Dr. Sherry Jarrell

Oh, the Irony: The Market Speaks, and Obama Has to Listen!

In a recent article, Moody’s announced that because of the U.S. federal government’s excessive spending and historic debt levels, it might have to reduce the Aaa rating of U.S bonds (http://thecitysquare.blogspot.com/2010/02/us-aaa-bond-rating-threatened-by-obama.html and http://risingpowers.foreignpolicyblogs.com/category/multipolarity/)
 

What this means in practical terms is that the cost of borrowing by the U.S. government will rise, which will increase spending via more borrowing or higher taxes or more money creation to pay for the higher interest costs.  Sound like a vicious cycle to you?  

Has anyone noticed the absolute irony of the world capital market having a seat at the table that assesses the viability of Obama’s policies? Obama has spent the last year denigrating free markets, and has laid the blame for the credit crisis squarely at the feet of those "greedy capitalists." Now he has to deal with a rating agency, which plays a pivotal role in the functioning of those very capital markets, evaluating the creditworthiness of the policies of the White House and its Budget Director, Peter Orszag.  

How wonderfully ironic! 

 

Every Economist, Mr. President? No, sir!

The President seems to believe that he can say whatever he wants and no one will hold him accountable. He now claims that "every economist, from both sides of the aisle, believes that the stimulus program created jobs." http://www.washingtonexaminer.com/opinion/blogs/beltway-confidential/Obama-says-every-economist-back-claim-stimulus-saved-or-created-two-million-jobs-83550017.html

I am an economist, Mr. President, and I know, based either on simple first principles of economics, or on a more rigorous controlled study of labor markets in each major sector of the economy, that the unemployment rate would have been much lower today had the stimulus program never occurred.  

You are either woefully unaware of the facts, Mr. President, or are purposefully distorting the facts. Neither is good.  When are you going to realize that just because you say something does not make it so. The world does not contort itself to support your version of the truth.

Do not put words in my mouth, sir.

The Farcical Freeze

President Obama's proposal to freeze parts of federal government spending over the next three years is a lot like a smoker buying a truckload of cigarettes today, then promising to "freeze spending" on cigarettes tomorrow.  He can keep smoking for years to come without spending another dime.

Federal government spending has increased so much over the last year -- by some estimates at a rate of 34% (http://www.usgovernmentspending.com/year2009_0.html#usgs302 -- that in December of 2009 the debt limit had to be raised to $12.4 trillion to help absorb a record-shattering $1.4 trillion deficit (http://www.washingtontimes.com/news/2009/dec/25/senate-oks-rise-in-debt-limit-to-124-trillion/).

The promise to freeze spending is actually a guarantee that spending will remain at record high levels for the next three years.  It effectively prevents a reduction in federal spending. 

How disingenuous of our President.  

 

The Fed sets up Unit to Police Itself

I'm not quite sure how I feel about this yet.  The Fed has just announced that it has appointed a long-time staffer with the New York Fed to head a newly created branch to oversee the the parts of its balance sheet acquired in efforts to bail out firms like AIG.http://blogs.wsj.com/economics/2010/01/21/new-york-fed-sets-up-unit-to-handle-bailout-balance-sheet/?mod=rss_WSJBlog   

These massive asset purchases, orchestrated by Timothy Geithner, the current Treasury Secretary and former New York Fed official, ballooned the Fed's balance sheet from $800 billion in primarily government bonds to $2.3 trillion in toxic assets.   

Now the New York Fed is overseeing the assets brought into the Fed by the Treasury Secretary as he moved from the New York Fed to the Treasury.  All while the Treasury functions are supposed to be isolated from the Federal Reserve's role in its implementation of monetary policy.
 

Smacks of the fox watching the hen house....

Actual Unemployment is Worse

Keep in mind, even as the number of first-time claims for unemployment insurance rose again this week, that the 10% U.S. unemployment figure understates the actual number of unemployed. Even the 17% underemployment figure, which includes those who are either unemployed or who are working part-time but would like to work full-time, fails to include many of those who have lost their jobs but, because they fail to qualify for unemployment, are not being tracked.  I know several such people personally; one has been unemployed for over a year. 

My point?  Structural unemployment is a serious economic issue.  But the solution is not to funnel more unemployment benefits to the unemployed.  The best thing the government can do is to reduce the barriers it has erected to a vibrant economy, including oppressive taxes, fees, paperwork, bureaucracy, and regulations that repress business productivity and raise prices.  By reducing these explicit and implicit costs, there is absolutely no doubt that the private economy will be able to employ more workers as it produces more output at lower prices. 

The best thing we can do as private citizens and neighbors is to treat each other right.  Keep the economy moving.  Put in a good day's work.  Volunteer or learn a new skill if you can't find a job.  Fill a need.  Buy smart.  And, finally, elect business-friendly local and national politicians.  It matters. 

Capitalism and the Daimler-Chrysler Saga (Part 3 of 3)

This is part 3 of a 3 part post on the saga of the ill-fated 1998 merger between Daimler and Chrysler.

The Daimler-Chrysler merger was troubled from the beginning. Investors sued over whether the transaction was a 'merger of equals' or a Daimler-Benz takeover of Chrysler. A class action lawsuit was settled in August 2003 for $300 million. A lawsuit by activist investor Kirk Kerkorian was dismissed in April 2005, but claimed the job of the merger’s architect, Chairman Jürgen E. Schrempp, who resigned in response to the fall of the merged company's share price. The merger was also the subject of a book Taken for a Ride: How Daimler-Benz Drove Off With Chrysler, (2000) by Bill Vlasic and Bradley A. Stertz.

It is questionable whether the merger ever delivered promised synergies or ever successfully integrated the two businesses. As late as 2002, DaimlerChrysler appeared to run as two still-independent companies.  In 2006, Chrysler reported losses of $1.5 billion.  In 2007, it announced plans to lay off 13,000 employees, close a major assembly plant, and reduce production at other plants in order to try to restore profitability.

It was all for naught.  In May of 2007, DaimlerChrysler announced that it would sell 80.1% of Chrysler to Cerberus Capital Management of New York, a private equity firm specializing in troubled companies. Daimler continued to hold a 19.9% stake. Daimler paid Cerberus $650 million to take Chrysler and associated liabilities off its hands, an amazing development given the $36 billion Daimler paid to initially acquire Chrysler. Of the $7.4 billion purchase price, Cerberus invested $5 billion in Chrysler Holdings and $1.05 billion in Chrysler’s financial unit. The de-merged Daimler AG received $1.35 billion directly from Cerberus but invested $2 billion in Chrysler LLC itself.

On April 27, 2009, Daimler AG agreed to give up its remaining 19.9% stake in Chrysler LLC to Cerberus and pay as much as $600 million into the automaker's pension fund.  On April 30, 2009, Chrysler LLC filed for Chapter 11 bankruptcy protection and announced a plan for a partnership with Italian automaker Fiat. On June 1, Chrysler LLC stated they were selling some assets and operations to the newly formed company Chrysler Group LLC, with Fiat retaining a 20% stake in the new company.

On June 10, 2009, the sale of most of Chrysler assets to "New Chrysler," formally known as Chrysler Group LLC, was completed. The federal government financed the deal with $6.6 billion in financing, paid to the "Old Chrysler.” The transfer does not include eight manufacturing locations, nor many parcels of real estate, nor equipment leases. Contracts with the 789 U.S. auto dealerships who are being dropped were not transferred.  Not a hint of the disastrous Daimler-Chrysler merger remains.

Capitalism and the Daimler-Chrysler Saga (Part 2 of 3)

Yesterday, I posted part 1 of 3 parts on the saga of the 1998 Daimler purchase of Chrysler in which I set up the question:  would the Daimler Chrysler merger, with its internationally traded share and U.S. disclosure rules, be enough to offset the secrecy of the German corporate governance standards at the time of the merger? In today's post, I provide the answer:

When DaimlerChrysler (DCX)  incorporated it adopted German corporate governance standards.  U.S. institutional ownership in Chrysler was largely replaced by European banks that not only directly monitor the working capital financing of DCX but also may sit on its Management and Supervisory Boards.  Such superior access and corporate control created distinct advantages for large German institutional owners relative to minority owners; foreign shareholders in the U.S. found themselves among this minority group.  These advantages included the ability to: expropriate the private benefits of control from minority shareholders; share these benefits with management, effectively creating a collusion, and; profit from trading DCX shares with superior information.  As a result, minority owners priced their shares less aggressively – i.e., the bid-ask spread widened -- to minimize their losses from transacting with controlling shareholders.  As their spread increased, U.S. minority shareholders’ trading costs rose and U.S. trading volume fell as it migrated to Germany, the relatively cheaper trading venue.

The merger between Chrysler and Daimler and consequent changes in corporate governance create an ideal clinical study for isolating our hypothesis about the failure of the enhanced disclosure requirements to effectively compensate for lax corporate governance standards in protecting minority shareholders.  To test this hypothesis, we explored changes in the bid-ask spread that are associated with the change in corporate governance and the control over the flow of information about the Chrysler assets.  We look “inside” the trading mechanism that creates the observed transacted stock price, namely the bid-ask spread, to generate evidence on shifts in the quality and quantity of information available to minority versus controlling shareholders.  The bid-ask spread should grow as minority shareholders learn that traders on the other side of the spread possess superior information about the company, information which is linked to their majority control of the firm and its senior management compensation, asset disposition, and financing and risk-taking strategies.

We found that the decision to merge and become a German stock corporation significantly weakened the protection of minority shareholders, particularly prior owners of Chrysler assets, and led to their expropriation by controlling shareholders and principal creditors of the consolidated firm.  The answer lies in the lack of protection afforded minority shareholders by the German corporate governance structure of the newly combined DCX entity.

Capitalism and the Daimler-Chrysler Saga (Part 1 of 3)

In a paper co-authored with Rick Harris, Tom McInish and Bob Wood, we explored the Daimler-Chrysler merger of 1998 to examine the interplay between disclosure rules in the U.S. and corporate governance standards in Germany.  Here is an overview of what we found.

Large shareholders typically control European and Asian industrial giants, leaving minority shareholders less than well protected.  In several studies of the legal protection afforded minority shareholders across 27 countries, German shareholder protection ranked among the very worst. In the early 1990s, Daimler-Benz, one of the largest firms in Germany, was no exception.  In 1993, with Deutsche Bank owning 24% of the equity, Mercedes AG Holding 25%, and the Emirate of Kuwait 14%, its controlling shareholders decided to cross-list Daimler-Benz on the New York Stock Exchange (NYSE).

All foreign firms that cross-list [list their shares for sale in more than one country] in the U.S. subject themselves to stricter disclosure standards.    In addition to listing on a major U.S. stock exchange, Daimler was required to file financial statements with the SEC and report any material non-financial information as well.   Cross-listed firms are also followed more closely by U.S. stock analysts and the business press.  These legal disclosure requirements and additional scrutiny by the investing community improved both the quantity and quality of information available to all shareholders about Daimler.

By early 1998, the cross-listed Daimler shares were widely held and actively traded worldwide, including significant volume originating in the United States. In September of 1998, Daimler and Chrysler shareholders, majority and minority owners alike, overwhelmingly approved a merger creating DaimlerChrysler AG (DCX) through an exchange of the cross-listed share for the first “global registered share” (GRS).  The so-called “merger of equals” was widely expected to realize both operating efficiencies and, via the informational transparency of the GRS, improved access to international capital markets.

Part 2 tomorrow.

Engine of Economic Growth is Sputtering

The engine of world economic growth is sputtering.  The most clearevidence of this is the lack of new business formation in developed nations across the globe.  Over the last year, the number of entrepreneurs starting new businesses in the wealthiest of nations dropped 10% from the 2006-07 level; in the U.S., that number fell by 24%. http://www3.babson.edu/Newsroom/Releases/globalgem2009.cfm

The contaminants in the fuel line are oppressive government policies that increase the cost of doing business, increase unemployment, and raise the risks to the current labor force of quitting their jobs to try to start new businesses.  

At a time when government should be encouraging venture capitalists and the formation of new business, it is instead putting on the brakes to this source of economic growth in the form of cap and trade, compensation regulations, fees on banks, and myriad other explicit and implicit new taxes.  In 2009, nearly half of U.S. employment was generated by small businesses; U.S. companies started through venture capital employed more than 12 million people, or 11 percent of private sector employment, and generated $2.9 trillion in revenues, or 21 percent of U.S. GDP.  

Fully 100% of economic growth is created in private industry.  Government simply redistributes that wealth, destroying some portion of it in the process.  Never have we needed non-interventionist government policies more.

We Need a New Term for Federal Reserve "Profits"

The Federal Reserve, it has been reported, earned record "profits" of over $46 billion in the year ending December 31, 2009.  The previous record profit was $34.6 billion in 2007. The Fed earned $31.7 billion in 2008. The financial crisis has apparently been very good for the Fed, although, as a non-profit entity, all its profits are turned over to the Treasury.  As an aside, I wonder what the Treasury plans to do with its windfall?Reduce taxes? Hmmm. 

Be careful, however.  "Profits" are a bit of a misnomer for the Fed's activities, because they pay for what they do by creating money out of thin air.  To buy a financial instrument such a treasury bill or mortgage-backed security, which is added to the left-hand-side of their balance sheet as an asset valued at cost, they create (and I do mean "create," in the true sense of the word) an equivalent amount of deposits on the right-hand-side of their balance sheet. It does not "cost" them resources as it would you, or me, or a business.  The "expense" is deducts from revenues to arrive at this period's profits consist mainly of employee salaries.  
 

