The Fed’s decision last week to resume monetary easing with Quantitative Easing 3 (QE3) is unprecedented in both its timing and duration, and is a clear indication that our economy is in dire straits. It is a direct contradiction to the assertions from President Obama and former President Clinton that our economy is on a slow path to recovery. Who should you believe, politicians trying to eke out a win for their party, or Fed head Ben Bernanke, a leading expert on the economy and the Great Depression?
Ironically, the move by the Fed may actually help re-elect President Obama. The flood of new money expected will increase real estate and stock market prices and may create the illusion that American wealth is increasing and that the economy is indeed recovering. However, all that new money will also devalue the dollar and thereby increase the cost of oil and other dollar-denominated commodities, which costs will increase headwinds for the recovery.
The re-election of the President is also likely to dampen the prospects for a long term recovery too, as the President apparently intends to “stay the course” and continue policies that have thus far failed to produce meaningful economic growth. In addition, given the President’s apparent inability to work with congress, it is unlikely that there will be the required entitlement, regulatory and tax reforms needed to affect meaningful reductions to the budget deficit and the national public debt, reductions necessary for a sustained and long term economic recovery.
Ben Bernanke certainly knows all that. So why would he announce QE3 now and risk politicizing the Fed with presidential politics? Why risk causing the re-election of an incumbent President who has thus far proven ineffectual in spurring an economic recovery? Why not continue a “ready to act when necessary” posture that has kept markets stable for the past several months?
Cynics believe Mr. Bernanke’s move was a deliberate attempt to re-elect the President, so he too can keep his job, which is certainly safer with a second Obama administration than it would be with a Romney win. However, given all the recent evidence of a global economic slowdown, it is just as plausible that Mr. Bernanke fears that without the swift, decisive and unprecedented action he took last week, the US economy would be risking a major economic backslide sometime this fall. In that scenario, it is understandable that Mr. Bernanke would be unwilling to wait to act and even be willing to risk assisting the re-election of the President. Further, he would be risking the long term success of his own QE3 program and long term recovery in order to stabilize the economy during the economically significant last quarter of the year.
Friday, September 21, 2012
Monday, September 17, 2012
President Clinton's TV Ad Needs a Reality Check
Bill Clinton’s TV ad supporting President Obama’s re-election is ironic on so many levels, but it grossly distorts reality too. Clinton says that republican policies under the Bush administration is how “we got here” and that the only way out is to continue with “President Obama’s plan.” So far I have not heard a plan for the future; his convention speech was a plea for Americans to “rally around his goals for the future,” which certainly is not a plan and sounds as though he wants us, collectively, to do his job for him.
As for how we got here, President Clinton says it’s Wall Street greed and republican policies, but there are other major reasons banks ran wild and the housing market boiled over, which the former president knows intimately. First, under his watch, Glass-Steagall was repealed; that was the banking law enacted during the Great Depression designed to explicitly prevent the banks from venturing into high risk businesses that could bring about their demise. Second, under his watch the Community Redevelopment Act, originally enacted under the Carter administration was aggressively advanced during his presidency, and encouraged banks to make home loans that did not meet traditional underwriting standards.
President Clinton says President Obama inherited an economic mess from President Bush, which is true, but history also shows that he himself passed a declining economy along to Bush in 2001. The stock market, a leading indicator of the economy, peaked in early 2000 and was on a clear downward trajectory by Bush’s inauguration, and completely capitulated after the events of 9-11, during President Bush’s first year in office.
Probably too much weight for our nation’s economic prosperity is attributed to the policies of presidential administrations. In recent history great economic success came from a republican and democrat president, Reagan and Clinton, who clearly set different economic agendas and visions for our nation, but each had one major trait in common, namely the ability to work with the opposing party in congress.
Going forward the most important lesson of the Clinton legacy for this president is the fact that Clinton’s success came mostly from his second term in office, when he reached across the aisle and decided to work with republicans. This president has thus far been unwilling or unable to do that and regardless of where the fault lies for that fact, it’s the president’s job to make that happen and get things done. If he is unable or unwilling to do that, the prognosis for a successful second term can not be encouraging.
