Econ 101

In economics 101 I learned that S=I. Savings equals Investment. What brought this to my mind was the recent news about the rich paying more in taxes. When a man has a lot of money there are two things he can do with it. First he can spend it and this of course is good for our consumer powered economy. The second is that he can save his money. It is from savings that banks accumulate the money that they lend. When a business wants to invest and expand they need money so they go to the banks for loans. If the banks have customers who have put money in savings then they have money to loan. The more money the banks have to loan the lower interest rate they can charge and the more incentive there is for business to expand. If you take money from a man who has a lot you are taking money right out of the economy and making it more difficult for business to operate. Now every day in the news a different expert comes out saying that businesses create jobs though expansion yet some of these same experts are suggesting that we raise taxes on the rich. Did they never learn about savings equals investments or did they just forget what they learned. Or maybe they just don’t know what they are talking about. I vote for the latter.

Mass health plan

Since Mitt Romney decided to run for president the Massachusetts State Health Care Plan he installed has come under scrutiny. The plans main benefit was that it increased the number of insured from 94% to 98% but at what cost. The first thing that happened was a shift of the cost of health care from the employer to the employee. Between 2005 and 2009 employer cost declined while employee cost increased by 21%. Individual bankruptcy filings increased by 35% from 2007 to 2009. Rising overall costs continued to increase and are expected to double in nine years. The people are wondering if the cost to insure that additional four percent was worth the benefit. Stay tunned!

Legacy

When I first got into the financial planning business I took a lot of courses to get a lot of initials behind name. I once joked that I would have to get larger business cards. In any event my interest directed me toward retirement planning and that is where I spent 25 years working. I recall in the early days I would be constantly searching for someone who understood pensions and I couldn’t find anyone. I had to learn on my own and as the years passed I discovered that I had become the expert I was looking for and associates were turning to me for help.
I am telling you this because of the all of the news about pensions and how unions are revolting not only in the US but in Europe. I understand why they are upset and they have legitimate reasons. The problem exist in both public and private pensions but more so in the public area.
Let’s go back in time to the 1950’s and you own a company and you want to set up a pension plan for your employees. You sit down with a pension expert and set out your plan. First he asks for the number of employees and their ages and salaries. Then he asks for turnover because you have to consider how many of your current employees will still be there at retirement age. Then he asks for your opinion on what inflation will be for the next 20 years so he can determine how wages will increase over time. Finally he asks how much you expect to earn on the pension fund over the coming years. It doesn’t take a rocket scientist to quickly understand that all of these estimates are just wild guesses. In order to overcome the problems associated with these guesses he suggests that you review your pension each year and make adjustments accordingly. Plans that were developed like this and adjusted like this remained solvent but often times these procedures were not followed.
In some state plans the need for funds was so great that they diverted pension money to other projects, things like bridges and highways. Now the government requires that pensions always have enough money to meet the needs of retirees so if there was not enough the plans were underfunded and the government demanded that they be brought up to spec. Now any professional pension consultant will tell you that you must be conservative on your projections of future earnings and using the inflation rate would be acceptable. When these plans diverted pension monies they made up the difference by estimating future earnings at a higher rate. Then as the years passed and elected officials found this new source of funds the practice continued until some states were projecting future earnings at 8% even though current inflation has been less than 3% for most of the past two decades. If I save $1,000 per year at 3% for 30 years I have $47,000 but if I use 8% I have $113,000.
Please understand that over the years many of the pensioners were given retirement benefits in lieu of wage increases. This allowed the states to continue on their spending spree by pushing off commitments to the later years. Well the later years are here. It is time to pay the piper. Since states are not allowed to declare bankruptcy they must come up with a way to resolve this problem and most will have to reduce benefits and people are not going to be happy about this. Some have suggested that congress pass the appropriate laws to allow states to declare bankruptcy but many say this could be unconstitutional.
Earlier I mentioned that public pensions are in worse shape than private pensions and the reason for that lies in the negotiating process. If you own a company you are looking at your money or your stockholders money when you renew your pension contracts, If you are in the public sector you are using public money. Which do you think you are more likely to covet?
Let us look at an example. Suppose there is an election for county commissioner. The union people select a candidate who is partial to their view and campaign for this person. The not only go door to door but they contribute funds for his campaign and he is subsequently elected. Now when it comes time to negotiate a new contract the unions leadership sits down across the table from the person they helped to elect and the two sides decided on how they will divvy up the tax payers money.
This process has been going on in cities and counties across the country for 30 plus years and we now see the results with public pensions having better benefits than the private pensions. Once this cozy arrangement was put in place not only were pension benefits increased but salaries and other benefits like health care were also padded.
For you people in my generation, if this is sounding familiar, don’t be surprised for the federal government has done something similar to social security. The money in social security was used to purchase government bonds and this money was then used for things like bridges and highways. This mixing of government money with social money is known by the happy name of unified federal budget.

