Plutocrats Plotting Payroll Tax Hike?

Key elements of America’s ruling class think you’re not giving enough money to Wall Street, so they have a plan to force you to give more. The so-called James-Ghilarducci plan would force workers to pay a new three percent payroll tax to fund a personal retirement account to be managed by Wall Street firms. The cost to workers would be partially offset by a tax credit of up to $600, and the government would (somehow) guarantee at least a 2 percent annual return, regardless of market conditions.

The plan is being pushed by Blackstone president Tony James, who just by coincidence also happens to be raising millions of dollars for Hillary. As a result, Hillary’s top aides are reportedly warming to his plan.

You have to be a fool to think that James is doing this out of goodwill and public spiritedness. The plan promises to provide firms like his with a huge spigot of cash for accounts on which the firms will charge lucrative fees.

Right now, laws prohibit retirees from investing 401(k) balances in risky and sometimes opaque ‘alternative investments’ offered by hedge funds and private equity firms. Maybe that restriction should be lifted, but James’ plan forces savers to participate.

Chris Tobe, a Democrat who advises institutional investors and who served on Kentucky’s pension board, put it just as bluntly: “James’ plan is a deliberate attempt to get around federal protections for retirees because alternative investments are not generally allowed in the 401(k) world. This is about making Blackstone and other private equity firms even richer than they already are.”

The most objectionable aspect of the James-Ghilarducci plan is its coercive nature. The retirement accounts would be mandatory, and workers would be forced to pay a new three percent tax. A typical household making $60,000 per year would have to cough up $150 every month. Maybe you had other plans for that $150, but the plutocrats have decided they know better; you have to hand the money over to Wall Street.

Worse, under the plan, individuals don’t even get to decide how their own money shall be invested. People can’t choose for themselves how to allocate their own portfolio. That will be decided by the plutocrats.

Under their proposal, “Retirement portfolios would be created by a board of professionals who would be fiduciaries appointed by the president and Congress,” James and Ghilarducci wrote in a New York Times editorial.

James is trying to sell the plan by promising real returns of 6 or 7 percent. In an economy that can’t manage even 3 percent growth, that promise is simply not realistic.

[E]conomist Eileen Appelbaum told IBT, the James-Ghilarducci plan is built on earnings projections that are fanciful.

“The plan’s promise of 6 to 7 percent returns is likely to prove unrealistic, and they fail to discuss the risks inherent in the risky investments that would have to dominate the savings portfolio that could yield such returns,” said Appelbaum, who co-authored the book “Private Equity at Work” and published a study suggesting lower private equity returns are a new normal.

“This proposal is about Wall Street getting more assets under management because that is where they make their money,” she said.

I also fail to see how government could conceivably guarantee the balances. The tax would generate something like $300 billion per year flowing into the new accounts. After one or two decades, the accounts would contain several trillion dollars. And these funds would largely be invested in assets that are relatively risky. In fact, investing in riskier assets is the whole point of the plan, which is to open up risky asset classes that are currently unavailable to 401(k)s. If we experience a crash like we did in 2009, and asset prices fall by 50% or more, the government would be on the hook for trillions in bailout money. Where would that money come from?

The other problem with the plan is that it would increase corruption by furthering ties between Wall Street and government. Wall Street would benefit from a steady source of cash, but the political class would get to dictate the terms of the deal to Wall Street. The government would decide how much Wall Street could charge in fees, and maybe even which firms could receive the cash. Government influence might also politicize the allocation of credit, which in the long term would impair the efficiency of financial markets and the growth of the economy.

What will happen, of course, is the same thing we saw with health care and pretty much every other part of the economy these days. It will be a bust out. The billions that pour into these new funds will be “invested” in things that benefit the rulers. Politicians will get advance notice on some new move so they can cash in their privileged status. The fund managers will kick back a piece of their rake to the politicians for the right to manage these funds. It will be systematic robbery of the middle class.

Will the plan be enacted? Hillary has not been campaigning on it, and when asked to comment on the article excerpted above, her campaign declined. So they won’t even talk about it. But if they don’t talk about it now, during the presidential campaign, then a future Clinton administration will have no political legitimacy for imposing it on the people. A policy change this significant should be debated during the campaign so that voters can have their say. To keep quiet and then spring the plan only after the election would betray the principles of representative democracy. That’s not to say it won’t happen, but if it does, it would be politically illegitimate.

Reminder: Banks Facilitate Government Theft

Megan McArdle recently wrote an excellent piece on the threat to liberty posed by moving to a cashless society. One of her anecdotes also reminded us of an ancillary point that McArdle might not have intended to make–it’s shockingly easy for the government to seize your bank deposit.

