Tuesday, December 16, 2014

OIl's Great Fall: This Time, The Bailouts Will Be Harder

In a desperate move, Russia's central bank recently raised a key interest rate by 6.5% to 17%, propping up the ruble at least momentarily.  This was after the ruble had already lost about 50% of its value in the past few months.  Even if the ruble stabilizes, Russia verges on economic collapse. 

Venezuela was already hitting the skids when the price of oil began its big swoon.  Now, it will possibly default on its sovereign debt.  Other oil producing nations are hurting, too.  Some could survive by drawing down their financial reserves.  Others may not have adequate reserves on which to draw.

The impact of the oil price drops on major financial institutions and financial markets players is much more opaque.  When a key commodity like oil, and the currencies issued by its producers, belly flop as we have seen in the past few months, big losses are inevitable.  Some of these losses could be greatly magnified by the leveraging effect of derivatives.  A crucial question for regulators is where these losses are landing.  Surely there are losses on Wall Street and in the City of London.  But proportionately much greater losses may have been sustained by Russian and other European banks.  Dec. 31, 2014 will mark the close of financial reporting periods for many banks and other institutions. At that point, they will be required to disclose their financial conditions.  It wouldn't be surprising if the losses are big.  Talk of bailouts might follow.

It's one thing for the taxpayers of a nation to bail out the banks of their own nation.  They may be frustrated and outraged, and demand the punishment of bank executives and others.  But they have a strong interest in preserving their own financial system.  It's another thing when a foreign country wants a bailout, just after it sent its Special Forces surreptitiously into a neighboring country to seize territory by force, lied to the world about what it was doing, and then made aggressive moves against many other nations--especially those that border it and have historically been dominated by it.  The West has imposed sanctions on Russian banks.  It can't now bail them out.  It's attempting to force Russia out of Ukraine, using financial leverage as a key weapon.  It can't provide Russia with a financial bailout.

Venezuela has for years been seriously hostile toward the U.S., while getting cozy with Cuba.  Its current predicament is the result of spending way more than it was taking in.  A bailout for Venezuela has no chance of receiving Congressional approval, nor would American generosity do anything to ameliorate the key problem, profligacy by the Venezuelan government in order to win over voters.  The IMF would impose financial discipline on the Venezuelan government as a condition of any international bailout, something the current Venezuelan government surely wouldn't accept.

Free market advocates have railed for years about the bailouts made in the aftermath of the 2008 financial crisis, proclaiming that handouts to the wealthy and powerful would only foster moral hazard and encourage undue risk taking at the expense of taxpayers.  They may have their way in the wake of oil's great fall.  Some of the key players likely to need a bailout won't be getting them.  Chips will fall where they may, and we'll see how the markets operate in the absence of government intervention.  The results will be good for some, bad for others, and undoubtedly painful for many. 

A destabilized Venezuela will probably experience internal political change.  But a destabilizing Russia is much less predictable.  As long as Putin is in power, who knows what will happen?  And what is the potential for Putin to leave power?  Not much and it's not likely to happen in a gracious way.  Demagogues at risk of losing power sometimes turn to foreign adventurism to stay in control.  The farther oil prices drop, the harder these questions will become, and the more disturbing the potential answers. 

Wednesday, December 10, 2014

Oil Prices: The Next Test For Central Bankers

Most of the benefits of falling oil prices are obvious.  Consumers, whose median incomes have been falling too, are fist bumping over lower gas prices.  Businesses are seeing some energy costs fall, burnishing the bottom line.  Members of Congress, who aren't doing jack about stimulating the economy anyway, can breath a sigh of relief over the economic stimulus from the gas pump.

Falling prices, however, have downsides.  Today, the stock market tumbled because energy stocks are under stress.  The more vulnerable oil producing nations might default on their sovereign debt (think Venezuela, and maybe others).  Many oil frackers are heavily leveraged, and they could start defaulting as their cash flow sputters.  Some financial market players are surely taking losses on falling currencies of many oil producing nations (the ruble being Exhibit A).  More opaquely, but perhaps of great concern, big banks, hedge funds and other financial market players might well be taking losses on derivatives contracts bets linked to the price of oil or the currencies of oil producing nations.  With oil price losses approaching the 50% level in the past few months, it looks like we have a bursting bubble on our hands--and the potential for another financial crisis.

