The Tea Party don’t care…just get the money

If the threats continue, global markets may actually break the U.S.’s leg…

George W. Bush was trigger-happy enough to invade Iraq based on doubtful intelligence reports. Tea Party-influenced house Republicans may be rash enough to let America’s credit standing diminish based on a tough-love libertarian economics.

American financial stability almost never faces a real, possibly-permanent threat, but the Republican debt-ceiling game may be one. Politicians, pundits, and occasionally even economists have all been saying this on TV, but with a subject (yawn) like credit markets, the stern warnings about dire consequences have failed to grab the popular imagination.

The problem is that Tea Party know-nothing’s like William Temple (Mister tri-corner hat) are putting intense pressure on Republican representatives. And those Republicans seem to care more about riding the Tea Party wave than preserving what’s left of American prosperity. What makes it real is that these congressmen have repeatedly failed to demonstrate an understanding of the possible consequences of their threats. One presumes a child-like faith in supply-side economics keeps them sleeping soundly.

Paul Ryan, the supposed economic brain of the group, has a half of an undergraduate degree in economics (the other half was poly-sci of course) and has worked as a “volunteer economist” at Dick Armey’s Freedom Works, a place known for inventing numbers rather than studying them. No one has ever paid him to foresee economic outcomes… the way real economists make their living. He’s never really been in finance, started a business or done anything that might have given him worldly economic insight, rather he’s spent most of his life chasing conservative donors around. It’s disconcerting that he is the best man house Republicans can come up with to formulate economic policy.

Meanwhile, John Boehner -the supposedly mellow Republican- showed up to a meeting to reassure Wall Street Exec’s and said exactly the wrong thing: No-can-do on that reasonable compromise…

He and Paul Ryan are probably calculating that they can demagogue this issue because it is complicated and abstract enough for most independents to believe the simple narrative that Republicans are using leverage to stop wasteful Democratic spending.

But if you’ve ever owed a substantial amount on your credit card, it’s quite easy to understand why this is a lot more dangerous than everyday political arm-twisting. Debtors know that every percentage point counts.

Here’s why:

Last year the U.S spent about 4.6% of it’s total budget paying the interest on it’s debt. Not a good thing, but not actually that unreasonable either, kind of like a well managed family’s mortgage. The Family got a home…the Obama administration prevented a global depression. However, unlike a good mortgage, a great deal of this debt is subject to adjustable-rates, meaning that monthly payments could rise dramatically if interest rates rise. The government bankers re-borrow much of the debt every three, six, or twelve months, as older notes come due.

How much could interest payments rise? Well politically inspired government defaults are not everyday occurrences so it’s hard to be sure. But one unnecessary, political default has happened recently and that can provide some comparison.

In 2000, the government of Peru decided to refuse payments on their bonds even though they had the money. They had just ousted dictator-ish leader Alberto Fujimori and decided they shouldn’t have to honor his debts. Unfortunately for everyone in the country, the bold move caused Peru’s borrowing cost’s to skyrocket. They soon discovered that it’s really hard to run a country without credit and agreed to recommence paying the old debt. Their rates came down again, but not all the way. Credit analysts now had to factor political instability into their credit rating. According to a recent report by JP Morgan Chase, the affair permanently raised Peru’s borrowing costs by half of a percentage point…permanently.

What is a mere 50 percentage points to you and me? Currently the Treasury pays about 2.38% to service debt, so raising that by .5% to 2.88% would actually cause about a 21% increase in the treasury’s debt premiums. This would happen over time, as the constant refinancing of older debt continued at the higher rates. So, letting the math stay basic, that means 2012′s debt servicing would likely take up 5.6% of the budget instead of the 4.6% it cost 2010. This would represent a spending increase of about $86 billion, far more than the government currently spends on the nation’s highways or its veterans, or even the State Dept.,  at least eight times what it spends on Environmental Protection and twice what it spends on Homeland Security.

