Coyote Blog

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.

I haven't posted at all on the brouhaha about mark-to-market accounting of derivatives and whether it was a contributor to the recent financial mess.  If I had to summarize the issue, I would describe it thus:  Investors want something more trustworthy than just management estimates of the value of complex securities -- so they would like an outside market-based reference point -- but the very complexity that makes these contracts hard to value as an outsider also tends to make their markets illiquid and volatile, making it difficult to get a good market value. 

Tom Selling addresses the problem of accounting for the value of credit default swaps here.  He makes what seems to me to be a common sense suggestion:

Requiring the asset and liability sides of derivatives to be separately
measured and reported seems like an amazingly simple fix that could
simplify regulation of the financial and insurance industries, reduce
the need for the disclosures in financial statements written so as to
discourage one from reading them, and help investors more easily assess
risk.

This certainly seems reasonable to me.  When one buys a revenue producing asset with debt financing, the two are listed separately as an asset and a liability, rather than as one "net" asset, even though they may be inextricably linked (say if the asset is collateral for the loan and the loan has high pre-payment penalties).  Any thoughts?  Does this make sense, or is it naive?

While I am not happy to see a historic company go bankrupt, and have vague but unspecific worries about some kind of general cascading financial problem, I am happy to see the government let Lehman go bankrupt without any sort of special intervention or bailout for a number of reasons:

• Bailouts create awful incentives for other large companies managing their risk portfolios
• I know many small business people who have gone bankrupt, and I once lost my job in a company bankruptcy.  There is no reason Lehman equity holders and managers should be immune from the same process just because their company is large and old. 
• Lehman's management has failed to get a positive return from the assets in their care.  A bailout only keeps these assets under the same management.  A bankruptcy puts these assets in the hands of new parties who hopefully can do a better job with them. 
• I strongly suspect that the hole in Lehman's balance sheet from underwater assets like certain mortgages is large compared to its equity but small compared to its total assets.  If this is true, equity holders will end up with nothing, but most creditors should come out close to whole when everything is unwound.

Like Megan McArdle, I found Obama's recent reaction to the Lehman bankruptcy to be wrong-headed but unsurprising.  Obama is blaming recent financial problems on an overly laissez faire approach by GWB in general (LOL,that's funny) and a lack of strong enforcement by the SEC in particular. 

But one has to ask, what laws were not enforced?  My sense is that these are all perfectly lawful portfolios of mortgages in which the one mistake was systematically being too generous in giving out credit.  Mr. Obama's party has always been a strong advocate of pushing banks to be more generous with credit, particularly to the poor, and of promoting home ownership as a national goal.  If anything, financial institutions are struggling because they were too aggressive in these goals.  McArdle writes:

This was not some criminal activity that the Bush administration should
have been investigating more thoroughly; it was a thorough, massive, systemic
mispricing of the risk attendant on lending to people with bad credit.
(These are, mind you, the same people that five years ago the Democrats
wanted to help enjoy the many booms of homeownership.) Lehman, Bear,
Merrill and so forth did not sneakily lend these people money in the
hope of putting one over on the American taxpayer while ruining their
shareholders and getting the senior executives fired.  They got it
wrong.  Badly wrong.  So did everyone else.

It appears from further Obama statements talking about lack of enforcement for predatory lending laws that the Democrats want to get back on the rollercoaster of whipsawing banks between charges of redlining (you are not lending enough to the poor) and predatory lending (you are lending too much to the poor).

Postscript:  While in retrospect there may turn out to have been laws broken, in situations like this, particularly when a management team is trying to head off a liquidity crisis, these tend to be of the reporting and disclosure ilk.  We saw back during the Enron failure that people tend to assume law-breaking of some sort to be the cause of a major bankrupcy or collapse, and to satisfy this notion the government aggresively pursued Enron executives.  But nothing for which Enron was prosecuted had anything to do with their failure -- all the violations were about disclosure and accounting methodologies.  The company would have still crashed, probably faster, without these violations.

Update:  More here

Due to the very nature of political pressures as well as poor accounting, a lot of government services are provided to the public below their true cost or market clearing price  (there are exceptions, like intra-city mail, but in these cases the government must pass laws to prevent private competition in order to maintain its market share).  When the government provides these below-cost or below-market-price services, it tends to crowd out private options.  So I am wondering why Kevin Drum is so surprised:

I guess rescuing them was the right thing to do. I'm still a little
taken aback by the apparent fact that American banks are now almost
flatly unwilling to make mortgage loans unless they're backed by Fannie
or Freddie, but that seems to be the case whether it takes me aback or
not. So rescue them we must. I suppose my next question is whether it's
worth thinking about how to restructure the American home mortgage
industry so that it can operate efficiently even in the absence of
massive levels of government backup. Or is Fannie/Freddie style backup
just the way the world works these days and there's no point fussing
over it?

As evidenced by the current bailout (and their huge accretion in market share over the last several years), Fannie and Freddie were under-pricing the service they were providing.  So of course, all things equal, bankers will demand the Fannie/Freddie backing because that will be a more profitable product and will be less work for the banker.  This seems like a "duh" kind of thing.  Like the "mystery" of why in Massachussetts, while everyone is obligated to sign up for health insurance, only the ones who were eligeable for free coverage did so.

I have written before of a similar phenomenon in business loans, where loans with SBA backing have crowded out everything else out there, such that a small business really can't find a lender who will make small business loans except with SBA backing.  Bankers are people too, and they can get lazy.  They have come to rely on these government programs, but certainly the lending function would still exist in a robust form if these programs did not exist.  Bankers would have to find other risk-mitigation tools, or else the loans would be more expensive, reflecting that the banks could not get rid of all the risk and had to price that into the loan.

By the way, don't you love the technocratic hubris of "thinking about how to restructure the American home mortgage
industry so that it can operate efficiently even in the absence of
massive levels of government backup."  Why do I, or Drum, or anyone outside of banking have to think about this at all?  I don't personally know the best private alternative to government mortgage gaurantees.  So what?  The financial field has been rife with innovation over the last several decades.  Just remove the government backup and let the the banks figure it out.  And let them go bankrupt when they figure wrong.

Postscript: As an ironic aside, the bank that holds my SBA loans was closed by the FDIC last week, my guess is due to a bad mortgage book in the Las Vegas area.  This doesn't have a lot of impact on me except that as I have paid down my loans, they became wildly overcollateralized, and I was in the process of trying to renegotiate some of my collateral out of the deal.  That will have to be put on hold, I guess.

Update:  More on government crowding out private options, in an entirely different industry:

Basic
dental care in Britain is free to those under 16 or over 60, the
unemployed, students, military veterans and some low-income families.
For others, government dentists offer lower prices than private
practitioners.

However,
the government does not cover cosmetic dentistry, and a recent
reorganization of the way dentists work has prompted many to leave the
public sector. Katherine Murphy, a spokeswoman for The Patients
Association, an advocacy group, said it was proving increasingly
difficult for Britons to get anything beyond basic dental care from
Britain's National Health Service.

Update #2: More on Fannie and Freddie, again via Rick Perry:

The
Fannie Mae-Freddie Mac crisis may have been the most avoidable
financial crisis in history. Economists have long complained that the
risks posed by the government-sponsored enterprises were large relative
to any social benefits.

We
now realize that the overall policy of promoting home ownership was
carried to excess. Even taking as given the goal of expanding home
ownership, the public policy case for subsidizing mortgage finance was
weak. The case for using the GSEs as a vehicle to subsidize mortgage
finance was weaker still. The GSE structure serves to privatize profits and socialize losses.
And even if one thought that home ownership was worth encouraging,
mortgage debt was worth subsidizing, and the GSE structure was viable,
allowing the GSEs to assume a dominant role in mortgage finance was a
mistake. The larger they grew, the more precarious our financial
markets became.

