Improving, not just saving, Social Security

Yeah, yeah, yeah. You’ve heard it all before. Social security is not looking so secure, but why does it really matter? I think most people would probably say because it would certainly be nice to get that monthly check in the mail once they’ve retired, particularly when 7.5% of every paycheck is taken out for it. Who likes to pay something for nothing? After all, the current system is projected to take in less money than it pays out around 2017, which means it will eat up the budget, which means even tighter capital markets and higher future debt. And then of course it’s projected to go bankrupt in 2040. It’s all very boring.

But the bigger reason we should fix social security - and not just patch it up with a million clever little ideas, say by lowering the inflation index or pushing back the retirement age, which will succeed only in postponing insolvency and making people work harder for less, but not really improve anything - is because of the enormous… opportunity cost! I wish it could cut aluminum cans in half or something, but we’ll have to settle for opportunity cost. Think about the difference between every dollar of your paycheck that goes into the Social Security Trust Fund, and then is subsequently spent immediately and preserved in the form of debt, versus every dollar going going into a well balanced mutual fund and earning interest. And then multiply over, oh, say four decades. Say on average you make a real income of $50,000 a year for the next 40 years, and the standard 7.65% of this is contributed to payroll taxes, this is $153,000 in principal. When that money goes into the Trust Fund, the government at best will nullify the deleterious effects of inflation, and worse yet, may actually lose purchasing power depending on the spread of government bonds versus inflation, or still worse, may decide never to pay it.

On the other hand, pick any ten year period of the stock market, any 10 year performance period of Wall Street, and the average returns will never be below 7%. Not during the Great Depression, not during S & L or dotcom, not now, not ever. Business cycles are real, they happen, but the ups and downs average to a healthy trend. Saying something is reliable because it has never failed is all you can really go on. For instance, people banking on the Social Security Trust Fund paying them out around the middle of this century often cite how much more reliable a Government IOU is because the government has never defaulted on its debt. True, but then the rationale of the safety of Wall Street is no less reliable. The government has never defaulted on its obligations. And Wall Street has never produced less than 7% per decade in returns, let alone a loss. So say over the 40 years you’ve contributed that $153,000 to the government and the market just hits the bottom of that 7% return, you still turn that money into over $600k. Assuming the best, this is a 400% difference from what the government would pay out, a very steep opportunity cost. Now there are no guarantees. And if people would like to play the “more conservative card” of just paying into the fund and getting a government guarantee, they should be able to. But, just like U.S. Senators, people should have the choice to contribute their income into actual funds. The Regular ol’ Person system could be essentially the same design as the Senators’. There would be a pension board that oversees 5 or so broad investment plans, divided by their equity/fixed income ratio, but all diversified and managed by professionals and overseen to regulate leverage and risk (something missing since about 2004 when the SEC removed net capital holding requirements). The point is people couldn’t just invest wherever the mood struck them, there would be a small menu of balanced funds to choose from. And because of the simplicity of the rules - 5 plans, no more than 10:1 or so leveraging, it would be clear whether funds were being abused/Madoffed in any way.

I hope that any future modification to Social Security does not reflexively deny individuals a choice in how their earnings are used. I think this is the compromise that can be struck - people who like the current system (retooled with some painful actuarial adjustments) can stay with it. But not allowing individuals a choice to place their payroll earnings into a balanced fund seems to me to be denying people an awful lot, and for nothing but the concerns of other people who would be unaffected. It would have the added benefits of freeing the government up from a lot of debt and providing much needed private capital injections to our financial institutions. A lot of this could be used to do things like deploy clean energy, build smart grids, in short create good jobs. And of course there are details, there always are. When money from current workers is placed in an investment fund, and not siphoned towards current retirees, there will have to be bridge financing in the form of more debt. Yet so long as much of Asia has a 30% savings rate, and so long as there are sovereign wealth funds, there will be ample capital to absorb a few more government securities. Plus, paying these off in the future will be easier than waiting for the system to slide into debt and paying then, as the pension system will be more sustainable and profitable thanks to new productivity from deeper capital markets and decreased government retirement obligations - meaning a broader economic base. And there will have to be cut off points for when people can make the transition. And there will have to be a little bit of private earnings skimmed by the Board as reserves to provide insurance to people who might pick particularly unlucky times to retire – in this way they would be guaranteed a minimal payment not below the regular system. Bueller?