Recall that it wasn't falling real estate prices alone that triggered the 2007-08 financial crisis.  It stemmed from a poisonous synergy of massive quantities of poorly underwritten mortgage loans, falling real estate prices, defaulting mortgage borrowers (many of whom didn't have the ability to repay the loans, measured by any reasonable standard), a compounding of the losses because falling prices precluded the availability of refinancing, the massive impact of these losses on the financial system through diverse and obscure derivatives contracts not well understood by market players and regulators, and, ultimately, a surprising concentration of losses onto a single entity (AIG-Financial) to which numerous key players in the financial system had unmanageable exposures.  Only an unprecedented bailout by the federal government prevented the collapse of the world financial system.

A sharp fall in oil prices doesn't necessarily mean the financial system is at risk.  There was a proportionately larger oil price fall in the middle of the 1980s which didn't result in a financial collapse (although this occurred before the evolution of complex derivatives markets that allow risk to metastasize with blinding speed).  Another big drop in oil prices in 2008-09 also didn't tip the big banks into bankruptcy (although they were already in major bailout mode by this time because of the mortgage crisis, so this instance may not prove much). 

But the proliferation of risks created by today's highly imaginative financial engineering can mean that any major drop in the price of a key asset like oil could surprise us in unpleasant ways.  One lesson from the 2008 financial crisis is that regulators didn't know where the hot tamale would land, until it hit the fan.  Regulators worldwide should be sending their examination SWAT teams into the major money center banks and other key financial institutions to scope out the direct, secondary and tertiary impacts of falling oil prices.  And that should be now--as in right now--not weeks or months from today when it may be too late to take protective action. 

Tuesday, November 25, 2014

Less Heroic Policing, Please

One thing the shootings of Trayvon Martin and Michael Brown, both unarmed black teenagers, reveal is that there may be too much of a fixation on heroics in policing.  George Zimmerman, a policeman wannabe working as a community watch person, pursued Trayvon even after a police dispatcher instructed him not to follow the young man.  Trayvon, whose suspect activities consisted of carrying junk food while black and wearing a hoodie, evidently became unnerved by Zimmerman and an altercation ensued.  Because the victim was dead and therefore not available as a witness, the evidentiary record assembled by the State of Florida wasn't as fulsome as would be ideal, and Zimmerman was acquited.  But if Zimmerman had simply obeyed orders and let a uniformed officer handle the situation, in all likelihood nothing would have happened.

Perhaps the most critical moment in the Michael Brown shooting was Darren Wilson's decision to get out of his police cruiser and pursue Brown alone.  Even though backup was less than two minutes away, Wilson evidently couldn't wait for reinforcements.  It's standard police procedure to take on violent suspects with overwhelming force (which means several officers).  An officer shouldn't go one-on-one with a suspect who is much larger and stronger than the officer.  Wilson's decision to go it alone is mystifying.  He had already been hit hard a couple of times by Brown, and injured to the point where he evidently convinced the grand jury that he reasonably feared for his life.  If Brown was that dangerous, why was Wilson taking him on alone?  Given the disparity in their sizes, and the fact that Wilson was already injured, his only ability to control Brown, it would seem, was with his .40 cal. pistol.  And that turned out to be the case. 

Before the Michael Brown shooting, Darren Wilson was commended by the Ferguson, MO police department for physically subduing a drug suspect.  Physical courage and dominance, it would seem, were honored.  But the police aren't fighting wars.  Valor is something that is usually not needed in policing.  Good judgment, self-control, and non-violent outcomes should be, and for most police officers are, higher priorities.  When Darren Wilson first spotted Michael Brown, the worst things Brown apparently had done were steal some cigars and walk down the middle of the street.  This is not a situation that should have escalated into a shooting.  When it did, and Brown was shot and ran, Wilson should not have pursued him alone.  Not when the outcome of that solitary pursuit might well depend on the use of his pistol.

The grand jury decided that Darren Wilson did not act unlawfully.  But just because something's legal doesn't make it good or desirable.  Heroics in policing are sometimes called for.  But, by all indications, we need a lot less heroism and much more sound judgment. 