So if the Fed purchased a bunch of assets with reserves that they created, where do the "profits" come from?  Keep in mind, there are two major drivers of profits.  One is efficiency, or doing more with your resources. The second is pricing power, being able to charge an above-competitive price for a good or service either because you own something scarce or you make up the rules of the game.  

First, two minor sources of income to the Fed are the interest and fees it charges for operating the financial system, such as check clearing and interbank electronic payments, and those it charged participants in the emergency loan programs it undertook to support credit cards and auto loans.

By far the largest source of revenue to the fed, however, came from its open market operations and the purchase of toxic assets.  The Fed had about $1.8 trillion in U.S. government debt and mortgage-related securities on its books by the end of 2009, four times the level in 2008, and the interest payments it collected on this huge pile of assets generated much of their (so-called) profits.  But interest payments are only one source of returns on financial assets. The other is "capital gains" or "price appreciation."  If and when the Fed sells these assets, some of them considered "toxic," there is a real risk that they will incur significant capital losses.   For example, the central bank recorded a $3.8 billion decline in the value of loans it made in bailing out Bear Stearns and AIG.

So the Fed’s profits are this period’s interest income minus the Fed’s minimal operating expenses; the capital base on which it earns income is basically “free.”  And all of these figures focus on one-period accounting entries, ignoring the huge potential negative stock of value the Fed’s activities are generating.

Don’t misunderstand. The Fed provides an invaluable service to the national and world economies, and they generally execute those services very well.  But when they begin to try to act like a business, replacing existing investment banking with their own activities, and parade around profit figures as if they meant the same thing as private industry profits, we must step back and take a moment to understand that Fed profits mean something entirely different from corporate profits. 

Senate Version of Health Care Reform IS a Tax increase!

The latest from Washington on Health Care Reform is the Senate's version which taxes insurance companies on plans valued at over $8,500 for individuals and $23,000 for couples.

President Obama has defended the tax as a way to drive down health costs.  "I'm on record as saying that taxing Cadillac plans that don't make people healthier but just take more money out of their pockets because they're paying more for insurance than they need to, that's actually a good idea, and that helps bend the cost curve," the president said in an interview with National Public Radio just before Christmas. "That helps to reduce the cost of health care over the long term. I think that's a smart thing to do."   http://www.cbsnews.com/stories/2010/01/07/politics/main6066223.shtml  

Huh?  Mr. President, you need an Econ 101 primer. Let's begin now, with supply and demand: s

Supply is an upward-sloping marginal cost curve, and includes the taxes and fees a business must pay to the government.  By imposing this tax, the supply curve of insurance companies will shift up and to the left, as shown in the graph, representing a higher cost per unit of insurance coverage.  The demand curve slopes down, so when intersected by a more costly supply curve, the final price to consumers rises and the amount of insurance coverage falls. Period. End of story. Indisputable fact.  And nothing Obama or the Senate says will change this fact, though they will try. 

This Health Care Reform: The Ultimate Intrusion

Once a single-payer health care program is enacted into law, the government will assume the right to tell us how to live our lives.  Our health will be their responsibility.  Government officials will feel empowered to tell us what to eat and drink, what risks to take, whether we can smoke, how much weight we can gain and how much exercise we must get. 

If you have any doubt, consider the following statements from the Obama administration over the last year. The clear message is if the government pays for something with tax dollars, it has both a right and a responsibility to tell the recipients of those dollars how to conduct themselves.

• "This is America. We don't disparage wealth. We don't begrudge anybody for achieving success," Obama said. "But what gets people upset -- and rightfully so -- are executives being rewarded for failure. Especially when those rewards are subsidized by U.S. taxpayers."   http://wcbstv.com/national/executive.pay.limits.2.926332.html

• President Obama challenged top bankers to explore "every responsible way" to increase lending, saying they were obliged to help after being rescued by taxpayers. He asked them to "take a third and fourth look" at their small-business lending. He also exhorted the executives — both in private and in public — to drop their opposition to an overhaul of the nation's financial industry.  "If they wish to fight commonsense consumer protections, that's a fight I'm more than willing to have," Obama told reportersin the Diplomatic Reception Room of the executive mansion.  http://www.msnbc.msn.com/id/34416646/ns/business-us_business/

• "Treasury has instruments that can address the excessive retention bonuses, and add provisions to ensure that taxpayers are made whole," [White House spokesman] Gibbs said.  http://www.msnbc.msn.com/id/29714402/ns/business-us_business/page/2/ 

• "I intend to hold these banks fully accountable for the assistance they receive, and this time, they will have to clearly demonstrate how taxpayer dollars result in more lending for the American taxpayer," said President Obama.     http://www.whitehouse.gov/the_press_office/remarks-of-president-barack-obama-address-to-joint-session-of-congress/

• Obama said it is "wholly unreasonable to expect that American taxpayers would or should hand this administration or any administration a $700 billion blank check with absolutely no oversight or conditions, when a lack of oversight in Washington and on Wall Street is exactly what got us into this mess."  Obama said taxpayers should be treated like investors if they are being asked to underwrite the bailout.  http://www.cnn.com/2008/POLITICS/09/23/campaign.wrap/index.html

• "What’s really frustrating me right now is that you’ve got these same banks who benefited from taxpayer assistance who are fighting tooth and nail with their lobbyists up on Capitol Hill, fighting against financial regulatory control," Obama added.  http://au.biz.yahoo.com/091213/31/2aafh.html

More Political Shenanigans on Health Care Reform

This topic may seem to be more about politics than economics, but anything related to health care reform is squarely rooted in the most important of economic issues:  the costs of doing business, the size of the government, and the potentially oppressive role of government in private industry. 

To that end, the following is a must-read, and should make you angry, no matter what your political persuasion.  http://bostonherald.com/business/healthcare/view.bg?articleid=1224249&format=text

In this article, we see how the Senate Democrats are going to do whatever it takes to get their version of health care reform through, even if it comes down to essentially stealing votes.  Could the timing of this Massachusetts special election, to replace the temporary replacement put in for the late Senator Edward Kennedy, be one of the reasons that the Senate wants to rush this reform through before the President's State of the Union Address, typically set for mid-January, though the White House is curiously reluctant to commit to a date....  ?

Troubling U.S. Unemployment Figures

The U.S. unemployment rate remains at a 26-year high.  This is troubling for two reasons. One, the struggle and suffering of the unemployed (and underemployed) and the impact on the world economy. 

Two, the mixed signals it gives policymakers.  I worry that the White House will think that it needs to do "more" of what it's been doing, and will dismiss any negative comments about its economic policies as a knee-jerk reaction to the unemployment figure when I, in fact, would be saying the same things if the unemployment figures had improved.  It would be a harder sell, true, but that doesn't change the facts.

The reason?  Because I believe we would be in a better position today, with lower unemployment -- no matter what the current unemployment rate -- and higher growth, had the stimulus program never been initiated.  I base this on my understanding of the fundamentals of how the economy works, how businesses create value, and how labor makes itself indispensable to industry.  

And none of these areas were helped or improved by the economic policies of this President. 

The Deficit and the Money Supply

As the New Year begins, many writers are looking back on the events of 2009.  Many are focused on the impact of the bailout and stimulus programs on the U.S. economy.   While some credit those programs with ending the U.S. recession, others worry about the resulting deficit and the ability of the government to sustain this level of spending into the future. 

I, for one, believe that the economy would have been better off without the bailouts and the stimulus program.  But proving that claim is a difficult task, not just for me, but for anyone trying to address the question.  

I have a research project under way that I hope will lead to a better measure of the impact of government spending on GDP, but it will be some time before those results are in.  In the meanwhile, I want to help to clarify some economic issues that underlie much of the debate about the stimulus and the deficit.

First of all, the deficit is defined for the fiscal year only.  It is a one-period measure.  The deficit for 2009, for example, is total 2009 government spending (including interest on debt, which is the cumulated book value of deficits) minus total 2009 government "revenues."   Government revenues consist of taxes plus the proceeds from asset sales (http://www.govsales.gov/HTML/INDEX.HTM). 

Second, the U.S. deficit is our trading partners' surplus.  Our borrowing is their lending.  There is nothing inherently wrong or weak about the U.S. running a deficit, or selling Treasury bills or bonds to finance spending.   

Typically, the Treasury avoids using the Federal Reserve's balance sheet for its tax collecting and check writing activities, expressly to avoid tainting Monetary Policy with Fiscal Policy, or "monetizing the debt."  Of late, however, under Geithner's leadership and Bernake's followership, that distinction may be blurred beyond recognition.  The current level of the money supply, given fairly stable reserve requirements and discount window policy, is largely determined by open market operations (OMOs), or the purchase (or sale) of newly issued Treasury bills and bonds with newly created Fed reserves; i.e., the famous "the Fed creates money with the stroke of a pen" or, these days," with a click on the keyboard."

Pre-Geithner, the Fed created money strictly through OMOs and changes in reserve requirements and discount window activities, with the goal of supporting GDP with the appropriate interest rate target without excessive inflation. Now, it's worrisome how much policy independence the Fed seems to have retained.  In a real economy crisis with rampant unemployment, should the Fed "do something?" And what if those actions exacerbate inflation? Now what is our policy priority:  lowering unemployment or lowering inflaton?

No easy task here: find just the right level of money supply growth that will find the right level of short term interest rates without over- or under-stimulating inflation.

Q3 GDP Revised Downward - Again

What a shock.  U.S. GDP is not growing at 3.5% per year, as originally reported, and celebrated with much fanfare from President Obama about how the stimulus program was working.   It is not even growing at the revised 2.8% annualized rate reported a couple of weeks later.  The latest re-revised figure is 2.2%.

Nearly the entire 2.2% annualized growth, or 3rd quarter growth of 0.55%, is driven by the cash for clunkers program, the government spending program (also called the stimulus program, but I have a big problem with that particular name), and the extended tax credit for first time home buyers. Which means that this increase in GDP is not only entirely temporary and fleeting, but will cause lower GDP later.  The cash for clunkers program did not create more overall demand for cars; it simply pulled some of the future demand for a new car into today, all the while wasting millions of tax dollars on administering the program, and putting some dealerships out of business in the process.   The spending program simply shifted profits from businesses to support other segments of society, all of which is temporary and destroys the productive capacity of the economy for many periods to come.  The extended tax credit to first-time home buyers is a real head-scratcher.  A curious time to redistribute funds from the producers in the economy to finance a program which lowers the cost to those home buyers who would not have the funds to buy a home in the first place....second wave of home mortgage foreclosures, anyone? 

The Poor Pay Czar: Comment and Reply

Patrice Ayme posted the following comment on my earlier post titled "The Poor Pay Czar:"

1) Self referential loops have proven a problem in logic. Should not they be a problem in the market, or is it that the market has nothing to do with logic? The CEO class, in the USA, is self referential. 2) Europe has now more big companies than the USA. Still, big European executives are paid at least ten times less than their USA equivalents. How come the market is so different in Europe? Is the fact that more compensation in Europe goes to talent located on lower rungs of companies, related to the higher performance of European companies in the last decade? After all, the total compensation being finite, paying more for talent at the CEO level means paying less for talent just below. An interesting aside is that CEO in the USA are much taller than average. Are size and compensation the only way they can dominate their subjects? A few years ago, Renault was all set to buy General Motors. At the last minute, though, Renault executives learned that GM executives intended to pay themselves more than ten times what Renault-Nissan executives were paid. So Renault scuttled the deal. US taxpayers are left with the bill: more than 60 billion dollars, no? (And GM will fail within a year or two.) It is true there are markets, and they can deal. But they are more or less free. There are not just markets. There are also classes too, and they can dominate, with extra market mechanisms. The CEO class in the USA sits on each others’ boards, determining each others’ compensations. In some other countries, this sort of incest is more limited (in others, it’s worse: China). In Germany, union representatives sit on boards. Generally those who really love their jobs will do them for free. Too much compensation is actually a distraction. And bad markets, thus exists. They are not just bear markets, they can lead to captive markets, and oligarchies… 

My reply to Patrice: 

Patrice —

Your view of markets is flawed, perhaps fatally so.

The U.S. labor market, for example, provides just the right incentives for individuals to work hard in order to improve the quality of their lives in ways that free people see fit.

There are some issues with that market in its current form, like minimum wage legislation and unions, but overall the U.S. labor market works quite well, particularly when viewed dynamically, through time, instead of as a snapshot at a point in time, as you seem to do.

Your comments ignore the fact that most CEOs work their way up through their companies, or in other companies, for many years, putting in long hours, sacrificing time at home and with family, in order to rise to the top, to take on the huge responsibility of guiding an organization to sustainable profits.

Right this moment, people are toiling away in industry at lower salaries, or in school at no salary, honing their skills, building relationships, learning about their industry, coming up with better ideas. A select few of these people will one day rise to become the CEO of a company, many of which do not even exist today. CEOs earn whatever the labor market, in its objective, efficient way, as disciplined by laws preventing fraud and by the instantaneous referendum on value creation represented by an active capital market, deems is justified.

Yes, there are temporary glitches in the functioning of the labor market, like Enron. Yes, there are unethical executives, like Maddoff.

But the fate of Enron, its executives, and Madoff is glaring proof that the markets in the U.S. work to ferret out the thieves and reward hard-working entrepreneurs and business people.

Parenting the Government: More Q and A

Patrice Ayme continues:

Hi Sherry:
I made several points. Indeed by “public utility” I allude to public as in res-publica.
Funny you said that a “national interstate roadway system” should be paid by taxes. As I said, in France, it’s private, and paid by the proverbial ‘end user’. So much for France being socialist and USA private profitist. Please forgive the neologism.

