Merry Christmas

I lied. I had to write another blog before the end of the year, particularly because of what's going on in D.C. with TARP money.

Treasury guru and tax cheat Tim Geithner is proudly puffing his chest proclaiming victory, as bank after bank lines up at the door to pay back TARP funds they received earlier this year. After all, this prevented a meltdown of epoch proportion and saved us all from financial ruin. And banks have stepped to the plate by paying us back, right?

Hold on Timmy. Let's re-visit the whole TARP debacle in the first place.

Those funds were issued to save failing banks and prevent insolvency, so in that respect, yes, the financial system was saved. Additionally, consider the fact that the FDIC is unable to make good on the deposits at Citi, Wells or Bank of America should one of them collapse. In this sense, TARP prevented the treasury from having to loan the FDIC another $500 billion (adding to our debt, of course.)

However, TARP funds were explicitly given to stimulate the economy through one of two methods. Banks were supposed to use the money to LEND - both to businesses and consumers. That ain't happening. The other proposal was to have banks use the funds to write off the debts as bad debts and start from scratch. That isn't happening either. If you have any doubt, just see how many foreclosures are going on nationwide and business closing are occuring.

In short, banks aren't lending anymore today than they were a year ago.

Instead, banks used the funds to prop up their balance sheets, or in some instance (cough...cough... PNC) buy weaker banks at a 0% interest rate.

Now the banks are proudly stepping up to the plate to payback those funds! Yippee skippy! This is good, right?

Maybe not. The reason Citi, Wells and BOA are so happy to payback the TARP funds is because if they don't, they will have their compensation capped. (cue 'crickets chirping in background noise' here....)

Yep. We're passing legislation that caps compensation to firms that accepted TARP or TALF monies. So what is any good CEO and/or board of directors to do? Pay the damn loan back, that's what! Otherwise, bonuses become obsolete and second homes need to be sold, girlfriends need to be dumped and yachts need to be crashed into the rocks.

So Citi and others are paying at back. They're doing it, of course, by issuing more worthless shares of stock that for some reason, investors are purchasing. Can't anyone read a balance sheet anymore and realize that banks are supposed to make money by making loans? Think about it for a minute. If Krispy Kreme stops selling donuts, is their stock worth very much? So why would BOA, Wells, etc. be worth anything if they aren't making quality loans or they haven't written the bad loans off and basically started over?

The irony, of course, is that we still proclaim victory and that the banks are acting admirably. That's crap and everyone knows it. Tax payers gave them free money for a year and now that they are demanding retribution, the banks are more than ready to give something back to the community. Give me a break.

Please do me a personal favor this Christmas. Take a small sum out of your large bank (if they accepted govt. money) and place it in the local bank that actually knows your name and address - one that didn't accept funds from Tim Geithner. You know the one. The bank president probably sits next to you at church or your kids plays soccer with the VP of lending's kid on Saturday. Stick it to the big banks.

Now they want to take the extra $200 billion and create jobs. Here's a novel concept. Give it back to me and my buddies who fronted it in the first place. Best estimates show that about 150 million of us pay taxes annually. Split the $200 billion up and mail us each a check. That way all of us would get a NON-TAXABLE check for about $1300, or $2600 for a married couple. It's our money anyway. Imagine how far $2600 would go for your family. I know ours would enjoy a much merrier Christmas, as we'd... GASP.... SHOP. Stimulating the economy on our own without the help of D.C.

This is bad, folks. Even for a professor who is supposed to be enjoying his month vacation. My blood pressure is almost above normal which isn't good for a guy that's trying to be Jimmy Buffett.

Tax is a dirty word

Well it's official - the state of Pennsylvania LOVES to tax its residents. One type of resident, however, seems to pay more than others. That resident is one who participates in 'sins,' like drinking (Allegheny County has a special drink tax to fund public transportation) smoking (currently about $2.45 per pack in PA) and gambling. MAdditional legislation is being proposed in Pittsburgh to tax gambling profits more so that the city can balance the books.

One sin flies under the radar, however, and it's actually worth examining - pornography.

It certainly makes one stop and ask why, doesn't it? After all, we're more than happy to tax smokers until they are literally blue in the face, and taxing adult beverages hasn't hurt profits or the number of drinks ordered. Doesn't it stand to reason that our society's appetite for pornography would remain consistent even with additional taxes?

Come to think of it, doesn't it make sense that the adult entertainers might actually be required to pay a portion of their hourly rate and claim 'tip' income, similar to my favorite waitress at Susie Q's?

While I'm no proponent of paying taxes, this industry has gotten a free pass too long and instead of burdening industries that are already paying more than their fair share, like bars and restaurants, shouldn't another industry shoulder some responsibility? Particularly when that industry likely serves alcohol and allows smoking?

So why don't our legislators touch this proposal with a ten foot pole (pun intended?) Only Senator Jane Orie, a Republican from McCandless, has attempted to tackle the debate so far, and she is getting no traction whatsoever.

As a free market thinker, it seems to me that our legislators are sending a clear signal that rather than stimulate the economy with tax paying businesses like restaurants, casinos, service companies, etc., they are suggesting it makes better business sense to get into the pornography industry. After all, it's basically a tax free business that has proven to be recession-proof. What kind of message is this? The industry is likely responsible for as many marital conflicts as drinking problems, gambling problems, etc., so if that's the hurdle to be classified a 'sin,' pornography definitely fits the bill.

It's got to be more than that. Perhaps our legislators have friends that run in these circles and contribute to not only their personal campaigns, but their personal entertainment as well. Who knows.

In any case, this is actually one tax I'd support completely, as it would actually legitimize the business, its participants and those who enter the darkened-doors.

Oh behave!

Good news coming out of Washington! Apparently there is no inflation and things aren't costing more.

What? Does anyone in Washington purchase their own food, gasoline or healthcare? I forgot - those expenses are covered by lobbyists.

On a serious note, the CPI is down about 1.3% compared to a year ago, meaning that goods or services that cost you $10 a year ago now cost about $9.87. So what's the real story?

Behavior finance and economics suggests that most consumers feel pain more vividly than they feel joy. Basically, we like to avoid losing money more than we like making the same amount of money, even though 'old school' economics teaches us that consumers seek to maximize their pleasure, or 'utility.'

Former Wimbledon champion and tennis great Ivan Lendl perhaps said it best when he was quoted saying "I hate losing more than I like winning." Remember, this is coming from a guy who used to win all the time.

We drive around searching for gas that is $2.72 per gallon instead of $2.75, but won't cross the street for cheaper gas that's $2.08 instead of $2.11. Why? It's a better bargain in the second scenario, after all.

The applications for the economy are far-reaching. We see gas prices going up, but forget that they are down 30% from a year ago. That doesn't offset the 29% increase in prices of fuel over the past six months. We have short term memory, and the figures seem to support behavioral theory. Consider the following (yes, I'm keeping the math simple because it's early and my brain isn't working too well yet)

Assume that gas a year ago cost $3.00 per gallon. A 30% drop in fuel would mean that gas costs $2.10. WOW! That's signficiant. Oops. Now gas goes up 29%, resulting in a new cost of $2.71. Yikes! That hurts, even though it's still less than the original starting point of $3.00.

