claim for disability insurance is denied, your appeal is heard by an Administrative Law Judge.  The ALJ will reverse 75% of the initial decisions.  Think about this: the appellant is represented by an attorney.  The government, on the other hand, does not have an advocate at the hearing.  As a former prosecutor, I’ll let you in on a little secret…it’s easier to win a trial or a hearing when there’s no one arguing against you.
6. The disability “trust fund” is expected to be exhausted in the next few years.   They are currently taking in 20% – 30% less than they are spending.  Go figure.
7. Some rocket scientists want to start to allocate more of our payroll taxes to disability (and away from Social Security) in order to save the disability fund.  Talk about robbing Peter to pay Paul.  Of course, this was our solution in the 1990s.  We’re a nation of morons.  Or better said, we’re a nation that has elected a bunch of morons.
8. In 2010, there were approximately $124 billion of cash payments under the disability system and the Medicare payments (to people receiving disability) cost approximately $70 billion.  The total spending is approximately $1,500 for every U.S. household.  It’s 7.3% of federal non-defense spending.
9. Spending has grown at a real rate (i.e., greater than inflation) of 5.6% for the past 20 years.  All other Social Security spending increased at a 2.2% real rate.  In 1988, disability spending was one in ten dollars spent by the Social Security system.  Now, it’s almost one in five dollars.

10. The average new awardee is 48.8 years old.  The present value of the cash and medical benefits that they will receive (until Social Security takes over) is $270,000.

Some Final Thoughts

I don’t dispute that plenty of people are disabled and need these benefits.  In fact, I want these people to receive payments.  I want the money to be there so that we can pay these people.  But there is far too much fraud going on.  I’m sorry, but 5% of the population is not disabled.  Work is becoming less physical.  Medical care is better.  There’s little reason to believe that real disabilities increase in a recession or that unemployment insurance exhaustees without money should have a higher incidence of disability than those with money. Finally, you can’t convince me that only 1% of disabled people recover in a year.

Two last random things to consider:

1. This is one factor (among many) that accounts for a drop in the labor participation rate (so the unemployment rate is misleadingly low).
2. While counterintuitive, you could also argue that this is a justification for extending unemployment benefits (like we did).  We need to give people time to find work.  Otherwise, some of them claim disability.  Once we lose them to disability, they’re gone.  You have to accept the fact that some people are gaming the system.  If we let them get on disability, the game is over and we just lost $270K in present value terms.

SOURCES:

David H. Autor, “The Unsustainable Rise of the Disability Rolls in the United States: Causes, Consequences and Policy Options,” National Bureau of Economic Research (December 2011).

Krueger, Alan, and Andreas Mueller. In progress. “Applications for Disability Insurance and the Exhaustion of Unemployment Insurance Benefits: New Evidence from a Survey of Unemployed Workers.”  (Cited in “Unemployment Insurance Extensions and Reforms in the American Jobs Act” by the Executive Office of the President)

Have a great week.

If you enjoy this blog, please forward it to others who may be interested.

If you want to receive these emails, here’s how:

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IMPORTANT: if you don’t receive the email in step 3 or you don’t click on the link, you won’t be on the list.  Sometimes, people who use corporate emails get blocked (it’s probably 50% of the time).  So if you don’t get the email, you know you need to use a personal email.

In Monday’s blog, I mentioned a presentation in Austin that was scheduled for tonight (Wednesday night).  Unfortunately, we decided to cancel it.  It looked like attendance was going to be low.

On a happier note, thanks to those of you who participated in the webinar on Monday.  It was the biggest one that we’ve ever done at McCombs.

I’ll be back to writing by Monday (if not sooner).

Have a great “rest of the week.”

Sandy

A NEW commercial…on Wednesday night, April 11th (this Wednesday), I’ll be presenting “Numbers All Americans Need to Know” in Austin.  Here’s the link if you want to sign up.

Also, don’t forget today’s (Monday) webinar (mentioned in my prior blog).  Here’s the link to that.

Now, on to today’s blog…

Robert Wilmers, M&T’s Chairman and CEO wrote a letter to his investors (as part of the company’s annual report) that has received a lot of attention.  After reviewing his company’s performance, his letter explained how the public no longer trusts banks or their leaders.  As a result, regulation is being enacted that will hurt the industry and the overall economy.

