Wednesday, April 30, 2008

Pride, A Leaky Boat and a Re-Design

Having finally grasped that life is a series of trade-offs (unless you have a Caribbean tax shelter and some sharp tax attorneys on staff), I come now to a trade-off I have grappled with for some time: to accept advertising or not.

There was no trade-off in the first year-and-a-half of this blog's existence; I blasted off a short commentary in perhaps an hour and then reveled in the glory of having 30 readers--on a good day. My website has been up since 1999, but in those early days the content--a listing of published articles and an excerpt of my first novel--rarely changed. I launched this blog on May 1, 2005.

Some 850 blog entries later, I find the satisfactions of having 5,000+ readers on a good day to be great, as is the intellectual stimulation of sharing ideas and information with you. But the time required to keep this leaky little craft afloat has leaped along with readership. Just answering email takes a few hours a day when traffic is heavy, and the research you have come to expect takes more hours a day. Readers Journal also takes time.

The site seems to require more bailing than ever, so to speak, and as the financial gunwales sink ever lower, I have to decide whether to scuttle the leaky craft or get it into drydock and make it financially viable.

And so now I am face to face with this question: have I refused ads out of a sort of intellectual pride, or even snobbery, or was it merely a facade to hide the fact nobody would want to advertise on this site anyway?

If I wasn't so stupid, and burdened with towering flaws of character, judgment and intellect, I might well be sitting on hundreds of thousands of dollars which would enable me to loll away my hours here at OTM without a financial care in the world. But alas, I am stupid, and abundantly burdened with flaws, and so I do have financial cares.

Now the folks at forbes.com have invited this site to join their soon-to-be-launched network of business and financial blogs. The idea, of course, is to make money--for forbes.com and the bloggers--by marketing ads on the highly selective 1,000 blogs in the network. (Yes, it's quite a unique privilege.)

You, the incredible readers of this site, have made heroic efforts since last March to donate cold, hard cash in significant sums, and I am in awe of your goodwill and generosity. The thought of any of you turning away because I have decided to accept ads makes my blood run cold.
On the other hand, I know that many of our most esteemed bloggers, such as Mish, Calculated Risk, the Big Picture, et al., all run plenty of ads, and no one seems to think less of them for it--or less of Financial Sense, Kitco, etc.

Some of you may reckon that since I'm raking in big bucks ($27.16 a month is my current estimate of future ad revenues) then there is no reason to contribute to the site. The site remains free so this is your option. Others may persevere in contributing money, and since my total income from the site from all sources will most likely stubbornly remain locked in the mid-four figures, your donations will continue to be both important and much appreciated. I will continue to solicit your donations until I inherit a lavishly appointed castle or am bestowed with google stock (or equivalent undeserved windfall).

There is another irony of pride here, too--the foolish idea that anyone would want to advertise here.

So stripped of all kinds of pride--that I am above needing compensation for keeping this thing afloat, that anyone would be dumb enough to advertise here, etc.--I've decided to see what happens if I toss my hat into the forbes.com network ring. If I make nothing from ads, then it's an easy decision to drop out (with tail firmly between my legs). If you loathe the presence of advertising, then fire up your ad blocking software or download a free ad blocker.

I wish I could report that I have the strength and funds to do this without compensation, but that simply isn't true. I could stop, or cut back to one post a week, and that is an option. It's a trade-off, and so I've decided to try the forbes.com network and the ads which go with it. I will launch a redesigned blog on May 1, the 3rd anniversay of this modest little outpost of the worldwide web.

I've been pondering some new features for months, and tomorrow you'll see if they were worth all the effort or not.

If you note the ads are for oftwominds.com, then that means nobody was dumb enough to buy any ad space here. (Whoopie for free-market capitalism!) Readers Journal and my fiction pages will remain ad-free.

Hopefully the new site won't be too annoying; there's no way to know but to try it. I appreciate you giving it a glance. The content, for better or for worse, will continue to be the usual jumble. My goal, as always, is to provide some value or entertainment, and to offer a worthy forum for your essays, commentaries and poems (Readers Journal).

Thank you, readers, for enabling the readership of this site to grow at what is to me a mind-boggling pace.

I received this email from A.E.T. yesterday, and I am humbled by her comments:

Thank you so much for your blog. and site. musings, writings, hidden history, King George Is Back song. I came across your site researching property value decline, and have learned so much more and have had a great time! I find you so much like my father (no longer here, early death, at 60, year 2000) and myself in your humor and intelligence, and am inspired by your writings.
I want to buy your book and to keep coming back to see what your latest fun is.
And you do a great job of explaining things with humor and on-it ness that I don't come across often!!!

I don't get emails like this very often, but A.E.T. makes the whole enterprise worthwhile.
I also want to share an email from distinguished climate researcher /scientist Geoff Sherrington:

There is so much material on this topic that it is only now, while conducting a search on the Net, that I came across your article in oftwominds.com some several months after it was posted.
I am the Sherrington referenced in relation to correspondence with Prof Phil Jones on global temperatures. Therefore, I have a special interest in reading such material.
Simply, I wish to say that your essay is one of the cleanest, clearest expositions of this complicated subject that it has been my pleasure to read. Indeed, I wish that I had your communication skills. Unless you indicate otherwise, I would like to use this article in several forums, mostly related to Inquiries afoot in my home country of Australia.
Congratulations on a job well done.
Geoff Sherrington, Scientist

Here are the two excellent articles on global warming in the Readers Journal archives; the first is by frequent contributor Protagoras (referenced in the email above) and the second is by frequent contributor Michael Goodfellow:
The Hockey Stick Breaks (Global Warming Data refuted) by Protagoras (6/26/07)
Global Warming: Our Story So Far by Michael Goodfellow (6/26/07)

I am honored to host such excellence on Readers Journal.


NOTE: contributions are acknowledged in the order received. Your name and email remain confidential and will not be given to any other individual, company or agency.

Thank you, John M., ($20), for your much-appreciated contribution to this site. I am greatly honored by your support and readership. All contributors are listed below in acknowledgement of my gratitude.

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Tuesday, April 29, 2008

Luckily, There's Delusionol (TM)

There's a new drug ad hitting the mass market--maybe you've seen it. This Delusionol (TM) ad is remarkably straightforward for a psychotropic drug ad, but of course I had to dig around to find the full side-effects, which include heightened risk of financial suicide, debt-bloating, nausea due to bankruptcy and HELOC-shock (the realization there's no more home equity to borrow).

The most pernicious downside of Delusionol (TM), though, is that it only lasts 3 to 4 months, six months maximum. Since Delusionol (TM) became the drug of choice in the Fed and Treasury in mid-January, that means the drug-induced scales of foolish optimism will fall from our financial leaders' eyes by June 15, no matter how many handfuls of Delusionol (TM) they gulp down.
Financial 'cold turkey' will be very unpleasant--for the Fed, the Treasury, the nation and the global financial markets. But until then, slam down a couple Delusionols (TM) and enjoy the market rally and the "bottom" in housing.



NOTE: contributions are acknowledged in the order received. Your name and email remain confidential and will not be given to any other individual, company or agency.

Thank you, Joseph V., ($5), for your generous contribution to this site. I am greatly honored by your support and readership. All contributors are listed below in acknowledgement of my gratitude.

Read more...

Monday, April 28, 2008

More on Catching the Bottom in Housing

Last week's entry Want to Know When Housing Has Bottomed? Here's How (April 23, 2008) garnered 109 Reddit recommendations, causing readership to spike 10-fold from roughly 3-4,000 per day to over 30,000.

After hastily arranging for additional bandwidth from my longtime web host, Busix, I read the 150+ comments logged on reddit. (A number of other readers had emailed me directly.)

As you might imagine, many readers questioned the entry's validity, while others raised specific issues which had been left unaddressed in the entry. Since real estate is a complex subject, these important topics deserve to be addressed. So here goes.

Many readers questioned whether a rental-property valuation had any bearing for an owner-occupied house/condo, while others questioned whether such a valuation made sense in high-priced areas like New York City, Vancouver B.C. and San Francisco.

Others felt my analysis was misleading because it ignored the accumulation of equity, tax breaks and the fact that paying down a mortgage's principal every month was not an expense like paying the interest.

All good points, all valid, all important--so let's dig in.

1. Homeowner vs. rental property investment. While it is certainly true that buying a home carries tax breaks (the mortgage deduction) and the possibility of equity appreciation, the fact that home ownership offers these merits does not, at least historically, translate into prices being propped up beyond a property's value as a rental.

Rents are set by supply and demand and by wage growth or decline; regardless of the property's assumed value, people can only afford to pay a percentage of their income as rent. The same is true, of course, of owner-occupied housing; if wages have been stagnant, as they have for the past 25 years, then the ability of potential buyers to pay higher monthly payments places a limit on the value of housing.

This constraint is lifted, of course, by low interest rates, which effectively drop monthly mortgage payments, enabling more people to buy houses. Unfortunately, the market responds to this new surge of demand by raising the price of homes. In the big picture, historically low interest rates enabled more people to become homeowners--and speculators.

Nonetheless, in the longterm, housing valuations remain tied to the population's income and the fair-market rent the property fetches--a number which is also tied to income. Here is the same price-to-rent data plotted slightly differently:

Please go to www.oftwominds.com/blog.html to view the charts.