The same calculations can be applied to the stock market. Assume your retirement plan had $50,000 a year ago and the market lost 25%. You'd be down to $37,500. It takes a 35% gain this year to get back to square one. Sadly, this is what's been going on with investments the past two years, creating opposition to something called the wealth-effect. In short, if consumers feel wealthy (good returns on their 401k, appreciating values on their homes, lower unemployment figures, etc.) they are more likely to spend. There hasn't been much good news or even 'paper returns' to allow consumers to feel wealthy - even a nice return in the market the past six months.

To further support this 'behavioral stuff,' as my wife calls it, consider an even-money bet. Let's say I flip a coin and we bet $1. If it comes up heads, I win $1 from you. If it comes up tails, you win $1 from me. Easy enough? We know that most people would take the bet. What if I won two straight times? Three times in a row? How about four or five?

What if I make the bet $10 per flip, or even $50? At what point do you jump off and act out of 'fear' rather than rationality? We allow the dollar amount to skew our ability to judge. Don't worry, I'm guilty of this too. Studies have shown that when the bet goes to $100 per flip, most folks would demand payment of $160 if they win. I'm not about to take the other side of that bet anytime soon, by the way.

See what I mean? We're easily tricked by math and to be frank, it stinks. I fall for it all the time and I study this junk!

So sit back, relax and take consolation in the fact that you are paying less for things today than you were a year ago while you're driving around looking for the cheapest gas station around.

Lining the litterbox with Time

I promised my doctor that I would keep my blood pressure in check, yet Time Magazine continues to get those numbers well above the 120 over 80 requirement.

In the most recent edition, Time suggests it's time to eliminate the 401(k) plan and instead, re-institute pension funds from corporations. The writer is Stephen Gandel, who apparently is not certain what direction to go. Please let me explain.

While Time is entitled to their opinion and Mr. Gandel entitled to his own, it seems to me that once your opinion is formulated and you've spent, oh, I don't know, twenty years or so writing about financial issues, you should have a pretty clear idea of where you stand.

Apparently Mr. Gandel has difficulty in that arena.

You see, he writes in the most recent article that the 401(k) has been a debacle, serving no one and simply creating fatter paychecks for executives. He attempts to site a simulation run by T. Rowe Price as an example of searching for an optimum portfolio, but doesn't give any clear indication of the results other than a fancy "most of the time the market goes up slightly. But some years - KAPOW - stocks and bonds do spectacularly poorly." Big word there, Mr. Gandel.

Especially coming from a guy that only three years ago suggested that 401(k) contributions were the smartest thing an individual consumer could make. That's right. Our beloved Gandel wrote that it would be wise to "contribute as much to your 401(k) that the employer will match." In short, he summarized a 401(k) contribution as a smart thing to do in an interview with http://www.first30days.com/

If you'd like to read his jibberish or need proof, please click here:

http://www.first30days.com/smart-investing/articles/stephen-gandel-on-smart-investing.html

Please also note that he thinks sometimes we need to "trick people into investing." Lucky for us he's writing for Time, eh?

No, Mr. Gandel. The answer is the same as it's always been. Small, regular contributions to a self-directed retirement account, with most of the contributions going toward stocks and growth while one is young, and then gently moving toward bonds and money markets as one gets closer to retirement is the best bet. Always. Prove otherwise if you don't agree.

A simple rule of thumb to follow is put your age into bonds (as a perecentage.) For example, I am 40 in December (ouch) and should have 40% of my retirement contribution going toward bonds funds and others 'safe' investments. No more than 10% of my portfolio should have my company's stock in it, by the way.

I ask each of you to call Time (their email is down) and ask them to begin behaving like a real magazine rather than allowing some journalistic hack like Stephen Gandel change his spots "Time and Time" again. Pun intended.

Answer truthfully.

Who can you name first, the Federal Reserve Chairman or Brad Pitt's wife?

That's what I thought. And while you're at it, why don't you take some time to explain to me the inner-working of the Federal Reserve system, like the number of branches it has, who the board of governors are and the primary role of the Federal Reserve. Psst. By the way, it is NOT the job of the Federal Reserve to insure your money at the bank. That's the FDIC, who we will mention later.

Not many Americans get beyond answering Angelina Jolie, by the way. Which is deliberate in design in my opinion.

After all, if you ran an organization that was created by Congress but wasn't responsible for opening its' books for audit, would you be in a hurry to make the organization well-known? That's exactly what are friends at the Federal Reserve are suggesting, by the way, when they appeared earlier this week in front of the House Financial Services Committee. The committee is suggesting the Federal Reserve open the books for an audit conducted by the GAO (General Accounting Office.) After all, it is our money and we would like to see exactly how it's being spent from time to time. And yes, I agree with Barney Frank on this one. Representative Frank is proposing this legislation.

The prevailing mentality seems to question what the Fed is hiding and why they don't want to open the books up for review by the very body that created their existence. Our friends at the Fed maintain the position that theirs "is a politically neutral position" and any dabbling in the books would have an adverse impact on the economy.

Psst. Excuse me, Mr. Bernake? Take a look around. The economy already is in shambles and by the way, I pay your salary and am your boss. Remember that Obama guy who re-appointed you? Yeah, well Joe Taxpayer voted him in and it's his job to make sure you're doing things right.

My thoughts? It's deeper than that. And at the risk of getting too technical, I'm going to tie-in previously mentioned FDIC (Federal Deposit Insurance Corporation) and our friend Shiela Bair. You're going to be hearing a lot from Sheila in the coming months, so I'd get used to hearing her name. She runs the FDIC, which is an insurance company in place that allows us to feel safe and secure knowing our money will be paid back to us if our bank should fail. The banks fund the insurance policy through their membership, and the organization was created in response to the great depression rush on the banks. Naturally the thought process was to avoid another run on banks when depositors felt unsure about their bank's stability.

Guess what, folks? They are running out of money at the FDIC. Sheila and her group had a balance of just over $45 billion in June of 2008 according to Fortune Magazine. As of close of business June of this year, the balance clung to about $10 billion. Gulp.

And with more banks set to fail (to date the FDIC has allowed 94 banks to fail this year and 25 last year) the FDIC is getting precariously close to the edge of needing it's own bailout. By the way, the FDIC has a list of over 400 troubled banks that could go under at any minute.

Shazam! Flash back to our friend Ben and his merry men at the Federal Reserve Board. The Fed has extended an open line of credit for up to $100 billion to the FDIC in case of emergency (think of it like a Visa card for you and a credit line of $1 million.) Additionally, new legislation passed this year allows the FDIC to hit that line for up to $500 billion in an extreme emergency. This is the same Fed that gave bailout funds, er, I mean TARP funds to banks like PNC so that they could buyout ailing banks at a 5% rate. Banks like National City, who otherwise would have already imploded and further hit the FDIC wallet, further reducing that $10 billion balance. Odds are good there's another bank of significance on the brink (Cough Cough... Citi....)

So back to our beginning question and resulting debate: Why is the Federal Reserve really afraid of opening up its' books and allowing the General Accounting Office to take a peek under the hood? Could it really be to avoid political bias, or could it be more a reason of fear. Fear that there is no oil in the engine, the battery is dead, the brake lines have been cut, the transmission is leaking and oh yeah, by the way, it's out of windshield wiper fluid too. I propose the latter.

