Archive for July, 2009|Monthly archive page

‘THE PROBLEM WITH PROFITS,’ by James Kwak at baselinescenario .com

In Uncategorized on July 31, 2009 at 12:50

Stephen Carter, one of my best professors at law school and also an accomplished novelist, has an op-ed in today’sWashington Post arguing that high corporate profits are a good thing, and as a consequence we need to have a strong and profitable for-profit health insurance sector. Here’s the essence of his argument:

High profits are excellent news. When corporate earnings reach record levels, we should be celebrating. The only way a firm can make money is to sell people what they want at a price they are willing to pay. If a firm makes lots of money, lots of people are getting what they want.

I agree that the pursuit of high profits is a good thing. That is what makes a free-market capitalist system work, and it’s what made me start a company eight years ago. But basic microeconomics says that high profits themselves are generally not a good thing.

In a competitive market, if one company is earning high profits, then other people will want to start new companies to compete with it. By entering the market, they increase competition, reducing profit margins for the original market leader; more companies and more competition also mean more innovation; both of these factors increase overall social welfare. In a true competitive market, one without barriers to entry or market power, companiesshould not earn any profits at all, because competition will drive price down to marginal cost. (Steve Goldman, one of my economics professors, once said that if you wake an economist up in the middle of the night and ask him or her, “what is price?,” he should answer, “marginal cost.”)

The real world is different, of course. Companies have to earn profits sufficient to cover their cost of capital. And if you invent a successful new product, you will earn excess profits for some period of time; but over time your competitors will catch up and those excess profits will go away (see the IBM personal computer, for example).

So if you see a company that has very high profits over a sustained period, there are two possibilities: either it is benefiting from a non-competitive market (e.g., it is a monopoly), or it is simply exceptional at innovating and staying ahead of the competition for years on end. If you see a whole industry that has sustained high profits, however, the latter explanation cannot hold, and you should immediately suspect a lack of competition.

In short, the thing that we should celebrate is not high profits, but competition. The pursuit of high profits is what motivates competition; but if a whole industry achieves high profits, then what you are seeing is not competition, but its opposite.

Now what’s going on in health care? Look at page six of this report. In most states, the combined market share of the top two health insurers is well over sixty percent. That is not a competitive market, but a market controlled by one or two companies.

In addition, there are good reasons why a free market is not how you want to allocate health care anyway. For one thing, as I have argued, a free market for health care is a market in which sick people die, because no one will sell a sick person an insurance policy that costs less than his or her expected costs under the policy.

Second, as Paul Krugman explains, health care is a good that does not conform to the basic assumptions that you need for free markets to produce optimal solutions. I won’t try to summarize, since he already summarizes elegantly. But before you dismiss Krugman as a liberal pundit, note that his main source is a paper by Kenneth Arrow – as in the Arrow-Debreu Theory, the centerpiece of general equilibrium theory and of mainstream microeconomics in general in the last fifty years.

Now, it is perhaps possible that private health insurers could be part of a well-functioning health care system – if, for example, they were not allowed to engage in medical underwriting (which is what makes sick people unable to buy insurance at any price they can afford). But that’s not the system we have now. Instead, we have local oligopolies, and if they earn high profits, that’s a product of market power and lobbying clout, not “lots of people . . . getting what they want.” (Do you know anyone who actually buys insurance – either someone in the individual market or someone who buys insurance for an employer – who is happy about what he or she is getting these days?)

Obviously companies should make profits; the need to make profits is what separates good companies from bad ones. And people should be able to get rich making excess profits that result from innovation; you can make a lot of money in the period between the innovation and the competition catching up with you. But if you see sustained high profits by an entire industry of corporate behemoths, you should be very, very worried.

By James Kwak



In Uncategorized on July 30, 2009 at 03:13
Richard Posner is against the proposed new Consumer Financial Protection Agency (CFPA).  This is, of course, not a surprise.  Posner has always been an articulate advocate of the view most often associated with economics at the University of Chicago: market-based outcomes are invariably better than the alternatives, and anything that interferes with consumer choice is a bad idea.

Posner wraps this opposition to the CFPA into an odd attack (near the end of his WSJ op ed) on the personal decision-making abilities of Richard Thaler – a leading economist on consumer choice, misperceptions, and mistakes. (More on Thaler here.)