Wednesday, November 19, 2014

Uber Shows Us Why Privacy Matters

It appears that a senior vice president at Uber, the online taxi service, suggested that the company ought to investigate journalists who offend the company.  In particular, Emil Michael, the SVP in question, seems to have directed his remarks at a BuzzFeed reporter named Sarah Lacy, who evidently has been critical of the company. 

Although Uber has repudiated Michael's remarks and pledged not to investigate journalists, let's think hypothetically about what a nasty corporation might do in order to dig up dirt on an individual.  There is the company's own database.  In the case of an online taxi service, that would include name, credit card information, and perhaps a lot of addresses.  Some you might not want your significant other to know about if you've been less than a paragon of fidelity.  Others you might not want your employer to know about if you've been interviewing discreetly for a new job.  Of course, there could be the address of the only abortion clinic in your city or a seedy hotel where the only things you could get are services from sex workers or illegal drugs. 

In addition, businesses corporations have access to commercial databases created by shadowy companies that vacuum up everything about you they can find on the Internet and sell it for a fee.  These databases might well include archived pages from social networking and other sites that you thought you deleted years ago (shiploads of stuff on the Internet have been archived, and a deletion on the active website doesn't necessarily mean all the archived stuff is gone).  Businesses can also hire snoops to snoop around online and otherwise.  They can get the name of the driver from the online taxi service, interview him, and find out that you were getting mighty friendly with someone in the back seat when you told your spouse you were going alone to a client dinner.  Or they can find out the name of the restaurant where you were taken, and interview the bartender to learn there was someone waiting for you who whisked you away after spending five minutes at the bar. 

No one is perfect.  For many, their imperfections can be uncovered online or through information available online.  Private interests can be bad.  Some can be evil.  There are fewer legal constraints on private interests digging up dirt online than there are on the government.  It's creepy to think that NSA or some other government agency might be sneaking peaks at our e-mail accounts.  But, ultimately, the government is subject to a variety of constraints that, at least sometimes, can be invoked.  A business corporation or other private interest that wants to do evil is much harder to rein in because of the paucity of rules.

Privacy laws are like locks on doors.  You lock your doors to keep undesired people out of the privacy of your home.  Privacy rules keep undesired people out of the privacy of your data.  Everyone wants a nonpublic place where they aren't subject to prying eyes.  Even the Uber SVP, Emil Michael, who reportedly claims that his inflammatory remarks were meant to be off the record.  (See http://www.cnbc.com/id/102199538). From the vantage point of his petard, Michael acknowledges the desirability of privacy.

It's unlikely Congress will do anything useful in the foreseeable future.  But if it wanted to shock us with a pleasant surprise, it could enact a strong set of privacy rules for online data and the use of online data.  After all, privacy matters.

Wednesday, November 5, 2014

Economic Consequences of the Mid-Term Elections

The economic consequences of yesterday's mid-term elections will be zero.  In order to boost the economy, the federal government would have to raise taxes, cut spending or both.  Even though President Obama now faces a majority Republican Senate as well as House, he won't agree to major tax cuts and the Republicans won't agree to major increases in spending.  So the fiscal impact of the mid-term elections will be effectively zero.  With the federal deficit lower than the historical average of 3% of GDP, there's room for fiscal stimulus but no political impetus for it.

Modest spending boosts may come from an increased military role for the U.S. in the Middle East.  Trying to suppress ISIS is becoming a game of whack-a-mole.  And American air power may have to target an al-Qaeda affiliate called the al Nusra front as well.  But such mission creep will be constrained as there is no public support for a resumption of ground warfare by U.S. troops.  The defense budget won't provide major stimulus.

Monetary policy is the only real game in town, and central bankers are the croupiers.  The Fed has just ended quantitative easing in the face of 3% plus growth by the economy, but there's nothing that stands in its way if it wants to fire up the monetary printing press again.  Just the push of a few computer keys, and the QE program is up and running again.  The Japanese central bank has recently placed a lot of QE chips on the table, putting a punch bowl on the table even as the Fed takes one away. 

The newly empowered Republicans in the Senate will probably increase pressure on the Fed to step back from accommodation.  That would be a fool's errand, as there is nothing the Republicans could actually do over the next two years to substitute for the loss of Fed accommodation.  If Republican pressure on the Fed slows the economy to stall speed, look for smashing Democratic victories in the 2016 Presidential and Congressional elections.

