Plum Crazy

Bernie Ebbers Is Still Not A Free Man

Given the number of times I wrote about how Bernie Ebbers was still a free man, it's nice to read this: Justices Turn Down Appeal by Ebbers.

The Capital Loss Fund

With my recent returns in the stock market, I have decided to start my own brokerage firm, one predicated on giving people a tax shelter by guaranteeing them losses in the stock market. I will charge a 10% administration fee. Anyone interested just let me know.

Because It Wasn't, Say, the Fraudulent Accounting

Lay says "witch hunt" triggered Enron demise.

From 1 to 7 to 3

Remember way back when (24 years ago to be precise) when the Justice Department sued to break up AT&T and introduce competition into the market? The local service was broken into 7 mini-monopolies. I could never figure out why the Justice Department somehow decided that 7 little monopolies were better than 1 big one. It's not as if consumers had choice in local phone service until recently. But it did bring down long distance rates nicely.

Anyway, here's what the landscape looked like after the initial split:

Nynex
BellSouth
Bell Atlantic
Ameritech
PacTel
SBC
US West

Here's what the landscape now looks like:

AT&T (SBC, PacTel, Ameritech, and now BellSouth)
Verizon (Nynex, Bell Atlantic)
Qwest (US West)

Just give it another couple of years, and we'll probably be back to one.

Met Him In A Bank Down in Dagobah

I love this picture from CNN Money.

"If rate I raise, burst, the frothy bubble will. If rates I lower, inflation will I get. Unclear, is the housing market."

It's Only A Footnote

One of FASB's favorite ways of providing investors with more information is requiring public companies to disclose information in the footnotes of their financial statements. This is where the disclosures about the cost of employee stock options or off-balance sheet financing appear. This sounds fine in theory, since a savvy investor or research analyst will simply read the footnotes and adjust the financial statements accordingly.

Unfortunately, it only sounds fine in theory. A new study indicates that auditors don't care much about errors in the footnotes (WSJ, reg req). Fortunately, auditors have independent oversight. Hopefully the PCAOB will take this study seriously and tighten up auditing standards.

Housing Dot Com?

Shades of the dot.com bubble in the real estate market:

"South Florida," he said, "is working off of a totally new economic model than any of us have ever experienced in the past."

It is? What's changed? Housing prices are no longer correlated with interest rates and wages? Housing demand suddenly exists in a vacuum?

Of course not. You can lose money in real estate in the short-term. Alan Greenspan is already making noises about the housing market being over-priced. The Fed is considering adding housing prices to the CPI. Do you know what this would do to the rate of inflation? It wouldn't be so low any more. Typically the Fed hasn't seen asset value as its business, but given the current state of the housing market, they are beginning to think it's their business. If they see inflationary pressures as a result, interest rates go up by more than a quarter point. They can raise rates enough to cool off the housing market. Although mortgage rates are driven by the market, not the Fed Funds rate, there is still a high degree of correlation between the two rates.

An environment of rising interest rates will also have an impact on the labor market. As businesses find their ability to borrow at attractive rates constrained, they will invest less. As they invest less, they will hire less. They may even fire workers. Workers will have less power to negotiate pay increases. Nominal wages may stagnate. Real wages may fall.

Mortgages rates go up, making monthly housing payments more expensive. Wages stagnate or go down. Less people may be working. This equals less demand for house purchases. If you only own the house you live in, you're more likely just to stay where you are (assuming you can still afford to with your other, adjustable rate debt, such as credit cards). If you invested in real estate that you're planning on renting or flipping, you're in a worse position. Real estate investors generally don't go for long-term fixed-rate mortgages, like those who live in the houses they buy do. They either go for short-term ARMs with balloons or short-term interest-only mortgages, where payments increase after a few years. Monthly payments on ARMs will go up, while those in the interest-only mortgages will also eventually face increased monthly payments. Rental prices are already stagnant, and most real estate investors aren't making a profit through rental income. Therefore, they can't cover the increase in their monthly payments by raising the rent. The market won't bear that.

What you wind up with in this scenario is a housing market where most people will stay where they are, but some people will be forced to sell since they can't afford the monthly payments. In other words, there's more supply than demand. What happens when supply is greater than demand? Prices go down. The only question is by how much, the answer to which would vary by region. In previous housing busts, average declines have been in the 15-20% range. Given that a fair amount of the current housing market is spurred by speculators, leading to greater than average price increases, there is a real possibility that we would see greater than average price decreases in a housing market downturn.

Let's end with a cautionary tale.

At the Nexus party in Brooklyn, Steve Nguyen, Ms. Romano's fiancé, said he was heeding Mr. Trump's [ed. real estate] advice. "He says buy, buy, buy," Dr. Nguyen said.

Donald Trump's casinos have declared bankruptcy twice, and he only staved off a personal bankruptcy because the banks were willing to subsidize him. Chances are the banks wouldn't be as patient and forgiving with you, Dr. Nguyen. You don't owe them enough money.

Just For Rick

Impairment charge. Financial controls. Discretionary reserves. Intangible assets. Good will. Bright line standard. SAS 70.

What's Worse Than a Six Hour Meeting about Sarbanes-Oxley?

A six hour meeting about Sarbanes-Oxley when you're not feeling well.

On the upside, Sarbanes-Oxley = More jobs for accountants and auditors. Sure, people scoff at me for being an accountant, but who does the government love, baby?

Calling All Economists

Whenever I travel into Manhattan from my job, I have the choice of taking the Long Island Rail Road for free, since I work there, or taking the subway. I often opt for the subway, to the surprise of a co-worker, who tells me it costs me $2 whenever I take the subway. Not true. I own an unlimited ride pass. The first person who can correctly tell me how much it really costs for me to take the subway wins. . . well nothing, except for my admiration as someone who understands the principles of economics.

Bernie Ebbers Haiku

You're going to jail
Accounting fraud doesn't pay
Don't steal the coffee

This Just In!

Our crack troops on the ground have just informed us that Bernie Ebbers is no longer a free man!

