State Of The Union: My RA: The Myths, Lies, and Illusions

So the other night President Barack Obama spoke on many different issues (first starting off which how a teacher worked extra hours) and then moved on to income inequality and talked about how this was the year of action. However, what caught my attention was a program he wanted to push forth called myRA. Note that this would actually the program would actually be passed by Congress before actually becoming part of the ever expanding tax code. How myRA works by guaranteeing "a decent return with no risk of losing what you put in". Let's step back a second to understand how false/hypocritical this statement is. Investment management companies and firms are highly regulated by the SEC. If any investment firm had this as advertisement they would be investigated by the SEC and charged with misleading advertising and possibly shut down (however when a government that is already going broke states it there is no issue).

The WSJ lays out how this would actually how myRA would work. The account would just allow for one investment (most corporations and companies that have 401k plans have options-under federal ERISA rules plans have to offer at least 3 investment choices- so choice is obviously not part of the plan). The principal is "protected" however to my knowledge inflation could erode this away as the bond is not adjusted for inflation. What the government is offering is a Treasury bond that will offer a variable interest rate (fluctuates with present day interest rates). The annual return from 2003-2012 is not great of only 3.61% (however the President did mention how the stock market had done well yet this new program wouldn't let people participate in it). Vanguard ran calculations and said if you put away $50 every other week for 11 years you would have $15,000 which does not solve any type of retirement crisis. The cherry on top of this regulatory sundae is that once the balance reached $15,000 participants would then be required to roll over the funds to an IRA at a private sector financial services company (think Fidelity or TD Ameritrade) and then could select a variety of options. I could only wonder who would be lobbying for this to actually become legislation.

According to the American Benefits Council there are over 650,000 401k plans. There are roughly 88 million participants in these plans.  In my experience some people don't trust 401k plans for a few reasons 1) They don't trust a 401k plan 2) They would rather spend the money or 3) They don't understand a 401k which leads them not to invest in it. 

If the President actually did some research he would find that most companies do in fact offer 401k. In a survey done 98% of companies surveyed companies already offer a plan with an employer match. In addition to this companies are also simplifying the investment options, providing more investment education, and increasing the employer match. There are many regulations that surround company benefits including 401k plans. For instance any employee that works more than 1,000 hours in a 12 month period of eligible for a 401k.  Essentially 401k plans can't be non-discriminatory (they have to be offered to at least 70% of the people who are eligible). This has to do with non-discriminatory laws that govern company plan benefits. People also forget that when a company matches an employees contribution that is essentially free money. Companies also have to hire plan trustees, custodians, and sometimes investment advisors who are themselves highly regulated by the SEC which does cost money. 

The obvious course of action is to stop providing programs such as Social Security that let people on to believe they are okay in retirement. If Social Security wasn't around would people be more or less prudent with their saves. The current taxation on Social Security is actually over 15% (if you include the employee and employer portion). Not only is Social Security taxed when you paid in but also the benefits are taxed as well. Martin Feldstein from Harvard has done some work in this area and actually found that Social Security reduces private savings by roughly 60%. Social Security is a whole different issue that I won't blog about here but the default program let's people sleep at night when in actuality they could manage their own money or hire a financial advisor to help them.

In summary, the President is proposing a retirement plan for people with little to no means when nearly 50% of people already live paycheck to paycheck. According to the report 44% of Americans are living with less than $6,000 in savings for a family of four. Now there are people who through their own misfortune or bad luck can't work and therefore can't save but that is a very small fraction of the overall population. I would be okay with even cutting these people a check and letting them at least decide how they use their resources instead of having a bureaucracy decide for them.

Many people choose not to pay attention in class during K-12 education, choose not study hard, choose to go out and party, get a job and choose not to put in the extra hours needed to get a promotion, choose to have children before they are financially ready, choose to spend money on things they possibly might not need (do you ever wonder how many people at the Cheesecake Factory really can afford it?). The right approach would be to get rid of the ridiculous burdensome laws that govern 401k plans (custodian, fiduciary, bookkeeping, etc.) in order to allow more companies (manly small businesses to offer them). The President seems to be separated from reality as he has never had to answer to customers, shareholders, or had any serious type of accountability. 

Mitt Romney: How Private Equity Works

Recently in the news Mitt Romney has been criticized for his tenure at Bain Capital. The common thing you hear is that Romney amassed great wealth by taking companies leveraging them with debt and selling them reaping millions in profits. People should understand how a company like Bain Capital works before making such statements.