But these are only the minimum consequences, hoping that the default-caused general panic most money-market dealers foresee does not happen (the way it did when Lehman Brothers did the same thing in 2008)… That would mean a global financial melt-down that would be impossible to quantify. No responsible member of Congress would want this. Right?

Well…May be. Most commentators seem to assume that Wall Street will ultimately control the house Republicans. More importantly most big players in the credit markets have shrugged off the whole thing as mere politics too.

But there are other voices on the wackier side of Wall Street that welcome the possibility of a government default. They think it’s just the sort of short-sharp-shock America needs to wake up to the dangers of the government’s social spending.

Who will a Tea Party harassed John Boehner listen to? And will libertarian congressional freshmen necessarily follow him, if he does betray his own belligerent rhetoric? Come August, conservative donors may find themselves unpleasantly surprised and ultimately impoverished, by the same radical politicians they have no-doubt financed.

Eighty-six billion dollars is still a lot of money for most people, even Republican donors.

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The Ryan Budget and the Atheist Guru

Allowing the orthodox wing of a party to take control of the message usually doesn’t lead to good things… As recent polls seem to indicate, the GOP’s very un-Christian obsession with the Social Darwinism of Ayn Rand hasn’t actually made them popular in Town Hall America.

Rand (posthumously) and her devotees in the radical wing of the Republican Party espouse the notion that government should steer clear of almost all commerce, for example: as between healthcare providers and patients, or miners and mine owners, natural gas drillers and people who live near wells etc., etc. The last election is supposed to have demonstrated that most Americans share this free-market loving tendency.

As it turns out this supposed American love of free-markets does not extend to medicare.

No matter how skillfully one spins the tale, informing senior citizens and the offspring that must look after them that they’ll get cupons to take to the doctor’s office instead of real health coverage doesn’t go over so well.

Blame their old-fashioned Judeo-Christian values perhaps, but even Republicans don’t actually seem to favor abandoning the old and infirm in favor of unregulated capitalism and budgets with room for preventative wars and off-shore tax loopholes.

Hollywood could have told them as much. Twenty-two years ago Rand-obsessed businessman John Aglialoro went to the studios to sell the idea of a film adaptation of Rand’s magnum opus Atlas Shrugged: he was firmly rebuffed.

The book is about the a mysterious, brilliant businessman, John Galt, who rebels against society’s “parasites” in the hope of setting up a truely free society where it’s every genius for themselves and to hell with everyone else. Somehow this didn’t strike Hollywood as a winning formula.

Seemingly not a man to let experience and professional judgment get in his way, Mr. Aglialoro sunk $25 million of his own money into the film, which opened on April 15th after loads of free promotion by Fox Network and FreedomWorks. Well, Atlas Shrugged: the movie earned $1.7 million on its opening weekend. This compares with Michael Moore’s sparsely funded and lightly promoted Capitalism: A Love Story, which managed to earn $4.5 million on its first weekend.

Counter-factual spin not withstanding, the unmistakable reality of the laughable box office results seem to have finally shown Mr. Aglialoro that the Hollywood execs were right after all. This is unfortunate for Mr. A, Paul Ryan and hardcore rightwing ideologues everywhere… even the $25 mil film failed to mainstream the winner-takes-all value system at the heart of the Ms. Rand’s philosophy and the current Republican budget proposals. Oh well…

In the end, odd though it may seem to some on the right, Americans may not yet be ready for an atheist anarchy dominated by super-genius businessmen.

Who is John Galt? Who cares?

 

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Navigating Debt

Budget Icebergs

This image is part of an effort to figure out how to use scale in economic illustrations in circumstances where numbers are so great they confound comprehension.

It was designed to show the relative size of the budget cuts recently agreed to as part of extending the debt ceiling in relation to the overall federal budget.

I started with a google bar chart based on a spread sheet of budget category percentages. The categories (i.e. Defense Department and Interest on The National Debt etc.) were then sized according to the size of the bars on the chart.

