The NYT has two Opinion pieces that are instructive today.  Not because they are right, but because they are myopic in their treatment of the issues at hand.  Nicholas Kristof writes of the raging opposition to Medicare when it was first proposed and written into law.  He revives headlines from the sixties that claim Medicare was a slippery slope to government control, and that “Never in the history of the world has any measure been brought here so insidiously designed to prevent business recovery, to enslave workers.”

Opposite Kristof is Gail Collins, writing about the recent outrage over screening for breast cancer in women between 40 and 50.  She does not give the situation a full sounding, just more or less relates her own story of having been tested routinely, given a clean bill of health, and then finding a cancerous lump through self examination. 

The reason I link these two is because they (Medicare and extensive screening for cancer) are great examples of programs that continued to grow in what and whom they covered without a check on how expensive the care was.  Kristof’s article is quite sarcastic, presenting the worries of detractors as totally misplaced.  Really?  The program is bankrupt, and expected to be trillions of dollars in the red over the next 20 years.  Is that a success?  Medicare began overrunning its cost estimates in the first year of existence and never looked back.  The pledge of the government at the time was that it would never add a dime to the federal deficit.  Sound familiar?  The fact that it took four decades to teeter on the brink of catastrophic insolvency is a success?  This is the old story of a man jumping off a 100-story building and at the 25th floor someone asks, “How’s it going?” and he replies, “Pretty good so far.”  This was used by Reagan to describe Social Security, although I don’t think he originated it.

As for breast cancer screening, the new report added one element to their previous findings - the cost of screening and treating false positives of all the women who are between 40 and 50 but do not have cancer.  The estimate was that for every 1,900 women screened between 40 and 50, 1 has cancer.  For women over 50, it is 1 in every 1,300 screened (approximately).  So the extra 600 screened and some treated or subjected to biopsies, etc. for what turns out to be not cancer leads to such increased cost as to make it not worth it, in the eyes of the committee.

This is rationing.  Did the committee draw the right conclusion on breast cancer screening?  I don’t know.  Can there be a “right conclusion?” 

We do not have unlimited funds.  Medicare has worked off of the premise that we do, because Congress has failed in its cost containment efforts, self destructing every time (see the Dr.’s Fix that is currently in front of legislators).  Medicare is a failed program not because it did not provide care, but because it cannot be sustained, and never, ever, could, even at inception.

Screening for breast cancer in women 40-50 saves some lives.  Screening for prostate cancer in men does as well.  Are the effective in terms of cost?  Those decisions are the difficult ones that we will have to make.  None of the snarky comments in the NYT, the WSJ, or elsewhere can change the facts.   We do not have unlimited funds.  We are aging as a nation.  Our method of providing healthcare today comes at such a cost as to be unsustainable at every level.

I wrote an article for DTI discussing how consumers are transmitting their intentions loud and clear, we just don’t seem to be listening.  Every day the drum beat grows a little louder.  In some island language of drumbeats and rhythm consumers are telling us that they have entered a long, near-dormant stage of spending.  It was brought on by many things, including their age & stage of life (demographics), their personal balance sheets (debt) and their income (unemployment).  But we know all these things.  What seems odd is that investors and analysts seem to be ignoring these things and are hoping beyond hope for a Christmas season that surprises to the upside.  The Christmas shopping season starts in earnest the day after Thanksgiving, dubbed Black Friday.  In a sense, many in the investment community are betting it all on black.  I think they will be sorely disappointed.

That disappointment is being telegraphed by retailers as they try to get ahead of the game.  Among the strategies being employed are preemptive strikes (Walmart pricing items at $10 or less, and early price cuts on desired items like TV’s) and limited offers (thin inventory).  While these approaches might make the bottom line attractive as a percentage, they do nothing to help the top line grow.  Revenue growth is the deal.  And it’s not happening.  Saks and Target both reported year-over-year declines in sales for stores open more than a year.  That story is playing out across the retail sector.

The consumer is telling us something.  Expect less.

In the 1990s we were educating people about the very predictable spending patterns of consumers and how, when coupled with the huge number of people at their peak in spending, this would cause massive consumption that would last through the 2000s.  Our view was that this party would come to an end around 2008-2010.  So far, so good.  As consumption drove corporate earnings and employment, those who were investing had to find a home for their dollars.  The explosion in self-directed retirement (Keogh, Profit Sharing, IRA, 401k, etc.) created bigger pools of dollars to be allocated, and the low interest rates of the era made bonds particularly unattractive.  Stocks exploded to the upside.

What we did not expect was that once the US stock market showed its dark side in the tech bubble and crash of 2000-2002, the asset bubble in the US would find what seemed to be safer ground - housing, and then later on commodities and some international venues - leaving US equities to more or less languish for the rest of the decade.  Even though US equties performed poorly, there was still a tremendous bucket of investment assets looking for an outlet that had promising returns.  After the crash of 2008-2009 we have all gotten religion about housing.  Many are wary of commodities after the drubbing they took late last year and this spring.  But we still must invest.  We are compelled to find a place to put those assets that we are saving for tomorrow.  As US equities rise and the Fed pursues its Zero Interest Rate Policy (ZIRP), we are seeing more funds flow into stocks.  With the onslaught of ETFs that are based on commodities and foreign markets, these areas are seeing tremendous inflows as well. 