Dear Jury in the Worldcom Trial

Would you please convict Bernie Ebbers already?

Thanks for your consideration.

Reason #219504 Why Bill Gates Is the Richest Man in the World

Because he has enough damn sense to regularly divest himself of his Microsoft stock and invest the profits in other things.

But it is things like this (WSJ; reg req), which make you feel like there is some justice in the world.

Mr. Ebbers, who at one time had assets estimated at more than $1.3 billion, never sold his millions of shares in his old company and saw the bulk of his wealth evaporate as WorldCom's stock was wiped out by its stint in bankruptcy protection.

Bernie, Bernie, Bernie. You never diversified? Dude, that's just frickin' awesome. And when I say awesome, I mean moronic. All that wealth wiped out when your house of cards came tumbling down. But, you know, it couldn't happen to a nicer guy.

I Wonder What Larry Lasser Is Up To These Days Anyway?

Somehow I have managed to become the first hit in a Google Search for Larry Lasser. For those not in the know, Lasser was CEO of Putnam Investments, until his ouster in 2003 as a result of the market timing scandal.

Not that I'm particularly worried about Lasser. He was being paid quite handsomely during his years at Putnam and was still given the remaining value of his contract upon his ouster.

Encourage Justin to Blog More

In an attempt to encourage Justin of Useful Genius to blog more, I have commented on his first and, as of now, only post Riddle Me This. Go, leave him comments. I've known Justin for several years. Well, known in the virtual sense, as I've never been to his hometown and, to the best of my knowledge, he hasn't visited New York in the years we've conversed. Anyway, he's a bright, funny, sarcastic guy. Like me, liberals find him conservative and conservatives find him liberal.

The current discussion is about competing claims regarding wage level increases and social security indexing.

There are a couple of competing claims running around the political spheres. I'ld like someone to reconcile the mutually exclusive conditions promoted by the same people.

Wages are not keeping up with inflation.

Re-indexing Social Security Benfit increases from wages increases to price level increases will result in a drop in the rate of growth of social security benefits.

So which is growing faster? General price levels or wages?

To which I respond:

Not having seen the first claim in context, I can't be sure, but a couple of questions come to mind:

1. Whose wages are not keeping up with inflation? Is the claim that overall wages are not keeping up with inflation, or just that wages for those on the lower economic rungs are not keeping up with inflation? I do know that the BLS has reported that wages for hourly workers are not, at this time, keeping up with inflation. That isn't necessarily the case over the long-term, however.

2. Assuming we are just talking about wages for hourly workers, what percent of overall wages do they make up? If, for example, the wages for non-hourly (presumably management) are high enough to constitute a significant minority of overall wages, then larger increases on those could, in fact, drive up overall wage increases to greater than inflation. Nonetheless, this would not benefit hourly workers.

This still leaves the long-term vs. short-term argument. Although wages for hourly workers are not keeping up with inflation in the short-term, that does not necessarily mean they are not keeping up with inflation in the long-term. I haven't seen statistics one way or the other. I could research it, but at this moment am feeling slightly too lazy to do so. So, if wages are, in the long-term, exceeding inflation, then presumably switching to inflation indexing will, in the long-term, drop in the rate of growth of social security benefits, even if that wouldn't necessarily be the case in a given year or short range of years. Much like even though the stock market may decline in the short-term, over the long-term, you can expect to see increases greater than inflation.

If you want to join in the discussion, please do so here.

Targeted Advertising

I was reading this article at WSJ.com (registration required) about the insurance industry* scandal, when I saw the funniest, absolutely most apropos click-through ad:

I thought that was just brilliant.

*Is it just me, or does anyone else find it odd that this scandal has gotten virtually no mention in the blogosphere? It is easily one of the biggest financial scandals of the last 10 years, and not a mention of it on any of the big blogs. I haven't really mentioned it, other than one post wondering when Greenberg's resignation would occur, because it just hits too close to home, and I work in a part of the business that has nothing to do with insurance whatsoever. I am the controller for the technology department. Well, they call me CFO for technology, but I always find that title to be a bit of overkill. Business unit controller describes my function quite well.

To Switch or Not To Switch

Switching costs. That’s what companies try to build into their model to dissuade you from switching to another company or brand. One of the highest switching costs has got to be changing back accounts. Especially with direct deposit and the various monthly payments directly debited from your account. Well, maybe not yours, but mine. Though if you’d be kind enough to let my payments come from your account. . .

Excuse me. I digress. There’s a new Bank of America across the street from me. Currently, I bank with Citibank, but there’s no ATM nearby my house, which has always been something of a pain. So I am seriously considering changing to Bank America. But the hassle. Coordinating the switch over will be a pain. I’ll probably do it for the long-term convenience.

When EF Hutton Talks, People Listen

Hopefully, when I talk, no one listens, as my guess on Google, way wrong.

Sizzle and Steak?

Google is still kicking some serious rear end. Up nearly 8 points a share on Friday. Not as impressive as Thursday but still good and a hefty 23 points total over its IPO pirce.

You know even if the thing does tank or slip back, anyone who got in for 85 and has gotten out did pretty well for themselves.

Sizzle or Steak?

Perhaps proving me wrong, Google shot up today from its IPO price of $85 to close at $100 a share (plus a few cents). I had questioned whether Google would justify its high IPO price, and before it went public yesterday, events seemed to bear me out. The floor for the IPO price dropped to $85 from $108, and Google shareholders sharply reduced the number of shares they were making public. One explicit and one implicit sign that the stock wouldn't debut as well as originally thought.

Is today's action an indication of better things to come? Some say no, and I tend to agree. I think today's ramp up is nothing more than market psychology, an emotional reaction driving people to get a piece of the pie before it becomes too expensive. My hunch is that the price will drop and probably soon.

(Not So) Pesky Bill

What's the most annoying about credit cards? Right, you think you pay off the full amount, but because your timing isn't quite right, you still incur a miniscule finance charge (in my case 52 lousy cents) and get a bill. Honestly, I can't even see it's worth it to the credit card company to bill you for it. Making matters worse, you can't even pay the sodding thing on-line because it's under one dollar.

