There a relatively new correlation between the stock market and employment, 401K contributions, that isn't receiving the attention that it deserves. Over the last 20 years, the stock market has enjoyed the benefit of a positive inflow of cash from 401Ks and retirement plans. It is likely that you will see this tailwind become as headwind for the market as more people draw on 401Ks and fewer people contribute. While there may be a net positive inflow in different sectors, inflows will be significantly lower than in the past.
There are three factors driving increased use of retirement savings. First, people are getting older and need income to live. Second, the unemployed will need a way to live and retirement savings is much cheaper than consumer debt. Third, even those that keep their job will need to need to paydown debt. Borrowing against a retirement plan will be attractive to many. In short, people are going to start using retirement accounts more and more.
This capital drain will cause some headwind for the market. This drain is going to occur at the exact same time as people reduce their commitment to retirement savings. There are three factors which will make people realize that saving for retirement makes no sense when they face insolvency in the present.
First, many of the unemployed have lost access to 401K plans which will constrain the inflow of capital into the market. They can't contribute a portion of a salary even if they have found a parttime job. Beyond the loss of employee contributions, the market is going to lose capital committed by employers as a match. In the net, the capital inflows from retirement plans will be growing more slowly over the next few years.
Second, companies are looking for ways to cut costs. As part of this initiative, employee benefits are under constant scrutiny. This scrutiny may play out in 1 of 3 ways. Companies may eliminate the benefit outright. Even if they keep the benefit, they may reduce or alter the matching payments. Even if the companies keep the benefit with the same matching terms, the market will still feel the loss of inflows if the company changes the match from cash to restricted stock. Given the labor market, it is difficult to image many companies increasing the capital allocated to matching retirement savings for employees.
Third, the most likely factor in reducing retirement savings will be the deleveraging of America. It is very difficult to justify saving for the future when the present is insolvent. Americans will shift resources currently set-aside for retirement to paydown debt. This process will be exacerbated by banks which are increasing interest rates and fees on access to credit. The basic problem is that consumer debt isn't tax deductible where retirement income is.
To give you some idea of how unfavorable retirement saving is vs consumer debt. If an employee puts away $1,000 with a $1,000 employer match, it will be worth almost $300,000 when the employee retires after 30 years (assuming an 8% return). After taxes, it will be worth something less. $1,000 of consumer debt at 14% will be almost 5 million dollars after 30 years. It isn't going to take a CFA for people to figure out that retirement savings simply makes no sense when they owe any consumer debt much less 2 trillion dollars of it.
Saturday, October 31, 2009
Wednesday, October 14, 2009
The New Normal
The government’s efforts to save the economy have met to date with mixed results. On the positive side, the larger banks have shown profits, where even Citigroup has shown a profit of sorts. On the negative side, unemployment is increasing and underemployment is skyrocketing. The media has termed this the new normal. I would prefer the term what-the-hell-did-you-expect to describe the near-term prospects for the economy.
Here is the problem. The economic equivalent of Boyle’s Law is that you cannot create or destroy economic demand without creating wealth. The government cannot create wealth. The government can shift demand from one business to another by changing the relative cost of goods. It can shift demand from the future to the present by lowering the cost of consumption, ie interest. The government cannot create demand by itself, nor can induce economic prosperity with fiscal stimulus.
Stimulus without innovation is nothing more than borrowing prosperity from the future. It is unavoidable truth that when you create demand in one industry, say in autos with a cash-for-clunkers program, you are reducing demand somewhere else. When I spend $20,000 on a car, it is $20,000 that I am not spending elsewhere. In the case where I borrow the $20,000, it is $20,000 that I am not spending sometime else. The sum of the government’s effort is zero, where we are pushing demand from one business to another or from the future to the present.
I serve as an illustration of the problem. I am replacing perfectly workable air conditioners and heaters because the government is taking money from someone else to help me pay for it. The money that I am spending replacing the perfectly good air conditioners and heaters means that I am not doing the painting which actually needs to be done until next year. This is a zero sum game at best – and a negative sum-game should we find that good painters become bad air conditioner installers.
The government’s current approach to stimulus is far from a best case situation. We are heavily subsidizing the auto and lending industries. Both of these industries suffer from massive excess capacity. In the best case of the example above, a good painter becomes a good air conditioner installer because the increase in demand will lead to hiring. In the America in 2009, however, businesses aren’t hiring because the increase in demand serves only to soak-up excess inventory. So, the painters just become unemployed. This is why you see the GNP bottoming but unemployment increasing.
