Posts tagged ‘accounting’

Engineering Intuition and The Media

I don't really want to ridicule Kevin Drum here for thinking out loud.  I really hate partisan Conservative and Liberal team-politics blogs, but I read a few to stay out of the echo chamber, and Drum is smarter and incrementally more objective (a relative thing) than most.

But this is really terrible, awful engineering intuition:

These two things together reminded me about an energy factoid that's always struck me as slightly odd: virtually every form of energy seems to be almost as efficient as burning oil, but not quite.

For example, on either a power/weight basis or a cost basis, batteries are maybe 2x or 3x bigger and less efficient than an internal combustion engine. Not 50x or 100x. Just barely less efficient. And you see the same thing in electricity generation. Depending on how you do the accounting, nuclear power is maybe about as efficient as an oil-fired plant, or maybe 2x or 3x less efficient. Ditto for solar. And for wind. And geothermal. And tidal power.

I'm just noodling vaguely here. Maybe there's an obvious thermodynamic explanation that I'm missing. It's just that I wouldn't be surprised if there were lots of ways of generating energy that were all over the map efficiency-wise. But why are there lots of ways of generating energy that are all surprisingly similar efficiency-wise? In the great scheme of things, a difference of 2x or 3x is practically invisible.

First, we have to translate a bit.  He mentions power to weight ratios for batteries in the second paragraph.  In fact, batteries have terrible power (actually energy storage) to weight ratios vs. fossil fuels, much worse than 2-3x for energy storage per unit of weight or volume.  That is why gasoline is still the transportation energy source of choice, because very few things short of plutonium have so much potential energy locked up in so little volume.  But I will assume he is comparing an entire electric drive system compared to a gasoline drive system (including not just energy storage but the drive itself) and in this case the power to weight ratios are indeed closer.

But here is the problem:  in engineering, a 2-3x difference in most anything -- strength, energy efficiency, whatever -- is a really big deal.  It's the difference between 15 and 45 MPG.   Perhaps this is Moore's Law corrupting our intuition.  We see electronic equipment becoming twice as powerful every 18 months, and we start to assume that 2x is not that much of a difference.

But this is why Moore's Law is so much discussed, because of its very uniqueness.  In most fields, engineers tinker for decades for incremental improvements, sometimes in the single digit percentages.

The fact that alternative energy supporters feel like their preferred technologies are just so close, meaning they are only 2x-3x less efficient than current technologies, explains a lot about why we skeptics of these technologies have a hard time getting through to them.

Wal-Mart's Bribery Problems

Walter Olson has been writing a lot about Wal-Mart and FCPA.  I don't have a lot to add except my own experience working for a large corporation in third world countries.

I worked for a manufacturer of industrial equipment for years.  In most countries in Europe and North America, part of our strategy was a dedicated in-house sales force that could provide a high level of technical support.  But we went away from that strategy when we went into third world countries, just the place where we needed more rather than less technical support for our customers.

Why?  A big reason was the FCPA.  There are many countries where it is simply impossible to do business without paying bribes.  Bribes are absolutely wired into the regulatory process.  In Nigeria, public officials are paid less with the expectation they will make it up on bribes, similar to the way we pay waiters who get tips.  The only way to legally work in these countries is to work through third party resellers and distributors and other such partners, and then tightly close your eyes to how they get things done.

What always ticks me off about these cases is the fake attitude of naivite in the press that seems to be constantly amazed that corporations might have to pay bribes to do basic things we take for granted here, like get the water turned on or have your goods put on a ship.  But in fact reporters can't be this naive, as they almost certainly have to deal with many of the same things in their business.  I would love to see an accounting of the grease payments the NY Times pays in a year in foreign countries.

I think most people when they hear these foreign bribery cases assume corporations were paying to get a special advantage or to escape some sort of fundamental regulation.  And this is possibly the case with Wal-Mart, but more likely they were simply paying because that is what you have to do just to function at all.

Everything I Need To Know About The Effect of Metrics on Police Behavior I Learned from The Wire

Scathing report on how NY police gamed the process to improve their reported crime numbers.  Nothing in this should be the least surprising to anyone who watched a few seasons of The Wire.

These are not just accounting shenanigans.  There were actions the directly affected the public and individual liberty.  People were rounded up on the street on BS charges to pad arrest stats while real, substantial crimes went ignored in a bid to keep them out of the reported stats.

There is one part in here that is a good illustration of public vs. private power.  People who fear corporations seem to have infinite trust for state institutions.  But the worst a corporation was ever able to do to a whistle blower was fire him.  This is what the state does:

For more than two years, Adrian Schoolcraftsecretly recorded every roll call at the 81st Precinct in Brooklyn and captured his superiors urging police officers to do two things in order to manipulate the "stats" that the department is under pressure to produce: Officers were told to arrest people who were doing little more than standing on the street, but they were also encouraged to disregard actual victims of serious crimes who wanted to file reports.

Arresting bystanders made it look like the department was efficient, while artificially reducing the amount of serious crime made the commander look good.

In October 2009, Schoolcraft met with NYPD investigators for three hours and detailed more than a dozen cases of crime reports being manipulated in the district. Three weeks after that meeting—which was supposed to have been kept secret from Schoolcraft's superiors—his precinct commander and a deputy chief ordered Schoolcraft to be dragged from his apartment and forced into the Jamaica Hospital psychiatric ward for six days.

Public vs. Private

Folks on the Left prefer public institutions over private ones because they percieve them as more "fair."  But the power of lawmaking and police and prisons allows public institutions to be far more abusive than private entities could ever be.  We spent months and years torturing ourselves about accounting abuses at Enron, but these are trivial compared the accounting shenanigans state institutions engage in every day.

Or consider this, from Europe, particularly the first bit

“In the event of default (i) any non-official bond holder is junior to all official creditors and (ii) the issuer reserves the right to change law as needed to negate any rights of the nonofficial bond holder.

