Tuesday, September 9, 2008

Autumn in the air, and in the pocket (2)

Arnhem Autumn Coming 1 Last essay, I reflected on the increase in household expenses, reflected in the Consumer Price Index.  I'd like to touch on the income side today.

For most people income has not kept pace with expenses.

Wage increases for most people I talk with have averaged just over 3% this year.  Investment income, whether from bank accounts, CDs, or bonds, has been less than 4%.  Stock values have declined generally since the start of the year (S&P 500 down 14%), and the loss in home value is approaching double digits in many US markets.  Now the US unemployment rate has risen over 6%, further heightening anxiety about people's income security.

Yet, we're persistently told that the top tier of wage earners are enjoying a banner year.  It's hard to understand how they could do it. The leaders of large companies are getting paid an enormous amount, but there are few positions to be had at that level. Even then, a lot of the compensation is deferred as options and bonuses rather than taken directly as salary.

For example, if my company granted me a thousand options at a price of $50, they say that I've received $50,000.  I can only sell them after a 4-year vesting period, and, if I were to sell at $60, my actual gain would be the price difference times the number of shares: $10,000.  I never see the $50K, and if the stock wobbles, I could get nothing at all.  I suspect that executive pay packages may have some of the same caveats.

Similarly, high-risk investments in hedge funds or private equity firms require that subscriptions for up to ten years before money (contributions or profit) can be withdrawn.

Much is made of speculators making windfall profits off of oil, grains, bank failures, and mortgage losses, but I think that this happens only within a small circle of traders, market-makers, and arbitrageurs who are close to the trading floors.

Entrepreneurs, living the dream of starting their own businesses, also seldom arrive at the exit gate where the buyout yields a huge payout.  My friend who heads Cambridge's Equity FIngerprint notes in his blog this week that the typical senior partner in a consultancy does far better.

The Republican Party mantra that "anyone should be able to make as much as they can because the path is open to everyone" is a myth.  Few are getting rich, and those who are share neither access nor rewards. I don't know why blue-collar voters keep buying into their lie.

Arnhem Autumn Coming 4 It's also clear that some of those making big money have been doing it off the backs of everyone else.  I'm not talking about academic entrepreneurs or company leaders who create value for customers, employees and shareholders (they've earned it), nor about the petty thieves who enrich themselves by stealing from expense accounts or others (they get caught).  Rather, I'm thinking of the financial wizards behind the continuing series of bubbles and bailouts.  The savings and loan crisis, the energy trading scandal, the dot-com bubble, the oil run-up, the sub-prime mortgage crash: it just seems to keep repeating.

There are three things I would like to see happen this time around to curb future excesses:

1)  Speculative booms should be damped down.  I don't believe that a cabal of insiders is manipulating markets.  Rather, there is a herd mentality that follows easy money.  As the frenzy grows, it gets more broad-based and more people get hurt when it ends.  These bubbles are recognized and discussed as they occur, but, because people are making money, nobody steps in with corrective feedback. Some combination of regulation, taxation, policy, or publicity is needed to deflate bubbles in a more controlled way.

2)  Government guarantees need to end.  Whenever speculators find a government-guaranteed investment,investors feel that they are protected from losses and moral hazard takes over.  The financial houses are able to package and obfuscate investments so that they appear safe when, in fact, they are increasing in risk and value with every resale.  And they find willing buyers at each turn because of the guarantees.  In the end, it grows "too big to fail", and we all pay the price of making the bondholders whole.

3)  Someone should be sorry.  If people have been deceptive, taken advantage of the system, or broken the law, then they should lose their gains and their place at the table for future trading.  I have heard that we shouldn't be searching for scapegoats or punishing the system as we deal with the current mortgage banking crisis.  But if we don't, then what will prevent mistakes from being made again and again in the future?  As with Enron (energy), Michael Milken (arbitrage), or the Hunt Brothers (silver), the people who  took the risks or bent the rules should be the ones to pay a price.

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