States Doubling Down To Make Pensions Solvent

There's a betting strategy that is especially common to blackjack players: when you lose a hand, keep doubling your bet until you win. In theory, you are assured of not losing anything. This theory depends on two factors: 1) having enough money to afford to keep doubling until you hit a hand, and 2) not running into a hot dealer. The other problem with this theory is that it begins with the assumption that you are going to lose and sets as a target "getting back to even". It appears that some states are subscribing to this strategy to try and "get back to even" when it comes to funding their public pensions. As private companies continue to move assets out of the stock market and into other vehicles like bonds, t-bills and cash, states that are watching their pension funds evaporate are instead buying into riskier high-return stocks.

“In effect, they’re going to Las Vegas,” said Frederick E. Rowe, a Dallas investor and the former chairman of the Texas Pension Review Board, which oversees public plans in that state. “Double up to catch up.”

Though they generally say that their strategies are aimed at diversification and are not riskier, public pension funds are trying a wide range of investments: commodity futures, junk bonds, foreign stocks, deeply discounted mortgage-backed securities and margin investing. And some states that previously shunned hedge funds are trying them now.

This is the same sort of behavior that caused banks and mortgage brokers to suffer the wrath of the President and the "banks are evil" crowd. That state governments are willing to do this is not only hypocritical, it's inane. After all, they have the recent memory of collapsing stock markets to show them why this is a bad idea.

Don't misunderstand; investing in the stock market is a good thing. Stocks are a great way to build wealth when you understand that results aren't guaranteed. I set aside a small bit each month to dabble with the understanding that it could be lost. What the states are doing is different; they're trying to cheat death in a sense. Public pensions all over the country are failing. The obvious answer is the cut payouts where practicable. Perhaps increase the retirement age. These are hugely unpopular with the benficiaries however and invoke the wrath of the unions. The other possibility is to raise taxes. This is hugely unpopular with the taxpayer and, with the rise of the Tea Party, this is not a good time to do that. That leaves cutting other programs and services to cover the shortfall. Instead, these states are opting for a fourth way: investing what's left into high risk/high reward stocks in an effort to snatch victory from the jaws of insolvency. It's the equivalent of letting it ride.

Perhaps I'm going to expose my lack of understanding of how fund management works and if so, I apologize. But it seems to me that pension funds should be handled the same way as a retirement fund for an individual. Earlier in a person's working life, monies are more heavily invested in stocks and other higher-risk investments. The purpose is to ride the market for years, surviving the dips under the belief that in the long run, the market will be ahead of where it was when you started. As you near retirement age, the balance of the investment moves ever more towards safer vehicles like bonds. This is to protect the gains made from the market and ensure a steady income once retirement is reached.

Pension fund managers should be able to determine where the payees are in that cycle and manage the funds similarly. In other words, if a large percentage of the workers to benefit from the pension are younger, more of the available funds would be in stocks. As the workforce begins to skew older, the funds are shifted to bonds and the like. That should provide a hedge against dips in the market and ensure that the older workers are taken care of. Again, forgive me if this sounds naive. I certainly bow to the expertise of any profession fund managers out there.

Of course. the role of unions can't be overlooked in this. Pension fund managers are loathe to revise the models on which the pensions are built, as revising the expected rate of return downward in a down market can have far-reaching effects on the budget and prompt a backlash from the unions.

The $30 billion Colorado state pension fund is one of a tiny number of government plans to disclose how much difference even a slight change in its projected rate of return could make. Colorado has been assuming its investments will earn 8.5 percent annually, on average, and on that basis it reported a $17.9 billion shortfall in its most recent annual report.

But the state also disclosed what would happen if it lowered its investment assumption just half a percentage point, to 8 percent. Though it might be more likely to achieve that return, Colorado would earn less over time on its investments. So at 8 percent, the plan’s shortfall would actually jump to $21.4 billion. Contributions would need to increase to keep pace.

Colorado cannot afford the contributions it owes, even at the current estimated rate of return. It has fallen behind by several billion dollars on its yearly contributions, and after a bruising battle the legislature recently passed a bill reducing retirees’ cost-of-living adjustment, to 2 percent, from 3.5 percent. Public employees’ unions are threatening to sue to have the law repealed.

One or two of these states could certainly hit it big; I've seen blackjack players hit their hand with the double down method before. But most of the time it doesn't work. You just run out of money too fast or you find yourself playing against a hot dealer. Most of these states are going to end up gambling their pensions away completely.