Thaler, also of the University of Chicago, hit back hard yesterday.  He is right that Posner mischaracterizes the CFPA proposal, and points out that his agenda – and that of Cass Sunstein, formerly of Chicago and now a czar in the adminstration – is simply to provide consumers with a framework for better decisions.  He implies that Posner defends defective baby cribs and their equivalent.

I would go further.

Think of it this way.  We’ve learned a great deal about how consumers make decisions, including when they get things right and wrong.  Behavioral economics, marketing, and related social science have made big strides (e.g., follow the work of Dan Ariely).

But all of this research is also available to companies.  Perhaps they knew some of this before from trial-and-error, but there is no question that many of the techniques corporate America uses – and we as consumers find ourselves “up against” – is cutting edge manipulation of our decisions.

We worry a great deal about how corporations lobby to shape their regulatory environment.  This is a struggle that is at least 150 years old in its modern form (e.g., railroad concessions), and much older if we think about powerful people bribing their way into advantageous relationships with the state.

In addition, companies now have powerful new tools to shape how we perceive our potential choices.  Some of these tools might be good for us also – I’m open to argument on this.  But within some particular spaces, including financial products, it’s clear that many of these “innovations” are actually clever ways to extract value from consumers.

Traditional Chicago economics always had its weaknesses – particularly when you focus on the fact that the “rules of the game” are often shaped by the more powerful.  Thaler and Sunstein (and others) are trying to modernize this view more generally, while keeping the element of consumer choice as central.

But if the balance of power has shifted – due to technological innovation in social science – further towards corporations and away from consumers, then the task ahead is much harder.

Unless companies are compelled to keep their offerings “simple enough to understand”, we will face repeated rip-offs and crises – both macroeconomic and personal – arising from our financial sector.

By Simon Johnson

‘HEALTH CARE COSTS, WITHOUT MENTIONING THE T-WORD,’ from the Times. “T” as in taxes!

In Uncategorized on July 30, 2009 at 00:47

The many-headed Hydra, with breath poisonous enough to kill, is one of the more gruesome beasts in Greek mythology. In Hercules’s great clash with it, he would cut off one of its heads, only to have two more appear. No matter what he did, he couldn’t keep up.

You can think of Congress’s efforts to pay for health reform as being a little bit like a battle to slay a many-headed Hydra.

Members of Congress have come up with one idea after another to pay for covering the uninsured. But they still haven’t put together legislation that could pass. And that’s in large part because most of those ideas have a basic flaw.

They do not raise revenue as quickly as health costs rise. The plan to impose a surtax on top earners, for instance, pays a decent chunk of the bill over the next few years. But the revenue from the tax rises only as fast (roughly) as the United States economy grows. The same is true of most taxes.

Health costs, on the other hand, are growing much more quickly than the economy. Over the last decade, the economy has expanded by about 20 percent, and health spending has ballooned 50 percent. The gap isn’t about to start closing, either.

So no matter what Congress has done to pay for its plans, it can’t keep up.

The numbers show there is only one sure way out of the problem, and, after months of roundabout discussion, that solution has re-emerged: It’s a tax on health care.

If Congress taxes health care, the revenue has a chance of rising with health spending. A health tax will also create an incentive for workers and businesses to slow the growth of health spending — thus reducing the amount of taxes needed to pay the nation’s health bill.

The health care debate is now in one of those calm-before-the-storm moments. After a flurry of activity last week, everybody is waiting for the Senate Finance Committee to release its bill.

That bill will immediately become the reference point for all the other big players. Republican leaders will take shots at it, hoping to keep moderate Senate Republicans from supporting it. Conservative Blue Dog Democrats will argue that the bill makes their case for a less expensive plan than the current House version, with less generous subsidies for the uninsured. Liberals will take their own shots at the bill. Most intriguing, President Obama will have to decide whether to make the bill his own.

The rest of us will want to focus on two questions. How serious is Washington about slowing the soaring the growth in health costs? And will Washington figure out a way to cover most of the uninsured?

As it happens, there is one policy that can help with both issues. It’s the same policy that will allow Congress to solve its herculean budget problem: Taxing health care.