Monday, November 3, 2014

Has the Supreme Court Entrenched the Two Parties?

The upcoming mid-term elections, in which Republican gains are strongly anticipated, are much more about anger than beliefs.  Voters are inclined to throw the bums out (which in some cases may mean Republicans instead of Democrats).  They are anti-incumbent and only incidentally sometimes in favor of the challenger. 

This would seem the ideal environment to launch a third political party.  The Republicans and Democrats have become increasingly insular--from each other, and especially from the middle of the electorate.  The strong showing by Independent Greg Orman in the Kansas senatorial race illustrates the willingness of voters to consider candidates from outside the box. 

But Orman, if he wins, will caucus with one party or the other.  He isn't looking to lead the charge for a third party.  Big Republican Money is flowing into campaign coffers to inflame voter anger.  Big Democratic Money is flowing in riposte.  Any attempt to create a third party would be crushed by these financial woolly mammoths. 

The Supreme Court in recent years has struck down various limits on campaign contributions, opening the way for large contributors to throw their weight around.  Even though voters may be increasingly ready for a choice other than Tweedle Dee and Tweedle Dum, few with deep pockets would be willing to fund a third party.  The existing parties, with their gerrymandered incumbents and established infrastructure, enjoy exacerbated advantages from the Supreme Court's antipathy toward restrictions on campaign contributions.  Regardless of the mood of the electorate, the chances for a third party to take root shrink as funding for the Republicans and Democrats increases.

There are political insurgencies.  But they take place within the established parties.  The Tea Party and its sympathizers have swung the Republican Party away from its traditional power brokers.  And the election of a black man to the White House came from the most successful political insurgency in over 40 years.  But, if you're hoping to see colors other than red and blue on political maps, you'll be waiting a long time, thanks in no small part to the Supreme Court.

Wednesday, October 22, 2014

The Turmoil of Economic Inequality

Of all the potential dangers of economic inequality--slow growth, reduced upward mobility, and so on--social destabilization is the most worrisome.  This is when people say, "Enough.  We're not waiting for things to happen.  We're making them happen.  Our way."

The pro-democracy demonstrations in Hong Kong were nominally over Chinese attempts to limit the freedom of Hong Kong's elections by vetting candidates.  Only pro-Beijing candidates need apply. But growing economic inequality in Hong Kong fueled the anger of the demonstrators.  Wealthy Chinese are buying up prime real estate in Hong Kong, pushing prices beyond the reach of the local middle class.  The wealthiest Hong Kong residents are, like the 1% elsewhere, growing disproportionately richer.  Job and other opportunities for many others are looking bleaker.  Middle class Hong Kong residents began to see less and less for themselves in the status quo.  They didn't take things quietly.

Democracy is a mechanism by which the 99% push back against the growing wealth and power of the 1%.  Without democracy, oligarchs and plutocrats flourish.  China has an authoritarian government, whose powerful members and their families are intertwined with China's economic elite.  The ordinary citizens of Hong Kong have no voice in the northern capital.  Public protest is only way for them to be heard.

Modern day mandarins in Beijing no doubt shivered when protest banners unfurled in Hong Kong.  Since the days of dynastic China, rebellions against the central government have usually ignited in southern China.  Far from the seat of power, the discontented more readily questioned claims to the Mandate of Heaven.  Indeed, both of the rebellions that unseated the last emperor, and then the Chinese Nationalist government (now a vestige on Taiwan), began south of the Yangtze River.  In recent weeks, Communist cadres have no doubt been taking more business trips to warmer climes.

Turmoil from economic inequality is not limited to Hong Kong.  In the city by the bay, middle and lower income San Franciscans have bristled at the invasion of the geeks from the Silicon Valley.  Young technocrats have driven up real estate prices and Yuppified neighborhoods that heretofore took pride in their eccentricity.  Charter buses used for commuting by the options-compensated have been attacked by the not-so-well compensated.  The so-called trickle-down theory isn't entirely benign.  Capitalism has losers, and the losers will push back.