Price is the market mechanism for clearing inventory. Instead of allowing the price to clear excess inventory, the government is stealing demand from elsewhere to justify the existing price. The market works best when it is allowed to punish these people who cannot price products well. In this case, the market is punishing random people who had nothing to do with the poor decisions in the first place. The consequence is socialization of stupidity, in which the foolish benefit at the expense of everyone else.
This consequence is most clear in banking, where the government has decided to subsidize risk. We have lowered the cost of capital well below it true value. These subsidies have led many businesses to form a bank holding company. Subsidies in the case of health care and agriculture are of debatable merit, but they at least subsidize a public good. Comically enough, we are encouraging people to take risk during a credit crunch when capital should be treated with a premium. This is a level of stupidity that should be beyond even government bureaucrats.
The earnings report from Goldman Sachs is an unavoidable outcome of our folly. 80% of Goldman’s earnings came from proprietary trading. The report doesn’t indicate the amount of public assistance that Goldman received. But, as a bank holding company, it is entitled to borrow at the discount window. It can access the Treasury Auction Facility. It can issue debt backed by the FDIC. So while it may have paid back the TARP funds, Goldman Sachs has many lines of public assistance to subsidize its proprietary trading group. Is proprietary trading a public good?
Folks if you are wondering why we are seeing mixed messages in the economic results. It is because the government has one of the worst economic agendas since the Great Depression.
Even by government standards, this is simply stupid.
Here is the problem. The economic equivalent of Boyle’s Law is that you cannot create or destroy economic demand without creating wealth. The government cannot create wealth. The government can shift demand from one business to another by changing the relative cost of goods. It can shift demand from the future to the present by lowering the cost of consumption, ie interest. The government cannot create demand by itself, nor can induce economic prosperity with fiscal stimulus.
Stimulus without innovation is nothing more than borrowing prosperity from the future. It is unavoidable truth that when you create demand in one industry, say in autos with a cash-for-clunkers program, you are reducing demand somewhere else. When I spend $20,000 on a car, it is $20,000 that I am not spending elsewhere. In the case where I borrow the $20,000, it is $20,000 that I am not spending sometime else. The sum of the government’s effort is zero, where we are pushing demand from one business to another or from the future to the present.
I serve as an illustration of the problem. I am replacing perfectly workable air conditioners and heaters because the government is taking money from someone else to help me pay for it. The money that I am spending replacing the perfectly good air conditioners and heaters means that I am not doing the painting which actually needs to be done until next year. This is a zero sum game at best – and a negative sum-game should we find that good painters become bad air conditioner installers.
The government’s current approach to stimulus is far from a best case situation. We are heavily subsidizing the auto and lending industries. Both of these industries suffer from massive excess capacity. In the best case of the example above, a good painter becomes a good air conditioner installer because the increase in demand will lead to hiring. In the America in 2009, however, businesses aren’t hiring because the increase in demand serves only to soak-up excess inventory. So, the painters just become unemployed. This is why you see the GNP bottoming but unemployment increasing.
Price is the market mechanism for clearing inventory. Instead of allowing the price to clear excess inventory, the government is stealing demand from elsewhere to justify the existing price. The market works best when it is allowed to punish these people who cannot price products well. In this case, the market is punishing random people who had nothing to do with the poor decisions in the first place. The consequence is socialization of stupidity, in which the foolish benefit at the expense of everyone else.
This consequence is most clear in banking, where the government has decided to subsidize risk. We have lowered the cost of capital well below it true value. These subsidies have led many businesses to form a bank holding company. Subsidies in the case of health care and agriculture are of debatable merit, but they at least subsidize a public good. Comically enough, we are encouraging people to take risk during a credit crunch when capital should be treated with a premium. This is a level of stupidity that should be beyond even government bureaucrats.
The earnings report from Goldman Sachs is an unavoidable outcome of our folly. 80% of Goldman’s earnings came from proprietary trading. The report doesn’t indicate the amount of public assistance that Goldman received. But, as a bank holding company, it is entitled to borrow at the discount window. It can access the Treasury Auction Facility. It can issue debt backed by the FDIC. So while it may have paid back the TARP funds, Goldman Sachs has many lines of public assistance to subsidize its proprietary trading group. Is proprietary trading a public good?
Folks if you are wondering why we are seeing mixed messages in the economic results. It is because the government has one of the worst economic agendas since the Great Depression.
Even by government standards, this is simply stupid.
Tuesday, October 13, 2009
"What Conservatives Don’t Get"
The Conservative mantra of the day blames the current financial crisis on the government’s over-regulation of an otherwise sound banking system. They want you to believe that the crisis stems from an intrusive government forcing lending standards lower by government fiat, namely the CRA. While the government is at fault here, the government's intervention in the banking system is only a component of a much larger problem.
