Wednesday, December 12, 2007

Subprime bailout

There is a lot written about Treasury Secretary's Hank Paulson's proposed "relief" package for subprime borrorers.  It can be summed up in three points:

  1. Moral Hazzard - this program rewards people who were foolish enough to make risky investments by financing for homes they cannot afford.   
  2. The role of the central banks on this matter, and for that matter, the government in general, is to provide liquidity so that an orderly liquidation of non-performing loans can be done.
  3. What's wrong with falling house prices vis-a-vis other commodities.   We cheer falling food, energy, and other consumer goods prices, but when the price of housing drops - the political class goes into full panic mode.   Housing is subject to the same laws of supply and demand.  Prices for housing must go down as well as up over the long term.

Saturday, November 10, 2007

Thinking about Chuck Clough and Jim Grant

      I have probably spent way too much time thinking about financial markets and my past/current employment in the financial services sector.  Two common threads have been going through my mind as I go through all the turmoil and uncertainty:  the first is that the political and economic climate (as well as some of the responses to it) are way to similar to the 70's, and the second is how the opinions of two prognosticators, Charles I. Clough (formerly the chief strategist of Merrill Lynch until sacked in 1999 because he was not "bullish" on equities enough) and James Grant (the long time publisher of Grant's Interest Rate Observer).

     As for the first point.   I think I'll leave it to say that history repeats itself, the first time as tragedy and the second time as farce, and will save the rest for another post.

     But back to my thoughts.   During the late 90's, I was working for a brokerage firm that beame Merrill Lynch Canada.   One of the perks of "Mother Merrill" is that they have TONS of reports at your finger tips.  So I downloaded everything and anything of interest.  The two people I gravitated to the most were  quantitative analyst Rich Bernstein and chief investment strategist Charles Clough.

   Clough was canned by Merrill for not being sufficiently bullish in the mid to late 90's during the tech bubble.    He advocated then a 50/40/10 stocks/bonds/cash portfolio when most of the competitors were advocating an 80/10/10.  His reasoning was as follows:

  • There was too much money floating around the economy.  Easy credit and low interest let to a rapid cap-ex spree.  Companies were financing additional capacity with debt.   Companies would continue to produce products as long as they could eat into the fixed costs.  This led to deflationary pressures as prices dropped to keep production at full capacity.
  • Inflation was not an issue because China and other emerging markets were able to absorb all this cap ex and still provide low prices, which the American consumer bought up in record amounts.
  • All this surplus money also found its way from capital assets to financal assets - driving up the prices of stocks beyond their fundamental fair value.
  • The U.S. economy, in his view, was a giant balance sheet with huge amounts of debt and equity being tied to inflated asset values. Clough figured that the day of reckoning would come soon whereby the national balance sheet would need to be de-leveraged to reflect more realistic prices.
 Clough was writing this stuff in 1997-1999.   He correctly forecasted the capex and financial asset bubble that was caused, and would have reasonably seen the bubble migrating from capital assets (e.g. semi-conductor factories, fibre-optic networks) to financial assets (stocks) to real assets (real estate and commodities).   As we have seen, brokerage firms despise pessimism, as it cuts into their lucratvie underwriting business, so Clough was shown the door.

James Grant had similar views.   I have posted previously about a luncheon meeting I was able to attend with the Detroit Financial Analsysts society.  I think his comments require repeating:

  • Jim is/was not impressed with Alan Greenspan, calling him a "glorified civil servant".  Jim believed that Greenspan pumped excess money into the system, ignoring the fact that inflationary pressures would be absorbed by emerging market trading partners like China.  The problem with the U.S. economy is too much money circulating, period.  Not the trade deficit, not the fiscal deficit, but too much money.   Too much money causes bubbles and inflation eventually.  Greenspan was lucky for most of this to happen on his successor's watch.
  • Interest rate cycles are long-term in nature.  They are mult-generational.  Interest rates were on a long-term downtrend from the end of the civil war until early in the 20th century.  This was a period of overall deflation as the U.S. went to a strict gold standard.  The discovery of massive gold deposits in South Africa coupled with the cyanide process of gold extraction changed all this (for additional information - see Milton Friedman's Money Mischief).
  • From the early 20th century until the the beginning of the great depression, interest rates went on a upward trend, culminating with the tightening of the money supply that brought about the great depression.
  • From the great depression until the early 1960's, interest rates went on another downturn, until the great society and the Vietnam war started another inflationary trend that started interest rates to rise - peaking in 1981 when Paul Volker vanquished rampant inflation.
  • The next great bull market in bonds started on that day in 1981 when long bonds were yielding in the high teens until 2004, when yields hit bottom.
Grant's point was that interest rate tends span decades, and what we are experiencing is the end of a long-term decline in rates and the beginning of a long-term increase which should last many years.  We are in a period of transition where assets will start to adjust to this reality.

     Although these comments were made several years ago - they are still appropriate.   I share the opinion that there is too much money in the market and that the supply has to remove this excess.  I also understand that in the short-term, this cannot be done without causing a major recession, as we need liquidity to clean up this mortgage mess.  On the intermediate term, we will start seeing the money supply retrench as these bad loans are wound up.  This will mean eventually higher interest rates, a stronger dollar, and some adjustment to commodity prices.

Saturday, November 03, 2007

Paul Tibbets, RIP

A man who did what he had to do.  Unrepentant.   Where have men like him gone these days?