America is a democratic nation, although increasingly dominated by Big Money as a result of U.S. Supreme Court decisions striking down various limits on campaign contributions.  Democratic Party get-out-the-vote efforts in 2008 and 2012 have held the forces of wealth at bay for now.  But countries tend to work best when they have a government of the people, by the people and for the people.  Economic inequality cannot continue to increase indefinitely; and consequently, it won't.  The only question will be how it ends.  Let's hope it doesn't end badly.

Sunday, October 5, 2014

The Student Debt Dilemma

Some predict that student debt will be the next asset bubble that will make the financial markets crash.  That's unlikely, but student debt is a huge and growing problem that gnaw away at economic growth until something changes.

Student debt won't bubble and burst like mortgages because the impact of losses wouldn't be centralized in the financial system.  The reason why mortgages, and their kissing cousins, mortgage-backed derivatives, almost blew up the world's financial system in 2008 is that when the ship hit the sand, the impact of losses was concentrated on the largest financial institutions, in particular an insurance company called AIG.  These institutions would have been rendered insolvent toute de suite, and the financial system would have been engulfed by a roaring flushing sound.

Some 20% or so of student loans are in default, and very possibly many more will never be fully repaid (for various reasons, it's sometimes possible to avoid default by paying small amounts of student loans but not be repaying fast enough ever to fully pay off the debt).  The impact of these losses will be spread out over time, and much if not most of it will fall on the U.S. government.  Which means that taxpayers will bear a lot of the burden, along with private investors.  But it will be a diffuse, albeit large, burden rolling out over years and decades.  There won't be a sharp poke in the eye at a discrete moment in time that will trigger a financial crisis.

But the aggregate amount of student debt keeps growing (it's over $1 trillion now), and the burden of repayment is growing commensurately (especially since interest rates on federal loans will float, and given today's ultra low rates, they can float only in one direction).  The burden of defaults and other nonpayment will also grow.  It's anecdotally said that student loans are holding up everything for many young adults--marriage, car purchases, home purchases, having children, and so on).  Maybe it makes sense that the sharing economy (car sharing, bike sharing, and the various iterations of the rental economy) is booming.  Young people can't afford to buy things, so they purchase the use of things for short periods of time.  This may be good for the environment, but it hinders economic growth.  If the burden of student loans becomes heavy enough, the impact could be lifelong, and entire lives could end partially unlived.

Student loans are almost impossible to discharge in bankruptcy.  It's easy to get federal loans--you just need to be admitted to an accredited institution--so there's an understandable reason for making them hard to ditch.  Otherwise, taxpayers could be asked to give free college educations to vast numbers of people.  And college educations provide lifelong benefits, so it's arguably fair to ask people to repay college loans, even if it takes a lifetime.

But student debt has become a bear trap for those who default.  Of course, their credit scores are knocked down.  That seems fair enough, but that's also where the kidney punches start.  Many employers won't hire a person with credit problems.  If you are laid off and then default on your student loans, you may not be able to get a new job to repay them.  Sometimes, you lose a professional license (like a nurse's license), which makes it even more difficult to find a job to repay the loan.  Defaulted loans continue to bear interest and penalties are imposed for default, thus ballooning the amount you have to repay.  So, if you have significant student debt, here's what you have to do:  (a) never lose a job; (b) never get so sick that you have to take major time off from work; (c) tell your aging parents that you can't help support them in their old age; (d) tell your spouse he or she can never lose a job, get so sick that they have to take major time off from work, and provide no support to their aging parents; and (e) never do anything that would otherwise result in default.  Getting to like rice and beans, network television broadcast to a TV with rabbit ears, and knitting your own socks, would also be good.

What will happen is, eventually, substantial relief will be given by Congress to student loan defaulters.  The exact scope and terms of the relief aren't easily predicted.  But it will happen.  Why?  Because the problem has become too big, and full repayment is increasingly unlikely for too many borrowers.  Since students from middle and lower income classes are the most likely to take out loans, the burdens are distributed in a regressive way.  Sooner or later, that will find expression in the ballot box.  When too many people labor under the burden of student loans, their combined political voices will overwhelm the lobbyists and influence peddlers employed by the student loan industry and the educational institutions that free-ride on easy educational credit.

