The WSJ today (D1) is telling yield-hungry bond investors to look at stocks. In the article, they compare the fortunes of someone who invested $1mm in Treasury bills back at the end of 1925 and spent only the income with the fortunes of someone who invested the same $1mm, spending only the income, in large cap stocks.
Let's assume they took the safe route, stashing the entire sum in Treasury bills and then left you to live off the interest. In 2006, your income would have been $48,000versus $33,000 in 1926, according to Ibbotson Associates, a unit of Chicago investment researchers Morningstar. Trouble is, because of inflation, $1 of interest in 2006 had less than a tenth of the spending power of $1 in 1926.
Now, imagine instead that your parents rolled the dice and plunked the $1 million in large‐company stocks. If you spent the dividends but didn't sell any shares, you would have pocketed a robust stream of income that climbed in 65 years and fell in just 15, Ibbotson calculates.
Even more impressive, your $1 million would have ballooned to $111 million over the 81 years ‐‐ and your income would have jumped from $54,000 in 1926 to almost $2 million in 2006. Indeed, your income would have grown at an average 4.6% a year, easily outpacing inflation's 3.1%.
Cash Back
Some U.S. stocks boast higher yields than 10-year Treasury notes.
Dow Jones Industrial Average 2.3%
High-dividend Dow Stocks 4.2%
10-year Treasury notes 3.9%
Wednesday, November 28, 2007
Tuesday, November 27, 2007
Tax breaks: What the leading candidates are proposing
The presidential front-runners are vying for votes with lots of new ideas, including new incentives to save, invest and buy insurance.
Presidential campaigning is a promise-making fiesta, and never more so than when it comes to taxes.
All of the leading 2008 presidential candidates have proposed new tax breaks. Some are designed to encourage behaviors such as investing in stocks or buying health insurance, or to promote economic growth. Others are offered as ways to make the tax code more fair in the eyes of the candidate.
These breaks will have an effect on federal government coffers, although just how much hasn't been measured yet. In some instances, when one tax break is proposed, it is intended to replace an existing break already on the books.
Below are some of the tax breaks that the presidential front-runners have proposed so far. Not all candidates are equally detailed in their proposals, nor has every candidate weighed in on each tax break listed here.
The front-runners were determined by the results of CNN's most recent national polls in which a candidate got at least 10 percent of the vote. Among the Democrats, they are Hillary Clinton, Barack Obama and John Edwards. From the Republican field, there is Rudy Giuliani, Mitt Romney, Fred Thompson, John McCain and Mike Huckabee.
INVESTMENT TAX BREAKS
One of the most politically divisive tax issues in the presidential campaign is whether to extend President Bush's tax cuts on long-term capital gains and dividends.
Currently they're both taxed at 15 percent (less for low-income taxpayers), and they are scheduled to rise by 2011 to 20 percent for capital gains and to ordinary income tax rates for dividends.
Edwards: Would make the first $250 of interest, capital gains and dividends tax-free for everyone, although he would favor raising the capital gains tax rate to 28 percent for taxpayers making more than $200,000.
Obama: Would eliminate capital gains taxes for business start-ups, although he would favor raising the capital gains tax rate to somewhere between 20 percent and 28 percent for taxpayers making more than $250,000.
Romney: Wants to eliminate the tax on interest, capital gains and dividends for taxpayers with adjusted gross incomes under $200,000, and would make the Bush investment tax cuts permanent for everyone else.
Giuliani, McCain and Thompson: Would make Bush investment tax cuts permanent.
Huckabee: Has called for the elimination of the income tax system and for a consumption tax to take its place. Under his plan, you would be taxed on what you buy, not on what you earn or save. So there would be no investment taxes.
SAVINGS TAX BREAKS
Using the tax code to encourage retirement and other types of savings has a long history, and it's one which at least three of the candidates would like to continue.
Clinton: Would expand the current savers' credit, which currently only goes to low-income taxpayers saving for retirement. She wants to offer a 100 percent matching tax credit for the first $1,000 saved for retirement by married couples making less than $60,000, and a 50 percent matching credit for couples making between $60,000 and $100,000. The credit - which is a dollar-for-dollar reduction of one's tax bill - would be refundable, meaning couples would receive it as a refund if they don't have enough of a tax bill to offset with the credit.
Edwards: Would expand the savers' credit. He would offer a refundable tax credit up to $500 a year in savings for families with incomes under $75,000. Currently you may qualify for an income tax credit up to $2,000 in retirement savings if your adjusted gross income is $25,000 or less ($50,000 or less if you're married filing jointly).
Edwards' tax credit wouldn't be limited to retirement savings, but could apply to savings for college, for a down payment, for starting a small business or for financial emergencies.
He also would offer low-income families an additional $500 refundable tax credit for savings. Additionally, he would allow families to deposit their child tax credits into tax-free savings accounts.
Giuliani: Has said he would expand tax-free savings accounts but offered no details.
Huckabee: Has called for the elimination of the income tax system and for a consumption tax to take its place. Under his plan, you would be taxed on what you buy, not on what you earn or save. So there would be no taxes on your savings.
MORTGAGE TAX BREAKS
Currently, you are allowed to deduct the interest you pay on your mortgage if you itemize your deductions. But since only about a third of taxpayers itemize, homeowners who take the standard deduction don't receive an additional tax break for owning a home the way itemizers do.
Obama: Would create a refundable tax credit equal to 10 percent of mortgage interest. The credit would be available to any taxpayer who has a mortgage and does not itemize their deductions. The addition of a credit means you would get a break on your mortgage interest even if you take the standard deduction. It would be in addition to, rather than instead of, the mortgage interest deduction.
HEALTH INSURANCE TAX BREAKS
All the front-runners have proposed reforming healthcare or at least making some change to the way health insurance is provided. Creating new tax incentives is one piece of their plans to make health insurance more affordable, encourage people to buy it and to encourage them to be more cost-conscious about medical expenses.
Currently, the portion of your premiums paid by your employer on your behalf is excluded from your gross income, meaning it is tax-free compensation to you. If you're buying health insurance on your own, you get no tax breaks for the premiums you pay.
Clinton: Wants to create health care tax credits for small businesses and a refundable "premium affordability" tax credit for individuals buying health insurance so that their premiums never exceed a certain percentage of family income.
Edwards: Has proposed creating a "health care market" of regional, non-profit purchasing pools that offer competing health insurance plans to companies without plans of their own and to individuals who don't have access to a plan at work or through public programs.
Edwards would offer a new tax credit for middle- and lower-income people who buy insurance through a Health Care Market. The amount of the credit would be determined by an income-based sliding scale and the credit would be refundable for those who don't have any income tax liability.
Giuliani: Would allow people who can't get insurance from their employers to exclude from their gross income up to $7,500 in health insurance costs for singles ($15,000 for families) if they buy health insurance on their own.
He also has proposed a separate health insurance credit for low-income Americans.
McCain: Would offer a refundable tax credit of $2,500 ($5,000 for families) to anyone who buys health insurance, whether through an employer or not. That credit would replace the tax-free nature of the portion of your premiums paid by your employer, which would become taxable income to you.
If your policy costs less than the value of the credit, you can deposit the remainder in a health savings account (HSA). HSAs let you save tax-free for medical expenses on the condition that you buy a high-deductible insurance plan to be used for catastrophic medical situations.
Romney: Has said he supports the deductibility of medical expenses, including the cost of health insurance and out-of-pocket expenses for anyone who has a plan that at least provides catastrophic insurance.
He also has called for an expansion of HSAs, which let you save tax-free for medical expenses on the condition that you buy a high-deductible insurance plan to be used for catastrophic medical situations.
Huckabee: Has said he would make HSAs available to everyone, not just those with high-deductible plans. HSAs let you save tax-free for medical expenses.
He prefers to move away from the employer-based system for insurance, but would offer taxpayers a deduction for the health insurance premiums they pay. For low-income taxpayers, they would get a credit instead. A credit is a dollar-for-dollar reduction of taxes you owe, whereas a deduction reduces your taxes by a percentage equal to your top income tax rate.
ESTATE TAX BREAKS
Currently estates worth up to $2 million are exempt from the estate tax. That exemption level will rise to $3.5 million by 2009. In 2010, the estate tax is scheduled to be repealed entirely for one year and then it will be reinstated in 2011 at a $1 million exemption level. The current top tax rate on estates is 45 percent. By 2011, it will increase to 55 percent.