So then I have a brainstorm. Earlier today I note that I really should buy some Carole King. So trying to make something good of something bad I order "Tapestry" through Amazon, tote up my new total on the credit card, and pay that amount instead. Maybe not such a pesky bill after all.

This Just In

An interesting twist to the upcoming Google IPO. Bears keeping an eye on.

Going, Going. . .

In a process befitting its status as an egalitarian search engine, Google is planning on selling its IPO through an auction, perhaps as early as next week. Where most IPOs are available only to the privileged and connected few, Google's approach is a democratic process that will enable anyone interested to get in on the ground floor. Or will it be the ground floor? That's the question. We all remember the days when IPOs were bid to astronomic heights - think Palm - only to fall precipitously within days, if not hours (again, think Palm).

Will an auction process create a bidding frenzy that will pump the price higher than it would go in a standard IPO? Google already seems overpriced, with the company placing the value at between $108 and $135 per share. Those prices would put its P/E ratio between 263 and 329. By contrast, the P/E for Yahoo is a “mere” 109, which would put Google at less than $45 per share. I don’t know about you, but I’ll be sitting this one out.

Finance Talk

I'm actually working on a project right now which indicates why it is so important to use after-tax cash flow for calculating NPV. This deal is comparing a straight purchase of some software without upgrade rights now and a re-purchase of the upgrade licenses in 4-5 years vs. a three-year payout with a fourth-year renewal option which would give us the rights to deploy the upgrade licenses in year 4-5. The cost of the payout if you renew for the fourth year is slightly less than having to do two separate purchases. If you don't renew for the fourth year, it's substantially less, but there is risk of slippage on the delivery dates for the next versions of two key components of the deal which would mean that the upgrades wouldn't be delivered in the three-year timeframe, so we might have to renew for the fourth year to preserve our upgrade rights. To be conservative, therefore, we want to analyze the fourth-year renewal option in the financials.

What is interesting about this otherwise routine analysis is that the economics of this deal are going to be made or broken on the tax treatment of the three-year payout with the fourth-year renewal option. If we can expense the payout for tax purposes, then the NPV of the deal is more favorable than the NPV of the two separate purchases. This is solely because of the accelerated tax benefits of the expense. If we have to capitalize the payout, then the NPV of the deal is less favorable than the NPV of the two separate purchases. I don't often run across analyses where the tax treatment so dramatically affects the comparative economics, but they do occur infrequently. It's times like this when I scoff at those who scratch their heads at my insistence at looking at the after-tax cash flow when calculating the NPV. Seems many companies don't bother and can't figure out why I do so. Saps.

Martha Stewart Jailhouse Living

Well, maybe not actual jail. But we can hope.

BTW, not to toot my own horn (oh, okay, yes, to toot it), but I predicted that Martha would be convicted in the comments to this post.

Bernie Ebbers Is Still a Free Man

...but maybe not for much longer. It's about damn time.

The Year End Close Blues

Post the restatement
The numbers don't net out
You posted the entry twice
There's a double count

Yes, I'm in Finance
F-I-N-A-N-C-E
Take pity on me

Yes, I'm in Finance
F-I-N-A-N-C-E
Take pity on me

Where's the bonus accrual?
We didn't accrue
HR said the check was cut
But the expense didn't come through

Yes, I'm in Finance
F-I-N-A-N-C-E
Take pity on me

Yes, I'm in Finance
F-I-N-A-N-C-E
Take pity on me

Vendor said they can't recognize
Their revenue
Cause an invoice wasn't paid
Bullshit, they don't book cash, they accrue

Yes, I'm in Finance
F-I-N-A-N-C-E
Take pity on me

Yes, I'm in Finance
F-I-N-A-N-C-E
Take pity on me

Yes it's those financial end of year close blues.

Thank you. Thank you. I appreciate my legions 3-4 fans coming out. I'll be somewhere all week.

Mutual Fund Madness

Yay, more financial scandals, just what we needed! Looks like some mutual fund managers were engaging in improper trading by timing their fund trades. Any bets on who gets blamed first, Bush or Clinton? I'm going with someone blaming Bush first ("The evil Bushies in league with the big bad corporations!"), with the inevitable follow-ups of "It started under the Clinton administration, therefore it's his fault!"

Bah, humbug. Neither of them is at all closely involved with mutual fund management. Wall Street scandals go much further back than that. They're all about greed, not politics. Isn't greed one of the seven deadly sins, thus proving its existence predates anyone's favorite political punching bags?

Executive Privilege

Although this won't do his credit card business any good, I have to have a little respect for Barclays chief executive Matt Barrett for speaking the truth.

Mr Barrett conceded that credit cards were an expensive way of borrowing and they were not recommended for what he called chronic borrowing. He then went on to declare: "I don't borrow on credit card because it is too expensive." He added that he had given his children some advice: "Don't get too much debt on a credit card."

He's absolutely right. Credit cards, with their high rates of interest, are no way to fund long-term debt. Let's suppose you have $5,000 on your credit card and are paying Barclays their 18% interest per year compounded monthly. If you pay the Barclays' minimum balance of 3% per month, it will take you 226 months to pay off your credit card, and you will have paid $4,799.06 in interest. If you could get a home equity loan at a rate of 7% (the prevailing rate in the UK) and used the same payment schedule, it would take you only 148 months to pay off the balance, and you would have only paid $1,164.83 in interest.

Suppose you don't own your home, so you go to a bank and get a 5 year loan for $5,000 with an interest rate of 8%. Your monthly payment would be $101.38, although it wouldn't decline each month as a credit card monthly minimum would. You would then pay off the loan during the 60 month time period, having paid only $913.17 in interest. If you wanted to pay a constant $101.38 each month to Barclays at the 18% interest rate, it would take you 91 months to pay off the same principal, and you would have paid $4,167.25 in interest. Maintaining long-term debt on your credit card simply doesn't make financial sense. You should keep your long-term balance as low as possible.