In the Minneapolis School District there are 3,300 teachers and 6,700 support staff. 1,500 of the support staff are members of the teachers union. If the teachers select a candidate who will negotiate contracts that are favorable to teachers and then work to get them elected, they have a very good chance of winning. If each teacher and spouse vote for a particular candidate that is 9000 votes. Now if they get their parents to vote that is another 18,000. Next if they have coffee parties and invite the neighbors plus make a small campaign contribution they can just about guarantee a win for their candidate. The proof of this is that
No DFL-endorsed candidate for the board has lost in at least 20 years.

Here are the results from the last school board election and it is easy to see why someone with a 27,000 vote head start will be the likely winner and you can be assured that all the teachers do vote.


3 seats 131 of 131 precincts (100%)

Lydia Lee *
61,623

Jill Davis
58,998

Carla Bates
54,691
Sharon Henry-Blythe *
39,476
Kari Reed
33,118
Doug Mann
28,416

This is why it is necessary for there to be a disinterested third party to negotiate contracts. Some thing similar to arbitration

Miranda

Last April the US picked up a suspected terrorist off the coast of Somalia and held him of a US Naval vessel for two months during which time they interrogated him. Then they shipped him to the United States and turned him over to the FBI who promptly read him his Miranda rights. I think it was a little late for that but now they say he is going to be tried in civil court. Last year the congress passed a law stating that no one could be sent to the US from Gitmo and tried here in civil court so this was Obama’s way to get around this law. Having witnessed this little tactic the congress will now broaden the law to include terrorist coming to the country from anywhere.
I believe that if you question someone for two months with no lawyer present and then read them their rights and take them to court you should have a slam dunk case and my guess is that is just what Attny Gen Eric Holder wanted. This whole thing looks like a sham and makes a mockery of the Miranda Act.

Getting elected

When a person decides to run for public office, particularly a national office, they are immediately faced with a dilemma. What happens when your basic principles conflict with your constituents? You can change your platform to fit with the voters and improve your chances of winning or you can stick by your guns and decrease your chances of winning. Assuming you are running because you believe you can make a positive contribution to the country, you realize that you can only make a difference if you win. So you decide to change your campaign to fit the desires of the people and after you are in office you move away from your campaign and toward your beliefs. This opens you to criticism from the other side but if you can pull it off you can get reelected. On the other hand if you don’t change and don’t get elected you can go home feeling like you are a person of principal and leave the improving the country to someone else.
We have such a choice going on at this time. Michele Bachmann is a person of principal who will not change to get elected and we have Obama who will. Here is a quote from Senator Obama in 2006 regarding raising the debt limit.
“The fact that we are here today to debate raising America's debt limit is a sign of leadership failure,” he said on March 16, 2006. “Leadership means that ‘the buck stops here.’ Instead, Washington is shifting the burden of bad choices today onto the backs of our children and grandchildren. America has a debt problem and a failure of leadership . Americans deserve better. I therefore intend to oppose the effort to increase America's debt limit.”
Here is President Obama in April of this year:
“Failure by Congress to raise the U.S. debt limit “could plunge the world economy back into recession,” President Barack Obama declared Friday.
Our inexperienced President found out that there is big difference between campaigning and governing.
But here is how you resolve the problem and get set for reelection.
Obama "thinks it was a mistake," presidential spokesman Jay Carney told reporters. "He realizes now that raising the debt ceiling is so important to the health of this economy and the global economy that it is not a vote that, even when you are protesting an administration's policies, you can play around with."

Obama election

The election of President Obama came along at a critical time in our history. We all know the story of the frog in the pan of warm water. The frog is quite comfortable as we slowly heat the water until the frog finally dies. Our economy has been in the warm water for the past fifty years, as we have been on an inexorable path toward European style social democracy. If John McCain had been elected we would just have continued down that slow road to self-destruction. President Obama accelerated the process to such a degree that he woke up the American people and a kind of quiet panic set in. With each new Czar, with each new regulation, with each new stimulus the people became more and more uncomfortable. The slow moving cloud of government encroachment turned into a threatening storm and now even those who were transfixed by Obama’s oratory are having doubts about the direction of the country. Add to this the unrest in the countries of Western Europe, countries who seem to reflect where we are heading and there is grave concern about our future. The silent majority as represented by the Tea Party is awakening and soon will use the power of the vote to bring on a new wave of hope and change. We see it in states like Indiana, Ohio, Wisconsin and Florida and soon we will see it in Washington. The rise in the growth of government will slow and perhaps even diminish with the emphasis on perhaps. In retrospect we may see the election of Obama as the best thing that could have happened. Time will tell.

