Not A Mystery

Talk about fast news cycles.

It’s the Economist’s Big Mac Index for 2010 … again!

In a sign of these unusually uncertain times The Economist has speeded up their news cycle, and in the process seems to be taking themselves and their index more seriously. Used to be we’d get annual updates to the index, this one has taken only six months.

I’m guessing that somewhere in the depths of the newsroom is an aspiring summer intern taking a run at the IMF and the ECB. And why not.

Just to review, The Economist has been publishing their (not so tongue-in-cheek) Big Mac Index since 1986. It’s a reality check on world-wide currency exchange rates, based on the concept of Purchasing-Power Parity. Purchasing-Power Parity (PPP) says that exchange rates are correct when the price of similar goods are the same in each country. The Big Mac survey compares the price of a Big Mac all over the world. The Big Mac is, after all, a basket of standard ingredients put together in a consistent process.

Coming Soon, A Ringtone Quoting Exchange Rates

And while I have a hard time getting excited about this morning’s price of a Big Mac in Krakow, the fact that Lisbeth Salandar would have to fork over SKr 48.4 in Stockholm if she wanted to treat Mikael Blomqvist might raise my blood pressure a few millibars.

When the world gets even more unusually uncertain we can probably expect the BMI to go live stream, with possibly a Twitter Feed and an iPhone app.

Hold the ketchup.

Being an expert must be harder these days.

Nobody seems to have any good answers to tough questions about the economy.

Morningstar pundits are usually pretty good when it comes to personal financial advice. But in is a recent answer on how to maintain yourself in retirement, they managed to coin the phrase ‘pre-tire’ when recommending that you just keep working.

… most retirees are going to have to make some hard choices … [it's] hard to generate a livable income unless you have a lot of money, [so] working longer is going to be part of the solution for a lot of pre-retirees.

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Which is probably not the solution most people are looking for.

But whether you like that or not, at least they were working in the present, or near future.

On the other hand we have Mohamed A. El-Erian, CEO and co-CIO of PIMCO, who at the end of a good piece on The Real Tragedy of Persistent Unemployment suggests that,

… policy makers should also come up with a comprehensive strategy that focuses on improving human capital, particularly through a greater emphasis on education and training; expanding infrastructure and technology investments, in part by creating a more friendly tax system; encouraging a bigger translation of scientific advances into economy-wide productivity gains; and better protecting the most vulnerable segments of society …

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And while I can’t disagree with Mr. El-Erian, the time-frame for his solutions are measured in generations.

It’s a good time to remind ourselves that the fun is in the journey and not the destination.

And Somebody Already Mortgaged The Parachutes

J. Wellington Wimpy was many years ahead of his time, and at least honest, when he offered that, “I will gladly pay you Tuesday for a hamburger today.”

The US Congress is getting close to passing new financial regulation, attempting to rein in our friends on Wall Street. Pending legislation would limit Investment Banks’ ability to trade for their own accounts, and effectively bar them from trading derivatives.

The bankers are pushing back.

Surprised?

The big banks argue that the Volcker proposal is misguided, for several reasons … the banks assert that the financial crisis of 2008 was a lending-based crisis caused by reckless loans made to unqualified home buyers. It was not, they say, a trading crisis.

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Wall Street Bankers "Getting Wood" Over The Volcker Rule

This is not quite the truth, or even a close approximation to the truth. It’s an outright lie.

• Investment banks packaged, securitized and re-sold the fraudulent loans made by originators, ‘enabling’ them to keep the hustle going.
• Investment banks deliberately ‘gamed’ the rating agencies so that sub-prime loans were magically converted to investment grade bonds.
• Investment banks invented new vehicles to peddle (trade) their products called Special Purpose Vehicles.
• Investment banks obfuscated what they were doing by re-branding (renaming) the slime that was inside these investments; for example No-Doc (Liar) loans became known as Alt-A loans.

And to say that the crisis was lending based? Get this. When Investment banks ran out of loans to repackage and sell, because their suppliers couldn’t make them fast enough, they invented a totally new class bonds called Synthetic CDOs that didn’t even require real mortgages at all!

It was truly breathtaking.

If you read only one book exposing the underbelly of Wall Street, get a copy of The Big Short by Michael Lewis. If you have an audible.com account, I can highly recommend the audio version read by Jesse Boggs. Listen while you are in the gym, and the adrenalin rush when you hear about these Wall Street thieves will definitely improve your workout.