People think for a second. The entire sub-prime market is only 500 billion dollars. Every mortgage could go bad, and you are looking at a something less than a 250 billion dollar loss. The real estate market has lost over 3 trillion in value or more than 10 times as much – and we have yet to see even 50% of the sub-prime mortgages default. If the Community Reinvestment Act was a fault, why is the housing crisis centered in the condo markets of Vegas, Phoenix, and Miami.
The housing crisis is a serious problem, but it is only a part of the larger problem which is debt, specifically consumer debt. In economic terms, investment debt is unpredictable, where the economic impact of the debt depends on the success of the investment. Consumer debt on the other hand is very predictable. It pushes demand forward getting consumers to buy today what they would normally wait to buy. When we express future demand today, we pull revenue streams forward, thereby overstating present revenue.
The builder, unfortunately, doesn’t think that his revenue is overstated, and neither does the banker who starts lending on looser and looser terms. To them, the boom will never end. So the builder, in turn leverages his wealth, buying things from people who find themselves suddenly richer. Those people in turn leverage their wealth, and so on and so forth, until the economy is brimming with imaginary wealth entirely built upon imaginary revenue.
The problem is that at some point there isn’t enough future demand to pull forward. We hit that point in 2007. Housing demand for 2007, 2008, and 2009 had been depleted, having largely been filled in 2004, 2005, and 2006. There was no cheaper capital to pull into the game of low interest rates. In fact, we were experience the opposite as interest rates on variable notes reset higher, forcing the housing crisis. Higher rates forced people to sell at the exact same time that demand was falling. This was the housing crisis.
In the net, the problem wasn’t the marginal poor person buying a house that he couldn’t afford. The problem was the near-rich person who bought the swimming pool for the house that he couldn’t afford. It was people spending imaginary wealth, borrowed from bankers who imagined growing revenue streams. Having worked in banking for 20 years, I can assure you that the government didn’t force bankers to make bad loans any more than the zoo keepers force lions to eat red meat. The government simply lowered interest rates below the rate of inflation and stood back to watch economic gravity take hold.
The government is almost entirely responsible for this mess, but as conservatives lets at least blame the right people, and learn the right lesson. Failing to assign the blame for economic bubbles is the reason that so many politicians try to create them.
People think for a second. The entire sub-prime market is only 500 billion dollars. Every mortgage could go bad, and you are looking at a something less than a 250 billion dollar loss. The real estate market has lost over 3 trillion in value or more than 10 times as much – and we have yet to see even 50% of the sub-prime mortgages default. If the Community Reinvestment Act was a fault, why is the housing crisis centered in the condo markets of Vegas, Phoenix, and Miami.
The housing crisis is a serious problem, but it is only a part of the larger problem which is debt, specifically consumer debt. In economic terms, investment debt is unpredictable, where the economic impact of the debt depends on the success of the investment. Consumer debt on the other hand is very predictable. It pushes demand forward getting consumers to buy today what they would normally wait to buy. When we express future demand today, we pull revenue streams forward, thereby overstating present revenue.
The builder, unfortunately, doesn’t think that his revenue is overstated, and neither does the banker who starts lending on looser and looser terms. To them, the boom will never end. So the builder, in turn leverages his wealth, buying things from people who find themselves suddenly richer. Those people in turn leverage their wealth, and so on and so forth, until the economy is brimming with imaginary wealth entirely built upon imaginary revenue.
The problem is that at some point there isn’t enough future demand to pull forward. We hit that point in 2007. Housing demand for 2007, 2008, and 2009 had been depleted, having largely been filled in 2004, 2005, and 2006. There was no cheaper capital to pull into the game of low interest rates. In fact, we were experience the opposite as interest rates on variable notes reset higher, forcing the housing crisis. Higher rates forced people to sell at the exact same time that demand was falling. This was the housing crisis.
In the net, the problem wasn’t the marginal poor person buying a house that he couldn’t afford. The problem was the near-rich person who bought the swimming pool for the house that he couldn’t afford. It was people spending imaginary wealth, borrowed from bankers who imagined growing revenue streams. Having worked in banking for 20 years, I can assure you that the government didn’t force bankers to make bad loans any more than the zoo keepers force lions to eat red meat. The government simply lowered interest rates below the rate of inflation and stood back to watch economic gravity take hold.
The government is almost entirely responsible for this mess, but as conservatives lets at least blame the right people, and learn the right lesson. Failing to assign the blame for economic bubbles is the reason that so many politicians try to create them.
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