Below, I have pulled out some of his comments about bankers.  In addition, here is a pdf of the relevant part of his letter (the part about the banks and not the part about M&T).  Here are some of his key comments and numbers about bankers:

1. A 2011 Gallup survey found that only a quarter of the American public expressed confidence in the integrity of bankers.
2. The Wall Street banks were central to the financial crisis and continue to distort our economy.  Main Street banks were often victims of the crisis.
3. The financial crisis has resulted in the decimation of public trust in once-respected institutions and their leaders.
4. The result of this has been rulemaking that will burden the efficiency of the American financial system for years to come and will potentially have broader implications for the overall economy.
5. Bank leaders used to be seen as community leaders and even national leaders.
6. The average compensation in the financial services industry used to be exactly the same as the average income of a non-farm U.S. worker.
7. Investment banks used to be kept separate from traditional banks.  Everyone specialized in markets and thoroughly understood those markets.
8. As banks started investing in areas where they possessed little knowledge, the reputation of banks and their leaders dwindled.
9. The subprime crisis was characterized by Wall Street banks betting on and borrowing against increasingly opaque financial instruments, built on algorithms rather than underwriting.  The banks created instruments that they did not understand.

10. Bankers contorted the overall economy.  Insurance, finance and real estate was 11.5% of GDP in 1950.  By 2000, it had reached 20.6%.

11. Today, the largest six banks own or service roughly 56% of all mortgages and nearly two-thirds of those in foreclosure proceedings.

12. One bank services almost $2 trillion and close to 30% of all mortgages in foreclosure.

13. Since 2002, the six largest banks have been hit by at least 207 separate fines, sanctions or legal awards totaling $47.8 billion.  None of these banks had fewer than 22 infractions.  One had 39 across seven countries, on three different continents.

14. According to a study done by M&T, over the past two years, the top six banks have been cited 1,150 times by The Wall Street Journal and The New York Times in articles about their improper activities.

15. At a time when the American economy is stuck in the doldrums and so many are unemployed or under-employed, the average compensation for the chief executives of four of the six largest banks in 2010 was $17.3 million – more than 262 times that of the average American worker.

16. One bank with 33,000 employees earned a 3.7% return on common equity in 2011, yet its employees received an average compensation of $367,000 – more than five times of the average U.S. worker.  (NOTE: I’m not sure where Wilmers is getting his data…the average US worker is not making $73,400…try cutting that in half.)

17. The Wall Street banks continue to fight against regulation that would limit their capacity to trade for their own accounts – while enjoying the backing of deposit insurance – and thus seek to keep in place a system which puts taxpayers at high risk.

18. In 2011, the six largest banks spent $31.5 million on lobbying activities.  All told, the six firms employed 234 registered lobbyists.

19. It is difficult, if not impossible for bankers – who once were viewed as thoughtful stewards of the overall economy – to plausibly play a leadership role today.

Wilmers continues on by saying that others were also at fault.  Here are a few of the best statistics he cited:

1. As of September 2011, of the 2.2 million mortgages undergoing foreclosure, about 730,000 (33%) were owned or guaranteed by the GSEs.  Of the estimated 850,000 repossessed homes, 182,212 (21%) were held by Fannie and Freddie.
2. M&T looked at a sample of 2,769 residential mortgage-backed issues originated between 2004 and 2007 with a total face value of $564 billion.  Of that sample, 2,679 (99%) were rated triple-A at origination by S&P.  Today, 90% of these bonds are rated non-investment grade.
3. M&T’s cost of complying with regulation has increased from $50 million in 2003 to $95 million in 2011.  In addition, their insurance premium to the FDIC (to maintain and replenish the Fund) increased from $4.5 million in 2006 to an annualized rate of $197.7 million at the end of 2011.
4. M&T’s “likely tally of annual compliance costs and revenue lost from these regulations is $342.6 million and would have represented 28% of pre-tax income in 2011.”
5. The Dodd-Frank Act contains, by one estimate, 400 new rulemaking requirements, only 86 of which were finalized by the start of 2012.

Wilmers concludes that the total distrust for bankers has led to rulemaking that will hurt our nation’s competitiveness.  My intuition is that he’s right.  We regulate in the rear-view mirror (creating rules that fix yesterday’s problems).  But, more importantly, he’s right because this is human nature.  The bankers were a huge part of the problem and they’re to blame for much of the rule-making that is going on.