If you are not familiar with the term “wood”, then here is your link to the Urban Dictionary. Caution, this link is not rated GP.

The good news is that if a catastrophic event destroys mankind our investments will be extremely well managed after we are gone. The bad news is that the computers doing it may be trading for their own accounts instead of ours.

This theater of the absurd scenario might be more plausible than you think, and occurred to me last week when our stock exchanges mysteriously melted down in the space of a few minutes.

I’m currently reading David Hoffman’s Pulitzer prize-winning book “The Dead Hand: The Untold Story of the Cold War Arms Race“. Its cheerful title is taken from a Soviet weapon system designed to have computers automatically fire a massive retaliatory nuclear strike at the US if Soviet leaders were ‘decapitated’ by an assumed US first strike.

The Soviets referred to a semi-automatic defense plan as the “Dead Hand.” The Dead Hand was a system that would fire a portfolio of SS-18′s on to the United States and Western Europe if its sensors made the conclusion that the Kremlin had been destroyed by a nuclear blast. The system was in place as early as the mid-80s. It is a bit of a miracle, given the demonstrated shortcomings of Soviet engineering, that it never made a mistake.

The Soviets claimed that they never actually set up a completely automated system, but instead would have had (surviving) lower level officials make the final decision on whether a strike was to be launched.

In any case I was struck by a parallel in last week’s breakdown of the US stock market. As I write this the SEC has still not tracked  down the specific cause of a 1000 point drop in the Dow that reduced a number of Dow Component stocks to pennies a share in the space of a few minutes. Everyone breathed a sigh of relief when, a few moments later, the market recovered as mysteriously as it had plummeted.

F2U Rio Linda, normally a quick recovery after a market drop is called Dead Cat Bounce by investors. So let’s refer to this event as a Dead Hand Bounce in homage to the anonymous computers that caused, and then corrected, the disruption.

Last One Out, Shut Off The Lights

Although the real cause of the market dislocation is still unknown, what is clear is that a number of computers were at the scene of the crime. And those computers place their trades so fast there is no way humans can be involved in real time to supervise.

By late Sunday, a cause of the slide hadn’t been determined … Still, some new details about what happened during the brief span Thursday afternoon that sent the Dow Jones Industrial Average into a nearly 1,000-point tailspin continued to emerge over the weekend …

But it is becoming clear that much of the decline was because of glitches in how the market functions. High-speed electronic trading, long held as a boon that has made the market more efficient, can also trigger sharp selloffs that overwhelm the market.

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Although everyone is relieved that this storm has passed, it reminds me of a that old saying, “Problems that go away on their own, come back on their own.“

And now that hackers know what’s possible, they will have begun working on their own version of the Dead Hand.

I wonder what they’ll call it.

Get a grip, because I’m about to tell you how to double your money with no risk.

While simultaneously bringing new meaning to the phrase, “go green”.

Let’s talk recycling.

Like me, I’m sure that many of your beer-drinking friends go on about the  hundreds of dollars they ‘make’ by taking their crushed aluminum cans to be recycled.

In these days of miserable interest rates on my savings account I figured it was time for me to see if this new income stream could improve my standard of living.

Unfortunately I don’t drink beer in cans, since I’m mostly a wine and craft-brew guy. But we do consume some Seltzer and Gatorade, both of which come in recyclable containers. Bravo.

Wait Until Goldman Sachs Finds Out

After investing in, and religiously employing, a can-crusher for several weeks, I accumulated what seemed to be a ton of aluminum. Well, not a ton, but at least a few pounds.

But when I delivered my load to be bought by the recycle guy I was crushed, crushed I say, by the meager payback. We are talking a couple of bucks for all that work and time. It seemed like I was paying a lot more for the aluminum when I purchased the cans in the grocery store than I was getting back in all my newly found green-ness.

Convinced I was getting shafted by the authorities I almost called my local Tea Party, but instead of going for comic relief, decided to do some calculations. Keep in mind that in the grocery store we pay the CRV (California Refund Value) deposit per container, but get paid back by the pound of material we present for re-cycling.

Here are our input figures after I did some careful weigh-ins:

• The CRV for all three containers is the same: 5 cents per container.
• The weight of 1 aluminum can is 1/2 ounce.
• The weight of 1 Gatorade 12 Fluid Ounce bottle is 1 ounce.
• The weight of 1 Gatorade 20 Fluid Ounce bottle is 1 1/4 ounces.
• The weight of 1 Gatorade 32 Fluid Ounce bottle is 1 3/4 ounces.