One final note to ponder, and then I'll let you go this fine morning. The Federal Reserve raises funds through auctions of Treasury Bills and notes, also known as DEBT. You issue debt when you don't have enough money to meet short-term expenses. Joe Taxpayer is footing the bill for this.

Let the banks implode. Get rid of the Federal Reserve and let the FDIC figure it's own way out of this one. Enough of the fiscal parenting for lousy monetary policies. Let's get back to basics and provide budgets that are real and attainable and a government that is there to merely implement the will of the people.

I can't believe I actually agree with Barney Frank!

Banking on our uncertainty

In an story that caught about a ten second blurb this week on Friday morning, the Federal Reserve is working on a plan to not only monitor pay compensation but also one that will allow the Fed to adjust or change the pay practices at Wall Street financial firms. Not just firms that accepted bailout funds, but any financial firm that the Fed deems necessary based upon the firm's excessive risk-taking practices. Also note that the language does not simply limit the pay for executives at the firm. It has the right to limit the pay to anyone that works at the firm according to a Wall Street Journal report.

Excuse me, comrade?

Where does one begin in an attempt to shoot holes in this idea?

Perhaps the easiest target is the Federal Reserve itself. You know the group, right? The same group that sets interest rates in order to manipulate the economy, avoiding recessions, inflation, speculative practices, steering the U.S. to continued economic prosperity and ensure that banks continue to lend to businesses and indivuals that deserve a loan. How's that working so far, Mr. Bernake?

Maybe it's better to look at the Fed based upon the past. The same history that gave former Treasury Secretary Hank Paulson a blank check to bailout Wall Street firms (of which I was critical, I might add.) The same history that kept interest rates artificially low for too long in order to allow the gluttonous behavior to continue. The same history that took budget surpluses at the end of the 1990's to a whopping $11 trillion debt. Again I ask, how's that working?

Consider the impact of keeping overnight rates at 0% (not a typo) since December of last year and no sign that they are going up anytime soon, and then asking a banker to not take some risk with 'free' money. Oh yeah, while you're at, throw in the fact that the Fed is asking banks to make loans to get the economy rolling.

Oh, maybe I'm being too harsh.

Surely there's some good, right?

Ah yes, the same Federal Reserve that has partnered with ACORN since 1977 to enforce bank compliance with the Community Reinvestment Act. In mortgage land, CRA loans (as they are called) are also known as 'subprime' mortgage loans to folks that generally would not qualify for a home based upon credit or ability to repay. How's that working?

To be fair, I hate the banks. Ask any of my students, and they will tell you the adjectives I use to describe most bankers are "lazy, fat and boring. And lazy. Did I mention lazy?"

But to be true to my roots, I also believe in capitalism, entrepreneurial spirit and the corporate structure. If a publicly traded bank like, oh I dunno, Bank of America, wants to make loans it thinks will perform and reward shareholders, shouldn't they be allowed to do that? After all, it's their job to maximize shareholder wealth - not anyone else's wealth. SHAREHOLDER wealth. If the shareholders think the CEO and board are doing a lousy job by taking too much risk with too little potential return, they can (and often will) fire the CEO and replace the board.

Similarly, if the U.S. government wants to get into the banking business, they have two ready-made platforms to execute that plan while remaining outside the circle of overseeing pay for private firms. Maybe the names Fannie Mae and Freddie Mac ring a bell in your head. If the Fed wants to be in banking, turn Fannie and her brother Freddie into large national banks that are required to adhere to strict compensation, risk and corporate management guidelines. Make them play by the same liquidity rules as the other banks and let all of the banks duke it out. Guess who will win, comrades? Yep. You, me and cousin Vinny due to increased competition and a level playing field.

What's next? Will the Fed determine it's their job to monitor and adjust the pay for professional athletes? Does Big Ben really deserve $110 million to throw a football? After all, he's taking a LOT of risk going out there against 330 pound men eager to rip him to shreds. Maybe they will think that doctors should only earn "X" per year regardless of their specialty, or that accountants cannot earn more than "Y." The system is already in place around the country in the form of government pay scales and in many instances labor-contracts, which primarily exist between governments and their employees, the exceptions being large unions like the auto-workers, mine workers, steel workers, etc.

Farfetched? We already have a minimum wage. Doesn't it stand to reason there could be a maximum wage? And while we are accustom to having a minimum wage to assist those with few valuable skills and protect workers from abuse, how does it feel knowing the shoe could be on the other foot, limiting your skills and placing a maximum value on what you have to offer? It's not as crazy as it sounds, folks. And it's happening and a rapid pace.

I'm not in the predicting business, but here's one for ya.

There are going to be three very large national banks in the next three to five years that are entirely government run. Their names are Bank of American, Chase and Citigroup. They will be merged and monitored by Fannie Mae and Freddie Mac, who will report directly to the Federal Reserve Board. The Federal Reserve Board is going to become a fourth branch of government.

Hold onto your wallet and get out your voter card to make sure it's still either Republican, Democrat, Independent and not Socialist or Communist.

Takin' care of business

Have you hit the skids yet? After all, the kids are back at school, school buses are clogging up the highways and nights are getting longer. Sometimes just for kicks my wife and I will hang out on the porch when it gets dark early and pretend that it's still summer. It's not, of course, but pretending is fun.

Pretending is not fun, however, when a business is at risk of making game-changing mistakes.

A business owner recently called me and asked for my evaluation of their current cashflows so I rolled up my sleeves and dug into some antiquated spreadsheets about customers, an unaudited profit and loss statement and an unaudited balance sheet. If those three things sound sorta, you know, casual, it's because they are. In short, it's like keeping your checkbook balance on a paper napkin or a grocery receipt.

Regardless, I did my best and came to the conclusion that only about 30% of the business promised to him by his customers actually resulted in a sale, yet the staff had to go through about 80% of the promised business. They were spending a ton of time working on potential sales that would never transpire, as history showed that the customer-base failed to deliver most of the time. Of course, there were a few notable exceptions, which I pointed out in my moderately formal report back to the client. The staff was frustrated because they felt like they were working too hard and too long. And they were correct. Unfortunately the company was not profiting from their efforts.

Upon delivering the report, I followed-up with a phone call and a lengthy discussion in order to point out some significant cost saving measures. The culmination of the call came when I suggested something radical - eliminating over half of his customers and focusing on the remaining customers that could deliver promised sales on a fairly regular basis. A final suggestion was to perhaps remove one or more of the positions that served the customers since there would be far fewer potential sales to screen in order to get to an actual sale.

To say I was pleased with my findings, both quantitative and qualitative, would be an understatement.

"Christian, I see your point but I'm thinking of adding staff so that we can hit the break-even point," was his response.

(Crickets chirping here, please.)

"Chris, are you there?"

It's as if my hard data and suggestions weren't even heard or acknowledged, and in fact, I was living in opposite world. I had suggested firing clients and staff, focusing on the core business and streamlining things - not taking on additional payroll, headaches and a bigger nut to crack.

Pretending is not a good option if you are a business owner. In fact, it's not a good option for anyone (unless you are a girl pretending to be a fairy princess or a kid that wants to throw the winning touchdown pass in the Super Bowl.)