In recent days, the Finance Committee has been considering precisely such a tax, on the health benefits that Americans receive from their employers.

The fact that these benefits are not taxed, as the Massachusetts Institute of Technology economist Jonathan Gruber notes, stems from “nothing more than an arbitrary administrative decision made 60 years ago.” Unfortunately, that decision created all kinds of economic damage. Because health care — unlike food, clothing and most other things — isn’t taxed, it’s effectively on sale. And when something is on sale, people often buy more of it than they need.

In the case of health care, they buy — or their employer buys for them — insurance plans that don’t make much of an effort to control costs. Rather than putting pressure on hospitals to root out administrative waste, the plans cover the cost of that waste. They also cover the costs of brand-name drugs that are no more effective than generic alternatives and other kinds of expensive care that do little to improve health.

As a result, the tax exclusion ultimately raises your tax bill, via wasteful Medicare spending. Indeed, if there is a single health care idea on which liberal and conservatives agreeincluding Douglas Elmendorf, director of the influentialCongressional Budget Office — it’s scrapping the exclusion.

Yet many politicians are loath to come out against the exclusion, for the obvious reason that it makes them sound pro-tax. The Blue Dogs may be the best example. They have rightly pushed House leaders to be tougher about holding down cost growth. But most Blue Dogs have not been willing to get specific, on the tax exclusion or most everything else.

To deal with this political reality, the Senate Finance Committee has become intrigued by a version of a health care tax, being pushed by the Massachusetts Democrat John Kerry, that comes dressed up with a whole lot of lipstick. The tax doesn’t fall directly on workers. It doesn’t even fall on employers. It falls on everyone’s favorite villain: health insurance companies.

Insurers that offered policies that cost more than a certain amount — perhaps $25,000 a year — would face a tax. The resulting tax revenue would help pay for covering the uninsured. Presumably, insurers would pass the cost of the tax onto companies, which would then become less willing to offer expensive plans. They would instead shift some of the money they are now spending on health insurance into cash compensation, which would, of course, be taxed, raising more revenue.

But packaging the plan as a tax on insurers still may not be enough to make it palatable. So Congress would also probably have it apply only to the most expensive sliver of plans. David Axelrod, the Obama adviser, recently mentioned the $40,000 plans at Goldman Sachs (a firm that is now apparently about as popular as health insurers).

With this narrow approach, the tax would raise only a small share of the revenue needed to cover the uninsured, and Congress would still need to rely on a hodgepodge of other tax increases and spending cuts. But starting to lift the exclusion would still help — especially if Congress set the threshold for the tax to rise more slowly than health costs have been rising. That way, more and more of the most expensive, least efficient plans would eventually be bumping up against the tax.

For all the budgetary elegance of the tax, though, its real importance is much larger. It would begin to chip away at the perverse incentives in our medical system.

That’s what matters. The idea isn’t to punish Goldman traders or, for that matter, unionized workers who have their own generous plans. The idea is to give companies and workers more incentive to choose medical plans that try to reduce unnecessary costs. Without that incentive, is there any wonder our health care system is so troubled?

This brings us back — and you knew this was coming, didn’t you? — to the many-headed Hydra. Eventually, Hercules realized his strategy wasn’t working. So he brought in his nephew, Iolaus, who torched the open wounds that Hercules inflicted on the Hydra, preventing any new heads from growing. And that worked. Hercules and Iolaus slew the beast.

How did they do it? By getting at the root of the problem.

‘JEB HENSARLING, GEORGE ORWELL,’ by Simon Johnson at baselinescenario .com.

In Uncategorized on July 29, 2009 at 02:32
The debate over re-regulation of the financial sector has finally, and irreversibly, turned partisan.  This helps define issues in ways that may be more familiar and thus easier to understand.

In the blue corner we have Treasury Secretary Tim Geithner.  Secretary Geithner’s overall banking policy continues to be problematic, and his broader re-regulation effort is hampered by all the free passes he gave to bank CEOs earlier this year.  But on consumer protection he has the right message and he delivered it forcefully to Congress last week: we need a Consumer Financial Protection Agency (CFPA) and we need it now.