Simply put: any increase in housing's valuation beyond the increase in income disappears when prices revert to the historic mean. In terms of purchasing power, income for most Americans has been stagnant for decades. While household income has climbed from the late 1960s as women entered the workforce, most of the income gains have flowed to the top 20%.

2. Housing prices won't drop much in high-value cities. First, please refer to my entry from June of 2007, Yes, Real Estate Prices Can Drop in Half--Even in Manhattan (June 8, 2007). If you read the academic paper cited in this entry, there is simply no way to claim "high-value areas can't go down." They have, and will again.

Just personally, I have friends who bought homes in the S.F. Bay Area in 1996-97 (the last bottom) for $145,000 to $165,000--perhaps 12-13 times annual rent or 120 times monthly rent. These homes were in a highly-sought after small city with excellent schools, and they shot up to $600,000 by 2006.

Will these homes decline in value to $150,000? Adjusted for inflation, if history is any guide, it's very likely.

3. A good reason to buy a home/property is the accumulation of equity. This has certainly been the case during the decades-long boom in real estate in the U.S. and other Developed nations, but it is by no means guaranteed. The fly in the ointment of this "rising tide raises all ships" scenario is Japan, a nation where property values outside of central Tokyo (and even there prices are softening again) are still declining almost two decades after the top of their real estate boom.

I know the usual arguments against this model occuring in the U.S., and they might have some validity, were it not for overriding financial realities. The most potent argument for the "real estate will always rise in the U.S." is population growth: Japan's population is declining while the U.S. population is rising.

There are two problems with this argument, both of which I have covered here in the past.
A. Population density can rise and fall. The same number of people can fit in a much smaller number of dwellings if times get tough; many more people can fit into a city without any more housing units being built. As I showed in Brain-Dead Predictions about Housing (January 2, 2008), San Francisco's population rose by almost 7% in a few years during the dot-com boom even as very few new dwellings were added in that timeframe.

And San Francisco has only moderate density compared to other cities--including low-rise Paris: The Downside of Density (November 7, 2005)

It should also be noted that there are literally millions of empty dwellings in the U.S.--and not all are scattered vacation homes. Density per dwelling is also historically low in the U.S. To say population couldn't grow as the number of existing dwellings remained constant is to ignore realities--most especially the millions of empty units/homes in the U.S.

As I documented in How Many Foreclosures Will Hit the Market? (May 1, 2006), about 40% of all dwellings sold in the bubble years were to investors. Those are by definition "bought to let/rent" and many, if not most remain empty even as hundreds of thousands of existing homeowners ababndon their homes due to foreclosure.

Over a year ago their were 2.1 million empty homes seeking buyers; and that was just what was listed for sale: Can 4% of Homeowners Sink the Entire Market? (February 21, 2007) Now millions more will be dumped on the market--or remain empty for future habitation.

U.S. Foreclosures Jump 57% as Homeowners Walk Away (Dan Levy, 4/15/08)
"About 2.5 million foreclosed properties will be on the market this year and in 2009, Lehman Brothers Holdings Inc. analysts led by Michelle Meyer said in an April 10 report."

Another factor is that immigration has been strong because the economy has been "strong" (even though it was an entirely debt-fueled "prosperity"). Once the recession really starts eroding incomes, jobs for immigrants will vanish and many undocumented workers will return to their home country as their own jobs/income has disappeared. Immigration may not be the force it has been over the last 25 years of prosperity.

B. The purchasing of real estate depends entirely on the availability and low cost of borrowed capital. Valuations mean relatively little, as very few people can afford to buy real estate with cash. If money dries up--and I believe historic cycles of debt accumulation and repudiation support a long cycle of higher interest rates and a paucity of available capital--then real estate falls in value regardless of "pent-up demand."

Bottom line: if the cycle of cheap, readily available money for borrowing has ended and a new cycle of rising rates and tight money/raised sensitivity to risk has begun, equity could actually shrink for 10-20 years.

Inflation could also ruin the rosy expectation of rising equity. If a property's value rose in nominal terms 4% every year, but real (purchasing power parity) inflation rose at 6%, at the end of 30 years the owner would have little net equity. Perhaps in nominal terms, the sum would appear substantial, but again, the only real measure of equity is inflation-adjusted--and with official inflation calculations so obviously rigged, then we would have to look at purchasing power as the only believable/accurate metric.

In other words: if equity is nominally $100,000 in 20 years, but a Big Mac costs $100, then how much is that equity truly worth?

If deflation reigns for the next generation as many believe likely, then purchasing a house for $300,000 and finding that it's worth $150,000 when you pay off the mortgage is a possibility. Now that might still be a worthy investment compared to renting, but perhaps not.
In this scenario--not at all unlikely in my view--then the renter who invested their money in other assets might accumulate more equity than the homeowner, who is sinking their money into an illiquid capital trap.

Several readers made the key point that real estate can be highly illiquid. In times of declining values and tightening lending, real estate has the unfortunate distinction of being hard to sell--unlike precious metals and stocks, which can be sold at almost all times in a few minutes.
A point no one made is real estate's high transaction costs. People move a lot in the U.S., and one's equity can be severely impaired by constant buying and selling. If you moved four times in eight years, then the transaction costs (roughly 7.5% - 10% of each sale, 6% commission plus closing and mortgage costs, including points), then up to 40% of your equity was eaten up by transaction costs--a staggering loss compared to the low transaction costs of selling bonds, precious metals or stocks/mutual funds.

For all these reasons, it might be true that someone who buys a house today and pays off a conventional 30-year mortgage might have a healthy pile of equity in 30 years' time--or they might not, depending on long-cycle macro-issues beyond our control and predictive powers.

3. Is GRM (gross rents multiplier) a valid valuation method? There are many ways to value property--income (net), comparable sales, etc.--and the GRM model is by no means the last word in valuing real estate. Nonetheless, it has the admirable qualities of atime-tested rule of thumb/heuristic, and can be a useful "test" of valuation reached by other means.

For more on the methodology and other valuation methodologies. I recommend Chapter Nine of California Real Estate Principles. GRM is covered on pages 247 - 249. (NOTE: I am not a real estate professional or in the business of finance, etc. I am merely a property owner and taxpayer.)

Another GRM rule of thumb is "100 times monthly rent." A property that rents for $1,000 would thus be worth $100,000.

These GRM rules are standard considerations in multiple-unit properties, and may not apply to all homes in all places. But regardless of GRM, any investor has to consider income as the key evaluation metric. If you're not making money on day one, then why are you risking capital?
Some readers objected to my insistence on "making money on day one." My reason was simple: you can put your capital to work in Treasuries and earn a return on Day One; why should anyone put their capital into real estate for some future promise of return, while absorbing losses with no foreseeable end? The answer would be: the future return promises to be much larger than that of a T-bill. But for the reasons stated above, such future returns in real estate may be less sure than widely assumed.

In general, at true real estate "bottoms," properties can be purchased which return a net profit from Day One.

4. You can't count mortgage principal as an expense. As astute reader Mike V. observed:

Your point that housing prices will reach an equilibrium when houses can be rented at a profit seems like a good one. The 6X to 10X "rule of thumb" for evaulating a rental property could be spot-on (I'm certainly not an expert), but, I found the example math you presented a little misleading. To find the point where Costs = Revenue when renting an apartment, you use the formula:

Mortgage payments + Other Costs = Rental Income

A mortgage payment is not strictly a cost. The interest paid on the loan is a cost, but the principal you pay is money you are exchanging for an equally valued asset (the house). That money isn't being spent, it's just changing forms, and shouldn't be treated as a cost.

A more accurate equation would seem to be: Mortgage Interest + Other Costs = Rental Income
There are (of course) many of factors that still aren't accounted for - increases in value of the home, the opportunity cost of not investing your money elsewhere, etc - but that seems like a more reasonable evaluation than the one you presented. Maybe the omission is what you meant by "making a profit from day-one", but I think rental property investors would certainly include the equity in the home they are paying for when evaluating an investment. Mike is absolutely correct, as anyone who has to fill out Schedule E (real estate rental income) knows. However, an investor may well want a positive cash-flow, in which case the entire mortgage payment would be considered. Also, if the investor refuses to count on future equity appreciation in "real" terms (not just nominal appreciation), then generating a net income from day one might still be the goal.

Investors get to deduct depreciation on buildings and major improvements, and of course this figures into their taxable net income.

This discussion raises the issue of leverage. One way to figure net income is to set aside the entire mortgage and ask: if I bought this property for cash, would the income minus expenses be positive? And if so, would it justifiy the investment of so much capital?

5. Using P-E ratios. As knowledgeable reader Andy S. noted, perhaps the better metric would be to calculate the price-earnings ratio (P-E) as is standard in analyzing stocks.

You state your rule of thumb in terms of a purchase price to gross rental ratio, but really the more classic way to compare returns on a property investment vs. expected returns on other types of investments would be to restate the ratio in terms of price to _earnings_, or, alternatively, it's reciprocal, yield. So, can you tell me what your rule of thumb comes out to when restated as a P/E ratio? (I have tried to search on phrases such as "historical investment property P/E ratio" on google and so far haven't come up with much good advice yet in terms of how to price property fairly in comparison to, say, for example, stocks, which have tended to exhibit long-term average P/E ratios of around 14-16.) The key to calculating PEs in real estate is to consider the leverage of borrowing. If an investor bought a building for $1 million in cash, and the building generated a net profit of $10,000 a year, that would be a paltry 1% return: not very appealing. This would result in a PE of 100.