As for how we got here, President Clinton says it’s Wall Street greed and republican policies, but there are other major reasons banks ran wild and the housing market boiled over, which the former president knows intimately. First, under his watch, Glass-Steagall was repealed; that was the banking law enacted during the Great Depression designed to explicitly prevent the banks from venturing into high risk businesses that could bring about their demise. Second, under his watch the Community Redevelopment Act, originally enacted under the Carter administration was aggressively advanced during his presidency, and encouraged banks to make home loans that did not meet traditional underwriting standards.
President Clinton says President Obama inherited an economic mess from President Bush, which is true, but history also shows that he himself passed a declining economy along to Bush in 2001. The stock market, a leading indicator of the economy, peaked in early 2000 and was on a clear downward trajectory by Bush’s inauguration, and completely capitulated after the events of 9-11, during President Bush’s first year in office.
Probably too much weight for our nation’s economic prosperity is attributed to the policies of presidential administrations. In recent history great economic success came from a republican and democrat president, Reagan and Clinton, who clearly set different economic agendas and visions for our nation, but each had one major trait in common, namely the ability to work with the opposing party in congress.
Going forward the most important lesson of the Clinton legacy for this president is the fact that Clinton’s success came mostly from his second term in office, when he reached across the aisle and decided to work with republicans. This president has thus far been unwilling or unable to do that and regardless of where the fault lies for that fact, it’s the president’s job to make that happen and get things done. If he is unable or unwilling to do that, the prognosis for a successful second term can not be encouraging.
Tuesday, May 15, 2012
Hedge Funds Earn Extraordinary Amounts of Ordinary Income
Investment funds, such as hedge funds and private equity funds, and their managers earn most of their income from profits on invested capital that is taxed at a preferential capital gains tax rate of 15%. Investment managers argue that they invest like everyone else, albeit on a grander scale and that they should not be penalized with higher taxes merely because they earn lots of money. Everyone else thinks it is outrageous that the very wealthiest among us should pay a preferential tax rate on their enormous incomes. Those investment managers should not pay higher taxes because they are wealthy, and most of their income does derive from capital gains. However, most of their income does not derive from their capital gains.
Preferential tax treatment for capital gains was enacted because of the realization that for most investors the capital they invest has already been taxed to them previously as wage or other ordinary income and because they need some additional incentive to take the risk of losing their money in investments. However, typically 90 percent or more of the equity capital invested by investment managers comes from third party investors who bear the risk of any investment losses. So why should those investment managers get preferential tax treatment for income they get that is derived from profits on another investor’s invested capital? Isn’t that income more realistically contingent fee income for a job well done? And shouldn’t that income be taxed as ordinary income?
No? Then maybe all companies should structure a portion of employee compensation as “capital gains” too. That compensation could be based on the value employees add to the value, or stock price in the case of a publicly traded company, of their companies. That income could then be taxed at preferential capital gain rates too. Critics might correctly point out that employees do not invest their own capital in such a scenario, and consequently are not eligible for capital gains treatment for any income earned. But isn’t that exactly what investment fund managers are doing?
Hedge funds and other investment funds earn an extraordinary amount of ordinary income. The proposal implicit in this commentary is less that the law should be dramatically overhauled, but more that it be slightly amended to coincide with the original intent and reasoning for the favorable tax treatment in the first place: that investors be encouraged to take investment risk.
Preferential tax treatment for capital gains was enacted because of the realization that for most investors the capital they invest has already been taxed to them previously as wage or other ordinary income and because they need some additional incentive to take the risk of losing their money in investments. However, typically 90 percent or more of the equity capital invested by investment managers comes from third party investors who bear the risk of any investment losses. So why should those investment managers get preferential tax treatment for income they get that is derived from profits on another investor’s invested capital? Isn’t that income more realistically contingent fee income for a job well done? And shouldn’t that income be taxed as ordinary income?
No? Then maybe all companies should structure a portion of employee compensation as “capital gains” too. That compensation could be based on the value employees add to the value, or stock price in the case of a publicly traded company, of their companies. That income could then be taxed at preferential capital gain rates too. Critics might correctly point out that employees do not invest their own capital in such a scenario, and consequently are not eligible for capital gains treatment for any income earned. But isn’t that exactly what investment fund managers are doing?