In the red corner, Representative Jeb Hensarling is rapidly emerging as a leader.  A member of the Congressional Oversight Panel and the senior republican on the House Financial Services subcommittee on Financial Institutions and Consumer Credit, he wrote last week in the Washington Timesthat the CFPA is “Orwellian”, because it would strip consumers of their rightful choices.

Mr. Hensarling seems dangerously close to slipping into double think.

He says that the House Republican “regulatory reform plan” will protect consumers.  (This plan was not available for outside review when I enquired last week; if you have a copy that can be shared, please send it to me.)  As far as I can see from his article – confirmed by what I heard before the House Financial Services Committee last week – the only tools they propose are those that have been tried and failed, repeatedly, in the recent past.

The key sentence in his op ed may be, “If we act responsibly, whether the mortgage blows up on us is largely within our control.”  This ignores all the evidence that consumers were duped, misled, or otherwise fooled into financial products that they did not understand and could not afford.

Mr. Hensarling says that financial products are completely different from toasters, which are regulated by the Consumer Product Safety Commission, because “No one wants a toaster that will blow up, and whether it does is largely out of our control.”  But regulation over consumer durables was introduced and tightened over the years precisely because the “free market” produced items that were unsafe (at any speed, or any toaster setting).

Mr. Hensarling claims that consumer protection will be very much against the interest of smaller companies.  There is no evidence to support this assertion – and it seems implausible.  Many smaller businesses have been scammed by Big Finance in the past few years – either directly, through the products they were sold, or indirectly, through the higher tax bill we all face as a result of bailing out the big banks.

And the bad behavior of big banks is closely connected to how the financial sector has been allowed – and is still allowed – to treat consumers.

Yesterday, at last, a major commercial bank CEO broke ranks and articulately made the case against the actions and structure of Big Finance, specifically Goldman Sachs – see Robert Wilmers, head of M &T Bank, writing in the Washington Post.  Hopefully, the finance lobby will more generally follow his lead – both in speaking out against the dangers of the biggest banks (and their “innovations”) gone bad, as well as in favor of protecting valued consumers against outrageous scams.

If consumers don’t trust financial services – and why should they, given all we’ve seen? – this will be a long and painful recovery.  Given what we know and have learned painfully about how our financial system operates, saying that “the market will provide consumer safety” is essentially the same thing as saying “the market will not provide” – you’re on your own, again.

By Simon Johnson

‘IS “GREEN” SET TO DRIVE THE CAR INDUSTRY?’ from In:Fact via Change/Agent.

In Uncategorized on July 28, 2009 at 04:25

Executive summary

Picture this. A crowded street full of bars and restaurants, gorgeous and wealthy people spilling out of drinking establishments and onto the footpaths. Suddenly the sound of a throaty engine rises above the pumping music and street noise, a prelude to the gobsmackingly powerful, tangerine sports car that pulls up. It’s quite simply beautiful. Every single conversation stops. Laughter trails off. And every single head turns.

That’s the power of a dream car.

And that’s what makes it quite amazing that, even if money were no object, six in ten people say they would rather buy a green car than a dream car.

Synovate surveyed more than 13,500 people across 18 markets about green versus dream cars, vehicle ownership, intent to buy in the next year and their attitude to cars, traffic, public transport and their need-for-speed.

”’SECRETARY GEITHNER’S CHINA STRATEGY: A VIEWER’S GUIDE,’ by Simon Johnson at baselinescenario .com.

In Uncategorized on July 28, 2009 at 03:27

On Monday and Tuesday of this week, Treasury Secretary Geithner – and Secretary of State Clinton – meet with a high-level Chinese delegation.  (Could someone please update the Treasury’s schedule of events? At 7am on Monday it still shows last week’s agenda; update, 9am, this is now fixed – thanks).

According to official previews (i.e., the apparent contents of background briefings given to wire services), the economic topics are China’s concerns about the value of the dollar (i.e., their investments in the U.S.) and the amount of debt that the U.S. will issue this year.

This is absurd.

China decided to accumulate over $2trn worth of reserves, most of which they are presumed to hold in dollars.  No one compelled, suggested, or was even particularly pleased by their massive current account surplus (peaked at 11% of GDP in 2007, but still projected at 9.5% of GDP for 2009).  We can argue about whether this surplus – arguably the largest on modern record for a major country – was intentional or the result of various policy accidents.