Clinton: Would increase the estate tax exemption level to $3.5 million.
Edwards: Would raise the exemption level to $4 million.
Romney, Giuliani and Thompson: Would eliminate the estate tax.
McCain: Would increase the exemption level to $10 million and tax the portion of an estate above $10 million at a flat 15 percent.
Presidential campaigning is a promise-making fiesta, and never more so than when it comes to taxes.
All of the leading 2008 presidential candidates have proposed new tax breaks. Some are designed to encourage behaviors such as investing in stocks or buying health insurance, or to promote economic growth. Others are offered as ways to make the tax code more fair in the eyes of the candidate.
These breaks will have an effect on federal government coffers, although just how much hasn't been measured yet. In some instances, when one tax break is proposed, it is intended to replace an existing break already on the books.
Below are some of the tax breaks that the presidential front-runners have proposed so far. Not all candidates are equally detailed in their proposals, nor has every candidate weighed in on each tax break listed here.
The front-runners were determined by the results of CNN's most recent national polls in which a candidate got at least 10 percent of the vote. Among the Democrats, they are Hillary Clinton, Barack Obama and John Edwards. From the Republican field, there is Rudy Giuliani, Mitt Romney, Fred Thompson, John McCain and Mike Huckabee.
INVESTMENT TAX BREAKS
One of the most politically divisive tax issues in the presidential campaign is whether to extend President Bush's tax cuts on long-term capital gains and dividends.
Currently they're both taxed at 15 percent (less for low-income taxpayers), and they are scheduled to rise by 2011 to 20 percent for capital gains and to ordinary income tax rates for dividends.
Edwards: Would make the first $250 of interest, capital gains and dividends tax-free for everyone, although he would favor raising the capital gains tax rate to 28 percent for taxpayers making more than $200,000.
Obama: Would eliminate capital gains taxes for business start-ups, although he would favor raising the capital gains tax rate to somewhere between 20 percent and 28 percent for taxpayers making more than $250,000.
Romney: Wants to eliminate the tax on interest, capital gains and dividends for taxpayers with adjusted gross incomes under $200,000, and would make the Bush investment tax cuts permanent for everyone else.
Giuliani, McCain and Thompson: Would make Bush investment tax cuts permanent.
Huckabee: Has called for the elimination of the income tax system and for a consumption tax to take its place. Under his plan, you would be taxed on what you buy, not on what you earn or save. So there would be no investment taxes.
SAVINGS TAX BREAKS
Using the tax code to encourage retirement and other types of savings has a long history, and it's one which at least three of the candidates would like to continue.
Clinton: Would expand the current savers' credit, which currently only goes to low-income taxpayers saving for retirement. She wants to offer a 100 percent matching tax credit for the first $1,000 saved for retirement by married couples making less than $60,000, and a 50 percent matching credit for couples making between $60,000 and $100,000. The credit - which is a dollar-for-dollar reduction of one's tax bill - would be refundable, meaning couples would receive it as a refund if they don't have enough of a tax bill to offset with the credit.
Edwards: Would expand the savers' credit. He would offer a refundable tax credit up to $500 a year in savings for families with incomes under $75,000. Currently you may qualify for an income tax credit up to $2,000 in retirement savings if your adjusted gross income is $25,000 or less ($50,000 or less if you're married filing jointly).
Edwards' tax credit wouldn't be limited to retirement savings, but could apply to savings for college, for a down payment, for starting a small business or for financial emergencies.
He also would offer low-income families an additional $500 refundable tax credit for savings. Additionally, he would allow families to deposit their child tax credits into tax-free savings accounts.
Giuliani: Has said he would expand tax-free savings accounts but offered no details.
Huckabee: Has called for the elimination of the income tax system and for a consumption tax to take its place. Under his plan, you would be taxed on what you buy, not on what you earn or save. So there would be no taxes on your savings.
MORTGAGE TAX BREAKS
Currently, you are allowed to deduct the interest you pay on your mortgage if you itemize your deductions. But since only about a third of taxpayers itemize, homeowners who take the standard deduction don't receive an additional tax break for owning a home the way itemizers do.
Obama: Would create a refundable tax credit equal to 10 percent of mortgage interest. The credit would be available to any taxpayer who has a mortgage and does not itemize their deductions. The addition of a credit means you would get a break on your mortgage interest even if you take the standard deduction. It would be in addition to, rather than instead of, the mortgage interest deduction.
HEALTH INSURANCE TAX BREAKS
All the front-runners have proposed reforming healthcare or at least making some change to the way health insurance is provided. Creating new tax incentives is one piece of their plans to make health insurance more affordable, encourage people to buy it and to encourage them to be more cost-conscious about medical expenses.
Currently, the portion of your premiums paid by your employer on your behalf is excluded from your gross income, meaning it is tax-free compensation to you. If you're buying health insurance on your own, you get no tax breaks for the premiums you pay.
Clinton: Wants to create health care tax credits for small businesses and a refundable "premium affordability" tax credit for individuals buying health insurance so that their premiums never exceed a certain percentage of family income.
Edwards: Has proposed creating a "health care market" of regional, non-profit purchasing pools that offer competing health insurance plans to companies without plans of their own and to individuals who don't have access to a plan at work or through public programs.
Edwards would offer a new tax credit for middle- and lower-income people who buy insurance through a Health Care Market. The amount of the credit would be determined by an income-based sliding scale and the credit would be refundable for those who don't have any income tax liability.
Giuliani: Would allow people who can't get insurance from their employers to exclude from their gross income up to $7,500 in health insurance costs for singles ($15,000 for families) if they buy health insurance on their own.
He also has proposed a separate health insurance credit for low-income Americans.
McCain: Would offer a refundable tax credit of $2,500 ($5,000 for families) to anyone who buys health insurance, whether through an employer or not. That credit would replace the tax-free nature of the portion of your premiums paid by your employer, which would become taxable income to you.
If your policy costs less than the value of the credit, you can deposit the remainder in a health savings account (HSA). HSAs let you save tax-free for medical expenses on the condition that you buy a high-deductible insurance plan to be used for catastrophic medical situations.
Romney: Has said he supports the deductibility of medical expenses, including the cost of health insurance and out-of-pocket expenses for anyone who has a plan that at least provides catastrophic insurance.
He also has called for an expansion of HSAs, which let you save tax-free for medical expenses on the condition that you buy a high-deductible insurance plan to be used for catastrophic medical situations.
Huckabee: Has said he would make HSAs available to everyone, not just those with high-deductible plans. HSAs let you save tax-free for medical expenses.
He prefers to move away from the employer-based system for insurance, but would offer taxpayers a deduction for the health insurance premiums they pay. For low-income taxpayers, they would get a credit instead. A credit is a dollar-for-dollar reduction of taxes you owe, whereas a deduction reduces your taxes by a percentage equal to your top income tax rate.
ESTATE TAX BREAKS
Currently estates worth up to $2 million are exempt from the estate tax. That exemption level will rise to $3.5 million by 2009. In 2010, the estate tax is scheduled to be repealed entirely for one year and then it will be reinstated in 2011 at a $1 million exemption level. The current top tax rate on estates is 45 percent. By 2011, it will increase to 55 percent.
Clinton: Would increase the estate tax exemption level to $3.5 million.
Edwards: Would raise the exemption level to $4 million.
Romney, Giuliani and Thompson: Would eliminate the estate tax.
McCain: Would increase the exemption level to $10 million and tax the portion of an estate above $10 million at a flat 15 percent.
Wish we had thought of that...
Low-risk trades put all others in the shade
Within the hedge fund industry there are some trades that are destined to live on in legend: Jessie Livermore’s claimed $100m profit from shorting the 1929 crash, Paul Tudor Jones’ prediction of the 1987 crash, from which he doubled his money in a month, or the $1bn profit George Soros reputedly made when sterling was forced out of the exchange rate mechanism.
But the forecast last year by a select group of hedge funds of a crisis in subprime mortgages has put even the most spectacular trades in history in the shade.
EDITOR’S CHOICE
1000% hedge fund wins subprime bet - Nov-25
One hedge fund in 10 to go bust, says Man - Nov-20
View from the Top: Peter Clarke - Nov-20
Hedge funds on new ground - Nov-20
Jabre raising second hedge fund - Nov-05
Hedge funds home in on UK targets - Nov-05
Leading the pack of hedge funds which benefited from the subprime fallout is John Paulson’s New York-based Paulson & Co. Last year, it raised $2bn for two funds betting on falls in subprime mortgage-linked securities and they are now worth more than $8bn. By the end of October, the first of these funds was up 550.8 per cent, even after fees which included a quarter of profits.