The reason I have only a little respect for Mr. Barrett is that his company encourages people to do precisely what he advises against, and despite the fact that UK interest rates have fallen 2/3 since 1992 to 3.5%, Barclays' credit card rate has dropped less than 1/3. Caveat emptor, but I don't have to have tremendous respect for Barclays or Mr. Barrett. Just because you can do something, doesn't mean you should.

I'm Really Rich

This is a highly effective tool for getting donations to charity. Seems that on a global basis, I'm within the top 0.241% of the richest people. On a gross salary basis. This doesn't take into account expenses, although even on that basis I'd still be pretty damn high when compared to most of the world. Keep in mind, though, that this is compared to most of the world. I would be a lot lower down if you were to only look at industrialized nations.

Also, I did know that about 50% of the world's population gets by on less than $2 per day. On that basis, most people in the U.S. are really rich.

Measuring Shareholder Value

I believe it is high time that CEO compensation be tied to more than just corporate earnings. I'll grant you that earnings are one measure of shareholder value and, on a surface level, the most important one. But in a year where layoffs are still going strong and the job market is still weak, the thought that CEO compensation may improve over 2002 leads to questions. I'd like to suggest that CEO compensation in a given year also be inversely related to the number of layoffs the company experienced that year, with one caveat - that only hold true if it was the same CEO who governed the company through boom times. We shouldn't be penalizing a new CEO for the mistakes of his/her predecessor.

The reason I make that suggestion is simple - huge layoffs in bad times implies inefficient hiring management during boom times. Many companies hire back all the people laid off during bad times once the market improves, only to have to let them all go again when there is another downturn. There are companies who avoid having to do that through more thoughtful hiring management. These companies forecast where they think the market for their product will be over a multi-year period and manage headcount on that basis.

Since most businesses have fairly definable cycles, this is not magic. About 12 to 18 months before the business forecasts a market downturn, it starts reducing headcount through attrition. Amazing. If you don't replace everyone who leaves voluntarily, when demand decreases for your product, you don't have to lay off massive amounts of employees. This benefits shareholders in multiple ways.

First, forecasting business cycles is a good thing. It allows for better planning on several fronts, all of which benefits shareholders. Shareholders ought to be encouraging this behavior.

Second, it increases earnings during the transition between the high and low points of a cycle. If headcount is reduced through attrition, expenses are lowered. In many cases, revenues are not so impacted, therefore earnings increase. Most shareholders, looking only at the fact that earnings are good, don't often stop to think that maybe earnings could have been even better. Perhaps they should.

Third, it increases earnings during the downturn. If you avoid massive layoffs through more efficient hiring management, you avoid having to pay out large amounts of severance. Once again, shareholders benefit.

None of this even considers the possibility that staffing levels during boom times are, in some cases, simply higher than they should be. In some businesses, there is a very direct relationship between product demand and need for headcount. So you expect to see huge swings in headcount tied to fluctuations in demand. This is not the case in all industries, however. Not even in those where we are very used to seeing massive layoffs during market downturns, such as on Wall Street. Although on the deal side of Wall Street, such a relationship exists, transaction volume on the market side does not necessarily change when it shifts from bull to bear. Therefore large layoffs on that side of the business during bear markets should be suspect.

I see no down side to shareholders demanding more efficient management from their CEOs. The best way to accomplish this is to tie CEO compensation to those efficient management practices. Let CEOs know that during bad times they will also be judged based on the number of layoffs that occur, and perhaps they might be incented to do a better job of managing headcount during good years.

Bernie Ebbers Is Still a Free Man

But he may not be one much longer, thanks to Oklahoma.

The Oklahoma attorney general on Wednesday charged MCI, its former Chief Executive Bernie Ebbers and five others with violating state securities laws by knowingly giving false information to investors.

It's about time that somebody recognized that Bernie "I'm In Control Here" Ebbers ought to be charged with something. Too bad it wasn't the Feds. The Feds have charged former CFO Scott Sullivan, but have not charged Ebbers. Minimally, Ebbers, under whose watch much of the fiscal wrongdoing took place, is guilty of gross negligence. As CEO, he signed off on the firm's financial statements. He should have known they were materially misleading, even assuming he actually did not (and that's a big assumption).

Oklahoma, O-K-l-a-h-o-m-a, Oklahoma, OK!

Budget Season Translation Manual Update #1

After working on the budget all weekend (thanks to the power outage), we have our first update to the Budget Season Translation Manual.

You say: "I also noted that you had budgeted Software maintenance under the Software Capital category, whereas it truly belongs in the Software Maintenance category. I took the liberty of moving it to the correct cost category."
You mean: "Oddly, the item you entitled Software maintenance belongs under the cost category also called Software Maintenance. Duh."

You say: "We'll remove that $1,000 item you asked about after next week."
You mean: "Yeah, that $1,000 reduction you asked for will really make a difference to your multi-million dollar budget."

More updates to follow.

Budget Season Translation Manual

Budget season. Duck season. Budget season. Duck season. Budget season. Duck season. Duck season. Budget season.

Damn, I lose again.

But now onto the Translation Manual (A Work in Progress).

You say: "Budget 2004 Submissions - Friendly Reminder"
You mean: "It's 5 pm. Do you know where your budget submissions are? Because we don't."

You say: "Are you still working on one of your templates? Because we only received numbers 1, 3, 4, 5, 6, 7, and 8 of the 8 you mentioned."
You mean: "Are you incapable of counting, or are you still working on one of your submissions?"

You say: "I think you meant to type 8 in that cell, not 8,000."
You mean: "Which part of 'Budget in whole thousands of dollars' didn't you understand? Unless you meant that you were sending your staff to $8 million in training courses each month. In which case, umm, NO!"

You say: "We'll run you a report on how many trips your staff has taken this year."
You mean: "How the hell do you have no idea about how many trips your staff has taken this year? Don't you actually approve them, or do they just fly off whenever they like?"

