If I was King for just one day, I would give it all away.
-Flock of Seagulls
Well, perhaps not. That would be the approach of our current Oval Office occupant. But what would you do? One day to re-write all the rules. Last week, I was on a Fox show called Decon-3, hosted by KT McFarland. (It can be seen here: http://ktmcfarland.com/2010/08/16/the-international-economy.) Towards the end of the show, KT asked this exact question. My fellow guest, Jack Bergen of Alcoa, got to answer the question first, but time ran out on the show before I could take a shot. Damn!
So, I’m going to answer the question here. I am King and I have complete authority to change the rules in an effort to fix what ails country. Tomorrow, I will abdicate and return to the financial industry. But my changes stay.
So here we go:
1. Institute a flat tax on personal income. Only tax money once. Corporate, dividend, and capital gains taxes are out the window. These changes would lead to an unprecedented economic boom as capital investment would flourish. People and businesses would actually understand the tax code, and compliance costs would drop by hundreds of billions. No one would have to tear their hair out every April.
Just as importantly, we would see a decline in political corruption. What many don’t understand is that the complexity of our tax code is, itself, a major source of corruption. Politicians hand out exemptions in exchange for political and financial support. We saw this as recently as the Dodd Frank bill, where Scott Brown’s vote was secured in exchange for exemptions for Fidelity and Putnam, both Massachusetts firms. Think they’ll be donating to the re-elect Brown campaign?
Texas 30th District
2. End Gerrymandering. This may seem an odd thing for me, the king, to focus on, but it’s an underappreciated problem. Gerrymandered congressional districts are created for one purpose: to create safe congressional districts for one party or another. This leads to a lot of bad things. First, it turns the House into one of political extremes. Since districts are contorted to be either very liberal or very conservative, representatives from those districts tend to reflect that. Further, since they don’t have to worry about re-election, the reps can feel free to be as extreme as they want.
Safe seats, like our tax code, are also a source of political corruption. When you serve for years and years and don’t have to worry about re-election, a strong sense of entitlement takes hold. Combine this with lack of accountability, and you have a recipe for malfeasance. Exhibit A: Charlie Rangel.
Iowa is the answer. Look at their district map:
It is put together by a bi-partisan panel that doesn’t split communities or counties. One look, and you know it makes sense. When I am king, all states will look like this.
3. Repeal Obamacare. The King says replace it with measures that will actually reduce medical costs. First, make insurance deductible at the individual level, not just the corporate. Second, let insurers sell across state lines, like car insurers. Third, institute tort reform to rid us of all the frivolous law suits. The plaintiffs’ lobby says these awards don’t amount to much in the grand scheme of things. They may be right, but what they’re missing is all the defensive medicine practiced so doctors can avoid said frivolous suits. That’s a huge number. Along these lines…
4. Institute the “British rule,” which is sometimes called “loser pays.” Really, it should be called the “rest of the world” rule, cuz that’s how it works most everywhere. Sue someone and lose, and you have to pick up their costs. The plaintiffs’ bar argues that this rule would limit access by the poor to the legal system. Baloney. If a poor person has a good case, a law firm could weigh the risk/reward of a contingency fee versus a payout to the defendants. They’d have to make judgments, in other words, as to whether a case has merit. Shocking thought, that.
5. Abolish public sector unions.John F. Kennedy used to get about a B- from the King. Recently, he went to an F when the King learned a single fact: he was the president who signed an executive order that legalized public sector unions. We are not amused. These unions are a pox on our country, and are one of the main reasons state and local governments are in the hole.
To understand why, consider a private sector union. Representing “Labor,” it sits across the table from management, which represents “Capital.” There is a natural and healthy tension, with each side needing the other. Compromise is necessary, and involves sacrifice from both sides.
Not so in the public sector, where unions sit across the table from politicians who represent other people’s capital, i.e. taxpayers. There is no incentive to be frugal, since the pols aren’t spending their own money. Better yet, by giving the unions everything they want, they get stuff back! Votes, money, volunteers, etc. A politician’s incentive is to give away the store, which is precisely what they’ve done. Enough already. The king says you’re done.
Well, there’s no doubt more, like fixing social security, but the king has had a busy day and must rest. It is August, after all. These five steps will return us to prosperity. I’d like to know your ideas. Please tell me what I’ve missed in the comments section.
Okay, it has nothing to do with money or finance, but I have to make just one comment on the Ground Zero Mosque.