Via TJIC:

Harvard plans to sharply reduce its greenhouse gas emissions in the
next eight years, Drew Faust, the university president, said.

The initial, short-term goal for the university will be to
reduce greenhouse gas emissions by 30 percent from a 2006 baseline by
2016, Faust said yesterday in a statement.

In the winter of 1990, my Harvard-owned apartment had its heating fail.  I called the administration for weeks before anyone would show up to look at it.  By this time, I actually had ice on the inside of my window panes.  Walking into my freezing apartment, a maintenance guy placed a thermometer in the center of my room, and then just stood there staring at it for 5 minutes.  At this point he had not asked me about my problem, nor looked at anything remotely connected with the heating system.

He suddenly sprung into action, looked at the thermometer, and started to walk out of the room.  "Wait," I said.  "What is wrong?  Do you know how to fix it?"  The Harvard maintenance guy says "Your room is only 53 degrees -- by state law we don't have to do anything unless it is below 50.*"  And then he walked out, with me screaming at his back.  Only when I sent a letter to the University, copied to the fire marshal, explaining that all was well because I found the room stayed pretty warm if I kept the oven on "broil" 24 hours a day and left the oven door open all the time, did I get any action to fix my heating.

It is scary to think that a university so reluctant to spend any money on heating rooms even 20 years go now wants to reduce its energy use by 30%. 

Of course, we all know how these things work:  creative accounting.  The Enron guys were saints compared to the accounting games played in the carbon accounting and offset world.  Harvard will probably say that "Well, we were planning to build a massive coal-powered electricity plant right in the middle of Harvard Yard, and by cancelling the project, we have reduced our emissions 30% over what they would have been and therefore made our goal.  Don't laugh - the UN and EU are doing EXACTLY this every day.

* Note that I cannot remember the exact legal standard quoted to me, but I think it was 50.

For about all of history, a large part of tax management has been in deferring recognition of income.  Everything being equal, its better to pay taxes further in the future, given the lower present value of deferred taxes.

This year is different.  As I talk to many other folks who run their own business, many are using every accounting trick in the book to pull income forward, into this year.  Why?  The reasoning is here.  Many folks are betting that their marginal tax rate will be going way up next year.  I know I will be drawing down every reserve and deferring every expense I can find to pull income into this year from next.

James Hansen, NASA climate scientist and lead singer in the climate apocalypse choir, responded to his  temperature data revisions a week ago:

What we have here is a case of dogged contrarians who
present results in ways intended to deceive the public into believing
that the changes have greater significance than reality. They aim to
make a mountain out of a mole hill. I believe that these people are not
stupid, instead they seek to create a brouhaha and muddy the waters in
the climate change story. They seem to know exactly what they are doing
and believe they can get away with it, because the public does not have
the time, inclination, and training to discern what is a significant
change with regard to the global warming issue.

The proclamations of the contrarians are a deceit

Um, whatever.  Remember, this is the man who had large errors in his data set, used by nearly every climate scientist in the world, for years, and which were only recently discovered by Steven McIntyre (whom Hansen refuses to even name in his letter).  These errors persisted for years because Mr. Hansen refuses to allow the software and algorithms he uses to "correct" and adjust the data to be scrutinized by anyone else.  He keeps critical methodologies that are paid for by we taxpayers a secret.  But it is his critics who are deceitful? 

In particular, he is bent out of shape that critics' first presented the new data as a revised ranking of the hottest years rather than as a revised line graph.  But it was Hansen and his folks who made a big deal in the press that 1998 was the hottest year in history.  It was he that originally went for this sound byte rather than the more meaningful and data-rich graph when communicating with the press.  But then he calls foul when his critics mimic his actions?  (Oh, and by the way, I showed it both ways).

Hansen has completely ignored the important lessons from this experience, while focusing like a laser on the trivial.  I explained in detail why this event mattered, and it was not mainly because of the new numbers.  In short, finding this mistake was pure accident -- it was a bit like inferring that the furniture in a house is uncomfortable solely by watching the posture of visitors leaving the house.  That's quite an deductive achievement, but how much more would you learn if the homeowners would actually let you in the house to inspect the furniture.  Maybe its ugly too.

So why does Hansen feel he should be able to shield himself from scrutiny and keep the details of his database adjustments and aggregation methodology a secret?  Because he thinks he is the king.    Just read his letter:

The contrarians will be remembered as court jesters. There is no point
to joust with court jesters. "¦ Court jesters serve as a distraction, a
distraction from usufruct. Usufruct is the matter that the captains
wish to deny, the matter that they do not want their children to know
about.

Why do we allow this kind of secrecy and spurning of scrutiny in science?  Is it tolerated in any other discipline?

Steve McIntyre has his response here.  McIntyre still has my favorite comment ever about Hansen and his gang:

While acolytes may call these guys "professionals", the process of
data adjustment is really a matter of statistics and even accounting.
In these fields, Hansen and Mann are not "professionals" - Mann
admitted this to the NAS panel explaining that he was "not a
statistician". As someone who has read their works closely, I do not
regard any of these people as "professional". Much of their reluctance
to provide source code for their methodology arises, in my opinion,
because the methods are essentially trivial and they derive a certain
satisfaction out of making things appear more complicated than they
are, a little like the Wizard of Oz. And like the Wizard of Oz, they
are not necessarily bad men, just not very good wizards.

Update:  If you have a minute, read Hansen's letter, and then ask yourself:  Does this sound like what I would expect of scientific discourse?  Does he sound more like a politician or a scientist?

Steve McIntyre, the statistician than called into question much of the methodology behind the Mann Hockey Stick chart, has some observations on adjustments to US temperature records I discussed here and here.

Eli Rabett and Tamino have both advocated faith-based climate
science in respect to USHCN and GISS adjustments. They say that the
climate "professionals" know what they're doing; yes, there are
problems with siting and many sites do not meet even minimal compliance
standards, but, just as Mann's "professional" software was able to
extract a climate signal from the North American tree ring data, so
Hansen's software is able to "fix" the defects in the surface sites.
"Faith-based" because they do not believe that Hansen has any
obligation to provide anything other than a cursory description of his
software or, for that matter, the software itself. But if they are
working with data that includes known bad data, then critical
examination of the adjustment software becomes integral to the
integrity of the record - as there is obviously little integrity in
much of the raw data.

While acolytes may call these guys "professionals", the process of
data adjustment is really a matter of statistics and even accounting.
In these fields, Hansen and Mann are not "professionals" - Mann
admitted this to the NAS panel explaining that he was "not a
statistician". As someone who has read their works closely, I do not
regard any of these people as "professional". Much of their reluctance
to provide source code for their methodology arises, in my opinion,
because the methods are essentially trivial and they derive a certain
satisfaction out of making things appear more complicated than they
are, a little like the Wizard of Oz. And like the Wizard of Oz, they
are not necessarily bad men, just not very good wizards.

He goes on to investigate a specific example the "professionals" use
as a positive example, demonstrating they appear to have a Y2K error in
their algorithm.   This is difficult to do, because like Mann, government scientists maintaining a government temperature data base taken from government sites paid for with taxpayer funds refuse to release their methodology or algorithms for inspection.

In the case cited, the "professionals" also make adjustments that imply the site has
decreasing urbanization over the last 100 years, something I am not
sure one can say about any site in the US except perhaps for a few
Colorado ghost towns.  The "experts" also fail to take the basic step of actually analyzing the site itself which, if visited, would reveal recently installed air conditioning unites venting hot air on the temperature instrument.   

A rebuttal, arguing that poor siting of temperature instruments is OK and does not affect the results is here.  I find rebuttals of this sort really distressing.  I studied physics for a while, before switching to engineering, and really small procedural mistakes in measurement could easily invalidate one's results.  I find it amazing that climate scientists seek to excuse massive mistakes in measurement.  I'm sorry, but in no other branch of science are results considered "settled" when the experimental noise is greater than the signal.  I would really, really, just for once, love to see a anthropogenic global warming promoter say "well, I don't think the siting will change the results, but you are right, we really need to go back and take another pass at correcting historical temperatures based on more detailed analysis of the individual sites."