It is hard to make a case that this level of investment is warranted.  For all of the talk of a rebounding economy, so far it is speculation of a bottom and ensuing move higher.  But the markets have already priced in a substantial rebound, acting like the forward indicator that so many say it is.   What happens if this turns out to be wrong?  Where do the funds go next?

We don’t have experience with this one; we are breaking new ground.  Never has there been a time when so much accumulated wealth could move so quickly among investment choices.  If we are correct in forecasting an extended period of slack global demand, which in turn would mean paltry earnings for financial securities, where will capital fly to next in the great chase for returns?  Cash is not a very attractive alternative if your future depends on earning 7-8% per year.  This question will haunt us as individuals, and many professionals as pension managers, in the years to come.

Of course the problem with bubbles is that no one knows exactly when they will end, so in order to remain competitive many people participate even though they are wary of the fundamentals.  I’d imagine that many of us fall into just this category.   I think the key is to remain as flexible as possible, willing to protect your investments at a moment’s notice.  Investing has just gotten much harder than it was for the last 25 years. 

For several years I’ve been teaching a two-day workshop that we call Demographic School.  The point of the workshop was to give attendees a full understanding of how we view the world, kind of looking at the economy through a demographic lens.  Part of this involves reviewing historical periods like the 1930s.  I always mention deflation as a time when prices fall, which sounds great.  The problem with deflation is that not only do debts remain constant, but incomes fall as well.  The early signs of falling wages are here, and the long-term ramifications are not comforting.

Professor Kenneth Couch did a small and obviously not exhaustive study of workers in CT and found that those returning to work after a period of unemployment were taking an average of a 40% pay cut.  As the WSJ reports, in previous downturns the pay cut was not as large, and it still took 6 years for workers to regain 80% of their previous pay. 

In the next 12 months, look for wage growth to go negative.  The implications for foreclosures and consumer spending are obvious.

The WSJ - and everyone else - is reporting this morning that the Obama administration is considering taking unused TARP funds and applying them to the federal deficit.  Everyone who suggested or went along with this should be publicly marked with the scarlet letters ”FF” for Fiscal Failure, which would allow us to know very quickly who can and who cannot get involved with fiscal policy.  The TARP funds were authorized by Congress, but were created by borrowing, which of course is part of the national debt.  To suggest that you will borrow more through one program in order to pay down borrowing through another program is nonsense.  It is nothing more than a political show to make observers think that we are doing something constructive, when in fact we are not.  The logical and boringapproach is, if you don’t need all the TARP money, don’t borrow it in the first place.

The FT ran a story this morning that describes 10 states as being much like California in not only their budget woes, but also their constraints in dealing with their fiscal issues.  The problems include loss of revenue, large budget gaps, legal obstacles to closing those budget gaps, and a history of mismanagement.  This is an issue that has been of particular interest to us for a long time, as we see it continuing to deteriorate, not improve, in the years ahead.  The affects of this are obvious and already appearing - less social services, longer waits for government services in general, and crowded classrooms.  Welcome to the future.

From both sides of the fence - credit demanded and credit extended - we are witnessing a contraction.  This is NOT a slowdown; this is not a case of slower growth.  We are in the midst of a true reduction in the amount of credit outstanding.  This is going on in conjuction with declining employment opportunities and reduced hours worked (33 hrs per week, continuing to be the lowest on record).  As I wrote in the HS Dent Economic Forecast in July 2009, we are moving to a world that as marked by less, and it is tied to  our ability and desire to purchase.

The Federal Reserve Flow of Funds report shows a contraction of consumer credit of $122 billion so far for the year, or a reduction of 4.75%. Consumer credit outstanding has been contracting for eight consecutive months, which is a record.  People truly are paying down debts.

At the same time, the availability of credit is contracting.  The NYT reported this morning that the major credit card companies have shed 72 million card accounts in the last 12 months, dropping the total number of cards outstanding to 555 million, an 11.5% reduction.  However, at the same time those companies have cut available credit lines from $4.6 billion to $3.4 billion, or a 26% decline. 

Bankers continue to tighten lending standards.  the latest Fed survey shows that 15% of senior loan officers are reporting that they are tightening standards.  While this is down from the meteoric 85% earlier this year, it still shows continued tightening of credit. 

As the noose closes, it will have an impact.  We will choke off even more of the economic activity.  Keep in mind, this does not in any way mean that economic activity will stop.  We are not saying and have never said that things go to zero.  It’s just a period marked by “less” as we go through an extended bout of private debt deflation.

Fannie and Freddie have a new program - when you default on your mortgage, you can trade in your mortgage through foreclosure and in return get a rental agreement.  Through rapid deterioration of the housing market and now prime loans, Fannie Mae and Freddie Mac have found themselves with around 100,000 homes that they own.  What to do with them?  Flooding the markets with excess inventory seems like a bad idea, so they chose instead to go into the landlord business.  The WSJ reports that the program will charge “market rents,” which are lower than the previous mortgage.  That seems obvious.  But it also brings up an obvious question - if rents are lower than the old mortgage payment, are the rents also lower than a mortgage based on current sales prices?