But we all pretend, don't we? We pretend that a relationship that has been horrible for twenty years is going to change, or that a job we hate will change once the economy turns around or perhaps a child/loved one that has been a hell-raiser will finally come around.

In relationships we call this 'vested,' or in poker we call it 'pot-committed.' In short it means that emotionally it's too hard to remove ourselves and it seems the only logical thing to to is see it through the (already known)outcome.

As a business owner, it's imperative to never become enamored with an idea that stops working or your 'baby.' Focus on the bottom line and once it goes to red, get out immediately.

GM, Chrysler, National Record Mart, Asbestos, Polaroid One Shots, typewriters and carbon copies were all great ideas too. Now they are all either firmly planted along the landing strip of business progress or approaching quickly. Sometimes (most times) technology impedes our ability to keep doing the same thing and make the same profits. The runway is covered with failed landing attempts.

Recognize when the business changes and prepare to make drastic changes to meet the challenge, or prepare to close shop. Those are the only alternatives in business, and in life, actually.

I have a friend that says "if I have to kiss a frog, I kiss the frog and move on."

I urge each of you to find the frogs remaining in your life, kiss them goodbye and move on. Only princesses get to kiss frogs and have them turn into a Prince.

Labor of love

Happy Labor Day folks. The deliberate writing and delivery of this blog indicates that while I appreciate the day off, I probably don't need it right now. After all, the kids have been in school exactly one week, I've been working exactly three weeks and football season hasn't even started so there's no reason to need a Monday off right now. But I digress.

At the risk of becoming one of those nasty, right-winged, hatred filled, venomous fear-mongers, however, I think a few minutes should be spent on just how much it costs to run a business before we simply kick back enjoy a cold beer and some potato chips this afternoon sticking it to 'the man.'

First and foremost, please remember that 'the man' is risking everything so that others can have a job; one that supports a family, pays a mortgage, puts new wheels on the minivan, braces on little Suzie and maybe even creates memories from Disney World or the beach each summer. According the the Small Business Administration, 80% of the businesses in the U.S. are classified as small businesses as well, so we're not talking Enron, MCI, AIG (fill in the blank of your favorite dirtball CEO here.) We're talking middle class America - machine shops, pizza shops, lawn care, funeral homes and small industrial companies.

Now on to the financial facts.

In the U.S. we have a progressive tax, which is accountant-speak for "the more you make the more you pay." We also have something called a marginal tax rate, which is any amount above a certain limit but not as high as the next bracket. For corporations this total tax rate can be as low as 15% on the first $50,000 of taxable income to as high as 39% on income of $100,000. This is tax corporations pay at the federal level.

Naturally states want their take, too. The national average state income tax is about 6.5%, but we don't like to be average here in Pennsylvania. As a result, corporations in the Keystone State pay 9.9% corporate income tax. To be fair, a portion of the federal income tax can be eliminated when a company pays the state taxes, but according to the Tax Foundation, in 2008 Pennsylvania corporations paid a combined effective tax rate of nearly 42%, second only to Iowa. This is 3.5% more than a company in Japan, by the way, and a full 4% less than a company located in Germany and 6% more than a company in Canada (aren't they supposed to be taxed higher than us?)

Okay. So you're not good with percentages. I am, though. These figures show that if you have a company in Pennsylvania that has $100,000 in taxable income the CEO takes home (drumroll please).... a whopping $58,000!

The really great thing is that the corporate owners, also known as shareholders, get to pay taxes on their dividends too! This is called double-taxation if you're keeping score at home.

So let's go back to 'the man' and see how he's feeling right now. By the way, he (or she, to be fair) is probably only taking part of the day off since there is work to be done, payroll to process, paperwork to file or orders to be filled. Is it worth the risk to own a business, putting your personal livelihood, your kids future, your spouse's trust, on the line so that others can argue over personal days, vacation time, call in when it snows, etc.? I don't know.

According to CNN employers lost about $900 million in lost revenue during March Madness as a result of employees trolling the Internet to catch up on scores, fill in brackets, etc. Lost revenue is even higher for fantasy football.

It's enough to make me tired and need a day off. Hey, wait. That's what Labor Day is for!

Lions, Tigers and Bears...and Black Swans?

I recently finished reading a book titled "Fooled by Randomness" by Professor Nassim Taleb. Taleb teaches Risk Engineering at NYU and is a former trader. He's a smart guy by any measure.

Taleb has spent most of his adult-life analyzing risk, learning to avoid risk and learning to profit from extraordinary circumstances. In finance they call these events "Black Swans;" the rare combination of a set of extraordinary events unfolding in the perfect order to create massive destruction to financial markets, models and financial plans, even by the most astute investor. For my friends in Western Pennsylvania, think of "Albino deer" or "Pittsburgh Pirates winning a pennant" and you'll understand how rare these occurences happen.

In short, Taleb also has been able to provide some evidence that we humans do a lousy job learning from the past, although we're more than capable of looking backwards after an event and criticizing the participants. If you have any doubt, simply listen to any call in sports show that takes calls from Monday morning quarterbacks analyzing what went wrong. They seldom offer a "how to make it better" solution, though.

Looking around and reading a recent letter addressed to President Obama from Taleb, I think it's time to recognize the Black Swan that might be in the room, cleverly disguised as indebtedness. In his letter, Taleb correctly points out that debt leaves little, if any, room for mistakes even in the best circumstances. Quoting the Roman proverb, "happy is he who owes nothing," I believe that the recent actions taken by all of our legislators have done nothing to stop the Black Swan from having offspring.

When you consider the fact that so much of our world is interdependent upon a million other fragments of society, the ability to identify potential hazards and trickle effects becomes nearly impossible to measure. (Measuring is what I like to do, by the way.) But how can one measure the impact of adding $9 trillion to the ever-expanding debt, which will exceed $20 trillion in ten years or less. How can adding debt to an already precarious position benefit anyone in the long run?

Taleb also correctly points out that many of the 'experts' are the same folks that created models that got us into the current (and most of the past) messes we are in today. Relying upon them to help solve the problem is merely a result of their own arrogance. Guess what arrogance leads to - more black swan events. Arrogance blinds us to our own predisposed prejudices, biases and flaws. Arrogance leads to group-think and herd mentality. Arrogance will lead us off of a cliff.

Cash for clunkers rewarded folks who bought vehicles that got lousy gas mileage. The bank bailouts rewarded Wall Street greed. Mortgage bailouts rewarded folks that bought too much house and speculated that prices would always go up. Auto bailouts rewarded lousy business models. Imagine rewarding your kids with a new car after they crashed the old one because they were drunk driving, or continuing to give your kids an allowance after they spent their savings on pot. You would never do that, would you? So why are we rewarding arrogant, risky behavior now? Because the 'experts' told us too, that's why.

In essence, we are rewarding poor judgement time and again and funding it from the tax payers who continue to play by the rules. Rewarding poor behavior is never a good option, but financing it with long term debt is an even worse solution.