Five years from now, one issue is going to dominate the news on the state and local level.  It's not going to be civil marriages or abortion of light rail.  It's going to be unfunded pension liabilities.  Nearly every city, county, and state government body has promised over-generous pensions to millions of their employees, and almost none of them have been putting any money aside to fund these future liabilities (unlike those evil and untrustworthy private companies, who may not always put enough aside but are at least doing something).

Most of us know that the government uses accounting methods and practices that would put private individuals in jail.  For example, Enron managers have gone to jail for accounting practices that allegedly attempted to hide liabilities and keep them off financial statements.  The government does this all the time, and routinely. 

Over the next few years, the GASB will require that governmental bodies reveal the size of these unfunded liabilities.  And you heard it here first, the numbers are going to be MASSIVE.  I am almost sure that the numbers will dwarf the shortfalls in Social Security and maybe Medicare as well.  Anyone want to be that politicians will propose to close these gaps by intelligent spending cuts rather than new taxes?  HAH!

From Cato@Liberty:

A common criticism of Social Security choice
(and defense of the Social Security status quo) is that there
are dishonest actors in private markets who would put people's private
account assets at risk of (in the words of the AFL-CIO) "corruption, waste and Enron-ization." These critics argue that society is much better off keeping Social Security in the honest, benevolent hands of Uncle Sam.

What must these critics be thinking about today's NYT above-the-fold article on teacher pension fund shenanigans in New Jersey? The lede says it all:

In 2005, New Jersey
put either $551 million, $56 million or nothing into its pension fund
for teachers. All three figures appeared in various state documents "”
though the state now says that the actual amount was zero.

Like many state and local government pension systems,
New Jersey's is woefully underfunded compared to the benefits it will
have to pay in the future. (This situation will make headlines in the
coming years, as state and local governments begin to disclose their
pension fund and retirement benefit system shortfalls in accordance
with a recent GASB
requirement.) In New Jersey's case, the shortfall is more than has been
publicly acknowledged, however: "an analysis of its records by The New
York Times shows that in many cases, New Jersey has overstated even
what it has claimed to be contributing, sometimes by hundreds of
millions of dollars."

From Marginal Revolution:

The FASAB has asked
that the United States government start including future Medicare and
Social Security liabilities in current budget deficit figures:

Monday,
the Federal Accounting Standards Advisory Board released a proposal in
which the government would have to account for the cost of future
Social Security payments year by year as people build up entitlements.

Seen in advance of its release by the Financial Times, the switch in
accounting practices would be an international accounting anomaly, as
most other governments treat social insurance as a political commitment
to pay future benefits rather than a financial liability, the newspaper
said.

The FASAB is made up of six independent members who support the
proposal and three opposing members from the U.S. Treasury, the White
House Office of Management and Budget and the Government Accountability
Office.

I support this change despite the fact it may result in what I consider bad outcomes (e.g. big tax increases) as the magnitude of future liabilities become clear.  Tyler Cowen also argues it may make these programs harder to scale back, since it shifts the future payments from a political promise to a financial commitment.  But just like free speech, one has to be consistent in one's support for transparency.

If this all seems arcane to you, let me give you some perspective.  Today, Jeff Skilling was given over 30 years in jail for various accounting-related frauds, supposedly hiding losses and liabilities from shareholders's view.  But what Skilling was convicted of doing were minor, subtle accounting tricks involving penny-ante sums of money compared to the egregious games Congress plays with accounting for the federal government's future liabilities.  Skilling was accused, for example, of booking future liabilities in certain joint ventures where they were hard to find; the feds, in contrast, do not book future liabilities at all.

More than any subject on Coyote Blog, my immigration posts have engendered more disapproving comments than anything else I have written.  I won't repeat my position except to say that I don't care if immigration is currently illegal, because my point is that it should be legal.  In short, my stance has been that our rights do not flow from the government but from our basic humanity, and therefore activities like association, employment decision-making, and property purchase should not be contingent on citizenship.  Its one of those arguments where I wish many on my side of the argument would shut up -- If the best argument you can muster for immigration is 'who will pick the lettuce', you are not helping very much. 

For the first 150 years of this country's history, our country was basically wide-open to immigration.  Sure, there were those opposed (the riots in NYC in the 19th century come to mind) but the opposition was confined mainly to xenophobes and those whose job skills were so minimal that unskilled immigrants who could not speak English were perceived as a threat.   It was only the redistributionist socialism-lite of the New Deal and later the Great Society that began to make unfettered immigration unpopular with a majority of Americans, who rightly did not wish to see the world's poor migrate to the US seeking an indolent life of living off of government handouts.

But, as Congress debates a series of immigration plans that make not sense and don't seem internally consistent, I will propose my own.  I hope that this plan will appeal to those who to date have opposed immigration because of the government handout problem.  I am sure it will continue to be unappealing to those who fear competition in the job market or who don't like to be near people who don't speak English very well.  This is an elaboration of the plan from this post:

1. Anyone may enter or reside in the US. The government may prevent entry of a very short list of terrorists and criminals at the border, but everyone else is welcome to come and stay as long as they want for whatever reason.  Anyone may buy property in the US, regardless or citizenship or residency.  Anyone in the US may trade with anyone in the world on the same terms they trade with their next door neighbor.
2. The US government is obligated to protect the individual rights, particularly those in the Bill of Rights, of all people physically present in our borders, citizen or not.  Anyone, regardless of citizenship status, may buy property, own a business, or seek employment in the United States without any legal distinction vs. US "citizens"
3. Certain government functions, including voting and holding office, may require formal "citizenship".  Citizenship should be easier to achieve, based mainly on some minimum residency period, and can be denied after this residency only for a few limited reasons (e.g. convicted of a felony).  The government may set no quotas or numerical limits on new citizenships.
4. All people present in the US pay the same taxes in the same way.  A non-citizen or even a short term visitor pays sales taxes on purchases and income taxes on income earned while present in the US just like anyone else.  Immigrants will pay property taxes just like long-term residents, either directly or via their rent payments.
5. Pure government handouts, like Welfare, food stamps, the EITC, farm subsidies, and public housing, will only be available to those with full US citizenship.  Vagrancy and squatting on public or private lands without permission will not be tolerated.
6. Most government services and fee-based activities, including emergency services, public education, transportation, access to public recreation, etc. will be open to all people within the US borders, regardless of citizenship status, assuming relevant fees are paid.
7. Social Security is a tough beast to classify - I would put it in the "Citizen" category as currently structured (but would gladly put it in the "available to everyone" category if SS could be restructured to better match contributions with benefits, as in a private account system).  But, as currently configured, I would propose that only citizens can accrue and receive SS benefits.  To equalize the system, the nearly 8% employee and 8% employer social security contributions will still be paid by non-citizens working in the US, but these funds can be distributed differently.  I would suggest the funds be split 50/50 between state and local governments to offset any disproportionate use of services by new immigrants.  The federal portion could go towards social security solvency, while the state and local portion to things like schools and medical programs.

With this plan, we return to the America of our founding fathers, welcoming all immigrants who are willing to take the risk of coming here.  We would end the failed experiment of turning citizenship from a voting right into a comprehensive license that is required to work, own property, or even associate and be present within the US border.  Since immigrants today who are "illegal" pay no income or social security taxes into the system today (they do pay sales and, via rent, property tax), this plan would increase tax revenues while reducing some welfare state burdens.