When I was just starting out as a journalist, the State of New York swooped down and seized all the money out of one of my bank accounts. It turned out — much later, after a series of telephone calls — that they had lost my tax return for the year that I had resided in both Illinois and New York, discovered income on my federal tax return that had not appeared on my New York State tax return, sent some letters to that effect to an old address I hadn’t lived at for some time, and neatly lifted all the money out of my bank. It took months to get it back.

There doesn’t seem to be any indication here that McArdle’s bank tried to warn her or that the bank put up any resistance to the government. When government comes after your deposit, the bank readily surrenders. Poof! Your deposit’s gone.

Another example involves the ongoing seizures of people’s deposits for allegedly engaging in “structuring.”

Since 1970 the humorously named Bank Secrecy Act has required financial institutions to report deposits of $10,000 or more to the Treasury Department, because such large sums of cash are obviously suspicious. You know what else is suspicious? Deposits of less than $10,000, because they suggest an attempt to evade the government’s reporting requirement, which has been a federal crime, known as “structuring,” since 1986.

In 2012 a Nassau County, New York, detective decided the banking records of Bi-County Distributors, a family-owned business that sells cigarettes and candy to convenience stores, were “consistent with structuring.” That judgment was enough to trigger an IRS seizure of all the money in the account, which caused an immediate financial crisis for Bi-County’s owners, brothers Jeffrey, Richard, and Mitch Hirsch.

Here the government has enlisted the banks to serve as spies, reporting on your deposit activities, and when the government decides to seize your deposit, the bank readily accedes. There’s not even the slightest notion that the bank might have a legal or moral obligation to protect the assets of its client from the depredations of government.

Or consider Greece, where the government last summer restricted peoples’ access to their deposits by enforcing a withdrawal limit of 60 euros per day.

In contrast, the government would seemingly find it much more difficult to seize or restrict access to funds in a non-bank institution, such as a mutual fund or hedge fund. Even a credit union, though subject to government oversight, might offer marginally more protection.

Of course, the banks would argue that when they cooperate in government seizures they are merely following the law. But experience shows that banks themselves enjoy considerable ability to shape the laws that apply to them, and they appear quite comfortable operating with the current laws that designate them as an effective spy network and enforcement arm for the government.

The fact is that banks and government have always existed in a close and symbiotic relationship. Through the process of chartering, every bank owes its very existence to government. And banking remains the most highly regulated sector of the entire economy.

Even in the early 19th century, when American banking was still in its infancy, banks were chartered at the state level primarily for political purposes, and individual banks owed political allegiance to particular factions and politicians. When the federal government later created the system of national banks now comprising roughly half of all bank assets, the purpose was not to serve the interest of the public. The purpose of the national banking system was primarily to serve the interests of government by requiring the banks to lend to the government.

The bottom line is that banks, although privately owned, could be considered quasi-government institutions. (Even the Federal Reserve is technically privately owned.) When you put money in a bank deposit, you are essentially putting your money in the hands of the government. Indeed, probably no asset is easier for the government to seize than a bank deposit.

Just something to keep in mind.

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Bernie Sanders Doesn’t Know Shit about Economics: An Ongoing Series

Sanders-Tweet-copyThe state of Vermont sends a guy to the U.S. Senate who doesn’t even understand the difference between a secured and an unsecured loan. And he’s running for president.

As president, Bernie Sanders will apparently consider it his job to ensure that interest rates and other prices make ‘sense,’ and if he decides they don’t make sense he’ll…what…issue a decree from the White House fixing the rates, like late-Roman Emperor Diocletian dictating the price of flax from the imperial palace? History records that it did not work out so well.

Back in 2011, the price of iron ore was $170 per metric ton. Now it’s only $43. What sense does that make? Maybe we should just abolish market prices and set prices to whatever makes sense to Bernie Sanders.

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LOLZ: In July, Goldman Sachs was bullish on China

From a Bloomberg report dated Wednesday, July 8.

Goldman Sachs Says There’s No China Stock Bubble, Sees Rally

Kinger Lau, the bank’s China strategist in Hong Kong, predicts the large-cap CSI 300 Index will rally 27 percent from Tuesday’s close over the next 12 months as government support measures boost investor confidence and monetary easing spurs economic growth. Leveraged positions aren’t big enough to trigger a market collapse, Lau says, and valuations have room to climb.