Shiller-Case Housing Index

Here are the housing prices per the Shiller-Case Index for major housing markets in the country.  Notice how Detroit and Cleveland compare to CA and FL.

H/T to Captain Capitalism for the primer on this.

Related news:

-  Michigan ranked fourth in foreclosures.  Yup, Granholms massive tax hike will fix that ailing economy, riiiiiiight.

Wednesday, October 31, 2007

Isn't this a no brainer

I got a good chuckle out of this:
Flaherty ignores pleas to control black-market cigarettes

OTTAWA — Pleas from senior federal officials for budget measures to help combat the black market in contraband native-made cigarettes went unheeded by Finance Minister Jim Flaherty, newly released documents show. ...

The documents, obtained by The Globe and Mail under the Access to Information Act, warn that Ottawa is suffering substantial tax losses as Canadian smokers switch to illegal, unregulated and untaxed cigarettes – profiting an extensive, cross-border network of organized crime using native land and operatives. ...

But figures in the government's Public Accounts released this month reveal federal tobacco revenues dropped to $1.6-billion in 2006-07, down from $2.97-billion two years earlier – suggesting a loss of more than $1-billion annually.
 Count me under the "not surprised" category.    Despiste the constant nattering from politicians about the "war on smoking" for "public health" reasons, the cries by revenue agents again focuses on the lost revenue.    

When you raise the prices of cigarettes from roughtly $4/pack in 2001-2002 to almost $10 today (over $10 in the Maritimes and Western provinces), you should not be suprised when  organized crime elements move in and take advantage of the "economic profits" you have given them.  Cigarette taxes are subject to the same laws of revenue and rates that the Laffer curve predicts.  

Second, this just proves that prohibition, whether the honest kind (booze in the 20's) or the more gradualist way (smoking the past 15 years) doesn't work, not to mention a gross violation of liberty.

If smoking is that much of a pox on society, then ban it and deal with the political fallout.  If not, then tax is reasonably and in the same manner as booze and you'll get your money to continue being hypocrites on the issue.

Saturday, October 27, 2007

Rangel's Tax "Reform"

 I spent some time looking over this tax "reform" package sent out by Mays and Means chairman Charlie Rangel (D-Harlem).  On first look, it has potential on some items but others are awful.

The good:

  1. Lowering corporate tax rates - these need to be brought in line with other economies.  However the proposal to drop from 34 to 31% is not enough.
  2. Getting rid of LIFO for inventory.  IRS has several methods for determing COSG for tax purposes.   LIFO, specifically as prescribed in the regs - is confusing, open to abuse, and doesn't always follow GAAP.  This will impact a lot of manufacturing and merchandising concerns.   There should be a phase in for these companies, and coupled with indexing corporate tax brackets - this isn't bad.
  3. Elimination of section 199 manufacturers deduction.   I still don't know why congress passed this monstrosity of a bill.  The reason they did it was due to the WTO ruling that the extraterritorial exculsion as an unfair subsidy.  Now, congress could have just lowered rates, changed the tax regime to what pretty well every other country in the world does and just tax income in the U.S. and not worlwide, but instead brought out the new manfucaturing activities deduction.  This is an excessively complex and difficult deduction to figure out for the initial benefit.  I know because I was responsible for figuring this out.    Rangel had it right that dropping rates and getting rid of this stupid and limited deduction.
  4. Getting rid of the AMT.  This is a stupid tax, and shows what happens when politicans create tax policy to target a small number of taxpayers - sooner or later it will expand to nail a significant number of taxpayers.
The Bad:
  1. Jacking up individual rates.  With his proposal to increase the top individual rate to 44% with the addition of surtaxes, this will kill a lot of small businesses who are set up as S-corporation or partnerships.   I know first hand dozens of former clients who have good job creating businesses who know will get soaked with at 25% increase in their federal taxes.  Now, the tax planning will shift back to C-corporations due to the distortions in top rates between corporations and individuals.  Stupid stupid stupid and will generate reduced economic growth (especially in the vulnerable construction industry, where the bulkof the business is in a S-corporation or partnership format).
  2. Distributive share of S-corporation income subject to self-employment taxes.   This now means that there will be a minimum a 4% and a maximum of 15% increase on earning on S-corporation earnings.  Stupid policy again.  So an S-corporation making $1,000,000 and one shareholder would have their federal tax burden go from approximately $350,000 to $440,000 due to the surtaxes on income and having it subject to self employment.  Tell me that isn't a job killer.
  3. Taxing carried interest at ordinary rates.   Another investment killer.  In the effort to go after "greedy" private equity managers, they want to change the investment definition of captial to be ordinary income.  This could have been better achieved under the regs for active trade or business, reasonable compensation, or even active trade or business.  But this proposal if expanded (and it would) could also spread out and kill the real estate sector too, which relies on carried interest to finance developments.
I agree with Rangel the tax rates should drop and all these preferences, deductions, and credits should go.  A broad base and low rates should be the goal of any well thought out tax plan.  But these proposals will distort economic activity, kill investment, and hamper economic growth.  And I haven't even factored in the expiration of the Bush tax cuts for 2010, which the Democrats salivate on not making permanent.

There is potential for reform in this bill, but there are some things that should not be passed at all.  Rangel's bill gives is telegraphing what a Deomcratic controlled congress will do with a Democrat in the white house, if you needed another reason not to vote for them.