There's a precedent for allowing student loans to be discharged in bankruptcy--that's bankruptcy itself.  When Lord Cornwallis' Redcoats surrendered at Yorktown in 1781, there was no such thing as bankruptcy.  Debtors were not only expected to repay their debts in full, but could be imprisoned until they did so.  As one might expect, the use of debtors prisons wasn't always fruitful.  A debtor in prison couldn't work or otherwise do much to repay.  But debtors were commonly imprisoned in the belief that the world was a better place for it.

However, as America grew into a bustling, vibrant industrial nation, voices of reform argued for giving debtors a chance for a fresh start.  Freed from old debt, individuals could more fully participate in the economy and provide for their families, thus strengthening future generations.  Creditors pushed backed, contending that a man's word should be his bond and that shiftless, lazy and prevaricating deadbeats shouldn't be able to hoodwink those that extended credit in good faith.  But the voices of reform won the debate, and America became one of the early adopters of the concept of bankruptcy.

Permitting bankruptcy shifts risks, placing more of the burden of default on creditors and less on borrowers.  As a consequence, market forces led creditors to adjust their practices, raising interest rates on all borrowers and eventually adopting the credit scoring system.  In effect, all borrowers pay for the defaults of some, but all borrowers have the option of bankruptcy.  Since you never know when life may blow up in your face, this may not be so bad.

The student loan crisis will eventually impel something similar. The sheer, growing size of the problem will force change.  Student loans increasingly are no longer just the problem of some, but the problem of many, most and perhaps even all. Of course, if student loans become dischargeable in bankruptcy, other changes will result.  Interest rates on the loans would likely increase, so that all borrowers cover the costs of defaults.  And educational institutions may be required to pay a portion of defaulted loans--at least for those students who don't graduate, so that colleges don't accept applicants who are unlikely to graduate and then free ride off the loan revenues from those students.  These changes would be appropriate, since taxpayers shouldn't have to fund handouts for the educational sector. 

The current student loan crisis is yet another illustration of the problems of easy credit.  Easy credit at first seems like a bargain, and everyone loves it.  But there's no free lunch, and the costs of easy credit will eventually emerge.  When the problem becomes so severe that it cannot continue in the present form, then it will change.

Sunday, September 21, 2014

The Online Challenge For Higher Education

Higher education is moving online, and that's a trend that will continue and expand.  The costs of college degrees have risen sharply over the past 40 years and this trend shows few signs of abating.  Cost considerations alone will force many students to look for online alternatives.  It doesn't matter that physical institutions offer the benefits of face-to-face classroom interactions and social opportunities that could create lifetime friendships.  When college costs continue to rise 5% or more a year, and incomes rise scarcely at all (except for the top few percent), numerous students from less privileged backgrounds will be financially squeezed out of traditional college experiences.  How quickly and how far online education grows depends on how purveyors of online education and traditional colleges confront certain basic challenges.

Online education has to prove that it can provide a quality education, one that makes its graduates competitive in the marketplace for good, well-paying jobs.  Online students obviously won't enjoy football Saturdays, beer in the student union, or impromptu chats with professors; nor will they be able to disgrace themselves with embarrassing behavior on fraternity row on weekend nights.  And it's difficult to replicate certain educational experiences online--laboratory work for physics and chemistry classes isn't quite the same if all you're doing is watching someone else do it through a computer monitor.  But the educational content of many, and perhaps most, college courses can be presented online with little or no loss of substance.

The online educational process may be more adaptable to meeting the needs of employers.  Physical institutions tend to subscribe to a traditional belief in the value of a broadly based liberal education.  While this concept remains valid, it isn't essential for everyone.  The billionaire founders of Microsoft, Oracle and Facebook are all college dropouts.  The denizens of academe may sneer at trade schools, but Europe's most powerful economy--Germany's--includes trade schooling as a crucial part of its educational system.   There is more to life than work, but life really stinks if you need a job and don't have one.  If online schooling can produce competitively employable graduates, it will transform education the same way that Amazon and Alibaba have transformed retailing.

Physical colleges have overpriced their product, and now confront an overcapacity problem.  The elite schools (the top 100 or so) will continue to do well because there will always be a certain segment of the population willing to pay (or having parents willing to pay) the costs of a name brand sheepskin.  Students aiming to be professionals--doctors, lawyers, and so on--will benefit from the friendships and contacts they make by being on campus. Students who don't really know what they want to do may be able to find a focus for their energies from exposure to the breadth of topics covered by a liberal education.