Ryan

When Paul Ryan came out with his plan to save Medicare, he opened the door for Nancy Pelosi to regain her position as speaker and she immediately knew that. It was a gift to her and the opportunity for the Democrats to regain control of the house and everyone knew it. The old time Republican leadership wanted to keep quiet until Obama came out with a plan but he didn’t have one. The budget he proposed in Feb was voted down by the Senate 97 to 0. It was then that pressure from the Tea Party and the newly elected 87 members of the house convinced the Republican leadership to cave and allow the Ryan plan to come to a vote. Now the Republicans are on the record of supporting changes to Medicare. At this point Pelosi is putting pressure on Obama to give up whatever but not to mention Medicare. Up to this point he has talked about Medicare but has put nothing in writing. He has said that he would reduce the fees paid to hospitals and doctors but that is about it. If he refuses to say any more he will put the Democrats in a strong position to recapture the house because they will demagogue the Ryan plan to death. They have already started with the ad showing grandma being pushed over the cliff. The Ryan plan was voted on and put forward but Obama has not responded. Rather than present a plan he just criticizes the Ryan plan and the press allows him to get away with that. I suspect that when all the dust settles we will once more push the can down the road and the idea of taking on entitlements will have to wait for some future date. For the first two years of Obama’s presidency the Democrats controlled both houses and during that time did not propose a budget. The government has now gone over 800 days without a budget.
The federal budget process is similar to the regular legislative process, but it is also different in some very important ways. First, because the Constitution requires that any bill raising revenue must originate in the House of Representatives, the House has traditionally taken the lead in the budget process.
Another distinctive feature of the budget process is that the President's role is more formalized and, therefore, significant. The Congress, by statute, has required the President to submit a budget to the Congress each year. By doing so, the President establishes the starting point and the framework of the annual budget debate.
There can be no honest debate until Obama submits his budget which he will not do unless he is forced to. As it stands now we can openly criticize the Ryan Plan but cannot criticize a plan that is non-existent.
The President has said many times that the deficit is a big problem and he wants to raise taxes on the rich but he wants to use the money to invest in education and infrastructure not to pay down the debt. This is now called revenue and invest instead of tax and spend and that is all that has changed.

Waste

I just heard a commercial concerning the deficit and cutting social security and it illustrates how to demagogue the issue. It states that instead of getting rid of waste and fraud some are proposing cutting benefits. My entire life I have heard politicians say they are offering a new program to benefit voters and it will not cost anything because they will pay for it by cutting the fat out of government and all of my life the government has gotten fatter.

Middle Class

I grew up in what was generously called a middle class neighborhood. My three older sisters and one younger brother always had clothes to wear and food to eat and that meant we were middle class. Even to this day the name middle class has a certain comforting ring to it. During the depression it was commonly said that we were poor but we didn’t know it because everyone was poor. This seemingly odd way of looking at things is still prevalent today but in a slightly different context. Today the way the well to do distinguish them is to have something that no one in their circle has. A good example is a diamond ring. Most women would like to have a perfect one carat diamond, mostly so they could show it off to their friends, who hopefully have smaller less than perfect stones. If they succeed in the labs at making these kinds of diamonds and mass produce them so they can be purchased for ten bucks then the mystic surrounding these chunks of carbon will be dispersed like smoke in the wind. The intrinsic value associated with these stones has to do with the fact that your friends don’t have one, so when they become available to the masses then no one will want one. This is the way it is with many things that we value in today’s world. No sense in having a million dollar home if all your friends have one so let us build a 5 million dollar home and so on. Diamonds and home aside for me it is hard to beat an early morning walk on a nice day and it is most gratifying when you are blessed with good health. Good thing that many people do not feel as I do about material possessions, as our whole economy would come tumbling down. I am not complaining about a consumer based economy but it doesn’t fit my life style. I am grateful for this wonderful country and fully realize that the profits from these consumed articles provide livelihoods for millions and the R&D financed by these same profits have given us super products like the Polio vaccine.
We lived about two miles from our grammar school and all of us walked each day starting in first grade. There were no school buses for people who lived in town. There was a group of five of us who walked together and parents did not have to worry about kids being kidnapped although that may not have been the case with rich kids, of whom I knew nothing about. To be honest the only reason I suspected there might be rich kids is that we saw them in movies. Movies are where we got outside of our world. While the thought of going out to a restaurant never entered our minds we knew they existed because we saw them in movies.
When I got into high school it too was about two miles away albeit in a different direction but we all walked together as before. There were only a few kids who had cars and no one in our group. I recall my dad always told me that I could buy a car whenever I wanted but I shouldn’t ask him to sign any papers. In those days you had to be 21 to have an official signature so I didn’t own a car until I was 21. Interesting difference in the high schools in my day versus the present is that while we did not have a parking lot for students we did have a smoking room for upper classmen. I used to smoke in those days and if you went into the smoke room at recess you didn’t need to have any cigarettes, you could just inhale the air.
No one had air conditioning but a few people got window fans and these were considered a status symbol. We were one of the first in our neighborhood to get a refrigerator. Before that we had an ice box and two or three times a week the ice man would come and we would purchase a 25 pound block of ice and that would keep things from spoiling.