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Quick commercial…for all UT alumni, I’m doing a free webinar on Monday at noon CST.  Here’s the link, where you can sign up.  It’s called “Numbers All Americans Should Know.”  I will discuss some of the key numbers concerning our unfunded liabilities, disability and healthcare.  Hopefully, it will be a good primer for understanding some of the basic numbers that people are talking about.  The webinar is a slightly shorter version of presentations that I’ve done recently in Ft. Worth, Dallas, D.C., NY and our Alumni Business Conference (so if you attended any of these, you probably don’t want to attend the webinar).

Now, on to today’s blog.  I read four articles that you might find interesting:

1. Student Debt for Retirees

The Washington post published an article (“Senior Citizens Continue to Bear Burden of Student Loans”) that said:

1. Americans 60 and older still owe approximately $36 billion in student loans.

2. More than 10% of those loans are delinquent.  As a result, it’s not uncommon for Social Security checks to be garnished.

3. Borrowers age 60 and above account for a little less than 5% of the outstanding student loans.  Americans aged 50 and older account for 17% of this debt.

4. Democratic Senator Richard Durbin has introduced legislation that would allow private student loan debt to be discharged in bankruptcy.

2. How China Steals Our Secrets

Richard Clarke, the special adviser for cybersecurity to President George W. Bush wrote a great op-ed piece in The New York Times.  It’s titled, “How China Steals Our Secrets.”  He argued that President Obama needs to promote legislation that will help the government stop stolen data from leaving the country.

In his piece, he said that FBI Director Robert Mueller “said cyberattacks would soon replace terrorism as the agency’s No. 1 concern as foreign hackers, particularly from China, penetrate American firms’ computers and steal huge amounts of valuable data and intellectual property.”  He quoted Gen. Keith B. Alexander, head of the military’s Cyber Command as calling the cybertheft “the greatest transfer of wealth in history.”

Clarke argued that by failing to act, Washington is effectively fulfilling China’s research requirements while helping to put Americans out of work.

3. GSA Chief Resigns Amid Reports of Excessive Spending

The chief of the General Services Administration (a federal agency) resigned and two of her top deputies were fired after they held a “training conference” for 300 employees in Las Vegas.  (Here’s a link to the story.)  The total cost (including the “planning” trips) was $823,000.  Some of the money was spent on a clown and a mind reader.  The truly offensive part of this whole thing is that they hired a clown when they probably could have had a Congressman appear for free.

Here’s the pdf of the actual report about the festivities.  It’s truly amazing that a group of people could work together and make such a bad decision.  While I know that many people read stories like this and generalize to “the government is always wasteful,” that’s not my goal.  Similarly, when I read about an incompetent doctor or a scandalous school teacher, I don’t assume that they are all that way.  (With that said, I have no problem thinking the worst about all politicians.)

4. Five Years After Crisis, No Normal Recovery

Carmen Reinhart and Kenneth Rogoff wrote a piece on Bloomberg arguing that they continue to be right and this isn’t a conventional economic recovery.  They take issue with a recent Fed research paper.  Reinhart and Rogoff have consistently argued that recessions that result from a financial crisis are deeper and last longer.

They also state that in ten of fifteen severe post-WWII financial crises, unemployment didn’t return to pre-crisis levels even after a decade.  That doesn’t sound promising.

Have a great weekend.

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Last Monday morning, Fed chairman Bernanke gave a speech titled, “Recent Developments in the Labor Market.”  It was an early morning speech (before the market opened).  Here’s the link.  Market commentators attributed the market’s 160 point Monday rally to Bernanke’s comments.  There was one main takeaway…monetary policy would stay accommodative.

Personally, I think it would be more exciting to see the market rally because of earnings or strong fundamental news.  It’s less exciting to think that the market is rallying because money is cheap and will stay cheap.

Regardless, I think that Bernanke’s comments were much more interesting than simply “viva la low rates.”  In today’s blog, I want to describe the most interesting things he said.  If you want more details (and who wouldn’t?), here’s a pdf of an outline that I wrote about the speech.  It will take just a few minutes to read and the back of the pdf file includes all of Chairman Bernanke’s slides.

Now, the short version of Bernanke’s key points…

1. There’s no question that there’s some good news in the labor market.  Payrolls have increased almost 250K / month for the past three months, there’s been a significant increase in aggregate hours worked, the unemployment rate has dropped, household expectations have improved, business hiring plans have improved, new claims for unemployment insurance have decreased and measures of breadth of hiring across industry have improved.