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“We should not underestimate the damage these steps have inflicted on Europe’s €8.4 trillion sovereign bond markets. For example, the Italian government has issued bonds with a face value of over €1.6 trillion. The groups holding these bonds are banks, pension funds, insurance companies, and Italian households. These investors bought them as safe, low-return instruments that could be used to hedge liabilities and provide for future income needs. It was once hard to imagine these could ever be restructured or default.

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“Now, however, it is clear they are not safe. They have default risk, and their ultimate value is subject to the political constraint and subjective decisions by a collective of individuals in the Italian government and society, the ECB, the European Union, and the International Monetary Fund (IMF). An investor buying an Italian bond today needs to forecast an immediate, complex process that has been evolving in unpredictable ways. Investors naturally want a high return in order to bear these risks.

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“Investors must also weigh carefully the costs and benefits to them of official intervention. Each time official creditors provide loans or buy bonds, the nonofficial holders become more subordinated, because official creditors including the IMF, ECB, and now the European Union continue to claim preferential status.”

This is not to say that bondholders in private entities don't get crammed down in a refinancing or bankruptcy.  But here we are talking about differential treatment of holders of the exact same class, even issue, of securities.

These Are The Folks Who Are Wrapping Themselves in the Mantle of "Science"

Oops.  Accounting error seriously overestimates benefits of biofuels.  

The European Union is overestimating the reductions in greenhouse gas emissions achieved through reliance on biofuels as a result of a “serious accounting error,” according to a draft opinion by an influential committee of 19 scientists and academics.

The European Environment Agency Scientific Committee writes that the role of energy from crops like biofuels in curbing warming gases should be measured by how much additional carbon dioxide such crops absorb beyond what would have been absorbed anyway by existing fields, forests and grasslands.

Instead, the European Union has been “double counting” some of the savings, according to the draft opinion, which was prepared by the committee in May and viewed this week by The International Herald Tribune and The New York Times.

The committee said that the error had crept into European Union regulations because of a “misapplication of the original guidance” under the United Nations Framework Convention on Climate Change.

“The potential consequences of this bioenergy accounting error are immense since it assumes that all burning of biomass does not add carbon to the air,” the committee wrote.

Duh.  This has been a known fact to about everyone else, as most independent studies not done by a corn-state university have found ethanol to have, at best, zero utility in reducing atmospheric CO2.

It is worth noting that the EU would likely have never made this admission had it solely been under the pressure of skeptics, for whom this is just one of a long list of fairly obvious errors in climate-related science.  But several years ago, environmental groups jumped on the skeptic bandwagon opposing ethanol, both for its lack of efficacy in reducing emissions as well as the impact of increasing ethanol product on land use and food prices.

Weird Coincidences

I spent four days last week trying to get my online backup file restored for Quickbooks, our accounting software.

One morning, we woke up and found our entire QB file corrupted.  I would insert cautions to QB users about such occurrences, but I think everyone already knows the problem.  Such a warning would be like reminding a New York resident about street crime.  We QB users always feel like we are walking on eggshells with QB, ready at any moment for everything to go haywire.  We live with it, because the program is useful and ubiquitous.

So I perform a backup every day, but recently started using the QB online backup facility.  This automatically backs up the file every day.  I still make a local backup from time to time, but I have gotten lazy.  When things went south the other day, my online backup was 10 days old, an eternity in our business.  I sent QB our file to try to execute a repair, but in the mean time I went to the restore command to restore the most recent online backup before the corruption.

Fail.  Fail.  Fail.  Fail.  After four tries, each 3 hours each, I got the idea maybe it was not going to work.  So I called QB and got their Phillipines tech support desk.  They walked me through some steps.  Fail. Fail. Fail.

Through all this time, we were entirely shut down accounting-wise.  Finally, in exasperation, I asked them to just post my backup file on an FTP server somewhere.  After all, we could both see the file exists, and it was just the QB proprietary file transfer protocol that was failing to restore it.  Well, three countries and four departments later, no one could post the file on an FTP server.  Or to my Amazon S3 account.  Or to a password-protected web page.

For God sakes, this is a software company?  Finally, they agreed to have someone at the third party contractor who runs the servers try to put the file on a DVD and mail it to me, LOL.

It was almost exactly at this point that I opened this XKCD comic:

I tell you, sometimes that site is totally dialed into my brain.  (by the way, as I blog, a signed version of this comic on the wall behind my monitor).

PS- eventually the Quickbooks people rebuilt my corrupted file before I could ever get the backup in my hands.  Object lesson here - don't ever give up on the original file, the Intuit guys have twice in my life fixed a file that seemed corrupted beyond all hope of recovery.

WTF? This is What They Mean by Oil and Gas Subsidies?

When the Left has talked about oil and gas subsidies, I have generally nodded my head and agreed that any such things should be eliminated, just as they should be eliminated for all industries.   They have in the past thrown out huge numbers for such subsidies that seemed high, but I have not really questioned them.  But then I see this chart at Kevin Drum's site

Seriously, nearly half the "subsidy" number is the ability of a company to use LIFO accounting on inventory for their taxes?  Since the proposition is to eliminate these only for oil and gas, what is the logic that somehow LIFO accounting is wrong in Oil and Gas but OK in every other industry?   In fact, at least the first two largest items are both accounting rules that apply to all manufacturing industry.  So, rather than advocating for the elimination of special status for oil and gas, as I thought the argument was, they are in fact arguing that oil and gas going forward be treated in a unique and special way by the tax code, separate from every other manufacturing industry.