Bank bonus

In the news daily we read about QE 2 (quantitative easing) and we wonder what it is. This time around QE 2 is set at 600 billion dollars. You recall that last year the Federal Reserve (Central Bank) came up with QE 1 and the bought up 1.7 trillion dollars in mortgages and this money went into the banks that owned these mortgages. The idea was that the banks would then have money to loan out to businesses and this would move the economy forward. The banks however chose to just buy no risk government bonds instead of risky loans to business. Since QE 1 did not stimulate the economy the Fed is now trying QE 2 and we will see what happens. Many experts say they are doing this just to show they are doing something but these same experts don’t expect this to improve the economy.
Normally when the Federal Reserve buys bonds they issue a government check and this check is deposited in some bank and the bank can now loan money. Since the law says that a bank must keep 10% of its loans in reserve the bank can loan out 90%. So how does this create money? Say the Fed buys a $1000 government bond and the bank


The fed gets its money from interest on the US bonds it owns
It the government needs money the fed can just write a check and it immediately creates the money
If the government needs money it goes to the fed and the fed writes a check and creates the money. The fed gets its money from thin air (writing checks) or from fees it collects from member banks or from interest it earns on government bonds that it has purchased in the past.
When the fed writes a check it is deposited in a bank and the bank can now loan out 90% of that money. When you turn government bonds into circulating money that is called monetizing the debt or what the man on the street calls printing money. So if the check was for $1000 and the bank loans $900 we have expanded the money supply by $900. Even though the fed has been doing this in large amounts QE1 was 1.2 trillion and QE 2 is 600 billion the money supply has not increased because so many mortgages have been called in though default and these shrink the money supply. Even today banks are not loaning money because they can purchase government bonds at three percent with no risk and they expect interest rates to rise in the future so rather than giving a home loan today at 5% they choose to wait until the rate goes up before making a loan

The Federal Reserve (Central Bank) is privately owned by member banks. The Fed gets its money from fees paid by these banks and from interest on it own portfolio which is primarily government bonds.
The Fed needed a lot of money to purchase the troubled mortgage bonds that the banks owned and for the first time in history the Treasury sold government bonds and gave the money to the Fed to buy these bonds. The member banks then received a large influx of good money to replace the toxic mortgage bonds with the idea that they would loan the money to expand business. However they used the money to purchase government bonds that pay three percent with no risk. By doing this they have made huge profits and have paid equally huge bonuses to their investment managers. How much skill does it take to buy government bonds. These bonuses totaled 143 billion in 2010. 37% of all profits are set aside for bonus pay.


TABLE 1: Bonuses and Compensation at the Top Six Banks (2010)
Bank
2010 Bonuses and
Compensation
Bank of America $35.1 billion
Wells Fargo $26.1 billion
JPMorgan Chase $25.4 billion
Citigroup $22.6 billion
Goldman Sachs $17.5 billion
Morgan Stanley $16.0 billion
Total for Top Six $142.7 billion

Fish flour

Back in the 60’s during one of the recurring famines in Africa a man on the east coast came up with an idea for what he called fish flour. He would net fish from the ocean, the kind of fish that are plentiful but not salable since they were too bony. These would be ground up and a solvent added to remove the oil. The water soluble part was then dried and ground into a fine white powder. At that point the oil was added back and the product was a high protein, high calorie flour and two table spoons per day would keep a person alive. He wanted to manufacture this product on a commercial level and use it as an inexpensive form of food for the people who were starving in Africa. His request for a permit was denied. The product contained the entire fish but it was safe since the drying process killed all micro-organism. The government said that since it was not good enough for the people of the United States, they could not allow it to be sold to others. Today the people in Africa are once again starving and we watch daily on the news unable to help. My guess is that those people would gladly eat this type of fish flour.

