For anybody who wants to enhance their comprehension of the American deficit/debt crisis I highly recommend White House Burning by Simon Johnson and James Kwak. The authors go into great detail explaining how our government has managed to amass so much debt. I enjoyed reading it for several reasons.
First, it provides much needed context on the history of American indebtedness. The authors explain how prior to WWII and Bretton Woods Congress insisted on balancing the budget within a reasonable period of time. This is not to suggest the nation never ran deficits, but rather the government put balanced budgets near the top of their priority list. Leaving the gold standard coupled with the Dollar achieving reserve currency status changed the calculus, and priorities, for Congress. Money became cheap and the politics around money made it difficult for any elected official to credibly insist on balancing the budget.
Second, White House Burning makes a compelling case for government. The authors spend many pages giving examples of all of the great things the government does. From providing for the national defense to unemployment insurance to funding scientific research to guaranteeing loans for business and residences to providing access to health care the list is truly staggering. Reading through and truly processing all that the government does, one begins to appreciate the value it adds to our lives every single day.
Third, this book helped me conceptualize what the driving costs of our deficit really are. Namely demographic trends. The social programs our government have provided are quite successful. People are living longer. That is great. It also means that more social security checks need to be sent every month and more doctor visits are made over a lifetime. These things cost money. The cost of providing those benefits and programs rises with the frequency and volume of consumption.
Fourth, one point the authors stressed which I found very insightful/troubling/eye opening: the government could announce tomorrow that they were going to cap medicare expenditures for everybody in a way that would solve the fiscal crisis completely. But that would just shift the burden from the government onto each individual to provide for themselves. Instead of Uncle Sam going broke, each citizen would go broke or be without medical care. In other words, solving the government debt crisis does not solve the problem of obscene health care costs. Seniors are particularly unable to provide for their own healthcare at reasonable costs. No insurance company is going to take on an individual in their 90s. Similarly, cutting social security would just shift the burden of retirement to citizens from the government. That is not to say that people should not take responsibility for funding their own retirements. It is just pointing out that eliminating social security payments and taxes may help the government’s fiscal precariousness, but it does not mean people will be more successful at saving for retirement. I found this point sobering.
Fifth, Simon Johnson and James Kwak then provide a detailed list of suggestions to tackle the deficit problem. They state from the beginning that their goal is not to produce a budget that runs a surplus and pays off debt. Rather, they hope to end up with a budget that is sustainable over time. They note that over time the economy will continue to grow and appetite for US Treasuries (the primary funding source for the debt) should remain high. By taking steps to stabilize today and slow down the growth of the debt, they argue the “fiscal crisis” will pass.
In Conclusion: White House Burning is a fascinating book. It provides intelligent discussion about the history of government debt and articulates the main drivers of debt today. The book is laden with graphs and charts and references to reports and news articles. It does not stop at describing the situation but takes the brave step of recommending changes to solve the problems. For anybody looking for a comprehensive discussion regarding the U.S. Deficit and Debt I highly recommend White House Burning.
Everybody knows that Barack Obama and the Democrats retained the presidency and a majority in the Senate by winning just about every single battle ground state. Everybody also knows that Republicans maintained their majority of the seats in the House of Representatives. I was trying to process this fact when I saw this tweet by @sethdmichaels which really got me thinking. In Michigan, Ohio, Pennsylvania, and Virginia the President won a clear majority of the vote. Further, ALL four Democrat senate candidates in those states won majorities of the vote. Yet the GOP won 42 of the 59 House races in play. Pretty amazing when you think about it. The GOP could not win the majority of votes in 8 separate state wide elections, but won over 70% of the House districts!
On Saturday November 10 I saw this post by Weigel and decided I needed to find concrete figures. I started collecting results from the Politico “Elections Results” page and compiling it into a spreadsheet. Could it be that more Democrat candidates received votes than GOP candidates? Is the effect of gerrymandering so great that it enabled the Republicans to win enough seats to retain the House?
