Sunday, January 25, 2015

Obama's 529 Mistakes

President Obama's proposal to tax earnings distributed from 529 college plans derived from future contributions is one of the worst ideas he's had in tax policy.  He would make withdrawals derived from earnings on new contributions taxable to the student (although withdrawals derived from earnings on funds already contributed would remain tax-free).  Let us count the ways this makes no sense.

Defies Tax Logic.  The redistribution of income through a progressive tax structure is a concept that virtually all Americans agree on, including many who are very wealthy.  However, Obama's 529 proposal creates a much smaller redistribution loop consisting of college students (and perhaps indirectly their families).  Students from more prosperous families will pay taxes that will subsidize students from less well-off families.  Why have a redistribution loop consisting of only the student community?  If that makes sense, why not have wealthier farmers subsidize less wealthy ones?  And why not have higher earning servers and bartenders (e.g., those at high end restaurants and hotels)  subsidizing the employees at Mickey D's.  Since college educations are so important to America's future, subsidies for middle-class and less fortunate students shouldn't come at the expense of other students who, through no choice of their own, were born into more prosperous families.  If redistribution of income is a societal goal, it shouldn't be done in a distorted way like this. 

Bad Social Policy.  Having children and raising them well is beneficial for America as a nation.  A healthy birth rate is crucial to America's future success as a nation.  More prosperous families are better able to afford to have children and raise them well.  The extremely low birth rates in Japan and Europe have seriously impaired the economies--and futures--of those nations.  Disincentives to have and educate children shouldn't be built into the tax code.

Bad Trickle Down.  Obama's 529 proposal effectively raises the cost of college for students from more prosperous families.  It defies economic logic to believe that won't have consequences.  Some students might lose opportunities when this happens.  Let's take this hypothetical example to see how that could work.  Valedictoria, a brilliant high school student from a well-off but not rich family, might barely be able to afford the unconscionably high costs of an Ivy League school if 529 plans remain unchanged.  But she would opt for a less expensive school (the well-regarded University of Home State) with the Obama changes because she doesn't want to or can't take on the additional debt required for the Ivy League (and wants to spare her parents that burden).  She opts for the less expensive school.  Her enrollment there could bump out a student who was marginally able to gain admission to the University of Home State.  The marginal applicant then goes to a less-well regarded school, perhaps losing educational quality and opportunities he might have had at the University of Home State.  Is the nation somehow better off if this happens?

Punishes Self-Sufficiency.  The people who fund 529 plans are the kind of people who, in past generations, would have been viewed as good citizens prudently saving for the future education and improvement of their children.  They hope not to rely on handouts or loans or governments to finance their childrens' educations.  They'd like do it themselves, thank you.  Indeed, self-sufficiency was once regarded as one of the most golden of American virtues.  In a land where there were many opportunities, but also many hazards, the self-sufficient were the bedrock and pillars of a growing nation that wanted to keep growing.  To be self-sufficient, you necessarily have to build your wealth.  Why penalize self-sufficiency by taxing college savings?   We have become a nation obsessed with instant gratification, the faux celebrity status offered by social networking, easy credit for all, and bailouts for almost every need imaginable.  Will discouraging self-sufficiency improve things? 

Friday, January 16, 2015

Did Someone Blow Up the Swiss Currency Peg?

Much to the surprise of numerous market players, the Swiss National Bank yesterday (Jan. 15, 2015) dropped its commitment to peg the Swiss franc at 1.20 to the Euro.  The Swiss franc suddenly rose some 20% in value, a price shift that clobbered anyone betting the peg would hold.  Losses have been sudden and very sharp.  A major foreign exchange broker, FXCM, has received an emergency $300 million bailout loan from Leucadia National.  Another forex broker, Alpari UK, has entered insolvency proceedings.  A new Zealand broker, Excel Markets, has been knocked out of business.

The Swiss National Bank's reasons for abandoning the peg aren't very clear.  But the abrupt demise of the peg is reminiscent of the UK's withdrawal of the British pound from the European Exchange Rate Mechanism in 1992, after a large hedge fund shorted over 10 billion pounds on September 16, 1992.  The Bank of England was trying to fight market forces that dictated a lower valuation for the pound, and in the end couldn't win that fight. 

A news story reports that in December 2014, there was a very large capital inflow into the Swiss franc, with some 34 billion francs being bought up.  See http://www.cnbc.com/id/102343957.  This is about 10 times the monthly average.  One can wonder whether this flood of capital was the result of a calculated move by one or a few big market players.  While there has for some months been a flight to safety resulting from the EU's economic slowdown (and the likely de facto devaluation in the near future of the Euro via ECB quantitative easing), Vladimir Putin's banditry in Ukraine, and the never-ending turmoil in the Middle East, December's inflow is so abruptly large than one cannot exclude the possibility that it was a move made by a few powerful players.  And if it was, they would have profited handsomely from the Swiss franc's recent price rise.

Thursday, January 15, 2015

Artificial Intelligence in the Stock Markets

Artificial intelligence has been much in the news recently.  Well-recognized deep thinkers have propounded profound thoughts that predict good and bad outcomes for artificial intelligence as it becomes ever more of a reality.  The takeover of the world by machines is inevitable--with monstrous consequences--or not, depending on who you ask.

There isn't much real-world empirical data relevant to the opposing sides of this argument.  But one big clinical trial is underway:  in the stock markets.  Most of the trading done today in the stock markets consists of computerized trading.  Institutional investors, like mutual funds, pension funds, and so on, comprise most of the rest.  Mom and Pop, trying to invest a few nickels for their retirement, are like pedestrians surrounded by massive semis barreling along at interstate speeds.

Much of the computerized trading is done by dynamic computer programs.  In other words, the computer doesn't buy and sell based on a static algorithm embodied in the program coding.  The program can change itself in response to market conditions and activities.  In essence, depending on what the program detects is happening in the market, it can alter its own coding without the need for a human programmer to keypunch and proofread line after tedious line of code.  The details of how these dynamic programs work are generally shrouded in commercial secrecy.  But we have a situation where computer programs take note of what's going on in their working environments, think about how to change themselves to be more effective (i.e., profitable) in light of changing conditions, and then alter themselves to do better.  That's getting rather close to what people do: try to change and improve themselves in order to advance their careers or make more money in their professional activities.

We have seen in recent years how computerized trading can cause mini-crashes and other short term  turbulence in the stock markets.  Mom and Pop are often finding the waters too rough, and suddenly see the virtue in the paltry returns of passbook savings accounts or certificates of deposit whose yields have been flattened by the nearly supine yield curve.  Even some professional money managers are looking for ways to fly over or around the storm clouds of computerized trading, moving trading to venues that claim to allow only "natural" (non-computerized) investors to participate.

For academic researchers and other prognosticators, the dynamic computerized trading in the stock markets could furnish a useful body of data with which to work.  The rest of us, unwilling guinea pigs in a clinical trial we didn't sign up for, can only look to financial regulators and other government officials to ensure that the results of the experiment don't turn out too badly,

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.