Unions

At one time in my career I worked in a union plant in Ohio. We had a cafeteria and part of a new contract with the union was that they could run the lunch room and the profits would go to the union. Shortly after this change became effective the employees in the lunch room had their pay cut. I mention this because President Obama has portrayed himself as a champion of the unions but when they negotiated the new contract with GM and Chrysler they put in a no strike clause which in effect pulls the teeth out of the union. Funny how things change, when you find yourself on the other side of the fence. I experienced a similar incident when I lived in Grand Forks. A good friend of mine was the head of the Teamsters for about 30 years and when he retired he ran for and was elected to the office of county commissioner. In this new position he had to negotiate contracts for the county with the county employees who were unionized. He was just at tight with the county money and the companies used to be against the Teamsters

Shame

There are a number of changes that occur in Mid-Life and some are better known than others. One of the lesser known is a man suddenly feeling the need to reconnect with the kind of relationship he had with God when he was younger. It often starts with a vague uneasiness and leads to questioning about his purpose for being here. He begins a journey to find out more about this and generally uses the wrong approach. I would like to use the analogy of a house to illustrate his misguided efforts.
He goes home one day and throws out all of his old furniture, rips up the old carpet and cleans from top to bottom. He paints, adds new floor coverings and furniture. He puts new siding on the house, new roofing shingles, new windows and finishes off with a brand new front door. Then he takes a big breath and stands back to admire all of his efforts and then throwing open the door says, OK God, I’m ready, come on in. And then he waits. Days, weeks, months and finally years pass but nothing happens.
One day while standing at the door his eyes wander across the room to the door leading to the basement and he finds himself drawn by some mysterious force to the door. He opens the door and closing it behind him, he finds himself standing on the landing in the dark. While standing there he comes face to face with his anger. He recalls the many times when things didn’t go his way and he just pushed the anger in and suddenly all of the pent up anger was sucked into the darkness and he felt a sense of relief.
He makes his way down the steps to the basement floor and there in the pitch black he sees his hidden fears and these too are pulled into the darkness.
Next he inches his way across the room to the coalbin and closing the door behind him he stands quietly in the dark and looks into the abyss of his hurts. All of the times that someone said or did something that hurt him but he never said anything. These too eased their way out of his inner soul into the dark room and he felt a tremendous sense of peace.
Then he sees an opening in the floor in the corner and getting down on hands and knees he crawls in and soon he is crawling on his belly down there with the slimy creatures of the dark and looking ahead he sees a rock and written the moss on the rock is the word, shame. He knows that when he turns over the rock he will have to face the shame that is hidden in the deepest recesses of his soul. He turns over the rock and suddenly he is upstairs standing in the front door with the bright sunlight shinning throughout the house.
It is then that he comes to understand that God does not come in through the front door of your ego but rather through the back door of your shame. When you expose your shame to the sunlight, you open the door for God

Legacy

Back in the 1950’s the CEO of a company had a ten or twenty year plan. He laid out the policies that would guide the corporation to a strategy of long term growth. When you went to work for these companies it was employment for life or as they said from the womb to the tomb. Somewhere in the late 60’s things began to change. The pressure on the CEO to perform shortened his horizon and the stockholders demanded better returns. By the late 70’s the next quarterly dividend was the new target for the CEO and if he did not perform, investors would sell the stock and move the money to some other company.
Then he was faced with the union and their threat to strike which of course would completely destroy the dividend so he told his negotiators that they must avoid a strike at all cost. The union was told that there was very little room for wage increases but the company could offer to increase the pension and other long term benefits like health care at early retirement. These type benefits were referred to as legacy benefits since they accrued at some future date.
Fast forward to today and we find General Motors with 200,000 employees and 670,000 retirees and they spend about $5,000 per car to pay for legacy benefits. Toyota and Honda who have very few retirees spend far less so GM goes broke. This was an early warning signal to what is going on in other areas.
Unionized Municipal employees get together and help elect certain individuals to the city council and later negotiate contracts with these people. The city says we don’t have much money for wages but we can offer you a better pension plan.
The teachers union selects candidates for the school board and helps to elect them and later they negotiate with these same people. The school board says we don’t have much money to offer in wages but we can increase your pension.
Forty years ago the federal government came to me and said, John from now on we will be taking money from your check so we can provide you with health care when you are 65. I said never mind I will take care of my own expenses and they said that was not an option. So I was forced to sign up for Medicare just as I was forced to sign up for Medicaid.
The day of reckoning is here and we all face the same situation that General Motors faced and there is not much we can do about it. You can whine and complain about the unfairness of it all but these various groups over the years have promised more than they can deliver. It’s plain and simple. The benefits we thought were there are not there