I think if you asked many prospective immigrants, they would agree to this deal - no handouts, just a fair chance to make a living and a life.  However, immigrant advocacy organizations are hugely unlikely to accept this plan, as most seem today to have been co-opted by various Marxist organizations who are opposed to anyone opting out of the welfare state (it is no coincidence that the recent immigration policy protests all occurred on May Day, the traditional Soviet-Marxist holiday).

Finally, I would like to offer one thought to all those who worry about "absorbing" ten or fifteen million new immigrants.  First, I would argue that we have adopted many more immigrants than this successfully in this country's history, including my grandparents and probably yours.  Second, I would observe that as recently as the last several decades, we managed to absorb 40 million new workers quite successfully, as I wrote here:

Check this data out, from the BLS:

• In 1968, the unemployment rate was 3.8%.  22.9 million women were employed in non-farm jobs, accounting for 34% of the work force.
• In 2000, the unemployment rate was 4.0%.  62.7 million women were employed in the work force, accounting for 48% of the total
• In these years, the number of women employed increased every single year.  Even in the recession years of 1981-1983 when employment of men dropped by 2.5 million, women gained 400,000 jobs

This is phenomenal.  After years of being stay-at-home moms or whatever, women in America decided it was time to go to work.  This was roughly the equivalent of having 40,000,000 immigrants show up on our shores one day looking for work.  And you know what? The American economy found jobs for all of them, despite oil embargos and stagflation and wars and "outsourcing".

The US Congress is considering a federal licensing requirement for all paid tax preparers.  Apparently, even most paid preparers can't get the returns correct:

The senators heard from investigators at the Government Accountability
Office, who found mistakes in virtually every tax return filled out by
commercial chain preparers. The investigators said they looked at a
tiny number of tax returns, and that their conclusions could not be
generalized to the rest of the tax preparation industry.

You know why?  Because I would bet you that the same amount of scrutiny could find errors in every single return submitted.  There is just no way to get it all right.  How about, you know, actually spending some time in Congress making the return easy enough that individuals don't feel the need to seek out paid preparers.  Of course, the real reason for this initiative is that higher-dollar CPA firms and large accounting firms would like Congress to sit on its low-price competition  (note that only chain-type firms were investigated).  As Milton Freedman pointed out long ago about licensing:

The justification offered is always the same: to protect the consumer. However, the reason
is demonstrated by observing who lobbies at the state legislature for
the imposition or strengthening of licensure. The lobbyists are
invariably representatives of the occupation in question rather than of
the customers. True enough, plumbers presumably know better than anyone
else what their customers need to be protected against. However, it is
hard to regard altruistic concern for their customers as the primary
motive behind their determined efforts to get legal power to decide who
may be a plumber.

Of course, the last paragraph of the article demonstrates there is already a solution in place for poor tax preparer service:

Had the IRS found these problems on real returns, many preparers would
have been subject to penalties for negligence and willful or reckless
disregard of tax rules

So why is licensing needed at all?

Of the more partisan blogs I read, I have always enjoyed Captains Quarters for being thoughtful and well-written.  Ed Morrissy is clearly as skeptical about open immigration as I am supportive of it, which  I am generally willing to put into the "intelligent people will disagree" category, until I found this bit a little frightening (emphasis added):

As I have written repeatedly over the past two years, we simply cannot
throw out 12 million people overnight, so some sort of guest-worker
program is inevitable, if for no other reason than to get an accurate
accounting of the aliens in our nation. Either that, or we will have to
herd people into concentration camps, a solution that will never pass
political muster even if were remotely possible logistically. That
program could form a basis of a comprehensive immigration "reform", if
properly written.

Is the implication that his only real problems with American concentration camps for people born in Mexico are logistical?  When one typically says that an idea can't pass political muster, they generally are referring (with a wistful sigh) to what they consider a good idea that for whatever reason could not survive the legislative process.  Let's be clear: herding people into concentration camps based arbitrarily on their birth location is abhorrent, not logistically difficult. 

I haven't called myself conservative for over 20 years, but I thought that most good conservatives would agree with the following statement:

"Our fundamental rights, from speech to association to property, are not granted to us by any government, but belong to us as a fact of our human existence."

Do conservatives still believe this?  I know liberals gave up on it a while back - that is why I pay a transaction "privilege" tax in Arizona, which presumes that the ability to conduct commerce is a privilege that is granted by the government.  But I thought conservatives stood by this statement.  But if they still do, then on what basis can they argue that people not born within the US border somehow have lesser (or no) right to conduct commerce in this country, to buy and live in a home in this country, to sell their labor in this country, etc.?   The only rights or activities or privileges a country should be able to deny non-citizens are those rights and privileges that flow from the government and not from our basic humanity.  Which are.... none (update: OK, maybe one: Voting, since this is inherently tied up with government.  I have written before about why I think voting is one of our less important rights).

I understand there are good and valid concerns about government handouts and taxpayer-paid services flowing to recent immigrants, but to solve this narrow concern, "reform" discussion should be about setting minimum qualification standards for such services or handouts, and not about putting Mexicans in concentration camps.

Update:  A number of readers have scolded me for overreacting to the Morrissey quote, arguing that the quote is just dry understatement rather than any revelation of sinister plans.  Fine.  I have friends who are both legal and illegal immigrants her in Phoenix, as well as several who are in-between (i.e. are constantly battling to hang on to their visa status by their fingernails) so I have personal emotions in the game here that may make me overly sensitive.

I will admit to a huge blind spot:  I just cannot comprehend why Americans, none of whose families are native to this land, get so upset about high levels of immigration, beyond the public services issue.  And the more I think about this latter, the more I am convinced making everyone legal combined with some eligibility waiting periods (for voting, welfare, etc) would generate more tax revenue than it would consume.  In fact, high levels of immigration may be the only viable solution to the demographic bomb we have with social security and medicare.  (By the way, the public services issue is one reason the Democrats have, if possible, an even less viable position than Republicans.  Our Democratic governor has publicly supported continuing free government services to illegal immigrants but opposed allowing them to work.  This makes sense, how?)

I do understand there is "law and order" argument that goes "well, those folks are breaking the law, and we have got to have respect for the law."  Here's a proposal.  Everyone who has never knowingly violated the speed limit, never done a rolling stop at a stop sign, and never tried illegal narcotics in college are all welcome to make the argument to me about the need to strictly enforce every law on the books.  This same logic is used to send refugees escaping Cuba back to Cuba, and it sucks. 

Would it be at all possible that the LA Times assign people to the business section that know something about business?

Over the last several weeks of the Lay-Skilling Enron trial, the prosecution has been putting on witnesses to testify that Enron management managed their earnings in quarterly releases by adjusting accounting reserves to increase reported income.  Here is an example:  Many companies, when they book sales, keep a reserve for noncollectable accounts.  Let's say that if a company books $1 million in sales, they might book 3% or $30,000 as a reserve against noncollectable accounts.  This reduces reported income by $30,000.  But the 3% is fairly arbitrary.  What if the bosses suddenly called down and said, you know, I think its only going to be 2.5%.  Then the entries would be changed and suddenly the company has $5000 more income.  And, if they retroactively changed the 3 to 2.5 for the last several quarters, tens of thousands of dollars might be added to this quarter's income.  Of course, in Enron's case, these entries and reserves were orders of magnitude more complicated and arcane.

So what's my beef against the LA Times?  They headline of their story on the activity I just described is:

Witness Says Enron Raided Fund

Orders to dip into reserves to inflate profit violated accounting rules, a former company accountant testifies.

What fund?  They make it sound like Lay and Skilling went into some bank vault somewhere and took money.  These reserves are not wads of cash sitting in accounts - they are accounting entries providing estimates of future expenses to be booked against current revenues.  What is undisputed is that management changed their estimates of these future expenses, which caused these paper reserve accounts to be reduced, increasing paper earnings.  You might reasonably argue that the only purpose for changing these estimates was to manipulate reported earnings in an unlawful way, and that is what the jury has to decide.  But how can you describe this as "raiding" a "fund", unless you want to portray the defendants in the worst possible light.