Companies like Bain Capital are known as private equity firms. Usually, a company like Bain will look at companies that are under-valued, in trouble, or help companies go from being private to public traded. Identifying under-valued companies and improving them creates shareholder wealth. Texas governor Rick Perry claimed Mitt Romney was a “vulture capitalist”. I would regard vulture capitalist as a compliment personally. In essence, Warren Buffett is a vulture capitalist when he invested in companies he believes a company is undervalued. Private equities companies don’t get paid unless they meet certain benchmarks. Also private equity firms have their own money on the line so they can’t be too foolish with it. The idea of private equity companies is to come and improve the company. Sometimes, this means firing workers. Firing people is not a bad thing considering some of those people probably shouldn’t have even been hired in the first place. Critics of Romney talk about the job layoffs however don’t talk about the success stories like Dominos Pizza, Staples, and Sports Authority. Yes, Mitt Romney had to fire people but I would argue this is a good trait for the future President to have given the large size of government. Businesses can fire people in the short term. However, no company is successful in the long term by continuing to fire people. New employees increase productivity and profits which make the company more valuable.

Critics argue that companies still went bankrupt since Romney “likes to fire people”. There is no guarantee that when a private equity company helps out a troubled company there will be success. In fact, more often than not there are more failures given the fact that private equity companies take on companies with the most problems. It would like looking at two different doctors with different patients. If one doctor always takes on the sickest and most ill patients we would expect the mortality rate to be higher. However, if the other doctor took on average healthy patients the mortality rate should be comparatively lower. Bain did take on companies with major problems however they did create value. From 1984-1994 Bain was involved in 77 deals. During this time Bain made $2.5 billion while only investing $1.1 billion. So Bain was making an annual compounded annual growth rate of 8.55% per year.

In the process, Mitt Romney also made money for himself. Romney himself is estimated to be worth over $200 million. This is impressive given he spent $54 million to run to eventually become governor of Massachusetts. According to an article entitled “Two Mitt Romneys: Wealth Man, Thrifty Habits” Romney for most of his life has lived like a middle class American. He likes flying JetBlue, while at Bain Capital ate brown bag lunches at his desk, and couldn’t justify spending money on a private jet. Also Romney was required to do chores even on Saturdays. In high school he didn’t even have a car even though his father was an executive at American Motors.
Many people want to criticize Mitt Romney and his ties to Bain Capital. However, when you look closer at what he actually did the record it would show that Romney and Bain Capital in the long run created jobs, wealth, and progress. As economist Dr. Walter E. Williams would say “the rich didn’t get rich by being stupid”.

Real World GDP Since 1969-2010

Looks like world GDP has continued to grow since 1969 in real terms. Despite what people say it looks like the whole world is adding $50 trillion of value every year.

Debt Ceiling Debacle

Recently, the House of Representatives passed a deal a day before the August 2nd deadline to raise the debt ceiling. The debt ceiling will cut $2.1 trillion over a 10 year period. Only $210 billion per year but that still is something. I am suspicious of what “cuts really mean”. Looking at the deal it looks like most of the “cuts” are smoke and mirrors and are do not start any time soon. The debt ceiling would be increase immediately by $400 billion. The problem is that the money is spent right away however the cuts don’t come until years later.

Discretionary programs (includes defense spending) would be cut by $741 billion. The discretionary cuts for 2012 would decrease by $21 billion and $42 billion in 2013. Yes, these numbers do seem large however in the context of $14 trillion in debt they would be just chairs on the Titanic. In addition to this, $156 billion would be saved in interest because the United States would have a lower interest rate. This is where I am a little lost because unless the government can refinance its debt I don’t understand how they will save money. Standards & Poor’s and Moody’s I would imagine are on the verge of downgrading the United States credit rating to AA or possibly lower. If the credit rating of the United States were downgraded it would increase the cost of interest not save money. Another problem is how spending cuts are defined. An important question is what is the baseline for the cut? If politicians are saying we get cuts from things we were already were cutting to begin with or used overstated figures to begin with it could look like there is a cut when in reality nothing really happened.

One of the biggest problems we have is not discretionary spending but non discretionary spending. This includes programs like Medicare, Social Security, and Medicaid. In 2010 the United States government spent $3.45 trillion on payments to individuals. People can get paid through Social Security, Medicare, unemployment benefits, and federal assistance programs. The GDP for the United States was around $14 trillion in 2011. This would say that close to a quarter of all of GDP is just the government sending checks to individuals. In fact, payments to individuals were 2/3 of all spending for 2010. In 1952, payments to individuals were under 20% of all federal spending.