But if the investor purchased the property with 10% down, then the $10,000 income would be in relation to capital invested, $100,000, resulting in a PE of 10--much more attractive.
Real estate fortunes have generally been built on just this leverage. In contrast, stocks can only be leveraged 50% via margin borrowing.

This raises another important issue: if buying will become so cheap at the bottom, why would anyone rent?

6. Why rent when buying is so cheap? Capital is the one-word answer. If we are indeed returning to a risk-averse, tight-money era, then buyers will need to pony up 20% down in cash (30% for investment properties). Not everyone with sufficient income to buy will have the 20% down (capital) to invest.

If the housing market continues to spiral down for years to come, would-be buyers might hesitate to sink their precious capital into an illiquid capital-trap which is losing value every year. (Again, maybe the house value remains stable in nominal terms, but if inflation is roaring ahead then the owner is losing value each and every day.)

Another reason might be that people expect to move within a few years. As noted above, transaction costs can eat up a big chunk of one's capital. Meanwhile, the transaction costs to buy and sell T-bills is negligible.

Lastly, would-be buyers may have read the headlines about property taxes skyrocketing as municipalities face declining tax revenues. Yes, their landlords will be passing along those increases--if and only if the market will bear it. In other words, Mr. Market will still set rental valuations, and property taxes only bear marginally on the market's price-setting; the incomes of the renters is the key variable.

On the other hand, cash-strapped, desperate cities/counties/states have no such market restraints. If they jack up property taxes by 20%, there is no restraint on their action except a political one, i.e. a Prop 13-type rebellion by the cash-strapped taxpayers.

I enjoyed the discussion and emails: thank you, readers, for adding to our collective knowledge.


NOTE: contributions are acknowledged in the order received. Your name and email remain confidential and will not be given to any other individual, company or agency.

Thank you, D.M.T., ($20), for your generous contribution via mail "from somewhere in the South" to this site. I am greatly honored by your support and readership. All contributors are listed below in acknowledgement of my gratitude.

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Saturday, April 26, 2008

It's Not Just Peak Oil: It's Peak Coal, Too

Way back on October 30, 2007 I received this startling email from well-informed reader D.L.F.:
We always hear about "peak oil," but I ran across this article and chart for "peak coal:"
Appalachian Coal: the faucet is almost dry.

I was finally nudged into doing further research by frequent contributor Riley T., who sent in this link to energyshortage.org which tracks energy shortages worldwide.

Various pundits and cheerleaders in the media and the coal industry ceaselessly tout the "fact" that the U.S. supposedly has 400 years of coal supply, and hence (or so we are to assume) we don't need no stinkin' oil, we'll just burn coal. We can gasify it, using the same technology the Nazis deployed in World War II. (Why does that factoid leave us less than reassured?)
But a funny thing happened on the way to energy independence on the strong back of limitless coal: the Department of Energy reckons Appalachia has about 10-15 years of coal left. Oops. First, Peak Oil, then Peak Natural Gas, and now Peak Coal. Dang.

I hope you're not too surprised when I tell you Peak Coal isn't even the worst of it. Not even close. Details, details; don't you hate it when facts disrupt your rosy scenario? Facts like the railroads can't haul any more coal, and the price of coal is rising rapidly, with no end in sight. Talk about inconvenient realities.

Building more coal-fired power plants:big mistake; Environmental expert explains why investors and power companies getting fired up for coal growth will get burned financially:

The rising costs of plant construction and coal transportation are also a major factor: New cost estimates are far higher than the old cost estimates. Coal-fired power plants were expected to cost approximately $1 billion apiece to build, but the big ones are costing closer to $3 billion apiece. Early cost estimates looked at what would happen if each plant was built by itself, but if we build dozens at a time, the competition for engineers and steel and concrete becomes very acute. So there’s major international competition going on.

In terms of fuel price, a lot of these plants are being built because people estimated that the price of coal would be relatively low for years to come, but coal prices today are about twice what they were two years ago. And US coal is now being sold overseas—put on ships and taken to markets that really need it and are willing to bid a higher price than we’ve been used to seeing. That’s a problem especially because when analysts predict that these plants are cost-effective, they’re assuming 30-50 years to pay off the bonds raised to construct them. In other words, the plants only make sense if you think that the fuel will be accessible for the next 40-50 years.

Finally, the railroads needed to get coal from mines to power plants are already overloaded—they’re operating at over 90 percent capacity. We don’t have the rail system in place to carry all the coal that would be needed to build 60 or 80 new power plants, and building those railways is going to be very expensive."

Have you ever passed by a large coal-fired electrical generation plant? The first thing you notice is the long, seemingly endless line of rail cars lined up outside. That's because a typical large plant burns 4 million tons of coal a year. At $56/ton, that's $224,000,000 a year for the fuel. If that were to double--which industry experts are predicting--then the bill for one large coal-fired plant would top $500 million. Each. How "cheap" is that electricity now?
Surging Coal Price:
BHP Billiton is close to a deal with South Korean steel giant Posco for a price of $US300 ($325) a tonne for coking coal in 2008-09, up from $US97 in 2007-08.

Thermal coal, which is used for power stations rather than steel-making, is expected to more than double from its existing level of $US56 a tonne."

Despite the near-certainty of doubling/tripling prices, Peak Coal, emissions of sulfur dioxide (cause of acid rain), the world is so desperate to maintain the status quo that more plants are being built, even in Europe:

Europe Turns Back to Coal, Raising Climate Fears (NYT, April 23 2008)

Efforts to curb greenhouse-gas emissions have yet to dent enthusiasm for coal (The Economist)

Meanwhile, China is famously building a new coal-fired plant a week: Pollution From Chinese Coal Casts a Global Shadow.

In the event you are skeptical about coal price increases, please check the statistics gathered by the Energy Information Administration. The first column is for Central Appalachian coal (12,500 Btu), the second Northern Appalachian (13,000 Btu), the third, Illinois Basin (11,800 Btu) and the fourth Uinta Basin (11,700 Btu).

Please go to www.oftwominds.com/blog.html to view the tables and charts.

(The first two are metals grade, the second two thermal grade.)
Those are increases of 10% - 20% in three out of the four regions within the space of six weeks. If that isn't "spiraling out of control," then what is it? "Modest adjustment for inflation"? What happens to all those rosy predictions of "cheap electricity" if coal doubles in price and then doubles again?

And recall that prices are set internationally for commodities. If a U.S. producer can sell wheat for $13/bushel, do you reckon he or she will sell it in the U.S. for $6? The same pricing mechanism is in play for coal. If U.S. producers can sell coal overseas for $100/ton, that will be the price here, too.

That's capitalism, baby. There are no discounts just because you expected the price to stay "cheap" for decades to come.

So is that the worst? Not by a long shot. It seems that burning 700 million tons of coal every year to generate about 50% of the electricity in the U.S. is releasing 1,000 tons of radioactive uranium and thorium every year.

The irony is a wee bit thick, isn't it? Here we all are, convinced by ceaseless decades of propaganda (or shall we say "one-sided presentations"?) about dangerous, horrible nuclear plants, while all the while burning entire mountains of coal that's releasing 1,000 tons of radioactive material into our environment every year--1,000 tons more than the radioactive materials released by all the nuclear plants put together and twice as much as all the uranium fuel burned to make 15% of the electricity in the U.S.

(Let me note right here I know the problem with nuclear waste disposal/storage, and I am not suggesting nuclear power is a panacea; I am simply pointing out that 1,000 tons of radioactive material, on top of CO2 and sulfur dioxide does not make coal "clean" or "healthy" for the people living around the plants, or "cheap".)

Let's turn now to a fascinating report issued by the Oak Ridge National Laboratory. Since it's a nuclear facility, we can expect some kind words for nuclear power; nonetheless, the facts are the facts, and here are the facts. Burning coal produces stunning quantities of radioactive materials.

Coal Combustion: Nuclear Resource or Danger

"First, coal combustion produces carbon dioxide and other greenhouse gases that are suspected to cause climatic warming, and it is a source of sulfur oxides and nitrogen oxides, which are harmful to human health and may be largely responsible for acid rain. Second, although not as well known, releases from coal combustion contain naturally occurring radioactive materials--mainly, uranium and thorium.

The article "Radiological Impact of Airborne Effluents of Coal and Nuclear Plants" in the December 8, 1978, issue of Science magazine concluded that Americans living near coal-fired power plants are exposed to higher radiation doses than those living near nuclear power plants that meet government regulations. This ironic situation remains true today and is addressed in this article.

The fact that coal-fired power plants throughout the world are the major sources of radioactive materials released to the environment has several implications. It suggests that coal combustion is more hazardous to health than nuclear power and that it adds to the background radiation burden even more than does nuclear power. It also suggests that if radiation emissions from coal plants were regulated, their capital and operating costs would increase, making coal-fired power less economically competitive.

Because existing coal-fired power plants vary in size and electrical output, to calculate the annual coal consumption of these facilities, assume that the typical plant has an electrical output of 1000 megawatts. Existing coal-fired plants of this capacity annually burn about 4 million tons of coal each year.