No one, outside of a few crazies, wants to legally bar this mosque from being built. They are merely suggesting that a whole lot of people are offended by it. Now, the Left practically traffics in taking offense. It is one of their principal currencies. Indeed, taking offense on behalf of others (who often haven't asked you) is a key tenet of political correctness.
70% of America is offended by this mosque, and yet all Obama, Bloomberg, and others can talk about is its legal right to be built. What about all those poor offended people? What about their feelings?
Answer: feelings only count if you are a member of a permanently aggrieved interest group.
If any of you guys are bored on Monday at 10 am, I will be on KT McFarland's online fox news show called defcom4. It's a one hour panel show, and the general subject is whether america's economic prospects have become to poor to support america's dominant role in the world (i.e. have we come to the end of Pax Americana?)
Not long ago, I went to a local school board meeting in the town where I live north of New York City. The meeting was about the proposed school budget, which voters in our town get to vote on. Our district was spending $28,000 per student, and I got up to the microphone and suggested this was too high, and that high property taxes were starting to have a pernicious effect on the town.
Cue the disapproving shaking of heads. He wants to take money from our children!
The next woman got up to the mic and said that we needed large school budgets to protect our home values. Then she declared those of us in opposition as "greedy." What I wish I had then said was this:
This town has been unfailingly generous to the school system for decades. In fact, the growth in the school budget has been close to 8%, far outpacing inflation. And yes, while good schools help home values, there reaches a tipping point where high taxes hurt more than good schools help. We passed that tipping point long ago. Now, property taxes are crushing our home values. Just as importantly, they are changing the culture of our town. We are becoming a temporary residence for people with school age children. They stay as long as they have kids in school, then leave. Retirees, who had paid off their mortgages years ago, can no longer remain because of property taxes. The voraciousness of the school system is slowly destroying our town from the inside, and yet you call me greedy?
The point here is that there is a moral and social component to keeping taxes low - it's not simply about individuals wanting to keep more money in their pockets. This is an argument that, in particular, Republicans need to hear, because while they profess to like low taxes, they retreat into their turtle shells every time a Democrat yells, "Tax cuts are for the rich!"
Republicans understand that tax moderation spurs economic activity. But not all possess the philosophical underpinning that gives one the confidence to fend off specious attacks. Many don't, in a nutshell, understand the morality of their own position. This makes them weak advocates.
My town is a great example. Taxes are driving away the elderly and actually breaking up multi generational families. The town is slowly losing its unique culture and institutional memory. Oh, and yes, our home values are getting crushed, but that's not an argument that the left is particularly concerned with. Playing on their pitch, though, they are supposed to be concerned with things like culture and population diversity. So they tell us, almost constantly. And yet their position on matters of tax runs counter to their own goals.
I remember Reagan's trickle down thesis being mocked, but history shows us over and over again that it is precisely how the world works, and thank goodness for that. Job creation - from CEO down to night janitor - doesn't happen without business creation. Business creation doesn't happen unless those that have capital (the rich!) can be enticed to remove it from the comfort of a bank account and risk it on some new enterprise. There has to be a reward in it, in other words.
That taxes affect economic behavior would seem to be straightforward enough, but policy makers rarely stop to consider it. Remember the Clinton era luxury tax? It was applied to expensive cars and boats, and the intent was to get more money out of rich people. Do you remember what happened? Rich people stopped buying. In particular, they stopped buying boats. The immediate and unintended consequence of this was that shipyards in Maine went out of business and lots of workers were thrown out of work. Rich people can do just fine without a boat, middle class workers cannot do fine without employment. Where's the morality in that?
There exists, I would suggest, a "taxation morality curve" that may look like this:
Sometimes concepts are understood most easily if one looks at the most extreme examples first. Zero taxation anywhere in society - the left edge of my graph - gets a score of "zero" morality. Government couldn't exist, and therefore there would be no property rights or assurance of liberty. Society would be dominated by well armed thieves. This is not conjecture, we can see it today in places like Mogadishu that have no functioning government.
The other end of the spectrum - full confiscatory taxation - produces the same result. At a 100% marginal tax rate, the entire economy would operate on the black market. Government couldn't exist since it couldn't collect anything. Thus, again, we would have a society dominated by thieves and violent anarchy. Justice would be a distant notion. I will also give this society a morality score of zero.
Since we know it is possible to construct a moral society somewhere in between, it therefore has to be that there exists a morality curve. This is interesting, because it is then a given that some taxation is highly moral. It pays for the things we need to preserve our rights and liberty. Rights are preserved, for instance, by the existence of our legal system, which must be supported by courts, public prosecutors, etc. Our liberty is preserved by a system of national defense as well as domestic law enforcement. These are not the only examples, but they are certainly the most important.