His merger and event arbitrage funds – which would normally make bets on takeovers and other corporate deals – have also taken positions in subprime-linked securities.
Three of these funds more than doubled investors’ money with their short positions, and investors say that in total, Paulson funds have made more than $12bn from the subprime bet.
“There’s never been a trade of this size of profit ever in the history of financial markets,” says Arki Busson, chairman of EIM Group, which has $13bn invested in hedge funds.
As a result, Mr Paulson is likely to be the highest-paid hedge fund manager of all time when the performance fees crystallise, taking profits estimated by his own investors at between $2bn and $4bn. That would be enough to buy himself 18,000 Bentley Continentals, the hedge fund motor of choice.
“He’s really made a lot of money out of what has in essence been quite a conservative bet,” says one of Mr Paulson’s investors. “There’s no doubt it’s been one of the greatest trades of all time.”
When Mr Paulson was raising money for his new funds last summer, he claimed that “in his entire career he’s never seen such a big opportunity”, another investor says.
It is argued that Paulson has generated these enormous returns from taking relatively little risk.
Houston-based Centaurus Energy, for example, is reported to have made 317 per cent (before fees) last year by betting the opposite way on natural gas prices to that predicted by Amaranth, which collapsed after losing more than $6bn in a week. And Red Kite, the London hedge fund, made more than 250 per cent last year in its metals fund thanks to a successful highly-geared bet on copper prices.
Kyle Bass, who runs Hayman Capital, a Texas hedge fund, says the short credit trade is “by far the best risk/reward position I have ever seen”. A fund Hayman runs jointly with Corriente Advisors was up 526.5 per cent for the year to October, according to letters to investors.
All the short funds are likely to have made significant further gains this month as the credit squeeze caused subprime-linked bonds to lurch further down. An index which tracks these bonds, the ABX index of BBB credits issued in the first half of last year, has plummeted from above 40 to 25 this month, indicating big profits from those using derivatives to take short positions.
Andrew Lahde’s California-based Lahde Capital, for example, has gained about 40 per cent this month, to become the first of the group to pass 1,000 per cent return this year.
However, there may be little further money to make from the trade. Lahde has already begun to return cash to investors, while at the end of September Paulson told investors it saw only a further 30-40 per cent to make from shorting – and it made almost 22 per cent in October alone.
Paulson said then that it was still too early to start buying mortgage exposure, but that when the time came Paulson’s accumulated expertise in the 18,000 individual securities in the market should make it “uniquely positioned to benefit from future long opportunities”.
Some point out that there was widespread concern about subprime quality before the collapse, so the prediction of trouble was not difficult.
“In terms of monetising a trade it is potentially one of the successful trades of all time,” says Neil Meadows, head of fixed income and macro research at New Finance Capital, which has $5.5bn invested in hedge funds.
“But in terms of the intellectual capacity of it, I don’t think it was so hard – everyone knew it was coming. Perhaps not the scale of it or the timing, but they knew it was coming.”
Mr Busson, whose EIM group has money with Paulson, disagrees. He says the skill comes not only in predicting the crisis, but also in the execution of the trades. Mr Paulson – along with several other managers – constructed complex portfolios of the assets they believed would be worst-hit, rather than just shorting an index.
“[Mr Paulson] has always been a very professional hard-working research-oriented guy. With all these great trades, there’s no secret – you need to do an enormous amount of homework.”
Within the hedge fund industry there are some trades that are destined to live on in legend: Jessie Livermore’s claimed $100m profit from shorting the 1929 crash, Paul Tudor Jones’ prediction of the 1987 crash, from which he doubled his money in a month, or the $1bn profit George Soros reputedly made when sterling was forced out of the exchange rate mechanism.
But the forecast last year by a select group of hedge funds of a crisis in subprime mortgages has put even the most spectacular trades in history in the shade.
EDITOR’S CHOICE
1000% hedge fund wins subprime bet - Nov-25
One hedge fund in 10 to go bust, says Man - Nov-20
View from the Top: Peter Clarke - Nov-20
Hedge funds on new ground - Nov-20
Jabre raising second hedge fund - Nov-05
Hedge funds home in on UK targets - Nov-05
Leading the pack of hedge funds which benefited from the subprime fallout is John Paulson’s New York-based Paulson & Co. Last year, it raised $2bn for two funds betting on falls in subprime mortgage-linked securities and they are now worth more than $8bn. By the end of October, the first of these funds was up 550.8 per cent, even after fees which included a quarter of profits.
His merger and event arbitrage funds – which would normally make bets on takeovers and other corporate deals – have also taken positions in subprime-linked securities.
Three of these funds more than doubled investors’ money with their short positions, and investors say that in total, Paulson funds have made more than $12bn from the subprime bet.
“There’s never been a trade of this size of profit ever in the history of financial markets,” says Arki Busson, chairman of EIM Group, which has $13bn invested in hedge funds.
As a result, Mr Paulson is likely to be the highest-paid hedge fund manager of all time when the performance fees crystallise, taking profits estimated by his own investors at between $2bn and $4bn. That would be enough to buy himself 18,000 Bentley Continentals, the hedge fund motor of choice.
“He’s really made a lot of money out of what has in essence been quite a conservative bet,” says one of Mr Paulson’s investors. “There’s no doubt it’s been one of the greatest trades of all time.”
When Mr Paulson was raising money for his new funds last summer, he claimed that “in his entire career he’s never seen such a big opportunity”, another investor says.
It is argued that Paulson has generated these enormous returns from taking relatively little risk.
Houston-based Centaurus Energy, for example, is reported to have made 317 per cent (before fees) last year by betting the opposite way on natural gas prices to that predicted by Amaranth, which collapsed after losing more than $6bn in a week. And Red Kite, the London hedge fund, made more than 250 per cent last year in its metals fund thanks to a successful highly-geared bet on copper prices.
Kyle Bass, who runs Hayman Capital, a Texas hedge fund, says the short credit trade is “by far the best risk/reward position I have ever seen”. A fund Hayman runs jointly with Corriente Advisors was up 526.5 per cent for the year to October, according to letters to investors.
All the short funds are likely to have made significant further gains this month as the credit squeeze caused subprime-linked bonds to lurch further down. An index which tracks these bonds, the ABX index of BBB credits issued in the first half of last year, has plummeted from above 40 to 25 this month, indicating big profits from those using derivatives to take short positions.
Andrew Lahde’s California-based Lahde Capital, for example, has gained about 40 per cent this month, to become the first of the group to pass 1,000 per cent return this year.
However, there may be little further money to make from the trade. Lahde has already begun to return cash to investors, while at the end of September Paulson told investors it saw only a further 30-40 per cent to make from shorting – and it made almost 22 per cent in October alone.
Paulson said then that it was still too early to start buying mortgage exposure, but that when the time came Paulson’s accumulated expertise in the 18,000 individual securities in the market should make it “uniquely positioned to benefit from future long opportunities”.
Some point out that there was widespread concern about subprime quality before the collapse, so the prediction of trouble was not difficult.
“In terms of monetising a trade it is potentially one of the successful trades of all time,” says Neil Meadows, head of fixed income and macro research at New Finance Capital, which has $5.5bn invested in hedge funds.
“But in terms of the intellectual capacity of it, I don’t think it was so hard – everyone knew it was coming. Perhaps not the scale of it or the timing, but they knew it was coming.”
Mr Busson, whose EIM group has money with Paulson, disagrees. He says the skill comes not only in predicting the crisis, but also in the execution of the trades. Mr Paulson – along with several other managers – constructed complex portfolios of the assets they believed would be worst-hit, rather than just shorting an index.
“[Mr Paulson] has always been a very professional hard-working research-oriented guy. With all these great trades, there’s no secret – you need to do an enormous amount of homework.”