Based on the predicted combustion of 2516 million tons of coal in the United States and 12,580 million tons worldwide during the year 2040, cumulative releases for the 100 years of coal combustion following 1937 are predicted to be:
U.S. release (from combustion of 111,716 million tons):
Uranium: 145,230 tons (containing 1031 tons of uranium-235)
Thorium: 357,491 tons
Worldwide release (from combustion of 637,409 million tons):
Uranium: 828,632 tons (containing 5883 tons of uranium-235)
Thorium: 2,039,709 tons
Consequently, the energy content of nuclear fuel released in coal combustion is more than that of the coal consumed! Clearly, coal-fired power plants are not only generating electricity but are also releasing nuclear fuels whose commercial value for electricity production by nuclear power plants is over $7 trillion, more than the U.S. national debt.

This figure is based on current nuclear utility fuel costs of 7 mils per kWh, which is about half the cost for coal. Consequently, significant quantities of nuclear materials are being treated as coal waste, which might become the cleanup nightmare of the future, and their value is hardly recognized at all.

How does the amount of nuclear material released by coal combustion compare to the amount consumed as fuel by the U.S. nuclear power industry? According to 1982 figures, 111 American nuclear plants consumed about 540 tons of nuclear fuel, generating almost 1.1 x 10E12 kWh of electricity. During the same year, about 801 tons of uranium alone were released from American coal-fired plants. Add 1971 tons of thorium, and the release of nuclear components from coal combustion far exceeds the entire U.S. consumption of nuclear fuels. The same conclusion applies for worldwide nuclear fuel and coal combustion."

So let's see: Peak Coal, prices skyrocketing with no end in sight, limited rail capacity to ship more coal, rising cost of transporting coal, intractable pollution/health problems, including a thousand tons of radioactive material released into the environment every year--what's not to like? Everything. Coal as savior? Not if you consider the financial and health-related issues.

Yes, it may be technologically feasible to scrub all the sulfur dioxide and all the radioactive particulates out of the millions of tons of coal ash and other combustion products released by the burning of 700 million tons of coal: but at what cost? If coal is no longer "cheap" even if you don't add in the health and environmental costs, then to call it cost-effective is delusional.

NOTE: contributions are acknowledged in the order received. Your name and email remain confidential and will not be given to any other individual, company or agency.

Thank you, Eugenio M. ($40), for your ongoing generous contributions both financial and intellectual to this site. I am greatly honored by your support and readership. All contributors are listed below in acknowledgement of my gratitude.

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Thursday, April 24, 2008

Subprime Country: A Nation Within a Nation

Knowledgeable correspondent Eugenio M. sent in a fascinating academic paper (I know, that sounds like a contradiction) which traces the similarities between the Developing nations' debt meltdowns in the 1980s and the current Subprime-triggered debt meltdown in the U.S.


The key take-away is how oil exporting countries' enormous profits--generated by the late-70s-early 80s spike in the dollar-denominated price of crude oil-- were recycled by U.S. banks into high-interest loans to Argentina and other risky Developing Economies. When Argentina et. al. defaulted, the losses drove Citicorp and Bank of America to the brink of insolvency.


Fast-forward to the 2000s: now this stupendous oil-revenue wealth has been supplemented by veritable mountains of dollars piling up in Asian exporters' accounts. Where to put all this cash to work in a low-interest rate world?


Answer: credit-risky mortgage borrowers in the U.S. The authors also report that bubblicious U.S. house prices far exceeded the heights reached during other advanced-economy banking crises.


The paper also charts how the U.S. current account deficit (trade deficit) at 6% of GDP is double that experienced by other advanced-economies at the height of their banking crises.
In other words: the U.S. housing bubble inflated in a macroeconomic setting of one extreme after another. It's not just housing prices which shot to the moon, but debt, leverage, the trade deficit, risky financial "innovations" and on and on.


Is the 2007 U.S. Sub-Prime Financial Crisis So Different? An International Historical Comparison:


"Next comes reality. Starting in the summer of 2007, the United States experienced a striking contraction in wealth, increase in risk spreads, and deterioration in credit market functioning. The 2007 United States sub-prime crisis, of course, has it roots in falling U.S. housing prices, which have in turn led to higher default levels particularly among less credit-worthy borrowers.
The impact of these defaults on the financial sector has been greatly magnified due to the complex bundling of obligations that was thought to spread risk efficiently. Unfortunately, that innovation also made the resulting instruments extremely nontransparent and illiquid in the face of falling house prices.


While each financial crisis no doubt is distinct, they also share striking similarities, in the run-up of asset prices, in debt accumulation, in growth patterns, and in current account deficits. The majority of historical crises are preceded by financial liberalization, as documented in Kaminsky and Reinhart (1999). While in the case of the United States, there has been no striking de jure liberalization, there certainly has been a de facto liberalization. New unregulated, or lightly regulated, financial entities have come to play a much larger role in the financial system.
During the 1970s, the U.S. banking system stood as an intermediary between oil-exporter surpluses and emerging market borrowers in Latin America and elsewhere. While much praised at the time, 1970s petro-dollar recycling ultimately led to the 1980s debt crisis, which in turn placed enormous strain on money center banks.


It is true that this time, a large volume of petro-dollars are again flowing into the United States, but many emerging markets have been running current account surpluses, lending rather than borrowing. Instead, a large chunk of money has effectively been recycled to a developing economy that exists within the United States’ own borders. Over a trillion dollars was channeled into the sub-prime mortgage market, which is comprised of the poorest and least credit worth borrowers within the United States. The final claimant is different, but in many ways, the mechanism is the same. Simply put: U.S. banks found a Third World nation of borrowers willing to shoulder high interest rates within the U.S. itself: let's call it Subprime Nation. Here are three snapshots of Subprime/Alt-A/No-Doc/Option ARM Nation:


1. Subprime Nation has little or no ownership of assets

2. Subprime Nation's mortgage resets will continue to climb through 2011

3. Subprime Nation has borrowed itself into a deep, deep hole

(Please go to www.oftwominds.com/blog.html to view the charts)

In an election year, politicos' electability rests largely on their ability to woo Subprime Nation's shellshocked voters. Leaving aside personalities, race and gender for a moment, let's consider the Pennsylvania Democratic primary results. Clinton won the majority of Caucasian "working class" (a.k.a. Subprime/Alt-A/No-Doc/Option ARM Nation) females and males; Obama won the majority of African-American and young/Caucasian urban dwellers.


Let's talk about political pandering, and what drives the rush to pander most/best. The 'gummit' must save Subprime Nation's citizenry from their own excess and lack of caution, we are told, lest their 'betters' (see wealth-distribution chart above) actually suffer as the meltdown proceeds into other asset classes like stocks and commercial real estate.


And as if cue, the "magic bullet" legislation which was supposed to hit insolvent Subprime Nation actually hits lenders and builders. Hmm. And who owns those institutions? Not Subprime Nation. They own zilch, nada, zero assets--but they do "own" debt--a lot of it.


It seems there are two nations within the borders of the U.S.: Subprime Nation, its wages and income shrinking, its gamble on the housing bubble lost, and those who are still pulling down big salaries and bonuses, still accumlating frequent flyer miles and still (occasionally) buying horrendously overpriced homes in San Francisco and other "islands" of wealth in a sea of debt and asset destruction.


Astute correspondent Jon H. sent in this reader-report from Urban Survival which describes the true plight of Subprime Nation:


"I wanted to tell you about what I saw at Wal-Mart this weekend that even took me aback. I stood in line at the self checkout while a woman in front of me rang up a few items. I didn't pay attention of course, but purchasing only a couple plastic food containers and a plunger couldn't have cost more than about $10. Each time she attempted to pay with a credit card, the machine belted out "card not accepted".


Being curious, I watched her try FIVE different cards, and I could see her hands beginning to shake as she laid he wallet down on the scanner to search for more cards. This was taking so long that I moved over to the next self checkout lane, where one man with his son were just finishing to ring up a few items he had purchased. I watched the other woman get help from one of the attendants, after which she abandoned the items and just left.


Meanwhile, I heard "card not accepted" from the new machine I was at. The man in front of me had the same problem. This time, he tried 2 credit cards until he finally pulled out his check debit card (it was the same one I had from the same bank) and his purchase was approved. He had only purchased a few items as well, undoubtedly not more than $10 also.


As I began to ring up my $6 order, I heard "card not accepted" from another self checkout around me, but I didn't bother to look. I just paid and left.


I realize this was only one incident, but now I'll be more alert in other stores to see if similar things happen. I have a feeling, though, that people are far more squeezed than most realize."

It doesn't take much insight to gather than Subprime Nation (or at least the Caucasian and Hispanic citizenry of that nation-within-a-nation) voted for Hillary Clinton as their most likely supporter/savior. The question, of course, is whether the next President can do anything to "save" Subprime Nation from its own debt explosion--and if such a "save" is even possible or helpful in the long run.


Though his stance seems to be changing, McCain recently said the 'gummit' should not be in the business of bailing out speculators. (Note to Mr. McCain: Mr. Bernanke has already spent $360 billion (link courtesy of patrick.net) doing exactly that--but it isn't the Subprime Nation speculators he bailed out, it's the Top 1% owns 90% of the Productive Assets Fat Cats.)