FYI, following simply supply and demand mentality, please recognize that the cash for clunkers is going to hurt the poor. It always hurts the poor, despite our elected officials best intent. If we remove clunkers from the car lots, the supply of used cars will go down. The only folks that cashed in on the program were folks who could afford to buy a new vehicle, right? Of course. The clunkers have to be scrapped, but the number of people demanding them (college students, workers making minimum wage, single parents, etc.) hasn't gone down. Voila! More demand than supplies equals higher prices. Nice.

Urge your congress person to STOP funding risky behavior with your money. Oh, and leave a comment or two if you don't mind. Writing this stuff keeps me up at night.

For the health of it

Ah it's that time of year again. Get the kids on the yellow bus, sit in traffic and think about stuff that bugs you.

Right now, one thing is bugging me (at least more than anything else) - healthcare reform.

Yes, it's controversial and yes, it's annoying but the reality is something is going to happen this year regarding healthcare and insurance whether you like it or not. Apparently to have an opinion differing from those in elected positions makes one 'Un-American' or an extremist.

However, I am going to propose something different with this blog today. I am going to suggest that people can actually have a civil conversation and debate about creative ways to help solve this problem. Here are the rules:

1. No berating an opposing view.
2. Your argument must be supported by facts
3. Please refrain from salty language (that's only allowed by me, the host. It's the only priviledge I get to enjoy.)
4. Have fun and no solution is off limits. (That's called brain storming - something politicians in DC are incapable of doing because it involves having a brain to storm with.)

So here's my idea (yes, my bullet-proof vest is zipped up and I have my big boy pants on.)

Require surgeons to post their performance, or track record, showing how many operations they've performed, the number of medical related issues that resulted from these operations and the years of experience their staff has. Basically a surgeon would be required to give a three year history on patients after the surgery. (Think of it like the label on the back of a breakfast cereal, only something that's easily written on an 8.5 x 11 piece of paper.)

Next, after reading the 'prospectus,' allow the patient the chance to either pay A) a price that includes the ability to sue the the doctor for malpractice or B) a price that does not allow the patient to sue for pain and suffering, but only lost wages.

In the auto industry they call this 'tort' or 'no tort.'

Now before you go berzerk on me, consider the following:

According to statistics from Stanford University, in 2005 about 20 million people underwent surgery with anesthesia. 12,000 of those patients died from a surgery that was unnecessary (i.e - plastic surgery, elective surgery, etc.) 106,000 died from medication errors associated with the surgery, 20,000 from hospital errors and 80,000 from infections resulting from the surgery (National Ledger, 8/21/2009.)

Let me do the math for you. That means that .1% of all surgeries resulted in death due to hospital errors during surgery. Other patients that died were a result of surgery that was not elective and required immediacy, such as heart attacks, cancer treatment, horrific accidents, etc. Let's call these things 'unpreventable' and outside of a hospitals ability to 'fix.'

Consider some of these facts, also from the National Ledger and confirmed from other sources such as National Institute on Health.

A study conducted by the AMA revealed that despite spending $3000 more per person on healthcare here in the US compared to Great Britain, twice as many American have diabetes and we also have a higher rate of heart attacks, strokes, lung disease and cancer than our friends across the pond.

What gives?

We're overmedicated folks. A forty-year study conducted by Dartmouth confirmed that as certain areas of the country spent more on healthcare, those folks died a faster pace than areas that spent less on health care. Is less really more?

The World Health Organization in 2008 found that the US has the worst track record compared to other industrialized nations when it came to preventable deaths due to treatable conditions such as bacterial infections and and complications from surgeries (both of which occur in hospitals, I might add.)

Next, cap the number/type of prescriptions one doctor can write. Do we really need auto-refills from an answering machine at the local pharmacy? Shouldn't SOMEONE monitor how the prescriptions are working PRIOR to reordering?

From personal experience, I literally stopped taking medication because I felt better and have eliminated my acid reflux problem. I still have 97 pills left from a 100 pill order, but the auto dialer at the pharmacy called to remind me that my prescription can be refilled and to place my order soon.

I am not an automobile needing an oil change.

Instead, through preventive maintenance NOT induced by drugs (you know, running, eating better and going to bed at a reasonable time) I helped my body heal. Old fashioned approach, but something that works quite well; not just for me but for all of us. We're not unique, folks, despite what people tell us.

So there it is.

We spend twice as much as Britain for care that is worse, so the solution before you and the rest of America is to do what? Spend more money?

Money is not the answer. In fact, money is what got us into this mess. Money for the drug companies, money for the lawyers, money for victims.

No. Remove the monetary element and begin letting people choose.

I anticipate many comments, discussions and ideas. That's what this is all about.

Improving Education

If you don't mind I'm going to pull away from healthcare reform and the stock market this week and discuss something that is near and dear to my heart - education. As a proud member of the Mars Area School Board I am a huge proponent of educating our young adults; not just so that they can get a better job and create a higher standard of living, but also so they can appreciate the gifts our world and our neighbors have to offer. Call it "education for the sake of education," I guess.

With that said, much has been said about finding ways to improve our educational system. One such proposal involves merit pay for teachers. On the surface this appears to be a great idea, and I'd challenge anyone to oppose methods for improving student performance.

However, when you look behind the numbers, it's very important to discover what the carrot tied to the stick is before implementing policies that reward teachers for improvements by their students. Additionally, it's important to evaluate administrators and their effectiveness.

Current proposals for merit pay seem to focus on improving test scores, which seems like a very real indicator of whether teaching methods are working and students are improving. After all, improved exit exams are clearly a sign that teachers are doing a better job teaching the things we deem to be important, right?

Not so fast.

Many economists have begun to analyze merit pay based upon improved scores and are discovering that teaching effectiveness actually decreases when financial incentive is tied to standardized tests such as the ones being proposed by congress. In fact, while scores certainly improve, student performance in areas goes down.

How can this be?

In order to analyze this, one needs to look behind the numbers and look at motivators. What motivates someone to teach?

First and foremost, it's pretty safe to assume that one enters the teaching profession to impact others first and make money second. In fact, the same holds true for police officers, social workers, nurses and healthcare workers and other community related type of professions. Motivators for this group would be things that impact the world socially first. Economists call these "social motivators (we're not much for creativity when it comes to naming things. Sorry.)
As a result, improving big societal topics like reducing childhood obesity, reducing violent crimes, reducing illiteracy, etc. are things that these groups would find quite endearing and they'd be happy to be a part of the solution. The evaluation process is cumbersome, time-consuming and difficult to measure; particularly over a short period.

However, when the "carrot" becomes something easily measurable, such as improved test scores, increased attendance or reduced drop out rates, the workers can and do modify their behavior so that they achieve the desired results.

Think about it for a minute. If you were given the opportunity to earn a 10% bonus based upon your product (children) improving their test scores, would you modify your teaching plans to include everything on the test? Absolutely. However, you might be overlooking true learning that occurs day to day; what everyone, including our President, is calling 'teachable moments.' Should we sacrifice teachable moments for the sake of a 1%, 2% or 5% improvement in test scores?

Study after study is beginning to reveal that merit pay for teachers might not be a fundamentally sound idea for this very reason. Imagine a police officer that worked on commission, earning $10 for every speeding ticket he or she generated. How about a firefighter that earned a commission on every fire they put out? (Would this lead to an increase in fires as well?) Maybe a doctor should earn commission on the number of surgeries he or she performs (aren't we going down this road already? How's that working out?)