What's more interesting, though, is that after a certain point, marginal taxation necessarily decreases societal morality. If the curve ends up at zero, it has to go into decline at some point. As with property taxes in my town, taxation manufactures immoral outcomes. Those immoral outcomes fall hardest on the working classes, not the rich.
It is no coincidence that my graph looks a whole lot like the Laffer Curve, which postulates that after a certain level of taxation, revenues decline. The existence of the Laffer Curve - as well as the Morality Curve - cannot be in doubt. The open issue is the shape of these curves, i.e. at what point of taxation does revenue or morality decline? I believe the "real" morality curve (and Laffer Curve) looks something like this:
But back to the process. How, exactly, does taxation create immorality? If you have been following these letters, you know I have looked extensively at state-by-state fiscal and taxation comparisons. Many states like New York, California, and Illinois are in dire straits and need to close enormous budget gaps. Many want to raise marginal rates, particularly on top earners. This is a bad idea with a highly immoral outcome.
Witness the recent experience of Maryland, where the state legislature raised the top rate on millionaire households to 6.25% from 4.75%. Using static analysis - which postulates that behavior is never affected by rate changes - they estimated that they would collect an extra $106 million in revenue. Instead tax receipts from rich filers - wait for it - fell by $257 million.
The number of millionaires filing fell by a whopping 30%. Certainly, some had income declines, but fully 12% didn't file, suggesting that most had just up and left. I'm guessing Florida is the beneficiary. (See: http://thenakeddollar.blogspot.com/2010/03/buy-florida-real-estate-plus-what-not.html.) You see, the people who have the most resources - and pay the lion's share of the taxes - are precisely the ones that can leave the easiest. In all likelihood, they already have homes in other states. Rush Limbaugh moving to Florida is costing New York close to $50 million over the life of his contract. How many dock workers or bus drivers do you need to cover that loss? LeBron James not coming to New York cost the state $12 million.
I'm not asking you to feel sorry for LeBron, Rush, or any of the other rich folks. Yes, it's immoral that they have to decide where they live based on something as ridiculous as tax rates, but they'll get along somehow. What's really immoral is what happens to the people who don't have the same ability to live where they want. If you run a hedge fund, you can do it from anywhere. If you depend on others for your employment, you can try to move, but you'd have to find someone else willing to hire you. Good luck with that right now.
Businesses are also much more mobile than in the past. Once upon a time, if the state of Michigan raised taxes on the auto industry, they could count on GM (et al) to swallow hard and pony up. Now, they can outsource. Take a look at Detroit and tell me that's not exactly what happened:
But more to the point, today's businesses are more information based. Why does an internet company need to be based in New York? It can move tomorrow.
So what happens is that the lower rungs of the economic ladder are left holding the bag. Taxes spiral upward and services are systematically cut. Poverty and crime escalate, people suffer. If we accept that human misery is a form of immorality - at least, when we know we could have prevented it - then you understand how high levels of taxation are immoral.
This is a message that all Republicans need to internalize. Only then will they become effective advocates. (Incidentally, I'm not being partisan here. I welcome Democrats to internalize it, too. I'm just not holding my breath.)
This is somewhat out of left field, perhaps, but for years in the letter I send to clients I always include a "website of the month." Since it has proved popular, I have decided to blog about them here as well. These sites run the gamut from humorous to useful to ridiculous.
The cost of living in New York is nuts. This leads a lot of people to fantasize about living elsewhere. The line of thinking goes something like, if I sold my home and cashed in all my chips, I could live like a king in [fill in the blank].
Well, I had a friend who, a couple of years ago, followed through. He was tired of Wall Street, didn't like his prospective cost curve, and so he moved his family to Boulder, Colorado. Why Boulder? I asked. Friends? Relatives? None of the above. He went on a website called "Find Your Spot" that suggests where you might want to live based on your personal preferences:
I went to the site to see where my "spot" is. They ask you dozens of question about your preferences on things like activities, culture, religion, climate, etc., and then - presto! - they rank the top 25 places in America where you should live. Here are my top five:
1. St. George, Utah (never heard of it, but now I want to know more)
2. Greenville, South Carolina (you can't go home again - or was that Ashville?)
3. Tulsa, Oklahoma (really?)
4. Clarksville, Tennessee (see: St. George, Utah)
5. Kent, Washington (a Seattle suburb - do they know I don't drink coffee?)
It's actually a fun exercise - try it yourself when you are looking to kill half an hour.