Our Menu, So To Speak

• The recycle value of 1 pound of aluminum is $1.57 per pound.
• The recycle value of 1 pound of plastic is 93 cents per pound.

Now we can calculate that it takes:

• 32 aluminum cans to make a pound.
• 16 small Gatorade bottles to make a pound.
• 12.8 large Gatorade bottles to make a pound.
• 9.14 extra large Gatorade bottles to make a pound.

So where do we find our best Return On Investment?

The envelopes please…drum-roll…for a 5 cent investment in each container our payback is:

• For each aluminum can, 4.9 cents returned, for a loss of 2%.
• For each small Gatorade bottle with cap, 5.8 cents returned, a gain of 16%.
• For each large Gatorade bottle with cap, 7.3 cents returned, a gain of 46%.
• For each extra large Gatorade bottle with cap, 10.2 cents returned, a gain of 104%.

Hmm pretty interesting.

Our beer-drinking friends are actually losing money even after collecting their re-cycle fees. They are generously donating 2% of their CRV to the State of California, and not even breaking even. Thanks guys.

On the other hand, those of us who work out every day, and drink Gatorade to replenish our electrolytes are not only happy and healthy, but if we supersize our investment to the Big Gatorade bottles, we will be making 104% on our money.

F2U Rio Linda, that’s otherwise known as doubling your money.

Oh, I discovered one more interesting fact. The State of California levies Sales Tax on the CRV, so when they increase the CRV evey so often it serves to increase their tax revenues.

Maybe it really is time to call in the Tea Party-errs.

In a nutshell, the way financial institutions (Big Bank) make their money is by knowing more than the other guy (that would be you). They will famously say that their priority is to serve their customers, and that capitalism depends upon them for the efficient allocation of capital. Also, that they are all in favor of shining the light of day on their operations.

Whatever.

We're Here To Allocate Your Capital

A better characterization of Big Bank’s approach to transparency and customer service is found in The Hitchhiker’s Guide to the Galaxy.

In The Hitchhiker’s Guide to the Galaxy, a notice ordering the demolition of someone’s house is found “on display” in a lightless, stairless cellar, in the bottom of a locked filing cabinet, in a disused lavatory, with a sign on the door saying “Beware of the leopard”.

A fine example of Big Bank’s drive for obfuscation is their lobbyist’s demands to not force them to trade derivatives on open exchanges. The reason Big Bank opposes exchanges is that,

Currently, the only way to trade many derivatives is to call up various dealers and ask for the price at which they are willing to buy or sell. The securities dealer profits from the difference between the prices at which it buys from one party and sells to another. Investors rarely, if ever, see details on the other side of the trade. Wall Street has signaled that it can live with a clearinghouse approach, but it is strongly opposed to exchange trading of derivatives, which would introduce price competition and lower the profits.

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But wait, it gets better. For those folks whose only connection with reality is the Adam Carolla podcast, here is an example of Big Bank’s service to customers and community.

The Securities and Exchange Commission filed a civil lawsuit against Goldman Sachs for securities fraud [last Friday]… charging the bank with creating and selling mortgage-backed securities that were intended to fail … Goldman let John Paulson, a prominent hedge fund manager, select mortgage bonds that … were most likely to lose value and … sold [those bonds] to investors … [which then] plunged in value …

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What’s been famously reported in the media is that Paulson made $1 billion on this scam (although he hasn’t been charged by the SEC along with Goldman). So, speaking of service to their community,

What’s not been noted is that as a hedge fund manager Paulson collects only (sic) 20% of the profits he generates for his investors, which means his investors made $5 billion dollars on that scam.

What’s not been noted is that as a hedge fund manager Paulson pays income tax on his fees as capital gains, not ordinary income like us ordinary folks. This saves him approximately $200 million in taxes on that $1 billion income.

What’s not been noted is that because these profits are capital gains to the investors also, neither Paulson nor his investors pay Medicare withholding of 1.45%, thus depriving Medicare of $102 million in payments.

What’s not been noted is that in many instances hedge fund profits are collected off-shore and so can be immune from any US taxes. We don’t know that this is the case with Paulson’s fund, but just mention it as a possibility.

Thank goodness we don’t depend on Big Bank for the Answer to the Ultimate Question of Life, the Universe, and Everything.