Additionally, studies are showing that the amount of money spent per pupil does not actually equate to improved student scores. This flies in the face of everything we're being told by legislators, yet we continue to believe that spending more money per pupil is the only solution. After all, money fixes everything here in the US. In fact, we spend more per pupil in the US than any other country in the Western Hemisphere. The return our investment is less than stellar if measured in economic terms.

Perhaps an overhaul of our education system is needed. Let's start with reptition. How can we expect students to learn and retain anything when they only need to go 1/2 of a year?

No. There needs to be merit based performance incentives, but the carrot needs to be something other than test scores. It needs to directly tied to things that the instructor can control, such as his or her daily attendance, improving communications with parents or guardians (both positive and negative communications) and representing the employer (in this case the school district) in a favorable light through community involvement, fundraisers, etc. - things that occur outside of normal school hours so that they can continue to do what they do best, which is teach.

Perhaps congress and the current administration could dangle a carrot tied to going year-round or districts that offer longer school days. Imagine how much your personal performance at work would improve if you were required to work 45 hours per week. Currently students in Pennsylvania high schools have to have 5.5 hours per day, five days per week, of instruction time. That's 27.5 hours per week, 180 days per year. If you want to stretch this over the entire year, it would be the equivalent of working a part-time job 13 hours per week, or a day and a half per week, all year. You can't learn anything of substance in this timeframe.

And we want to tie teachers down with more standardized tests? It's counter-intuitive, but it tugs at our emotional reasoning.

This is called Behavioral Economics, by the way.

I know that my ideas are not popular right now, and most likely, society is going to put merit pay in place based upon test scores. Additionally, I don't see any politician suggesting full-time, 8 hours per day for students aged 12 and older. Don't look for it anytime soon, either.

Let me be one of many others to verbally come out and say this is a bad idea and will ultimately lead us to a decrease in efficiency as a society. If you have any doubts, look at the runway of failed education reforms like No Child Left Behind, Standardized Exit exams, etc.

We're not solving the bigger problems which is teaching students to embrace learning for learning's sake. That's too hard.

Health care reform

Let me be the first to admit that I seldom, if ever, need my employer-sponsored healthcare package. I'm probably one of the lucky ones. I'm also not a doctor (and I've never played one on TV) so I don't know the total story when it comes to billing, paying, services, wait times in emergency rooms, elective surgeries, etc.

With that said, however, I understand business, finance and people...in that order.

So it's no surprise that business people despise the new healthcare reform package offered up by the government. And to be fair, who can blame them? The current tax system already imposes 15-35% income tax on businesses, and individual states throw more on top. Mix in 7.5% taxes into the social security fund, 1.65% into unemployment on the first $7,000 earned by each employee and most businesses can fairly say they pay upwards of 45% to the government. That's a lot of money, particularly on small business owners, which make up 80% of all employers in the US according to the Small Business Administration. If you owned a business that made $100,000 per year before taxes, how would you feel if you only took home $55,000 -$60,000 per year and were being asked to pay more?

Not sure about you, but I'd hire fewer people and actually consider firing a few, too. That doesn't sit too well ever, but especially now given our current 9.5% (reported) unemployment.

On the finance side, the system stinks worse than the Pittsburgh Pirate's front office (maybe) and there's no end in sight. How can an insurance company charge one fee, accept another from the healthcare provider and not be held to better standards? While I fully support price discrimination, as most economists would (if you don't know what price discrimination is, think "Ladies night" or "kids eat free" or the way the airlines price tickets and you'll understand the concept) health insurance price discrimination makes no sense whatsoever from a financial point of view. The pricing scheme is so convoluted that I actually do know why things cost so differently from one provider to the next - they don't know how to price their product or service.

People. Now this is a different story entirely.

Shame on us. We know better, yet we continue to try and get something for nothing or ask for more support so that we don't need to modify our behavior that lead to the problem! Rather than asking Uncle Sam to come up with a solution, maybe it makes more sense to modify our diets, exercise more, smoke less and eat more veggies so that we don't need to go to the doctor's office as often. If we go less, the demand for the product goes down and providers would need to find a better method to attract our business, such as, oh I don't know.... LOWER COSTS?

Ah, the "preventive" maintenance argument. That one hurts the most, as it actually involves personal responsibility, but it makes the most sense.

Think about it. If fewer of us needed to go to the doctor's office, emergency room, surgeons, etc. because our bodies were better equipped and healthier, those needing services would have quicker access, less tired healthcare providers and insurance companies that weren't questioning everything?

I'd love to call it innovative, but it's as old as the hills.

So consider my healthcare reform today by reforming your old habits. Take a walk, turn off the television and put down that bag of chips.

Let's try this again

There ain't no cure for the summertime blues - that much is sure.

And the worldwide economy seems to support this theory, plodding along painfully slow like a Pittsburgh Pirate's baseball season.

The question I get most from students and friends is "when will it end?" Sadly, I don't know and I'm not sure anyone knows. Experts are currently feuding over another stimulus package, and I promised my wife and kids that I wouldn't get angry this summer so I won't touch that hot potato. Instead, I want to focus on the good things I see happening, despite unemployment at 9.5% (closer to 13% when you put part-time employment into the mix and assume they'd prefer to be full-time) and a California government writing I.O.U's while a Pennsylvania government can't do the one job they are elected to do - pass a budget.

I want to count the good things today, and there are many.

First and foremost is that there is finally productive conversations taking place at very high levels, unlike the previous six months of political maneuvering. I think that some (not all) of the politicians recognize that times are tough.

Gas prices are about $1.40 less this year than last year and we have already passed the traditional 'high mark' of July 4th. This bodes well to improve consumer sentiment in the coming months.

The stock market is flat, which beats the heck out of investments falling faster than a kid doing a cannonball at the local pool. Folks have finally seen the bleeding on their 401k's, IRA's and college savings accounts stop. In fact, they most likely saw the balances improve last quarter and they should be up about 10% year to date.

The herd is finally getting thinner as companies have begun to realize the impact of their cost cutting measures and the consumer is benefiting from the slimmer margins. I'm not suggesting we're spending more, but I am suggesting that we're at least spending the same and the feeling of doom and gloom is gone. There's light at the end of the tunnel.

Housing is near the bottom in most major markets, but not all. Here in Western PA, while the market is anything but robust, it is steady and homes are selling.

I am not about to call a bottom on a market, or a top for that matter. But I can observe, and right now, it seems to me that the worst is well behind us. And while we might not enjoy 6-8% growth for many years to come, I am going to suggest that a moderate 2-4% growth rate is not always a bad thing and beats the alternative of negative growth.

We're living within our means and that's a good thing. Banks are making loans to people who deserve them and those who pay their bills on time. How can that be bad?

Oh, and the best thing about July is that I go on vacation at the end of the month. I'm refreshed and ready to write, so please look for weekly updates. I also joined the Examiner.com staff as a freelance writer and will be tackling local business issues on a fairly regular basis. Add this site to your favorites please and leave some comments!

Stimulate this

So Congress is set to throw another $900 billion into the crapper on a stimulus package.