My guess is that the people who wrote this at the LA Times are the same ones who keep writing about the "Social Security Trust Fund" as if it is an actual pile of cash in a bank vault somewhere, and not money long ago spent by Congress.

Personally, I think you are insane to be a CEO or a board member of a public company under Sarbanes-Oxley.  There is no way I am going to sign a document on threat of prison that no one of the thousands of employees who work for me did anything to screw up the books.  Heck, I run a private company owned only by me where there is no incentive other than to report the numbers like they are, I sit next to my bookkeeper who is the only other one who touches the books, and I still find errors from time to time in past periods.

But what got me going on this post was a TV interview I tuned in the middle of last week.  I can't find a version online or even the name of the people interviewed, but the gist of the discussion was how Sarbanes-Oxley was going to prevent Enron-type situations that bankrupt investors.

I wonder how many people believe this?  Because Enron was going down, with or without the accounting shenanigans.  Its trading-based business model followed a life-cycle that should be familiar to anyone who has been in trading -- that is, they had unbelievable margins early on, but as others figured out what they were doing and duplicated it, the margins narrowed.  As trading margins narrow, the only way to maintain profits is to increase volume, leveraging up your capital into larger and larger trades at narrower and narrower spreads.  This volume strategy requires a very low cost of capital, which means low borrowing costs and a high stock price.  By hiding debt and losses in off-book subsidiaries, the Enron managers may have delayed the ultimate reckoning (by keeping equity prices high and its bond yields low), but the accounting games were not the cause of the failure.  In the same way, the march of long distance rates towards zero ultimately brought down Worldcom, not accounting.  In the latter case, if you borrow lots of money to buy long-distance companies, as Worldcom did,  assuming say 20 cent per minute long distance rates and then the rate goes to 5 cents, you are probably in trouble.

I am all for curbing the imperial CEO and giving shareholders and boards more power to police accounting and establish transparency.  I am not sure SarbOx does any of this.  My gut feel is that five years from now we will view SarbOx as more of an enabler for state attorney general self-promotion (as each races to try to prosecute some high-profile CEO for arcane accounting errors) and tort bar shenanigans.

I am honsetly curious, do any of you, as equity holders, feel better about your equities today with SarbOx than without it, especially given the added expense every company has had to take on?  It would be interesting to test the market's perceived value of SarbOx by allowing shareholders to vote to opt in or out of SarbOx.  Not only would their voting be interesting, but, if they opt out, it would be interesting to see if the stock price goes down (meaning SarbOx has perceived value) or up (meaning SarbOx is mostly perceived as extra regulatory expense).

The NY Times has a fairly scary (though not particularly surprising) article about unfunded retirement obligations of government bodies.

Thousands of government bodies, including states, cities, towns, school
districts and water authorities, are in for the same kind of shock in the next
year or so. For years, governments have been promising generous medical benefits
to millions of schoolteachers, firefighters and other employees when they
retire, yet experts say that virtually none of these governments have kept track
of the mounting price tag. The usual practice is to budget for health care a
year at a time, and to leave the rest for the future.

Off the government balance sheets - out of sight and out of mind - those
obligations have been ballooning as health care costs have spiraled and as the
baby-boom generation has approached retirement. And now the accounting rulemaker
for the public sector, the Governmental Accounting Standards Board, says it is
time for every government to do what Duluth has done: to come to grips with the
total value of its promises, and to report it to their taxpayers and
bondholders.

Its not too surprising to most of us that the government, which is actively putting Enron managers in jail for hiding liabilities off-balance-sheet, turns out to be a far worse offender at the same practice.  The few agencies that have performed the actuarial calculation are coming up with staggering numbers:

Stephen T. McElhaney, an actuary and principal at Mercer Human Resources, a
benefits consulting firm that advises states and local governments, estimated
that the national total could be $1 trillion. "This is a huge liability," said
Jan Lazar, an independent benefits consultant in Lansing, Mich. "If anybody
understands it, they'll freak out."...

Maryland, for example, now spends about $311 million annually on retiree health
premiums. But when that state calculated the value of the retirement benefits it
has promised to current employees, the total was $20.4 billion. And the yearly
cost will jump to $1.9 billion under the new rule, according to an analysis for
the state by actuaries at Aon
Consulting, which advises companies on benefits.

I usually severely discount consultant scare numbers like "$1 trillion", particularly after the year 2000 bug orgy of doomsaying, but if Maryland, an average size state, is facing $20 billion, then a trillion may only account for state governments.  The number may well be higher when you include cities, counties, school districts, etc. 

While this is clearly bad news, there is also a silver lining.  Politicians for years have given away richer and richer public employee retirement benefits because they appeared "free"  (free to a politician being anything that doesn't have to be paid for when he/she is in office).  By changing accounting standards to force acknowledgment of this liability, politicos will at least have to address true costs of any future giveaways.

As a minimum, most public authorities are looking to change benefits for new employees, which is an entirely reasonable response that should have been taken years ago.  Just as past changes in public accounting for pensions caused agencies to shift benefits to 401K's from defined benefit pensions, so this rule-changes in retiree medical care will certainly change benefits packages.

However, that being said, I have a much bigger problem with several state's proposals to retroactively reduce benefits for existing retirees and employees.  These retirement benefits are a contract, and should not be allowed to be changed casually, any more than could an agency just choose to renege on a municipal bond payment.  Sure, the commitments may have been irresponsible, but that does not make them automatically void.  Private companies from time to time get themselves in a similar mess, and the only way for them to relieve themselves of some of this liability is through the bankruptcy process.  Public agencies should be forced to do the same.  They should not be able to use their coercive legislative power to just make these obligations disappear at the stroke of a pen -- they need to go through the pain of a bankruptcy, where all creditors, not just pensioners selectively, will need to share in the haircut.

Everything old is new again.  Back in the late 70's, all the talk was about the world running out of oil.  Everywhere you looked, "experts" were predicting that we would run out of oil.  Many had us running out of oil in 1985, while the most optimistic didn't have us running out of oil until the turn of the century.  Prices at the time had spiked to about $65 a barrel (in 2004 dollars), about where they are today.  Of course, it turned out that the laws of supply and demand had not been repealed, and after Reagan removed oil price controls and goofy laws like the windfall profits tax, demand and supply came back in balance, and prices actually returned to their historical norms.

Today, as evidenced by the long article on "peak oil" in the NY Times Magazine this weekend, we are apparently once again headed for imminent disaster.  The Freakonomics blog has already chimed in with a partial rebuttal, but I wanted to share some of my own thoughts.

Are the Saudis hiding a reserve shortfall?  Much of the peak oil phenomena consists of Paul Ehrlich type doom-saying that takes pains to ignore the laws of supply and demand.  However, the question of Saudi behavior is an interesting one.  Lets for a moment hypothesize that the Saudis were indeed somehow running out of oil.  One thing the article misses is how bad a thing this would be for the Saudi leadership.  The author notes that the ruling family shouldn't care, since it is already rich, so declining oil revenues won't hurt it.  But that misses the point.  With a large percentage of the world's oil, the Saudis are a country that must be treated with respect and deference.  Without oil, Saudi Arabia becomes that Arab nation that virtually enslaves half its population (ie the females) and that funds much of the world's terrorism, including the 9/11 attacks.  Suddenly, without oil reserves, the Saudi's might find themselves moving up the Bush-Rumsfeld priority list for a little visit from the US military.  I have no way of knowing if the Saudis are hiding anything -- the fact that some Saudi fields are using secondary and tertiary recovery methods (as noted in the article) really does not mean much.  But if they were losing reserves, they sure would have the incentive to hide it.