Friday, October 19, 2007

Government Chutzpah on the subprime market

My friends at The Other Club brought up how Massachusetts Governor Deval Patrick wants to force mortgage companies to forgive loans on low income borrows who bit off more than they could chew, linking to a Boston Globe article on the matter:  
Governor Deval Patrick [D, Mass] plans to introduce an ambitious program today to assist Massachusetts communities in preventing foreclosures by pressing lenders to accept losses on their mortgages so that homeowners are able to sell their properties and pay off smaller loan balances....
In one key part of the plan, the state would press lenders to agree to a "short sale" with homeowners late on their monthly payments. In a short sale, lenders accept less than the full value of the loan, so that the homeowner can sell the house at today's market price - typically less than he or she paid for it - and use the proceeds to pay off the smaller loan balance. Short sales are a way for borrowers to prevent foreclosure.

But Thomas Callahan, executive director of the Massachusetts Association for Affordable Housing, which provides mortgages to homebuyers with modest incomes, said the administration does not have leverage, legally, to force lenders to cooperate. He said most subprime lenders are out-of-state companies that are not regulated by the state.

What is funny (or sad) about this is that both these initiatives had one Deval Patrick ivolved, either as a civil rights attorney for the Clinton Administration or as Governor of Massachusetts.   Deval Patrick was responsible for bullying financial institutions into making loans to various preferred groups, regardless of credit history or proof of actual discrimination.  From Reason Magazine:
 In an October 26 Washington Post story, Deval Patrick, head of the Justice Department's civil rights division, defended the administration's aggressive stance by saying, "It's nuts to think that we could reverse the effects of 300 years of deprivation by a few court decisions and a few good statutes."...

Perhaps the most breathtaking civil- rights enforcement affects financial services. Along with the proposed CRA regulations, the Justice and Treasury departments are pursuing banks and other financial institutions that are allegedly violating fair- lending practices. Justice has already sanctioned banks in Mississippi, New England, South Dakota, Georgia, and Maryland for supposedly discriminating against members of racial minorities. Barnett Bank, Florida's largest, is under investigation.

But there's little evidence that systematic discrimination is taking place. In the Maryland case, Chevy Chase Savings Bank was forced to cough up $140 million to African Americans by, for example, offering below- market- rate loans to minorities and placing ads in black- owned newspapers. Justice showed no evidence that Chevy Chase, the largest thrift in the D area, had denied loans to individuals because of their race. Rather, Chevy Chase hadn't opened new branches in predominantly black neighborhoods. The bank had been operating branches in African- American neighborhoods, but that didn't satisfy civil- rights enforcers: Either those branches had been acquired in a merger or the neighborhoods in which these branches operated had been predominantly white when the branches opened.

Two governors of the Federal Reserve System have criticized the proposed CRA regulations, saying financial institutions will make risky loans to women or racial minorities so that they can avoid discrimination lawsuits. Fed Governor Lawrence Lindsey considers the regulations a blatant power grab by political micromanagers in Congress and the White House. He has recently encouraged public comments, presumably critical, of the regulations. And Governor John LaWare told the Dow Jones News Service, "I feel very uneasy about the de facto allocation of credit and banking resources by administrative fiat."

Let's review.   Clinton administration threatens lenders into giving sub rate loans to minority borrowers even though they would not qualify under normal lending practices.   Clinton administration, with Deval Patrick at point, states that quantative measures like credit risks and default rates don't matter - just that the loan portfolios should "look like America".
     Without going into detail on the abject stupidity of this policy, the banks did a cost benefit analysis and essentially figured it that it would be cheaper to throw the dice, loosen their credit standards to minority lenders, and risk some defaults instead of throwing a lot of money into attorney's fees fighting the government.
     Now that the governments demand for looser credit standards has played role in the sub-prime mortgage mess, these same government officials now chatise the banks for their "predatory" lending practices, and now demand regulation to "fix" the problem.

Why aren't we surpised.

Tuesday, October 16, 2007

Friday, October 05, 2007

Jennifer Granholm, meet Bob Rae


It seems that Jennifer Granholm has taken a page from the Bob Rae/Floyd Laughren playbook and has passed a massive tax increase to cover the state budget deficit. Michigan, struggling to keep jobs in the state with a declining manufacturing and job base, is now in a worse position thanks to the Democrats in Lansing. Among those goodies passed recently were:

1. An increase of the personal income tax from 3.9 to 4.3%.
2. Expanding the 6% sales tax to cover a variety of services.

Let's see now. Bob Rae, the socialist premier of Ontario was unexpectedly voted a majority government for his NDP party in 1990, when the recession began. Their answer was a massive increase in welfare spending and tax hikes, which exacerbated the situation, further worsening the economic condition of Ontario.

Rather than do a bottom up re-evaluation of all government spending and setting priorities, Granholm and her Democratic co-conspirators in the legislature jacked up taxes. They seem to forget that it is businesses that create jobs in the state, and no private sector jobs mean no lush government jobs for their supporters. But hey, why let something like history and economics get in the way of a good tax hike?

The exodus of jobs and people out of Michigan will only accelerate with this, and it makes my decision to leave Michigan look better with the passage of time.

The good news is that if history is any indicator, in 2010 we will have the Michigan verson of Mike Harris as governor.