I gave the example of waterworks. Private French companies lead worldwide in that domain. That means French (local) government use taxes to pay them. But recently some government realized they could get more services by doing the work themselves. So, in this case, they start as before: taxes. But then, instead of paying some giant private French water company, they pay municipal workers and engineers to do the work. Cost less (less taxes), better service.

Call that an anti-Jarrell universe. A mystery, like anti-matter. How could that happen? Very simple: think about it: the municipal government does not have shareholders (just stakeholders) and does not have to pay dividends, and does not have to increase the value of the shares by showing profits. It actually has no profits to make. So the end user (the denizen of said city under his city government) saves money (i.e., taxes), improves services.

This example, of course carries to health care. France has also a competition of public and private health care systems, large pharmaceutical companies, etc… And has done more face grafts (in public hospitals) than the rest of the world combined… and the first successful gene therapies (also in public hospital), etc. Was is it not to like? If profitist ideologues in the USA were not so greedy, they would see the necessity of having a strong public sector, be it only to keep the private sector honest.

By the way, French politicians are regularly condemned for corruption, and it’s not because they are richer than their colleagues in the USA, by a long shot…

My reply:

Ah Patrice….here we go again! For one, I did not say that government “should” pay for a national highway system, I said that we do pay for a national highway system. A positive statement, not a normative one.

I guarantee you that in any universe – not just the Jarrell one – the true cost of anything paid for by the government with tax dollars is understated by several orders of magnitude. And, possibly, overstates benefits. It is simply factually incorrect to say that the cost (the true economic cost as measured by the use of resources) of providing the service is less when provided by the government. The one-period ACCOUNTING cost put on paper by some government office, as reported to the press, and swallowed whole as fact by readers, may be less. But it is literally, factually impossible for the true costs to be reduced by inserting a redistributive middleman between consumers and business.

You also fail to understand the relationship between stock prices and economic value. You should step back, slow down, and consider the following. Let’s get dollars and stock prices and dividends and profits out of the equation entirely and just think about the amount of goods and services provided versus the amount of resources used up in the production of those services. Measure it however you want — quality of life, health of the citizenry, happiness, kumquats. Now ask yourself which is the most “efficient”method of providing final goods and services, where efficiency is measured, as it should be, as the number of units of output of the good and service provided per unit of resources used up in production process. The “dividends” and “capital gains” in this analogy are the EXTRA value created from a capitalist system; take one input, create 2.5 outputs, added value is 1.5. The government as provider creates zero extra value, if we are lucky, and negative value, if we are realists: take that same input, chew up half its value in bureaucracy, buying votes, and redistributing the consumption decisions of a free people toward something they would not choose to purchase in the first place (otherwise, why the government program in the first place?), and produce 0.5 total outputs, a loss of 0.5. The social loss from moving from capitalism to collective command and control is 2: from plus 1.5 to negative 0.5.

Yes I am including spending on defense and clean air and roads. When we spend on collective goods, we use resources less efficiently. This spending infringes on our economic freedom, but some goods and services are necessary to protect and preserve the system that enables that economic freedom.

You and I can and most certainly do disagree on where to draw the line on what goods and services the government should provide over the objections of a free people, but we cannot disagree on facts. Your claim that government provision of goods and services is less costly than private industry is factually incorrect.

Parenting the Government: Comment and Reply

From Patrice Ayme on www.Learningfromdogs.com:

Agreed about too much taxes without adult supervision…

Now something related to think about. Why not make American freeways private? The US government could sell the Interstate system, making lots of profits (are not profits the best thing?), then the private owners would make even more profits. No more taxes to pay for the roads, etc… One could extend that to the army. Make the army completely private, headed by the operators of the ex-Blackwater, I mean “Xe”. Army guys would be encouraged to make profits, as their predecessors in France around 1200 CE (interestingly called “Les Grandes Compagnies” = The Great Companies”).

And so on.
In France, freeways are actually private, and toll. But of course they were built and paid for by private capital (protected by law recognizing them as of “public utility”). It works well, nobody is complaining: superior surfacing, no holes, no debris, and advanced freeway architecture, differently from American freeways.
The high speed train network is according to similar lines.

Superior economic organization is all within that concept of PUBLIC UTILITY.

Profit is not the superior economic organizing principle. Public utility is.

Pirates made profits, so did Roman governors and Persian Satraps, or Carthage.

The USA can learn a lot from its sister republic, France. Another example is waterworks. Starting around 1850, private water companies grew in France. They soon became extremely profitable, and several private French water companies are now the largest water companies in the world.

This worldwide success did not escape the attention of typically suspicious French citizens. Some city engineers noticed that they could do the same cheaper. So, paradoxically, a rebellion against the French water giants has started in France, and some city governments are now running, cheaper and better their own waterworks, after wrestling back control from the private water giants.

It is not whether it is private for profit or government for public which matters. what matters is the maximization of public utility. At least in a democracy. In a banana republic, it’s different, true.

My reply:

Patrice: Just to clarify before I comment, by “public utility” you mean the benefit of the whole of the public? And your focus is on what is being delivered or consumed and how much good that does for the citizen?

I assume your point is the superiority of government supplied goods and services — specifically as it is done in France — over the profit motive of private companies. Again, you miss the point that the government would have no resources to spend without private industry. All the government does is to shift profits around in the economy. Now some of that shifting, like from private profits to public goods (and by public good I mean one where the consumption of the good by one individual does not reduce availability of the good for consumption by others; and that no one can be effectively excluded from using the good, like clean air, national defense or, effectively, a national interstate roadway system), is necessary and desirable. We, as a country, defined the need for public goods in our Constitution, but we have strayed very far away from that ideal over time, to our detriment.

The Future of Video Stores

Tim Clodfelter of the local Winston-Salem Journal wrote a very interesting piece on the future of brick-and-mortar video stores and video rental places such as NetFlix and Red Hat. I happened to be quoted in the article as an economist (the comment about "reducing the average cost every time we watch a purchased video" was supposed to be a joke!), but actually met up with Tim in my role as mom and pseudo-agent!  My 15-year-old daughter was standing in a very long line of young ladies waiting to audition for the Coen Brother's remake of True Grit. Tim was there to get the story on the open casting.  I asked him over hoping he would talk to my daughter.  He and I got to talking instead, he found out that I was an economics teacher, and pulled out his notes on the Video Store story.  He ended up talking to me and several other parents in line, all of whom had a different approach to viewing movies.  The resulting article follows http://www2.journalnow.com/content/2009/dec/20/dont-count-video-stores-out-yet/: 

Sunday, December 20, 2009

  Winston-Salem 

Don't count video stores out yet

Journal photo illustration by Richard Boyd II

Here are some of the advantages (and disadvantages) of different methods of renting movies:

Independent video stores

Pros: Can have eclectic selection, more personalized service; helps contribute to local economy. 
Cons: Few stores left; have to leave home.

National chain

Pros: Large inventory, special offers. 
Cons: Mostly mainstream titles; declining industry; have to leave home.

Rent-by-mail DVDs

Pros: Don't have to worry about late fees; large inventory. 
Cons: Harder to browse; have to wait for movies to arrive in mail.

Vending machines

Pros: Convenient, quick. 
Cons: Only mainstream titles; still risk late fees; have to leave home.

On-Demand

Pros: No need for a DVD player; quick. 
Cons: Limited offerings.

Buying movies

Pros: Good way to build a library of favorite films; don't have to pay to watch a movie multiple times. 
Cons: Can get pricey; storage may become an issue; risky with unfamiliar titles.

By Tim Clodfelter

JOURNAL REPORTER

Published: December 20, 2009

Changes in the video industry have led Carol Baker to diversify the offerings at her store, King Video Station in King, in recent years.

"We're still hanging on," she said. Her store, which began renting videos back in 1983, added tanning beds eight or nine years ago, and also sells lottery tickets and acts as a payment center for Duke Energy.

"We've had to add those things in order to compensate for the loss of video sales," she said. "For the ones who have ample space, it just makes a good mix."

But she is looking forward to the holidays, saying that winter is traditionally a busy time for video rentals.

"During the vacation period between Christmas and New Years' is a good rental period," she said. "Until that, though, everybody is busy shopping." Her store also sells gifts cards during the holidays.

If independent video stores are struggling, it's because there are almost too many options available to consumers.

Once upon a time, the only way to see a movie on your schedule was to drive to the local video store. Now, you can rent movies by mail or watch them in streaming video online or through a device that connects to your TV set. With Redbox, you can rent the movies from a vending machine, many of which are at the front of grocery stores and large retail stores. Cable and satellite have video-on-demand options that offer the latest hits and catalog titles. And many public libraries offer videos for free.

But don't count video stores out just yet, said Shawn DuBravac, the chief economist and director of research for the Consumer Electronics Association.

"I don't necessarily see them going away, but their business models are evolving," he said.

Changing times

The NPD Group, a market research firm, found that video rentals from traditional brick-and-mortar video stores accounted for 47 percent of the rental market between January and October, down from 63 percent in the same period of 2008. Rent-by-mail was 28 percent in 2008 and 33 percent this year; vending machines grew from 9 percent in 2008 to 20 percent this year. The study did not include video-on-demand options.

Video rentals from all sources have declined from a peak of $10.4 billion in 2001 to $8.2 billion in 2008. But the numbers are back on the upswing, said Denis Cambruzzi, the vice president of corporate development at Adams Media Research.

In 2001, traditional video stores accounted for the majority of rentals, with $10.3 billion. That figure dropped to $5.5 billion in 2008.

A report from Adams Media Research found that in 2009 there are still more than 19,000 stores nationwide that specialize in video rentals, a number that declined by more than 3,800 between 2001 and 2008. The number of nonspecialty stores that included video-rental departments, such as grocery stores, fell much more sharply, going from more than 17,000 in 2001 to just 712 in 2008, many of them closing their departments and leasing space to vending machines.

"We've seen a tremendous amount of innovation in delivering video to consumers just in the last two years alone," DuBravac said. "There are different pricing models, delivery methods, and you can pick it up at a convenient location."

Blockbuster, for instance, added a rent-by-mail service several years ago and is installing vending machines around the country. By the end of 2009, the chain will have 2,500 machines nationwide; by the end of 2010, that number is expected to expand to 10,000, according to Michelle Metzger, a spokeswoman for Blockbuster.

Blockbuster also offers video-on-demand through TiVo and some Samsung devices. But the company remains devoted to brick-and-mortar buildings.

"There's still something to be said for the family ritual of going to the video store to rent movies," Metzger said. "We still have over 3,000 stores here in the U.S."

Independents to chains

In the 1980s, there were a number of locally owned video stores in the Winston-Salem area, such as Action Video and Video Village. Over time, national chains such as Blockbuster, Movie Gallery and Family Video moved in, drawing away their business. Now, only a handful of video stores, most of them chains, remain.

And even the numbers of chains are dwindling. One of Blockbuster's Winston-Salem locations, on West Clemmonsville Road, closed this year. Another, at North Point, is in the process of closing, selling off its inventory and moving employees to another location.

Kaisha and Kelvin Jones of Winston-Salem were loyal customers at the North Point Blockbuster.

"We're movie fanatics," said Kaisha Jones as she browsed through the used DVDs on sale at the store. "We have small kids, and it's expensive to go to a movie theater."

She said they have tried Blockbuster's online rent-by-mail service, but found that they were coming into the store more often.

"They have real nice clerks giving customer service," she said. "And you run into friends while you're here. I'm still a people person."

They use Redbox as a backup, but, Kelvin Jones said, "There's more of a selection here."

They plan to switch back to Blockbuster Online, but said that they would miss the store.

Rent by mail

Rudy Schmidt, a retiree from Clemmons, said she prefers Netflix. She said that rental stores "are too expensive, and it's a pain in the neck to bring stuff back."

With Netflix, she said, "you can hang onto it as long as you want, and get the movies in what order you want them."

She subscribes to one of the least expensive Netflix plans, allowing her to rent one DVD at a time for $8.99 a month. She returns one disc and gets the next usually within two days. Options are available for renters to get as many as eight discs at a time, which costs $47.99 a month. But the most common plans are for up to three movies at a time for $16.99 a month.

Netflix started in 1997 and now has more than 10 million subscribers who can access up to 100,000 titles. There are more than 50 distribution centers in the United States, the closest being in Greensboro; if a title is not available at the nearest hub, it will be sent from farther away.

A few specialty video stores, such as Video Vault in Alexandria, Va., offered rentals by mail in the age of videotapes. But rental costs were high because of shipping expenses. DVDs and Blu-rays are much smaller than tapes and easier to mail, which made Netflix and similar services such as Greencine and Blockbuster Online viable.

"Netflix continues to grow, and video stores continue to decline," said Steve Swayze, the vice president of corporate communications with Netflix. He said that the company has had 28 percent year-over-year growth. Of its 100,000 titles, 17,000 are also available as streaming video.

Rent by box

Redbox, which started in 2004, focuses more on the current hits, with each kiosk holding 150 to 200 titles. The kiosks are found in more than 17,500 locations nationwide, including Wal-Mart, grocery stores and McDonald's. Rentals cost $1 a night.

According to a company spokesman, Redbox rents more than 1 million DVDs each day. Though most of its titles are new releases, the company says that it does carry some popular classics and children's titles in response to customer feedback.

Laurie Hardin, a Winston-Salem resident, said she frequents Redbox machines at Harris Teeter stores, combining trips to the grocery store with video runs. She has been using Redbox for six months and uses an online option that lets customers reserve titles before they come in the store.

"I love it," she said of Redbox. "If they ever took it away, I'd be heartbroken."

Sherry Jarrell, who teaches economics and finance at Wake Forest University, said she can't imagine traditional video stores making a comeback.