We should also recall that fully 40% of the housing purchased in the bubble years was bought by speculators. As the bubble house of cards tumbles down, then even middle-class real estate speculators are finding that they have have just been issued passports to Subprime Nation.
What drove Americans to eagerly immigrate to Subprime Nation? The simple, and I think inadequate, explanation is simple pure human greed: to get something for nothing, to join the free-money bandwagon.


As I have suggested here before, I think the underlying motivation was to make up the decades of stagnant/sinking income and the decades of rising prices--not for food back then, but for college and medical care and much else that defined the "middle class" lifestyle--via speculation in an asset class everyone understood (or thought they understood): housing and real estate.


Now that the bet to make up for decades of declining income has been lost: now what? Though Obama's comment about "bitter" rural dwellers has earned him a lot of spilled ink and indignant ire, I wonder if he wasn't mis-describing something important. Perhaps Americans of all ethnicities, religions and types--rural, small-town and urban dwellers alike--aren't bitter so much as despairing: depairing about staying in the middle class (college education, secure employment with medical benefits, home ownership with a 30-year fixed rate mortgage, etc.) or about bootstrapping themselves up into the middle class.


These are not phony concerns. Global wage arbitrage (i.e. somebody overseas can do your job for much, much less than we pay you), temporary/contract jobs replacing full-time jobs, the erosion of employer-provided pension plans and healthcare--these are real. State college tuition, once relatively cheap, has risen to the point that being saddled with tens of thousands of dollars in student loans is considered "normal" now, when a generation ago they were unheard of.


Just as disturbing is the rise of cheating in American schools and life: cheating on exams, fabricating or exaggerating resumes, etc. The trend points to a people desperate enough and fearful enough of "losing their big chance" to throw away personal integrity for a cheap "A" or liar-loan or puffed-up resume. What does a fabricated excellence or expertise say about the holder of that resume? Nothing good, that is certain.


So now the question becomes: have Americans more or less given up? Have they lost confidence in their own abilities to prosper in a hyper-competitive world? Is that why so many were eager to belly up to the roulette wheel of the housing bubble and throw down their borrowed chips on a last-ditch gamble "for the good life," a life of new cars and suburban homes, all acquired without savings or sacrifice?


Frequent contributor Harun I. wrote the following in response to yesterday's entry on the "bottom" in housing, and it is a powerful commentary on the psychology of want/need, optimism and confidence:


"Beyond all mathematical reasoning we simply have not reached the point of maximum pessimism in anything. The magnitude of all the varied issues (credit, weak dollar, energy crisis, food crisis, budget crisis (state/federal) and their convergence is misunderstood at a conscious level.


I don't perceive doom because doom is relative. There will be those that prosper in all circumstances even if it is not readily apparent.


I believe the trick is to be confidently optimistic based on trust in ones efficaciousness in any environment. Perhaps it is a lack of trust in ones' abilities that leads to fear and despair."

It is sobering to contemplate the possibility of a debt-ridden, anxious nation within a nation, a nation of residents who may, at some deep level, have lost confidence in themselves, in their supposed leaders, and perhaps in their nation itself.


NOTE: contributions are acknowledged in the order received. Your name and email remain confidential and will not be given to any other individual, company or agency.


Thank you, Steven R. ($20), for your unstinting, generous contributions to this site. I am greatly honored by your support and readership. All contributors are listed below in acknowledgement of my gratitude.

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Tuesday, April 22, 2008

Recessionary Rumblings from Around the World

My wife and I are blessed with many friends from around the world. As a result, we receive rmails with "on the ground" intelligence/reporting which is often unreported or mis-reported in the mainstream media.

Here is a report from a young Turkish gentleman whom we met when he was studying in the U.S. Both his parents are hard workers and have built small businesses which enabled him to study abroad for two years. A close relative married a Saudi gentleman, so he has visited Saudi Arabia extensively. He recently completed his compulsory military service in the Turkish Army. In other words, he is an acute observer with broad experience in many cultures, and his report cannot be dismissed as naive or uninformed:

"The climate here is changing in a bad way. We started to get less rain and yesterday even there is 10 days to may (still april) I saw 30 degrees celsius on the thermometer of the car yesterday and it didn't drop below 25. Last year the water resource for the city was not filled so we were close to the edge of getting out of water. Last year in Istanbul we saw 42 degrees C maximum. I can feel that the seasons have moved like 1.5 months ahead.

Right now my current job here is boring. It is mostly related with budgeting the operations in Turkey. Business life and economy here is getting worse and worse. They say that a big crisis is coming. I want to change my job but it is risky in these times. The salaries have started to drop very very low. The population around the Marmara bay region is rising, lots of unemployed people. Wages are dropping in every field.

The gas price is around 2.5 USD per liter here. People started to buy diesel powered cars and switched to LPG but this is followed by government tax increases on LPG and diesel. There is a big plan for the middle east and whats going on the border is just a part of it. My grandfather did his military service over there (Iraqi/Turkish border) and once he told me that he saw petrol coming out from rock cracks. That region has big underground resources and also the southeastern part of Turkey. I believe the crisis is created in order to change the borders and let big international oil companies get the advantage of the resources.

I believe worldwide growth has stopped. You see it with the stopping of mortgages in USA and inflation, but the signs here are more apparent. Here every capital owner became a real estate developer, for the last years the construction sector made a big expansion here. Right now it has a sharp stop. Some investors didn't even think if there is enough demand in the market for the price they are building flats for. Industries for construction have made great income but investors in housing has turned their money into matter that's not going to be sold. Now we started to receive the international crisis, it shows its signs with the high exchange and interest rates. I believe many people will have big losses. Hard days are approaching for everybody.

Here in Turkey the government is based upon a group that wants to turn the regime into an islamic regime in a hidden way, lots of arguments appear here between the secular regime supporters and the islamic sides. This has started to effect peoples daily lives. Women are disturbed for their clothing sometimes. In Istanbul some areas have European type modern living whereas some parts look like the most strict parts of Iran. You can see similar type of clothes. We are based upon a democratic regime but the Army needs to show some reaction in order to keep the secular system. Many people think that this will lead to an internal war."

Clearly, the real estate bubble bloomed in Turkey, too, and now the music has stopped there as well as in the E.U., Asia and the U.S. Wages are dropping, unemployment is rising along with petroleum costs and taxes, machinations over oil roil the geopolitically critical border with Iraq, and a "religious right" hungers for political power. Sound familiar?

Meanwhile, in the "do you really think you work too hard?" file, here is a snippet from a good friend in Japan:

"Haruyuki is really busy. He leaves home for work at 6:30 and comes back home around midnight."

That is not atypical in Japan, where a word was coined for "dropping dead from overwork."


From China comes a personal report of the Chinese stock market mania. Two years ago, the Shanghai stock market began its bubblicious ascent from 2,000 to 6,000, and during the last wild leg up last year the media was reporting thousands of brokerage accounts were being opened every day by regular Chinese citizens eager to join the free-money frenzy. I asked one of our close Chinese friends if anyone in her family had entered the fray, and here is her report:

"My father bought stocks from 10 different companies in 2007, and he made money in 2007. But in 2008, according to him, affected by the US economy, the stock market has dropped from 5900 points to 3140 points. He has around 10,000 RMB (about 8 months of his pension) that is stuck in the stock market (he won't sell, he will just wait). His roommate bought stocks from two companies, made some money in 2007, but now he also has around 6000 RMB that's in the market."

The Renminbi (a.k.a. the yuan) was 8.5 to the dollar a few years ago and is now about 7 to the dollar, meaning 10,000 RMB is about $1,450--a substantial sum in China where the average wage for factory workers and service employees is about $300-$400 per month (3,000 RMB).
So these retired gentlemen had invested between two and four months' average wages in the stock market--not a giant sum but a substantial one, roughly equivalent to $6,000 to $10,000. (Or figured another way, eight months of Social Security pension would also equal about $9-$10,000, using $1,100-$1,200/month as a typical full-retirement Social Security payment after a lifetime of work.)

And just like we did (or at least I did) in the 2000-2002 dot-com stock market bust, they are holding on as their portfolios go into the red, waiting for a recovery that will never happen (bubbles don't reinflate a year or two later).

From this and other personal reports from China, I think we can safely conclude that ownership of Chinese stocks became very widespread as the bubble took off, with a high percentage of everyone with savings (i.e. most people) joining the investing/speculating bandwagon. It also seems safe to conclude that like every other human being, those who saw their investments rise to dizzying heights in 2007 are loathe to sell now and take big losses. They will wait for recovery, in essence trapping their capital to avoid losses.

If the Chinese stock market continues its reversion to the mean (decline back to 2,000 or lower), then the losses will be widespread and significant. Will those losses cause widespread social disorder? Not likely, but they will certainly effect the investors' sense of wealth and prosperity. And as we all know, the "reverse welath effect" is a key factor in recession: once you feel poorer, you cut back your spending.

These reports suggest the recession will be global, and more painful than the cheerleaders/ mainstream media is reporting.

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Monday, April 21, 2008

The Worst of All Possible Worlds

Today's exercise: design a policy which produces the following results:

1. fills a veritable gulag of prisons with a half a million nonviolent men and women
2. feeds a global Mafia of unprecedented size, wealth and influence
3. nurtures a ghetto culture of endless turf wars, murder and mayhem
4. despite spending hundreds of billions of dollars, the policy utterly fails to meet its "official" goal of limiting the supply of certain commodities

Congratulations, you've just designed the U.S. "War on Drugs." The failures of this "war" are so monumental that they beggar description. Not only are illegal drugs still readily available, the "war" has spawned a global Mafia which reaps billions of dollars in profits, enabling it to extend its reach into other businesses.