42.

Close on the hooves of our Skinny Cow report comes further bovine news from Wall Street, which we’ll put under the category of Fatted Calves.

Fatted calf is a metaphor or symbol of festive celebration and rejoicing for someone’s long-awaited return. It derives from the parable of the prodigal son in the New Testament. In biblical times, people would often keep at least one piece of livestock that was fed a special diet to fatten it up, thus making it more flavorful when prepared as a meal. Slaughtering this livestock was to be done on rare and special occasions. Thus when the prodigal son returns, the father “kills the fatted calf” to show that the celebration is out of the ordinary.

The CDO's May Be Synthetic, But The Meat Tastes Great

Yesterday we learned that Goldman Sachs and John Paulson are accused by the SEC of fattening up a bunch of clueless investors.

The Securities and Exchange Commission filed a civil lawsuit against Goldman Sachs for securities fraud on Friday, charging the bank with creating and selling mortgage-backed securities that were designed to fail.

According to the complaint, Goldman let John Paulson, a prominent hedge fund manager, select mortgage bonds that he wanted to bet against because they were most likely to lose value and packaged those bonds into the “Abacus” investments, which were sold to investors like pension funds. As those securities plunged in value, Goldman and the Paulson hedge fund made money on their negative bets, while the Goldman clients who bought the investments lost billions of dollars.

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Strangely, this whole episode came to light not thru regulatory oversight, but from a recently published book on the financial meltdown “The Greatest Trade Ever“ by Gregory Zuckerman.

Unfortunately, even though the regulators are now on the case, they have come after the gourmets with civil instead of criminal charges.

We’ll take whatever we can get, “Cin cin”.

Last week we noted ATT’s whining about a $1 billion [non-cash] charge they were being forced to take because of Obamacare. In fact the new law just eliminated a 7-year old scam allowing them to ‘double-dip’ by taking a tax deduction on healthcare premiums that were actually being paid (for them) by the government.

A simple back-of-the-envelope calculation showed us ATT had saved so much money over the past 7 years, that the new $1 billion charge still left them with a $1.6 billion profit. Not a bad return on a smallish lobbying investment.

But now we learn that by their own standards of what is material information ATT shouldn’t even have brought the matter to anyone’s attention in the first place.

So, This Is The New AT&T

Turns out that ATT has been mum (F2U Rio Linda, that means ‘silent’) about another significant liability making that $1 billion write-off look like chump change.

AT&T Inc. is seeking to dismiss a long-running pension case alleging age discrimination that seeks $2.3 billion in damages, according to documents filed this week in a federal court. The suit alleges a 1998 pension change effectively froze the pensions of 40,000 older management employees at AT&T, in some cases for years, but not those of younger employees …  Legal papers filed Monday… include the first publicly disclosed estimate for potential damages. The $2.3 billion potential claim dwarfs the well-publicized $1 billion noncash charge the company will take to reflect the recent loss of its deductions for health-care subsidies it receives from the government.

But because this case includes an age-discrimination claim, under federal law the judge could send it to a jury trial. If a jury found that the company willfully discriminated against older workers, it could award punitive damages that would double the size of the claim to $4.6 billion.

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So how is it, you might ask, that ATT neglected to tell their shareholders about this potential damage to their share price?

Last May, the Securities and Exchange Commission asked AT&T why it hadn’t disclosed its potential exposure in the pension case. AT&T responded that it didn’t think the case met the reporting threshold for disclosure, SEC filings show.

I guess the SEC will need to re-write their regulations so that we take into account politics when deciding what is and is not material.

But wait, it gets even better.

To butress their case ATT revealed that even if they lost a $2.3 billion cash judgement it would have no real impact because the retirement account is so well-funded it could simply absorb that hit. At the same time we are being told that the Obamacare $1 billion non-cash write-off could trigger a loss of such magnitude that ATT might have to cancel or cut back retiree health benefits.

This simply boggles the mind. Or maybe not.

As we approach April 15th., otherwise known as Tax Day, it’s time once again to mention the staggering corruption of the US Senate, the world’s ‘greatest deliberative body’.

For well over three years (!) there has been an attempt to get rid of a loophole in the tax code granting hedge fund managers a lower tax rate than ordinary people who work for a salary. A gift that cuts their tax rate in half, assuming they even pay any taxes.

And what group is proudly standing in the way of tax reform? The US Senate, whose members are worried about damage to their own cash hoards.