Monday, November 26, 2007
The Fed announced today intentions to pump in liquidity
In response to heightened pressures in the money markets for funding through year‐end the NY Fed announced this morning that it will be pumping in liquidity into the money markets via a series of overlapping long term repo agreements that will extend into year‐end. They pre‐announced the first repo operation that will take place on Wednesday, November 28th and mature on January 10, 2008 for an amount of $8billion. The timing and amounts of subsequent term operations spanning the year‐end will be influenced by market and reserve developments according to the Fed. Ultimately the goal of the Fed is to provide sufficient reserves into the system to resist upward pressure on the Fed funds rae that would drive it up above the Fed target rate. However, as we have seen just recently at the end of this summer into September, the Fed is likely to err on the side of adding too much reserves and we could see the effective Fed funds rate trade below thetarget.
Wednesday, November 21, 2007
Is the U.S. economy melting down?
Whether the Federal Reserve realizes it or not, the United States economy is reeling from a one-two punch of plunging real estate values and a full-blown credit crunch that might not be alleviated with additional rate cuts.
While the Fed might have had a role in creating what has come to be known as the subprime mess, because of the way it has evolved, the Fed's ability to deal with it is rather limited. There are a number of reasons for this.
First and foremost is the fact that, on the real estate side, the damage has already been done. Because short-term interest rates today are well above the 45-year lows plumbed from the middle of 2003 through mid-2004, those mortgages with adjustable rates have or will reset to much higher rates even if the Fed decides to lower rates by a quarter of a point or even more.
As a consequence, there will likely be more delinquencies and foreclosures, which, besides causing pain for those homeowners, will result in more homes on the market, thereby depressing their prices.
In turn, this will affect other homeowners, even those with fixed rate mortgages and who and are current with their payments. They will likely be unable to use their homes as ATMs, tapping the equity to supplement their incomes.
They can't turn to savings, either, since, collectively, the nation's homeowners have been spending more than they have been earning for the past two years. The last time this happened was at the bottom of the Great Depression.
This alone is why consumers are reducing their outlays on all kinds of goods and services -- luxuries and necessities alike. Indeed, you know there's a problem out there when Starbucks reports a decline in traffic in response to, among other reasons, a 9 cent hike in the price of a cup of coffee.
Another reason why the Fed alone will not be able to ameliorate this crisis is that its main jurisdiction is over the banks, and the problem is now centered in the financial markets. This is because the banks no longer have these loans on their books, having turned them into securities and sold them to others.
In turn, these mortgage-backed securities were used as collateral for the issuance of debt, whose value, as you know, is far lower than originally thought. This has caused massive write downs by holders of these securities, cutting into their profits, but more importantly, depleting confidence in the financial system. And this reduction in confidence is spreading beyond the financial markets and residential real estate to commercial real estate as well.
To the extent the banks are involved (by holding on to some of these securities), their capital is being reduced and thus their ability to make new loans.
we need not remind you that the ability to borrow money is the lifeblood of not just business, but consumers, too.
Not surprisingly, the combination of lower real estate values and reduced availability of funding is beginning to reduce business spending on new plants and equipment. This is overwhelming the positive effect that the lower-valued dollar is having on our exports.
So while the Fed is preoccupied with communications and forecasting, the financial markets remain frozen while the economy is melting down.
While the Fed might have had a role in creating what has come to be known as the subprime mess, because of the way it has evolved, the Fed's ability to deal with it is rather limited. There are a number of reasons for this.
First and foremost is the fact that, on the real estate side, the damage has already been done. Because short-term interest rates today are well above the 45-year lows plumbed from the middle of 2003 through mid-2004, those mortgages with adjustable rates have or will reset to much higher rates even if the Fed decides to lower rates by a quarter of a point or even more.
As a consequence, there will likely be more delinquencies and foreclosures, which, besides causing pain for those homeowners, will result in more homes on the market, thereby depressing their prices.
In turn, this will affect other homeowners, even those with fixed rate mortgages and who and are current with their payments. They will likely be unable to use their homes as ATMs, tapping the equity to supplement their incomes.
They can't turn to savings, either, since, collectively, the nation's homeowners have been spending more than they have been earning for the past two years. The last time this happened was at the bottom of the Great Depression.
This alone is why consumers are reducing their outlays on all kinds of goods and services -- luxuries and necessities alike. Indeed, you know there's a problem out there when Starbucks reports a decline in traffic in response to, among other reasons, a 9 cent hike in the price of a cup of coffee.
Another reason why the Fed alone will not be able to ameliorate this crisis is that its main jurisdiction is over the banks, and the problem is now centered in the financial markets. This is because the banks no longer have these loans on their books, having turned them into securities and sold them to others.
In turn, these mortgage-backed securities were used as collateral for the issuance of debt, whose value, as you know, is far lower than originally thought. This has caused massive write downs by holders of these securities, cutting into their profits, but more importantly, depleting confidence in the financial system. And this reduction in confidence is spreading beyond the financial markets and residential real estate to commercial real estate as well.
To the extent the banks are involved (by holding on to some of these securities), their capital is being reduced and thus their ability to make new loans.
we need not remind you that the ability to borrow money is the lifeblood of not just business, but consumers, too.
Not surprisingly, the combination of lower real estate values and reduced availability of funding is beginning to reduce business spending on new plants and equipment. This is overwhelming the positive effect that the lower-valued dollar is having on our exports.
So while the Fed is preoccupied with communications and forecasting, the financial markets remain frozen while the economy is melting down.
Thursday, November 15, 2007
What's sinking the dollar?
Things do tend to go to hell all at once, so maybe it should be no surprise that the dollar tanked as the subprime mess was getting rapidly worse and stock markets were whipsawing, mostly downward.
The dollar's fate is especially worrisome because of its historic role as the world's reserve currency and its obvious importance to the world's largest economy. In today's interconnected global markets the dollar's movements are part cause, part effect -- but on net it's hard to see the dollar getting much stronger anytime soon.
The forces behind the dollar's weakening have been building for years but didn't have much effect until recently.
Most fundamentally, we Americans have been living beyond our means, buying more from the rest of the world than the world buys from us (that's the trade deficit); to do that, we have to give foreigners claims on our assets in the form of government bonds and corporate bonds, or sometimes the assets themselves.
A country as rich as America can do that for a long time, but eventually the world ends up holding more dollars than there is dollar-denominated stuff they want to buy, so they start offloading dollars. They also worry that any country with loads of debt -- even the U.S. -- may be tempted to inflate its currency, and that fear reduces its value.
Since the U.S. has been running huge trade deficits the past several years -- about $700 billion this year -- the stage has long been set for the dollar to drop. What shoved it over the edge was the subprime mess and worries about a U.S. economic downturn. If the economy looks to be slowing down, investors bail out of U.S. assets and turn to investments that must be bought with other currencies. When the Fed tries to perk up the economy by cutting interest rates, as it has done twice recently, it makes the dollar even less attractive because investors can get better rates in other currencies, such as the euro.
What makes investors really nervous is that the trend could become self-reinforcing. A Chinese government official sparked a particularly sharp selloff of the dollar when he said his government would be moving its reserves out of weak currencies and into strong ones -- goodbye, dollar; hello, euro. Since China holds more than $1 trillion, its actions could move markets, pushing the dollar down further, prompting dollar holders to shift out of it further, and so on.
Even if we avoid that scenario, more dollar weakness is probably ahead, at least relative to China's yuan and other currencies of developing nations. As Alan Greenspan points out, when their living standards are rising faster than ours, their currencies will probably appreciate vs. ours. Remember, he says, that the Japanese yen was once 300 to the dollar and eventually strengthened to below 100 (it's now around 113). The trend continues: In just the past year the dollar has weakened 13% vs. the Indian rupee and 11% vs. the Colombian peso, for example.
By the way, Warren Buffett told us all this would happen. In mid 2002, for the first time in his life, he began buying foreign currencies, thus betting against the dollar. He explained his reasons most extensively in a Fortune article he wrote (Nov. 10, 2003). The main factor he cited, the trade deficit, is much worse now. For a year or two after the article, his bet seemed to be a loser. But now, as usual, he looks prescient. To top of page
The dollar's fate is especially worrisome because of its historic role as the world's reserve currency and its obvious importance to the world's largest economy. In today's interconnected global markets the dollar's movements are part cause, part effect -- but on net it's hard to see the dollar getting much stronger anytime soon.
The forces behind the dollar's weakening have been building for years but didn't have much effect until recently.
Most fundamentally, we Americans have been living beyond our means, buying more from the rest of the world than the world buys from us (that's the trade deficit); to do that, we have to give foreigners claims on our assets in the form of government bonds and corporate bonds, or sometimes the assets themselves.