Unfortunately I quickly discovered that I had to cheat when I rendered the Spending Cuts because rendering them in actual scale would have made them too small to read. I had to make them three times bigger. To make matters worse, a week later the Congressional Budget Office figured out that the effect of the cuts had in fact been hugely overstated by Congressional leaders.

The parties involved in negotiating the cuts had claimed that approximately $38.5 billion had been removed from the 2011 budget… But the CBO analysis revealed the cuts only amounted to about $352 million in actionable spending reductions (i.e. less than one hundredth of the claimed amount). So the scale in the drawing actually overstates, by about 300 times, the amount of the spending cuts actually enacted… 0.0001% of the national bubget.

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The Oracle Speaks

The Oracle. Courtesy Wikimedia Commons

When it comes to printing money, a passionate back and forth between interested parties should be expected. Inflation hawks see 1970’s stagflation in every uptick of oil prices and want the money printers to stop now. Doves see hordes of unemployed folks losing homes to a jobless recovery unless the presses continue. As QE 2[1] enters its fifth month, the argument has become popular sport in the blogosphere and on talk radio. Everyone, from cabdrivers to Donald Trump, seems to have a “common sense” prescription for monetary policy. Thank goodness the government has central bankers charting a course between inflation and growth based on institutional wisdom. Right?

Well…Maybe. In March the éminence grise of central banking, Alan Greenspan, told CNBC that the Federal Reserve’s tools for predicting inflation don’t work. One by one he derided core inflation[2], the output gap[3] and inflation expectations[4] as unreliable predictors.

“The problem is none of these indicators will tell you when inflation is about to take hold” he told CNBC’s Rebecca Quick.

The timing of his observations is remarkable. The United States is undertaking one of the great monetary interventions of all time, following one of the worst recessions. The challenges faced by Fed chairman Ben Bernanke are nearly unprecedented. Last week the Fed’s balance sheet reached a daunting $2.6 trillion and counting. Yet, long-term unemployment in the US remains essentially unchanged, despite otherwise positive jobs reports and corporate profits.

With friends like these…

Naturally, Bernanke has little choice, but to assure doubters that things are proceeding according to plan. After all, his primary job is maintaining confidence in the currency. He must be feeling undermined by his famous predecessor telling the world that the Fed is in uncharted territory, without a compass.

The former chairman’s views came in response to questions about Fed methodology raised by Lakshman Achuthan of ECRI, an advisory firm that relies on business cycle analysis rather than predictive models. Achuthan says the Fed’s models, have resulted in a tendency to wait until it’s too late to slow growth.

Fine. Mr. Achuthan is an outsider aiming to persuade the Fed to try a different approach. Mr. Greenspan is the consummate insider who, by agreeing with him, seems to be taking aim directly at the prestige of the institution itself.

This sowing of doubt is hard to explain given that Mr. Greenspan, more than anyone, knows the central bank must inspire confidence to be effective. Yet, how else can one interpret statements like this:

“The one thing we (central bankers) all pretend we can do, which we can’t, is forecast. The future isn’t very bright. And the one way you can tell is, whenever a central bank is doing something, there are five different explanations as to why it’s going to happen this way, that way or the other way. If we knew as much as we’re supposed to know, we wouldn’t be having this issue of huge differences of opinion.”

Well, thanks for explaining that Dr. Greenspan, we feel much more confident now.


[1] Quantative Easing 2: the Federal Reserve’s policy of purchasing treasury securities, which raises the amount of cash as opposed to securities in investor’s portfolios.

[2] A measure of prices that excludes volatile food and energy.

[3]A measure of under-utilization of US capacity and consequent lack of need to hire workers or increase wages.

[4]A measure of the market’s and consumer’s expectations regarding future prices, usually derived from surveys or the yield on inflation protected bonds relative to normal bonds.