Hedge funds and other investment funds earn an extraordinary amount of ordinary income. The proposal implicit in this commentary is less that the law should be dramatically overhauled, but more that it be slightly amended to coincide with the original intent and reasoning for the favorable tax treatment in the first place: that investors be encouraged to take investment risk.
Saturday, August 6, 2011
What does S&P's downgrade of US credit mean?
It was sobering to wake up to the news that Standard & Poor's downgraded the credit of the USA from AAA to AA+, but it’s unclear whether S&P’s downgrade now makes more sense than Moody’s and other credit rating agencies' decision to delay theirs. Our current and pending finances more than justify the action as our nation’s finances continue to accelerate beyond the realm of reason. To the extent that S&P’s downgrade serves as a wake-up to our political leaders to get their fiscal act together before even more dire consequences occur, then the downgrade is probably good for America over the long term.
However, it’s unfathomable that the most powerful military and economic power the world has ever known now has a lower credit rating than more than a dozen other nations. How is that possible and what does the downgrade really mean? America is still the only nation in the world that can ultimately back up its promise to pay its bills (and defend other nations rights to do the same) with its superior economic and military might, which is why the US dollar, as battered as it’s been in recent years, is still the world’s reserve currency. How can Germany and France, for example, and other smaller members of a European Union (EU) that is crumbling before our very eyes still have AAA ratings? The imminent (hopefully) bailout of the EU will likely and ironically include assistance from America, just as our TARP program bailed out European banks along with our own.
What happens to all those AAA sovereign credit ratings if our newfound fiscal awareness leads to a scale back of our multi-trillion dollar program to keep the world safe from terrorists and open for international trade? What does it mean that Canada, our northern neighbor, is now the only AAA rated nation in the Western Hemisphere? Can AAA rated Switzerland truly remain a safe-haven without backup from American security? For that matter, what happens to the world’s well being if US financial aid and physical assistance shrinks to meet its new budget? Are other AAA rated nations going to risk jeopardizing their coveted superior ratings by offering to pick up the slack?
Aside from the disappointment and embarrassment of losing the superior credit rating enjoyed since such ratings began, S&P’s credit downgrade is probably justified and necessary. However, S&P will be remiss unless it updates other sovereign ratings in the new light of America’s loss.
However, it’s unfathomable that the most powerful military and economic power the world has ever known now has a lower credit rating than more than a dozen other nations. How is that possible and what does the downgrade really mean? America is still the only nation in the world that can ultimately back up its promise to pay its bills (and defend other nations rights to do the same) with its superior economic and military might, which is why the US dollar, as battered as it’s been in recent years, is still the world’s reserve currency. How can Germany and France, for example, and other smaller members of a European Union (EU) that is crumbling before our very eyes still have AAA ratings? The imminent (hopefully) bailout of the EU will likely and ironically include assistance from America, just as our TARP program bailed out European banks along with our own.
What happens to all those AAA sovereign credit ratings if our newfound fiscal awareness leads to a scale back of our multi-trillion dollar program to keep the world safe from terrorists and open for international trade? What does it mean that Canada, our northern neighbor, is now the only AAA rated nation in the Western Hemisphere? Can AAA rated Switzerland truly remain a safe-haven without backup from American security? For that matter, what happens to the world’s well being if US financial aid and physical assistance shrinks to meet its new budget? Are other AAA rated nations going to risk jeopardizing their coveted superior ratings by offering to pick up the slack?
Aside from the disappointment and embarrassment of losing the superior credit rating enjoyed since such ratings began, S&P’s credit downgrade is probably justified and necessary. However, S&P will be remiss unless it updates other sovereign ratings in the new light of America’s loss.
Tuesday, February 8, 2011
Economic Recovery Hinges on Business Finagling
Top-down empirical evidence from corporate America as of Q4 2010 is showing a robust increase in business sales and earnings, nearing in some cases pre-financial debacle highs. Bottom-up and admittedly anecdotal evidence of how companies are meeting those sales targets is less encouraging.