I'd like to spend the next few paragraphs explaining how this stimulus, designed to help Americans, is actually going to have a negative impact.

The stimulus, while containing some details, has one really significant piece of data that shows up - any company taking funds from the stimulus and/or tarp will be required to utilize products and services from American companies. This is being done as a way to create jobs.

Here's where I'm going to get in trouble, especially living in the rust belt.

It's going to KILL the economy rather than stimulate the economy. Here's why.

If a company, let's say Caterpillar, decides to take stimulus funds they are now immediately handcuffed to American suppliers, regardless of price. As a result, and through a really miserable few quarters, the American suppliers will not be required to go through competitive bidding to ensure they are a low-cost provider and high quality provider. This will result in higher priced materials going to Caterpillar.

Now Caterpillar, while certainly concerned about consumers, has also suffered in the past few quarters. Do you think that they will actually swallow the added costs associated with dealing with only a few suppliers? Yeah right. That cost will be passed on to the consumer through higher prices. (this is what we economists and finance folks call "Inflation.")

Given our current unemployment levels of about 7.5%, most real folks would have a hard time swallowing higher prices; especially since they, or someone they know, are probably unemployed.

Now, let's bring in the REALLY big issue with this stimulus. How would you feel if America did this and you were, oh, I don't know, China? Remember that little country that is home to nearly a third of the world's population? Oh yeah. By the way. The own a lot of our debt.

The Chinese Government probably wouldn't take too kindly to not being able to bid on American projects. And while I'm sure they'd like to play nicely together, maybe they'd decide that they would stop accepting bids from American companies. This is not a good scenario, but it is highly likely.

Also likely is the fact that they could literally deflate our currency by 25-40% overnight by simply selling the debt we owe them back into the market. This would create "hyper inflation," which is as scary as it sounds. Think "inflation on steroids" and you'll see my point.

Imagine walking into your grocery store today and paying $1 for a loaf of bread. Three days from now that same bread might cost $1.35. Next week it could be $1.60.

Finally, a good rule of thumb with regard to printing money and giving it away (that's what we're doing) is this: $1 trillion of new debt equals about $3000 per person additionally owed to pay back the national debt. We're currently paying over $1 billion per day in interest on this debt. Guess who gets to pay that? My kids. The cost to a family of four is about $126,000

Leave them alone. They are currently on the hook for about $33,000 (each) toward the debt.

Can't we show SOME responsibility and begin taking control of our financial lives? You CANNOT create consumer demand and solve financial issues by creating additional debt. For crying out loud, that's what got us into this mess in the first place!!!

If this makes you as angry as it makes me, check out the Adam Smith Institute blogsite to learn more about taking control of government finances.

And call your congressional representatives. Don't write them. Call them and wait to talk to a live voice. Tell them enough is enough and to stop spending your kids money.

You must be positively negative

Ah the dreaded bye week. Those of us here in Pittsburgh have come to loathe a weekend away from the Steeler football season. After all, what else is there to do on a Sunday afternoon after church and brunch besides watch football?

Glad you asked! We can talk about positive and negative coorelation and how it relates to your portfolio of stocks and investments, of course!

Let me start with a simple illustration. How many of you are married? Oops. I forgot that I can't see if you're raising your hand or not, but I can tell you this. For those of you that are married, I'm fairly certain that you and your significant other don't often see eye to eye on what to do during the dreaded bye week. Am I right?

After all, some of us (myself included) are excited that we can still watch Brett Favre throw a couple of zingers or the Colts play someone, etc. Football doesn't stop just because (gasp) the Steelers aren't playing.

Others (usually the other half of the married couple) find this a perfect excuse to head to the shopping outlets, meet aunt Ethel for a late lunch, shop some more and basically avoid the television set at all costs.

Hmph... a dilemma here for our married couple, isn't it? Well, not really.

This couple has (in investment terminology) a "NEGATIVE" coorelation. They are moving in opposite directions, and while it might not be a good thing at the time, it has great long term ramifications that are a good thing. For instance, the husband may compromise and shop for a while, so long as they can stop at the Quaker Steak and Lube for the 4 o'clock game and some wings. Both parties win out by meeting in the middle. This compromise is what eventually makes the marriage stronger, the bonds thicker and the relationship great.

The newlyweds, however, cave to each other and try to do whatever the other wants, right? This is called "POSITIVE" coorelation, and it can be deadly; not just to the strength of the marriage, but to a portfolio of stocks.

Huh? How does this relate to stocks?

Think of it like this. If you had a portfolio of stocks that had Microsoft, Dell, Gateway and Hewlitt Packard, how would all of them react to a slowdown in the economy? Well, since they're all technology stocks, all would likely respond the same way. This is just like the newlyweds reacting the same way to every issue. POSITIVE COORELATION is very bad for a portfolio.

Now think of a portfolio that has MSFT, Exxon, Pfizer and Wells Fargo. All four of these stocks are in different industries (software, oil, pharmaceuticals and banking) so all four might react differently given the same economic conditions such as an oil crisis, recession, war or market meltdown. This is NEGATIVE COORELATION and something we desperately want for our portfolio. In fact, we strive to acheive total negative coorelation in portfolios (at least the eggheads running our mutual funds do, anyway.)

We can then either OVERWEIGHT or UNDERWEIGHT our portfolio while still maintaining negative coorelation. For instance, you might really think that the oil industry is set to boom, so you can own more shares of Exxon while at the same time, still own Microsoft, Pfizer and Wells Fargo. This is what CFA (Chartered Financial Analysts) do on a daily basis to ensure diversification and negative coorelation for their clients.

With all this said, it would be unfair to NOT mention the recent pummeling the market has taken in the past two weeks. However, with proper BETA weighting, portfolio diversification and patience, I can tell you that I believe there is light at the end of the tunnel - although the Feds had nothing to do with this.

It is my best guess that there is another six to nine months of market jitters remaining, but we are through the worst at this point in time. As soon as consumer confidence rebounds (again, my opinion, but when gas prices drop below $3.00 per gallon nationwide) and we have a president elected, things will come back. It is going to be a slow, methodical climb out, but one worth watching.

I would also suggest that we are near some historic price lows for some very strong companies that have been dragged down by the market, such as GE, Pfizer, Coca Cola and Altria (Phillip Morris.) These are companies with strong fundamentals, good balance sheets and solid products that traditionally can survive a recession. I do not currently own any of the companies listed, but I plan to very shortly.

Well, the 4 o'clock game is on now (we compromised today) and that's all for now.

Click on our Google and Adsense partners to help me pay the rent and please send me some comments. It gets lonely here in cyberspace.

$700 Billion bomb

I told you that a vacation would do me a world of good. The result is two blogs in three days. But all of the credit cannot be given to rest - let's thank Treasury Secretary Paulson and Fed Chairman Bernake too. After all, it's not everyday the two get together on CNBC and talk to members of congress asking for quick passage of $700 Billion.

And at the risk of being labeled conservative in my common-sense approach to this whole thing, I would ask each of you to consider the following before giving Paulson carte blanche authority to buy these mortgages at "a deep discount."