 

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The Beltway Bubble

Only Certain Magical Forms of Free Speech Can Penetrate the Bubble

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Bonus Land Board Game

“Bonus Land” was intended as a board game and was made to fulfill an assignment on regulation and proprietary trading. It was completed in December, 2010. It was hand drawn and pasted together using glue, a xerox machine and Photoshop (before I had much familiarity with Adobe CS3)

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BlackRock, seeking edge, becomes a One-Stop Shop for Retiring Investors and their Advisors

The purchase of Barclays Global Investors by Blackrock Inc. (NYSE: BLK) in December of 2009 completed the transformation of the company from an obscure niche firm specializing in closed end, fixed income funds and risk management into the largest asset manager in the world. The purchase also made BlackRock a virtual one-stop shop for institutional investors, investment advisors, retail investors, and even governments.

It was a bold stroke, but investors and analysts worried that the firm was venturing into unknown territory, with lower-fee commodity, index and industry ETFs. The company was also facing a huge corporate integration challenge, practically tripling in size overnight. The purchase of BGI increased Blackrock’s assets under management from $1.28 trillion to $3.44 trillion, an increase of over 168%.

Early in 2010, the market punished the firm by pushing its stock price down over 40% to $141 per share, from a high of $239.  Lately earnings growth and fund inflows have helped the stock to recover somewhat. It’s currently trading between $165 and $169, while competitors in the asset management business like State Street Corp. (NYSE: STT) and Franklin Resources Inc. (NYSE: BEN) have largely returned to last year’s highs. The sluggish price suggests that Wall Street is not entirely convinced the merger is a success.

However by growing in size, and pairing its risk-managed hedge fund background with highly transparent, liquid and retail-friendly alternatives to traditional mutual funds, BlackRock may be anticipating trends that that will change the investment management landscape in the near future. In the end BlackRock’s purchase of BGI may prove prescient.

The looming retirement of the baby boomers

Starting in 2011, the first of the 78 million Americans born between 1946 and 1964 will begin the transition to retirement, causing a steady increase in the number of retirees that will continue for decades. Significantly, according to the U.S. Census Bureau, this generation will live much longer than its predecessors with one in nine making it to the age of 90.

This portends great changes for asset managers. According to the Census Bureau’s survey of consumer finances, the retired, or almost retired, now control nearly two thirds of all assets in the United States. Teresa Ghilarducci, a professor at The New School for Social Research who studies retirement investing, says the baby boomers are likely to cause a tectonic shift in the priorities of the investment community away from the traditional focus on accumulation and relative performance to an emphasis on income and protecting principle. She points out that baby boomers increasingly fear an impoverished old age.

“Recently, a Gallup poll asked what Americans wanted from government, most chose guaranteed pensions more than guaranteed jobs or health care,” she said.

Retirees will present a challenge to traditional mutual funds

Mimi James, a consultant at McKinsey & Co.’s New York office says her firm has been measuring changes in these investor’s attitudes.

“People going into retirement are not really interested in relative performance, in the end a benchmark doesn’t help pay your rent or health insurance, outcome oriented funds are growing at a much faster rate than the mutual fund industry as a whole. People are interested in stuff like inflation-indexed performance, target-date lifecycle, tax managed and principal protected products,” she said.

According to James, most traditional, long-only equity and bond funds that have been marketed according to investment styles and/or a specific focus, are going to have trouble adjusting to this changed emphasis. Not only are retirees making choices in a market in which many buy-and-hold traditionalists have been badly burned, but also a market where the traditional “safe” alternatives like treasury bonds have gotten very expensive. James believes this means retirees are likely to become more insistent with investment advisors about asset allocation and diversification.

And advisors trying to satisfy this demand should find BlackRock’s wide range of ETFs across geographic and asset class boundaries, an attractive and convenient option.

Ghilarducci advises retirees in charge of their own investments to be thorough in terms of doing their homework about performance. Those who take her advise will discover that according to Lipper the majority of narrowly focused, actively managed mutual funds, in addition to being more expensive in terms of cost ratios, generally underperform low-cost index funds and ETFs. Will they continue to pay more for underperformance?