"Brick-and-mortar stores are having an uphill battle," she said. "It's so convenient (online). The availability is higher online and the costs are lower. Once people switch, they never go back."

Jarrell doesn't use Net flix or Redbox, but goes with another option: She buys most of her movies rather than renting them. "I don't like the hassle and late fees," she said. "I have a big collection, and we like having them and being able to re-watch them."

Plus, the more times that she watches a movie, she said, the more cost-effective it is to buy it.

DVDs have a different business model than videotapes. Videotapes were initially released for the rental market, with prices averaging $60 to $70 a tape, so stores would buy them to rent out to customers; about four to six months later, the cost would drop to a retail price in the $20 range so individuals could buy them. But DVDs are sold at retail prices, generally $15 to $25, at the same time they come out for rent, making them a more attractive option to buy.

Rent on demand

DuBravac said that the rental world will be undergoing even more change in years to come.

The Consumer Electronics Association expects digital-streaming video to grow more popular in the next few years. Netflix streaming videos can be watched on a computer or on a TV set that is equipped to show Web content, or one that has a Netflix-compatible Blu-ray player or PlayStation 3.

Another streaming video option is video-on-demand, or VOD, which is available through cable services and some satellite providers. Time Warner Cable has seen steady increases in its video-on-demand in the past few years, said George Douglas, the vice president of marketing for Time-Warner Cable's Carolinas region.

"One of the things that really ramped up use of VOD pretty heavily was when we added free On-Demand," Douglas said. Those included content from channels such as CNN, Golf Channel and Cartoon Network.

The company now has an average of 5,800 hours of on-demand programming available on 50 channels in the Triad. The average customer, he said, watches four to five video-on-demand programs each month, ranging from music videos to movies.

Despite the changes in recent years, DuBravac said that physical media -- DVDs and Blu-ray discs -- will remain in the equation whether they are rented, ordered through the mail or picked up at vending machines.

"One thing we know," he said, "is consumers will have access to more content than they know what to do with."

tclodfelter@wsjournal.com


727-7371

Fractional Reserves of the U.S Banking System Explained

The Federal Reserve, or Central Bank, is the banking system’s bank. It is the lender of last resort. It is through the Central Bank that banks settle their accounts with each other. The central bank serves as a clearinghouse for checks written by depositors, and it holds the commercial banks’ reserves.  Bank reserves (vault cash, and deposits by banks at the Central Bank or the Fed) are monies held out of circulation by banks to satisfy the Fed’s reserve requirements and the currency demand by the public. Excess reserves are those held above the legal reserve requirements to handle uncertain demand.  Bank deposits not held in (required plus excess) reserves are used to make loans and earn interest.

When banks make loans, they do not actually lend out the equivalent in cash but instead create on their balance sheet a loan asset and an equal liability called a demand deposit.  Such lending by banks is limited only by reserve requirements (set by the Fed) and the cash they need to satisfy cash withdrawal demand by their customers.  As these loans are then re-deposited by the borrower, the multiplier process continues as fractional reserves are held back and the balance is “lent” out again.

So when the Fed begins to pay interest on excess reserves, it not only reduces lending, but shrinks the money supply and the liquidity it represents by a multiple of the funds not lent. 

The Fed is paying banks to NOT lend!

The President of the United States recently pressured the heads of the nations’ largest banks to increase lending to small business and homeowners (http://tinyurl.com/ycjrzcp).  Obama claimed that the banks, as recipients of federal bailout funds, had an unusually heavy responsibility to take such measures in order to create more jobs and help nurse the economy back to health.  All of this was done very publicly and with much fanfare.  Worldwide press coverage was universally favorable.

Seems reasonable, doesn’t it?

But it is not.  You are being duped.  I can’t tell whether whoever writes this stuff for Obama knows the truth and skillfully skirts it, or just writes flowing prose with no connection to the truth that curries voter buy-in by blaming Wall Street and Corporate America for all that’s wrong in the world.

First of all, the Federal Reserve is now paying banks to not lend. You heard that right:  the Federal Reserve is paying banks interest on both their required reserves, which are portions of deposits they are required to retain, and their excess reserves, which are deposits the banks could lend but haven’t (http://tinyurl.com/ybgnetk). Historically, the cost to banks of holding excess reserves has been the interest they would have earned if they had been lent.  Banks hold excess reserves as a sort of cash management tool; insurance that if the bank manager misjudged their customers’ demand for cashing checks, for example, the bank wouldn’t hit the headlines as the first bank since the Great Depression that “ran out of money!”  But that insurance cost them.

Now, the Federal Reserve is paying banks to hold excess reserves.  They are paying banks to not lend, while President Obama scolds them for not lending!  Either he doesn’t know about the Fed’s new policy, doesn’t care, or doesn’t understand. I frankly don’t know which is worst.

Secondly, how is increased lending supposed to create new jobs?  Bear with me here, because the bold, brash economic truth of the matter is a bit more complicated than the press coverage and the teleprompters would have you believe.

Profits enable growth: income growth, job growth, wage growth, new businesses, more choices, and a higher quality of life.   Profits are created when a business hires labor and buys or rents physical capital, combines them using processes, software, expertise, creativity, and risk-taking, and produces a product or service that a free society chooses to purchase. There is simply NO other way to create profits.    Now you need both a business to make the good, and a customer to buy the good, before you have profits.  But increasing demand alone does not create profits or jobs.  The way to see this is to imagine that we were at capacity output right now: increasing demand would simply increase prices, not output or jobs.

Lending to businesses – assuming they can generate enough cash flows to pay the interest charges -- fuels their demand for productive capital.  But the capital could sit in the corner gathering dust.  It is the profit motive of businesses – what they choose to do with the new capital that the lent dollars enabled – which incents business to hire more labor and produce more efficiently. Not a scolding from the President.  Particularly a President who has made it clear that he believes that “now is not the time for profits”(http://tinyurl.com/y8g4nn7); that the greed and excess of fat cats on Wall Street led to the financial crisis (http://tinyurl.com/ydrhp3s); and that insurance companies take advantage of Americans (http://tinyurl.com/yb4yrmg).  Not a President who presides over a Congress which is spending at record rates and raising taxes on business at every turn.

Government Spending is like a McDonald's Burger

At times when money is tight and our resources are stretched to the limit, it pays to spend our money wisely.  That is why it makes so much more sense to reduce the costs imposed on private industry instead of increasing spending by government.  Industry takes their earnings and reinvests them to create sustainable wealth creation: they hire and train workers, conduct research, build and perfect machinery and robotics, and develop brand equity and a reputation for quality. All of these endeavors represent lasting value creation. What is spent on these things this year will continue to create revenues, wages, and profits for years to come.

Government spending is pure consumption.  It is temporary and fleeting.  It keeps the beast alive for one period, and then the process has to start all over again next period. When we approve a massive spending bill, it covers government purchases of goods and services for the next year, maybe less.  In one end; out the other, with nothing left to show for it, except a hungry program that needs to be fed again next year, and the next and the next.  Government programs in and of themselves never produce lasting value; only in conjunction with private industry is any wealth or value created. And even then the government purchases have pushed aside, prevented, crowded out, or priced out purchases that would have been made by the private economy.

So, please, keep this in mind whenever you think of any type of government spending or tax increase: it is here today, gone tomorrow. 

An Overview of Macroeconomics

    Macroeconomics is the study of aggregate supply and demand, and looks both internally 

to the workings of the economy and externally to how a domestic economy interacts with others 

worldwide.  Macro builds on the principles of microeconomics, which is the study of prices and 

quantities of individual goods and the markets where these goods are produced and sold. In macro, 

"price" refers to some index of the prices of domestic goods and services, and "quantity" refers 

to some measure of the value of domestic production or "output." One common measure of output is 

gross domestic product ("a measure of the productive activity of a country computed on the basis 

of the ownership of the factors of production"). A country's standard of living is usually directly 

correlated with its real output, or the value of total output corrected for inflation. 

    Unlike microeconomics, macroeconomics started with the idea that prices and markets do not 

continuously resolve all of the coordination requirements of a modern economy. Such "failures of 

coordination" (Keynes) seem likely when one views the economy as the collective sum of thousands of 

microeconomic markets. For example, although most economies around the world have experienced generally 

positive trends in their gross domestic product, short run positive and negative deviations (recessions 

and, in more dramatic examples of the failure of coordination, depressions) around the trend line, or 

"business cycles," are common. 

    Inflation is the rate of change of the average level of prices, where the price level is 

usually measured as a price index.  Inflation rates are typically quoted in annualized percentages.  

In normal times, the inflation rate is procyclical: it rises in periods of high growth and declines 

in periods of slow growth.  Unemployment, by contrast, is usually countercyclical. The U.S. inflation 

rate was as likely to be negative as it was positive before World War II; since then, price levels 

have risen fairly consistently.

     Financial markets play a key role in macroeconomics.  It is here that resources are collected 

from savers and lent to producers for investment in the real economy.  The real economy stands in 

contrast to the nominal (or financial or monetary) economy.  The real economy is concerned with the 

production and consumption of goods and services; the nominal economy deals with the trade in assets, 

such as monetary and financial instruments.  Physical investment, which is the acquisition of the 

physical means of production by firms, provides one channel by which financial markets affect the real 

economy.

    Two fundamental approaches to macroeconomic policy have arisen, both of which are concerned 

with how to manage the inevitable failures of coordination between the micro units in the economy. 

Demand side: the use of government demand to smooth out fluctuations in the economy, mainly to avoid 

protracted recessions. Supply side: improving the efficient utilization of labor and capital resources

to enhance the productive capacity of an economy.

    One can also usefully separate the approaches to macroeconomic policy into laissez-faire and 

interventionism.  Keynesians are frequently characterized by the view that markets are imperfect and 

that government holds an information advantage and should engage in active policy interventions in the 

economic activity of the markets.  Monetarists see politics and bureaucracies as barriers to government 

attempts to deal successfully with market failures, which they see as just one step toward a self-correcting 

market mechanism.   Monetarists tend to reject activist policies because of uncertainties, policy lags, and 

government incompetence.

    Which of these two approaches are currently in favor depends on the state of our knowledge of the 

causes and effects in macroeconomics and also, perhaps largely, on politics.  The close link between the 

state of the economy and politics is summed up by the "misery index," which has no scientific basis but so 

closely predicts the political fortunes of incumbent governments that most believe it does contain substantive 

information about the electorates’ views on how well the government has managed the economy.  The misery index 

is the sum of the inflation rate and the rate of unemployment, two measures of national performance that are 

easily understood and monitored by the voting public.  Incumbents tend to be thrown out when the misery index 

is rising.   Economies are alike in that they hold their governments responsible for the health of the economy. 

Where they differ is in how hands-on the government should be (a "normative," as opposed to a "positive," 

statement) in making things better!

The Poor Pay Czar

The poor pay czar is lamenting his task: how to limit the pay of executives at companies receiving a bailout without undercutting the ability of the firm to secure talented management.  "It's a delicate balance!  Very difficult indeed."  Well, Mr. Czar, difficult for you, maybe, but a piece of cake for the labor market.  That's exactly what the labor market does, day in and day out, quite naturally.  

Compensation should not be the purview of an appointed administrator serving at the pleasure of the executive branch of the U.S. Government.

Yes, President Obama! Cut taxes!

President Obama said a good thing yesterday.  He proposed cutting taxes to small business to help spur job creation and economic growth.  This is good. Very good. Here's why:

Beyond the theoretical justifications for cutting the capital gains tax, how much wealth would actually be added to the economy if we cut the current capital gains tax rate of (an average of) 15%? I estimate that every dollar of capital gains collected by the government costs the US economy approximately $6.80 in economic wealth.   This is how I came up with this estimate.  

For every $100 in corporate earnings, a 15% capital gains tax represents $15 that the firm could have either distributed as dividends (for a 0% net growth rate in next period’s earnings), or reinvest in the company to generate future growth (with a growth rate of 20% per year considered healthy).  Most experts agree that a reasonable estimate of a sustainable annual growth rate in earnings is somewhere between these two extremes, say 5%. 

I combine this 5% growth rate with a ten-year investment horizon and a discount rate of 12% per year (using the 80-year average rate of return on the S&P 500) and find that the Present Value of the annual savings of $15 in capital gains taxes is $102. So every dollar of Capital Gains protected from taxes produces approximately $6.80 ($102/$15) in new economic wealth for our economy.

This increase in economic value enables economic growth in America, while also creating more jobs for Americans as companies create more revenues to allocate to new hires and higher salaries.  Every dollar that is collected by the government in capital gains taxes could have supported an additional job instead. In an economic time when the unemployment rate nears 10%, cutting the capital gains tax and increasing the production value of our economy is critically important. 

Parenting the Government

Okay. If you tried this ploy on your parents, you wouldn't get away with it.  If your kids tried it you, you wouldn't fall for it either.  So why are the American people letting the Government get away with this ploy?  I don't know. And I don't get it.  Maybe there is just so much going on that it gets lost in the mix. Maybe it's because of the deceptive and disingenuous way it's being presented by Pelosi, Reid, and Obama.  

Here's the ruse:  "Give us more of your money today, and we will reduce tomorrow's health care costs. We will increase efficiency.  And we will do all of this without increasing the budget deficit!"  

Yeah, right.

What exactly is stopping them from reducing health care costs and improving the efficiency of health care delivery now? Why do they need more money today to accomplish these things tomorrow? What magical powers does the next dollar of tax collections have that the current ones don't? 

Exactly.  None.  So when Congress asks to increase taxes and the deficit in order to fix health care tomorrow, let's respond to them as we would our clever but errant children: Ask to see some proof today first. 
 