In fact, many of these are merely changes to the amortization and depreciation rate for up-front investments.  Typically, politicians of both parties have advocated for the current rules to encourage investment.  Now I suppose we are fine-tuning the rules, so that we encourage investment in the tax code in everything but oil and gas.  I will say this does seem to be consistent with Obama Administration jobs policy, which has been to try to stimulate businesses that are going nowhere and hold back the one business (oil and gas drilling) that is actually trying to grow.  I am fine with stopping the use of the tax code to try to channel private investment in politician-preferred directions.  But changing the decision rule from "using the tax code to encourage all manufacturing investment" to "using the tax code to encourage investment only in the industries we are personally sympathetic to" is just making the interventionism worse.

This is really weak.  Not to mention flawed.  Unless I am missing something, a change from LIFO to FIFO or some other inventory valuation rules will create a one-time change in income (and thus taxes) when the change is made.  LIFO only creates sustained reductions in taxable income, and thus taxes, if your raw materials prices are consistently rising (it actually increases taxes vs. FIFO if input prices are falling).  Given that oil and gas prices are volatile, its hard to see how this does much except extract a one-time tax payment from oil companies at the changeover.

By the way, I am pretty sure I would be all for ending government spending on "ultra-deepwater and unconventional natural gas and other petroleum research," though ironically this is exactly the kind of basic research the Left loves the government to perform.

Mandating Faulty Accounting to Reach Absurd MPG Standards

President Obama wants a 56.2 mile per gallon standard for cars by 2025.  Both advocates and opponents of this say the only way to make this is if everyone drives an electric car or plug in hybrid.  But the fact of the matter is, even those don't get 56.2 mpg, except through an accounting fiction.

A while back I ran the numbers on the Nissan Leaf. According to the EPA, this car gets an equivalent of 99 MPG.  But that is only by adopting the fiction of looking only at the efficiency in converting electricity to power in the wheels.  But the electricity comes from somewhere (the marginal kilowatt almost certainly comes from a fossil fuel) and the new EPA methodology completely ignores conversion efficiency of fuel to electricity.  Here is how I explained it at Forbes:

The problem is that, using this methodology, the EPA is comparing apples to oranges.   The single biggest energy loss in fossil fuel combustion is the step when we try to capture useful mechanical work (ie spinning a driveshaft in a car or a generator in a power plant) from the heat of the fuel’s combustion.  Even the most efficient processes tend to capture only half of the potential energy of the fuel.   There can be other losses in the conversion and distribution chain, but this is by far the largest.

The EPA is therefore giving the electric vehicle a huge break.  When we measure mpg on a traditional car, the efficiency takes a big hit due to the conversion efficiencies and heat losses in combustion.  The same thing happens when we generate electricity, but the electric car in this measurement is not being saddled with these losses, even though we know they still occur in the system.

Lets consider an analogy.  We want to measure how efficiently two different workers can install a refrigerator in a customer’s apartment.  In both cases the customer lives in a fourth floor walkup.  The first installer finds the refrigerator has been left on the street.  He has to spend much of his time struggling to haul the appliance up four flights of stairs.  After that, relatively speaking, the installation is a breeze.  The second installer finds his refrigerator has thoughtfully been delivered right to the customer’s door on the fourth floor.  He quickly brings the unit inside and completes the installation.

So who is a better installer?  If one only looks at the installer’s time, the second person looks orders of magnitude better.  But we know that he is only faster because he offloaded much of the work on the delivery guys.  If we were to look at the total time of the delivery person plus the installer, we’d probably find they were much closer in their productivity.  The same is true of the mileage standards — by the EPA’s metric, the electric vehicle looks much better than the traditional vehicle, but that is only because someone else at the power plant had to do the really hard bit of work that the traditional auto must do itself.  Having electricity rather than gasoline in the tank is the equivalent of starting with the refrigerator at the top rather than the bottom of the stairs.

The DOE has actually published a better methodology, going from "well to wheels," creating a true comparable efficiency for electric cars to gasoline engine cars.  By this methodology, the Nissan Leaf all electric car only gets 36 MPG!  In fact, no current electric car would meet the 56.2 MPG standard if the accounting were done correctly.  Which is why the EPA had to create a biased, inaccurate MPG equivalent measure for electric vehicles to artificially support this Presidential initiative.

Medicare and Social Security Trustee Reports

Here is some analysis of these reports. A few things I found interesting

  • I have always understood the "trust funds" for these programs were a crock, that we had spent the money in these funds years ago.  But the accounting fiction is important for a reason I did not know - when the trust fund is used up from an accounting standpoint  (vs. a cash standpoint, where it is not only already used up but never existed) in 2036 or whenever, statutory authority for spending is capped at annual tax collections, which at that point will be way, way below programmed spending levels.
  • Medicare alone is projected to grow to 6% of GDP.  wow.
  • The reality of Obamacare's promises of cost reductions is starting to appear, as already these supposed cost reductions are being discounted by folks who have accountability for getting the numbers right.

One thing to note -- Social Security actually has some shot at being repaired, because benefits are a fixed, predictable amount (as long as your actuarial tables are right).  Medicare and Medicaid are far harder, because the benefits are open ended, and every recent "fix" has tended to shift incentives to encourage rather than discourage more spending.  Note, for an example, the political pressure to eliminate the part D donut hole that actually is there to provide incentives to camp drug spending and prices.

Shareholder Suits

From Overlawyered today:

"A new study in the Financial Analysts Journal casts serious doubt on the premise [of litigation social efficiency], at least when it comes to shareholder class actions. In most cases, the authors found, the litigation mainly serves to punish shareholders who have already suffered from a downturn in their stock. Only suits targeting illegal insider trading, and to a lesser extent, accounting fraud were associated with subsequent higher long-term returns."

Way back in early 2006 (have I been blogging so long?) I was guest blogging at Overlawyered and I wrote this:

But from a philosophical standpoint, shareholder suits have never made much sense to me. While I can understand the shareholders of the company suing a minority shareholder who might be enriching themselves disproportionately (e.g. Rigas family at Adelphia), suits by shareholders against the company they own seem"¦ crazy.