To be continued as the budget season turns.

Full Employment for Consultants Act

Corporate governance consulting mushroomed after last year's outbreak of accounting scandals led to a crackdown on executive behavior, but experts now question the need for such a cottage industry.

Every time Congress passes new accounting regulations, accountants and consultants make more money. Why? Because, in the interest of making things more transparent to the investor, Congress passes laws that are harder and harder to comply with. One day Congress will decide to pass the law that will truly make things more transparent to investors, but will be easy to comply with - No more off-balance-sheet financing. No off-balance-sheet financing would have equaled no Enron tactics. All those partnerships were nothing more than a way to keep financing off Enron's balance sheet. Had there been no such thing, Enron's true level of debt would have been readily apparent to investors, and the company would have gone bankrupt without the accompanying ugly mess.

In the meantime, however, accountants (other than Arthur Andersen) and consultants thank Congress for making sure companies keep their pockets well-lined with fees.

Finance Onomatopoeia

The acronym for financing received to keep bankrupt companies running - DIP*.

*It stands for debtor-in-possession.

Heartwarming

A story to warm the cockles of a libertarian's heart.

Lawmakers who hiked cigarette taxes in search of needed cash may find themselves in the precarious position of losing a chunk of the billions of dollars their states receive from the nation's top tobacco companies.

By boosting excise taxes to more than $1 per pack in some cases, states have pushed smokers to abandon their brands or quit altogether. That in turn has threatened the profit picture for leading U.S. cigarette makers, analysts say.

Now had they hiked taxes to encourage people to stop smoking and improve their health, they could at least claim success. But they lacked even pure motives, wanting only to punish smokers financially to rake in more cash to the state coffers. I love this story.

Social Insecurity

In my view of the ideal world, retirement savings would be completely left up to the individual. And I’d be married to a guy looking remarkably like Oded Fehr. However, I recognize that we don’t live in that world. In order to achieve the aim of privatizing Social Security, we must look at other options.

The main structure would be to retain a government-mandated percentage of salary deduction and matching employer funds, but have it flow into an IRA that is controlled by the individual. It is certainly the simplest method of privatizing Social Security. It is also certainly the second least likely to be adopted method (the first being the one where there is no government mandate at all). This idea causes nearly as much of the great “What if” fear as my ideal method causes.

“What if there is a market crash that wipes out people’s retirement savings?”

That is the great “What if” that any method of privatizing Social Security needs to address to have any chance of being adopted. Unfortunately any means to address it cause us to compromise even further with the idea of big government. We must decide which form of big government we are most willing to live with, understanding that not making such a compromise will leave us in the worse position of having to retain the status quo of a completely government-run retirement savings scheme and the resultant sub-optimal returns.

The first compromise would put us in the position of accepting a form of welfare. Government aid would be provided to people on a means-tested basis. This would ensure that no elderly are left starving, which should go some way to assuage public concerns. It also allows you to completely dismantle the existing Social Security bureaucracy and leverage off the existing welfare system bureaucracy.

The second compromise would put us in the position of accepting government restrictions on the types of investment vehicles one could maintain in the IRA. No naked options. No derivatives of any other sort. Those two are probably easy enough swallowed, since it is doubtful that the investment houses would let most people use their relatively meager retirement savings on naked options or other derivatives anyway. You have to have a pretty fat portfolio before they’ll let you invest in those instruments.

You could, however, go even further with the restrictions, since most people are uncomfortable with the idea of unfettered freedom to invest in any equity instrument. “Look at the dot.com failures,” they’ll tell you. “Look at a bunch of companies with no sustainable business models that people were regularly warned not to invest heavily in by the Fed chairman,” I reply, but to no avail. Unfortunately most people are simply unwilling to accept the consequences of freedom. They either want the safety net provided by government assistance or someone to tell them what to do. If the compromise we accept is someone to tell them what to do, their ability to invest in equity instruments must be curtailed also. You place limits on the percentages of their portfolio they can invest in equity, allowing them mostly to invest in market-indexed mutual funds and fixed income. You can even vary these percentages based on age, meaning that a younger person with a longer time horizon can invest in more equity, and an older person can invest mostly in fixed income. These are sound strategies that individuals should be following anyway. If you are close to retirement, you ought not to be placing assets you will need to live on in risky instruments. Unfortunately, the whole concept of risk is one many people only grasp when they’re reaping the upside potential.

Such a mechanism would allow you to dismantle the existing Social Security bureaucracy. You might have to keep on a few advisors to make determinations as to the restrictions, but that would be far smaller than the massive structure currently in place. The downside is that you are restricting people’s decisions. You are accepting a soft ceiling on returns in exchange for the comfort of a soft floor.

The last option is to retain a government-run system on an opt-in basis. Those who want the government to invest their retirement savings for them and accept a sub-optimal return can do so, those who do not can choose to invest their retirement savings as they see fit. If you opt out, you agree to no government assistance later. The infrastructure to run such a system would be completely funded out of the taxes of those who opt in. In some ways, this is the system I like most. It provides people with choice. It does retain a huge bureaucracy, but at least the users will pay for it. My main fear is that when there is a critical mass of people who don’t have sufficient retirement savings, the retained bureaucracy will do what bureaucracies are wont to do – increase its power by lobbying to have all retirement savings run through it, and we’ll be right back where we are today.

None of the proposed solutions are ideal. All require a compromise with big government. I do feel, though, that accepting some form of compromise will improve the system we currently have. The only question becomes what form of compromise. Ultimately, I believe that is up to the public to decide. I only wish the government would make public some options (and the ones I laid out are surely not the only ones) and give us the chance to decide. Let there be some public debate. However, I fear they are too in love with their own power and imagined brilliance to do so. They will leave it all up to themselves; firmly believing they know better than we do. And we will let them.