But the point is, legitimate debate about the system doesn’t have to ruin anything. Those who think the government is the best universal retirement planner and want that legal guarantee can have it. And those who would prefer to fund government managed private investments with their money can do that. Now this is bipartisanship This isn’t a parlor room discussion or a game of gotchya between editorialists (oh how Stiglitz, Krugman, Summers, Brooks et. al. love to seem the smartest guy in the room). It’s a very pragmatic day-to-day kitchen table decision. And I think given the choice, people should be given more opportunity, not less.

On another note, the CBO recently scored the House stimulus bill. It estimates 7% of the energy investments will be spent within 2 years and less than 50% of the transportation dollars spent in 4 years. This is too slow to provide immediate stimulus and generally conforms with what the Council of Economic Adviser's new chair Christina Romer has shown in her work. I think the second half of TARP ($150b to buy up worst assets, $150b for continued recapitalization and $50b for mortgage refinancing, which could save 1m+), combined with a more focused $100b stimulus could have great effect.

"I always go through the process of hating it, hating myself, thinking I've fooled them, I can't actually do this." –Heath Ledger

When Heath Ledger is nominated next Thursday for his second Academy Award, exactly one year since his death, he will have fooled no one. In his final role he made vintage Jack Nicholson look bad, and he appeared to barely be trying. My favorite line in the Dark Knight is the baptismal bedside conversion of Harvey Dent into Two-Face, where the Joker slurs, “You know, they’re schemers. Schemers trying to control their worlds. I’m not a schemer.” This line belays the Joker as the twisted half-brother of Holden Caulfield, or Ben Braddock in the Graduate, or the American transcendentalist Thoreau - someone lost , but almost entirely because they are searching too hard to ever notice when they've stumbled onto something. The great irony is that one year after his death; Heath Ledger will have found what he always thought was alluding him. I hope now Heathy can get some rest.

Peace in the Middle East

Almost as reliable as the turning of pages on a calendar is the cycle of violence in the Israeli-Palestinian conflict. Here’s to ’09 being a peaceful year in the Middle East, but it’s looking all too predictable. Let’s be clear – the rockets being launched out of Palestinian territory that perennially kill innocent Israelis is completely unacceptable. It is tragic, it is wrong, and it is terrorism. The international community is in agreement that the goal is to stop this scourge (and I would add there are many other goals, but this is the most immediate). The debate among reasonable people seems to be what the best mechanism to achieve this end is. I would argue that there needs to be considerably more effort placed in pulling the rug out from under extremists by drying up their recruitment base and trying to fill the vacuum that is left by poverty and deprivation. The June '07 illiberal democratic election of Hamas is entirely predictable given the extreme living conditions in the West Bank and Gaza. Crippling poverty, hugely underproductive land, overpopulation, disease and little prospect for the future, not to mention connections to many family and friends who have died in previous violence, makes for the perfect platform for extreme ideologies to flourish. Reverse these conditions and you will almost certainly see a considerably more liberal democracy emerge and Israel achieve its objective of not having a terrorist organization ruling across its border. I think we have seen for decades that the current approach (heads of state signing pieces of paper and militaries launching offensives) has not produced a lasting solution. Decrees, promises, foreign observers, summits, envoys, seem to be trying to force a solution in many respects, rather than trying to actually build one . So long as the fundamentals on the ground remain the same for millions of people in Gaza and the West Bank, these top down solutions will likely continue to lack a mechanism capable of enduring stability and peace. It is imperative that sovereign countries protect themselves, yet so long as innocent blood is spilled on both sides, and so long as there is extreme poverty and deprivation (particularly in Gaza and especially under the current blockade) there will be no scarcity of people willing to give their lives for tragically backwards causes. This is exactly why Defense Secretary Gates, in an unprecedented move, lobbied last summer for a doubling of the foreign assistance budget for the State Department, because he knew it would translate into direct security benefits.