Irrespective of underlying cause, any country that runs such a current account surplus is implicitly taking a great deal of currency risk – China was in effect deciding to take the biggest ever official long-dollar position.  The idea that the US government should spend time reassuring them is somewhere between quaint and not good strategy.

If China decides to now shift out of dollars, what would happen?  Remember that the US left the world of fixed exchange rates and associated rigidities a long time ago – back in the early 1970s.  The dollar would surely depreciate and inflation would likely rise.  But who cares?

A weaker dollar would help our exports.  It’s not honorable for the issuer of a reserve currency to talk down its own exchange rate (hence the Rubinesque “strong dollar” rhetorical trap), but if a third party leads a big sell-off, what can we do about it?

Treasury’s concern is not really the value of the dollar – particularly as they would like a bit of inflation at this point; again, if it’s China’s fault that the real value of our debts falls, that might play (or spin) well in Peoria.  Instead, Treasury’s concern is the large amount of debt that they/we are trying to issue.

If China is worried about the future value of our debt in renminbi, then Treasury will have to pay higher long term interest rates.  But, as Treasury and the White House have been emphasizing, what really matters for our long-term fiscal solvency is bringing Medicare and associated costs under control.  Any strategy that relies instead on indefinitely low long-term interest rates is illusory – and any investor who thinks we will be like Japan in this regard is in for some disappointment.

The real issue for discussion this week should be China’s current account surplus and the pressing actions needed to bring this under control.  The US should put on the table the possibility of more assertively taking China to the World Trade Organization over its fundamentally undervalued exchange rate and associated trade policies (Arvind Subramanian’s idea).  The exchange rate dimension should have been dealt with by the IMF, but unfortunately that organization has (again) ducked its responsibilities on this issue.

The Treasury apparently thinks it should be deferential and on the defensive vis-a-vis China.  This is not only bad economics, this is bad geopolitical strategy.

By Simon Johnson

”’UP 40%, BUT STILL FEELING DOWN,’ from the Sunday N.Y. Times. IMPORTANT READ. Why it is so important NOT TO LOSE MONEY! Warren Buffet’s first rule of investing!

In Uncategorized on July 27, 2009 at 02:27

While we are not satisfied with our performance in the last quarter, we are happy to report that we didn’t lose as much money as the average stock mutual fund.

That wouldn’t be a very sexy sales pitch: mutual fund managers don’t typically phrase their shareholder letters quite that bluntly.

But the truth is that for most investors, it’s more important to avoid big losses than to rack up big gains. That may seem a milquetoast approach, but in the miserable market of 2008 and early 2009, minimizing losses was the best that most people could do. And because of the ugly math of investing, it has been extraordinarily difficult to recover from big declines.

“People often don’t understand why they are still in a deep hole, even after they’ve had a year of great returns,” said John Bogle, the founder of Vanguard and the creator of the first index mutual fund. It is because when your portfolio shrinks substantially, you need an enormous gain, in percentage terms, to climb back to where you started. This is part of what Mr. Bogle (citing Justice Louis Brandeis) calls “the relentless rules of humble arithmetic.”

Here’s how the math works:

Suppose you lost 40 percent in 2008 — roughly the decline in the Standard & Poor’s 500-stock index. One dollar at the start of the year would have been worth 60 cents at the end. Then say that after that loss, you posted a gain of 40 percent (the rough increase in the S.& P. 500 from its March low through the middle of July). That’s a spectacular return.

Time to celebrate? Not really.

A 40 percent gain on 60 cents is 24 cents. Your original $1 is now only 84 cents — you’re still down 16 cents.

Mr. Bogle did some calculations based on the assumption that you invested $1 in the S.& P. 500 at its peak. By March this year, the index had dropped 57 percent, reducing your dollar to a mere 43 cents. After a 40 percent gain, your little stash was worth only 60 cents. Even worse, he said, is the “exponential factor” in losses and recoveries. If your initial investment fell 50 percent, you would need a 100 percent gain to return to the starting line. If you lost 75 percent, you would need 300 percent.