Reserve accounting is a tricky thing.  The vagaries of reserve accounting are very difficult for outsiders to understand.  I am not an expert, but one thing I have come to understand is that reserve numbers are not like measuring the water level in a tank.  There is a lot more oil in the ground than can ever be recovered, and just what percentage can be recovered depends on how much you are willing to do (and spend) to get it out.  Some oil will come out under its own pressure.  The next bit has to be pumped out.  The next bit has to be forced out with water injection.  The next bit may come out with steam or CO2 flooding.  In other words, how much oil you think will be recoverable from a field, ie the reserves, depends on how much you are willing to invest, which in turn depends on prices.  Over time, you will find that certain fields will have very different reserves numbers at $70 barrel oil than at $25.

Trust supply and demand.  Supply and demand work to close resource gaps.  In fact, it has never not worked.  The Cassandras of the world have predicted over the centuries that we would run out of thousands of different things.  Everything from farmland to wood to tungsten have at one time or another been close to exhaustion.  And you know what, these soothsayers of doom are 0-for-4153 in their predictions.  Heck, they are about 0-for-five on oil alone:

Most experts do not share Simmons's concerns about the imminence of peak oil. One of the industry's most prominent consultants, Daniel Yergin, author of a Pulitzer Prize-winning book about petroleum, dismisses the doomsday visions. ''This is not the first time that the world has 'run out of oil,''' he wrote in a recent Washington Post opinion essay. ''It's more like the fifth. Cycles of shortage and surplus characterize the entire history of the oil industry.'' Yergin says that a number of oil projects that are under construction will increase the supply by 20 percent in five years and that technological advances will increase the amount of oil that can be recovered from existing reservoirs. (Typically, with today's technology, only about 40 percent of a reservoir's oil can be pumped to the surface.)

One of the problems with oil is that governments have a real problem with allowing supply and demand to operate.  I have wondered for a while why Chinese demand has kept growing so fast in the face of rising prices.  The reason is that the Chinese government still is selling gasoline way below market rates, shielding consumers from incentives to reduce consumption.  On the supply side, I also wondered when I was in Paris why gasoline prices as high as $6 per gallon were not creating incentives for new sources of supply.  It turns out that nearly $4 of the $6 are government taxes, so none of this higher price goes to producers or creates any supply-side incentives.  Instead, it goes to paying unemployment benefits, or whatever they do with taxes in France.

Even in the US, which is typically more comfortable with the operation of the laws of supply and demand than other nations, the government has been loathe to actually allow these laws to operate on oil.  During the 70's, the government maintained price controls that limited demand side incentives to conserve, thus creating gas lines like the ones we are seeing in China today for the same reason.  When these controls were finally removed, a "windfall profits tax" was put in place to make sure that producers would get none of the benefit of the price increases, and therefore would have no financial incentive to seek out new oil supplies or substitutes.  Within a few years of the repeal of these dumb laws, oil prices fell back to historical levels and stayed there for 20 years.

But meddling with prices is not the only way the government screws up the oil market.  I laugh when I see people with a straight face say that we have not opened up any big new fields in this country since Prudhoe Bay.  This is in large part because the three most promising oil field possibilities in this country -- ANWR, California coast, and the Florida coast -- have all been closed to exploration by the government.

In addition, the government has, through a series of energy bills that are each stupider than the last, managed to divert valuable energy investment capital into a range of politically correct black holes.  All we seem to get are unsightly windmills in Palm Springs that always seem to be broken and massive ethanol subsidies that actually increase oil consumption rather than decrease it.  It should come as no surprise that  despite government subsidies for a range of automotive technologies like fuel cells and all-electric cars, the winning technology to date has been hybrids, which weren't on the government subsidy plan at all.

Don't Ignore Substitutes.  All the oil doomsayers tend to define the problem as follows:  Oil production from current fields using current methods and technologies will peak soon.  Well, OK, but that sure defines the problem kind of narrowly.  The last time oil prices were at this level ($65 in 2004 dollars), most of the oil companies and any number of startups were gearing up to start production in a variety of new technologies.  I know that when I was working for Exxon in the early 80's, they had a huge project in the works for recovering oil from oil shales and sands.  Once prices when back in the tank, these projects were mothballed, but there is no reason why they won't get restarted if oil prices stay high.  At $65 a barrel, even nuclear starts looking good again, though we would have to come up with a more sane regulatory environment.  Look for venture capital to steer away from funding the next shoelace.com and start looking for energy investments.

Dueling Catastrophes.  As a final note, its funny seeing the New York Times crying "disaster" over the peak oil scenario.  Those who read this blog know that I am skeptical that the harm from man-made global warming is bad enough to justify large, immediate Kyoto-like reductions in hydrocarbon consumption.  However, the New York Times is on record as a big believer in and cheerleader for immediate cuts in hydrocarbon consumption to head off global warming.  So why is peak oil so bad?  Shouldn't they be celebrating an ongoing drop in oil availability, which would force the world to produce less CO2?  Along the same vain, it is funny seeing a publication that has decried over and over again our dependence on Saudi Arabian and other foreign oil at the same time lamenting the fact that Saudi Arabia is running out.  If that's true, won't Saudi reserve declines solve the whole dependence problem, one way or another?

Postscript:  The other day, I found one of Paul Ehrlich's doomsday books from the 70's in a used book store.  When I have a chance, I am going to post some of its predictions, which were treated with breathless respect by most of the media, including the NY Times.

Last week, Tyco's Dennis Kozlowski was found guilty of looting the shareholder's assets for his own personal gain.  Good.  Too many CEO's treat public companies as their own, rather than other peoples' companies for which they have fiduciary responsibility.  And, unlike the Dick Grasso mess I commented on earlier, this was a much clearer case of looting as opposed to just negotiating themselves a good deal.  (update:  Stephen Bainbridge has a different take here)

According to the Wall Street Journal, which requires a subscription:

The guilty verdicts are in for L. Dennis Kozlowski and Mark H. Swartz. For Tyco International Ltd., the company they looted, there may be more court dates to come.

Tyco was hit with dozens of shareholder lawsuits in
2002 and 2003 as the company disclosed waves of accounting problems
that sank its stock. It has restated results several times, going as
far back as 1998. A July 2003 restatement cut about a billion dollars
from pretax profit over several years.

The convictions
lend credence to the plaintiffs' allegations that Tyco was grossly
mismanaged. The suing shareholders already have a strong leg to stand
on: Tyco's string of past restatements amount to an admission that its
accounting was deeply faulty. Shareholders claim they were deceived by
accounting practices that presented rosy pictures of the performance of
the company and its acquisitions, then suffered losses following the
revelation of allegations against Mr. Kozlowski and the restatements.

I have never been able to justify most lawsuits by shareholders against companies in which they own shares.  Any successful verdict 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 are 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 often made by past shareholders who held stock at the time certain wrongs were committed, they are paid by current and future shareholders, who may well have not even owned the company at the time of the abuses, and may in fact be participating in cleaning the company up.  So their argument is that because the company was run unethically when I owned it, I am going to sue the people who bought it from me and cleaned it up for my damages?  Though it never happens, the more fair approach would be for current shareholders to sue past shareholders for the mess they left.

The vast majority of these suits are dreamed up by attorneys for the benefit of attorneys.  They help shareholders not at all.

Postscript: There are a couple of circumstances where these suits are entirely justified.  The two that come to mind are:

• Suing a particular group of shareholders who somehow got disproportionate rights in the company or disproportionately benefited financially at the expense of other common shareholders.  A good example would be suing the Rigas family at Adelphia Communications for hosing the minority shareholders.  Note, however, I am talking not about suing the company, but suing certain owners who abused minority shareholders to their benefit.
• Suing to modify certain governance rules that are seen to be unethical or illegal.  I would hope this would be a last resort after trying a number of proxy fights and other remedies, but this can in certain circumstances be the last protection of minority shareholders abused by the majority.