If the assets can be purchased at such a deep discount, why isn't anyone else rushing into the market to scoop these up? Additionally, consider the fact that Bernake and Paulson are suggesting that they will pay a fair market value for these assets. Huh? If they pay fair value for these assets, or in some instances, above fair value, isn't that the same as creating profits for Wall Street?

The next point to consider is that Paulson used to work for Goldman Sachs. Before the White House tapped him to be Treasury Secretary, Paulson ran Goldman Sachs and made about $50 million per year. I can only speculate that he still has shares in GS today. By the way, Sachs is no longer an investment bank and will likely survive this implosion. The cynic in me is guessing that they will be the first in line when it comes time to dump these valuable mortgage assets, too.

Here is the point that drives it home, however. I know that we all hate history, but I'm going to ask you to go back to your eighth grade civics class and revisit the New Deal in 1933.

That year, the New Deal disallowed investment banks from also acting like commercial banks. Five years later, the New Deal created Fannie Mae to increase liquidity in the mortgage market. This allowed lower down payments and easier terms to obtain home loan financing. Freddie Maca was created in 1970.

Skip ahead to 1989 and the Savings & Loan debacle. The government stepped in when the S&L's were writing bad loans before it was en vogue and had a TON of bad loans on the books. This action changed everything - setting precedent to banks and other investment firms that if you make bad loans, the government had yoru back and would bail you out.

In 1995, Congress re-established the CRA (Community Reinvestment Act) that emphasized lending to low-moderate income borrowers in less affluent communities. If a bank was going to buy another bank or merge with another entity, it had better adhere to CRA standards in order to get its plan approved. Homeownership skyrockets to over 65% of all Americans that could be homeowners becoming homeowners.

Flash forward to 9/11. Rather than allowing the market to shoulder the burden for bad loans that occurred as a result of the business slowdown due to the terrorist acts of that day, the Feds decide to continually lower interest rates; from 6.5% to 1%. This allowed an artificial "inflation" in the market for loans and created a new demand.

Now, we find ourselves in the same predicament and we are following the same exact path! It has to stop.

Worse yet, we are allowing Paulson the ability to do whatever he wants, whenever he wants, with our money. No checks or balances here, sir.

There is an alternative and it's a simple thing to enact. Sadly for congress, it doesn't come with pomp and circumstance or a $700 Billion price tag. It's changing an accounting rule that currently requires banks to list loans as assets and value them at their current price. In case you haven't followed the mortgage market, you probably would have more luck selling sand in the desert right now than selling a mortgage on Wall Street. This is why the market liquidity crunch has hit. Not because of foreclosures, which are bad, and not because of subprime lending, which is also part of the problem.

Think about it this way. If you absolutely HAD to sell your house today. Not tomorrow, not next week, but today, would you get top dollar for it? NO WAY JOSE (my five year old daughter's favorite quote.) THAT'S what is going on in the mortgage/banking market right now.

These investment banks don't have to sell their mortgage loans today, but they have to value them on their books based upon today's demand... go figure.

The real culprit is a little accounting requirement. Sorry it's not sexier, but that's too hard to explain I guess.

Please, I am asking you as someone that really doesn't want his children to pay for this horrible plan to spend two minutes and contact Congressman Altmire and Senators Casey and Specter and ask them to please NOT sign this horrible piece of legislation.

Send me your comments and don't worry, there will be another post Monday.

Bailing More than Water

Well it's been one of those weeks in the economy. And while I attempt to stress the importance of everything to my students, I can't help but wonder if any of them get it.

The reality of the situation is very simple: our federal government is bailing out private enterprises faster than Homer Simpson can dunk a donut. It concerns me beyond compare.

To date, the feds have stepped in and assisted Lehman Brothers buy out Bear Stearns, and they've also taken over Fannie Mae and Freddie Mac. As of this writing, there is speculation that they might assist an entity buy out Lehman Brothers. Yes, the same Lehman Brothers that just purchased Bear Stearns about six months ago. The automakers are also asking for $50 billion in government handouts (fortunately, they will probably only get $25 billion.)

Throw in an election year with two candidates that desperately want to win, and it's evident our federal reserve system is really just an ATM (except they don't get to keep the $2.00 fee each time.)

I'm not going to argue whether or not the economy is in dire straits. It is. I don't need Ben Bernake to tell me that and my students don't need me to remind them that their dollar is worth about $.85 compared to last year. That's called inflation.

What I am going to argue, however, is this: I don't think the government should step in and bail ANYONE out - ever.

Get your pencils out for this terribly complex economic/financial formula. Risk = reward. Whew. Got it? Good. Repeat after me. Risk = reward.


So I have to ask you this. Where is the risk to start and mismanage a business if you know the government is going to come in and save the day?

And make no mistake about it. Each of the companies seeking goverment assistance has been horribly mismanaged for years, not just the last few months. Fannie Mae and Freddie Mac epitomize mismanagement, providing deep pockets for Wall Street while simultaneously spending in excess of $150 million in lobbying during the past decade. There is a reason prices of housing escalated so quickly - both agencies allowed consumers to qualify for loans they couldn't afford, with debt ratios in excess of 50% of a homebuyers GROSS income. Think about that for a moment. You make $4000 per month before taxes, utilities, groceries, car insurance, etc. and Fannie Mae tells you to go ahead and take that $2000 per month payment. Where does the rest of the money go?

Throw in the fact that you could purchase a home with $0 down payment (as in ZERO) and you have a recipe for disaster. Nevermind the fact that often the buyer had impaired credit and the seller was paying part, or all, of the closing costs associated with the transaction. Appraised values were inflated, inspections were skewed and sometimes even the real occupancy of the owner came into question. Oh, and everyone made gobs of money.

Even my first year business student recognizes the flaws in this business model. Mismanagement 101, my friend.

So I return to my basic question. Are you willing to kick in the $10-15 BILLION required to bailout Fannie Mae and Freddie Mac?

To be sure, GMAC isn't exactly the model of efficiency and Lehman has been called "greedy" from time to time. They, too, are asking for help.

For argument sake, recognize that we are spending about $10 billion per month on the war on terror in Iraq. Should we rob Peter to pay Paul? That's what we're doing.

How do you pay for these bailouts? There are two ways and neither one is a good option.

1. Alternative revenue sources (political speech for "raise taxes.")
2. Print more money since the value of Treasury Bonds will run more risk than current yields support. If this occurs, something called Hyperinflation will occur and yes, that's worse than it sounds.

There is an answer and it is a painful one.

Allow the markets to take care of themselves. Penalize Fannie, Freddie, GMAC, Lehman and any other company that fails due to mismanagement by letting them become extinct. Yes, it will hurt - bad. But investors will learn their lesson and adjust accordingly. If they don't, they will risk losing on their next investment.

The message being sent right now is "too big to fail." Tell that to Enron, MCI/Worldcom, Adelphia. On the flip side, is Microsoft too big to succeed? We try to break up successful models, calling them a monopoly. Where is the fairness? Is Wal Mart next to be broken up, or are they better of simply running themselves into the ground too?

Risk = reward. If you take big risks, you are entitled to big rewards - or big losses.

You cannot regulate risk any better than you can regulate deman; something communist countries discovered through the black market. And while I don't want to insinuate that we are heading toward communism, we are certainly further away from a free market economy today than we were a mere ten years ago.