Tuesday, June 30, 2009

Hypocrite of the Day: American Federation of State, County and Municipal Employees

Clearly the head of the American Federation of State, County and Municipal Employees (“AFSCM”) union has no sense of irony, and perhaps no sense at all.

In a letter to the Chairman of the Board of Citigroup, the head of AFSCM dutifully exerts his unions influence as a significant shareholder (3% ownership by union pension funds) and urges Citigroup to change its compensation structure at its investment bank. All shareholders should have their views heard, and I applaud the AFSCM for taking an active role as a shareholder – a vital piece to restoring appropriate corporate governance in this environment.

However, the suggestions in the letter, coming from a union leader, takes the concept of unintentional comedy to a new level. Two phrases from the letter (can bee seen here: http://www.scribd.com/doc/16942549/Unions-Letter-to-Citigroup-on-Pay-Raises) made me laugh out loud considering the author was a union boss:

1) “a great deal more pay that has no tie to performance.”
2) “reward executives for long-term value creation, not just showing up for work”

First of all, there is no industry where the compensation is more directly linked to performance than the investment banking industry. If you produce profits, you are rewarded with your share of those profits, if you produce losses, you are likely to be fired, or at best, you can expect bonus day to pass you by. Citigroup will not be increasing the salary of traders who have lost millions (if they are even still around to collect a salary). What Citigroup and the rest of the industry is trying to do is insulate its best talent from the insane legislation spouting from Congress relating to compensation, because if they don’t, that talent, and all of its revenue producing ability (remember, many traders/bankers have continued to generate significant profits through the crisis) will leave to foreign competitors or hedge funds, both of which are not subject to Congress’ insanity. Defections like this will only hurt AFSCM’s investment in Citigroup.

The negative consequences of the historic concentration on short term profits is a valid critique, however, all banks have taken steps to start to address this (less cash, much more restricted stock, longer vesting periods).

Maybe the AFSCM is not directly responsible for the financial crisis resulting from the extortionate demands of unions at companies across the country (the bankrupt Auto and Airline industries are first to mind), but I’m sure its union contracts have contributed significantly to the fiscal crisis’ of states, counties and municipalities across the country. Isn’t the main tenant of any employee unions that compensation and benefits are explicitly linked to seniority rather than performance? Based on his logic, perhaps he should do the right thing and re-negotiate his union contracts to ensure the compensation of his membership is directly linked to the employees performance and the surplus(yea, right) or deficit their employers run.

There is a lot of hypocrisy floating around these days, but I’ve yet to see anything this blatant and comedic. The unions detachment from reality never ceases to amaze me.

Tuesday, June 16, 2009

Obama’s Accountants Have Some Explaining To Do

What if I said I could buy a brand new Ferrari for $10,000. Would you believe me?

President Obama sat in front of the nations doctors yesterday, and with a straight face, claimed his far-reaching Ferrari of a health care reform plan would cost around $1 trillion over the next 10 years. While it was acknowledged that it could go higher, quoting $1 trillion over 10 years seems to be unrealistic, and borderline fraudulent.

If a publicly traded company made this claim and it turned out to be understated, the executives of that company could be thrown in jail. Shouldn’t we hold our elected officials to the same standard – or an even higher standard - after all, it’s our money they are throwing around. If they were required to be held to this standard, they might be more careful about the numbers they throw around when trying to push an agenda.

Without getting into detail or the merits of this plan (dubious) or the unintended (er, ignored) consequences on patient care, doctor recruitment, taxes, private health insurance industry, economic growth, etc. (disasterous), I would really like to focus on how preposterous it is to claim that this will only cost $1 trillion over the next ten years. $1 trillion per year, maybe, but over 10 years, not a chance.

As we all know, if a true reflection of the costs were known, the American people, and Congress, would balk at the proposal as being too expensive. Therefore, the $1 trillion quote is just politics as usual – lie to the American public because they don’t know any better.

For example, part of Obama’s plan includes coverage for the 50 million Americans that are currently without insurance coverage. An admirable goal of any health care reform, but we need to be realistic about the cost of this coverage, and forthcoming on how it will be paid for.

I’m no health care professional or expert, but I am an accountant and a minimal amount of research and some common sense shows that there is no way this amount is possible.

Let’s assume that only the 50 million American’s without health insurance coverage are the beneficiaries of this new reform (a very conservative assessment).

In 2009, Medicare covered approximately 45 million people at a cost of $425 billion. If we assume 0% increase in medical care over the next 10 years (when actually it has increased at an average rate of approx 8% per year), and a 0% increase in the amount of people insured over 10 years, this equals $4.25 trillion dollars over the next 10 years. Even if we present value those future costs to today, and apply a discount rate of 4% (Treasury just issued 10yr notes at 3.99%), the US would have to borrow $3.4 trillion today to pay for the next ten years of health care reform – 3.4 times the amount quoted by Obama.