(Crossposted at Say Anything)

Book Publishers Trying To Become The New Record Companies

There's a really interesting look behind the big Amazon vs MacMillan Publishing fight over at Pajamas Media. The condensed version of the dust up is that Apple's iPad and its new iBookstore has opened the door for publishers to push against Amazon's ebook pricing structure.

The key is the mainstream publishers’ worry that e-books will cannibalize the sales of physical books. Mainstream book publishers, along with mainstream music publishers and the legacy media newspapers, are actually primarily manufacturers. The costs of the content, in royalties to the authors, are only about 10 percent of the cover price of the book, and less than that for the record. It’s the costs of setting type or mastering, printing the books or pressing the disks, shipping, cataloging, and selling them that dominates the costs of publishing.

Now, along come e-books and readers, like the Kindle and the iPad. Suddenly the whole business of publishing has changed. You can sell a physical book or an e-book — but each copy of the e-book costs literally one one-millionth as much to produce.

What Apple and MacMillan and the others are doing is trying to preserve their existing business model by forcing the price of e-books to be high enough to not cut too badly into the physical book market. What Bezos and Amazon are doing is trying to cut the price of e-books to encourage adoption.

Where have I heard this sort of story before. Oh yeah! Record companies have been fighting this war with iTunes, Rhapsody, Amazon and the Zune store for a while now. How's that going for them?

It looks like book publishers are hellbent on repeating the mistakes of the record industry. By fighting to preserve a business model that ignores advances in the technology and the evolving preferences of its customer base, they are setting themselves up for years of pain. The death of the traditional paper book is coming. It might not seem as inevitable as the death of CDs, but it's coming.

Book publishers should do the same thing record companies should have done when the writing first appeared on the wall: open up their own online stores to sell eBook versions of their materials. Let the buyers decide what they're willing to pay for an electronic copy of a book. Gradually (as is practical) move more and more of their offerings to electronic form. Cut back on traditional printing runs. When eBook technology becomes ubiquitous (and thus cheap), the publishers would be well positioned to function in the new market landscape.

Instead, they're willing to let third parties like Amazon and now Apple set themselves up as middlemen. It's going to cost them in the long run.

I Learned An Important Lesson About Government By Waiting Tables

There is a story about a college professor who challenged his students to put their faith in Socialism to the test by agreeing that everyone in the class would receive the same grade, to be determined by averaging the individual grades earned in the class. You can read the whole story here. Of course, this story is apocryphal. I doubt any school would allow a professor to make such an arrangement with his students.

I have however seen this dynamic play out in the workplace before. While in college I worked in several restaurants and bars as a waiter and sometimes-bartender. Places like these handle the tips their employees make differently. Most place I worked allowed you to keep the tips you earned. Naturally, you had to claim tips as income at tax time. One place though, used what is called “tip pooling”. Tips went into a pool each day and were doled out to each server who worked during that day as a percentage based on the number of hours worked. I say that only one place I worked did this, and I say this because once was enough.

The goal of tip pooling is to encourage everyone to work hard and make the pool as large as possible. Paying out from the pool based on the hours worked is supposed to be “fair”. In reality, tip pooling is quite the opposite. Rather than encouraging workers to build the pool up, it encourages laziness. Like in the story of the “socialist college class” above, there were always people that did the bare minimum they could get away with, knowing there were people on the floor working hard and building up the tip pool. At the end of the day there was always grumbling when the tips got divided up.

Over time, there was a marked decrease in the service as the harder workers realized they were working not only for themselves, but also for their lazier peers. Some left for other jobs. Some stayed behind and grumbled. I wised up and joined the first group.

The lesson is one I’ve kept with me to this day. If you put people in a situation where they are forced to support others with their labor, their effort will slacken in more or less direct proportion to how much they perceive they are being exploited. Let them keep what they earn, or most of it at least, and most people will work hard to build a bigger pool.


(Crossposted from Say Anything)

Spot The False Dichotomy

I found this link in a discussion about deflation, which is starting to pick up steam as the new Cause of Our Destruction. It takes you to a page with a handy chart (yay visual aids!) explaining deflation, the deflation spiral, and how it can be remedied.

I thought this was pretty great until I realized it was using a false dichotomy in it's explanation. Can you spot it? If your economic views are similar to mine you'll probably see it pretty quickly. Think about it for a minute before reading the next paragraph.