A country as rich as America can do that for a long time, but eventually the world ends up holding more dollars than there is dollar-denominated stuff they want to buy, so they start offloading dollars. They also worry that any country with loads of debt -- even the U.S. -- may be tempted to inflate its currency, and that fear reduces its value.
Since the U.S. has been running huge trade deficits the past several years -- about $700 billion this year -- the stage has long been set for the dollar to drop. What shoved it over the edge was the subprime mess and worries about a U.S. economic downturn. If the economy looks to be slowing down, investors bail out of U.S. assets and turn to investments that must be bought with other currencies. When the Fed tries to perk up the economy by cutting interest rates, as it has done twice recently, it makes the dollar even less attractive because investors can get better rates in other currencies, such as the euro.
What makes investors really nervous is that the trend could become self-reinforcing. A Chinese government official sparked a particularly sharp selloff of the dollar when he said his government would be moving its reserves out of weak currencies and into strong ones -- goodbye, dollar; hello, euro. Since China holds more than $1 trillion, its actions could move markets, pushing the dollar down further, prompting dollar holders to shift out of it further, and so on.
Even if we avoid that scenario, more dollar weakness is probably ahead, at least relative to China's yuan and other currencies of developing nations. As Alan Greenspan points out, when their living standards are rising faster than ours, their currencies will probably appreciate vs. ours. Remember, he says, that the Japanese yen was once 300 to the dollar and eventually strengthened to below 100 (it's now around 113). The trend continues: In just the past year the dollar has weakened 13% vs. the Indian rupee and 11% vs. the Colombian peso, for example.
By the way, Warren Buffett told us all this would happen. In mid 2002, for the first time in his life, he began buying foreign currencies, thus betting against the dollar. He explained his reasons most extensively in a Fortune article he wrote (Nov. 10, 2003). The main factor he cited, the trade deficit, is much worse now. For a year or two after the article, his bet seemed to be a loser. But now, as usual, he looks prescient. To top of page
Boo-yah this: 'Lazy Portfolios' beat 'Mad Money'
Why waste 15 hours a week and lose a $72,000 'opportunity cost?
By Paul B. Farrell
This column, originally published Nov. 6, has been updated with a link to Jim Cramer's response.
ARROYO GRANDE, Calif. -- Last week I finally listened to the "Mad Money" show for a full hour. When channel surfing in the past I'd move on after 30 seconds. It's about as educational as Saturday morning cartoons. What I heard was a manic distraction for addicted personalities. But there I was, alone in the car on a five-hour trip back home. So I made a conscious decision to listen to the entire show, first time (and last!). "Oh god, what torture," I screamed aloud somewhere near Gilroy, the garlic capital of the world: "This is crazy-making, what a waste of time!"
Of course that was the voice of passive investors coming out from deep within my soul, speaking for the 90 million American investors who don't have the time to waste watching this inane "entertainment" program that's brainwashing innocent minds, repeating the dot-com drumbeat of the late 1990s. Seriously, most folks have real jobs that take up most of their time, real families, real outside interests, real lives to live.
Fortunately many Americans have figured out that active trading is a dead-end street. Remember University of California-Davis finance Profs. Terry Odean and Brad Barber and their famous study of 66,400 accounts at a major Wall Street brokerage? They concluded that transaction costs, fees and taxes ate much of the pretax returns: "The more you trade the less you earn." Active traders actually made a third less than passive buy-and-holders. And it's still true.
OK, assuming you're one of America's 2 million to 5 million fairly active traders, calm down. I know you're dismissing what I said. But stick with me for a minute. Take a deep breath before you fire off a nasty email. Quash those emotions and let's look at this another way.
Figure your 'opportunity cost' of trading
You already know that the Odean and Barber research tells us that traders are running the race with a huge handicap. So, let's quantify traders' "opportunity cost," the "economic cost of an opportunity foregone" when they spend time playing by "Mad Money" rules (or any other trading game). In short, what's your time worth if you watch "Mad Money" daily and do the "homework" Cramer recommends?
Jim Cramer's a brilliant trader. I interviewed him in the late 1990s when he was a hedge fund manager. He didn't like my criticism of the Mutual Fund Derby Race on TheStreet.com, of which he was one of the founders. Said I was "over the top." That was at a time when a competing dart-throwing chimpanzee's index called Monkeydex was beating America's top funds.
The fact is, what was "over the top" was TheStreet's manic racetrack imagery that encouraged passive investors to start trading funds, only to rue the day a couple years later when the market tanked and lost $8 trillion in a three-year bear/recession. That was bad media. And last week's "Mad Money" program is the same kind of subtle brainwashing that's misleading passive investors unconsciously into high-risk trading.
Work the numbers. Cramer's emphatic: "Do your homework, the right homework." That can mean many things, depending on your approach to stock research. But one thing's certain, Cramer says: "Doing homework could take as much as an hour per week per position."
But when he says that to investors, "they look at me as if I am some kind of old-fashioned teacher who is asking for way too much in this busy world in which we live. That's just plain wrong."
Good advice. But the one hour daily "Mad Money" show is such a manic wisecracking racetrack mentality with funny costumes, bizarre sound effects and boo-yah cheers that it totally undercuts the subtlety of doing passive "homework." It's more like a hard-sell infomercial to get you to buy a trading system "guaranteed to make you a successful trader."
Except "Mad Money" is drawing people into a new 2007 Derby Race, targeting traders with the minds of kids chasing instant gratification. Read Jim Cramer's response.
'Mad Money's' wasted 'opportunity cost' Here's the hard facts folks: How to quantify the economic "opportunity cost" of the "Mad Money" game. Cramer's right, you must do serious analysis of your "positions." OK, so for five hours a week he overwhelms your mind with tons of opportunities. Let's say that somehow, when the smoke clears, you have 10 "positions."
Now let's do the math in this simple economic equation: If you're following Prof. Cramer's rules and doing your "homework" you're watching "Mad Money" five hours a week and doing another 10 hours of "homework" on your "positions." That's potentially 60 hours of your valuable time each month, on top of your full-time job. Assuming you're a professional or business executive, let's say your time's worth $100 per hour, probably more.
So, bottom line: Your economic "opportunity lost" for 60 hours is at least $6,000 a month or $72,000 a year, playing by "Mad Money" rules. Get it folks? Your time is valuable. If you're worth a minimum of $100 an hour and you spend 60 hours a week on any activity, you darn well better be earning at least $72,000 a year. And to make that kind of money at, say, 15% a year you'd need more than $400,000 capital at risk.
My guess is that most of the "Mad Money" audience takes the easy route: They just go emotionally gaga over some of Cramer's manic stock picking and buy some, without doing the necessary hours of "homework."
'Lazy portfolios' outperform 'Mad Money'
The vast majority of American investors, probably 95%, will likely never waste their valuable time playing "Mad Money's" new Racing Derby, watching and doing all the necessary homework. The odds aren't very good anyway: the unofficial tracking site CramerProject.com says Cramer's chance of making a wrong call is about 42%. That means that nearly half the time you may be misled.
How about portfolio performance? CramerProject.com says the 30-day average return on the Cramer Index was 14.90% on Nov. 2, though undoubtedly much less on an after-tax basis. The Web site tracks a "Jim Cramer index" of more than 1,600 stocks. You can find data on Cramer's individual stock picks on TheStreet.com, a staggering 3,000 from the prior three months -- about 50 a day. But to get a peek at some of his portfolio data you have to subscribe to his service for $400 a year. Now suppose you're a full-time teacher, cop, attorney or entrepreneur running your own business. You don't have an extra 60 hours a month. Or maybe you're already a nervous active trader whose family wants more quality time, and isn't making that $72,000 breakeven ROI for your valuable time.
So, compare the "lazy portfolios:" They require almost no time, so you can continue making money on your job plus add some nice passive money from your customized lazy portfolio, without wasting the "opportunity cost" on trading. See how the lazy portfolios stacked up in the third quarter.
True, only five of our eight lazy portfolios return more than the 14.9% from "Mad Money's" active trading. But that is giving Cramer a tremendous benefit of the doubt, since the lazy portfolio returns are computed as an annual gain and the "Cramer index" is a 30-day moving average. On Sept. 17, for example, that average was closer to 9%.