The best long-term approach to weakening radical extremists (like elements of Hamas) is to eliminate their resource base. Yes this means more traditional approaches like cutting off supply lines and raiding weapons caches, but even more it means providing an alternative of hope in the face of despair (and just as importantly, being seen as providing an alternative). Extreme poverty and deprivation is a surefire accelerant of extremism. Over a period of years if the international community, perhaps led by Israel, were to step up humanitarian relief and development assistance for its impoverished Palestinian neighbors, I think it is very likely that a vast majority of the extremist recruitment base could be dried up. Clothes, food, medicine, fertilizer, seeds, generators, schools, community centers, hospitals - basics - would help ensure another generation of youth is not caught up in the cycle of a false but often too attractive violent ideology. Extreme ideology feasts on the kind of fatalism brought upon by miserable conditions. Such assistance would literally be the physical embodiment of a neighbor’s compassion and would win hearts and minds from ideological zealots. Building an economy and investing in a viable alternative and moderate political coaltions will engender stability and a 2-state solution infinitely better than a team of pro negotiators and yet another rounds of furious document signing. One approach leverages a concrete mechanism to drive moderation, the other merely ordains it. Political parties are more an appendage of the prevailing situation and desires of the people than an apparatus capable of executing whatever U.S. statesmen broker. In other words, invest in a viable alternative, not simply agreeable language.

Ad hoc security crackdowns or another round of well-branded Summits will unfortunately fall short without treating the situation on the ground. Let's also be clear here - there will always be evil people for whom a military response is the only appropriate solution, and here Israel and the West must remain vigilant. Yet so to must the West realize that there are inherent risk factors that make it relatively much harder or much easier for extremists to operate. Opportunity and hope remains a vastly underutilized weapon in the war against extremism.

The Top 10 Technology Trends of 2009: I Pick them!

10) Mobile. It’s the future. Mobile cars, mobile cigarettes, mobile gummy bears. Mobile is the buzz word out there and it’s here to stay. If it’s mobile, invest in it. In 2009 your i-phone will become the j-phone, it will become not just a restaurant locator, credit card and way to ignore other people in awkward social circumstances and seem busy, but also become truly mobile based, leveraging mobility, perhaps even becoming a vehicle, much like the segway.

9) Breakthrough in the toilet industry. This is an often overlooked piece of technology, literally! But can you imagine the market size here, I estimated it at over $19 million annually, in toilets alone! I actually predict a facebook app that will predict when you have to use the restroom, and then just go for you! I’m thinking it will work via some kind of anal catheter maybe directly connected to your i-phone that will be RSS based with your profile. Can you imagine that shit?

8) Green. Again, just one of those buzz words people keep talking about, just over and over again, everywhere, just constantly yapping about it non-stop. So it must be good. It’s right up there with mobile for slick little web 2.0 mini-segments on the Today show and faddish editorials in the WSJ. I think the biggest green technology in ’09 will almost assuredly be tote bags. Think purses, but bigger. People will not want to use things or purchase things anymore, waste not want not! So they will have to carry everything that they could possibly have to use during the day with them at all times. Car oil, knives, cat nip, Kleenex, Styrofoam, all in the new green tote bag. It’ll get heavy, so I’m thinking the deluxe models could be on wheels with smallish gasoline engines to propel them. BIG $.

7) 2012 Presidential election. We just got through one of the quietest political seasons ever, with very limited citizen involvement, and people will look to finally get back off the sidelines and there could be real excitement for the upcoming 2012 election in ’09. To tell you the details I would need you to sign a non-disclosure, but I am heavily invested in a new web-based news platform that will basically focus exclusively on politics, providing a sort of insiders look at the campaigns and key players and general political intrigue. Huge untapped market with absolutely no competition here. I’m still looking for that breakthrough once in a generation candidate, but ’09 could be the year we finally get one.

6) Robotics. Ever since most of us were kids we knew this was just going to be a money factory some day. It has already been 8 long frustrating years since Stanley Kubrick set our expectations so high with his masterful space drama 2001 a Space Odyssey. It’s bound to happen in ’09 baby, I mean it is two-thousand –and-nine. Come on already Honda! Figure it out!