After my earlier post on Walmart, I got to thinking about a number of Walmart-related topics.  My brain is a bit too fried on Friday night to organize these thoughts too much, so here they are, roughly following my stream of consciousness:

Exxon may have finally handed off the Great Satan title

The socialists of this country (who now generally call themselves progressives but its pretty much the same thing) usually need a company they can focus their attention on.  In the 1960's, this was probably General Motors, though defense contractors in the Vietnam War made a run at the title.  After the oil embargo of 1972, that title clearly moved to Exxon. I remember in one month in the early 1970's, the head of Exxon got called into Congress twice in a few weeks, once to combat the urban myth that oil companies were greedily holding oil off the market to drive up prices, and once to explain to Congress why they were greedily trying to expand oil production in Alaska.  My family and many of my friends worked for large oil companies, and we had several friends who were injured by letter bombs from domestic leftist terrorists (though the media did not call them terrorists then).

Exxon held the great Satan title for a long time.  It probably could have shed the title with low oil prices in the 80's, but the stupidity of the Valdez mess in the mid-80's and the vociferous opposition to the politically correct Kyoto accords in the mid-90's help them retain the title for a record number of years.

Finally, however, it appears that a new contender is at hand.  Walmart, so recently the most admired corporation in America, has become the new socialist whipping boy and lawsuit magnet.  Just search for Walmart in Google and you will get pages and pages of Wal-mart bashing sites.  Its kind of an amazing story how the former blue collar low-price hero of the working man trying to make ends meet has suddenly become a class enemy.  However, coming from a family that had many members who worked for Exxon, it comes as some relief to pass the Great Sata title on.

I wish everyone at Walmart could make $100,000 per year

In this, I am exactly in the same boat as Walmart detractors.  I would love for everyone at Walmart to make a ton of money.  Whether this is realistic is another story.

In America, people take jobs voluntarily

I would generally class this as a blinding glimpse of the obvious, but it appears that it has to be said.  And, if you accept that people are operating in their own rational self-interest (by the way, this is not a given -- many on the left do not think the average American is smart enough to make decisions for themself and that they need smart technocrats to look after them).  Anyway, were was I?  Oh yes, if you accept that people operate in their own rational self-interest, then by definition the job for Walmart employees is their best option, and any other option is worse.

This is the logical fallacy of those who attack Walmart (or offshore companies) for paying too low of wages.  Their concern is that these wages are lower than they, as an outside obviously smarter than everyone else observer, think they should be.  The reality is that these wages are higher than that employee's other options, and therefore is an improvement over that job not existing at all.  Note this story I told in an earlier post:

Progressives do not like American factories appearing in third world
countries, paying locals wages progressives feel are too low, and
disrupting agrarian economies with which progressives were more
comfortable.  But these changes are all the sum of actions by
individuals, so it is illustrative to think about what is going on in
these countries at the individual level. 

One morning, a rice farmer in southeast Asia might face a choice.
He can continue a life of brutal, back-breaking labor from dawn to dusk
for what is essentially subsistence earnings.  He can continue to see a
large number of his children die young from malnutrition and disease.
He can continue a lifestyle so static, so devoid of opportunity for
advancement, that it is nearly identical to the life led by his
ancestors in the same spot a thousand years ago.

Or, he can go to the local Nike factory, work long hours (but
certainly no longer than he worked in the field) for low pay (but
certainly more than he was making subsistence farming) and take a shot
at changing his life.  And you know what, many men (and women) in his
position choose the Nike factory.  And progressives hate this.  They
distrust this choice.  They distrust the change.  And, at its heart,
that is what opposition to globalization is all about - a deep seated
conservatism that distrusts the decision-making of individuals and
fears change, change that ironically might finally pull people out of
untold generations of utter poverty.  (update:  good post in the Mises blog on Taco Bell and wages here)

It's Wages vs. Prices, not Wages vs. Profits

In aggregate, because they have so many stores, Walmart makes about $10 billion a year in pre-tax net income.  Which is a lot.  But when looked at as a percentage of sales, it is pathetic.  Given its nearly $300 billion in sales, this is about a 3.5% return on sales, which while not unusual for retailers, in the grand scheme of American business is pathetically low.  I would have to shut down my business tomorrow if I only made 3.5% of sales -- I couldn't support the investments I have to make.

Its illuminating to compare this to all those small family owned boutique
businesses that Walmart supposedly shuts down.  So here is a little
example.  Lets say that the alternative to Walmart in Smallsville, USA would be a series of boutique stores, like
the mythical Nan's Clothing Shop.  Lets
say Nan does $250,000 a year in sales,which
would actually make her shop more successful than average, particularly for smaller town mid-America.  If Nan had to live with Walmart's profit margin of 3.5%, she would end up with an annual profit of  ... $8,750.   And, if Nan is working full-time trying to make the store work, and assuming 2300 hours a year, which is probably low for a small business person, she would be making a whopping  $3.80 an hour running her store, such that she would be much better off (leaving out the personal satisfaction of running your own business) working for Walmart at the average wage there of $6.50 an hour. 

While socialists and progressives are programmed in the deepest recesses of their DNA to blame everything on profit, the wage savings Walmart may get are not going to profit.  Their profit margins are low, in fact lower than most of the smaller stores they are replacing.  If there is a wage trade-off going on, it is between lower wages and lower prices to consumers.  Which obviously makes socialist demagoguery a bit less compelling, since it means that in some sense consumers and not Walmart are to blame if wages are too low, since presumably it is consumers who make the choice to switch from the higher cost traditional boutique alternatives to Walmart.

Walmart detractors have one good point - Walmart gets far too much preferential tax treatment

I don't know why it is, but Walmart is a magnet for taxpayer subsidies.  Not only does the government love to hand out tax breaks to Walmart, it local governments go so far as to use eminent domain to put together land parcels for them.  If I was a local retailer and had my tax money used to subsidize a new competitor, or worse got my land siezed to hand over to Walmart, I would be pissed off too.

I have not really studied Walmart's tactics in this, but my sense is that they have gotten good at getting neighboring communities competing with each other.  This is a crock and a waste of taxpayer money, and nearly as bad as subsidizing sports teams.  I have a long post on the sad practice of subsidizing business relocations here.

A final thought on the most unpublicized economic miracle of the last century

Since many of Walmart's attackers focus on their treatment of women, in part due to numerous accusations of discrimination in pay and promotions, it led me to a final thought about a great economic miracle that occurred in this country in the last decades of the 20th century.

Check this data out, from the BLS:

• In 1968, the unemployment rate was 3.8%.  22.9 million women were employed in non-farm jobs, accounting for 34% of the work force.
• In 2000, the unemployment rate was 4.0%.  62.7 million women were employed in the work force, accounting for 48% of the total
• In these years, the number of women employed increased every single year.  Even in the recession years of 1981-1983 when employment of men dropped by 2.5 million, women gained 400,000 jobs

This is phenomenal.  After years of being stay-at-home moms or whatever, women in America decided it was time to go to work.  This was roughly the equivalent of having 40,000,000 immigrants show up on our shores one day looking for work.  And you know what? The American economy found jobs for all of them, despite oil embargos and stagflation and wars and "outsourcing".

I would love to see women at Walmart making more money, and some day they probably will.  Even so, though, the fact that so many have found work there is a miracle unto itself. Remember that the alternative to a $6.50 job at Walmart if the left is successful in eliminating these jobs is probably not new $15.00 jobs - it is no job at all.  Just ask the French.  Also see my recent post on the minimum wage.

Update:  This is some pretty smart PR by Wal-Mart to deflect the sprawl argument often used against it.  By the way, I challenge someone to define sprawl adequately for me in the context it is used by people who are decrying it.

In the span of one hour this morning, I got to "enjoy" both my most and least favorite business activity.