Here at home, inner cities are riven by endless drug-centric turf wars and murders. Pushers are the "big men" in the ghetto, the ones young men and women respect and hope to emulate. In an attempt to render the consequences of dealing drugs so horrendous that people would forsake the immense wealth and prestige to be gained, the penalties for drug dealing and possession have been ramped up to insane "minimum sentences" which exceed those for rape and manslaughter.

How doomed-to-fail is this "war"? Let's start with geography. Take a nation with thousands of miles of unguardable coastline and borders, then toss in the fact that small, low-flying aircraft ensure its airspace is porous as well. Now guarantee an immense cash reward to anyone who successfully penetrates these thousands of miles of coast and border with a small shipment of drugs.

Gee, do you think somebody will try, and succeed?

Let's move onto lethality. Have you seen those headlines about 15,000 traffic deaths caused by drivers smoking marijuana? Strangely enough, there are no such headlines, even though millions of people routinely use marijuana.

The 15,000 people killed every year by drug-addled drivers are killed by alcohol-addled drivers, not marijuana-addled drivers. Yet nobody seems to make this simple observation. Every decade, 150,000 Americans are senselessly, needlessly murdered by alcoholic-impaired drivers. Hundreds of thousands more are injured.

And marijuana is so dangerous that we have to imprison you for years if you deal it?

Next, let's ask: if cocaine and heroin were legalized tomorrow, would you run right out and become a junkie? It's really not that appealing, is it, and so what are we so frightened of? Research suggests that a small percentage of any human population has a genetic propensity for addiction; these people seem to find a way to become addicted to alcohol, prescription medication or an illegal drug regardless of the restraints, and perhaps they would be better served by a policy of legalized drugs prescribed by doctors, out in the open, where they could be encouraged to seek treatment.

Contrary to movieland depictions of certain overdose and death, many junkies (heroin addicts) function in "day jobs" much like many prescription drug addicts. From a public health point of view stripped of ideological panic and fear, the legal drugs (alcohol, nicotine, and dozens of powerful prescription drugs) kill, maim and cripple more people than do illegal drugs--so what exactly is the criteria for distinguishing legal from illegal if harm, addictiveness and secondary effects such as 15,000 deaths due to alcohol-impaired drivers are not counted?

A more rational policy would be:

1. the U.S. government would buy the entire poppy crop in Afghanistan and the Golden Triangle, and the entire coca crop of South America by outbidding the current buyers. This makes perfect economic sense; why spend $100 billion on a worthless "war on drugs" when $100 million would buy the entire global crop of heroin poppies and coca leaves?
2. all drugs would be legalized and the price dropped to a few dollars per month for all current addicts who registered and obtained their "prescription" from a doctor or clinic. Marijuana would be equivalent to tobacco, controlled for quality and limited to those 21 years of age and older. It would be taxed and sold by the same retailers who sell cigarettes and alcohol now.
3. with the cost for heroin, cocaine and marijuana dropped to a few dollars, the illegal drug trade and its panoply of crime, murder and other ills would vanish overnight. The crimes associated with controlling turf and dealers would vanish too, along with the countless property crimes committed by addicts seeking money for their fix.
4. "Big Pharma" and the tobacco companies would be invited to enter the marijuana trade, ensuring quality and heavy lobbying to keep the product "safe and available to responsible consumers."
5. all the Mexican drug cartels' secret fields of marijuana in national forests would be rendered worthless as commercial growers were licensed.
6. with addicts to all drugs registered and coming to clinics for their supplies, the possibility of weaning them from addiction would increase.
7. law enforcement could stop wasting money and staff on the senseless, worthless, grossly ineffective "war on drugs" and focus on violent criminals.
8. a drug-crimes amnesty would clear nonviolent drug users and petty dealers out of prison, enabling major cost savings which could be applied to teaching the released prisoners some useful skills.
9. the "cool factor" in illegal drugs would vanish, as the appealing "forbidden" aspect of drugs would quickly fade. Once anyone can get drugs at a clinic, it's just not cool.
10. Crystal meth addicts could be switched over to "safer" marijuana or cocaine.

I know some of this will be a stretch to those of you who have absorbed decades of propaganda about how awful and horrible illegal drugs are, while hundreds of thousands of innocents have been killed by drunk drivers with nary a whisper of official recognition of the dangers of alcohol. And let's not forget the millions killed by incredibly addictive, fully legal cigarettes. Meanwhile, unbeknownst to those around him, a heroin junkie goes about his daily job, his supposedly horrific addiction bothering no one.

Yes, marijuana is harmful, and heroin and cocaine are dangerous drugs which can kill when abused. So are prescription "legal" drugs. Sadly, the hundreds of thousands of dead killed by drunk drivers and cigarettes attest to how "safe" and "harmless" these legal drugs are. And let's not forget the thousands who die in overdoses, planned and unplanned, of perfectly legal prescription drugs.

Setting aside the propaganda, on strictly public health and financial metrics, legalizing and controlling all drugs equally is the only rational policy. As the U.S. slides into recession/depression/financial cataclysm, perhaps the propaganda will give way to this one unavoidable reality: we can no longer afford the $100 billion prison complex/gulag and the failed "war on drugs," regardless of what fantasies/insanities have held sway for decades.
Addiction and drugs are not pretty, but better to have them in the open and low-cost; an immense burden of crime would disappear overnight. That alone has value almost beyond a price tag.

Disclosure: I don't partake of any drugs but wine and beer, which in modest quantities have long been considered either part of a meal or medicinal in nature. If abused, both become as deadly as any illegal drug.

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Thursday, April 17, 2008

Curing a Schizophrenic Immigration (Non) Policy

Don't you think it's a wee bit schizophrenic to offer millions of (low-paying) jobs to undocumented immigrants while at the same time erecting fences to keep them out?

This is the very definition of schizophrenia. As I have noted here before on numerous occasions, the problem is not poor people seeking work, it's the people who are hiring them.
You want to seriously stop the flow of undocumented workers into the U.S.? The solution is straightforward:

Charge every employer, formal or informal, a $10,000 fine per day, per undocumented employee. If the employer can't pay, then liquidate their business (or home) and sell it at auction the following month.

This may sound harsh (especially if you're the employer), but I guarantee the number of jobs being offered to undocumented workers would quickly plummet, and you wouldn't need some idiotic fence which is doomed to fail regardless of how many billions of dollars you throw at it.
So why won't we penalize the employers for offering the jobs? Because they're making huge profits off the undocumented workers, that's why. In the field I know well, construction/building, here are the facts. Other fields will differ, but the general conditions will apply.

In 1977, 31 years ago, I earned $7.50/hour as a young carpenter with about 3 years experience. Even at official inflation, that is equivalent to $26.50 today. (Figuring "real inflation" would put it well above $30/hour). More experienced carpenters/"lead men" earned $10-12/hour, or about $35/hour in today's dollars.

The legitimate contractor/builder paid FICA (Social Security) of 7%, unemployment insurance and Temporary Disability Insurance (5% or so) plus Workers Compensation (being a dangerous trade, the rate was about 25-30% of wages). So the equivalent cost today of that $7.50/hour would be $26.50 X 40% ($10.40) for direct overhead = $37/hour--for an apprentice carpenter and about $47/hour for an experienced carpenter.

I did not live like a bond trader on $7.50/hour in 1977, and $26.50/hour today is a decent wage but not a great one, as construction is cyclical and lay-offs/bad weather etc. reduce the days worked.

So what do you guess small builders/developers paid undocumented workers during the housing boom? Try $12 to $15/hour cash (no taxes or insurance paid), or about a third of a legitimate wage. Did you notice a 2/3 drop in the labor cost of those McMansions? Gee, I guess not. Then what happened to all that money that used to go to legitimate skilled labor and the taxes and insurance to provide some minimal security to them?

It went into the pocket of the builders/developers. Now the big national builders hired legal workers and paid market wages--they had no choice. (If they got around labor laws and all the liabilities, it's news to me).

So here we have a totally schizophrenic nation, happily exploiting anyone who can make it across the border but at the same time bemoaning their arrival. If that isn't insane, I don't know what is.

I know the usual excuse is that "we can't find any Americans to do the work." Well, did you offer a legal worker (of any color, creed, ethnicity, gender, etc.) a living wage comparable to what was standard 30 years ago? We hear the same thing in the H-1B visas /high-tech hiring "debate"--"we can't find enough qualified Americans." Again, the question is: what wage did you offer? Something similar to what was standard 10 or 20 years ago (adjusted for inflation), or did you offer 2/3 or 1/2 of a legitimate wage?

There are "experts" available to gin up phony "we really really looked for legal American workers but couldn't find a single one, boo-hoo" applications, and that alone should raise the suspicion in our minds that the "crisis" is not in available workers but in profiteering: if the employer can find someone to work for half or 2/3 of the standard wage, then that's a huge incentive to hire undocumented workers/cry for more H1-B visas for young people from abroad who will willingly accept low wages in order to build a legal toehold here.