Goldman Sachs is sticking with its optimistic forecast in the face of record foreign outflows, the biggest-ever selloff by Chinese margin traders and a chorus of bubble warnings from international peers. The call hinges on the success of unprecedented government efforts to revive confidence among individual investors who watched equity values tumble by $3.2 trillion over the past three weeks.

“It’s not in a bubble yet,” Lau said in an interview. “China’s government has a lot of tools to support the market.”

In the seven weeks since Lau made his prediction, the CSI 300 has fallen 23%. At this point, for his 12-month prediction to come true, the index would have to rally 65% in just over 10 months. Hey, it could happen, but we wouldn’t bet on it.

As always, the best investment advice is to ignore all investment advice.

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How to Spot a Financial Bubble

We don’t agree with everything former OMB director David Stockman has to say, but he is a very entertaining writer.

The meme of the day—–that China doesn’t have so many gamblers—-is hilarious. From stem to stern, China’s version of red capitalism has evolved into the greatest gambling den in history. The whole thing is a giant punt—from 60 million empty high rise apartments, to ghost cities and malls, to endless bridges, highways and airports to nowhere, to laying down more cement in three years than the US did during the entire 20th century.

But today’s Wall Street admonition to move along because there is nothing to see in the plunging red bourses really takes the cake. In fact, yesterday’s 8.5% plunge on the Shanghai market—–mostly in the last hour and in the face of $1 trillion of state buying power and several thousand paddy wagons thrown at sellers, malicious or otherwise—-is merely a foreshock; it’s a fateful warning about the global-scale financial temblors heading at the incorrigible army of dip buyers in New York, London and their farm teams elsewhere.

In the first place, upwards of 90 million households are in the Chinese stock market, most of them buried under margin debt. Among them, they hold exactly 258 million trading accounts and a significant fraction of these were opened in just the past year by Chinese pig farmers, bus drivers and banana vendors, among millions of quasi-literate others.

The country went nuts speculating in stocks just like it has in empty apartments, coal mines, expensive watches, Macau slot machines, fine wines, copper stockpiles, and almost anything else that can be bought and sold. So when the Beijing overlords go into full panic mode about the stock market plunge, they actually have a reason: There are more trading accounts in their red casinos than there are people in Japan, Korea, Thailand and Malaysia, combined!

This reminds us of Joseph Kennedy, father of JFK, who claimed he knew the 1929 stock market was a bubble ready to burst when he overheard some hotel bellhops discussing their stock purchases. Recall also that the dot-com bubble that burst in 2000 was accompanied by the advent and proliferation of at-home day trading, and that the housing bubble of the following decade gave us ‘flip this house’ TV shows. When the hoi polloi start actively engaging in speculation, run away!

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The Greek Endgame

From the Financial Times:

Greek lenders face bankruptcy on Monday if the country fails to strike a deal with creditors over the weekend, according to senior bank executives, as they described frantic efforts to keep the country’s financial system afloat and their preparations for an uncertain future.

The banks have been leaking cash at a rate of more than €100m a day even with capital controls that were imposed to restrict withdrawals, one banker said. There will be no money left for customers by Monday unless the European Central Bank agrees to lend them more money, this person added.
Echoing that assessment, the head of the Greek banks association told Greece’s Skai TV on Thursday morning that cash points would have money until Monday, but did not say what would happen after that.

Pretty sure that the EU will give Greece some more free money and kick the can down the road for another year or two. It looks like the day of reckoning is postponed once again. Now Italy, Spain, Portugal and soon France will want the same deal. That’s when the euro implodes.

Why are Baseball Contracts Guaranteed?

Reader Craig Purpus brings to our attention a New York Times piece about the new $210 million contract signed by baseball pitcher Max Scherzer. Baseball contracts usually run five years or so, but Scherzer’s contract is unusual in that it promises to pay him for the next 14 years–probably well past the end of his pitching career. Indeed, the contract calls on Scherzer to pitch only for the next seven years.

Under the contract, Scherzer’s salary is fixed at $15 million per year. The contract provides no annual salary increases, not even to compensate for inflation. The author of the article takes this fact as evidence that people expect very little future inflation. While that inference is not unreasonable, the same inference can more reliably be deduced from the fact that inflation-adjusted bonds are not currently selling for much of a premium. The more interesting question is why the contract spreads the payments over such an unusually long period. Unfortunately, the article offers no answer.

One aspect of Scherzer’s contract that is not unusual is that the payments are guaranteed. That is, Scherzer will get payed the same whether he pitches well or poorly, or even if he suffers an injury and cannot pitch at all. Some of the New York Times’ readers questioned why the club would offer such a guarantee.