5) Professional sports franchises. If you find yourself in a position to become the owner of a major league sports team in ‘09 I highly recommend pulling the trigger. You will not regret it. I am currently exploring turning my fantasy NFL, NBA, NHL and MLS teams into actual franchises. It’s legally complicated, but I think the courts have left some wiggle room here. If I pull it off I will pretty much be living in one of those sweet luxury boxes full-time! And with several owners out there clearly senile, I’m talking to you Al Davies and Steinbrener, it is a wide open competitive landscape.

4) Anti-counting movement. Counting will really lose momentum after being the mainstay of societal organization for over 15,000 years (15,000 is now so whatever!) The world is all 0s and 1s anyway. So yeah, 10 is way bigger than I thought so I’m skipping to number 1.

1) Credit default swaps. I am up to my eyeballs in these things. I swap agreements on e-trade on an hourly basis, betting on everything from daily rainfall totals in the Amazon basin to municipal tobacco ordinances to John Mayer’s relationship status to pooled toxic-ass mortgages and I just keep going in deeper and deeper. I am clinically addicted to credit default swaps. Anything that sounds as pro as “credit motherfuckin’ default swaps” has got to be just sick. In 2009 AIG will emerge from this little bumpy patch unscathed, and look for Lehman Brothers to rebrand with a sexier Lehman Sisters and as Kanye says, watch the money pile up.

A Housecall for Incoming Health and Human Services Secretary Daschle

HHS Secretary-designate Daschle will have a lot on his plate. He will oversee the largest federal agency, administering everything from Medicare to the FDA to global health initiatives, at a time when his boss has promised massive reforms in healthcare. It’s going to be a tough job. To kick things off, Daschle has said he plans to embark on a discussion of healthcare reform with households all across America, a sort of big-tent experiment in brainstorming. This is a genuine and admirable goal, if not hard to understand coming from a man who has spent the last 30 years visiting people as a professional politician. Both Obama and Daschle have literally been on the road for years, and they are not short on (often very personal) stories about healthcare in America. But how could a couple more months of it hurt? I think Secretary Daschle should focus on three key areas if he hopes to simultaneously improve the quality of care Americans receive, and the number who receive it.

One, he needs to contain costs. Healthcare expenses are growing far faster than the revenue base is expanding and at the current trajectory, non-discretionary spending will eat up the entire federal budget in about 25 years. A good model of controlling prices can be found in Japan, where they have half the per capita healthcare costs and twice the per capita utilization rates as Americans. That sounds good. In Japan the government has sole purchasing power of pharmaceuticals and healthcare procedures. They use their massive negotiating power to exert downward price pressure on everything from the cost of antibiotics to the cost of an EKG. Private insurance providers can still design their own policies and set their own prices, but the basic inputs that go into those plans are purchased in bulk by the entire government. The same concept is already pervasive in the private sector, where a few key buyers negotiate entire supply chains. Secretary Daschle’s HHS would be a great place to house the Office of Negotiation, where they set up 5-year forward purchase agreements on the largest and most common drugs and procedures.

Second, just like decoupling in the electric utilities sector, there needs to be decoupling in the medical sector. Utilities over the last decade or so have realized that electric providers in a normal market have no incentive to be efficient; in fact they have an incentive for their customers to use as much energy as possible because it translates into larger profits. This results in excess energy usage and general inefficiency. This has been more or less solved via utilities taking a percent or two out of monthly electric bills and redistributing it based on a formulaic measure of a company’s energy efficiency. Suddenly energy efficiency is monetized and energy providers start paying attention. The same basic idea should be established in the medical industry, where doctors, particularly specialists, have an incentive to carry out, and charge for, expensive procedures. Daschle’s HHS should charge a small fee to existing healthcare providers (maybe .5%) and reward medical providers who are particularly efficient in their utilization. This does not mean doctors will be rewarded for not doing expensive procedures for sick patients who need them; it means they will have an incentive not to do procedures just because they are profitable (which is perfectly rationale). HHS could measure certain key and widely available statistics, like referral and utilization rates and costs per treatment at the institutional level, and then reward those institutions accordingly, decoupling profit from wasteful overutilization.