Taking Stock of the War

I want to cover this off before any accusations start (and I've seen accusations of this type before around the blogosphere). The stock market is up today because there is renewed optimism that the war will be over quickly. This reduces the level of risk and uncertainty in the market. The level of risk has been too high for most investors lately, so a lowering of risk causes the market to rise. The market is not going up because Wall Street and investors are war-hungry people who get off on bloodshed. Okay?

The Blog Market

Well, Blog Shares is now in beta and already has over 400 listings. I'm trying out a strategy that I hope pays off. I bought 1000 shares in two blogs that were selling for slightly more than one cent each. The first one, From Komforthaus with Love, currently is worth nothing, so that one hasn't come close to paying off. But even if I never recoup, I only lost $14.06 of fake money. The other one, Killing Time - Hk94.com, is holding steady, so it's still worth the $12.90 I paid for it. But if that sucker goes up a couple of cents, I'm doing all right.

I'd like to thank those players who bought shares in Plum Crazy too. However, noting the value of the links that I have today, it appears as if it could drop in valuation. I'll let you draw your own conclusions.

UPDATE: I read on the BlogShares home page that Seyed is getting irate e-mails. I think those people suck. The thing was in alpha until yesterday afternoon, is now in beta, and it's free, dammit! Ooh, it doesn't work perfectly. Well, if you all want something that works perfectly, make your own damn blog market. I think BlogShares is a great idea. It actively encourages bloggers to link to each other and to ping Weblogs.com. It's also just downright fun. We're all about competition, so this is another venue for bloggers to compete in. What more could a blogger want? Links, traffic, and a high share price. Go Seyed!

Larry Lasser Update

Those of us concerned about Putnam CEO Larry Lasser's ability to live on nothing but his $1 million salary no longer need worry. Apparently Larry will be getting a bonus for 2002 after all - $7 million. Sure it's less than half of his 2001 bonus of $17 million and one quarter of his 2000 bonus of $33 million. But at least Larry won't have to start hocking his Rolexes to maintain his lifestyle. I know I'll be sleeping better tonight.

It's A Hard Knock Life

It must be tough to be Larry Lasser. Going from a $33 million bonus in 2000 to a $17 million bonus in 2001 to no bonus in 2002. They expect the man to actually live on just his $1 million salary? Oh, the humanity.

UPDATE: Oops, the papers spoke too soon. It's not yet known whether or not Lasser will receive a bonus for 2002.

Monopoly Money

This case represents one of the things I found the oddest about the government's decision to end AT&T's monopoly - Rather than making phone service truly competitive, the government decided to break up one, relatively efficient monopoly to form seven smaller ones (RBOCs). Over the years, those seven smaller ones have collapsed down to four regional monopolies. Consumers got competition in the long distance arena, but, until recently, none in the local arena. This drove prices down for long distance service, but there was no such corresponding price drop for local service.

Eventually the FCC decided to open up the local market to competition as well. This presented one problem though. All the lines were owned by the RBOCs. This was one of the reasons it actually made sense to allow a monopoly for phone service in the first place. Rather than have lots of small, independent companies laying phone line, it made sense to have one, big company own the phone lines and, as a "natural" monopoly, face government regulation.

As a side note, anyone who believes that there are no times when allowing natural monopolies makes sense ought to come check out the NYC subway system. Because the system grew by having several independent companies running lines, you cannot use the same cars on all subway lines. The tunnels and tracks aren't the same size. It's simply inefficient and makes upgrades difficult. By the time the government did get involved, the inefficiencies were already in place.

Back to the RBOCs, though. Since they own all the phone lines, other companies wishing to compete in the phone market need to lease the lines from the RBOCs, despite the fact that it isn't in the best interests of the RBOCs to lease them the lines. As a result, the RBOCs provide degraded service to their lessees. In order for competition to be fair, the government still has to regulate them. If the government is going to have to regulate anyway, why the hell do they want to regulate multiple companies? It would be far more efficient to have just one company to regulate.

With respect to the case itself, it is a consumer of AT&T's local phone service suing Verizon for poor service. Now it strikes me that the consumer should be able to sue AT&T for poor service, since that is the entity with whom he has the agreement. He has no agreement with Verizon. AT&T, the party with the contract with Verizon, should then turn around and sue Verizon to recoup any damages, if the cause of the poor service is Verizon's treatment of AT&T's leased lines. Although this may sound efficient, there are broader contract principles at stake in this case. If the consumer's case is allowed to go forward, it makes it possible for companies to face lawsuits from people with whom they have no direct relationship. That, I think, is far more problematic than the inefficiency described.

Buy Bin Laden, Sell Hussein

The stock market has started to rebound on reports that the U.S. and Pakistan are close to capturing Osama Bin Laden.

"It's all Bin Laden," said Matthew Johnson, managing director of trading at Lehman Brothers. "The market is reacting to the fact that they are coming close to capturing someone we thought was dead."

Well, I never believed he was dead. So if they capture him, I expect profuse apologies from those who made fun of people who didn't think he was dead. So there.

Me To Accountants

Tough luck. All is fair in love and marketing. Live with it.

Off to a Doubtful Start

In what we can only hope is not a harbinger of things to come, the Accounting Oversight Board had its first meeting last week. During this inaugural meeting, they voted on such important topics as paying themselves $452,000 annual salaries and ratifying a lease to move their Washington headquarters into collapsed accounting firm Arthur Andersen's old space. They also voted down a proposal to rotate their own auditors every 5 years, saying the issue required further study. Yes, these are the people who are supposed to restore investor confidence. I don't know about you, but I'm feeling somewhat confident now - that this board will be meaningless.

The Fundamental Things

The much anticipated dividend tax cut, while sound long-term policy, will not be a quick fix to boost the stock market (WSJ article, registration required). The article echoes much of what was previously said in this post and its comments and adds to it.

The abolition of the dividend tax will provide a further premium to dividend-paying stocks, as investors will be willing to pay more for the higher return. Companies who pay dividends tend to be those that are more mature, not the high-growth companies. However, if a greater premium is paid for dividends, then some of those high-growth companies will alter their current strategies and offer dividends to their shareholders.