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The answer probably has something to do with risk. A purely performance-based contract would impose the cost of injury risk on the player–if he got hurt and couldn’t pitch, he wouldn’t get paid. In contrast, a guaranteed contract relieves the player of this risk and transfers the risk to the club. This transfer of risk to the club is probably efficient because the club is in a better position to bear the risk. Compared to the player, the club is invested in a more diverse set of assets and also likely has a greater tolerance for risk. Essentially, the club is less risk averse than is the player, so it makes sense for the risk to be borne by the club.

QE Draghistyle

From the Wall Street Journal:

FRANKFURT—The European Central Bank said Thursday it will purchase eurozone countries’ government bonds, a landmark decision aimed at combating stagnation and ultralow inflation in a region that has emerged as a top risk to the global economic recovery.

ECB President Mario Draghi said the ECB will buy a total of €60 billion ($69 billion) a month in assets including government bonds, debt securities issued by European institutions and private-sector bonds. The purchases of government bonds and those issued by European institutions will start in March and run through September 2016, Mr. Draghi said. The risks associated with the bonds of EU institutions will be shared, but purchases of other government bonds won’t be subject to loss sharing, Mr. Draghi said.

The ECB also lowered the interest rate it charges on its four-year loans to banks by 0.10 percentage point.

The decision marks a new era for a central bank that was modeled on Germany’s conservative central bank in the late 20th century—at a time when fighting inflation was more of a priority than combatting stagnation, weak consumer prices and recurring financial crises.

The euro slumped and was recently at $1.1530, from over $1.16 just before the announcement.

The announcement to buy government bonds, a policy known as quantitative easing, or QE, was made Thursday by Mr. Draghi at a news conference following the ECB’s policy meeting. Officials kept its main lending rate unchanged at 0.05% and a separate rate on overnight bank deposits parked with the central bank at minus 0.2%, meaning banks must pay a fee to keep surplus funds at the ECB.

Wow. Although we think that more liquidity is not a long term solution to sovereign credit and European structural economic problems, the current policy is setting up some interesting incentives. For example, if the ECB buys bonds from a bank and pays it “cash” and the bank wants to hold the extra deposits at the central bank it will be taking a .2% haircut!  What happens if -.2% turns out to be the highest return on a risk adjusted basis?  Anyway, as we head towards dollar parity you might want to book a Euro land vacation.

Manager ‘truly sorry’ for blowing up hedge fund

Here is the story via CNBC:

A hedge fund manager told clients he is “truly sorry” for losing virtually all their money.

Owen Li, the founder of Canarsie Capital in New York, said Tuesday he had lost all but $200,000 of the firm’s capital—down from the roughly $100 million it ran as of late March.

“I take responsibility for this terrible outcome,” Li wrote in a letter to investors, which was obtained by CNBC.com.

“My only hope is that you understand that I acted in an attempt—however misguided—to generate higher returns for the fund and its investors. But even so, I acted overzealously, causing you devastating losses for which there is no excuse,” he added.

The existence of the hedge fund industry actually presents an interesting puzzle.  Why would very rich people be willing to pour money into a fund that steals their money and doesn’t tell them what they do? Is it the financial market equivalent to getting your fix by spending a week at the craps or blackjack tables in Vegas? If 70% of mutual funds with the managers paid 1% of assets per year and 0% of the profits can’t beat their appropriate index, there is no way a hedge fund charging 2% of assets per year and taking 20% of the profits will ever beat out index funds.

Ignore the big-money managers’ predictions for 2015

Brett Roi at Marketwatch provides some good investing advice:

Buy Japan. Buy Europe. Buy technology. Avoid energy. Avoid Russia.

That’s what the Big Money is saying as we get ready for the new year. This is according to the latest in-depth survey of institutional money managers conducted by Bank of America Merrill Lynch. In total, the poll-takers interviewed over 150 professional investment managers around the world with nearly $450 billion in assets under management.

There’s only one problem with this. The Big Money folks are more likely to be utterly wrong than utterly right.

That isn’t just because they are subject to the usual factors like herd instinct and professional self-preservation. It’s also because even though they like to think they are trying to beat the market, they actually are the market they are trying to beat.

This insight makes a strong case for passive, low cost, index investing.  But for those of you who have a higher risk tolerance and an unclouded crystal ball, all you have to do is pick the asset class that will have the best return for the upcoming year. Also, don’t buy losing lottery tickets at the gas station, only buy winning ones.