And if we really don't have enough qualified software, slaughterhouse, farm, etc. labor already living here legally, then clearly we need some new systems/policies:

1. a system which provides huge, immediately painful financial disincentives to hiring undocumented workers

2. a system which offers some incentives to paying living wages to citizens/legal residents
3. a national clearinghouse of all available positions which seeks to place unemployed legal residents in jobs somewhere in the country

4. an immigration policy which processes needed workers and arranges for their legal arrival (and departure, if necessary) quickly and efficiently--which is certainly not the system we have now.

As longtime readers know, my stepmom is Mexican-American--born here in California, as American as anyone else. Though she is not an undocumented resident, our conversations have certainly alerted me to the insane hardships our schizophrenic (non) policies create--dividing families, etc.

The current insanity actually encourages undocumented workers to stay here because they fear not being able to get back in, or having the $2,000+ to hire a "coyote" to "escort" them back across.

Amidst all the fantastic insanity of essentially encouraging U.S. employers to hire undocumented workers on the one hand and then decrying their presence on the other, here is a rather lush irony: as the U.S. slides into a deep, prolonged recession, the undocumented workers are leaving on their own accord because the jobs are drying up:

Crossings By Migrants Slow as Job Picture Dims:
Francisco Lopez, a 43-year-old illegal immigrant and the parent of two U.S.-born children, earned about $50,000 a year transporting construction material, but the work dried up and he now drives a taxi to make ends meet. "To live in America these days is to suffer," said Mr. Lopez, who lives in the Chicago area. "I'm not recommending to my friends back home that they come here. I'm thinking of leaving myself."

Dawn McLaren, a research economist at W.P. Carey School of Business at Arizona State University who studies immigration, says that arrests of illegal crossers tend to fall a year before an economic downturn and begin to climb ahead of an economic boom. "I use the number of apprehensions at the border as a leading economic indicator," says Ms. McLaren.

I for one am tired of a schizophrenic non-policy which winks at employers paying 1/3 - 1/2 the legitimate wage and overhead costs (and please don't tell us you'll go out of business if you had to pay real wages--your legitimate competitors manage to do so) and then wags its finger angrily at the destitute person who accepts the job. If employers offered a living wage, they might be surprised to find willing workers after all. And if you truly can't find anyone to do the work for a legitimate wage, then you should start lobbying for a practical, efficient immigration policy which actually recognizes the reality of your needs as a legitimate employer.

We as a society have to "get real" and stop turning a blind eye to who's profiting from employing millions of undocumented workers. As the saying goes, "follow the money/profits."

If we're going to turn a blind eye to the employer who hired the undocumented worker, then let's be logical and turn a blind eye to both equally. Or equally logically, let's turn our wrath and anger on the employers as well as the undocumented workers. They're two sides of the same crazed coin.

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Wednesday, April 16, 2008

The U.S.A.: The Third World's First Superpower

Readers Journal has been updated. Check out 15 fascinating thought-provoking new comments and a new essay, On Capital Traps.

To those of you currently ensconsed in quiet, comfortable suburban America, the notion that the U.S. shares a number of disturbing traits with Third World countries might seem implausible or even insulting. But please read on before passing judgment.

Here are some key traits the U.S. shares with Third World nations--trends which are only growing more visible with each passing month:

1. Income and wealth inequality. One of the defining characteristics of Third World countries is extremes of income and wealth; a relative handful of families/elites control most of the property, wealth and "means of production" (wealth generating assets) while the majority of citizens own and earn essentially nothing.

Here in the U.S. it's not that visibly extreme, but facts are facts: a relative handful own the vast majority of key wealth-producing assets:

The Growing Gap in the United States Between the Rich and the Rest
There is also another measure called the Gini coefficient. It measures the concentration of wealth at different percentile levels, and does an overall computation. It is an index that goes from zero to one, one being the most unequal. Wealth inequality in the United States has a Gini coefficient of .82, which is pretty close to the maximum level of inequality you can have.

A household in the middle — the median household — has wealth of about $62,000. $62,000 is not insignificant, but if you consider that the top 1 percent of households’ average wealth is $12.5 million, you can see what a difference there is in the distribution.

Things are even more concentrated if you exclude owner-occupied housing. It is nice to own a house and it provides all kinds of benefits, but it is not very liquid. You can’t really dispose of it, because you need some place to live.

The top 1 percent of families hold half of all non-home wealth.

The middle class’s major assets are their home, liquid assets like checking and savings accounts, CDs and money market funds, and pension accounts. For the average family, these assets make up 84 percent of their total wealth.

The richest 10 percent of families own about 85 percent of all outstanding stocks. They own about 85 percent of all financial securities, 90 percent of all business assets. These financial assets and business equity are even more concentrated than total wealth.

We are much more unequal than any other advanced industrial country.

Perhaps our closest rival in terms of inequality is Great Britain. But where the top 1% percent in this country own 38 percent of all wealth, in Great Britain it is more like 22 or 23 percent.
What is remarkable is that this was not always the case. Up until the early 1970s, the U.S. actually had lower wealth inequality than Great Britain, and even than a country like Sweden. But things have really turned around over the last 25 or 30 years. In fact, a lot of countries have experienced lessening wealth inequality over time. The U.S. is atypical in that inequality has risen so sharply over the last 25 or 30 years.

For more, please see:
Wealth, Income, and Power by G. William Domhoff
Growing Wealth, Inequality, and Housing in the United States (Joint Center for Housing Studies, Harvard University, 29 pages)

So what separates the U.S. from elite-owned Third World nations? Rather like the young lady who agrees to an evening with a wealthy stranger for $1 million, we've already established the inequality; the rest is mere haggling over the details.

2. The gutting of public services to pay burdensome interest on massive public debt. In the Third World, this process has been given an innocuous-sounding name by its enforcers, the World Bank and the IMF (International Monentary Fund): Structural Adjustment Program (SAP).

The world's bankers have long found it highly profitable to lend vast sums of "easy money" to Third World dictators, elites and kleptocrats, and then have their governments go in and forceably collect the interest when the overburdened borrowers defaulted. In 1904, President Theodore Roosevelt warned the European Powers not to land forces on Santo Domingo when it defaulted on its debts; instead, he sent U.S. forces to the customhouse to collect tariffs in order to pay the aggrieved European creditors.

In the current version of the game, the World Bank and the IMF require the debtor nations to agree to a Structural Adjustment Program, which slashes public spending in favor of interest payments to the western lenders. The U.S. Federal government has no limit on what it can borrow except the willingness of fools--oops I mean creditors--to keep lending it more money via buying its Treasury bonds.

But even with no limits on borrowing, the cost of the interest will soon squeeze Federal Spending. The interest on the Federal Debt is poised to exceed the cost of Medicare or even the Pentagon/Defense: $429 Billion according to the U.S. Treasury.

Here's a good chart of annual Federal expenses.

Unlike the Federal government, states, counties and cities cannot borrow unlimited amounts of money to fund their budget deficits. But states and various agencies have worked around this annoying limitation on their spending by selling "municipal bonds" which were theoretically designed to fund multi-year infrasructure projects. But in many cases, these have ended up funding expenses that have nothing to do with buildings, and of course the interest on this debt grows along with every new bond issued. And in California, that's billions more each and every year.

As recession slashes tax revenues at all levels of government, the interest on the stupendous public debts will eat up an ever-larger percentage of the public budgets, forcing cuts in payrolls and services--such as filling potholes and keeping libraries open. Welcome to the Structural Adjustment Program for the U.S.A. The Third World experienced massive declines in public welfare and infrastructure spending in the 1980s--now we will get a taste of the debt-induced belt-tightening ourselves.

3. The gutting of public services as public employee elites rally round their salaries, benefits and fiefdoms. One of the distinctions of a Third World economy is the extremely high premium placed on securing a government bureaucracy position, as these are essentially the only secure jobs in the entire country.

As the SAP slashes spending to pay the ever-increasing interest on debt, the public employee elites fight tooth and nail to maintain their perquisites, sacrificing public services to keep their security and benefits intact despite massive cuts in tax revenues. You will soon see libraries and fire stations closed, public health and recreation programs cut, etc.--but magically, the upper-echelon public payrolls will not decline.

Frequent contributor Michael Goodfellow sent in this article about fire battalion chiefs earning $270,000 a year in Silicon Valley--far more than the mayor.

Who is San Jose's highest-paid employee? You may be surprised:

San Jose's highest-paid employee last year wasn't the city's top manager, lawyer or doctor. The mayor and city council? Not even close.

The highest-paid worker was a fire battalion chief. Ivan Lee earned a total of $270,367, including $125,195 in base pay, an eye-popping $108,116 in overtime and $37,055 in other cash compensation, such as back pay from a labor contract settlement.

Three other battalion chiefs were among the city's 10 highest-paid workers in 2007, with total cash compensation - excluding benefits - of up to $244,847.

The latest figures, requested by the Mercury News, come amid a heated City Hall debate over employee pay and benefits. Personnel costs account for two-thirds of the city's operating budget, which has been plagued by multimillion-dollar deficits.

And salaries have grown 38 percent since 2000, almost twice the cost of living increase reflected in the consumer price index. Mayor Chuck Reed has called for smaller raises, angering city unions.

Of San Jose's nearly 7,000 full-time workers, nearly a third earned more than $100,000 last year, and 37 made more than $200,000 - nearly double the number in 2006.

The average city worker's base pay is $82,328 - almost twice Santa Clara County's 2006
median individual income of $47,283, the most recent figures available.