You know how that will turn out. And so does Congress. That's why they just keep promising the moon.  What I don't get is why we continue to let them get away with it.  

The Insanity of Medicare 2.0

We've all heard this definition of insanity: doing the same thing over and over again but expecting a different result.  

Here, in a nutshell, is the insanity of the current U.S. health care debate:

1. Medicare, the government's single-payer wealth redistribution health care program, is quickly going bankrupt.  No one disputes this fact.  

2. When President Obama refers to "cutting costs of healthcare," he is referring to cutting the Medicare budget. Period.  No increased efficiencies, no improved services, no reduced market-clearing prices. No, cutting costs refers to reducing the fraction of the U.S. government's tax collections devoted to Medicare.

3. The new Health Care Plan is fundamentally a new Medicare program. Let's call is Medicare 2.0.

4. Medicare 2.0 is being funded in large part by cutting the current Medicare budget item. We are supposed to ignore the fact that the funds cut from the current Medicare program will be spent on Medicare 2.0.  

5. The Medicare 2.0 plan shifts as much as 25% of its (under)estimated costs (e.g. payments to physicians) to other accounts.  The costs are still there; these obligations would still need to be paid by the government under the proposed legislation, but Congress is hoping the public won't "count" the shifted costs if they slap another name on them, further fostering the illusion of "lowering costs of health care."

5. Medicare 2.0 will also go bankrupt but, as a larger, more far-reaching entitlement program, the impact on the U.S. budget will be larger and more far-reaching.

Corporate Executives, I need your input!

Hello All,

I need some backup from corporate executives! Please have a look at the sequence of comments and replies in the thread on "Anger over Executive Compensation" on www.learningfromdogs.com,

http://learningfromdogs.com/2009/11/28/anger-us-compensation/#comments

where I am one of five co-authors who are attempting to discuss important issues with integrity and thoughtfulness. The comments this post are receiving are decidedly one-sided.  Henry Mintzberg's recent piece in the Wall Street Journal calling for the end to all corporate bonuses didn't help much.

http://online.wsj.com/article/SB10001424052748703294004574511223494536570.html

So, I need for you to add your insight and input! Please comment!  Thanks.

Let's Introduce Obama's left hand to his right!

As I was perusing the business press this morning, an article caught my eye:  “That would make a great post!” I thought to myself.  I continued reading through the rest of the articles, intending to go back to the one that piqued my interest to compose a comment.  Of course, when I went back, I could not find it!

But in the process of looking for that particular paragraph, I noticed something troubling. Something that, should my students’ papers include the same, would bring their score down by a full letter grade, if not more.

That troubling observation can be summed up in two words:  internal inconsistency.  My students and I don’t agree on everything, and don’t have to.  They can take any point of view in their written assignments in my class, but their views must be well-articulated, free of factual error and, perhaps most important of all, internally consistent.

The internal inconsistency of the policies coming out of Washington discussed in the news gave me a bit of a headache. While one article stressed the problems with winding down the massive mortgage-related asset accumulation at the Federal Reserve, another discussed the Treasury Department’s efforts to push banks and other mortgage companies to provide more relief to troubled homeowners.  While one article concluded that all executive compensation bonuses should be outlawed, another discussed how President Obama was reaching out to those very chief executives for advice on how to save jobs.  The Federal Reserve strives to ease credit while paying banks to hold onto their excess reserves rather than lend them out. The business section contains a half a dozen articles on programs and legislation – from health care to cap and trade -- that will increase taxes, and one or two articles on how businesses are having to cut back, convert full-time employees to part-time contract workers with no benefits, just to survive.

We need leaders in Washington who can step back and survey the whole of the landscape, who can see that the policies being promoted by Obama’s left hand are slapping up against those being waved about by his right. 
   

We shouldn’t be spending money to rescue bad mortgages when the policies of the government created those bad mortgages in the first place.  We shouldn’t be punishing private business executives while pretending to ask them for advice that the White House had absolutely no intention of following in the first place.  We shouldn’t be raising taxes and the other costs of doing business when we need private industry to keep our labor force gainfully employed. 

In fact, full employment is the key.  Focusing all policy, all efforts, all spending, on allowing free enterprise to do what it does best – hire labor and capital to produce goods and services that private consumers want and need -- is the solution to the problem. 

For example, gainfully employed people who go to their local bank to get a mortgage will be assessed on their true credit-worthiness without some Treasury Department official breathing down the next of the lending officer and telling them they have to extend credit for the greater good.    With full employment, foreclosures fall to normal levels.  Mortgage-backed securities are priced correctly.  There are no toxic assets for the Federal Reserve, in cahoots with the creative-accounting-extraordinaires at the Treasury Department, to pile onto their balance sheet. And the Fed would not now be undergoing experimental reverse-repos (WSJ20091130) to try to unwind the massive increase in assets (from $800 billion to $2.5 trillion by the time it’s over) without further upsetting the credit markets, fueling fears of latent inflation, and undermining the strength of the dollar. 

Ah, the internal inconsistency— better yet, the ETERNAL inconsistency -- between business and politics. 

U.S. Growth Rate Revised Downward

As expected, the Commerce Department http://www.marketwatch.com/story/us-third-quarter-economic-growth-revised-to-28-2009-11-24 has revised downward its estimate of the U.S. growth rate from the third quarter of 2009. Citing weaker consumer spending than originally estimated, the annualized growth rate is now 2.8%, down from 3.5%, far too weak to make any progress on the employment front. 

Paul Krugman's Endless Ego

In a recent New York Times op-ed (http://tinyurl.com/NYTimes-Krugman-Nov2709), Paul Krugman continues his boundless quest to become the "it" guy in the world of economics.  I have taken issue with his command of basic economic facts in the past -- a gutsy, if not insane thing to do given the man was awarded a Nobel Prize in Economics.   In this post, however, the topic is more about ego than economics.

In this op-ed, Mr. Krugman says (and I kid you not), "...But after the debacle of the past two years, there’s broad agreement — I’m tempted to say, agreement on the part of almost everyone not on the financial industry’s payroll — with Mr. Turner’s assertion that a lot of what Wall Street and the City do is “socially useless.” And a transactions tax could generate substantial revenue, helping alleviate fears about government deficits. What’s not to like?"

Well, I disagree with the idea that what Wall Street does is socially useless.  And I am not on the financial industry's payroll.

Nope, I'm just a simple ole' economist, using my head, training, and experience to consider this idea, map out the pros and cons, and analyze the logical end-game of such a tax.  I conclude that it is a really bad idea.

Why?  There are lots of reasons, but I will mention only two. One, raising taxes reduces private economic activity, which will curtail growth, reduce tax revenues and increase the deficit.  Two, taxes distort the price signal between suppliers and demanders of goods and services, including financial capital, reducing economic efficiency.  

His reasons?  Other than citing one academic study (while ignoring the many others that reach a different conclusion), he gives no economic reasons for his views.  Instead, he make claims. He claims, for example, that “socially damaging behavior … caused our current crisis.”  He says that the financial services industry is “bloated” and needs to be cut down to size.   He says that the new tax is okay because it raises revenues for the government which, he claims, should make us all feel better about the deficit and, apparently, the size and nature of government spending under Obama. And, the lamest of all, for no other reason than to hide behind their skirt, he claims the existence of some phantom majority, apparently to create the impression that anyone with a different view is clearly in the minority.   A tactic that should be beneath a Noble Prize winner.

Mr. Krugman, I so disagree with you.  Even in an op-ed piece -- perhaps especially in an op-ed piece – I believe that one needs to reign in an ego that would parade claims as facts, especially when each of those claims is disputed by your fellow economists, none of whom stooped so low as to imply that you were paid for your views.

 

Commercial Real Estate and the U.S. Financial System

The U.S. banking system remains vulnerable to sizeable potential losses as the housing market struggles to recover.   Estimates of these losses range from $500 billion to $1 trillion. The Federal Reserve Board is especially concerned about the impact of commercial real estate on many regional and small banks across the country.  Occupancy and rental rates continue to decline dramatically as 2009 draws to a close, and the worst seems yet to come. 

Commercial real estate loans on banks’ balance sheets total almost $1.1 trillion dollars.  With near-term commercial real estate losses topping $100 billion, the Wall Street Journal estimates that as many as one-third of small and mid-size U.S. banks could experience financial distress. 

 
 

Troubled banks restrict lending until they can raise more capital.  In this illiquid market, expect banks to fight for survival by raising lending rates, shortening maturities, and lowering loan amounts.  Credit will continue to shrink in the U.S., which spells big trouble for any economic recovery. 

 

Housing and the Recovery

As an economist, I am frequently asked for my predictions on when the economy is going to turn around.  Have we reached the bottom?  Have we begun to recover?  Might we go into a second, perhaps more severe recession? 

Those are tough questions to answer.  Business cycles are notoriously difficult to predict.  In fact, about the only thing we know for sure is that no two business cycles are alike. Each is unique in some significant way. 

Changes in the housing market may be one of the most meaningful indicators of a recovery, because housing stability is such a fundamental indicator of how households are budgeting their income.  Notice that I did not say that the level of homeownership was a useful indicator; instead, I look to changes in the housing market, either away from or toward an apparently sustainable and affordable supply of homes, for evidence of where in the business cycle the economy may be.

Despite record low mortgage rates and first-time home buyer credits, the U.S. housing market remains anemic.  Rising foreclosures in several major metropolitan areas will keep housing prices low for some time to come.  The U.S. currently has about 1.7 million excess housing units available.  Typically, about 1.3 million new households are formed in the U.S. per year.  But with the unemployment rate topping 10%, new household formation will fall to about 1 million per year.  If new home construction remains at its current level of about 600,000 units per year, it will take over 4 years (1.7 million/400,000) for the excess supply of housing to be absorbed and housing prices to recover. 

Recovery rates will be much slower in some markets, such as in Florida, Nevada, and California, but I believe that the rest of the U.S. along with most other developed economies are looking at a three- to four-year period of time before housing and thus the overall levels of output return to their pre-recession levels. 

Why the Anger over Compensation?

It came up again in conversation today:  someone was offended and upset over the level of compensation of some senior executives in the U.S. economy.   I have to admit I just do not understand the anger. And I have a fundamental lack of respect for the arguments that have been served up thus far in support of the position. 

I have tried to resist drawing the conclusion that the anger is born of envy, but I am very close to throwing in the towel on that one.  Why should we begrudge anyone who earns a healthy salary, especially in an economy that provides each of us the opportunity to aspire to the same?

Even if there were reasonable ways around the practical issues and costs associated with legislative caps on salaries -- how to set them, who sets them, using what measures, what value judgments -- it simply makes no sense.  It is the antithesis of a competitive market economy where individuals have the incentive to learn, grow, work hard, and succeed.  It ignores the role played by capitalism in creating a strong and vibrant private economy that provides endless opportunities for all who want to put in the hours and the effort to succeed.  

U.S. corporate governance rules provide the framework for determining the compensation for senior executives, and it works remarkably well.  Each shareholder, or owner of the company, gets one vote on material issues such as reorganization. The Board of Directors is responsible for hiring and firing senior management on behalf of the shareholders.  If the shareholders do not like the decisions of the board, including those that set the level and form of compensation for senior management, they have at least two, very effective choices. They can either sell their shares in the company or they can vote to replace the board members.  The board can take several steps if, after negotiating the compensation package for senior management, the executive fails to perform. The board can withhold the bonus, renegotiate the terms of the contract, or fire the executive.  Then the long, mostly objective arm of the competitive labor market will determine the market-clearing value for the skills and experience of the recently fired executive.  

One thing I've never quite understood is why the market doesn't seem to exact more punishment on senior executives who run their companies into the ground.  Maybe there is an old boys network that looks out for ex-executives; maybe my observations are biased; maybe I notice only those cases where failed executives rise again.  But it's an empirical question, in any case; we can gather data on the issue and study it objectively.   

Regardless of the conclusions of such an analysis, however, decisions about executive compensation must remain in the labor market where your ability to produce economic value still reigns supreme over your ability to curry votes and political favor.  

Heads Up Marketers and City Planners: The US City of the Future (part 3 of 3)

Back to the future - a new way of seeing forward

The concluding part of a three-part paper previously published by Gary Shoesmith, Garst Reece and Sherry Jarrell in Marketing Research Spring 2006. Part One is here and Part Two is here.

What kinds of business establishments will thrive in the U.S. city of the future?  To answer this question, we examined the count of the number of establishments per business category listed on yellowpagecity.com, adjusted proportionately to represent a population of 500,000, and found the following results.

Death services. Although the strain on the healthcare system has received much attention in relation to ageing in the United States, the next logical step—death—is rarely mentioned, although it certainly represents many business and professional opportunities.  Our data suggest that the number of funeral facilities and cremations per 500,000 residents might double or even triple by 2025. The same applies to the number of cemeteries and companies listing monuments.

Healthcare. Along with roughly 30% more doctors, our data suggest that a range of medical services and products will be in greater demand by 2025. Nearly all of them relate to age. Consistent with the expectation that mental and self-care disabilities increase with age, listings also jump considerably for alcohol information and treatment, and counseling services. This trend doesn’t occur, however, for mental health services.

Real estate and living arrangements. Real estate listings significantly increase across the six MSAs, along with a substantial growth in listed land surveyors. The number of listings for nursing and convalescent homes moves from an average of 30 for the current MSAs to 50 for the 2020 and 2025 cities. There’s an even larger average rise in the number of retirement communities and homes.