The World's Greatest Body, Deliberating

Is corruption too strong a word? I don’t think so; especially at this time of year when I am writing my own check to Uncle Sam.

Riding high on the bank bailout, hedge fund managers posted record paydays in 2009 … the top 25 managers earned $25.3 billion in 2009 … [meanwhile] the government reported that unemployment was stuck at 9.7 percent, with 15 million Americans out of work … To add insult to injury, some hedge fund managers and, more commonly, private equity fund managers are able to pay a much lower rate of tax than the typical working professional.

The tax disparity results from an outdated rule that lets a money manager in a private partnership treat a chunk of his fees as if they were long-term capital gains, taxed at a special low rate of 15 percent. Fees for managing someone else’s money should be taxed as ordinary income, like wages and salary, at rates as high as 35 percent.

President Obama has included a provision to end that special treatment in his most recent budget. For three years running, the House has passed a bill to close the loophole. In the Senate both Democrats and Republicans have resisted, all for fear of losing lucrative campaign donations.

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It does get even better for the fund managers. What’s not reported, because it adds some complexity to the story, is that capital gains have another wonderful trait when it comes to taxes. Unlike ordinary income, capital gains can be offset with capital losses.

Then the tax rate goes to Zero.

As far as I’m concerned, all babies look like Winston Churchill.

"Never Was So Much Owed By So Many To So Few"

I’ve never thought of babies as contributing members of society. But now that’s changed.

Parents aren’t just raising adorable kids. They are also producing little human capital units that are likely to grow up, get jobs, pay taxes and raise little human capital units of their own.

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But wait, it gets better.

Turns out that the parents of the capital unit pay lower taxes compared to their childless peers because of the peculiarities of our tax system. However, this is more than made up for by the taxes paid by their kids (capital units) as they grow up and go to work.

So we “breeders” can hold our heads high, knowing we are contributing more to society than everyone else; while our kids are actually moving the freight.

Which, if you think about it, could be a bigger Ponzi Scheme than ObamaCare.

Who wants to tell the Conservatives?

[Note: if you want compare real leadership to "no you can't" statements, click here for Churchill.]

The usual suspects are shocked, shocked they say, over last week’s annoncement by ATT and several other large corporations that they would have to take (non-cash) write-offs because of new rules in ‘ObamaCare’ taking effect immediately.

In ATT’s case the number was $1 billion.

The charges relate to prescription-drug benefits for retirees. Companies that provide this benefit, as AT&T does, receive a federal subsidy, plus they can deduct the value of this subsidy from their taxes. The health overhaul cancels the deductibility of the subsidy.

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Omigod. We all knew this was going to cost us, but we never imagined it would happen within days! The destruction of capitalism is even closer than we thought.

A little digging however, turns up the fact that the current health care bill just reverses a payoff to those same companies made 7 years ago.

The charges are related to a 2003 law providing a prescription-drug benefit under Medicare. At the time it was adopted, some companies were threatening to drop drug coverage for their retirees, since this would now be available through Medicare. Congress voted them a 28% tax-free subsidy for continuing to provide coverage to retirees eligible for Medicare.

The subsidies caused the cost of companies’ obligations for retiree benefits to decline. AT&T, for example, saw its obligation drop by $1.6 billion at the time.

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A back-of-the-envelope calculation says that the $1.6 billion gift to ATT compounded over the past 7 years is worth something like $2.65 billion today if we grant the financial wizards at ATT the ability to get 7.5% return on their capital. Not so bad. That’s still $1.65 billion of extra profit to keep compounding into the future.

What’s really going on here, is that the corporations taking these write-offs are signaling that they may use this ‘increase in costs’ as an excuse to cut back on their retirees’ health benefits. To be generous we’ll call their statements a case of mis-direction.

Which brings to mind the classic game of mis-direction:

The three-card Monte game itself is very simple. To play, a dealer places three cards face down on a table [and] … shows that one of the cards is the target card, e.g., the Queen of Spades, and then rearranges the cards quickly to confuse the player [who] … is then given an opportunity to select one of the three cards. If the player correctly identifies the Queen of Spades, the player wins an amount equal to the amount bet; otherwise, he loses his stake.

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Mis-Direction Is The Name Of This Game

It would be nice if corporations would call a spade a spade, but that’s not in the cards.

[Tip: If you clicked the WSJ link and want to get past Rupert's pay-wall, here's your key.]