Any successful verdict for shareholders against the company would effectively come out of the pockets of the company's owners who are.. the shareholders. So in effect, shareholders are suing themselves, and, win or lose, they as a group end up with less than if the suit had never been started, since a good chunk of the payout goes to the lawyers. The only way these suits make financial sense (except to the lawyers, like Bill Lerach) is if only a small subset of the shareholders participate, and then these are just vehicles for transferring money from half the shareholders to the other half, or in other words from one wronged party that does not engage in litigation to another wronged party who is aggressively litigious. Is there really justice here?

OK, you could argue that many of these shareholders are not suing themselves, because they are past shareholders that dumped their stock at a loss. But given these facts, these suits are even less fair. If these suits are made by past shareholders who held stock (ie, were the owners) at the time certain wrongs were committed, they are in fact paid by current and future shareholders who may well have not even owned the company at the time of the abuses, and who may in fact be participating in cleaning the company up. So these litigants are in effect making the argument that because the company was run unethically when they owned it, they are going to sue the people who bought it from them and cleaned it up? Shouldn't the payment be the other way around, with past owners paying current owners for the mess they left?

I understand that theoretically they might have an incentive improvement from the threat of these suits that improves corporate governance.  But this is mitigated by the fact that most corporations consider these suits to be random landmines without merit, to be avoided if possible, to be settled if necessary, but that have little bearing on the underlying governance of the company.

Is GM's Equity Real?

There was a fair amount of blog reporting on GM's IPO papers, focusing on various outsized risks reported in those documents.   But for someone who has read a fair number of red herrings in the past, I can tell you these over-the-top risk statements are virtually pro forma.  The lawyers don't want any suits down the road about failure to disclose, so every risk up to and including getting kidnapped by evil trolls if you buy the offering are listed.

Via the Accounting Onion, I found an issues I have not seen well-reported.  Tom Selling argues that without some accounting shennanigans at its reorganization, GM's equity should be negative.   Reading between the lines, it does not appear that he is very confident that the SEC, which is a branch of GM's ownership group, will do much about it.

The 1099 Landmine

The Senate will take a vote today to repeal the hugely onerous 1099 provision from the Obamacare legislation.   Good news, though Obama is opposed to the repeal as he feels (probably correctly) that it will open the floodgates to further repeals and amendments.  Which is pretty disingenuous, as one of the soothing memes he handed out when the legislation was being rushed through Congress was that there was plenty of time to amend and fix its rough edges.  How he needs to decide if he was lying about that, as Congress addresses a rough edge that had nothing to do with health care but created a huge and largely useless burden on businesses.  I know that this provision would really kneecap my business.

Meanwhile, small businesses are staring in horror toward 2013, when the 1099 mandate will hit more than 30 million of them. Currently businesses only have to tell the IRS the value of services they purchase from vendors and the like. Under the new rules, they'll have to report the value of goods and merchandise they purchase as well, adding vast accounting and paperwork costs.

Think about a midsized trucking company. The back office would have to collect hundreds of thousands of receipts from every gas station where its drivers filled up and figure out where it spent more than $600 that year. Then it would also need to match those payments to the stations' corporate parents.

Most Democrats now claim they were blindsided and didn't understand the implications of the 1099 provision"”which is typical of the slapdash, destructive way the bill was written and passed. As the critics claimed, most Members had no idea what they were voting on.

Democrats are trying to water down this repeal:

Yesterday the White House endorsed a competing proposal from Florida Democrat Bill Nelson that would increase the 1099 threshold to $5,000 and exempt businesses with fewer than 25 workers. Yet this is little more than a rearguard action in favor of the status quo; the Nelson amendment leaves the basic architecture unchanged while making the problem more complex.

Businesses would still have to track all purchases, not knowing in advance which contractors will exceed $5,000 at the end of the year. It also creates a marginal barrier to job creation"”for a smaller firm, hiring a 26th employee would be extremely costly. The Nelson amendment also includes new taxes on domestic oil production, as every Democratic bill now seems to do.

This analysis is dead on -- our company generally cannot predict exactly how much we will purchase from a specific vendor in a year, so we would still have to collect tax ID's from every single vendor, not knowing which would cross the hurdle.

Kevin Drum Is Still Repeating This Absurd Claim About Social Security

From Kevin Drum

Bob Somerby is following the latest Social Security chatter and hopes that Paul Krugman can explain how the trust fund works in an understandable way:

The trust fund is just an accounting fiction "” a pile of worthless IOUs! Generations of voters have been misled by such skillfully-wrought presentations.

....Krugman is our most valuable player by far "” our only player at the top of the press corps. Can he disentangle the trust fund scam in a way average people will understand? We don't know, and it isn't his job; no player should be expected to carry the ball on every play from scrimmage. Tomorrow, we'll offer our own ideas at how the "there-is-no-trust-fund nonsense" might best be approached, in a way average people can follow.

Well, hell, I'll take a crack at it. Here's the simple version.

In 1983, when we last reformed Social Security, we made an implicit deal between two groups of American taxpayers. Call them Groups A and B. For about 30 years, Group A would pay higher taxes than necessary, thus allowing Group B to reduce their tax rates. Then, for about 30 years after that, Group A would pay lower taxes than necessary and Group B would make up for this with higher tax rates.

This might have been a squirrelly deal to make. But it doesn't matter. It's the deal we made. And it's obviously unfair to change it halfway through.

This is an incredible fantasy.  Absolutely no one thirty years ago (Drum dates the "deal" to 1983) explicitly or even secretly crafted any such deal.  Seriously, is Drum really positing that a Democrat-dominated Congress led by for-god-sakes Tip O'Neil really said "lets have poor people pay some of rich people's taxes for thirty years?"  Just last night I was reading a quote from Hitler late in WWII that asserted he actually let the British escape from Dunkirk on purpose because he wanted the British to know he had no real quarrel with them.  While it certainly is true Hitler never really wanted a war with Britain, this is just a self-serving rewrite of history.  Drum is doing the same thing.  Its amazing to me that an obviously intelligent person can convince himself of this.