I tabulated results from the following states: Michigan, Ohio, Pennsylvania, Virginia, Wisconsin and North Carolina.* In four of the states (Michigan, Pennsylvania, Wisconsin and North Carolina) there were more ballots cast for Democrat House candidates than Republican House candidates. Yet Republicans won 9 of 14 MI house races, 13 of 18 PA races, 5 of 8 WI races and 9 of 13^ NC races. In Ohio and Virginia the total House vote by party was fairly even (less than a 5 point spread in both) yet the GOP won 12 of 16 OH races and 8 of 11 VA races. In other words, of the 80 House races in these six states Republicans won 56 (70%) and Democrats won 23 (28.75%) with one race undecided.
Republicans control the state legislatures as well as most of the governorships in these states which means the GOP drew the new Congressional districts as a result of the 2010 census. This enabled the GOP to gerrymander the maps to give them the best chances to win. As the table shows, the Republicans did not let that power go to waste.
My comment: I point out these figures not because I think Republicans cheated or acted inappropriately. I am not crying that the system is rigged. I am sure Democrats did the same thing in the states they controlled (Maryland, New York, Illinios, and California immediately jump to mind) to exaggerate their numbers. I write this because I believe the system is flawed. The Democratic party won the Presidential popular vote, they won almost every major Senate toss up and they won more House ballots. To argue that House Republicans have “a mandate” that is on par with the President is sheer madness. The GOP disproportionately benefited from re-districting.
I am not trying to argue that the only reason the Republicans retained the House is due to redistricting. There are plenty of reasons which might explain the results. I am simply suggesting that by counting all House ballots together, as we do in the Presidential popular vote, we would see that the House would be much tighter.
If there is anything to take away from the data above, it is the importance of winning control of the district drawing process. The constitution mandates the government to conduct a census every 10 years and subsequently reapportion House districts to reflect the updated numbers. Strategists, pundits and voters alike should be sure to consider this power when the 2020 election rolls around.
* As I made this table less than one week after the election there are still votes to be counted. Totals are definitely going to change. That being said, the vast majority of votes have been counted and I find it unlikely that the results will change dramatically in any direction.
^ At the time of writing North Carolina’s Seventh district was too close to call. The Democrat candidate was listed as having a 533 vote lead. It is likely this race will go to a re-count.
Friends and followers of tacwos you are probably asking yourself, “Why did that lazy bum stop writing already?” I’m here to tell you I have a good excuse! Recently I became a contributor to the website Emerging Money. I file a column there five days a week. You can find everything I have posted by following this link. It is a great site covering emerging markets with plenty of original, thoughtful content.
I do have a couple posts for this site that I started but never got around to finishing. I am hopeful to get them up soon. Thanks for your patience and keep sending me ideas of things you would like to see covered.
In 2009 UBS admitted to facilitating tax evasion by U.S. citizens. In response Congress passed the Foreign Account Tax Compliance Act (“FATCA“) to help the IRS improve collections of foreign income. As the IRS has issued new rules and forms derived from the act, many foreign financial institutions have told U.S. investors that their money is no longer wanted. At the same time record numbers of American citizens have renounced their citizenship. Could it be the U.S. has extended their reach too far?
that’s a complicated way of saying: New rules are being written which will extend the ability of the IRS to track investments made overseas. In anticipation of these rules going into effect foreign banks and hedge funds are divesting themselves of U.S. investors. They complain that these rules are too complex and onerous because they require them to also monitor the companies they do business with. If a business partner is non-compliant with FATCA the foreign financial institution will be required to withhold more profits than usual from their clients and report all income to the IRS. Rather than develop compliance measures these financial institutions have opted to cut ties with Americans. They would rather forego the wealth of the world’s richest country than have to comply with FATCA’s rules. This trend is troubling for American investors because it means they have fewer options and less access to foreign markets.
One response American investors with large holdings have opted for is renunciation of their American citizenship. Most recently, it was revealed that Facebook co-founder, Eduardo Saverin gave up his citizenship in favor of becoming a resident of Singapore. Speculators believe this decision was motivated primarily to avoid taxes on his Facebook stock. But he is also an active investor with holdings in Europe and Asia which would make him, and the firms, subject to the new law. It is not much of a stretch to think this did not factor into his mind. And there are reports (linked above) suggesting that more U.S. citizens are leaving so they can continue to stay invested overseas and avoid any impending tax increases.