2. There are still many negative signs in the labor market.  Private payrolls are still five million jobs below peak (plus the population has grown).  The unemployment rate is well above a sustainable level (and 3% above the 20 year average).  Total hours worked are below pre-crisis level.  Long-term unemployment is very high.  We’ve seen more of a decline in layoffs than an increase in hiring.

3. Okun’s law suggests that we need to have GDP growth 2% higher than our potential growth (for one year) in order to lower unemployment by 1%.  As a result, it seems like the positive employment numbers are not in sync with the pace of expansion.

4. While the decrease in the participation rate has had an impact, we have seen a drop in the unemployment rate of marginally attached workers to the same extent as the overall unemployment rate.  This indicates that the “weak” are getting jobs at the same rate as the overall population.  This story contradicts the idea of the weak simply dropping out.

5. The increase in employment reflects a catch-up from outsized job losses during recession.  Employers feared that the economy was going to be even worse than it turned out to be.  In addition, they may have feared a credit crunch, so they tried to conserve cash.  Employers are simply getting back to normal staffing.

6. To the extent that we’re just recovering from “over-firing”, we need high growth to lower the unemployment rate further.

7. The high percentage of people who have been unemployed for longer than six months reduces our productive capacity over the long-term.  We have a loss of skills.  It could also slow our rate of recovery in the short-term because it takes longer to match these people to jobs.

8. It takes older workers longer to find new jobs.  This is a structural unemployment problem that has been raising our unemployment rate because a larger percentage of our labor force is older (the aging baby boomers).

9. Since we need higher growth to regain jobs, this can be supported by continued accommodative policy.  In addition, if our unemployment is generally cyclical (rather than structural), this also speaks to continued accommodative policy.

10. Even if the unemployment problem is mostly cyclical, if it continues on for too long, it can become structural.  Skills can atrophy.

Have a great week.

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Today, I want to share three articles that I found interesting.  They involve:

1. profit margins (is the stock market expensive)

2. the FHA – the next housing disaster

3. an unbelievable article about student debt

Profit Margins

James Montier of GMO wrote an interesting piece titled, “What Goes Up Must Come Down!”  Here’s the link to their site.  Here are some of his key ideas:

1. U.S. profit margins are at record highs according to NIPA data.  See Exhibit 1.

2. It’s strange to see these record high margins during such a weak economic recovery.

3. GMO believes in reversion to the mean.  (Wall Street analysts, on the other hand, expect profit margins to continue to rise.)

4. I always think about total return as a combination of:

A. change in price/earnings multiple (it can contract or expand); plus

B. change in earnings; plus

C. dividend yield.

But, Montier broke it down a little bit more.  Instead of just using change in earnings (the second variable), he used change in sales plus change in margin.  (Change in sales and change in margins is the same as change in earnings.)  He argues that S&P 500 profit margins are currently 7.8% and should revert to 6% over the next seven years.

5. These are the assumptions that result in GMO’s estimate that real returns from stocks will average .4% for the next seven years.

6. He argues that the government deficit is the reason for the high margins.  Once the government slows its deficit, profits will drop.

The FHA

Business Week published an interesting article this week, called “FHA Bailout Risk Looming Larger After Guarantee Binge”.  Here’s the link.  A few ideas from the article:

The FHA guarantees $1.1 trillion in home loans.  This has tripled (to $1.1 trillion) since 2007.   They have been counting on growth in home prices to rebuild their insurance fund.

Moody’s predicts that home prices will fall 3% in 2012 before growing 1.4% in 2013 and 6.5% in 2014.  The FHA used projections that called for increases of 1.2% in 2012 and 3.8% in 2013.

NYU Professor Andrew Caplin says that losses will be deeper than the FHA predicts because the agency uses a home-price index that excludes distressed sales.

By law, the fund is supposed to hold 2% of its portfolio in reserve.  As of September 30th, it held only .24%.  It has paid out $37 billion to cover defaults over the past three years.

Joe Gyourko of the Wharton School predicts that taxpayers will be on the hook for between $50 billion and $100 billion.

Student Debt

There have been loads of articles recently about the cost of college and the amount of outstanding student debt.  But, you need to read this article.  Student debt is starting long before college.  Here’s the link.

Have a great weekend.