Here is the real, simple explanation of the Social Security trust fund:  Social Security was spinning off huge piles of money and no Congress person of either the Coke or the Pepsi party could resist grabbing it and spending it in a way that would support their reelection.  They ended up spending it all.  Every bit of it, all gone.  The Social Security trust fund is the Enron 401K plan stuffed with Enron stock.

Drum gets to his bizarre theory because he believes the fiscal discipline problem over the last 30 years was all due to tax cuts rather than spending, and that all these tax cuts were for rich people.   Of course, throughout the last 30 years, the share of taxes paid for by the rich have steadily risen, so the claim is absurd on its face, but the false assumptions it is built on are ones that every progressive accept as holy writ.

This paragraph is particularly a howler:

The physical embodiment of this deal is the Social Security trust fund. Group A overpaid and built up a pile of bonds in the trust fund. Those bonds are a promise by Group B to repay the money. That promise is going to start coming due in a few years, and it's hardly surprising that Group B isn't as excited about the deal now as it was in 1983. It's never as much fun paying off a loan as it is to spend the money in the first place.

It would be some exercise to try to define groups A and B in a non-overlapping manner.  The fact is everyone is in group A, as almost everyone overpays into Social Security on a return on capital basis -- the retirement income most people get represents generally a negative net ROI on the "premiums" paid.  And it is amazing to me that I have never heard that we now have government bonds that must be paid back only by a specific sub-section of the population.  It may very well have been a progressive assumption that only rich people would be on the hook for every dollar of government debt run up over the last 30 years, but that fact will likely be a surprise to just about everyone else in the country.  Here is his conclusion:

But pay it off they must. The rich have been getting a loan from the middle class for decades...

Delusional.

Insurance Expense Ratios

One of the arguments Democrats have made for nationalized health care is that government expenses will be much lower than private companies.  This is on its face absurd, given most people's experience with government agencies, but is nominally supported by low expense ratios in Medicare.  I won't go into this today, but this is more an artifact of the way government does accounting as well as operations decisions at Medicare which may be non-optimal (e.g. Medicare does much less claims verification and investigation than private companies, which is why we see huge fraud cases from time to time).

Anyway, we get a fresh example of private vs. public expenses on a very comparable basis in California workers comp.  The public State Fund acts as an insurer of last resort as well as a competitor to many private providers.  The fact that it is an insurer of last resort will increase its loss ratios, but its expense ratios of management or "claims adjustment" expenses should be similar.  But of course they are not.

State Fund's unallocated loss adjustment expense ratio was a whopping 51.4% last year compared to 8.9% for private carriers, while State Funds allocated loss adjustment expenses were 9.8% compared to the industry's 13.8% respectively.

This means the management expense ration of the state agency is 61.2% of premiums vs. 18.7% for private companies.  This just makes laughable the pious requirement in Obamacare that insurance companies keep their expense ratios under 20% -- or else the more efficient government agency will take over.

We are facing a huge 29.6% increase in workers comp rates in California, in part because the very high State Fund expense ratios are averaged into the calculation.

Hair of the Dog?

WTF is this designed to accomplish, except to give Obama something to crow about in one or two news cycles while doubling down on the same kind of practices that got the housing market and banks into the current mess?  This reminds me so much of the final days of the government in Atlas Shrugged.  Fannie and Freddie are bankrupt?  Well, lets do the same thing to the FHA, just to save our sorry government jobs for a few weeks longer.

The Federal Housing Administration is heading toward a taxpayer bailout, yet the president's latest mortgage modification plan would further increase the agency's exposure to risky mortgages. Mark Calabria calls it a "Backdoor Bank Bailout."The administration's plan would encourage borrowers who owe more than their house is worth to refinance into FHA-insured mortgages. Therefore, the risk of a future foreclosure on these mortgages would fall to the government and taxpayers instead of private lenders.

A recent study from economists at New York University found that the FHA is underestimating its risk exposure. One of the problems is that the FHA isn't properly accounting for the risk to underwater FHA mortgages that have been refinanced into new FHA mortgages. So it's hard to see how the president's plan to refinance private underwater mortgages into FHA mortgages won't further exacerbate the situation.

Stock Up on Meeses and Gippers

The CBO, which Democrats frequently tell us to pay close attention to only when it is giving them the answers they want, is not particularly sanguine about the US budget deficit:

President Obama's fiscal 2011 budget will generate nearly $10 trillion in cumulative budget deficits over the next 10 years, $1.2 trillion more than the administration projected, and raise the federal debt to 90 percent of the nation's economic output by 2020, the Congressional Budget Office reported Thursday.

In its 2011 budget, which the White House Office of Management and Budget (OMB) released Feb. 1, the administration projected a 10-year deficit total of $8.53 trillion. After looking it over, CBO said in its final analysis, released Thursday, that the president's budget would generate a combined $9.75 trillion in deficits over the next decade.

Bruce McQuain, as always, has some good analysis.

States, apparently, are not in much better shape:

Pension plans for state government employees today report they are underfunded by $450 billion, according to a recent report from the Pew Charitable Trusts. But this vastly underestimates the true shortfall, because public pension accounting wrongly assumes that plans can earn high investment returns without risk. My research indicates that overall underfunding tops $3 trillion.

The problem is fundamental: According to accounting rules adopted by the states, a public sector pension plan may call itself "fully funded" even if there is a better-than-even chance it will be unable to meet its obligations. When that happens, the taxpayer is on the hook. Yet public pension plans ignore market risk even as they shift into risky foreign investments, hedge funds and private equity....