Unable to offer the dizzying and ultimately disastrous array of credit formerly available just a few short years ago, some companies have resorted to low tech and even pedestrian gimmicks in order to boost sales. Some methods benefit consumers and sellers alike, such as the buy-one-get-one-free policy (BOGO), enabling sellers to dump costly inventories while enabling consumers to stock up on items for future consumption. The BOGO policy is supplanting cheap and abundant credit as a popular method for encouraging consumers to consume today by borrowing from future purchases. What will drive future sales?
Less compelling are the “now you see it now you don’t” discounts that appear certain hours throughout a day, or on the internet but not on the phone, or in print but leave out important caveats that detract from discount offers. Some discounts don’t offer brand confirmation on receipts making consumers wonder if they’re getting what they pay for. Competition is fierce as businesses will do anything get consumers attention.
Unsavory and deceptive approaches to gin up sales further indicate an anxiety and desperation among sellers not seen in recent history. For example, have you noticed lately some of your monthly bills contain superfluous jargon that confuses you? It would seem that some companies hope you pay their bills without reading them, and it’s a fact that others will reward you for joining their automatic payment plans, so you never have to read their bills again. If you’re diligent and actually read your bills you may notice unaccounted charges, and learn that the agreement’s fine print automatically initiates the purchase of an additional service, unless and until you explicitly call them and tell them you don’t want it. Sometimes that service will automatically renew unless it is explicitly terminated. Even when those unexpected charges turn out to be an error, customer service representatives will attempt to sell you something new, even before THEIR error is corrected. Heads they win, tails you lose! Aggressive sell tactics have existed forever, but were once only used by small or fly-by-night purveyors. Now even image conscious corporate giants and household stalwarts heretofore synonymous with good customer service use those tactics. They have become so common that comparing experiences has become a mainstream pastime among many consumers.
It is clear that an economy 70% based on private consumption must expand that sector before meaningful economic recovery can occur. With unemployment chronically high, public and private pension plans under duress for decades to come, new household formation temporarily stalled and the housing sector in the doldrums in the near term, consumer incomes and spending are unlikely to expand much for quite awhile. Corporate America would be well advised to concentrate on offering consumers products and services they desire and need, instead of relying on deception and gimmicks to meet their sales goals.
Unable to offer the dizzying and ultimately disastrous array of credit formerly available just a few short years ago, some companies have resorted to low tech and even pedestrian gimmicks in order to boost sales. Some methods benefit consumers and sellers alike, such as the buy-one-get-one-free policy (BOGO), enabling sellers to dump costly inventories while enabling consumers to stock up on items for future consumption. The BOGO policy is supplanting cheap and abundant credit as a popular method for encouraging consumers to consume today by borrowing from future purchases. What will drive future sales?
Less compelling are the “now you see it now you don’t” discounts that appear certain hours throughout a day, or on the internet but not on the phone, or in print but leave out important caveats that detract from discount offers. Some discounts don’t offer brand confirmation on receipts making consumers wonder if they’re getting what they pay for. Competition is fierce as businesses will do anything get consumers attention.
Unsavory and deceptive approaches to gin up sales further indicate an anxiety and desperation among sellers not seen in recent history. For example, have you noticed lately some of your monthly bills contain superfluous jargon that confuses you? It would seem that some companies hope you pay their bills without reading them, and it’s a fact that others will reward you for joining their automatic payment plans, so you never have to read their bills again. If you’re diligent and actually read your bills you may notice unaccounted charges, and learn that the agreement’s fine print automatically initiates the purchase of an additional service, unless and until you explicitly call them and tell them you don’t want it. Sometimes that service will automatically renew unless it is explicitly terminated. Even when those unexpected charges turn out to be an error, customer service representatives will attempt to sell you something new, even before THEIR error is corrected. Heads they win, tails you lose! Aggressive sell tactics have existed forever, but were once only used by small or fly-by-night purveyors. Now even image conscious corporate giants and household stalwarts heretofore synonymous with good customer service use those tactics. They have become so common that comparing experiences has become a mainstream pastime among many consumers.
It is clear that an economy 70% based on private consumption must expand that sector before meaningful economic recovery can occur. With unemployment chronically high, public and private pension plans under duress for decades to come, new household formation temporarily stalled and the housing sector in the doldrums in the near term, consumer incomes and spending are unlikely to expand much for quite awhile. Corporate America would be well advised to concentrate on offering consumers products and services they desire and need, instead of relying on deception and gimmicks to meet their sales goals.