And three, if Obama and Daschle really want universal coverage they will have to subsidize about the lowest quintile of American households. This is a decision Americans will ultimately have to make, but controlling prices and rewarding efficiency will still not be enough to provide universal coverage. Obama proposes instituting a healthcare tax on employers who do not contribute to their employees’ coverage as a means to fund subsidy programs. This seems like a good idea, as it preserves price parity across the market, as every firm will have to meet the same basic operating costs (chipping in to provide basic healthcare and not free-riding on firms that already do). Revenues here could be distributed by Daschle’s HHS based on a family’s combined income level to provide basic coverage for the uninsured.

I don’t think Secretary Daschle will be knocking on my door anytime soon, but I hope that once he hears from all these households that he starts getting specific soon. Generic goals or hollow bromides have gotten us nowhere with healthcare reform in the past, and today’s no different. Healthcare reform will be a long difficult debate, and policymakers should start working on the nuts and bolts now. None of these ideas is easy or particularly desirable, but neither are higher taxes in the future for worse benefits.

A special recipe for the holidays and one of my personal faves, just prepare and enjoy!

"You take some chocolate ... and you take two pieces of bread ... and you put the candy in the middle and you make a sandwich of it. And that would be a cake." -Andy Warhol

Oh, and he left out the oven part, be sure to put it in one of those

MLS to Portland and Some Econ

After Adrian Hanauer’s brilliant orchestration of bringing MLS to Seattle (in ’09 baby!) I think it’s Portland’s turn. Check it out - http://www.mlstoportland.com/ With an estimated cost to the city of $85m and annual benefit of $30m it would be a big win all around. Bring MLS to Ptown baby!!

And here are 10 macroeconomic prescriptions that might be good now that everyone’s talking about economic policy in DC.

10) Independent World Class Regulators for all Large Financial Firms – Independent Meaning they set their budget and world class meaning they follow GAAP, this wasn’t the case for GSEs or I-banks – this includes 10% reserve ratios, not 2.5% say like Fannie and Freddie, e.g. better leveraging

9) Housing PITI – Principal Interest Taxes Insurance – Documented and verified. This only became a rule in July 2008 when Bernanke pushed it though at a Fed meeting! (And it won't take effect until Feb '09) Why did it take so long to require borrowers to check a box at the end of their mortgage docs releasing their tax records? Then Standard and Poor's or Moody's would have had actual data to base their bond ratings on. The FDIC has been restructuring loans at or below a 30% debt/income ratio to much success (but it can only do it to assets it has acquired, which is basically IndyMac) - this would be a good threshold for lenders to loosely base restructuring (after all they will take a bit of an interest rate hit, but it's better than losing the whole loan). There's also a new study which estimates a million mortgage defaults could be prevented via utilizing $10b of TARP to increase the fees HUD provides private mortgage securitizors (source of over 50% of current defaults) get for restructuring a loan. Right now there is little incentive for them to make the effort to restructure versus just write off or auction off.

8) Global Exchange Harmony – If you trade in a market you are subject to its rules, for instance European/London traders in NYMEX are often exempt as they are considered to be regulated from abroad, not good, e.g. close loopholes. If a satellite trading shop for a European firm opens in Atlanta it should be fully regulated by the U.S.

7) Fix Entitlements – Non-discretionary spending is 65% of federal spending today and will continue to spur deficit spending and eat up the budget, which crowds out private investments – either a Greenspan style fix by say indexing benefits to the CPI rather than wage and bumping up the retirement age, or more innovative (and promising) approaches like volunteer personal savings accounts (the market has never had less than 7% returns over a decade, ever)

6) Infrastructure stimulus – Largely in the form of revolving loans to states and localities, including national direct current electricity grid (particularly applied in so called 'solar parks' which establish all the prerequisites for solar permitting and transmission in government land leased by private firms, removing the uncertainty that currently inhibits at scale development along with #5) and water infrastructure

5) Embrace the clean economy – less taxes on labor and income and more on pollution. The marginal social cost of carbon according to the Stern Report, the International Academy of Sciences and the U.N. is about $30/ton CO2, conveniently about the exact amount needed to make renewables and sequestration cheaper than coal, tar sands, oil shale etc. The IRS could oversee this program with existing authorities at the point carbon enters the economy, either the ground or port, and then recycle all revenues back via tax cuts.