I admit there are some clear shortcomings to the analysis above, but I believe they are offset by some very conservative assumption (i.e. zero cost inflation over 10 years, only based on 44.8 million participants, etc.). These shortcomings include the exclusion of the cost savings plans envisaged by the Obama Administration ($200 billion cut from hospitals and $313 cut from Medicare and Medicaid over the next 10 years – neither of which would put a material dent in the analysis above - if they turn out to work), and the fact that generally, patients covered under Medicare are older and in need of more healthcare than younger citizen. I have no way of guessing what this amount is, but I doubt it would reduce this amount down from $3.4 trillion to the $1 trillion quoted by the Obama Administration.

To overcome the fact that Medicare’s patients are older and in need of more care, let’s look at an example of national health care (i.e. care for all). I live in the UK and have been exposed to the National Health Service, and while it is competent in emergency situations, it is dangerously inefficient in all other health care situations. Again, the pluses and minues of national health care is a debate for another time, but let’s focus on the costs.

The 2009 budget for the mediocre-at-best NHS in England is approximately £100 billion. The population of England is around 50 million, so again it roughly matches the population of Americans without coverage that would benefit from a new plan. Again, I highlight this as a conservative assumption because the Obama plan is not just for those currently without coverage, many more will end up under this option, and the numbers will increase as the governments influence will eventually price out private insurance companies – but again, this is for another debate.

Using a similar approach to above, applying the current exchange rate of approx. 1.60 USD/GBP, the present value of the UK’s budget, in dollars, over the next 10 years is $1.3 trillion.

Before we compare this to Obama’s $1 trillion number (after all, what’s $300 million between taxpayers?), consider these facts that make this number an extremely conservative calculation to apply to any new government run and funded health care scheme:

  1. This assumes the US health care costs are the same as the UK’s (they are not, the US costs are much higher. To illustrate this point, I have worldwide private health insurance, excluding the US. If I include the US, my premium would triple!)
  2. This also assumes no growth in costs or people covered over a 10 year period (again, extremely unlikely)
  3. This assumes the US can implement this system with the same efficiency as a system and infrastructure that has been in place for 60 years
  4. The NHS is a pure single payers system, it owns its own hospitals, and directly employs its own doctors and staff – a cost benefit that could not be matched by any US plan in the short term.
  5. Even with this budget, the NHS is seriously underfunded and is running a huge deficit, so its costs are even higher than the budgeted amount.

Therefore, even an unrealistically conservative cost analysis shows a larger number, 30% larger, than the cost quoted by the Obama Administration.

In summary, two simple calculations and a bit of common sense is all it takes to put some very large holes in the Obama administrations cost projections, I just wonder why nobody has challenged the Obama Administration’s math?

Friday, June 12, 2009

An Anti-Populist, but Real Life Response to the 90% Bonus Tax

Note: I originally wrote this on Facebook on March 20th, and it spurred my interested in starting a blog, so I'm posting it here as my first real blog.

I’m not a blogger [or wasn't when I wrote this!], and don’t usually don’t feel the need to vent on paper like this, but it’s down right frightening what’s happening in Washington these days, so I’m making an exception. My preference would have been to link to a story making these points, but I’ve yet to see these points properly illustrated in the press, so allow me to write it below.

The tipping point that turned my frustration into fear is the bill passed that will “levy a 90 percent tax on bonuses paid to employees with family incomes above $250,000 at companies that have received at least $5 billion in government bailout money.” (AP article)[Disclaimer: I work for an investment bank – I’m not a fancy credit trader, but an accountant. If you’ve stopped laughing, it’s also worth noting that this legislation doesn’t impact me so the following is not sour grapes, it’s a very real concern.]

Let’s assume for a minute that this law is constitutional (doubtful) and turns into law - does this make anyone else nervous? Are we happy with a government that can retroactively and selectively tax hard working American’s at a 90% rate? Do they even know who they are punishing, and in many cases ruining financially? Do they really think everyone caught by this proposal are directly responsible for the losses racked up at these companies?

For every CDS trader who lost his shirt on bad trades, there are 100’s of other bank employees who get hit with this tax, despite having absolutely nothing to do with the losses, and in some cases were a major reason why the losses weren’t even bigger (for example a commodities or FX trader who’s earned the Bank millions and millions in profits during 2008).

Should traders who bet the house and lost it deserve big bonuses? No, and they were shown the door a long time ago. Some senior management at these firms remains but they are already under voluntary and TARP restricted pay packages. Therefore, the vast majority of the people left to clean up the mess had little or no influence over the losses that occurred.