Even with that edge, the lazy portfolios stack up well. The Aronson Family Portfolio's one-year return of 23.5% is beating "Mad Money's" number by a wide margin. And the lazy fees, taxes and transaction costs are less than with active trading, if you reflect on the Odean-Barber research.
And even more embarrassing, the passive three-fund "Second Grader's Starter Portfolio" is also beating the CramerProject Index, 19.5% to 14.9%. And that kid's a full-time student, so he doesn't have time to watch "Mad Money." Plus he's doing some real "homework" and it looks like he's already learned a valuable lesson that goes over the heads of the "Mad Money" crowd: "The more you trade the less you earn!" Boo-yah! End of Story
By Paul B. Farrell
This column, originally published Nov. 6, has been updated with a link to Jim Cramer's response.
ARROYO GRANDE, Calif. -- Last week I finally listened to the "Mad Money" show for a full hour. When channel surfing in the past I'd move on after 30 seconds. It's about as educational as Saturday morning cartoons. What I heard was a manic distraction for addicted personalities. But there I was, alone in the car on a five-hour trip back home. So I made a conscious decision to listen to the entire show, first time (and last!). "Oh god, what torture," I screamed aloud somewhere near Gilroy, the garlic capital of the world: "This is crazy-making, what a waste of time!"
Of course that was the voice of passive investors coming out from deep within my soul, speaking for the 90 million American investors who don't have the time to waste watching this inane "entertainment" program that's brainwashing innocent minds, repeating the dot-com drumbeat of the late 1990s. Seriously, most folks have real jobs that take up most of their time, real families, real outside interests, real lives to live.
Fortunately many Americans have figured out that active trading is a dead-end street. Remember University of California-Davis finance Profs. Terry Odean and Brad Barber and their famous study of 66,400 accounts at a major Wall Street brokerage? They concluded that transaction costs, fees and taxes ate much of the pretax returns: "The more you trade the less you earn." Active traders actually made a third less than passive buy-and-holders. And it's still true.
OK, assuming you're one of America's 2 million to 5 million fairly active traders, calm down. I know you're dismissing what I said. But stick with me for a minute. Take a deep breath before you fire off a nasty email. Quash those emotions and let's look at this another way.
Figure your 'opportunity cost' of trading
You already know that the Odean and Barber research tells us that traders are running the race with a huge handicap. So, let's quantify traders' "opportunity cost," the "economic cost of an opportunity foregone" when they spend time playing by "Mad Money" rules (or any other trading game). In short, what's your time worth if you watch "Mad Money" daily and do the "homework" Cramer recommends?
Jim Cramer's a brilliant trader. I interviewed him in the late 1990s when he was a hedge fund manager. He didn't like my criticism of the Mutual Fund Derby Race on TheStreet.com, of which he was one of the founders. Said I was "over the top." That was at a time when a competing dart-throwing chimpanzee's index called Monkeydex was beating America's top funds.
The fact is, what was "over the top" was TheStreet's manic racetrack imagery that encouraged passive investors to start trading funds, only to rue the day a couple years later when the market tanked and lost $8 trillion in a three-year bear/recession. That was bad media. And last week's "Mad Money" program is the same kind of subtle brainwashing that's misleading passive investors unconsciously into high-risk trading.
Work the numbers. Cramer's emphatic: "Do your homework, the right homework." That can mean many things, depending on your approach to stock research. But one thing's certain, Cramer says: "Doing homework could take as much as an hour per week per position."
But when he says that to investors, "they look at me as if I am some kind of old-fashioned teacher who is asking for way too much in this busy world in which we live. That's just plain wrong."
Good advice. But the one hour daily "Mad Money" show is such a manic wisecracking racetrack mentality with funny costumes, bizarre sound effects and boo-yah cheers that it totally undercuts the subtlety of doing passive "homework." It's more like a hard-sell infomercial to get you to buy a trading system "guaranteed to make you a successful trader."
Except "Mad Money" is drawing people into a new 2007 Derby Race, targeting traders with the minds of kids chasing instant gratification. Read Jim Cramer's response.
'Mad Money's' wasted 'opportunity cost' Here's the hard facts folks: How to quantify the economic "opportunity cost" of the "Mad Money" game. Cramer's right, you must do serious analysis of your "positions." OK, so for five hours a week he overwhelms your mind with tons of opportunities. Let's say that somehow, when the smoke clears, you have 10 "positions."
Now let's do the math in this simple economic equation: If you're following Prof. Cramer's rules and doing your "homework" you're watching "Mad Money" five hours a week and doing another 10 hours of "homework" on your "positions." That's potentially 60 hours of your valuable time each month, on top of your full-time job. Assuming you're a professional or business executive, let's say your time's worth $100 per hour, probably more.
So, bottom line: Your economic "opportunity lost" for 60 hours is at least $6,000 a month or $72,000 a year, playing by "Mad Money" rules. Get it folks? Your time is valuable. If you're worth a minimum of $100 an hour and you spend 60 hours a week on any activity, you darn well better be earning at least $72,000 a year. And to make that kind of money at, say, 15% a year you'd need more than $400,000 capital at risk.
My guess is that most of the "Mad Money" audience takes the easy route: They just go emotionally gaga over some of Cramer's manic stock picking and buy some, without doing the necessary hours of "homework."
'Lazy portfolios' outperform 'Mad Money'
The vast majority of American investors, probably 95%, will likely never waste their valuable time playing "Mad Money's" new Racing Derby, watching and doing all the necessary homework. The odds aren't very good anyway: the unofficial tracking site CramerProject.com says Cramer's chance of making a wrong call is about 42%. That means that nearly half the time you may be misled.
How about portfolio performance? CramerProject.com says the 30-day average return on the Cramer Index was 14.90% on Nov. 2, though undoubtedly much less on an after-tax basis. The Web site tracks a "Jim Cramer index" of more than 1,600 stocks. You can find data on Cramer's individual stock picks on TheStreet.com, a staggering 3,000 from the prior three months -- about 50 a day. But to get a peek at some of his portfolio data you have to subscribe to his service for $400 a year. Now suppose you're a full-time teacher, cop, attorney or entrepreneur running your own business. You don't have an extra 60 hours a month. Or maybe you're already a nervous active trader whose family wants more quality time, and isn't making that $72,000 breakeven ROI for your valuable time.
So, compare the "lazy portfolios:" They require almost no time, so you can continue making money on your job plus add some nice passive money from your customized lazy portfolio, without wasting the "opportunity cost" on trading. See how the lazy portfolios stacked up in the third quarter.
True, only five of our eight lazy portfolios return more than the 14.9% from "Mad Money's" active trading. But that is giving Cramer a tremendous benefit of the doubt, since the lazy portfolio returns are computed as an annual gain and the "Cramer index" is a 30-day moving average. On Sept. 17, for example, that average was closer to 9%.
Even with that edge, the lazy portfolios stack up well. The Aronson Family Portfolio's one-year return of 23.5% is beating "Mad Money's" number by a wide margin. And the lazy fees, taxes and transaction costs are less than with active trading, if you reflect on the Odean-Barber research.
And even more embarrassing, the passive three-fund "Second Grader's Starter Portfolio" is also beating the CramerProject Index, 19.5% to 14.9%. And that kid's a full-time student, so he doesn't have time to watch "Mad Money." Plus he's doing some real "homework" and it looks like he's already learned a valuable lesson that goes over the heads of the "Mad Money" crowd: "The more you trade the less you earn!" Boo-yah! End of Story
Buffett's Estate Tax Ear-Bender
More new taxes? That's the surprising mantra of America's second richest man: Warren Buffet. On Wednesday, the billionaire investor and philanthropist urged the Senate Finance Committee to keep the controversial estate tax. Buffett, whose net worth is over $57 billion, has heavily crusaded for more taxes on the rich. While many of his peers may disagree, Buffett staunchly believes that the current tax system favors the elite and overburdens the middle class. Perhaps in a sign of how near-and-dear the tax issue is to Buffett, the head of Berkshire Hathaway addressed the committee without a prepared speech (according to one of his personal assistants). Speaking off the cuff, he said a repeal of the estate tax would unjustly benefit America’s wealthiest.
The estate tax has been a hot-button issue on Capitol Hill this year. Under a 2001 law, the estate tax will be gradually reduced until 2010, when it is suspended for on year. Then in 2011, the tax returns in full force, and estates worth over $1 million could face a 55% tax. While some Republicans have pushed for the tax’s full repeal, many Democrats want the tax to stay in place. It is unclear where Republicans and Democrats will find common ground, but many expect the sides to reach a compromise before 2011.