Monday, December 13, 2010
It’s the Economy, not Politics, Stupid!
Many democrats and republicans are wrestling with President Obama’s proposal to extend the Bush tax cuts and other items, each believing their party’s approaches to be superior for solving our immediate and long term economic problems. Even the President enlisted the support of former President Clinton to sell his proposal in an attempt to capitalize on his administration’s prosperity during the mid-to-late 1990s. Republicans point to the Reagan 1980s and to supply-side economics employed at that time as holding the key to our economic prosperity going forward. Of course, republicans claim Clinton’s success should be at least partially attributed to republican influence in congress at that time, just as congressional democrats claim to have reined in Reagan. The fact is that notwithstanding political differences, key economic metrics from those periods are remarkably similar. Each period grew jobs at approximately 2 percent per year; Clinton added more jobs, but GDP grew slightly faster under Reagan.
Each party discounts the role of non-political factors to Clinton’s and Reagan’s success. However, both administrations coincided with a dramatic decline in long term interest rates and stable low inflation. Neither administration had to manage an active war, although Reagan presided over and spent us through the successful completion of the Cold War. Reagan benefited from following the economically turbulent and eventually stagnant 1970s and Clinton benefited from the global technology boom including the proliferation of the internet, probably the most transformational change since the invention of the printing press.
Going forward, many professional economists place limited confidence in democrat-favored government spending as an economic stimulus, and typically point to its failure during the Great Depression and, more recently, during the first two years of the Obama administration. The recently fortified republican congress is aggressively seeking a more supply-side approach, emphasizing tax cuts for small businesses and individuals. The republican view is that putting money in the hands of the private economy will succeed in stimulating the economy where massive public spending could not.
Notwithstanding all the uncertainty about economic policies and the confusion added by all the politics, it should be clear that growing our economy is one of the necessary ingredients to solving our hopefully short-to-medium term economic doldrums and our long term deficit. If the past thirty years of prosperity has shown us anything it’s that policies that stimulate economic growth and employment are ultimately good for stimulating tax revenues.
Each party discounts the role of non-political factors to Clinton’s and Reagan’s success. However, both administrations coincided with a dramatic decline in long term interest rates and stable low inflation. Neither administration had to manage an active war, although Reagan presided over and spent us through the successful completion of the Cold War. Reagan benefited from following the economically turbulent and eventually stagnant 1970s and Clinton benefited from the global technology boom including the proliferation of the internet, probably the most transformational change since the invention of the printing press.
Going forward, many professional economists place limited confidence in democrat-favored government spending as an economic stimulus, and typically point to its failure during the Great Depression and, more recently, during the first two years of the Obama administration. The recently fortified republican congress is aggressively seeking a more supply-side approach, emphasizing tax cuts for small businesses and individuals. The republican view is that putting money in the hands of the private economy will succeed in stimulating the economy where massive public spending could not.
Notwithstanding all the uncertainty about economic policies and the confusion added by all the politics, it should be clear that growing our economy is one of the necessary ingredients to solving our hopefully short-to-medium term economic doldrums and our long term deficit. If the past thirty years of prosperity has shown us anything it’s that policies that stimulate economic growth and employment are ultimately good for stimulating tax revenues.
Saturday, April 10, 2010
Dow Reaches 11,000-- What's Next?
The range of opinion on the future path of the stock market is as wide as ever. Optimistic investment pundits pointing to daily improvements in some economic metrics see opportunity for gains in the short-to-medium term, but hasten to caution that those gains may be short lived as significant market headwinds arriving as early as this fall could derail the market's climb for many years to come. Some are hopeful that those headwinds will mitigate if republicans regain control of congress next November and temper the Obama administration’s anti-growth tax-and-spend economic agenda.