In a recent AEI working paper I've shown that the typical state employee public pension plan has only a 16% chance of solvency. More public pensions have a zero probability of solvency than have a probability in excess of 50%. When public pension assets fall short, taxpayers are legally obligated to make up the difference. The market value of this contingent liability exceeds $3 trillion.

Productive people in this country are about to get plastered with huge new taxes.  Hang on.

Cutting the Right Expenses

In 2003, my company was in some serious financial problems.  Post 9/11 commercial insurance premiums had just risen substantially, so much so that my premiums went up more than my total annual profits.  At the same time I found out that a number of operations I had just acquired were profitable only because they were not in compliance with labor law, and my crash program to bring them into compliance was going to put me deeply in the red for that year.

I did a whole bunch of things to right the ship, but the two most important were 1)  I eliminated a whole layer of management, slashing 5 vice-presidents and having all the front line managers report directly to me; and 2)  I eliminated the smallest and worst performing business units.

Now, contrast this to what governments do in the same situation.  Their first response, of course, is to do something I could not do - compel more revenue for themselves by increasing taxes.  Those of us who make our living by the free decision making of others don't have this dictatorial option.

The second thing that governments do is cut their MOST important, MOST valuable operations.  In Seattle, it was always fire and ambulance services that would be cut.  Because the whole game was to find the cuts that would most upset the public to try to avoid the necessity of having to make cuts at all.  Its an incredibly disingenuous process.  Any staffer of a private company that made cost savings prioritization decisions like government officials would be fired in about 2 minutes.

The third thing that governments do if forced to actually, really cut costs (meaning that every other stalling tactic, taxation method, and accounting trick has been exhausted) is to cut field staff who actually do the work rather than high-paid, bloated administrative staffs.  This means teachers get cut but not vice-principals.  And it means that preventative maintenance gets cut and not transit staffers:

Having removed a mere 25 employees so far, and having just suffered its deadliest year ever, Metro officials now want to raid $10 million from the agency's preventive maintenance fund in order to cover operating expenses, including salaries and benefits. Metro managers would rather skimp on passenger safety and reliability than clear out the system's deadwood and force serious concessions by the transit union.

Moreover, even as it asks riders to sacrifice, Metro is fattening itself up, hiring two new "senior planners," one to a newly created position. According to Metro's official job description, they will be "responsible for participation in the development of an annual business plan ... identifying opportunities for future growth and development" and "defining future strategies."

Life Support for Government

I have warned about this before:

In fact, Hollywood's portion of the stimulus package reveals an important factor of the Recovery Act: The money is not going to areas that would more directly stimulate the economy but instead to provide ongoing life support to deficit-ridden federal, state and local agencies.

That is the main impression I have gotten when reading the stimulus jobs data base -- the fake districts and BS accounting did not catch my eye so much as the fact that all the jobs seemed to  be saved jobs in government agencies.  I am pretty sure that had the stimulus been originally sold with its true goals -- to help stave off financial accountability in state and local governments -- it would have had more difficulty passing.

Though some of us saw this even in the bill itself (this blog, Jan 27, 2009)

So do you see my point. The reason so much of this infrastructure bill can be spent in the next two years is that there is no infrastructure in it, at least in the first two years!  42% of the deficit impact in 2009/2010 is tax cuts, another 44% is in transfer payments to individuals and state governments.  1% is defense.  At least 5% seems to be just pumping up a number of budgets with no infrastructure impact (such as at Homeland Security).  And at most 6% is infrastructure and green energy.  I say at most because it is unclear if this stuff is really incremental, and much of this budget may be for planners and government departments rather than actual facilities on the ground.

Because Minor Drug Cases Weren't Clogging the Courts Enough

The civil courts of Maricopa County (which includes Phoenix) are being overwhelmed by photo-radar cases from state photo-radar trucks on state highways.

In the 2008 fiscal year, ending June 2008, the total annual filings in the justice courts amounted to 435,014, which included DUI, traffic, misdemeanor and civil cases, according to the county. Since November 2008, speed-camera cases have flooded the justice courts, averaging 42,326 cases a month, accounting for 50 percent of the filings. Administrators for the justice courts expect the total might reach 600,000 this fiscal year.

Of course the solution proposed is not to get rid of the photo radar but to raise fees to cover the administration.  But you could have guessed that without me telling your, couldn't you?

Answer: Zero

Here is the question:  In estimating the number of net jobs created by the stimulus package, how many jobs did the Administration assume were lost when hundreds of billions of dollars were pulled out of private hands and distributed by public authorities?

And the answer to that question is just one reason the analysis is absurd.  I have seen a lot of good critiques about accounting in the jobs numbers.  But the biggest single problem is that it is assumed that the trillion dollars Obama has pulled out of private capital markets (via deficit spending) wasn't really doing anything productive, so that redirecting it into pork-barrel programs chosen by Congress based on their campaign donor lists and run by government bureaucrats would use the money much better.

Anyone believe this?  So why have I not seen a single reporter ask the question, "But how many jobs were lost from where these funds were taken?"  Just because they are invisible or hard to count does not mean they don't exist.

Survey on US Migration to IFRS

Tom Selling and Pat Walters are looking for participation in their survey on issues related to IFRS (international accounting rules) and their migration to the US.  Folks knowledgeable about these issues, either from the accounting or management side, are encouraged to participate.  Tom wrote this invitation:

This is a brief announcement of an online IFRS survey that I have prepared with Pat Walters of Fordham University.

I invited Pat to collaborate with me because we have divergent views on the questions being asked.  Thus, I hope that together we have achieved a modicum of balance in the survey's design--particularly in the phrasing of the questions and response choices offered.  There are only 12 multiple-choice questions, and afterwards, I cordially invite you to express your own opinions regarding its design by posting a comment to this blog post.