According to Buffett, the estate tax is important, because it bridges the gap between the poor and rich. “A meaningful estate tax is needed to prevent our democracy from becoming a dynastic plutocracy,'' he said. He said low taxes on the rich (many of the richest Americans are taxed at the lower dividends and capital gains rate) have given them an unfair advantage over the middle class, which fork over a greater percentage of their income to the government.
In a recent interview with Tom Brokaw of NBC, Buffett produced a document that showed he had about $49.6 million in taxable income, 18% of which was paid to the government. For comparison, he said the average federal tax rate for a Berkshire employee was nearly double that–33%.
Proposing a more-direct redistribution of wealth, Buffett said the approximate $24 billion in proceeds from the estate tax, should be redirected to the poor. One way to do it, he argues, would be to give $1,000 tax credit to 23 million low-income households.
Buffett’s focus on U.S. economic disparity may seem like a modern dilemma, but his arguments echo the words of Theordore Roosevelt, the 26th president of the United States. In 1906, the president Roosevelt told Congress: "The man of great wealth owes a peculiar obligation to the state, because he derives special advantage from the mere existence of government,” he said. And the man of great wealth “should assume his full and proper share of the burden of taxation.”
While Buffett’s tax position, seems like an unlikely perch for a man that has aggressively accumulated wealth, he has been a longtime proponent of wealth redistribution. He doesn’t just talk the talk, he also pays up—big. In 2006, Buffett pledged to give 85% of the value in his Berkshire Hathaway stock to charitable organizations. The lion share of that—about $30 billion over 20 years— will go to the Bill and Melinda Gates Foundation. For all of 2006, Buffett gave away $4 billion, or 7% of his wealth.
But Buffett is not a lonely black swan in the Forbes 400 circle. Fellow philanthropist, Bill Gates has said that he is committed to his late father’s pro-tax policy. In addition, George Soros, the chairman of Soros Fund Management, has also lobbied Congress to keep the tax on the books.
The estate tax has been a hot-button issue on Capitol Hill this year. Under a 2001 law, the estate tax will be gradually reduced until 2010, when it is suspended for on year. Then in 2011, the tax returns in full force, and estates worth over $1 million could face a 55% tax. While some Republicans have pushed for the tax’s full repeal, many Democrats want the tax to stay in place. It is unclear where Republicans and Democrats will find common ground, but many expect the sides to reach a compromise before 2011.
According to Buffett, the estate tax is important, because it bridges the gap between the poor and rich. “A meaningful estate tax is needed to prevent our democracy from becoming a dynastic plutocracy,'' he said. He said low taxes on the rich (many of the richest Americans are taxed at the lower dividends and capital gains rate) have given them an unfair advantage over the middle class, which fork over a greater percentage of their income to the government.
In a recent interview with Tom Brokaw of NBC, Buffett produced a document that showed he had about $49.6 million in taxable income, 18% of which was paid to the government. For comparison, he said the average federal tax rate for a Berkshire employee was nearly double that–33%.
Proposing a more-direct redistribution of wealth, Buffett said the approximate $24 billion in proceeds from the estate tax, should be redirected to the poor. One way to do it, he argues, would be to give $1,000 tax credit to 23 million low-income households.
Buffett’s focus on U.S. economic disparity may seem like a modern dilemma, but his arguments echo the words of Theordore Roosevelt, the 26th president of the United States. In 1906, the president Roosevelt told Congress: "The man of great wealth owes a peculiar obligation to the state, because he derives special advantage from the mere existence of government,” he said. And the man of great wealth “should assume his full and proper share of the burden of taxation.”
While Buffett’s tax position, seems like an unlikely perch for a man that has aggressively accumulated wealth, he has been a longtime proponent of wealth redistribution. He doesn’t just talk the talk, he also pays up—big. In 2006, Buffett pledged to give 85% of the value in his Berkshire Hathaway stock to charitable organizations. The lion share of that—about $30 billion over 20 years— will go to the Bill and Melinda Gates Foundation. For all of 2006, Buffett gave away $4 billion, or 7% of his wealth.
But Buffett is not a lonely black swan in the Forbes 400 circle. Fellow philanthropist, Bill Gates has said that he is committed to his late father’s pro-tax policy. In addition, George Soros, the chairman of Soros Fund Management, has also lobbied Congress to keep the tax on the books.
3 Myths About the Turbulent Market
The past few months haven't been short of hair-raising moments in the stock market. From panic to jubilation, and then back to panic, it's hard to tell what's been going on. A credit crunch, a housing crash, a weak dollar, lower interest rates -- it's a lot to take in.
Regardless of whatever problem pops up, there are several investing myths that resurface during turbulent market periods. Here's just a few of them to think about.
Myth No. 1: You can time the market.
Take it easy, Nostradamus. The stock market can be about as twitchy as a shivering Chihuahua. This year alone, we've had several days when the Dow went up or down more than 300 or 400 points in the blink of an eye. Short-term stock movements are determined by buy and sell orders, and people buy and sell for all sorts of reasons -- not all of them rational.
Whether it's a wealthy CEO selling a large block of shares to pay for a new yacht, a hedge-fund manager looking to jump in and out for a quick trade, or a complete novice crossing his or her fingers and hoping for the best, there is no reason to assume you can predict what people will decide to do in the future.
You also have to take into consideration the out-of-the-blue events that make market timing nearly impossible. Suppose you thought Citigroup was due for a quick rebound after it fell from $48 to $42 per share in mid-October. You gather some fancy candlestick charting program that churns out pretty numbers and tells you Citigroup is bound for success. Fantastic! Back up the truck!
Well, not so fast. Before you know it, Citigroup comes out with staggering writedowns and the ouster of its CEO, leaving investors no less than 20% worse off in the matter of a few days. Ouch.
Once in a while you'll get lucky, but don't kid yourself. You can't time the market. Save the fortune-telling for the good folks at the other end of those 1-900 numbers.
Myth No. 2: Fallen stocks must rise again.
What goes down by no means has to come back up. Many of the homebuilding stocks, such a Beazer Homes, D.R. Horton, and Pulte Homes, have taken gut-wrenching hits in the past year, but that doesn't necessarily mean they are cheap. The past several years were a boon to the homebuilding industry, and it could be many, many years before we see construction return to those levels -- if ever.
When you're looking for a cheap stock, it's important not to fixate on how much a stock has fallen from its high. True, bargains are often found in stocks that have taken a beating, but the amount a stock has gone down doesn't dictate whether it's cheap or not. Baidu has gone down some 20% in the past week, yet it still trades at a triple-digit price-to-earnings ratio.
Myth No. 3: Volatility hurts you.
This is one of the biggest myths in all of stock market lore. The majority of investors will be net buyers of stocks over the coming years or decades. Since most of us plan on being investors for the long haul, you should welcome volatility as your friend.
If you're investing in a retirement account that you don't plan to withdraw from for, say, 20 years, but you plan to contribute frequently to it, the best thing in the world that could happen to you is to have a massive stock market crash that lets you purchase investments at bargain prices. Yet many investors panic and head for the hills at the first sign of trouble, even if they know the trouble will be only temporary.
Yes, we're having a credit crunch right now. Sure, housing is ugly at the moment. But does that mean you should dump everything and put your cash under your mattress? Not even close. When the market becomes turbulent, as it has in the past few months, and your favorite companies go on sale, consider yourself lucky. Look past the short-term noise and think about what the goal of successful investing is -- to make money over time.
There are plenty of myths out there. Everyone in the stock market wants to make quick and easy money, but in reality, that's not how the world works. Develop a sound investing plan, stick to your guns, and don't be tempted by greed or fear as the market gyrates to and fro.
Wednesday, November 14, 2007
Our 'Voluntary' Tax Code
The Wall Street Journal, November 14, 2007
By Donald L. Luskin
Should we stop worrying and learn to love the "mother of all tax reform plans" put forward by House Ways and Means Committee Chairman Charles Rangel of New York?
The bill would raise taxes by $3.5 trillion over the coming decade, according to Louisiana Republican Rep. James McCrery, a committee colleague of Mr. Rangel's, making it the largest tax increase in history. There has been so much concern that such a tax increase would hurt financial incentives that drive economic growth that House Speaker Nancy Pelosi distanced herself from Mr. Rangel's plan almost as soon as he announced it.