If the main culprits of the losses are already gone, who will this impact? Who is left to absorb the full force of this “message” from Congress?

The target of this misguided and theatrical outrage will end up being a large number of hard working individuals who had no direct involvement or control in the losses that caused the bailouts and were just unlucky enough to work for a company that made some bad decisions and was bailed out by TARP (and in the case of GS and MS, involuntarily bailed out).

I’m all for going after the bad guys, but despite the public perception of Wall Street driven home by the pandering, egomaniacal, small-minded individuals in Congress and the Obama Administration (including the President himself), not everyone that works for an investment bank is evil, greedy or rich. There are no doubt exceptions to this point, but we shouldn’t regulate based on the exceptions at the expense of everyone else.

There are two huge consequences to this decision that apparently eludes the idiocracy in Washington:

1) Impact on those taxed
2) Results of affected employees leaving to go work at a Bank/Hedge Fund that has not taken TARP funds.

Let’s illustrate the first point with a little story – Mr. Bent Dover is a manager in Goldman’s finance department. He’s studied hard at school, worked very hard at every job, and paid all his taxes. Based on this experience and knowledge he could expect to earn about $200,000/year working as a manager in the finance department. Since Bent works for an investment bank, that income is split between salary and bonus – about 50/50, so he has a documented salary of $100,000, and expects a bonus in the neighborhood of $100,000.

Mrs. Dover works part time while taking care of the kids in their rented Hoboken apartment. She earns $50,000/year in her job. A family of four living off of $250,000 in New York is comfortable, but that family does not have a mansion with staff, does not drive Italian sports cars, does not fly first class – it doesn’t afford an extravagant lifestyle in the NYC area.

The Dover family relies on Bent’s bonus for everyday expenses, day-care providers, etc. not for Rolexes or trips to Monaco. So how does this proposal impact the Dover family? Ignoring the extremely complex tax code, let’s assume that the Dover’s meet the $250,000 bogey set by Congress, and by the stroke of Obama’s pen, Bent’s after tax bonus payment goes from $65,000 ($100,000 taxed at 35% - remember the government is already taking at least 35% of his income) to $10,000 ($100,000 taxed at 90%). That’s an after tax difference of $55,000, roughly reducing Bent’s take home pay by 50% for the year, and his families living expenses by 34%. The Dover’s new effective tax rate is now 57% (that’s before factoring in state taxes, sales taxes, etc.).

Does Bent deserve this type of treatment from his government? His responsibility was financial reporting, and not risk management, yet he is being vilified financially for performing that role at Goldman instead of HSBC or an unregulated Hedge Fund.

Which brings me to the second important point – if you are threatened with a 90% tax rate what is the most likely plan of action? Leave the US Bank and go work for a foreign bank or a hedge fund.

Jobs are tight now, but there will always be room for profitable employees at these institutions, and they will jump ship – it probably won’t take a month from when this legislation is passed.

Once the economy picks up again and markets are functioning, and this tax remains in place, I anticipate that the foreign banks and hedge funds will sweep through the Goldmans, MS, Citi’s, BofA’s of the world and easily walk away with their best talent (assuming they haven’t paid the TARP money back yet). The American banks will be left to rebuild their depleted talent pool while their foreign and unregulated competitors gain significant market share and profit the most from the eventual rebound in the economy.

What’s the impact of this?

Without the right people, it’s

1) billions more will be lost through ineffective management/hedging/exit of these complex instruments still on the books – potentially losses would dwarf these bonus amounts, and
2) their ability to repay the bailout loans will come into question.

To risk the overall health and future of the American financial services industry over these bonuses is shortsighted and dangerous. Let’s not forget, the government is getting a very nice return on the TARP investments, and to my knowledge, nobody has defaulted on those obligations. TARP was not a hand out (unlike the pork in the stimulus bill or the auto bailouts) it was a loan that will in all likelihood be paid back, with interest, in the near future.

Hopefully the Senate has a more reasonable approach to this issue that both panders to the ill-informed populist sediment, but doesn’t burden American workers or companies with excessive taxes out of spite.

If these companies were fraudulent, take them to court and try and prove fraud or other illegalities, but don’t punish them without a trial through the tax code. All Americans should be wary of a Congress that is ready and willing to selectively drop a 90% tax on American workers where it sees fit

Welcome to theantipopulist.com blog!

With politicians on both sides of the asile rushing through proposals that pander to the current headlines and cable news blowhards, without regard to the future unintended consequences, I've decided to start a blog highlighting my views on these proposals.

I've never tried anything like this before, so I hope to keep it interesting and build up some interest in these debates.