Although stocks tend to outperform bonds over the long haul, gains that big are hard to come by. And that, in a nutshell, is why it’s better to avoid big losses in the first place.

Hersh Cohen, chief investment officer of ClearBridge Advisors, a Legg Mason subsidiary, says he believes in this philosophy wholeheartedly. “Make sure you don’t get killed on the downside,” he said. That’s more important, he said, than “worrying about the upside.”

Mr. Cohen has managed the Legg Mason Partners Appreciation fund for 30 years, over which he has beaten the S.& P. 500, according to Morningstar. The fund has returned 11.9 percent annualized, compared with 10.9 percent for the index and 10.4 percent for the average large-capitalization stock fund. (For the last 14 years, he has co-managed the fund with Scott Glasser.)

Last year was “the worst in my career in 40 years of managing funds,” Mr. Cohen said. Partners Appreciation lost 29 percent, and he said he “went home depressed about it every night.” Still, that performance was much better than the overall market and a vast majority of stock mutual funds.

MR. COHEN focuses on companies with “superior balance sheets” and rising dividends. At the moment, in his estimation, those include Wal-Mart, Travelers, Johnson & JohnsonCisco Systems and Berkshire Hathaway.

Mr. Cohen holds a doctorate in psychology — a background he calls most helpful in “market extremes.” He says he tries “to act on extremes — but to act the other way,” cutting back when the market is euphoric, and increasing his bets when others panic “and stuff is being given away.”

For his part, Mr. Bogle has reduced the risk of big losses by diversifying most of his own portfolio into safer fixed-income holdings — 80 percent of it — which, he said, is appropriate for his age. He is 80 and holds index funds, and while he remains bullish for the long term, he said that by being cautious he has enjoyed a “consistently good night’s sleep over the last few years.”


In Uncategorized on July 25, 2009 at 13:05

 The cheesiest line in investing is that “It’s a stock-picker’s market.” It’s intended to mean that the times require superior selection abilities to make money, when the truth is that being an above-average money manager requires superior skills regardless of conditions. In short, it’s always a stock-picker’s market.

But the new thinking for many investors and industry watchers is a bit different, and it can be summed up like this: “It’s a market-picker’s market.”

A market-picker, in this case, is someone taking the top-down view of investing, the “global macro” take, in economist-speak. From there, picking the broad market or portion of the market that seems to be working enables an investor to hold big, broad market segments and ride positive momentum.

It’s a bit backwards from conventional thinking during tough times, because the standard wisdom has been that there are good buys even in the worst of markets — hence, a “stock-picker’s market” — where you can buy a great business, confident that it will reward you in time. In this new way of thinking, the idea is that the economy drives broader market segments, so instead of working to find the right stocks, investors buy an index fund or exchange-traded fund that tracks the right segments, and then ride it until bigger shifts put some other arena into favor.

“Entire markets move, but they really move like tectonic plates,” saidJack Ablin, chief investment officer at Harris Private Bank, whose new book “Reading Minds and Markets” is a good guide for someone who wants to pursue a top-down, economy-driven strategy. “They trend, they move in deliberate fashion, they move rather slowly. So if you can catch a pretty good trend, you can ride it and not have to be trading all the time.

“You have to decide if you want to focus on the stock market or the economy,” Ablin continued. “The stock market is the dog and the economy is the man walking the dog. Over short periods, it is very difficult to determine where the dog is going to go — it’ll move this way or that — but eventually the dog has to follow the man walking it.”

A focus on asset allocation

The stock market has certainly bitten the hands of plenty of investors, which is precisely why a global-macro strategy is so appealing right now. It’s not day-trading, or market timing, because those tactics involve paying more attention to the stock market, not less. Instead, this is more like an asset-allocation plan based on what an investor believes will do best next.

“All of the studies show that asset allocation accounts for 95% of your ultimate investment performance,” Ablin said, “so why is it that people take 95% of their time picking stocks and only 5% doing asset allocation, deciding which areas they want to invest in and why?”

Ablin points out that one plus for global macro investing is that the top-down approach tends to allow people to make either-or decisions, putting one strategy or market against the other. In an oversimplified example, that leaves an investor making decisions like “growth or value,” “U.S. or China,” or “stocks or bonds.”