While this may seem, on the face of it, to be a good thing in the short-term, it is not necessarily. By paying out dividends, these firms will have less money to pursue growth strategies, such as acquisitions and capital expenditures. Much of what fueled the last bull market was a long, continuous period of corporate M&A and capital purchases. Companies who are issuing dividends will also not be able to buy back as many shares of their stock, which will depress earnings per share and, in turn, market gains. This is no short-term stimulus.

In the long-term, however, this will reward companies who, while not having superstar growth rates, have sustainability of earnings. The importance of that was lost during the dot.com bubble. People, suckered in by the lure of fast money, lost sight of the fact that the fundamentals had not changed. Multiples cannot be maintained on revenues. That point was driven home to us with a bang, or really a crash. Stock prices are driven by long-term profits. So while this move does not provide a quick fix for the market, it does offer the promise of a more stable market in the long-term. The fundamental things apply, as time goes by.

Ratings Stock Over-Rated?

Despite some high-profile ratings missteps, shares of debt rating agency Moody's are still doing very well. However, some analysts are beginning to wonder if the stock might be overvalued (sorry, it's WSJ, registration required). A few factors playing into this:

1. Earnings have grown 30% annually for the last two years. It is unlikely this will continue, with the company forecasting 15% growth for 2003.

2. If the equity market starts to pick up again, which is being forecast by many industry watchers, the bond market will be less attractive to investors. This will lead to a decrease in the amount of corporate debt issuance, which will lower the revenue generated by the rating agencies.

3. There are currently three large ratings agencies in the United States. S&P controls around 41% of the market, Moody's around 38%, and Fitch 14%. There are significant regulatory barriers to entry into this market, so their combined market share has been well protected. The SEC is considering changing that, however. It said a decision will be forthcoming by the end of this month.

Interesting to see what will happen. I think the government should remove some of its imposed regulatory entry barriers to allow for increased competition in this market. There will still be significant natural barriers to entry, and the SEC does need to oversee the ratings agencies and make sure the analysts are qualified. However some competition might shake the agencies out of their comfort zone, causing them to react more quickly with ratings changes. They are notoriously slow to upgrade or downgrade debt.

Please note, this is not a recommendation to trade Moody's stock. I do not make investment recommendations. I am not an equities analyst by trade.

Taxes, Taxes, Taxes

The Bush administration is expected to propose an economic stimulus plan that would exempt 50% of an individual's dividend receipts from taxation. Other facets of the plan include a targeted tax credit for corporate capital expenditures, an acceleration of income tax cuts currently scheduled for 2004, and an extension of federal unemployment benefits. What is conspicuously absent is a Democratic suggestion to reduce payroll taxes for lower-income workers. Aides are concerned that the President is vulnerable to charges from Democrats that he is focusing on higher-income taxpayers, and had encouraged him to drop the plan to accelerate the 2004 cuts.

“If you pay taxes, you’re due tax relief, and the time that it’s needed most is now, as opposed to later,” the official said. “The president is concerned about helping those who are shouldering the burden of this recovery.”

Nearly everyone pays taxes in one form or another. Yet not everyone is going to get the tax relief they are apparently due under this plan. Any meaningful tax reform cannot look at income taxes in a vacuum, as though they are the only taxes that matter. Furthermore it is not only the higher-income taxpayers that are shouldering the burden of the recovery. Lower-income taxpayers consume goods as well, and they spend a higher percentage of their income to do so. They deserve tax relief, and the best way the federal government can provide it to them is to reduce payroll taxes. The President says he does not want to, because it would endanger Social Security. I submit that he should acquiesce to the Democrats on this, and then turn it around and use it as a spur towards Social Security reform.

I also object strenuously to the characterization of rate cuts for higher-income taxpayers as the primary means of economic stimulus. The consumption rates of lower-income taxpayers are much higher, since there is a certain level of consumption that one almost needs to do in order to survive (generally referred to as fixed consumption). In uncertain times, it is not a given that higher income taxpayers will use the additional disposable income for consumption, since their fixed consumption is already well covered. They may, in fact, choose to put it in safe investments, such as government bonds rather than even equities. Lower income taxpayers have a higher probability of using the additional disposable income for consumption.

If the idea is that the higher income taxpayers create wealth by creating jobs, than the tax cuts should be targeted at companies, not individuals. This is why I favor the targeted tax credit for capital expenditures. Such a credit will incent businesses to purchase capital equipment, driving up the revenues of the manufacturers and resellers, which could lead to new jobs. However, reports say that the acceleration of rate cuts is likely to be dropped as part of a compromise anyway.

Nor do I see how a tax cut on dividends provides much economic stimulus. The logic appears to be that it will improve investor confidence and encourage people to invest in profitable companies. I don't see how dividend tax cuts improve investor confidence. Investor confidence has been shaken by a series of accounting scandals and concerns over analyst independence, not by taxation of dividends. I further don't see how this encourages people to invest in profitable companies. Many highly profitable companies do not pay dividends (see also Microsoft). Indeed, profitable companies in aggressive growth industries rarely pay dividends, preferring to reinvest all corporate profits in growth strategies. It is usually the more mature companies that pay dividends. While I do think it is sound long-term policy, and in fact would prefer to see 100% of individual dividend receipts be tax-exempt (as it ends double taxation), I simply do not see it as much economic stimulus.

All in all, the only facets of this plan I see providing economic stimulus are the targeted tax credit for capital expenditures and the extension of unemployment benefits (as it will almost certainly be used for consumption). In fact, I wouldn't even say the extension of unemployment benefits will lead to stimulus as much as it will prevent decline. I have to say I'm disappointed in the reported plan.

Gee, Ya Think?

Greenspan: Economy Has Hit 'Soft Patch' - Reuters

So Long, Mr. Webster Update

It's official. William Webster has resigned as head of the new accounting oversight board.