My least favorite activity is always paying taxes, but within that broad category (remember that being in 10 states and 25 counties means that I file over 50 different tax returns or one sort or another every year) my least least favorite are business property tax returns.  If you have not run a small business, you may not be aware of what a pain these are (individuals don't have to file them, and large companies have poor schleps in accounting to do it). 

First, business property tax statements usually have to be filed by county, so I have to do a zillion of them.  Second, governments require that you report every year and in great detail on essentially every asset your business owns in a state or county.  A business must report these assets, usually with a description, date purchased, original purchase price and estimate current market value.  Imagine as an individual if you had to report this information on everything in your house - furniture, computers, appliances, tools, etc.  Now imagine doing it for a business, which owns a lot more miscellaneous stuff than you have in your house.

What really irritates me is that filing some of these statements requires the person filling out the statement to take a chance.  Clearly, no one is going to list every asset, down to the last pencil and paper clip -- you are going to establish some reasonable cutoff, and group similar assets into catch-alls like "miscellaneous tools" or "office supplies".  Note however, that this is taking a chance:  In counties that require detailed asset listings, there is never any statutory language like "you can ignore items under $100 as de minimis" or "you can group similar items".  Technically, you are supposed to list them all.  Take my word for it, this is very, very tedious.

But wait, as the Ginsu knife guy would say, for our business there is more aggravation.  We do business as a concession holder on federal lands.  For example, we might run a US Forest Service campground.  By US law, states and counties may not charge the US government property taxes on these facilities.  BUT, certain of the most acquisitive states, including California and Washington, have devised taxes that get around this requirement.  These two states make me pay the federal government's property taxes for them at the facilities I operate.  This is kind of like being forced by law to pay your landlord's taxes for him.  I always find this terribly irritating, all the more so since now that I know the game, when time comes to bid on concessions in these states, I just subtract the estimated taxes from what I am willing to pay the government in rent, in effect ensuring that the US government ends up paying the tax. 

This whole enterprise left me feeling depressed, when a couple who I had called about a manager position at a new store concession of ours at Clear Lake State Park in California called me back.  It turned out this couple is incredibly entrepreneurial, has great business experience, and are very well-suited to running my operation with minimal supervision.  I was thrilled to find them, and they were in turn thrilled to find an outdoor summer job opportunity in a nice location which could be flexible enough to accommodate a person with a disability (one of the couple has Parkinsons).  There is NOTHING I enjoy more than finding great people to work for me, and finding such people is all the sweeter if I can offer them an opportunity that uniquely fits their own needs. 

Over the last several days, more revelations have emerged that the Bush administration seems to be spending unprecedented amounts of taxpayer money for third party PR support of administration policies.  There is nothing that makes me madder than politicians using my money to help cement their own position in office.  For all the majesty of the office, the President is still the taxpayers' employee, and we should expect an honest accounting of his performance and programs.  What makes this even more ridiculous is that the US Presidency is the greatest bully pulpit in the world -- no one gets more of a chance to get his/her point of view into the public domain than the President.  But Bush is generally a crappy communicator, so he has squandered this opportunity and is forced into paying others to speak for him.

Often business people like myself lament that the government needs to be run like a business - meaning more focus on efficiency and productivity and process improvement.   But there are a number of ways the the government is NOT like a business.  The key difference is that a private company can, at the end of the day, give outsiders the brush-off.  As a private company (with no public stock float) I don't have to tell anyone anything about the decisions I have made or why I made them.  I am not only allowed but expected to pay money (in the form of PR, sales, advertising, etc.) to  put a public spin on my products and services -- this is called marketing.  The government, of course, is not supposed to do this.  They have an accountability to everybody.  (actually, even CEO's of public companies are not supposed to do this either, at least with their shareholders, but they do).

The Bush administration wants to believe they are still running their own private business, rather than a public trust.  They have used 9/11 and the war on terror as excuses to pull a veil of secrecy over decision-making, data, and even mistakes that often have little to do with national security.  They have set a number of unsettling precedents around managing their public image, and their payments for PR and good press fall into this category.

Last Thursday I spoke at the the Phoenix Enterprise Network about buying your own business, a topic I discuss in more depth here.  The audience was pretty full, not for me, but in expectation of Sharon Lechter of Rich Dad, Poor Dad fame.  Since Ms. Lechter and her partner Robert Kiyosaki have become the chief evangelists of starting your own business, a lot of people were there who were interested in that topic.

I found that for at least one reason, I was probably the wrong person to speak at this function.  Many people in the audience seemed fixated on my Harvard MBA and felt intimidated that somehow they were under-qualified or undereducated to be entrepreneurs. 

I tried as hard as I could to convince folks that everything I learned at Harvard was virtually useless for running a small business.  I told them (truthfully) that my Harvard diploma hangs in my laundry room, since that was the only thing I really learned to do well at school.  I emphasized that knowledge and passion about the business you want to start is much more important, and that everything else could be learned.  Night courses in certain areas could help, and I would focus on two areas:

• accounting:  it is always good to know accounting.  It is never good to entirely trust someone else with the books.
• marketing and competitive advantage:  the one "framework" that still serves me well from my MBA is that I never look at an idea or business without asking what I am going to do with it that is different than competitors. 

In reality, the Harvard sheepskin on my wall actually hurts me running a small business as often as it helps me.  For example, many of my employees when they first work for me seem intimidated by the degree, and assume I must know everything and therefore they are afraid to raise concerns or share ideas.  Any of my managers who read this will probably laugh, because most have gotten some version of my speech on this topic:

DO NOT assume Warren has a secret plan or brilliant idea on any subject that he has not told you yet.  Assume that if you have not heard from Warren on a topic, he either has no clue there is an issue at all or else he has no idea what to do.  Therefore, do what you think needs to be done, and call Warren if you need help.

By the way, if you are in the Phoenix area, the Enterprise Network not only has one of those exceedingly rare and valuable two-letter URL's, but it is a great group if you are an entrepreneur or you business sells to entrepreneurs.

I don't know whether it warrants the "crisis" moniker (to me, government is always in a disastrous state), but Social Security is indeed facing an enormous cash flow shortfall in just a few years.  Those who use bogus government accounting to say that there is no problem until 2042 are either disingenuous or delusional.  People making this argument are saying that yes, cash flow will be negative, but those negative cash flows will come out of the huge Social Security trust fund, which won't be depleted until 2042.

Um, the only problem with this is that... there is no Social Security trust fund.  I mean yes, there is such a thing on paper with a large number next to it, but there is no actual pool of cash or investments to draw on.  The "trust fund" is full of government IOU's to itself - the actual cash was spent for general budget needs over the years.  As a result, in just a few years, Social Security will require:

• Massive new taxes
• Large benefits cuts
• A complete restructuring of all parts of the program
• More government borrowing

Good post at Assymetrical Information goes into it in more depth.

When I describe what I do, the most common reaction is for people to ask "So how did you get into that?" The answer, as they used to say in the old electric razor commercials, is that it interested me so much, I bought the company.

Now, at some level, corporate acquisitions were not new to me -- I had worked with acquisitions and acquisition analysis in many of my corporate jobs. But these were large acquisitions - at least $20-$40 million in sales, and it was funded out of a large corporation's cash flow.

One fateful day, I decided that A) I hated working for other people and B) I had no groundbreaking entrepreneurial ideas of my own so that C) if I wanted to own a decent sized business, I would have to buy one.

Unfortunately, I had NO CLUE how to go find companies that were for sale and that I could afford. In fact, I was not sure at that point such opportunities even existed (again, when the rubber met the road, my Harvard MBA let me down). And, if the questions I get asked all the time are any indication, I was not the only one who didn't know how any of this worked.

So, let me share how it all worked for me. This is part 1. Also see part 2 and part 3.

Continue reading ‘Buying a Company Part 1 (or how I got into this)’ »