The government holds over $1 trillion assets in building and equipment. In addition to this there is around $919 billion of assets in land. Also the government owns $392 billion of mineral rights. These assets consume even more government resources since they have associated maintenance and replacement costs. The assets could be sold off to private investors who would pay taxes on them, create jobs, and increase productivity. One great idea is for the government to trade people government owned assets for Social Security benefits. The Social Security beneficiaries would have assets that they could use or sell if they wanted to and the government would be putting wasting assets to better use. Another idea for Social Security is to allow people to opt out of it. The idea would be to phase out Social Security over time since it takes money from the young to pay for the old. Privatizing or changing the age people can retire will prolong the solvency of Social Security a few years but the solution to solving Social Security is to phase it out.

Around 7.54 million people are on unemployment benefits. I would be interested to see what would happen if unemployment benefits were cut 10% or even 20% to see how people would respond. It would be wiser to set up the unemployment benefits would be to pay 100% of the benefits for a few months and then start lowering the percentage of benefits by 15% or so every month so people didn’t become dependent on it. I would much rather spend the unemployment benefit money on training out of work people than just paying people to do nothing.

I unfortunately I don’t see a brighter future on the horizon in the United States unless politicians take serious steps in order to get our fiscal house in order. I am really surprised neither party talked about this during the debt talks. Politicians talk about raising revenue. This could easily be accomplished by getting rid of the arcane and complex tax code we have and replacing it with a flat tax that would tax everyone at the same rate without deductions. Doing this would save everyone time and money and bring in more revenue since people wouldn’t be trying to shift income or assets to avoid paying taxes. Time will only tell our destiny though.

Frank McCourt and How Not To Run a Baseball Team

Recently Frank McCourt has been in the news. I usually don’t read Vanity Fair but this month there was a good article about Frank McCourt and his wife Jamie McCourt. Frank McCourt is the owner of the Los Angeles Dodgers. In essence, right now the Los Angeles Dodgers are broke. McCourt can’t pay its bills and owes millions of dollars to various parties. The Dodgers owe slugger Manny Ramirez $20.9 million, Andruw Jones $11 million, and Hiroki Kuroda $4.4 million. Not only do the Dodgers owe players but are around $400 million in debt. Apparently, Frank McCourt has had a divorce which has caused some financial hardship however his spending is out of control for even a billionaire. The McCourt’s net worth in 2009 was $1.2 billion. In 2010, the couple started to go through a divorce. To start off McCourt was had many different homes. Here is a list of their estates

-$27.3 million beach home in Malibu

-$21.3 million Homby Hills, California (near Playboy mansion)

-$19.5 million home Cap Cod

-$16 million Massachusetts home (main home

-$6.5 home Homby Hills

-$6 million ski condo in Vail, Colorado

-$4.7 million land in Cabo San Lucas

-$7.7 million lot in Yellowstone

-$360,000 per year for a suite in the Montage hotel
Don’t the McCourt’s realize people can only live in one place at a time? What is very interesting is that Frank McCourt has an economics degree from Georgetown. The McCourts were also paying a hair dresser $10,000 a month to cut their hair five days a week. Reportedly the couple also paid $100,000 per year for “positive energy”. The recent divorce is now causing even more financial issues as Frank McCourt has to pay his wife $225,000 per month plus over $400,000 per month to pay the mortgages. No this is not a mistake his wife is getting $625,000 per month or $7.5 million per year.

One problem the McCourt’s got into is they were using the Los Angeles Dodgers as an ATM. The McCourts bought the Los Angeles Dodgers for $421 million in 2004. By 2009, the Dodgers had taken on $459 million in debt. What is really confusing is how Forbes can claim the value for the Dodgers is hundreds of millions when the team is consistently losing money. Apparently, the McCourt’s took out $108 million for personal distributions. One deal that could have saved the McCourt’s was a possible deal with Fox. The deal would have been worth anywhere from $1.5 billion to $3 billion. McCourt would have given Fox the rights to broadcast Dodger games for the next 20 years. One problem was Major League Baseball (MLB) has to approve any deal like this. Budd Selig the commissioner of the MLB didn’t allow the deal to go through. Then Budd Selig goes in and has MLB take over the day to day operations of the Dodgers. Is Budd Selig aware of private property and the rights associated with it? McCourt was trying to get a hedge fund to lend him $150 million in order to manage the day to day operations and pay off debts. What is interesting however is everyone seems to think Selig did the right thing by stepping in. However, looking at the McCourt’s finances what genius was in charge of allowing them to purchase the team? MLB has financial rules and guidelines and most likely looks at an individual’s liquidity in order to see if they can afford the team.