4) 50% margin call (collateral) for paper (non-deliverable) hedging and speculating, today it’s often 2-5% which encourages speculating and thus bubbles

3) Warranty on bond ratings – If collateral backed bonds get a rating from one of the big agencies that proves grossly inaccurate they should take big haircuts in their contracts

2) Successful WTO Doha round – Trade needs to be opened up, and this means new negotiations with more flexibility on easing subsidies and accepting developing economy safeguards (this was the big sticking point)

1) Relax – Expectations and anxiety are self-fulfilling, losses are only realized if you sell, most of the big banks had balance sheets that were OK, it was the market cap losses that did them in. Citigroup for instance has lost $2b each of the last couple quarters, on a balance sheet of nearly $2 trillion and with tons of cash on hand (and $25b more thanks to TARP). And yet they have a current market cap of $21b, grossly undervalued in my opinion, traders would benefit from some perspective - any company, even very strong ones, can be undone by 90%+ market cap losses (which all that have gone under have sufferred). If bovine mass hysteria dictates market positions, any company can be victim - and valuation models are powerless in the face of this. If Wall Street focuses on creating wealth rather than manufacturing it (creating wealth includes products, services, consulting, insurance, liquidity/risk management, and manufacturing it includes things like arbitraging bond rates with SIVs (structured investment vehicles) or backing capital raises with deteriorating underwriting standards, like subprime backed collateralized debt obligations or massive paper speculation/derivative bets). Wealth production beyond wealth creation is the root of bubbles, and they will always burst.

Also, I think the Big Three should get their additional $25b, which is far far less than it would cost the economy if they failed. But they need to realize this is a bridge loan in two senses: 1) getting on a sustainable cash flow trajectory and 2) finally innovating. The top reason they are in this position is not because of events of the last few months but because they have been making the same vehicle since Carter was in the White House, and actually have gone backwards in fuel efficiency. As a result they've had their shirt handed to them by Japan and German automakers. Maybe with the Chevy Volt the Big Three can finally be out front on the innovation curve instead of three decades behind.

Channeling Norman Mailer

The Calzaghe-Jones fight is tomorrow night. I’ve always deeply respected boxing, and ever since getting HBO it’s become a new little hobby, a slight step up from my main collegiate hobby of gluing beer bottle caps to the ceiling, or testing which detergents actually make for the freshest smelling laundry. But anything requiring a hot glue gun or sniffing your sweatpants like crack either belongs on closed-circuit television or in a halfway house, definitely not fraternities. Yet for a pale weak washed up distance runner, such as myself, the badass tattooed prize-fighter seems to exhibit a strong allure. Ever seen that nanosecond glance between a fighter right after a knockout and his girlfriend sitting ringside in a cocktail dress? It’s the human equivalent of a lion killing a gazelle and then roaring to the whole pack that the feast is ready, pretty hot. I guess we’re most drawn to that which best conforms to our own self delusions. Ha. Ha. Both fighters are future Hall of Famers and looking to finish their careers with a big win. They’re also both superlative businessmen, their promotional outfits co-produced this whole thing from start to finish, an extreme rarity. They are simultaneously partners and adversaries. This makes for an entertaining pre-fight build-up, as two people who clearly like each other have to exhibit faux-hate to make for a more compelling narrative. Their incentive is to advance their business interest by pretending to hate the one person for whom their business interest actually depends. This split-personality incentive actually makes for a fuzzier, more intelligent sport (and also more enduring because they are masters of their own destinies). And as far as picks, from the guy who thought the Seahawks would be incredible this year no less (on a related note: dammit), Calzaghe is the very real deal. He can shift between straight power punches and super-smooth combos at will, and is flat out awesome in the later rounds, where so far no one has been able to keep up, even a little. He does seem undersized relative to Roy Jones Jr, the first man in over a century to carry both the light heavyweight and heavyweight titles, and size can overcome even significant ability gaps. Otherwise he seems hard to beat – except maybe by a close friend.