Sunday, September 02, 2007

Mortgages, housing, interest rates, and all that

I just came back from spending a week in Charlotte NC. Despite the fact that Charlotte is a much larger city with a much larger economic base, housing there is considerably less than what it is here in the Hampton Roads area. I would dare say 50% less, just comparing what I can purchase there versus here with a given budget.

That being said, it is interesting to see some weakness in the housing market, and it is about time. Michigan, is about a year and a half ahead of the curve on this, as their tipping point really started with Delphi declaring bankruptcy in October 2005. After that date, the real estate market in Michigan started to nosedive. At this point, housing is 30-50% off the peaks of late 2004/early 2005. Lenders are lowballing appraisals, taking 10% off the lowest one, and then demanding more down payment. Michigan is also in the top three states for foreclosures, trailing only California and Nevada.

What is happening in Michigan is starting to happen throughout the country. This was an asset and credit bubble, plain and simple. It what happens when there is too much money chasing a finite amount of assets. There is plenty of blame to go around: The dumb schmucks who bought beyond their means have little sympathy from me. Neither do the mortgage brokers who just wrote mortgage after mortgage on "liar loans" and dubious appraisals. They were so greedy with the commissions that they cranked out loan after loan. Well, they sold them all right, but these brokers are often on the hook for any defaults for five years after they sell them off. Seeing these brokers saddled with their defaulted loans will look good on them.

I have no sympathy for the bond rating agencies, who slapped investment grade on these asset backed securities, even though these tranches had a lot more risk than what many were led to believe. Standard & Poors, Moodys and the like have a lot of egg on their faces after telling institutional investors that these MBSs were AAA or BBB grade after all these defaults.

The institutional investors, who were so desperate for yeild that they bought these securities, are just as liabile. Caveat Emptor - all that additional yield leads has some risk, and investors were way too complacent.

These excesses are typial at the end of a credit cycle. We have just witnessed, in my opinion, the end of a 26 year bull market in bonds, dating back to 1981. We are now entering a 20 or 30 year period of raising interest rates. Interest rate cycles are historically very long-term, and we're looking at the start of a new period after shaking out the excesses of the markets from the past few years.

There was too much money out there, and now the rammifications of such excesses are starting to reverborate through the economy. The question is how long will it last for.

Sunday, June 03, 2007

Ridiculous Housing Prices in Hampton Roads

I have been following the housing market in the area, with the ultimate intent of purchasing a house. However, I have found that the market here is ridiculously overpriced. The Virginian-Pilot reported that in February 2007, median home prices were approximately $244,0000 in the area. That was an increase of 31.5% from 2005. That article stated that median prices went up on average from $170,000 to $220,000 in one year! Another tidbit on this would be that median income increased 20% to almost $52,000 during a comparable period.

All this information brings up a lot of concern. Housing prices have appreciated well in excess of household income. This means that people are becoming more leveraged and are incurring greater financing costs to purchase the same house. I would wager that the median family's net worth has not increased though - as many are using the increased home values for consumption via home equity lines.

The worst part about this appreciation in home values is that it has made it too costly for me to purchase a home at this point. The problem is that if one looked at what you can purchase for the median home price in the area - you have two options: (1) an hour plus long commute; or (2) living in a not-so-desirable neighborhood. So if you wish to avoid that, you're looking at $300,000 + for a mediocre piece of property. Now I make above the median income, but not that much more, and there is no way in hell that I am paying $300K for a dumpy house in a working class neighborhood.

Call me a snob, but I also learned a hard lesson from personal experience and professionally as a former stock broker; that is the first rule is "Never overpay for the merchandise." I have made inquiries with several real estate snake oil salesmen. I mention to them that I'm a CPA, make slightly above the median income, and would like a house in a good middle class neighborhood with fellow professionals, good schools, etc that is less than a 40 minute drive to work. Well, essentially I found out is that unless I want to shell out $350K, I can forget the bourgeois dream here for now. I find it ridiculous to pay in excess of five times my annual gross income for real estate.

This has to change as it is unsustainable. However, markets can remain irrational longer than I can remain solvent. I have seen a lot of markets with better economic fundamentals and better median incomes that have substantially lower housing prices, and if things don't correct, many job seekers will avoid this area due to it's overpriced housing market.

Saturday, June 02, 2007

Wednesday, May 16, 2007

Monday, May 14, 2007

Homeland security in a nutshell

Once again, leave it to Mark Steyn to state the obvious...

... It's time to hunker down in Fortress America. Which brings me to the fourth lesson: What fortress? The three Duka brothers were (if you'll forgive the expression) illegal immigrants. They're not meant to be here. Yet they graduated from a New Jersey high school and they operated two roofing companies and a pizzeria. Think of how often you have to produce your driver's license or social security number. But, five years after 9/11, this is still one of the easiest countries in the world in which to establish a functioning but fraudulent identity.

Consider, for example, the post-9/11 ritual of airline security. You have to produce government-issued picture ID to the TSA official. Does that make you feel safer? On that Tuesday morning in September, four of the killers got on board by using picture ID they'd acquired through the "undocumented worker" network in Falls Church, Virginia. Half the jurisdictions in the United States issue picture ID to people who shouldn't even be in the country, and they issue it as a matter of policy. The Fort Dix
boys were pulled over for 19 traffic violations, but because they were in "sanctuary cities" any cop who suspected they were illegals was unable to report them to immigration authorities.