Consequences for America: With investment opportunities being closed off to Americans it will be more difficult for them to gain access to global markets and diversify their positions. Over time this may lead to lower returns and, therefore, lower tax revenues. Further, because our dollars are not as able to flow into emerging economies, it will be harder for us to wield influence as they grow larger. If the recent trend of citizen renunciation continues the U.S. will be losing access to many successful, sharp minds and their investment savvy. Not only do they leave, but they generate great animosity and probably feel like they will not be welcomed back.
There is Opportunity: If there are banks out there refusing to service American investors because the compliance costs are too high, perhaps there are also banks who are already compliant and willing to move to Singapore or Hong Kong and fill the void. They may not have the immediate expertise to create financial products that match the quality of local branches, but there is reason to be hopeful that with time they will match our foreign counterparts. Growth opportunities for American banks are not readily apparent these days so this news could be welcomed by them and shareholders. A second offshoot is that U.S. citizen investors may look harder for good investment opportunities within. Perhaps the next facebook is already invented but just needs somebody to provide the funding for them to make the leap to greatness. FATCA creates many headaches and red tape for those investors with assets overseas. But it also encourages them to bring their business home and work on improving America.
It didn’t take long for shareholder derivative suits to be filed against JPMorgan Chase in the wake of the $2 billion dollar trading debacle. Papers submitted in the Southern District of New York by three separate law firms allege JPM mislead investors about the extent of the trading loss prior to the May 10th announcement. While the shareholder frustration over the 12% drop of JPM valuation is valid, filing suits will ultimately do more harm than good for investors and their stock in the company overall.
This is not to excuse JP Morgan’s risk taking and cavalier behavior. The bank is not sufficiently policing itself and this lack of oversight allowed the Chief Investment Office to open positions larger than most senior executives were aware. Many prominent members in congress and aspiring to join Congress have discussed the need for government oversight. If more significant regulation was in place it is possible that positions of this magnitude would not be permitted and the whole ordeal could have been avoided.
There is no doubt that the Chief Investment Office was in the business of operating in risky areas. The CEO, Jamie Dimon, has been an outspoken advocate for freedom for banks to engage exotic and risky markets. Lets be clear, it’s highly unlikely that any position JPM held was illegal. Shareholders are upset that Jamie Dimon dismissed questions about the positions in April by saying there is a “tempest in the teapot.” They could rightfully argue that had they been informed of the type and weight of positions the Investment Office entered into, they would have sold their shares, avoided the risk, and ultimately the decline. But this seems like wishful thinking. Had JPM disclosed their bad positions in mid-April, the stock would have immediately tumbled then. The banking industry is always going to be a risk taking business. Given the size of JPM there will undoubtedly be bad calls that result in significant trading losses. It is a peril of being in the business. For an investor to second guess the company now, when they made a misstep, is cruel. As they say, hindsight is 20/20.
Setting aside the faulty basis for the suit, taking legal action against JPM further contributes to the devaluation of the stock. JPM will need to expend significant resources defending themselves in each case. Lawyers will need to be hired, executives’ will have their days interrupted for depositions and trial preparation, and any judgment or settlement will be paid directly out of JPM’s cash reserve. Each of these factors will be an expense that shrinks the bottom line, hurts profitability, and draws resources away from more efficient uses — all very negative for any shareholder. Second, filing a lawsuit generates plenty of negative publicity. The lawsuit will drag on for months, if not years, and constantly pop back into focus, reminding Congress and the public about JPM’s miscalculation. This period of prolonged, recurring negative press means JPM will be constantly having to defend their brand through increased marketing and public outreach. That is, at the expense of profits for the shareholders.
All this aside, members of the litigation class should not expect to receive compensation equal to their trading loss because the Court and lawyers will need to cover their overhead and fees first. Realistically the only ones benefiting are the lawyers — on both sides. Why would shareholders agree to harm the company they own to line the pockets of others?
Litigation in this case would do nothing to bolster the long term prospects of the company, and instead, only serve to undermine their future growth potential. Shareholders should leave the second guessing to the government instead of piling on to make matters worse.