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Today, I want to start with a quick commercial and I hope you’ll forward this to anyone who you think may be interested.  We’re starting a new program at McCombs – The Master of Science in Finance.  The degree consists of 36 credit hours and takes ten months.  This is going to be a great program for recent college graduates who want to gain deep finance knowledge.  There is no prior finance training or work experience required.  If you’re interested, here’s a link to learn more.  I’m looking forward to teaching Investments in the program.  Now, on to this week’s blog…

Many times, I blog about papers or articles.  Every so often, I suggest that you should really read an article for yourself.  This is one such time.  The Dallas Federal Reserve Bank released their annual report this week.  The lead article in the report was written by Harvey Rosenblum (the Dallas Fed’s Director of Research and Executive Vice-President).  It’s titled, “Choosing the Road to Prosperity: Why We Must End Too Big to Fail – Now”.  Here’s the link.

Here are some of the most important points from the article (many lifted verbatim):

1. The road to prosperity requires a roadmap that finds ways around the potential hazards posed by the financial institutions that have been deemed “too big to fail” (TBTF).

2. The top five banks controlled 52% of bank assets in 2010.  In 1970, this was only 17%.

3. The term TBTF disguised the fact that commercial banks holding roughly one-third of the assets in the banking system did essentially fail, surviving only with extraordinary government assistance.

4. Monetary policy operates by impacting the decisions made by businesses, lenders, borrowers and consumers.

5. The Fed has kept interest rates low since December of 2008.  This has had a punishing impact on savers.

6. Usually, easy monetary policy helps the economy rebound much faster.  One problem is that banks still have toxic assets.  As a result, banks are still less willing to lend.  Individuals and businesses are concerned about the future and are less willing to borrow.  Low interest rates don’t provide the stimulus necessary.

7. Banks need more capital.  Monetary policy can not be effective when a major portion of the banking system is undercapitalized.

8. Most Americans came away from the financial crisis believing that economy policy favors the big and well-connected.  They saw a topsy-turvy world that rewarded many of the largest financial institutions that lost risky bets and drove the economy into a ditch.  These events left a residue of distrust for the government, the banking system, the Fed and capitalism itself.

9. TBTF has violated the basic tenets of a capitalist system.  Capitalism requires the freedom to succeed and the freedom to fail.  (Quoting Allan Meltzer, “Capitalism without failure is like religion without sin.”)  Capitalism requires government to enforce the rule of law.  (The privatization of profits and socialization of losses is completely unacceptable.)  Capitalism requires businesses and individuals be held accountable for the consequences of their actions.  (Virtually nobody has been held accountable for their role in the financial crisis.)

10. People disillusioned with capitalism aren’t as eager to engage in productive activities.  They’re likely to approach economic decisions with suspicion and cynicism, shying away from the risk that drives entrepreneurial capitalism.

11. There are two challenges facing the US economy in 2012 and beyond.  In the short-term, we need to repair the financial system’s machinery so that monetary policy can have a greater impact.  To secure the long-term, the country must find a way to ensure that taxpayers won’t be on the hook for another massive bailout.

12. Dodd-Frank has inadvertently undermined growth by adding to uncertainty.  The law’s sheer length, breadth and complexity create an obstacle to transparency, which may deepen Main Street’s distrust of Washington and Wall Street, especially as big institutions use their lawyers and lobbyists to protect their turf.

13. Policymakers can make their most immediate impact by requiring banks to hold additional capital, providing added protection against bad loans and investments.

14. The big banks that pose systemic risk should be forced to hold additional capital.  This will result in more “skin in the game” and add market discipline.

15. Small banks did not cause the crisis and should not have additional capital requirements.

16. The assumed future bailout of TBTF banks gives them a significant advantage in the cost of raising funds.  Requiring TBTF banks to hold more capital will level the playing field.

17. Banks aren’t being required to raise more capital until 2016 or 2017.  But, there will be advantages to banks that move quicker.  Banks that quickly clean up their balance sheet will be able to raise capital quicker.

18. The Fed’s zero-interest-rate policy assisted the banking industry’s capital rebuilding process.  It reduced banks’ cost of funds and enhanced profitability.  We are taxing savers to pay for the recapitalization of the TBTF banks.

19. We need to codify and clarify Dodd-Frank quickly.  We don’t need hundreds of pages of regulation.  We need more capital.

20. Under Dodd-Frank, future bailouts must be approved by the Treasury secretary.  This means that the President ultimately decides.  The result is that this will be a political decision.  If the new law lacks credibility, we’re more likely to have another financial crisis.