Again, as a matter of policy. On the one hand, America creates a vast federal security bureaucracy to prevent another 9/11. On the other hand, American politicians and bureaucrats create a parallel system of education and welfare and health care entitlements by contriving in the maintenance and expansion of a vast network of fraudulent identity that corrupts the integrity of almost all state databases. And even though it played a part in the killing of three thousand Americans, leaders of both parties insist nothing can be done to stop it. All we can do is give the Duka brothers "a fast track to citizenship."

The Iranians are already operating in the Tri-Border area of South America. Is it the nothing-can-be-done crowd's assumption that the fellows who run the armies of the "undocumented" from Mexico into America are just kindhearted human smugglers who'd have nothing to do with jihad even if the price was right? If you don't have borders, you won't have a nation — and you may find "the jobs Americans won't do" covers a multitude of sins.

Saturday, May 12, 2007

Teacher' Union Redux

The final installment of Ron French's series on the impending fiscal problems of the Michigan Teacher's Pension plan is in today's Detroit News. Once again, we see how Teacher's unions are featherbedding their positions as the expense of taxpayers and the children the purportedly support.

The lessons that can be imparted are several from this series:

  1. Actuaries are smart people. However, they have been lousy in terms of estimating life expectancies of retires and retirement costs of a group of people thirty years in the future. This not a criticism of their work (I took a lot of actuarial science courses in school - it is not easy stuff) but more so a reflection of the reality that we know crap about what will happen thirty years from now. The point is - defined benefit plans should be really called defined bankruptcy plans as they become unfundable due to unpredictable increases in life expectancies and new health care technologies.
  2. Anything involving the government will not be solved until it is too late. Because things like public employee pensions are an "inside baseball" issue - politicians don't really deal with it - rather they just capitulate to the feather bedders in the public sector unions and give them what they want. This is another example of why public sector employees should never have the right to join a union. In fact, if this is not another example of why government should not run a lot things that they could contract out to the private sector.
  3. The taxpayers and the kids ultimately get screwed. We already knew that all this increased education spending is not for education. Real education spending per pupil has in real terms increased several fold in the the last forty years with no improvement in student performance (actually student performance in the US has dropped during this period). This just reinforces the argument that all this spending "for the children" really goes to fat cat school administrators, corrupt teacher unions, white elephant "facilities", and now, as Ron French points out - a gold plated pension plan that is soaking up a huge portion of school budgets across the state.

Friday, May 11, 2007

Nice Work if You Can Get it

Go read Ron French's second installment on the failing Michigan Teacher's Pension Plan in today's Detroit News. Today's installment is titled "The $1,470-an-hour loophole: Retirees work for 13 days to earn lifetime health care"

Thursday, May 10, 2007

The impending insolvency of public school pensions in Michigan

This special feature in the Detroit News by Ron French was an eye opener. This is one of the more acute examples of the impending crisis in government - the cost of all those lavish civil service pensions that will make the unfunded liabilities of the Big 3 auto makers seem like a pittance. I have to give Ron French credit for all the great investigative reports he puts in and the fact that he is generous with his time in responding to reader e-mails. If you like his work, send him a note telling him. Go to the News and read the article with the charts. This is a series worth reading.

Michigan's education time bomb: Costly, loophole-ridden retirement system threatens public schools
Ron French / The Detroit News
Michigan's school retirement system is riddled with loopholes and slipshod policies costing taxpayers hundreds of millions of dollars and driving the state's public education system toward financial crisis.