We are also trying to reach many more stakeholders than any other survey has reached to-date on the IFRS adoption/convergence question.  To that end, we hope you will choose to email the link at the bottom of this post to anyone else whom you think might have an interest in taking it.

Pat and I thank you in advance for clicking here to take the survey, or by pasting this ugly link in your web browser:

http://www.surveymonkey.com/s.aspx?sm=pF0E3UgdSV_2bHMQvdAnXv8w_3d_3d

Totally Inconsistent

Two excerpts from Obama's speech:

That's why under my plan, individuals will be required to carry basic health insurance "“ just as most states require you to carry auto insurance.

Oh, jeez, I sure wish that were true.  Auto insurance covers only catastrophic damages, such as totaling your car or incurring serious liability by hurting someone.   It does not cover regular repairs, preventative maintenance, etc.  Also, state-mandated auto insurance has a range of coverage caps -- if you want a higher cap, you can pay for it.  No one expects their company to pay their auto insurance, and if a company were to provide it it would be considered a taxable benefit.  Compared to our current health insurance system, auto insurance-like health insurance would be a brilliant improvement.  Despite his making this analogy, this is absolutely NOT what he is suggesting.  Also from his speech:

Under this plan, it will be against the law for insurance companies to deny you coverage because of a pre-existing condition. As soon as I sign this bill, it will be against the law for insurance companies to drop your coverage when you get sick or water it down when you need it most. They will no longer be able to place some arbitrary cap on the amount of coverage you can receive in a given year or a lifetime. We will place a limit on how much you can be charged for out-of-pocket expenses, because in the United States of America, no one should go broke because they get sick. And insurance companies will be required to cover, with no extra charge, routine checkups and preventive care, like mammograms and colonoscopies

Update: OK, here is another good pairing, from the same source -- first, he says that a public option will not be subsidized:

They argue that these private companies can't fairly compete with the government. And they'd be right if taxpayers were subsidizing this public insurance option. But they won't be. I have insisted that like any private insurance company, the public insurance option would have to be self-sufficient and rely on the premiums it collects.

But then he makes this comparison:

It would also keep pressure on private insurers to keep their policies affordable and treat their customers better, the same way public colleges and universities provide additional choice and competition to students without in any way inhibiting a vibrant system of private colleges and universities.

See?  The public option will not be subsidized and will work just like public universities which are highly subsidized.

By the way, it is almost impossible for government NOT to subsidize such an entity, in part because of the way government accounting differs from private accounting.  Government accounting is on a cash basis, so large up front investments show as a first year loss with no future expense implications.  In operation, it means capital spending is pretty much free.  And numerous charges that private firms take on, such as liability insurance, are not charged for on government books.   I compete with the government a lot, and have investigated this dynamic in depth.  Even why my costs are lower, the government, because of the way it accounts for things, often thinks its costs are much lower than mine and they under-price us.

The 93% Subsidy

I wondered today what kind of subsidy a rider on the Phoenix Light Rail system was receiving.  Hillary Foose, the public information officer of Metro light rail, was kind enough to send me a link to this board presentation.   Since the rail system opened mid-fiscal year, I will use their own projections for the 2009/2010 fiscal year.

Public accounting is a pain in the butt for someone used to private finances, because it is all cash accounting rather than accrual and they mix together capital expenditures with operating expenditures.  But the table on page 62 carves out the operating budget for the existing 20-mile line from the development and capital budgets.    Here are the key numbers:

Fare Revenue:  $8,985,159

Operating Expenses:  $33,733,168

So already on an operating basis we have a 73% subsidy.  But we have sunk $1.4 billion of capital money into building the line  (actually this is a little low as Metro has spent tens of millions more this year).  Unfortunately, in government accounting, there is no depreciation or interest charge that shows up.   So I am going to charge them with the payment on a 30-year $1.4 billion 5% note, which would be just over $91 million a year.

Totaling the $91 million with the other operating expenses, we get a 93% subsidy for light rail.  This means the true cost of the $1.75 ticket for a light rail ride is actually $25!  METRO says that light rail riders love the service.  I should think anyone who gets a $25 service for $1.75 should be happy.

Another way to look at the subsidy is on a per rider basis.  So far, METRO has averaged about 17,000 round trip riders per weekday (based on about 34,000 boardings per day).   The $115.8 million annual subsidy (capital+expense minus revenues) works out to just over $6,800 per rider per year that the rest of us (who may not live or work near the line**) pay each current rider.

There are a number of ways in which I have likely understated the subsidy:

  1. I used their June revenue projections, which likely will continue to be revised downwards as ridership continues to slump
  2. I used their own expense projections, and we know how often governmental bodies hit their expense numbers
  3. I assumed no new capital spending necessary over a 30 year life.  Rail experience has shown this to be overly-optimistic.  Rail lines have to be rebuilt every 15-20 years or so.  They take tons of capital maintenance dollars.   When we look back twenty years from now, we'll likely come to the conclusion I grossly understated the capital charge.

**Footnote: Since over a third of the capital to build the line came from the Feds, many of the people subsidizing the METRO riders don't even live in this state.

Update: The other thing I left out is lost parking revenue.  The revenue numbers for fares is in fact overstated.  It should net out lost parking revenues, for example at baseball games.  This is the only time I ride the Metro, because I substitute a $2.75 Metro round trip ticket for a $10 city garage parking expense.  But the city has never acknowledged this cannibalization.

Update #2: I have posted an update here

Being Slower and More Beauracratic Than GM Can't Be Good

One of the reasons GM entered bankrupcy was that its slow and ponderous beauracracy couldn't handle the pace of the modern marketplace.  But one thing even than beauracracy could do was produce dealer rebate checks in a timely manner.  When many of your dealers are running on only a thin cash flow margin, even GM knew it was important to get rebate checks to dealers quickly.