Perhaps the most surprising pattern, at least initially, is the dramatic increase in the number of listings for mobile home dealers and mobile home parks and communities. Insurance studies have shown, however, that the percent of manufactured (mobile) home owners who are age 65 and older has risen from 26% in 1990 to 30% in 2002. Similar percentages are cited for owners who are retired. In addition, over the same period, the amount of owners age 80 and older has changed from 3% to 7%. Therefore, the future might be replete with mobile homes. The data might reflect the strategy of retirees selling larger homes to extract the equity, which is used to help fund retirement and buy a less-expensive manufactured home.

Activities. The data show a marked increase in the number of associations, clubs, churches, and fraternal organizations, which supports the description of mature adults as “joiners.” Bingo games are more popular in the 2020 and 2025 cities. Perhaps most noticeably, more golf is played in the 2020 and 2025 MSAs, requiring many more golf courses and golf-related products and services—not just in Florida, but also in Youngstown, Utica, and Scranton. Residents in the 2020 and 2025 cities also spend more time at the library, at recreation centers and parks, and reading newspapers.

Finance. Services that will be in higher demand as retirees seek assistance in managing their retirement assets include credit and debt counseling services, insurance, loans, mutual funds, and stock and bond brokers.

Products. The number of listings for new and used automobile dealers increases between the 2005 and 2025 cities, as do listings for new and used furniture dealers, health and diet foods, hardware, lawn and garden equipment and supplies, service stations, TV and radio equipment sales and service, and vitamins. But the data also reveal many other rising trends that are likely age-related, such as for antique dealers, arts and crafts, ceramic equipment and supplies, embroidery, gift shops, giftwares, jewelers, and security-related products. The substantial increase in florists is probably related to the number of hospitals, funeral facilities, and crematories in the cities.

Services. The Yellow Pages listings indicate many more business, employment, and investment opportunities in the future. Several categories relate to home improvement, such as contractors for remodeling, landscaping, and swimming pools. Home maintenance also is in greater demand in cities with older populations. Similarly, listings related to servicing and repairing automobiles, furniture, and jewelry rise across the three pairs of cities—along with beauty salons and massage. Pets apparently deserve no less, as pet washing and grooming services are in greater demand in cities with older populations.

Research Implications

This innovative methodology for studying various aspects of the future reveals that many of the detailed trends across the three pairs of cities have significant implications with respect to new product development and marketing. For example, marketers need to begin partnering with development and land use officials to anticipate future growth in demand for golfing facilities, churches, parks, libraries, cemeteries, and mobile home parks. And medical services providers must be prepared to meet the demands for home health services and many other healthcare preferences of older adults in an increasingly competitive environment.

Although it’s true that many factors other than age will shape future spending patterns, such as changing tastes among mature buyers, new technology, and various economic factors, many of these trends are almost entirely age-related. Therefore, it’s unlikely the future will look that different from Lakeland today, where the share of the population age 65 and older is identical to that projected for the nation in 2025.

The United States will not be a nation of Floridas in 2025; it will be a nation of Lakelands.

The Power of Words

I can hear it like it was yesterday, resonating in my head, crowding out the doubts and negative thoughts, filling my mind with possibilities:  yes, I CAN do it!

I was in my junior year of college and had no idea what I was going to do with my life.  It was becoming quite a burden.  Because I had always been good in school, i.e., the “smart one,” everyone had expected so much of me when I went to school.  I really envied my older sister; she had always been the pretty one, the popular one, the one who got invited to the prom by not one, but three young men.  And, it seemed to me at the time, she was so lucky because no one expected her to go out and concur the world after high school.   She didn't go to college; she went to secretarial school and studied to become an airline attendant instead.  I envied her in every way possible!  But at least I had something: I was “the smart one,” or so I thought!  Years later, my sister went back to school to study psychology.  She earned a 4.0 and was invited to continue on to earn her Ph.D.  I’ll be darned if she wasn’t the smart one, too! And she is a wonderful and thoughtful person to boot! But I digress.

Anyway, I was in my junior year of college at the University of Delaware.  I went to the University of Delaware largely because I had to pay for college myself and could only afford in-state tuition. Although it was a perfectly acceptable school, I had dreamt about going to an Ivy League school.   After all, my older brother had graduated from an elite private high school and had gone to college on a scholarship. But those things seemed out of my reach, especially for a girl.

My brother was now in graduate school in Chicago, and he and I were talking on the phone one night. Ours was an awkward relationship, particularly in person.  It was much easier to talk on the phone or write letters.  Less personal maybe.  More safe.

The fact that we didn’t speak often and weren’t warm and comfortable in person made his comment to me all the more unexpected and memorable and, as it turns out, life-altering. I was telling him about some academic articles I had studied in class. The articles were about economics and regulation, and were so intellectually challenging but accessible and clear.    They were written by Sam Peltzman and George Stigler.  My brother said to me, “Sherry, both of those men are professors here at the University of Chicago.  You should think about applying to the Ph.D. program.  I can see you going here. You can do it!”

Well, you could have knocked me over with the tip of your pinky finger.  My brother, a lifelong withholder of gratuitous compliments and small talk, had just told me, his pesky little sister, that I should pursue a Ph.D. in economics under the professors whose work I so admired, at the school he was currently attending.

After regrouping, I asked him what a Ph.D. was and what one did with a Ph.D.  I remember his saying something about research and teaching.  I also vaguely remember that by the end of the conversation, I had a plan for crammin in as much math and economics before taking the GMATs.  But what stood out to me then and, every time since when I've had doubts about my skills or career, were those words, those glorious, uplifting words:  “You can do it!”

So be careful what you say, especially to those who look up to you.  Words can cut you to shreds, but they can also fill you with pride and hope and the joy of what is possible.  My brother’s words changed my life; teaching fulfills me; it makes me feel like I am making a small, positive difference in this world.  And I often tell my students, with the tangible memory of how it made me feel all those years ago when I first heard it, “You can do it!”

Heads Up Marketers and City Planners: The US City of the Future (part 2 of 3)

Back to the future - a new way of seeing forward

Part Two of a three-part paper previously published by Gary Shoesmith, Garst Reece, and Sherry Jarrell. Part One is here.

In this post, we examine the current income and spending patterns from metropolitan statistical areas (MSAs) with age demographics similar to those projected for the U.S. economy in 2020 and 2025.  Two MSAs are selected for each year to verify that differences in buying patterns across cities are because of differing age distributions, not peculiarities in the cities.

We began with U.S. Bureau of Census data on the percent of total U.S. population expected within five age groups through 2025. The share of U.S. population attributed to people age 65 and older is expected to increase from 12.4% today to 16.3% in 2020 and 18.2% in 2025. By 2025, nearly one out of every four drivers will be age 65 or older, compared with 15.6% today.

Income and Spending Patterns

We find that, although many mature adults are highly mobile, most stay put; this results in the Northeast and Midwest remaining key mature markets.  Three of our four 2020 and 2025 MSAs are in Ohio, New York, and Pennsylvania. We also find that older consumers:

• spend more of their income: The spending per income ratio rises from .67 today, to .76 for the 2020 MSAs and .77 for the 2025 MSAs.

• continue to depend on their cars and prefer them to public transportation.

• spend increasingly larger shares of their income on healthcare.

• make TV a key element of their lifestyles.

• remain in their homes and avoid nursing homes.

• are politically conservative.

• are civically active and wield growing influence.

• are joiners.

• spend heavily on housekeeping supplies, household furnishings and equipment, new vehicles, entertainment, computers, healthcare products, vitamins, healthier foods, and reading materials.

• spend less on apparel, cosmetics, and fast food.

Retail spending data

We find that the percent of retail spending on necessities such as products at food and beverage stores and the subcategory of grocery stores is generally higher in all six of our MSAs, compared with the nation. The same is true for the general merchandise store category, which includes discount stores.  We also observe generally lower spending shares relative to the nation in the more discretionary categories of clothing and accessories stores, furniture and home furnishings stores, electronics and appliance stores, building materials stores, and garden equipment stores.

The more important observations relate to spending patterns across the three pairs of MSAs. Looking at food and beverage stores, spending as a share of total retail sales declines across the three pairs of MSAs with increasingly older populations. Beginning with an average of 17.2% in the 2005 MSAs, spending at food and beverage stores drops to 14.1% in the 2025 MSAs.

Similarly, the subcategory of grocery stores falls from 15.1% today to 12.2% in the 2025 MSAs. Note that the approximately 3 percentage point declines in these categories are in spending relative to total retail sales, and that within the categories, the decreases in spending are nearly 20%. For example, for every $1,000 in retail spending in the 2005 cities, approximately $151 is spent at grocery stores. That compares with $122 in the 2025 cities. Thus, although spending shares at food and beverage stores are higher than the national average in all six MSAs, the spending shares fall across the three pairs of MSAs as their populations become increasingly older.

The trend also is downward over time for food service and drinking places, from an average of 9.7% in the 2005 MSAs to 7.5% in the 2025 MSAs—with the trend again representing a roughly 20% absolute dollar spending decline per capita within the category. These results support the expectation that older consumers eat healthier and in less quantities (especially in the case of fast food), and also spend fewer dollars at drinking places.

Per capita spending at clothing and accessories stores decreases from an average of 4% of retail sales in the two 2005 cities to 3.2% in the 2025 cities. As before, although the 1% drop appears small, it represents an approximately 20% reduction in per capita spending.

What types of stores benefit from older populations?

Our results indicate increased spending on furniture, automobiles, and homes. Looking at the per capita shares of total retail spending for furniture, home furnishings, and electronics and appliances, spending shares rise from an average of 2% in the 2005 MSAs to 3.9% in the 2020 MSAs and 4.2% in the 2025 MSAs. This suggests a doubling of per capita spending at furniture and related stores. There are similar patterns for the subcategories of furniture and home furnishings stores, and electronics and appliance stores. Spending also generally rises at building materials and garden equipment stores. Upward trends across the six cities additionally are shown for motor vehicles and parts, and healthcare and personal care.

In the third and final installment of this research, we will discuss the specific types of business establishments that will thrive in the U.S. city of the future.

Government Spending: All Demand, no Supply

The headlines are full of claims about the number of jobs created or saved by the stimulus package, the impact of the Cash for Clunkers program on U.S. output and, the latest, the reduction in the deficit from the proposed U.S. health care reform legislation.

What total rubbish.

Government spending is just that -- SPENDING.  It does not, can not, never has, and never will CREATE any output, economic wealth, or job.  The only way -- and I mean the ONLY way -- that profits or wealth or a new job is created is through a business.  Businesses are the only entity that can hire labor and capital and combine them in such a way as to create a product or a service that society may decide is worth more than it costs. And that spread between the cost of production and what society is willing to pay is economic value; it is the generation of profits that then enables the taxes that the government collects to spend on the goods and services it thinks America ought to consume.

Private industry is the job creator.  Not the government.   And this is not wishful thinking, or a political point of view, or a theoretical model.  It is an unmitigated, irrefutable fact.

 

Heads Up Marketers and City Planners: The US City of the Future

Back to the future - a new way of seeing forward

Part One of a three-part paper previously published by Sherry Jarrell, Gary Shoesmith and Garst Reece

Market research on the ageing of the U.S. baby boomer generation has focused on the spending habits of these older consumers. A new approach enables marketing researchers to observe the future now: Examine income and spending patterns from metropolitan statistical areas (MSAs) with age demographics similar to those projected for the U.S. economy in 2020 and 2025. With knowledge of these trends, they can begin preparing to meet the demands for particular products and services.

“Find a comfortable couch, lie back, and close your eyes. … Let your mind wander toward the future. Move, slowly, to the year 2030. Now open your eyes. What do you see? You see a country whose collective population is older than that in Florida today. You see a country where walkers outnumber strollers.” Laurence J. Kotlikoff and Scott Burns in The Coming Generational Storm (The MIT Press, 2004).

Projected Age Distribution, U.S. Bureau of Census data

There has been much speculation regarding the effects of the aging population on the U.S. economy. By the year 2025, more than 18% of the U.S. population is projected to be age 65 or older, greater than the percentage in Florida today. This has led some to describe the future of the United States as “a nation of Floridas.” Furthermore, the aging of the United States is not expected to pass with the demographic bulge produced by baby boomers (those born between 1946 and 1964). The U.S. population also is aging because of increased life expectancy and decreased numbers of offspring. As a result, current research projects that the U.S. age profile soon will transform from the current pyramid shape, with older groups at the top, to more of a barrel shape, with roughly 40% of the population divided fairly evenly between the youngest (under age 15) and oldest (over age 65) groups. This new profile will persist for decades.

Although much has been said about aging baby boomers leading to potential crises in Social Security and Medicare, we are more interested in the economic prospects of their retirement as they relate to consumer spending: in particular, whether they have saved enough to maintain their standards of living in retirement. In this regard, the Congressional Budget Office (CBO) reviewed studies from the past decade on the retirement prospects of aging Americans, and found evidence that varied with the standard used to define “enough.” Some studies defined it as the level that maintained the retiree’s working-age standard of living, whereas others defined it as levels that made the retiree as well off as his or her parents at the same age.

The picture that emerges from the CBO study is that baby boomers, relative to their parents at the same age, have higher real incomes, are preparing for retirement at the same pace, and have accumulated more private wealth. Furthermore, the savings behavior of baby boomers and other future retirees is dependent on their views of the health and stability of government benefit programs. If they believe that they will receive all of the government benefits they have earned, then they will tend to work and save less. If they believe that these programs are in trouble, then they might increase savings and postpone retirement.

What impact will changing age demographics have on future spending patterns? We obtain a more complete picture of future spending by observing aggregate spending patterns in local economies that resemble the future now: those cities where “walkers outnumber strollers” today. This novel research approach is based on actual observed data, rather than on speculation and long-term statistical forecasts, both of which are notorious for inaccuracy.