Pessimists acknowledge those daily improvements but believe that the market’s dramatic recovery since March 2009 is primarily the result of temporary government and Federal Reserve intervention that has stabilized the economy and the markets. They believe that the private economy is not yet self-sustaining and cite the persistence of many of the circumstances that caused the great crash last year as gnawing reminders that it is premature to claim victory over our economic woes. Furthermore, they believe the dramatic expansion of debt and deficits among the world’s major governments is a substantial threat to full global economic recovery and long term prosperity. Pessimists concede that congressional gridlock next year could stop the rampant government spending, but hasten to point out that gridlock won’t reduce the already robust government debt and deficit that inevitably higher interest rates will further exacerbate.
The optimists know that bull stock markets begin with seemingly unimportant short term economic improvements, but the pessimists know that market moves also anticipate the long term health of the economy. And, everyone knows that the US economy relies heavily on a US consumer that continues to weaken under the pressure of chronic high unemployment, growing credit restrictions, negative home equity, and bleak prospects for higher taxes, not to mention the negative outlook for both public (social security/Medicare) and private pension systems. Imagine what a spike in oil prices would do to consumer spending, as the situation between Israel and Iran approaches a climax later this year.
Given our economic predicament, it is rather amazing that the market has recovered so far so fast, especially because optimists and pessimists agree that our critical economic challenges are likely to reemerge as issues later this year and fester for many years. If the hard times do start as early as this fall, there is a real risk that a correction could begin as early as next month. Everyone knows that the market typically retreats during summer months, and if investors anticipate bad times ahead, it is more than a possibility that the slightest provocation could cause a major decline sooner rather than later. After all, who wants to be on vacation when the market corrects?
Moreover, one must wonder how the currently cheerleading financial media factors into the market's good fortune lately. The media continues to encourage short term investment even in the face of an imminent, potentially violent market turnabout. When will the media trot out all the so-called doom-and-gloomers? After the correction begins, as they did last time? It would be instructive to balance all the bullish reports with the views of some well informed market bears, BEFORE the downturn actually begins. No one wants to hear their market autopsies AFTER the market starts sliding. The bears have been caged for so long, let's hope the mere media appearances of them do not themselves trigger a market correction.
Pessimists acknowledge those daily improvements but believe that the market’s dramatic recovery since March 2009 is primarily the result of temporary government and Federal Reserve intervention that has stabilized the economy and the markets. They believe that the private economy is not yet self-sustaining and cite the persistence of many of the circumstances that caused the great crash last year as gnawing reminders that it is premature to claim victory over our economic woes. Furthermore, they believe the dramatic expansion of debt and deficits among the world’s major governments is a substantial threat to full global economic recovery and long term prosperity. Pessimists concede that congressional gridlock next year could stop the rampant government spending, but hasten to point out that gridlock won’t reduce the already robust government debt and deficit that inevitably higher interest rates will further exacerbate.
The optimists know that bull stock markets begin with seemingly unimportant short term economic improvements, but the pessimists know that market moves also anticipate the long term health of the economy. And, everyone knows that the US economy relies heavily on a US consumer that continues to weaken under the pressure of chronic high unemployment, growing credit restrictions, negative home equity, and bleak prospects for higher taxes, not to mention the negative outlook for both public (social security/Medicare) and private pension systems. Imagine what a spike in oil prices would do to consumer spending, as the situation between Israel and Iran approaches a climax later this year.
Given our economic predicament, it is rather amazing that the market has recovered so far so fast, especially because optimists and pessimists agree that our critical economic challenges are likely to reemerge as issues later this year and fester for many years. If the hard times do start as early as this fall, there is a real risk that a correction could begin as early as next month. Everyone knows that the market typically retreats during summer months, and if investors anticipate bad times ahead, it is more than a possibility that the slightest provocation could cause a major decline sooner rather than later. After all, who wants to be on vacation when the market corrects?
Moreover, one must wonder how the currently cheerleading financial media factors into the market's good fortune lately. The media continues to encourage short term investment even in the face of an imminent, potentially violent market turnabout. When will the media trot out all the so-called doom-and-gloomers? After the correction begins, as they did last time? It would be instructive to balance all the bullish reports with the views of some well informed market bears, BEFORE the downturn actually begins. No one wants to hear their market autopsies AFTER the market starts sliding. The bears have been caged for so long, let's hope the mere media appearances of them do not themselves trigger a market correction.
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