Schools are laying off teachers, scrapping programs and mothballing extracurricular ctivities to pay for the spiraling pension and health care bills of retirees -- some of whom qualify for generous benefits by skirting state retirement policies, often with the knowledge and assistance of the state office charged with administering the $3.5
billion program.
The impact could be devastating to public education in Michigan, the only state that makes its schools bear the entire burden of retiree pensions and health care. This year's bill -- an estimated $1,015 per student -- is more than schools spend on books, buses, computer technology and building maintenance combined. And it's going to get worse.
The retirement assessment -- set by the state but paid by individual school districts -- is now at a record high of 17.74 percent of each district's payroll. That rate is expected to jump to 30 percent by 2020 -- a level that all sides agree would break the backs of Michigan schools.
Phil Stoddard, head of the state office that administers the retirement fund, defends the system. "I wouldn't say that it's too generous," said Stoddard, executive director of the Office of Retirement Services. But Tom Clay, former director of the state's Executive Budget Office, disagrees. "It's a time bomb," he said. "It's a train wreck. Use whatever term you want. And it hasn't reached (the worst of the) crisis yet."
An analysis by The Detroit News of data obtained through the Freedom of Information Act found: An estimated $2 million per year in taxpayer dollars is spent on retirees who qualify for lifetime health care through a loophole. People who worked in state public schools for at least 10 years earlier in their careers can return to work for 102 hours -- about 13 work days -- at age 60 and receive taxpayer-funded health care for the rest of their lives.
Hundreds of "retired" school administrators are collecting pensions and retiree health care while continuing to collect a salary working the same jobs as contract employees, increasing the retirement burden. The practice, which one critic calls "a scam," costs taxpayers about $25 million a year.
As much as $1 billion could ultimately be lost through a program that sells early retirement at a discounted price. School employees can buy up to five years of service credit, paying the state so they can retire after 25 years instead of 30. But the purchase price of those years of service factors in the cost of pension benefits but not retiree health care. More than 23,000 school employees have purchased a total of almost 100,000 years of service. At current health care rates, that would cost school districts $1 billion -- as much as the state spends on road construction and repair each year.
Some districts are pushing more experienced teachers and administrators to retire early so they can save money by hiring younger employees. But those short-term savings quickly turn into long-term costs. Not only are schools losing some of their most experienced teachers before they have to, but also most of those retirees, some as young as their late 40s, begin drawing lifetime pension and health care benefits
Schools may shave $30,000 from their payroll a year by replacing a veteran teacher with a teacher straight out of college, but that retiree will cost the overall state school retirement system about $50,000 a year. "They're saving money now but paying more later," said former state treasurer Doug Roberts, now director of the Institute for Public Policy and Social Research at Michigan State University. "There's no advantage to it."
Michigan pays for lifetime health care for employees who, in some instances, work as few as five years in public schools. That health insurance is considered to be a premier plan with excellent benefits and low co-pays, according to a health care insurance analyst. The schools paid $634 million in medical bills for retirees and their spouses and dependents in 2006.
Cobbled together by two decades of amendments, protected by a powerful union and ignored by a timid Michigan Legislature, the Michigan Public School Employees Retirement System (MPSERS) is headed for a financial crisis that could devastate schools and ultimately threaten the benefits of thousands of Michigan retirees. The crisis has been building for years, but reform efforts have been thwarted by a befuddling circle of unaccountability. Cash-strapped schools pay the bills but don't administer the system; the state Office of Retirement Services administers the program but is powerless to change policies; the Legislature can change policies, but has been in no rush because it doesn't pay the bills.
Today, the school retirement system is buried under $25 billion in unfunded liabilities for retiree pensions and health care. The ballooning cost of public pension plans like Michigan's school retirement system "have the potential to be the savings and loan scandal of the next decade," said Tim Braun, policy analyst of the Mackinac Center for Public Policy. Despite dire warnings, there is little appetite in Lansing to reform the system. "It represents a failure of political wills by the past two governors and the Legislature," Braun said. "(And) the costs are going up dramatically every hour we don't fix it."
The Michigan Education Association, the state's teacher union, scoffs at the plan's doomsayers. "People don't understand what they're talking about," said Allan Short, director of government affairs for the MEA. "It's an excellent system that serves as an incentive to keep people in education."
No one questions the need to provide good benefits to attract qualified employees for Michigan schools. But the benefits -- and the loopholes through which some qualify -- are threatening the very schools those benefits are meant to protect.
"The program is completely unsustainable," said former state treasurer Roberts. "Something has to be done."Main reason for budget cuts. Ten years ago, schools spent $485 per student to pay for pensions and retiree health care. Today, schools spend $1,015 per student. Driving those costs are rapidly rising health care costs and a growing number of retirees.
The state's 553 school districts have no control over their retirement bill. The cost is set by the MPSERS, which last year sent out checks for pensions and health care bills totaling almost $3.5 billion to more than 151,000 retirees and surviving spouses. Each year, MPSERS actuaries project the total cost of retiree pensions and health care, then bill individual school districts to cover the cost. Districts pay a percentage of their payroll -- the bigger the district, the bigger the bill.
Because between 80 percent and 85 percent of a school's budget is payroll, a small bump in the retirement assessment can lead to financial hardship.
For example, this school year, the retirement rate rose 1.4 percent. That small increase cost rural Fowlerville Community Schools an additional $200,000; suburban Troy School District more than $1.1 million; and the state's largest district, Detroit, a whopping $11.1 million. While other school expenses such as fuel costs also are rising, retirement costs are the main reason districts across the state are scaling back programs and staff. "The impact (of retirement costs) is huge," said Tim McAvoy, director of community relations at Troy School District. "We've made $27 million in budget adjustments in the past three years."
For Michigan schools to have paid the same amount in retirement costs this year as last, they would have had to cut $700 million in payroll -- the equivalent of laying off 9,300 teachers statewide.
Michigan schools receive about 70 percent of their funding from the state through a per-student allowance. Increases in that allowance are supposed to cover increased costs of everything from payroll to pencils. But in recent years, the entire increase has been swallowed up by escalating retirement costs. From 2003 to 2006, the state increased the per-student allowance by $175. During those same years, the MPSERS bill jumped $178 per student.
Utica Community Schools, one of the biggest districts in the state, slashed its staff by 215 people in the past four years, partly to pay for increases in the retirement assessment. "It (retirement costs) has a dramatic impact on our budget," said Utica Superintendent Rick Montcalm, who is searching for ways to cut another $8 million from next year's budget.
Southfield schools, which this year will spend $13.6 million for retirement, cut its child care service and adult education to save money. "It's been difficult," said Southfield Assistant Superintendent Ken Siver. Retirement costs now eat up 14.3 percent of districts' $7,085 per-student allowance and 13 percent of total school funding.
Citizens Research Council of Michigan, a state budget watchdog group, projects that the MPSERS contribution rate that was 12 percent as recently as 2002 will hit a staggering 30 percent by 2020 -- the equivalent of $6 billion in today's dollars.
"We don't want to wake up someday and find that our system has gone bankrupt," said Don Wortruba, director of legislative affairs for the Michigan Association of School Boards. "If nothing is done, we could reach a point where the classrooms implode or the (retirement) system implodes and people who have been counting on health care won't have it."
Plight mirrors that of Big 3 In many ways, the financial straits of Michigan's public schools mirror the plight of the Big Three. Detroit's automakers and the schools both have offered generous retirement benefits to retirees for decades. As retirees live longer and health care bills rise, retirement costs have skyrocketed. Most organizations that offer retiree health care are dealing with rising bills.
But the schools' predicament is magnified by a stampede of employees retiring at younger ages. In the past decade, while the number of public school employees rose 7 percent, the number of school employees retiring per year jumped 36 percent. Today, about 82 percent of all school employees retire before age 65; 64 percent leave by age 60, with 25 percent retired by age 55. The exodus begins around age 46, when employees with 25 years of service who take advantage of an early-out program retire and begin receiving their pension and retiree health care.
As the number of retirees increases, so does the cost to the schools. Schools spent $338 million on health care for retirees younger than 65 in 2005. That's more than the state spends to run its 29 community colleges. School superintendents such as Sandra Feeley Myrand of Lakeview Public Schools in St. Clair Shores have been warning of a crisis for a decade with little effect. The faults in the system are well-known and, in some cases, agreed upon by Democrats and Republicans. Yet there has been little action in the Legislature to address the problem.
"What legislators say is they don't know what to do," Feeley Myrand said. "They don't understand how the schools operate. What does that say about what they think of the value of education?"
Republicans and Democrats agree that the system is headed over the cliff. Yet reform measures that are introduced every year die quickly in the state Senate and House. The Mackinac Center's Braun calls the school retirement system the "third rail of Michigan politics," meaning it is political suicide to try to curb teacher benefits. Even loopholes that impact few retirees and cost the state millions have not been closed. "We've got these big problems we've been trying to fix for years," said Tom White, director of legislative affairs for the Michigan School Business Officials, a group representing public school business managers. "Yet we've not found a legislature that has the political will to make these changes." Even if the system were reformed now, it would take years to make a notable difference, Roberts said. MPSERS contributions will continue to rise as retirees covered by the current policy move through the system. "It will take time, but that doesn't mean the state shouldn't address it now," Roberts said. "Otherwise, in 20 years, somebody else is going to be writing about this issue, and it's going to be a lot worse."