In the next post, we discuss our sometimes surprising findings on the spending patterns in the U.S. city of the future.

It May be Time to Reassess the Insider Trading Rules

On the face of it, prohibiting insider trading seems to be fair and reasonable.  Insider trading laws, refined over time in court on a case-by-case basis, define “trading on the basis of inside information” as any time a person trades while aware of material nonpublic information (Securities and Exchange Commissions Rule 10b5-1, which also creates an affirmative defense for pre-planned trades.)  SEC regulation FD ("Fair Disclosure") also requires that if a company intentionally discloses material non-public information to one person, it must simultaneously disclose that information to the public at large; in an unintentional disclosure, the company must make a public disclosure "promptly."  Lastly, the Williams Act gives the SEC regulatory authority over insider trading in takeovers and tender offers.

The intent of the insider trading laws is to prohibit a person with inside information from profiting at the expense of the public by trading on that information. As I said earlier, this seems fair enough.  But there are at least two significant problems with a fair and reasonable application of the insider trading rules.

One issue with insider trading laws which has been well articulated by Donald J. Bourdeaux over the years is that insiders could react to the proprietary information by foregoing a planned purchase or sale of stocks. This “non-trading” reaction to inside information is inherently undetectable, rendering about half the distribution of all insider trading activity unobservable. Bourdeaux argues that the insider trading laws are applied so capriciously that the markets would be better off and stock prices would reveal more accurate information if all insider trading laws were repealed.   

I personally would not go that far.  I do feel that there are clear instances where an individual who controls the flow of private information about a company could unfairly profit from delaying its release and trading in the interim.  An unexpected earnings announcement comes to mind as a fairly clear example.  This seems to be the case in the most recent insider trading allegations involving individuals at Galleon Group and SAC Capital Advisors.

Just because someone has proprietary information about a company does not mean that that individual either knows or controls the public’s reaction to that information. Knowing the information is not the same as knowing the consensus market opinion about the company’s future stream of cash flows and risks!  For one thing, the public may react differently than expected to the release of the information. Or, new information may become available that counteracts the inside information.  Third, the inside information may be factually incorrect.  Or, finally, the market may have already put two and two together and essentially inferred the essence of the so-called private information on their own, from other sources and developments, so that when the inside tip is released to the public there is no price reaction.

Recall that the stock price is nothing more, and nothing less, than the market’s consensus opinion about the value of the company’s future stream of profits or earnings.  Investors and other market participants base their valuation of a stock on innumerable observations about the future prospects for a firm; when people trade on the basis of that information, their forecasts of profits and risks become incorporated into the new stock price.  For example, suppose an investor learns something about a company which leads him to believe that the stock is now worth $11 a share.  Another investor, who currently owns the stock, puts the stock valuation at $9 a share.  If these two trade, they will strike a deal at somewhere between $11 and $9, say $10; this then becomes the new publicly reported stock price.  When they trade on their forecasts, the information upon which those forecasts are based is now reflected in the stock price.  If they did not trade, the stock price would have remained at $9 per share.

Let’s couch this example in terms of insider trading. Say a company executive overhears a dinner conversation by a judge presiding over a case.  The judge, feeling good, observes that he thinks the jury will acquit company management in an on-going lawsuit.  One would think that this is clearly good news for the company, which should make the stock price rise when it becomes public.  The executive, acting on insider information, quickly buys up extra company stock in order to profit when the verdict is announced.  If it turns out that the judge was wrong, or the stock price had already incorporated the probability of acquittal, easily gleaned from other, publicly available news reports, then the insider would have earned no abnormal profits.  Is this a case of illegal insider trading?  I do not know and, to be blunt, neither do you; this issue is decided in court, literally on a case-by-case basis; the arguments are difficult and complex, hinging on the “quality” and “timeliness” of the information, whether the so-called information was available otherwise to the average investor, and whether the insider would have traded differently without the information.  In other words, the court tries to rerun history as if the judge hadn’t had one too many cocktails that night.

The fact of the matter is that we rarely learn about such cases. Almost without exception, the only insider trading that generates enough attention to ever get to court are those in which someone makes enough profits to make the public stockholder feel hoodwinked;  the many cases where the insider guessed wrong about the eventual impact of the information on the public stock price never see the light of day.  Public stockholders do not bother to sue in cases where the insider loses money! And because we never hear about such cases, we are led to believe that trading on proprietary information necessarily creates an unfair advantage to the insider, which is not always so.  

Latest U.S. GDP figures a mirage

The press recently celebrated the 3.5% annualized rise in the third quarter in reported U.S. GDP http://money.cnn.com/2009/10/29/news/economy/gdp/index.htm

I urge caution in interpreting these figures at face value.  After all, the current GDP of the U.S. economy is simply the intersection of aggregate demand with aggregate supply.  As the figure shows, GDP increases with increases in either the demand or supply curve, although increases in demand are accompanied by rising price levels while increases in supply push prices down and real incomes up.  

The quarterly figures make clear that the increase in demand was driven almost entirely by the expansion of government spending; the other three components of demand – consumption, business spending, and net exports, were either flat or falling.  Government spending is inherently short-term; it does not create wealth or enable sustainable growth.  In fact, neither consumption nor net exports create sustainable economic growth either.   Only business investment in new productive equipment (which includes business fixed investment, new residential housing and additions to inventory) has the potential to create sustainable growth in U.S. GDP, and then only when the investment leads to a permanent increase in the productivity of the business, namely a rightward (increased output per input) or downward (decreased cost) shift in the Aggregate Supply curve.  And there was little chance that the reported increase in GDP resulted from a long-term increase in the productive capacity or efficiency of the U.S. economy, as Business Investment was soundly negative in the 3^rd quarter of 2009.

  

Limit investment risk? The dialogue continues...

Continuing with yesterday's post, I received the following comments from three colleagues from around the world:

Thanks Sherry.

Your response confirms that I do not understand what the heck is being done in our name!

I have no idea how we have been so stupid as to allow politicians and bankers to make such a mess. In the UK, at the BBC, we have a brilliant young economics journalist (Stephanie Flanders) who, for me, described the situation superbly; to paraphrase, she said “before this crisis, bankers would often wonder whether, if they made a mess of everything, the taxpayer would bail them out … now they know!!”

These organisation are not too big to fail, they are too big to succeed. From my point of view, our reaction to this behaviour has been completely counterproductive. Perhaps we should outlaw people entering politics until they have brought up children!

John L., UK

“Well, for one, if a financial product “fails,” the consequence is purely financial – it is not injury or death.”

Hmmmm!! What does “purely financial” mean? In one sense, all life depends on what is “financial”; if one has no money, one is then either dependent on charity, turns to scavenging or dies.

Many innocent people have been totally devastated by this crisis (most likely indeed to the point of death), caused by NO FAULT of their own. Many have suffered who did NOT take excessive risks with their money (i.e. were not driven by excessive greed).

I appreciate Dr Lewis’ modesty about his financial knowledge; the problem there is that if “ordinary” people and laymen like – for example myself – do not comment and/or get involved in financial matters, then we are leaving them to “the experts”. and you can guess exactly how I am rating financial experts at the moment.

On a personal level, I honestly believe I am totally innocent of this financial shambles caused by the greed of “experts”, who were so clever that they took most of the risks with other people’s money! And then they got bailed out with MORE of the same people’s money. I am very cross indeed, and by golly I am not alone!

Chris S., Germany

By way of encouraging debate, I tend to agree with Chris and John. I’m not sure, genuinely unsure, if the consumers of financial products want ‘risk’. But I am sure that humans are very poor at assessing risk.

By way of example, I have this notion that riding a motorbike is ‘risky’ and that flying a light aircraft less so. But in the UK the accident statistics show that both activities carry the same risk of death – thus my intuition is faulty.

Also, in many cases in life, the degree of risk is under my control even with products that have some form of consumer protection.

But with financial products how does a consumer really calculate the risk that he or she is potentially exposed to and, more importantly, is there any method to allow that consumer to renegotiate the contract if the risk changes during the life of the financial product? I doubt so.

To my mind there is great asymmetry between the trumpet blowing headlines advertising a financial product and the reams of very small print at the foot of the advert that include ‘the value of investments may go down as well as up’ or words to that effect. It’s meaningless!

Paul H., from UK, now in Mexico, moving to Arizona

My necessarily detailed response as it appears on LearningfromDogs http://learningfromdogs.com/. 

Many ideas are more complex that we appreciate.

One of the great bonuses in being part of the author group of Learning from Dogs is that we are all having to dig in deeper on issues than we might otherwise do.  Part of the weakness of our modern busy lives is that we run the risk of forming or reinforcing opinions 'on the fly'.  The modern media tends towards this approach.  But on a Blog that strives to write about integrity it behoves us all to be more careful about what is correct if, indeed, there is a correct answer.

John Lewis first posed the idea of whether financial products should be regulated in terms of consumer safety, like your toaster!  Sherry Jarrell then replied to that as a comment which was worth being made a separate Post.  That Post then attracted comments and, again, in amongst them was another detailed reply from Sherry that has been made the subject of this Post.  As implied, many of today's issues are far too important to be left to the headline writers.  Here's Sherry:

My understanding of the original question was “should there be a minimum level of safety, guaranteed by the government, for financial products.” My answer was, basically, “no.” The comments that have followed seem to me to be responding to a different, unspoken, perhaps deeper issue, and that is what is the proper role of government in protecting its citizens. Even with the question recast in a broader context, however, my response is still no, but I should explain it a bit better.

First of all, I am absolutely opposed to a government bailout of any organization, whether it is financial or manufacturing, large or small. At the same time, I am equally opposed to the government trying to displace or distort what should be the voluntary consumption and investment decisions of its citizens and private industry.

Private businesses strive to create wealth. They do so by employing physical capital and labor to produce a good or service that creates profits, i.e., that sells for more than it costs. Typically, though, a company has to spend money to make money; its costs occur earlier in time than its revenues, so it must raise financial capital, either from internal sources (retained earnings or private equity), or from external sources, namely the debt or equity markets. Investors buy this company’s securities in exchange for a positive return on their money. If the investor buys debt from this company, there is a legal contract backed by the court governing the timing and circumstances for paying back the money. If the investor buys stock, then they, as residual claimants of excess cash flows, accept the uncertainty that they may or may not get their investment back. But the investor would not have bought the stock in the first place unless there was good reason to believe that the company would continue to pursue profits and create economic value. And, in deference to Chris, I do not equate the pursuit of profits with “greed.” It is the pursuit of profits that employs labor, enables financial capital, and enables investment in the future, whatever specific form of investment that may take for the individual. And individuals choose to invest, or “save,” disposable income not consumed; they choose to invest in order to earn a return which enables higher consumption later, for themselves or their children or their charity. Investors are not forced to invest, forced to buy a home, forced to take risks. They choose to do so; and they should be able to do so with full information on the true risks of generating a return.

No one can guarantee a stock’s value; no one can guarantee a stock’s return. But the capital market can set a fair price for a stock; this is the price that, in relation to the expected future dividends and capital gains driven by the earnings generated by management, provides an expected rate of return that compensates the investor for the level of uncertainty about the future profits. An example might help: if you are guaranteed $105 next period in exchange for $100 today, you have earned a 5% riskless rate of return. This return compensates you for delaying consumption and for any reduction in purchasing power caused by expected inflation. But if there is a 50% chance you will get $100 next period and a 50% chance you will get $110 then, even though you expect $105 on average (.5 x $100 + .5 x $110), you will not pay $100 for that deal, because you require a higher expected return to compensate you for the added risk that you may end up with the $100 payoff. You would pay a lower price, say $97, which would generate an 8.25% return (($105-$97)/$97). The extra expected return is generated by a wider spread between the price today and the expected level of payoffs tomorrow; the required return increases as the uncertainty about the payoffs increases. And, yes, Paul, these risks can be “renegotiated” at any time: if you don’t like the returns you are earning on your stock, sell it! An active capital market provides ease of entry and exit, and the liquidity that accompanies it.

It is a little more complicated with derivative securities like options, hedging, and insurance, but the same principle applies: the less certainty about future payoffs, the higher the expected return the market requires before it lends the money and buys the financial instrument in the first place. If the government steps in and somehow limits that risk by trying to guarantee future cash flows to stockholders and other investors, the entire capital market would cease to exist as we know it. Liquidity would dry up; firms would be limited in the size of their operations and their ability to redeploy assets and grow; output and employment would drop. The reason the U.S. economy is as strong and vibrant as it is is because of our labor market, our capital market, and free enterprise. These markets are supported by the legal and regulatory systems that define the rules of the game; they are damaged when the government steps in and tries to play the game or change the outcome of the game.

The financial crisis began when an excessive, untimely number of home mortgage foreclosures began to surface. It is my conclusion that government intervention in the mortgage market caused this spike in foreclosures, which ultimately snowballed into the financial crisis we’ve all observed. Before the government intervention, lenders and potential homeowners negotiated mortgages just fine for decades. Homeowners provided information to the banks and mortgage brokers about their financial status so that the lenders could assess the risk or uncertainty of getting their money back; the less certain the bank was about the homeowner’s ability to make the mortgage payments, the higher the rate of return required. The higher rate of return could take the form of a higher down payment and/or a higher interest rate on the mortgage loan. Notice the analogy to the risk-return relationship of stocks.