Did you see it? It's all good until it gets to the part about how to deal with it once the interest rate gets near zero. Specifically, it's this: it identifies massive government spending as the only way to combat deflation. Oddly, there is no mention in this beautiful and otherwise useful chart about lowering taxes or cutting spending. The choices are reduced to spiraling unemployment or massive spending. Bad chart! Bad, bad chart!

Just So We're All Clear

(click on image to enlarge)

A few points:

• Bailing out AIG (or any other bank) was a BAD IDEA.
• The bonuses were contracturally obligated payments that were intentionally and on purpose left untouched by the bailout bill. A passage meant to rescind these payments was struck out by Senator Chris Dodd.
• The payments amount to .094% of the money.
• $50 billion of the money went to help out other banks (include $36 billion to European banks)
• AIG execs were throwing money at politicians before, during and after the company was bailed out. Wonder if any bailout money found its way into a campagin coffer?
• Did I mention that bailing out AIG (or anyone else) was a BAD IDEA?
  

Get mad about bailout money getting paid to executives at a failing corporation. I'm mad too. But wake up to the fact that all this manufactured outrage (by Dodd and other politicians) is just a smokescreen to keep you from questioning their policies.

One Number To Rule Them All

A fascinating and infuriating article on Wired that tells how a mathematical formula contributed to the market meltdown. It's a lesson in looking for the easy path and the power of the mentality of crowds.

The part that I'll remember the next time this happens (and it will, eventually):

In financial markets, everybody doing the same thing is the classic recipe for a bubble and inevitable bust.

Wired: Recipe for Disaster: The Formula That Killed Wall Street

Capitalism School

Milton Friedman takes Phil Donahue to school on free market economics. The video might be old, but the message is timeless.

Why We Don't Want (Or Need) Another New Deal (Updated)

There's a lot of talk about what the government should do to address the current financial crisis. My answer to this question is, government should do almost nothing. The more the government tries to fix things, the more muddled they are likely to become and the longer the current recession is likely to last.

This article opinion piece relays a brief history of the New Deal and explains why a majority of the actions taken by FDR ultimately prolonged the Great Depression. Read and forward it to everyone you know who thinks government's job is to take care of you.

Update: The Congressional Business Office likes the new stimulus package over the next two years, but says it will reduce GDP over the next ten years compared to if the government does nothing.

This doesn't fill me with confidence, either.

(this was originally posted at 7:17 am)

Tax Fun

Earlier this year I moved from Minnesota to North Dakota. This means that for part of the year I was paying state taxes to one state and to another from about the middle of March on. I downloaded my W-2 today (thanks, no more waiting till April!) and compared the amounts witheld for taxes in each state.

Since I'm not supposed to discuss my salary I won't be using any dollar amounts. Luckily, God created percentages, so I can both laugh/shake my head in disgust at Minnesota and cover my butt at the same time.

Minnesota took 6.2% of my eligible take-home pay. North Dakota took 3.0%. Minnesota has a budget deficit approaching $4 billion dollars. North Dakota has a $2 billion surplus.

Today's lesson: higher taxes mean more money for your government to squander.

Some may argue that I'm not taking into account what I get back (if anything) as a refund. To that I say, shut up. No, actually that's true. But from experience (again, not using dollar amounts) I know about how much I usually got back from the state. It wasn't a lot. And even if it was, Minnesota still had that income to do with as it pleased until April of the following year, every year, before having to give it back. Kinda like an interest-free loan. And still, $4 billion in the hole.

I'm Not Shocked

Elizabeth Warren is a Harvard Law professor on the panel overseeing the $700 billion bailout package. She is shocked (shocked!) that banks on the receiving end of the bailout have decided there is no reason to disclose what they are actually doing with the money.

Are you shocked? I'm not shocked. How about you -- you shocked? I didn't think so.

BAILOUTS ARE BAD.

You Saw This Coming, Right?

In my post about governors lining up for some of that free federal money, I said:

It's almost like if the government starts handing out taxpayer money like beads at Mardi Gras, everybody puts their hands out.

How right I was. Apparently the porn industry is now asking for a bailout:

"The government’s handing out money to the auto industry,” Francis, producer of the “Girls Gone Wild” video series, said on the phone from his Santa Monica office. “Why shouldn’t it hand some to an industry the nation could not live without?"

If douchebaggery were a mystical art, Joe Francis would be a Jedi Master. But I have to agree with his logic. The industry's big problem of course, is how to continue to get people to pay for something available free on the internet.