So it is a bad sign that the government, who wants to run the auto industry, the banking industry and soon the health care industry, can't seem to process checks in a timely manner:

Some New Mexico auto dealers have backed out of the cash-for-clunkers program and more may do so as the federal government takes its time providing cash reimbursements.

Dealers across the state are owed more than $3.6 million, according to a dealers' group which says that so far Uncle Sam has only written three checks totaling about $14,000....

Dealerships put up the cash for the rebates after being told by the Obama administration they would be paid back within 10 days of the sale.

And here:

Hundreds of auto dealers in the New York area have withdrawn from the government's Cash for Clunkers program, citing delays in getting reimbursed by the government, a dealership group said Wednesday.The Greater New York Automobile Dealers Association, which represents dealerships in the New York metro area, said about half its 425 members have left the program because they cannot afford to offer more rebates. They're also worried about getting repaid....

Schienberg said the group's dealers have been repaid for only about 2 percent of the clunkers deals they've made so far.

Many dealers have said they are worried they won't get repaid at all, while others have waited so long to get reimburse

The problems cited in other analyses are two that I see all the time in dealing with the government:

  1. Obsession with minute paperwork errors, and rejection of applications for the smallest errors.  For a variety of reasons, government clerks in this kind of program seldom have the knowledge, the incentives, or even the ability to parse between errors and omissions that matter and errors and omissions that are irrelevant.   In fact, if the same application comes back 5 times, that's just more job security.  I have discussed this a number of times, as state liquor license boards have rejected our applications repeatedly for ridiculously small, meaningless errors (here and here, for example)

    Here is my prediction:  You will soon see someone inside the government blaming the dealers, saying it is all because they are not following the 300-page process correctly or not filling out the forms correctly.

  2. Absolute unwillingness to write a check.  Some of you know that I am in the odd position of being a libertarian who does a lot of business with the government, a result of my effort to privatize the operation of public recreation.  I am in the position of sometimes paying the government money (I typically don't get paid to operate a facility, I operate it for profit and pay the government a rent or concession fee) and sometime in the position of getting paid.  The government always demands all of its money owed to it well in advance (think of withholding, where you pay the government your taxes months before the true April 15 deadline).  The government only pays in arrears, and sometimes well in arrears.  Last winter, my funding troubles (when my bank holding my line of credit went bust) were aggravated by the fact that the government took 15 months to pay us $175,000 they owed us, at the same time it demanded an additional $500,000 in advance rent payments on the next year.

By the way, since every post related to the government this month must be related to health care in some way, what they government is doing on cash for clunkers is highly related to the difference in overhead costs between Medicare and private insurance companies.

The cash for clunkers processing is taking a long time in part because the government is worried about fraud and wants to make sure every car it pays out on was really qualifying and destroyed properly.  This takes time and manpower and overhead.  But this is exactly what private medical insurance companies spend their overhead on -- making sure that claims are real and justified and are not padded.  Medicare has lower overhead costs, in part because of government accounting hides some overhead, but in part because Medicare does not do any due diligence before it cuts a check.  It gets a form, it sends out a check.  It does little checking to see if the claim is real.

Government and Regulation

One argument about regulation that seems to be gaining traction through the recent financial crisis is "See, private action and enterprise is not infallible.  They can make mistakes that have costs for everyone.  Therefore they need to be regulated." 

I don't have time for the full refutation of this, but a few thoughts:

  • No one ever said that private actors in the economy are infallible or even universally honest.  However, no one has ever been able to make the case that government employees are any more infallible or honest. 
  • There are a couple of reasons government regulators are going to be demonstrably worse than the marketplace in making decisions.  The first is information -- a few actors in Washington can never have the same access to information as thousands of actors across the country or around the world.  The second is incentives -- while regulatory hawks cite private greed as a bad incentive in the marketplace, bureaucratic incentives can be at least as problematic.
  • Governments are subject to all sorts of rent-seeking initiatives, not to mention regulatory capture, that undermine regulatory effectiveness.  Just look at the bailout bill. Wooden arrows?

For some reason, the argument "private actors screwed up" seems sufficient justification for regulation.  The burden of proof should instead be "the government could have done better."

Here is a nice example of how regulation really works, from an interview with Warren Buffett:

QUICK: If you imagine where things will go with Fannie and Freddie, and
you think about the regulators, where were the regulators for what was
happening, and can something like this be prevented from happening
again?

Mr. BUFFETT: Well, it's really an incredible case study in regulationbecause
something called OFHEO was set up in 1992 by Congress, and the sole job
of OFHEO was to watch over Fannie and Freddie, someone to watch over
them. And they were there to evaluate the soundness and the accounting
and all of that. Two companies were all they had to regulate. OFHEO has
over 200 employees now. They have a budget now that's $65 million a
year, and all they have to do is look at two companies. I mean, you
know, I look at more than two companies.

QUICK: Mm-hmm.

Mr.
BUFFETT: And they sat there, made reports to the Congress, you can get
them on the Internet, every year. And, in fact, they reported to
Sarbanes and Oxley every year. And they went--wrote 100 page reports,
and they said, 'We've looked at these people and their standards are
fine and their directors are fine and everything was fine.' And then
all of a sudden you had two of the greatest accounting misstatements in
history. You had all kinds of management malfeasance, and it all came
out. And, of course, the classic thing was that after it all came out,
OFHEO wrote a 350--340 page report examining what went wrong, and they
blamed the management, they blamed the directors, they blamed the audit
committee. They didn't have a word in there about themselves, and
they're the ones that 200 people were going to work every day with just
two companies to think about. It just shows the problems of regulation.

The problem, of course, is that Fannie and Freddie were doing exactly what Congress wanted them to do -- systematically lowering mortgage underwriting standards.  They won't put it that way now, but that is  what spreading home ownership to lower income families really amounted to.