The mortgage market was operating smoothly. Yes there were foreclosures but this possibility was priced into the interest rates charged on the loans. Then the government stepped in with its “every citizen has the right to own a home” social engineering initiatives. No longer was it the face-to-face negotiation between the banker and the potential homeowner. Now the banker had to satisfy government mandates on the number of mortgage loans made to high-risk customers; because these customers would have failed to qualify otherwise, banks had to reduce the costs to the homeowner, either by waiving the down payment, accepting a lower credit score, or lowering the interest rate below that which would compensate the bank for the uncertainty of the borrower. All of these measures reduced the expected rate of return the bank could earn on these loans. Left to their own devices, without the mandates of Washington, these mortgages would have never been approved. From the homeowners’ and taxpayers’ perspectives, the initiatives from Washington basically reduced the price of the mortgage to them. And, as prices come down, demand goes up. People who would not have “bought” the mortgage at the higher price are now in the housing market because the government has basically used its power over the banking industry to limit the price banks can charge for their service; to limit the rate of return they can earn to below that required to compensate them for risk.

But Washington had another carrot to offer the banking industry; Fannie Mae would buy those underpriced subprime mortgages from the banks to get them off their books. (I know this from firsthand information; I teach MBA students, a number of them are former mortgage brokers who left the industry because they couldn’t justify making loans to people with low credit scores anymore just to satisfy government mandates.) Now the homeowner would make their mortgage and interest payments directly to Fannie Mae. Fannie Mae then pooled all the mortgage funds together, and resold the principal and interest payments as new distinct derivative securities. Buyers of the repackaged mortgage payments often sold commercial paper to fund their purchase, so now the commercial paper market was dependent on the timely receipt of mortgage loans payments by subprime borrowers. Notice that the risk of mortgage default was not reduced by the government mandate, but the return earned by the lender was. This is the distortion caused by a politically motivated mandate being inserted into what should be an objective business decision made by private industry.

Fannie Mae, as a government-sponsored entity motivated by fulfilling a political mandate and assessed by the number of low income families who now owned a home, certainly had no incentive to determine the true risk of the mortgages they purchased or the new securities they issued. The value of the mortgages and the rate of return on the new Fannie Mae securities were determined by government edict, not by a freely functioning capital market serving private businesses seeking to maximize their efficiency and their profits. The signal normally provided by the rate of return about the value of the investment was distorted.

The only real “greed” I see in this picture is of the political variety; the desire by politicians to hold on to their power and position by diverting tax dollars to segments of society they hope will return the favor by contributing to their campaign or voting for them and keeping them in office. The only people taking “risks with other people’s money” are the politicians. Investors purchase securities in order to benefit from business risk; their money is not “taken” by business or financial experts; it is invested. It is tax dollars that are taken by power-hungry politicians to buy votes and support; it is tax dollars that are spent on exorbitantly risky ventures, like bailouts, like Cash for Clunkers, like purchasing the very toxic assets that their mandates created.

That’s my view.

Should the Risk of Financial Products be Regulated?

A lively debate from LearningFromDogs blog about the wisdom of regulating the safety of financial products ....  http://learningfromdogs.com/2009/10/30/consumer-financial-product-quality/

Consumer ’safety’ for financial products

with one comment

Are we missing a lesson that has been applied for years?

I have resisted any temptation to comment on the economic situation on Learning from Dogs. The contributions from others are based on far more knowledge and understanding of the subject then I will ever have.

However, I feel obliged to ask humbly for some clarification about something that bothers me. Are we putting the cart before the horse? Are we ignoring the relationship between provider and consumer in finance?

The regulatory regime applied to the vast majority of products which are allowed to be sold to the public is such that there are probably more stringent safety standards for an electric toaster than for most, if not all, financial products!

Much of the talk of regulation and restraint, in the current climate, seems to relate to remuneration of people working for financial organisations. But, why does it matter what they receive? In other fields, success is rewarded and the shareholders, admittedly fairly indirectly, have some say on the policy in that area. Why should they not pay what they wish?

On the other hand (to coin an economic phrase!),  the minimum standards of the products are set by regulators.

In other fields, if a supplier cannot demonstrate, to the satisfaction of the regulators, that its product meets specified safety standards, then that product is not allowed to be offered.

It is very simple! I am not referring to contracts, customer service, compensation and so on; I am referring to a threshold level of safety below which the product is not allowed to be sold or operated. Think: “cars”, “aeroplanes”, “electrical appliances”, “children’s toys”, and … well anything else!

To be even clearer, this is not about “perfect safety” which is, of course, not available at any price. This is not about blame. This is not about guarantees. It IS about inspection, testing, certification, regulation … oh and policing!

Can anyone explain why this approach cannot be applied to financial products? (Sherry attempts to here.)

By John Lewis

p.s. as chance would have it the image of the toaster at the head of this Post was taken from an article talking about a recall of the Viking Toaster – point made rather well, don’t you think?

My first attempt at a reply apparently hit a nerve!  Those comments tomorrow.

Sherry’s reply.

A great question, John: why do we not have a threshold level of safety for financial products, as we do with cars and toys?

Well, for one, if a financial product “fails,” the consequence is purely financial – it is not injury or death.  A financial product simply represents a financial investment today in exchange for financial payoffs tomorrow.

The less certain those payoffs, the higher the minimum required return on that investment. If the returns were certified or regulated in some way, risk would be reduced, and the required return would also fall.  Limiting risk exposure throws out the baby with the bath water:  less risk means lower returns on the investment.  Look at the real returns to U.S. Treasury Bills – they are almost zero!

There is a role for regulation in financial products and that is for disclosure of relevant information.  When we invest in a financial product, we are putting our money at risk in exchange for future expected cash flows.  We forecast those cash flows on the basis of material information about the firm, its products or services, and its management and strategy.

Even here there is a fine line between the right to know and proprietary information that enables a firm to invest its own funds in the hope of generating a large return in exchange for taking risks.

The Securities and Exchange Commission’s requirement for a 20-day window between the time a bidder makes a tender offer for a target and the time the target shareholders must decide whether to accept the offer or not is an example of a regulation that crosses the line, in my view.

In a misguided attempt to protect shareholders from fly-by-night tender offers, the SEC has created an environment where multiple competing bids can arise, driving down the return to the original bidder and limiting the incentives for firms to productively redeploy assets through tender offers.

By Sherry Jarrell

Update: Real cost of Cash for Clunkers Program

In an earlier post, I noted that I thought that the real cost of the cash for clunkers program went well beyond the $4500 rebate per car.  Edmunds.com just came out with an analysis that shows that the cost of the program, once purchases that would have occurred during that period without the rebate are taken into account, at $24,000 per car!  http://content.usatoday.com/communities/driveon/post/2009/10/620000657/1  

Clunker program a failure? Where's your proof?

 I was asked by a reader recently about my claim that the Cash for Clunkers program was a failure.  He said, and I quote, "And your proof is...?"  Here is my response:

Hello Ramon, Thanks for the comment. My conclusion that the Cash for Clunkers program was a failure was based on three factors. One, it did not have the intended consequences on the environment; for those folks who purchased a marginally more fuel efficient car now, rather than later, the added fuel efficiency was likely more than offset by the pollution generated by destroying the old car, and by the loss in additional fuel efficiency they would have enjoyed had they waited a year or two to replace their current vehicle with an even later, even more fuel efficient model year. Two, the costs of the program, which are much greater than the $4500 rebate, far exceed any benefits generated (Abrams and Parsons in the Economists' Voice (http://www.bepress.com/ev/vol6/iss8/art4/) estimate that the costs of the program exceeded the benefits by about $2000 per car, which I think is an underestimate.) The list of costs include but are not limited to the additional paperwork and private and public workers needed to administer the program, the interest costs to dealerships of financing the rebate program while awaiting the government checks (some less capitalized dealerships actually went out of business because of the program), the costs of destroying the old vehicles, and the cost of lives lost and injuries sustained in accidents in smaller, less safe but more fuel efficient cars, just to mention a few. Last, this "injection" into the economy -- which, in reality, is the blatant substitution of private consumption choices with public policy, and an affront to our economic freedom -- costs the economy untold sums by putting off the inevitable failure of automobile companies that fail to produce cars the population values sufficiently to keep the auto companies in business without being propped up by the government. Case in point: GM's plunge of 45% and Chrysler's fall of 43% in the months following the rebate program; Honda and Toyota also reported double-digit slides, while Kia and Hyundai had double-digit increases. New car sales fell in September as the predicted post-"cash for clunkers" slump dragged the U.S. market down to its lowest levels in seven months (http://www.allvoices.com/news/4286397-clunkers-letdown-slump-auto). I wish it weren't so, but I'm afraid that good business is not the strong suit of our policymakers. Thanks again for your question. I hope you find my comments useful. Sherry Jarrell

Zombie Stocks: Not for the Faint of Heart

[http://in.sys-con.com/node/1157066#. By Eric Frazier, Advancement: University Relations, Wake Forest University.]

Two weeks before Halloween, the Securities and Exchange Commission again warned investors against buying shares of bankrupt companies, but like those creatures in horror films that rise from the dead, so-called "zombie" stocks--shares of companies that failed during the financial crisis--are still on the march.

Take, for example, Washington Mutual and Lehman Brothers. At the end of last year, their stocks traded at 2 cents and 3 cents per share, respectively. With no future earnings in sight, shares of Washington Mutual recently traded around 20 cents, and Lehman Brothers shares have hovered around 15 cents--spectacular gains fueled by what many consider nothing more than gambling.

Critics have called on the SEC to halt the trading of such stocks to protect unsophisticated investors who might be lured into unwise trades. But Lecturer of Finance Sherry Jarrell, who teaches a graduate-level class on investments and portfolio management in the Wake Forest University Schools of Business, disagrees.

While Jarrell doesn't think investing in zombie stocks is a sure-fire profitable strategy, she doesn't consider it gambling either, because there is an expectation of gain. Jarrell also doesn't believe those who are trading zombie stocks are ignorant or unsophisticated. "To outlaw these stocks means that you've truncated an avenue for people to express their different risk preferences," Jarrell says. "If someone wants to go on that haunted trail, let them. It's not like they're taking advantage of people on the other side of the trade."

Washington Mutual and Lehman Brothers lost their standing to be listed on stock exchanges, so traders have to keep up with prices through a quotation service known as the Over the Counter Bulletin Board, which unsophisticated investors are unlikely to access. Other troubled companies, such as Fannie Mae, Freddie Mac and AIG, whose shares are widely considered to be zombie stocks, are still listed on major exchanges. The federal government's own backing of those companies weakens any argument against allowing individuals to invest in them, if they dare.

One project Jarrell assigns her students is to identify a publicly traded stock they believe the market has significantly mispriced. By definition, she says, the exercise requires the same calculation made by traders of zombie stocks--reaching a different conclusion about a stock's future cash flows and risks than that of the market.

Jarrell points out that all investments carry a degree of risk proportional to potential returns, and investors have varying tolerances for risk. Some hide from risk; others seek it out. She recalls a study some years ago that found striking similarities in the blood chemistry of day traders on Wall Street and jet fighter pilots. "It turns out they need a certain amount of danger to feel normal," Jarrell says. "They seek risk in order to feel comfortable."

Let's Limit TARP Legislator Pay!

Seems that Congress is hell bent on replacing the best-functioning labor market in the world with their own unique brand of wisdom.  Well, I have a better idea.  Why don't we slash in half the pay of all those Congressional leaders who came up with the TARP idea in the first place, since they are spending our money, and I think it is clear that they are spending our money unwisely, which is precisely the logic they use to confiscate the salaries and bonuses of the bail-out executives.

Moral of the story?  Government should not be in the business of trying to run a business. The TARP bailout should have never seen the light of day.  With no TARP bailout, Congress would not have had it's latest excuse for grabbing up yet more of the private economy's resources for trying to put this country back on track toward improved productivity, output, jobs, income, and security.

A tax is a tax is a .... COST !!!

We've talked a lot about taxes as revenue to the Government and the inefficiency of government spending on this blog, but a far more important issue is the impact of taxes on the costs and output of businesses.

Any imposed cost to business is a "tax," whether it's called that or not.  And any tax is an additional cost to that business, which lowers its output, reduces employment, and raises prices of goods and services to you and me.  

How does a manager or business owner decide on the optimal level of production?  How does a manager decide whether to hire one more person, expand operations to a third shift, ship its product to a distant market, or to outsource?  By comparing the additional costs of that decision to the additional revenues it generates.  If the revenues cover the costs, then the manager forges ahead.  If they don't, the company can't expand without incurring losses and eventually going out of business.   Our desire or need for goods and services, along with our ability to pay, creates demand.  A company's costs of production (labor + capital equipment) along with any taxes or fees imposed by local, state, and the federal government, create the supply.  The two sides -- supply and demand -- are totally independent of each other; they come from two entirely different places in the economy.  But where they meet is where prices are determined:  prices determine the revenue of business, and thus the level of costs that can be covered, and thus the level of production and employment and consumption that can be sustained by private industry.   Taxes are a REAL cost of doing business; they are a REAL drain on productivity, innovation, and entrepreneurship.

The press is spilling over with reports of new taxes being considered by Congress and the White House: Cap and Trade, Value Added taxes, increases in capital gains taxes, higher minimum wages, sin taxes, additional costs of health care....  each and every one of these taxes pushes the costs of doing business higher, reduces the output of the economy, reduces employment, and raises the prices of goods and services.  It squeezes the private economy, it suffocates entrepreneurship, kills commerce, and it idles people and factories and local businesses.  It hurts everyone.   New taxes should be challenged and fought like our economic lives depended on it.....because they DO!

No actual gains from Clunker program

It should come as no surprise to anyone that the U.S. car companies are slumping once again.  The Cash for Clunkers program was a wasteful, inefficient publicity stunt or, worse, an actual attempt by the Federal Government to stimulate the economy.  The worse part is that the program cost the economy jobs: many healthy, profitable dealerships had their company taken away from them by government edict under this program, never to return.  It's almost criminal.