You can reach Ron French at (313) 222-2175 or


Tuesday, May 08, 2007

Michael Barone's Demographic Realignment of America

I cannot recommend enough reading this insightful article by Michael Barone on the Wall Street Journal. He discusses migration of non-immigrant and immigrant populations within the United States.

One of the key points he makes is about the flight of the middle class from the coastal cities to the interior cities. Putting on my CPA cap, I made this observation that Barone does briefly touch upon.

There is some sort of relationship between taxes and the patterns. The states with the largest middle class flight (MA, CA, NY, CT, NJ) also, interestingly enough, have the highest tax burdens, while the states with the largest growth (AZ, GA, NV, NC, TX) have much much lower taxes.

Saturday, April 28, 2007

Those Pesky Constitutional Amendments

Reading through Captain's Quarters, Ed found an article advocating the disarming of America and turning it into a police state. This is the absurdity that only a socialist could advocate:

LAST week's tragedy at Virginia Tech in which a mentally disturbed person gunned down 32 of America's finest - intelligent young people with futures ahead of them - once again puts the phenomenon of an armed society into focus for Americans.

The likely underestimate of how many guns are wandering around America runs at 240 million in a population of about 300 million. What was clear last week is that at least two of those guns were in the wrong hands.
When people talk about doing something about guns in America, it often comes down to this: "How could America disarm even if it wanted to? There are so many guns out there."
Because I have little or no power to influence the "if" part of the issue, I will stick with the "how." And before anyone starts to hyperventilate and think I'm a crazed liberal zealot wanting to take his gun from his cold, dead hands, let me share my experience of guns.
As a child I played cowboys and Indians with cap guns. I had a Daisy Red Ryder B-B gun. My father had in his bedside table drawer an old pistol which I examined surreptitiously from time to time. When assigned to the American embassy in Beirut during the war in Lebanon, I sometimes carried a .357 Magnum, which I could fire accurately. I also learned to handle and fire a variety of weapons while I was there, including Uzis and rocket-propelled grenade launchers.
I don't have any problem with hunting, although blowing away animals with high-powered weapons seems a pointless, no-contest affair to me. I suppose I would enjoy the fellowship of the experience with other friends who are hunters.
Now, how would one disarm the American population? First of all, federal or state laws would need to make it a crime punishable by a $1,000 fine and one year in prison per weapon to possess a firearm. The population would then be given three months to turn in their guns, without penalty.
Hunters would be able to deposit their hunting weapons in a centrally located arsenal, heavily guarded, from which they would be able to withdraw them each hunting season upon presentation of a valid hunting license. The weapons would be required to be redeposited at the end of the season on pain of arrest. When hunters submit a request for their weapons, federal, state, and local checks would be made to establish that they had not been convicted of a violent crime since the last time they withdrew their weapons. In the process, arsenal staff would take at least a quick look at each hunter to try to affirm that he was not obviously unhinged.
It would have to be the case that the term "hunting weapon" did not include anti-tank ordnance, assault weapons, rocket-propelled grenade launchers, or other weapons of war.
All antique or interesting non-hunting weapons would be required to be delivered to a local or regional museum, also to be under strict 24-hour-a-day guard. There they would be on display, if the owner desired, as part of an interesting exhibit of antique American weapons, as family heirlooms from proud wars past or as part of collections.
Gun dealers could continue their work, selling hunting and antique firearms. They would be required to maintain very tight inventories. Any gun sold would be delivered immediately by the dealer to the nearest arsenal or the museum, not to the buyer.
The disarmament process would begin after the initial three-month amnesty. Special squads of police would be formed and trained to carry out the work. Then, on a random basis to permit no advance warning, city blocks and stretches of suburban and rural areas would be cordoned off and searches carried out in every business, dwelling, and empty building. All firearms would be seized. The owners of weapons found in the searches would be prosecuted: $1,000 and one year in prison for each firearm.
Clearly, since such sweeps could not take place all across the country at the same time. But fairly quickly there would begin to be gun-swept, gun-free areas where there should be no firearms. If there were, those carrying them would be subject to quick confiscation and prosecution. On the streets it would be a question of stop-and-search of anyone, even grandma with her walker, with the same penalties for "carrying."
The "gun lobby" would no doubt try to head off in the courts the new laws and the actions to implement them. They might succeed in doing so, although the new approach would undoubtedly prompt new, vigorous debate on the subject. In any case, some jurisdictions would undoubtedly take the opportunity of the chronic slowness of the courts to begin implementing the new approach.
America's long land and sea borders present another kind of problem. It is easy to imagine mega-gun dealerships installing themselves in Mexico, and perhaps in more remote parts of the Canadian border area, to funnel guns into the United States. That would constitute a problem for American immigration authorities and the U.S. Coast Guard, but not an insurmountable one over time.
There could conceivably also be a rash of score-settling during hunting season as people drew out their weapons, ostensibly to shoot squirrels and deer, and began eliminating various of their perceived two-footed enemies. Given the general nature of hunting weapons and the fact that such killings are frequently time-sensitive, that seems a lesser sort of issue.
That is my idea of how it could be done. The desire to do so on the part of the American people is another question altogether, but one clearly raised again by the Blacksburg tragedy.
Dan Simpson, a retired diplomat, is a member of the editorial boards of The Blade and Pittsburgh Post-Gazette.