But the days when getting a college degree in anything and still being readily employable for a good salary are long gone.  There is increased pressure on kids at the high school level to choose a field and get a focused education so they can get a job.  Mid-tier colleges that provide good students with a good general education will find that's often not enough.  And even as they struggle to adapt, they'll be competing against numerous other mid-tier colleges that are struggling to adapt.  Reality is that a lot of mid-tier colleges have limited half-lives.

Much of the problem lies in the easy availability of educational loans.  There is no meaningful underwriting process for these loans.  Anyone admitted to an accredited institution can get a loan.  And, in order to preserve the principle that there's no free lunch, these non-underwritten loans are virtually impossible to discharge in bankruptcy.  For many kids, educational loans are like a pact with the devil--easy to enter into, but binding for eternity.  Many colleges are culpable participants in this pact.  They used the availability of easy education credit to raise tuition and fees much faster than incomes were rising, and to pad the compensation of administrators and top level college officials.  They aren't stuck with having to repay defaulted loans of their students.  So they have every incentive to encourage students to take out loans that benefit the college and its officials, but impose no costs when the educations they provide aren't sufficient to land the students good jobs.

Political considerations preclude any meaningful reform of college loan programs that would balance the costs and benefits, particularly by penalizing colleges for churning out graduates who can't repay loans that the colleges helped them obtain.  But economic forces will compel change.  Many high school graduates, looking at the bear trap college loans can become, will choose low cost routes through community college, trade schools, and, increasingly, online education.  Many physical colleges that have floated on the cushion of educational loans will have to downsize or close, as their cost structures cannot be sustained by their likely future revenue stream.  They will no doubt lobby the political process, whose knee jerk reaction will be to make college loans even easier to obtain.  But that will, if anything, make the problem worse, not better.  Students, having been served too many coffee drinks by well-educated baristas, won't take the bait. 

The economy as a whole is better off if students can obtain high quality, low cost educations.  Indeed, as the American middle class continues to decline, inexpensive higher education may offer one of the few avenues for recovery.  The end result will be workers who can succeed, prosper, and consume, rather than have pauper's lives in quasi-debtor prison. 

Wednesday, September 3, 2014

Easy Money: Reinvesting Dividends

Some of the easiest money comes from reinvesting dividends.  Over long periods of time (such as 20, 60, or 80 years) dividends accounted for a little more than 40% of total stock market returns.  Stated otherwise, if you spent dividends, as opposed to reinvesting them, your portfolio would have enjoyed only a little more than half the return it could have gotten with reinvested dividends.  Remember that reinvesting dividends has a compounding effect, and compounding is very, very good for your net worth (see http://blogger.uncleleosden.com/2009/09/if-you-love-compounding-compounding.html).  Your total return can be greatly magnified with compounding, accounting for well over half the long term return.

It's easy to reinvest dividends when you invest in mutual funds.  On the account opening form, just check the box for reinvesting dividends and interest, and the mutual fund's administrator will do the rest. Dividend reinvestment plans (DRIPs) offered by the company issuing the stock are clumsier, since you have register with the company and the shares are less liquid (not so easily sold).  Some brokerage firms will reinvest dividends received in your account.  However, you may not have from DRIPs or brokerage accounts the diversification that offers a reasonably steady flow of dividends.  The easiest way to reinvest dividends is through mutual funds (make sure you choose a fund with low costs).

You'll have to pay taxes on the dividends if they're held in a taxable account (although possibly at a lower rate than what you pay for ordinary income).  If your investments are in a tax-sheltered account like a 401(k) or IRA, dividends will be reinvested as a matter of course and you'll pay taxes when you withdraw the money, or convert or transfer to a Roth account.  For money from tax sheltered accounts, taxes will be assessed at ordinary income rates.  But taxes are imposed on dividends even if you don't reinvest.  So they're don't really affect your decision whether or not to reinvest.

Reinvesting makes money for you while you're sleeping, cooking dinner, playing golf, mowing the lawn or indulging in more screen time than you'd ever allow your kids.  Don't pass up this chance to make easy money.