But fear not. As Mr. Rangel wrote on this page two weeks ago, his bill would "restore a sense of equity and fairness that is critical to the success of our voluntary tax system." That's right, he called our tax system "voluntary." That means we don't have to worry about the incentive effects, since we won't actually have to pay any of that $3.5 trillion -- unless we want to.
So when April 15 comes around, I encourage you to be like Herman Melville's Bartleby and say: "I prefer not to." But wait. By April 15 you'll already have paid, since taxes are involuntarily withheld from your paycheck. Nothing can be done about that, even if you don't volunteer to file a tax return. And if you don't file a return, you'll find yourself involuntarily in jail.
You'll then have to yield to the opinion that Mr. Rangel wasn't being entirely straightforward in writing that our tax system is voluntary. But then, he wasn't being entirely straightforward in writing that his bill, which would further raise taxes on the "rich" who already pay the great majority of federal taxes, has anything to do with equity and fairness.
Perhaps from Mr. Rangel's perspective, our tax system is indeed voluntary. After all, he chooses who pays taxes, how much they pay and how their money gets spent. If he wants to raise our taxes to support a $2 million earmark to create a Charles B. Rangel Center for Public Service at the City College of New York, he can volunteer to do that -- but the rest of us have no such choice.
To be fair, our tax system is indeed voluntary in certain respects. For example, wealthy liberals like Warren Buffett, who call publicly for higher taxes on the rich in the name of fairness, can volunteer to pay more themselves any time they wish to do so. All Mr. Buffett has to do is send a check to Department G -- that's G for "gift" -- at the Bureau of the Public Debt in Parkersburg, W.Va.
Why not try an experiment in which the tax system is made truly voluntary? Already 42 states (as well as the District of Columbia and Puerto Rico) raise revenues with lotteries, through which citizens voluntarily paid $57 billion last year. It's a long and noble tradition. Before the birth of Christ, the Han Dynasty ran lotteries to raise the revenues used to build the Great Wall of China.
Government could be entirely financed by voluntary taxation. Yes, the government would have to be small enough to make do, and citizens would have to be sufficiently public-minded about it. But all 13 original American colonies ran lotteries, and playing them was considered a civic duty. Proceeds from lotteries established Harvard, Yale, Columbia, Dartmouth, Princeton, and William and Mary -- and paid for the cannons that defeated England in the Revolutionary War.
But today, Mr. Rangel might find that the volunteerism in today's tax system is a dangerous thing. His bill would raise the tax rate on capital gains income, but the cap-gains tax is voluntary to the extent that one doesn't have to pay it until one chooses to sell an appreciated asset. That fact is not lost on Mr. Buffett, who believes the rich should pay more taxes, but who has never volunteered to sell even one share of his vast holdings in Berkshire Hathaway -- and thus has never volunteered to pay any cap-gains taxes.
What if every investor did that? It's nice to imagine a nation of long-term investors just like Mr. Buffett. But if stockholders never sold any of their investments, the economy, incomes and job creation would slow to a crawl because a growing economy depends on capital moving freely and continuously to its perceived highest and best use.
Mr. Rangel should also bear in mind that taxes on labor income are voluntary in the sense that one can choose not to pay them by choosing not to earn any labor income -- that is, by not working. All the rich need to do in order to make true Mr. Rangel's characterization of our tax system is to retire to their yachts, rather than continue to contribute to the economy by running hedge funds or doing private equity deals.
When that happens, Mr. Rangel will get a lesson in supply-side economics he'll never forget. Some say that the Laffer Curve is wrong, and that tax cuts don't result in higher tax revenues. But when America's most productive workers stop working -- even a little bit -- in reaction to the incentive effects of the "mother of all tax reform plans," they'll see that the Laffer Curve was right after all, and that it can cut both ways. Involuntary tax hikes result in voluntarily lower tax revenues.
Mr. Luskin is chief investment officer of Trend Macrolytics LLC.
By Donald L. Luskin
Should we stop worrying and learn to love the "mother of all tax reform plans" put forward by House Ways and Means Committee Chairman Charles Rangel of New York?
The bill would raise taxes by $3.5 trillion over the coming decade, according to Louisiana Republican Rep. James McCrery, a committee colleague of Mr. Rangel's, making it the largest tax increase in history. There has been so much concern that such a tax increase would hurt financial incentives that drive economic growth that House Speaker Nancy Pelosi distanced herself from Mr. Rangel's plan almost as soon as he announced it.
But fear not. As Mr. Rangel wrote on this page two weeks ago, his bill would "restore a sense of equity and fairness that is critical to the success of our voluntary tax system." That's right, he called our tax system "voluntary." That means we don't have to worry about the incentive effects, since we won't actually have to pay any of that $3.5 trillion -- unless we want to.
So when April 15 comes around, I encourage you to be like Herman Melville's Bartleby and say: "I prefer not to." But wait. By April 15 you'll already have paid, since taxes are involuntarily withheld from your paycheck. Nothing can be done about that, even if you don't volunteer to file a tax return. And if you don't file a return, you'll find yourself involuntarily in jail.
You'll then have to yield to the opinion that Mr. Rangel wasn't being entirely straightforward in writing that our tax system is voluntary. But then, he wasn't being entirely straightforward in writing that his bill, which would further raise taxes on the "rich" who already pay the great majority of federal taxes, has anything to do with equity and fairness.
Perhaps from Mr. Rangel's perspective, our tax system is indeed voluntary. After all, he chooses who pays taxes, how much they pay and how their money gets spent. If he wants to raise our taxes to support a $2 million earmark to create a Charles B. Rangel Center for Public Service at the City College of New York, he can volunteer to do that -- but the rest of us have no such choice.
To be fair, our tax system is indeed voluntary in certain respects. For example, wealthy liberals like Warren Buffett, who call publicly for higher taxes on the rich in the name of fairness, can volunteer to pay more themselves any time they wish to do so. All Mr. Buffett has to do is send a check to Department G -- that's G for "gift" -- at the Bureau of the Public Debt in Parkersburg, W.Va.
Why not try an experiment in which the tax system is made truly voluntary? Already 42 states (as well as the District of Columbia and Puerto Rico) raise revenues with lotteries, through which citizens voluntarily paid $57 billion last year. It's a long and noble tradition. Before the birth of Christ, the Han Dynasty ran lotteries to raise the revenues used to build the Great Wall of China.
Government could be entirely financed by voluntary taxation. Yes, the government would have to be small enough to make do, and citizens would have to be sufficiently public-minded about it. But all 13 original American colonies ran lotteries, and playing them was considered a civic duty. Proceeds from lotteries established Harvard, Yale, Columbia, Dartmouth, Princeton, and William and Mary -- and paid for the cannons that defeated England in the Revolutionary War.
But today, Mr. Rangel might find that the volunteerism in today's tax system is a dangerous thing. His bill would raise the tax rate on capital gains income, but the cap-gains tax is voluntary to the extent that one doesn't have to pay it until one chooses to sell an appreciated asset. That fact is not lost on Mr. Buffett, who believes the rich should pay more taxes, but who has never volunteered to sell even one share of his vast holdings in Berkshire Hathaway -- and thus has never volunteered to pay any cap-gains taxes.
What if every investor did that? It's nice to imagine a nation of long-term investors just like Mr. Buffett. But if stockholders never sold any of their investments, the economy, incomes and job creation would slow to a crawl because a growing economy depends on capital moving freely and continuously to its perceived highest and best use.
Mr. Rangel should also bear in mind that taxes on labor income are voluntary in the sense that one can choose not to pay them by choosing not to earn any labor income -- that is, by not working. All the rich need to do in order to make true Mr. Rangel's characterization of our tax system is to retire to their yachts, rather than continue to contribute to the economy by running hedge funds or doing private equity deals.
When that happens, Mr. Rangel will get a lesson in supply-side economics he'll never forget. Some say that the Laffer Curve is wrong, and that tax cuts don't result in higher tax revenues. But when America's most productive workers stop working -- even a little bit -- in reaction to the incentive effects of the "mother of all tax reform plans," they'll see that the Laffer Curve was right after all, and that it can cut both ways. Involuntary tax hikes result in voluntarily lower tax revenues.
Mr. Luskin is chief investment officer of Trend Macrolytics LLC.
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