Where do I begin to cut this up. The logic and ignorance of the law and basic freedoms is so breathtaking - usually the kind that I only associate with Academics. This idea is akin to saving social security with the "Logan's Run" solution of killing all the elderly upon reaching a given age.

Wednesday, April 25, 2007

The real tax grab in Michigan

It seems that everyone talks about how the SBT is a "job killer" in Michigan. Granted, the single business tax is a onerous one that is responsible for its share of jobs leaving the state, but a lesser known tax is probably taking a bigger toll on Michigan businesses. That would be unemployment taxes, otherwise known in the business as SUTA.

The state of Michigan has been aggressively, and often over zealously targeting businesses for "SUTA dumping". That is, by definition, the transfer of employees from one entity with a high experience rating for SUTA taxes to one with a lower rate. The Michigan Treasury has been targeting businesses, rightly and wrongly, with huge assessments under this premise, because they hope to get quintuple penalties if they can make the charges stick.

The state has been targeting professional employer organizations (PEOs) with huge (sometimes multi million dollar) assessments, then try to bully the taxpayer into paying the amount. I know of a case where the treasury had a agent back date reports to say that SUTA dumping existed when it did not. This agent, in a tax tribunal hearing, took the fifth when asked whether or not he back dated a report stating he thought there was SUTA dumping. This agent, when I worked in Metro Detroit, did the SUTA audit on the client, and after several weeks at my former office going through all the records, originally reported that there was no wrong doing by the taxpayer. A few months later, the client received a massive assessment, and was accused by the Michigan Treasury of SUTA dumping. A good friend and former colleague of mine represented the client in tax tribunal when the fifth was taken.

This is not the first time the state treasury has bended the rules in order to revert to the Roman tax collection method. This harassment of Michigan employers, along with their back door methods to raise taxes by jacking up payroll taxes for employers, is not a good way to keep them in the state.

Way to go Governor Granholm! Back door payroll tax increases and egregious behavior by your auditors is not the way to bring jobs into the state.

Sunday, April 15, 2007

Finally back

Hi everyone,

After an exceptionally busy tax season, where I started to ramp up the 60+ hour work weeks in early January, I finally am not burnt out to the point where I don't feel like writing. But, not like there hasn't been a lot of interesting stuff going on.

The first thing that catches my attention is the collective stupidity that is the Democratic party up in Lansing, Michigan. I've been reading the Detroit News rather religiously over the past few months, so when I read some of the stercoraceous ideas emanating from the state house, all I can think of is Bob Rae's illustrious stewardship of the province of Ontario.

Michigan is a state that has been economically hammered. It's core industry is fighting to survive. Major employers have either downsized (Big Three, Tier One auto suppliers) or relocated (hello Pfizer and Comerica). The state has the highest mortgage foreclosure rate in the nation, and people are leaving the state in droves (myself included).

All these signs scream for leadership. Drastic action must be taken to help Michigan right a listing ship with bold ideas. What have we seen from Jennifer Granholm and her allies in the state legislature in order to solve these issues and the huge budget deficit that is a result of this? Some of the ideas have been:

  1. 6% sales tax extended to services
  2. 2% sales tax extended to services
  3. Implement an estate tax
  4. Change the income tax from a flat 3.9% to a graduated rates
See a trend here? Tax your way back into prosperity... worked so well for Clement Attlee in the 1940's and Bob Rae in the 90's.. hey.. third time's a charm!