It’s a bit harder to decide how the relative valuation of, say, China stacks up to small-cap domestic stocks. While Ablin’s book suggests relying heavily on price/earnings ratios, he notes that it’s more like a cabbages-to-kiwis comparison, rather than an apples-to-apples spot check. But if you can find a market with strong relative valuation and momentum, you’ve got a shot, Ablin said.

Critics will note that proponents of making a change to global macro are changing horses in the middle of their run, a classic market mistake where the investor goes after what works, right before it craters and something else comes into vogue.

Global macro has a lot of appeal right now, in part because, while the domestic stock market has been in rebound mode, critics note the economy is still teetering on the edge of another big decline, with the prospect of inflation and more just waiting to yank the happy dog’s walk to a short stop. It’s the strategy for people who got tired of trying to be a brilliant stock-picker or a dedicated buy-and-holder.

Ablin, however, has been using and refining his system for about 20 years now — acknowledging that the advent of ETFs has made it much easier and more cost-effective — so it’s not like he’s changed because the system failed him. In fact, early in 2007, monitoring P/E ratios on small- and large-cap stocks — precisely the kind of decision he’s suggesting investors make — suggested that he rebalance toward the big names. In the two years since, the Standard & Poor’s 500 (.SPX


) beat the small-cap Russell 2000.

Take a test run first

That’s the kind of pursuit-and-avoidance strategy Ablin, and others, now advocate. Still, Ablin is careful to suggest that investors not throw out their old strategies, but rather test their acumen as a market-picker, either with a small percentage of assets or in paper trades until they are comfortable that they can make global macro work on their own.

And while the tools now exist to make this strategy easier to follow — ETFs allow for fast, easy trading and well-defined market segments — this is not a strategy that will take advantage of leveraged funds trying to capture the trend times two or three. Those turbo-charged funds tend to work best in a rapid-trading environment, not the “tectonic plate” movement of global macro.

What remains to be seen, however, is whether this strategy can stand the test of time. As a general rule, investment theories that make it out of the institutional world into the mindset of the general public tend to stop working — or at least working at peak levels — once they get there. Indeed, if everyone tries using the same tools and metrics to read the market, there’s real potential for those devices to become less effective.

The investment world is littered with things that sounded like good ideas, only to burn their true believers. But for anyone who believes that buy-and-hold is dead, global macro is a realistic alternative; and yet, because markets will always be difficult, it will always be a “market-picker’s market.”

‘BERNANKE AND THE LOBBIES; CONFIDENCE ILLUSION ,’ by Simon Johnson at baselinescenario .com.

In Uncategorized on July 24, 2009 at 12:33

Ben Bernanke is opposed to the creation of a new Consumer Financial Protection Agency.  Disregarding his organization’s disappointing track record in this regard, he claims that the Fed can handle this issue perfectly well going forward.

He thus adds his voice to the cacophony of financial sector lobbyists favoring the status quo.

At the same time, Bernanke and the lobbyists talk about the importance of consumer confidence for the recovery.  But how can you expect anyone to have confidence enough to spend and borrow when so many people have been so badly treated by the financial sector in recent years?

What happens when there is a scare regarding food contamination in the US or globally?  People buy less of that kind of food until the government assures them that (1) we know understand the cause of the problem, and (2) it will not happen again.

Word has got around that many financial products are not safe – as well as the idea that the debt levels encouraged by the finance industry are not always healthy.  Consumers are going to be more careful and, if there is no way to reassure them fully, they may be excessively careful.

In addition, we have learned that allowing financial firms to abuse consumers is very bad for our overall financial system health – leading directly to the current crisis, loss of jobs, and still rising unemployment; all of this further undermines confidence of all kinds.  If the financial system can turn nasty or even nastier, we should all carry more “precautionary” savings.

There’s no question that some financial firms would like to return to abusive practices, figuring they can once again make money and then move on.  Yet serious financial sector firms would prefer to clean up their acts and work with properly informed customers.  These firms are making a bad mistake in opposing the CFPA.

If the CFPA does not make it through Congress – and right now it seems a toss-up – this will just feed the backlash against finance more generally, e.g., in the 2010 midterm elections and beyond.  There is no way that is good for overall confidence.  It just doesn’t make sense for well-run financial firms to go down this road.