So, why do you suppose a grocer would give away something for free? Past the expiration date? No, doubt it. That sounds like law suit city. My guess is that this stuff isn't selling and that the cost of removal (something small) exceeds the cost of giving it away (zero).
After I began to analyze the various financial situations of our 50 states (see: Where Should I Live Where I Won't Get Crushed?), it dawned on me there was an incredible opportunity in the Tri-State area (New York, Connecticut, and New Jersey). All three are basket cases, and no sane person should move to them unless they have to. (Connecticut is slightly less awful than the other two, for what it's worth).
But there is an incredible concentration of wealth and industry in the area. Yes, it has been slipping away, but it's still there. The opportunity is if just one of these three states gets it economic act together - reduces public debt and taxation - it would hit the ball out of the park. People - particularly the successful ones who pay taxes - would move in droves.
Which is why I found it interesting that Connecticut's governor, Jody Rell, has scheduled lunch next week with a number of successful New York hedge fund managers. The agenda: move here and we won't hose you as badly as New York!
Mayor Bloomberg responded by saying that this is what New York should be doing, i.e. making itself attractive for people and businesses. Albany has other ideas, though. New York will be the likely loser in this game. The question is, who will be the big winner? Rell or New Jersey's Christie?
Irving Picard is now going after various Fairfield Greenwich entities as well as many of its principals personally. He believes they were in on the Madoff scam, or at least knew it was happening. I agree with this - sort of.
Fairfield's due diligence was, indeed a joke. I blogged about this in detail here:
But I am quite convinced that the executives at Fairfield didn't suspect that Madoff was running a Ponzi. I believe they thought he was running a different sort of scam, one known as front running.
Madoff also owned a reasonably successful brokerage firm, which meant he was dealing with a lot of order flow. Front running involves trading in front of your clients, and it is quite illegal. It would have enabled Madoff to provide the incredibly consistent returns that he did simply by crediting over profitable trades (to his investment arm) as he needed them. There had been talk around the Street for years that this was going on. I had heard it myself, and clearly Fairfield did as well.
Think about the difference. In a Ponzi, the game always ends, and the money is gone. Fairfield would have known their doom was inevitable, and nothing about their behavior suggests this. On the other hand, if Madoff had been running a front-running scheme, the money would have been real, and the risk entirely Madoff's. If the SEC had come along and busted him, presumably Fairfield would have pleaded ignorance, gone home with their assets (less, possibly, an SEC haircut), and not shared in culpability. This explains why they hardly ever did any due diligence on Madoff. They didn't want to know anything. They needed plausible deniability.
When the true nature of the scam became known, it must have rivaled history's great "Oh, crap" moments.
Another possibility is that this was a way to quietly channel money to Madoff from other Fairfield funds without letting this fact be completely clear to investors (i.e. ones that had possibly taken a pass on the direct Madoff feeder). Also very bad.
This is supposed to be a blog (mostly) about investment theory and practice, although really it admittedly wanders off-piste.You may have noticed it has veered more and more into the political realm of late. Sadly, this is because politics and the economy (and therefore investing) have become inextricably linked as the government continues to extend its reach almost everywhere.
Which brings me to the Dodd and Frank's "Wall Street Reform and Consumer Protection Act." It is 2300 pages long, and almost assuredly no one other than a few congressional lawyers and staffers have read it. As readers of this blog know, Johnston's Law asserts that unintended consequences rise with the square numbers of pages in a bill. And, already, on Day One we see our first, and it's a doozy: the shut down of the ABS market.
The Asset Backed Securities market is what funds car loans, credit card loans, and small business loans. It is vital to the functioning of our economy. It seems that the bill forces ratings agencies to accept liability for the quality of their ratings. Mind you, a rating is very clearly only an opinion, but the agencies will be placed in harm's way nonetheless (harm, in this case, being from the devil's minions in the plaintiff's bar).
So, the ratings agencies are simply saying, "screw this," and are refusing to rate ABS. The problem with that, though, is that many forms of ABS are required by law to be rated. Rut roh! This has led to an overnight shut down of the ABS market. Ford has already pulled a large auto loan offering.
Interestingly, the ratings agencies had no idea this was in the bill. It apparently wasn't in an earlier version. This underscores the fact that no one knows what's in it. Obama, who doesn't know the first thing about finance, certainly doesn't. Dodd and Frank? Please.
If Day One has led to the unexpected shut down of the ABS market, what will Day Two bring? Day One Hundred?