This reads just like a Third World country, where the bureaucrats get twice the pay and immeasurably more pension and healthcare benefits than the average private worker.

4. Secure "formal" jobs are replaced with insecure "informal" jobs. You know the drill: fire all your salaried workers in a downsizing, then hire back the best as contract workers without benefits or pensions.

With secure permanent positions as rare as gold statues, laid-off workers take part-time jobs, or reluctantly enter the "informal" job market as handymen, babysitters, etc. On a societal-wide basis, this means the destruction of tens of millions of once-secure or relatively secure jobs, which are then replaced with completely insecure, informal jobs with no pension or healthcare protections/benefits.

Again, this is a primary characteristic of a Third World economy.

5. As the economy falters, a vast prison-state/gulag acts to control petty criminals and provide patronage-rich public-worker positions. Sell a gram of cocaine, go to jail for 25 years. The prison guards union is one of the most powerful and feared lobbying organizations in the state of California, surpassing even the mighty Teachers Union and trial lawyers for political power. More prisons? You can bet we need them....

6. As secure, decent-paying jobs vanish, the working poor turn to the Military for secure jobs with benefits. Over one million Americans have served "in theatre" in Iraq, and despite the grueling war there, the Armed Forces have met their recruitment goals in every category but retention of mid-rank officers-- chief petty officers, lieutenants and captains (Army and Marines). Where else can you nail down $50,000 - $60,000 in benefits and earn cash re-enlistment bonuses? And in 20 years, you'll have earned a bulletproof pension and Veterans Administration benefits--oh, and if you haven't noticed, the VA is now the best-run large-scale medical services organization in the U.S.

(That is not to say there haven't been hellish stories from wounded Iraq-War vets; but some of these problems stem from the tangled, snafu-ridden "hand-off" of the wounded from active-duty U.S. Military facilities to long-term VA care.)

7. Top-level public education is increasingly expensive and thus increasingly out of reach for average citizens's offspring. Since when did students have to borrow tens of thousands of dollars to attend public universities?

It's time to overhaul Prop. 13 to save state:

University of California students now contribute $1 for every $2 the state chips in - in the mid-'60s, that ratio was 1 to 19. When I was at Cal in the late 1960s, student loans were almost nonexistent, but now the average annual cost of attending UC is nearly $24,000 a year, and half the students have to take out loans to graduate.

It's hard to believe now, but in the pre-Prop. 13 era, public support for higher education was taken as a given - not just in the flush 1960s, but in much leaner times. In 1933, when California Gov. James Rolph proposed cutting UC's budget, the UC Regents protested that he was breaking faith with the people, and UC President Robert Gordon Sproul responded with words that have a tragic relevance today: "When a state prunes too severely the intellectual life at the top, it produces increasing poverty and despair at the bottom."

From 1/19 to 1/2--that's quite a shifting of costs from taxpayers to students. This too is Third World, where even public education costs more than most people can pay without going deep into debt.

Put this all together and what do you have? A nation which clearly shares key characteristics with oft-maligned Third World "basketcase" nations which are wallowing in debt, unfilled potholes, overflowing prisons and declining public-sector services.

Does that mean the U.S. is a Third World state? Of course not; but the above trends should raise our collective awareness of the risks ahead.

For more on SAPs and the structural changes they triggered in the Third World, please read Planet of Slums by Mike Davis.

NOTE: contributions are humbly acknowledged in the order received. Your name and email remain confidential and will not be given to any other individual, company or agency.

Thank you, Jeff O. ($100), for your stunningly generous contribution to this humble site. I am greatly honored by your support and readership. All contributors are listed below in acknowledgement of my gratitude.

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Tuesday, April 15, 2008

Tax Day Ramblings

Readers Journal has been updated. Check out 15 fascinating thought-provoking new comments and a new essay, On Capital Traps I don't know about you, but I wrote some tax payment checks yesterday.

I'd like to complain about having to pay $980 more (above and beyond my estimated tax payments) to the U.S. Treasury and the Golden State, but I don't have any sympathy for myself--all it means is I underpaid.

My total Federal tax was not giant--and of course, neither was my income, net, gross, net-net, however you want to figure it. But that's the trade-off, isn't it? You make more money, you pay more taxes--or you can cheat, or move to a no-tax nation. That's the trade-off; If you prefer to live in France or Denmark, you'll pay even more taxes.

The people I have sympathy for are the salaried or self-employed folks who earn more than $160,000. They're the ones paying most of the taxes--not the corporations, and certainly not the lower-income wage-earners--42 million out of 130 million filers pay zero Federal tax.

Source: Summary of Latest Federal Individual Income Tax Data:
The top-earning 25 percent of taxpayers (Adjusted Gross Income over $62,068) earned 67.5 percent of the nation's income, but they paid more than four out of every five dollars collected by the federal income tax (86 percent). In 2005, the top 1 percent of tax returns paid 39.4 percent of all federal individual income taxes and earned 21.2 percent of adjusted gross income. I'd have to nearly triple my adjusted gross income to reach the top 25%, so my hat goes off to those paying most of the nation's income taxes.

I am not so sure about the wisdom of letting 32% of all income-earners pay nothing. Yes, they're low income or have many dependents or large deductions, but when a third of the people pay nothing in taxes, I wonder if their perspective on the coming budget deficits isn't a wee bit skewed.

Let's be direct: if you pay nothing, you're not focused on how much you're paying, but on how much you're getting in Federal benefits/credits, etc. A third of the nation, regardless of their political beliefs, will vote to raise taxes or borrow from our children and their kids rather than cut benefits out of a very powerful self-interest.

Add in the millions who pay little or no taxes but who receive Social Security and Medicare benefits, and you're up to about half of all potential voters with a distinct self-interest in doing anything but cutting benefits.

I'm not sure that's healthy for the Republic. Maybe we'd have better collective judgment if everyone with income (yes, even tax-free municipal bonds) paid some Federal tax-- including any business with operations here in the U.S.

But it seems that even as corporations have reaped record profits for the past 7 years, their share of the nation's tax burden has plummeted: THE DECLINE OF CORPORATE INCOME TAX REVENUES:

Treasury Department figures show that actual corporate income tax revenues fell to $132 billion in 2003, down 36 percent from $207 billion in 2000. Corporate revenues represented only 7.4 percent of all federal tax receipts in 2003. With the exception of 1983, this represents the lowest level on record (these data go back to 1934).

Although taxes paid by corporations, measured as a share of the economy, rose modestly during the boom years of the 1990s, they remained sharply lower even in the boom years than in previous decades. According to OMB historical data, corporate taxes averaged 2 percent of GDP in the 1990s. That represented only about two-fifths of their share of GDP in the 1950s, half of their share in the 1960s, and three-quarters of their share in the 1970s.

The share that corporate tax revenues comprise of total federal tax revenues also has collapsed, falling from an average of 28 percent of federal revenues in the 1950s and 21 percent in the 1960s to an average of about 10 percent since the 1980s.

No precise estimate exists of the amount of income that corporations shelter from income tax. As noted, the Joint Committee on Taxation believes that the amount of corporate tax shelter activity cannot be measured with existing data.

Beyond this evidence, another sign that corporate tax sheltering is on the rise is the divergence between the "book" income that corporations report to their shareholders and the income that these corporations report to the IRS for tax purposes. A number of studies conducted in recent years have identified very large gaps between 'book' and 'tax' income, including a 1999 Treasury Department analysis that concluded that tax shelter activity was one of the factors causing this divergence.

A more recent National Bureau of Economic Research study reached similar conclusions. It found that this gap has grown and that in 1998, some $154 billion — or more than half of the gap between “book” and "tax" income for that year — could not be explained by the traditional accounting differences. The author concluded that "the large unexplained gaps between tax and book income that have arisen during the late 1990s are at least partly associated with increased sheltering activity."

So our problem as taxpayers seems to be a distinct lack of offshore tax shelters. Being a foreign corporation is also a huge plus, it seems: Most US firms paid no income taxes in '90s:

An estimated 94 percent of US corporations reported tax liabilities amounting to less than 5 percent of their total income in 2000. The corporate income tax rate is ostensibly 35 percent, but companies are able to reduce their effective burden by claiming various deductions and credits.

Foreign-owned companies fared better in some respects than their US-based competitors. The report found that 71 percent of foreign-controlled corporations paid no taxes on their US income, while 89 percent had liabilities of less than 5 percent of their income. A corporation is a legal entity, but it has no conscience, sense of duty or ethics. Cheating via bogus tax shelters goes hand in glove, it seems, with preparing a P&L statement, and all those wonderful Japanese and European firms which make billions here in the U.S. seem not to be hindered by an obligation to contribute any taxes to the source of their Midas-like wealth.

There is an excuse for all this, of course; "globalization." We pay taxes in Japan or Germany or Bermuda (heh-heh)--or maybe not, but it's globalization, pal; we're just here to make the big profits. Taxes are for the workers and consumers to pay. You're lucky we're here at all, buddy.

Four cheers for globalization's secondary benefits, like tax-free zones for corporations.

NOTE: contributions are humbly acknowledged in the order received. Your name and email remain confidential and will not be given to any other individual, company or agency.

Thank you, Don E. ($13), for your steadfastly generous contributions to this humble site. I am greatly honored by your support and readership. All contributors are listed below in acknowledgement of my gratitude.

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