So Long, Mr. Webster

The Wall Street Journal is reporting that William Webster is likely to resign as chairman of the new accounting oversight board due to continuing questions about his involvement in U.S. Technologies. As head of U.S. Technologies' audit committee, Webster was responsible for firing its auditor, BDO Seidman, after Seidman pointed out some irregularities.

The accounting industry is in need of reform, as the Enron and WorldCom scandals highlight. This gives the Bush administration the chance to place some real reformers in two key positions and take on the mantle of protecting the investor. If they do not, they leave themselves vulnerable to charges by Democrats that the GOP is protecting Big Business at the expense of the regular guy, which could come back to haunt them in two years. Unfortunately, there have been no signs from the administration that they intend to follow that tack.

$ 9 Billion and Counting

Ah, more restatements to come at WorldCom. And Bernie Ebbers is still a free man.

UPDATE: If anyone is counting, this restatement is actually larger than the estimated 2001 GDP of several African nations, including Zambia and Rwanda. Check out how many other nations have GDP lower than WorldCom's restatement.

And Pitt Speaks

In an address at the Securities Industry Association's annual meeting, Harvey Pitt called on Wall Street executives to restore investor confidence and attributed his downfall as SEC Chairman to personal and political attacks.

Regulation can never substitute for people doing their jobs honestly, dedicated to serving their customers as the fiduciaries they are.

While this is undoubtedly true, the fiduciaries have shown us time and again that they are not acting with the interests of their customers. Investor confidence will not be restored by people saying "We're sorry. We promise not to do it again." Until their behavior proves to us that they won't do it again, I fear that regulation is needed to bring investors back to the market.

Levitt Speaks

Former SEC Chairman Arthur Levitt speaks about what is needed at the SEC. Although he doesn't come right out and say that Webster should resign, he broadly hints at it:

Harvey Pitt split the commission vote [the two Democratic commissioners out of five voted against Webster] on whoever was chosen to head the oversight body by giving that body such an action [recommending Webster]. Only a united—a unanimous—commission vote would remove the taint of politicization, which is the death knell of a commission intended to ensure the public of its independence, its integrity and its freedom from political influence.

...

So much of public confidence is a question of appearance. You need people on the board who really are recognized for their professionalism and independence and total freedom from being viewed as political choices.

More Questions About Webster

BDO Seidman, the accounting firm fired by U.S. Technologies, has released documents purporting to show that William Webster fired the firm after it had warned him about financial problems at U.S. Technologies. Webster maintains that he has no recollection of being told about accounting problems prior to firing Seidman, claiming that the firm was fired for being too costly and taking too long on audits. Edited notes released by Seidman indicate that Webster was a participant in a call in which Seidman discussed three key issues at the company, one of which was "Recording significant transactions on a timely basis."

President Bush has urged us to hold off on judgment and wait for the investigation to be completed. This is the absolute wrong tack to take, although I fear it presages a doomed future for any meaningful accounting reform. The purpose of the accounting oversight board is to help restore investor confidence, not to protect Webster's reputation. So many questions about his fitness to run this board have arisen that the need for him to resign to protect the ultimate goal of the board should be clear. The lawsuit filed by Seidman against Webster for making "false and misleading statements" regarding its dismissal will eventually either restore Webster's reputation or damage it further. If swift, assertive action is not taken regarding the accounting oversight board is not taken, however, what will restore the damage to its credibility?

What to do with Webster

Now that Harvey Pitt has resigned as SEC Chairman, the question of whether William Webster should remain as head of the new accounting industry oversight board looms even larger. One top Democrat, Rep. Barney Frank, who will be the ranking Democrat on the House Financial Services Committee, has already called on him to resign. The Republicans cannot afford to let the Democrats make the state of the SEC, the accounting industry, and the integrity of the markets their issues and should also call on Webster to resign. Any perceived weakness by the public on cracking down on accounting fraud could come back to haunt them. The Democrats will jump at it as a way to prove to the public that the GOP stands for corporations against the little guy.

Webster himself has said that if the controversy regarding his role at U.S. Technologies impedes the board's ability to function, he would resign. This is not good enough. One of the stated goals in creating the board was to restore investor confidence in the accounting industry. It should be clear that a man involved in a company accused of accounting fraud is not the right man to do that. He should resign now, and let the new SEC Chairman, whoever that will be, propose his/her own candidates.

To Cut or Not To Cut

UPDATE 2: On further reflection, I do not think this is a good sign. With the expectation of more aggressive fiscal policy, an aggressive rate cut like this one indicates that the Fed thinks the economy is in need of both aggressive fiscal and monetary policy to turn it around.

UPDATE: Well, the cut is in, and it's an aggressive 50 basis point cut. Wouldn't be surprised to see the market shoot up for the rest of the day.

That is the question in the aftermath of the Republican victory. Will the FOMC deliver the expected 25 basis point rate cut? Or will it decide that with a Republican-controlled Congress, fiscal policy will become more aggressive, so monetary policy does not need to be as aggressive? We'll find out in about a half-hour. Stay tuned.

A Strong SEC

Daniel Akst has an interesting column in The New York Times on how corporations benefit from a strong SEC.

Don't Refinance Just Yet

Economists expect a further rate cut may come at next week's FOMC meeting, amidst slower than expected GDP growth and a startling drop in consumer confidence.

A Fund-amentally Sound Policy?

Meanwhile back at the Corporate Governance Summit for Institutional Investors (is that a mouthful or what), U.S. fund managers are espousing a cautious approach to corporate reform.

"I think our principle is going to be 'if we don't like the way a company is run we should have avoided it before buying it'," Lasser said. If Putnam, which oversees some $238 billion in mutual funds and other portfolios, discovers after it bought a stock that there is some problem with management "probably we should sell it rather than hold it and attempt to change it."

All in all, this sounds like a workable policy. First of all, they really have a duty to their fundholders to sell off shares in a company they don't like. Second of all, if an institutional investor sells off their holdings in a company and lets it be known why they are doing so, this will place pressure on the corporation to change anyway. Much better than working behind the scenes and keeping the stock price inflated by doing so.