Industry thought leaders,  the American Bankers’ Association, the Financial Services Roundtable, and other interest groups should switch their positions and support the CFPA – if they really want consumer confidence in financial products and more generally to return.

The Fed, it seems, just wants to defend its turf.  This is unfortunate, particularly given its ambition to become even more responsible for the safety and soundness of the entire financial system.  How can our financial system ever be sound when so many elements prey on so many consumers’ confidence?

By Simon Johnson

‘EVERYTHING YOU SHOULD KNOW ABOUT CAPITAL GAINS TAXES, ‘ from The Motley Fool. ‘HOW TO MAKE LOTS OF MONEY & NOT LIFT A FINGER.’ Easy read, on the money, good for future reference.

In Uncategorized on July 23, 2009 at 06:18

Countless investors have successfully built huge nest eggs by finding great stocks and holding onto them for the long term. But if you want to hang onto as much of your wealth as you can, there’s something you should make sure you don’t do.

Yes, doing nothing may be exactly the right move when the time comes for you to start spending down your assets. Rather than cashing in the long-held winning stocks in your portfolio, you may find that by holding onto those winners, you can legally avoid paying huge amounts of money to the folks you’d least want to have it — the IRS.

There’s a lot at stake

If you’ve invested for any length of time, you’re probably well aware of the taxes that apply to your investment gains. Short-term gains — profits you earn from investments you hold for one year or less — are subject to income tax at your ordinary income tax rate. But if you hold onto your stocks for more than a year, then you get to pay tax at a lower rate — a maximum of 15%. In fact, lower-income taxpayers in the 10% and 15% tax brackets pay nothing at all on their capital gains.

That sounds like a good deal — and it is, in comparison to the way things were after the 1986 Tax Reform Act, when capital gains were taxed at exactly the same rate as any other type of income. But if you’ve held onto your stocks for a long time and seen them climb through the roof, then even a 15% haircut means a lot of money out of your pocket. Just consider how much income tax you’d pay from holding these stocks over the long term:


Stock Length of
time held
$10,000 Investment
Capital-gains tax 
at 15% rate
Intel (INTC 



20 years $215,116 $30,767
Dell (DELL 



20 years $1,593,750 $237,563



20 years $137,783 $19,167
Pfizer (PFE 



20 years $101,141 $13,671
Oracle (ORCL 



20 years $527,805 $77,671
General Mills (GIS 



20 years $87,747 $11,662
Amgen (AMGN 



20 years $615,474 $90,821
Source: Yahoo (YHOO 


)! Finance.


As you can see, if you were fortunate to have had your money invested in those stocks over the decades and decided to cash them all in to finance your retirement, you’d pay more than $480,000 in income taxes.

Don’t share your gains

Almost half a million bucks to the IRS? That’s not where you want your retirement money going. But is there anything you can do about it, or are those taxes just inevitable?

Well, the answer is that it depends. If you don’t need that money for your own living expenses, then that potential tax liability may disappear. After your death, any assets you own get what’s called a stepped-up basis. That means that if your heirs inherit the shares from you and then sell them immediately, they don’t have to pay any capital gains tax at all.

You don’t typically run into that kind of a tax break. For instance, on traditional IRAs, your heirs do have to pay income tax on remaining funds as they make mandatory withdrawals of assets from their inherited accounts. But not with stocks held in regular taxable accounts.

Obviously, that creates a big opportunity. If you can just hang onto those shares until your death, then neither you nor your heirs will ever have to pay that $480,000 in taxes. That’s an awfully big incentive to stand pat on your winning stocks.

Planning for lower taxes

Of course, if you need the money from those stocks to finance your own lifestyle, then your own needs should generally trump those tax considerations. But you may want to rethink the order in which you decide to draw down your savings. Although paying tax prematurely by withdrawing from retirement accounts often costs more in the short run, you may create long-term savings by going ahead and paying tax that’s completely unavoidable in favor of preserving the stepped-up basis tax break.

It’s rare that you can earn big tax savings from doing absolutely nothing. Yet that’s exactly what stepped-up basis can do for you and your loved ones. By planning for the future, you can cut the IRS out and leave more for those who deserve your money more.