21. Ultimately, Dodd-Frank leaves TBTF entrenched.

22. The TBTF survivors (of the financial crisis) look very similar to 2008.  They maintain corporate cultures based on the short-term incentives of fees and bonuses derived from increased oligopoly power.  They remain difficult to control because they have the lawyers and the money to resist the pressures of federal regulation.  Just as important, their significant presence in dozens of states confers enormous political clout in their quest to refocus banking statutes and regulatory enforcement to their advantage.

23. We must break the nation’s biggest banks into smaller units.  (Of course, this will be difficult to do.)

24. A financial system composed of more banks, numerous enough to ensure competition in funding businesses and households but none of them big enough to put the overall economy in jeopardy, will give the United States a better chance of navigating through future financial potholes and precipices.  As this more level playing field emerges, it will begin to restore our nation’s faith in the system of market capitalism.

Have a great week.

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Why the participation rate matters.  Everyone following the markets is aware that the unemployment rate has dropped from approximately 10% to 8.3%.  Part of this improvement is the result of job creation (which is a great thing).  But, part of the decrease in unemployment is simply the result of fewer people “participating in the labor force.”  In other words, to calculate the unemployment rate, we divide the number of unemployed people by the number of people participating in the labor force.  To be part of the labor force, you need to either have a job or be actively looking for a job.  So, if you quit looking for a job, you no longer count as unemployed.

The participation rate has dropped.  The labor force participation rate has dropped from 67% to 64%.  If the participation rate were 66%, the unemployment rate would be 11%+.  It’s important to understand whether the participation rate will return to the 66% – 67% range.  If it will return to that range, it means that we have to create many more jobs as people return to the work force.

A recent paper argues that the drop in the participation rate is a demographic trend.  I want to share a recent Chicago Fed Letter written by Daniel Aaronson, Jonathan Davis and Luojia Hu.  It’s titled, “Explaining the Decline in the U.S. Labor Force Participation Rate.”  Here’s the link.  In this paper, they argue that approximately half of the decline in the participation rate can be explained by demographic patterns.  (The remainder of the drop is caused by the recession.  Realize that people always drop out of the work force when there is a recession.)  Much of this blog entry is lifted directly from their paper.

Explaining the prior increase in the participation rate.  From the early 1960s through the end of the last century, the labor force participation rate increased.  See chart 1 below.  This was the result of several factors:

1. more women entered the labor force (one-in-three women were in the work force in 1948, but this reached 60% by the mid-1990s)

2. the large baby boom cohort entered their prime working years during the 1970s and 1980s

3. improvements in health technology increased the health and longevity of the work force; it also forced people to work longer in order to accumulate enough wealth to support lengthier retirements

4. there was a shift away from manual labor occupations (which tend to have shorter average career lengths)

The participation rate has dropped during this decade.  Since peaking at 67.3% in early 2000, the labor force participation rate has dropped approximately 3.3% to 64%.  This decline is twice as large as any since World War II.  The authors conclude that just under half of the drop can be traced to long-running demographic patterns.  These demographic patterns include:

1. the ongoing retirement of baby boomers – in 1996, the first baby boomers turned 50, an age when labor force participation traditionally peaks

2. there has been a long-running downward shift in teen work activity (and this picked up speed during the later half of the 2000s)

We’re below trend, but the trend in participation is down.  While the participation rate is below the trend (by approximately 1%), the trend is expected to continue down.  See Chart 3 below.  Note: this chart may look odd to you because the numbers are higher than you expect (since the participation rate should be near 64%).  The reason for this is that this chart just shows 16 – 79 year olds (ignoring everyone 80+; these older people have a low participation rate).

Why the trend is down.  If you examine the trend LFPR (labor force participation rate), it has fallen 1.2% since 2000.  This is just under half of the 2.7% drop in the 16 – 79 year old LFPR.  The 1.2% drop is the result of the changing age distribution of our population.  Two-thirds of this drop in trend comes from a 4% increase in the fraction of the population out of prime working age (25 – 54).  See chart 4 below.  The remaining one-third is due to changes in gender and educational attainment within age groups as well as changes in labor force participation behavior within groups.  Again, a lot of this final 1/3 is from the drop in teen LFPR.

The future and why this matters.  The authors expect the LFPR (trend) will drop another 2.7% during the next decade.  To some extent, this is positive news because it means that we will not have to create jobs to re-employ people.   Of course, this is also bad news because it is a reminder of the demographics that are going to crush our entitlement programs.

Have a great week.

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