Delta Airlines agreed to purchase an oil refinery outside Philadelphia from ConocoPhillips for $180 million. The refinery was just one month away from being shut down as it was not producing enough profit for ConocoPhillips to justify keeping it open. Delta estimates that the purchase will save the company as much as $300 million a year because of the economic benefits of “vertical integration.” Critics are skeptical that Delta will have the managerial expertise to operate a refinery better than a bonafide oil company.
that’s a complicated way of saying: Delta Airlines purchased an oil refinery in an attempt to control their fuel costs. Traditionally air carriers purchase jet fuel on the open market and employ “hedges” to limit the cost of jet fuel. In the past few years the price of oil has increased rapidly and undermined the profits of airline companies. Last year fuel purchases accounted for 36 percent of Delta’s operating costs! When you consider the amount of labor it takes to run an airline and the expense of acquiring and maintaining a large fleet of aircraft, 36% is quite a staggering number. Delta’s purchase of the refinery is an attempt to remove jet fuel price volatility and stabilize their profits.
What are the potential benefits of owning a refinery? Delta will be able to easily supply fuel to their hubs in JFK and LaGuardia and throughout the northeast. Eventually the company hopes it will cover approximately 80% of its fuel needs in North America. Receiving fuel from one source will make it easier for Delta to monitor fuel quality. Furthermore, Delta will have effectively cut out one middleman in their supply chain.
This purchase can also be seen as introducing more competition to the refining space. Delta is potentially showing the airline industry an innovative way for them to stabilize costs. Other oil refiners may be forced to lower their prices, improve fuel quality or provide fuel in a more efficient way in order to prevent other airlines from following Delta’s lead.
Removing parts of the supply chain is known as vertical integration. Remember the steel companies and railroad companies of the late 19th century? They started buying up coal and coke mines, successfully driving down the costs of the inputs they needed to produce their primary products. Delta, by refining its own fuel, is expecting to create economic efficiencies to control the cost of their most expensive input and improve their bottom line.
Further, Delta argues that paying $180 million ($30 million of which is funding provided by the State of Pennsylvania) is such a cheap price that even if the venture fails it will not harm their primary business.
What are the potential problems of owning a refinery? Delta Airlines does not have the technological experience or expertise to run an oil refinery. Their skill is in transporting passengers and cargo in airplanes. Why do they think they would be able to do a better job of operating the refinery than ConocoPhillips? Better than a company whose business model is based on producing and distributing fuel from oil? One of the side-effects of an effective, free market, in my opinion, is the specialization of firms. Vertical integration does not lead to higher profits because the savings to the company of lower prices and smoother distribution will be outweighed by the lost production to be expected due to the foreign business. Delta’s purchase looks to prove this tenet wrong.
Second, while Delta has cut out the middleman of the refiner, they will still need to purchase oil, needed to refine into jet fuel, on the open market. The price of oil is the commodity that fluctuates in price. Refined fuel and gas usually follow the same direction as oil. Undoubtedly there is some markup after refining which will be saved. But if the goal is to shield the company from surges in the price of oil, the purchase of the refinery will not achieve that result.
Delta’s rebuttal: Delta will argue that they do not need to refine fuel in a “profitable” manner. Rather, they need to simply refine fuel so it is cheaper than if they had to purchase it on the open market. Any time they can remove a middleman from their supply chain, they are reducing markups and saving money.
Regarding expertise and experience, Delta will say that they are hiring the same people who were operating the refinery before. They will already come with the necessary knowledge to operate the facility in a cost effective way.
My thought: This seems like an unnecessary risk for Delta. Especially since fuel prices appear to be declining a bit. In my opinion they should continue to employ their strategy of hedging fuel costs and buying on the open market from the refining experts. If Delta can operate the plant smoothly and efficiently, it will certainly be a boon for the company. However, I think the chances of Delta making the refinery work better than ConocoPhillips are not good. As a Delta shareholder I am now looking for a good exit point of the stock.
There are plenty of other compelling reasons to own the company, particularly if you agree that fuel costs are going to decline. Time will tell if this was a smart move, but I predict it will end up being a mistake.
Osborne Hazel