Corporate CEOs: Do They Make Too Much?

Once concept I have been thinking about for a while is executive compensation. The media and average person will say these people are paid outrageous sums of money even when their companies go down the drain. The only exception I actually agree with these people on was the financial bailout where CEOs were paid a lot even though their companies were bailed out by the government.


Beginning in the 1970’s companies began as part of executive pay to give certain employees stock options in order to align the same values between employees and managers. In 1992, the Securities and Exchange Commission (SEC) wanted publicly traded companies to offer more disclosure in terms of how executives were paid in order to allow shareholders more transparency. Companies before June 2005 did not have to expense stock options on their income statement. After June 2005 companies had to expense stock options or show them as a cost. Today options make up a large part of executive compensation. What is ironic however is that when CEOs were paid millions of dollars without stock options people complained because it was too much. When these people complained and said that CEOs should be paid based on how well the company does the CEOs started to make even more money and people complained even more. People seem to get upset with the amount of money other people make no matter how they are compensated.

Steven Kaplan at the University of Chicago has studied executive compensation and has some interesting data on executive compensation. Kaplan makes the important observation that when looking at CEO pay there are important things to look at. First, since such a large part of how much CEOs are paid is in stock options. Stock options are awarded to CEOs but they are not really worth anything until they are exercised. I really don’t believe people understand how executives are granted these options. Basically, executives who often have worked at the company are awarded them because they have performed well, created value, and often have been with the company more than a decade. All these are requirements just to get the stock options. On top of all this there is a time CEOs have to wait from the time the options are awarded to exercise them. Once employees are granted stock options they can’t sell them. A vesting period or waiting period is requires and this could be as little as 2 years or 10 years. Usually companies that are established have longer vesting periods since they want to reward long term behavior. So to complain and say that executives and CEOs are in it for the short term is nonsensical considering they have to wait long periods of time to cash out their stock options.

Kaplan’s research also shows that companies in the top ten percent of actual pay (not what the options were worth when granted but only after exercised) had stock returns that were 90% greater than companies within the same industry over the previous 5 years. However, companies in the bottom ten percentile in their industry saw their stock underperform 40% over the previous 5 years. So in essence what this means is that CEOs that don’t perform well will lose money since most of their compensation comes in the form of stock options. Turnover in these companies has also been increasing. In the 1970s, around 10% of Fortune 500 CEOs lost their jobs. In modern times, around 60% of Fortune 500 CEOs lose their jobs. One large reason CEOs are fired are because of poor performance. Another explanation for why CEOs are making lots of money is that the only way a company can make more profit is by expanding or adding more employees. CEOs will only add employees if they think value can be created. So as a firm grows in the number of employees CEOs are in charge of managing more resources. Research from Gabaix and Landier in 2008 showed that since the 1980s firms have increased in size by a factor of four to seven times which is the same increase in CEO pay. According to Kaplan’s data CEO pay from 2000-2007 was decreasing (I haven’t seen his data after 2007). CEOs these days are put under more scrutiny than ever before. After the 1992 rule by the SEC there was more shareholder activism and regulation regarding publicly traded companies. Sarbanes Oxley has also made CEOs basically sign their life away if there are any mistakes. It is interesting to see how many CEOs going into private equity and hedge funds as opposed the other way around.

CEOs are actually underpaid compared to people in private equity and hedge fund managers. In 2010, John Paulson earned $2.4 billion. In the same year Larry Ellison was paid $84.5 million. Or to put this in a perspective a union leader would understand a hedge fund manager is making 28 times the amount of a CEO! In fact the top twenty five hedge fund managers are paid more than the combined amount all of the CEOs in the S&P 500. Hedge fund and private equity firms don’t have to worry about the same kinds of regulation as public companies (maybe this is one of the reasons they make more).

So the case by be that CEOs are underpaid. CEOs work extraordinary hours, have to deal with burdensome regulations, have to take the blame if the company goes down the tubes. Shareholders can always vote CEOs out of their position. To think that CEOs just sit around and count their money and pick out wallpaper like I believe some people do is foolish. Firms have been expanding which explains some of why CEOs are now making more. Also the technological revolution of the 1980s and 1990s allowed CEOs to create more value. If people really believe CEOs are overpaid they should try to become a CEO so they can make oodles of money and drive down the price an average CEO can make.