What the entities are doing is betting on an improvement in the housing market, waiting to sell inventory when things are better.  These are the same entities that told us in no uncertain terms in the summer of ‘08 that they needed no government funds, and are now $100 billion into our pockets as taxpayers, most likely needing more in the months ahead.  Having these entities become real estate speculators doesn’t make me feel better.

Falling fertility

Oct 29th 2009
From The Economist print edition

Astonishing falls in the fertility rate are bringing with them big benefits

The above story appears in the latest edition of the Economist, a magazine we read faithfully as it gives an interesting “outside America” perspective on things.  This story has no political leaning, but instead quantifies the effects of falling birth rates.  In very un-typical fashion, the analysis couldn’t be more wrong in it’s conclusion.  The Economist points to the wonderful virtues of falling birth rates, clearly identifying a “goldilocks” generation where there are fewer children and fewer aged than there are workers.  So far, so good.  The article goes on at length about how wonderful this is, with its increase in output, more opportunities for women to join the workforce, increased productivity, etc.  Many countries are cited as examples of how this story goes - most of Europe and the US - and there are many countries cited as being in this storybook chapter of thier history right now.  But what comes next?  That question is not answered.  Only in passing is Japan mentioned as having issues because of  few workers per retiree and with almost no children coming along to revivie the economy.

It would have been much more enlightening for the article to delve into the truly long-term implications of a falling birth rate in the context of the current economic systems in place around the world.  A 20, 30, or even 40 year view is not enough.  We need to understand our obligations and abilities on a full 80 year cycle to clearly see how our policies of today will help or hinder the generations of tomorrow. 

As we contemplate phenomenal increases in government responsibility and liability, we need to do so with our eyes wide open.  To say such programs have worked elsewhere is only compelling if such programs worked during both goldilocks times and times of contraction.  So far such analysis has not made it to the scene. 

 In a seemingly unrelated article, Evan Ambrose Pritchard wrote a great piece in the Telegraph on why Japan should be the worry of the world instead of the US, as their financial situation is deteriorating by the day.  I say seemingly unrelated because it is an article about the failure of Keynesian economics as employed by the Japanese over the last 20 years, but the real driver of the failure is the totally wrong response of the Japanese government to their real problem - falling birth rates fifty years ago.  In the face of such a demographic shift, taking on more economic burdens at the government level was the complete wrong thing to do as the expectation going forward is for economic contraction.

I’d love to see the Economist take their analysis to the next step, asking what comes after the goldilocks period when you have an aging workforce and no replacement children.  It’s difficult to get much of anyone to look that far over the horizon.

Not every loser chosen by the government is a fat cat banker making millions of dollars, or a perceived corporate bad actor such as Lehman.  Many are just ordinary people, which is what makes some of the choices of the US government over the last year so much more difficult to fathom.  At issue is the results of the auto industry bankruptcies earlier in the year and how the pension mess has fallen out. We have written on this subject numerous times, and today the NYT has a feature on it (NYT, B1, 10/27/09).  The example “loser” is a woman who took early retirement at Delphi as the company encouraged, received a pension of $2,925 monthly since retirement, but after the end of the bankruptcy she will receive $390 monthly.  That’s correct - from $3k a month to $400.  I’d say that qualifies as losing. 

So what was makes her a loser?  Not being in a union is the short answer, but it’s not the full answer.  When GM spun off Delphi in the late 1990s, the Delphi United Auto Workers were given a promise that if their pensions were underfunded by Delphi that GM would “top-up” the payments.  So far, so good, as these are the dealings of private companies with their labor. 

Then Delphi does indeed go bankrupt in the mid 2000s.  The company quits making full contributions to their pension plans for all workers - UAW, United Steel Workers, white collar workers, etc.  In fact, they make tiny fractional payments.  Just as you would expect, four years and one heck of a bear market later, the pensions are all dramatically underfunded.  So Delphi does what is expected of a company in bankruptcy, they kick their pension obligations to the PBGC, which pays according to a very un-generous schedule, NOT according to what your pension benefits were at the company.  This is where the Delphi UAW workers hold up their trump card, the one that says GM has to “top-up” their pension payments in the event of underfunding.  Still, so far so good.  Except, GM is now bankrupt too.

This is where the winners and losers are sorted.

GM now agrees to make those payments. But there’s more.  The steel workers, electrical workers, and other unions cry foul because only the UAW is covered.  So GM graciously agrees to top up all union payments.  White collar payments? No.  Nada.  Zip.

Where did GM get the funds to make such payments, since they were bankrupt?  From taxpayers, who infused the company with $53 billion.

This is the same convoluted scheme that allowed unsecured creditors (union health trust) to jump ahead of secured creditors (bond holders).

 There are real consequences to these actions.  Those that control capital, both investors and corporate officers, will long remember these actions and include them in their decision-making in the years to come.  To pretend that such things have no consequence is disingenuous.  To treat these situations lightly, when they have such a devastating and unequal affect on people, is callous.