Retirees may want their index investments to be cheap, but they won’t want them risky

In the era of Bernie Madoff and Allen Stanford, the risk-aversion of retirees could make Blackrock’s one-stop shop approach advantageous for an investor’s peace of mind. A recent survey of investment advisors by McKinsey revealed that because of an increasing focus on due diligence by clients, advisors are choosing to deal with fewer firms. The survey showed that advisors surveyed allocated 64% of their client’s investments among just three firms. BlackRock’s size not only achieves economy of scale, but makes things easier for the advising community.

More money flowing into IRAs and 401Ks

Another trend brought on, in part, by the aging of America is the stress that many pension funds face, as they struggle to maintain defined benefits in the face of fewer contributions, losses from recent market exposure and increased numbers of retired payees. This is leading most US employers to switch to defined contribution rather than defined-benefit pension plans. This means pools of capital that were once invested by institutions will increasingly be invested by individuals, Ghilarducci expects a heavy marketing push by asset managers to reach these customers. BlackRock’s economies of scale will allow the firm to out spend rivals on marketing with a smaller proportion of overall revenue. Traditional firms will face a choice between low name-recognition, or spending beyond their means.

Institutional investors will also want cheaper market exposure

For the remaining defined benefit plans, fund managers, struggling to fill the contribution and market loss gaps, are also likely to be good customers for BlackRock’s combination of products.

With metrics increasingly indicating that mutual funds rarely outperform the market, James says fiduciaries are likely to demand cheaper sources of beta or market exposure and more reliable track records for alpha (risk-adjusted performance). This way of analyzing asset allocation could also bode well for BlackRock. With highly liquid, relatively low-cost, ETFs satisfying the need for cheap beta and BlackRock’s more actively managed hedge funds competing to provide managers with reliable alpha.

And risk managed outcomes

Michael O’Brien who works at BlackRock’s Global Client Group, says institutional customers increasingly are asking for specific risk outcomes, BlackRock’s historic specialty.

“We are seeing a number of clients presenting us with the problems they’re facing” O’Brien told Currents, the company’s newsletter. “(They are saying) ‘Here are my liabilities. Build me something to outperform these liabilities by 1% at a specific level of risk’ or ‘design me something that outperforms inflation by 4%.’ So they’re turning the tables back on to fund managers… speaking in a language that articulates their own issues” he said.

Retirees need a guarantee

Beyond ETFs, BlackRock’s traditional focus on risk management will help to provide another key to success with retiree-investors. Ghilarducci says that people who’ve seen the value of core holdings like homes and plan portfolios diminish, just as they approach retirement, are likely to seek out products that are based on defined results, like income for the rest of their lives. The people who represent them need to be aware of this.

“Studies have shown that guaranteed income makes people happier than the possibility of appreciation,” she said.

For this reason one challenge to traditional asset management is likely to come from insurance companies because of their expertise in hedging and ensuring risk and history of offering guaranteed benefits with products like annuities, says James.

“This is just right outside the experience of most asset managers, traditionally they’ve just tried to beat the market by a few points and relied on diversification to manage risk… generally they’ve paid less attention to using hedging to provide predictable results like those offered by insurance companies” she said.

BlackRock’s background in risk management includes the business of advising insurance companies on hedging downside risk to insure performance. And since 2007 the firm has even been teaming up with insurance companies to offer retail financial products that combine low risk growth with annuity-like guaranteed benefits. These products don’t seem to have caught on yet, but it’s still early days in the retirement of the baby boomers.

As America’s population ages, both retail customers and institutional clients may start turning away from traditional funds marketed according to an investment style or narrow focus and turn to asset allocation through the use of ETFs and risk-adjusted, outcome-oriented products. BlackRock’s product mix will allow it to give these increasingly risk averse customers what they want and its size will allow the firm to keep the price reasonable.
Written as an Assignment for CUNY Graduate School of Journalism, December 10, 2010

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Is BlackRock Trimming The Fat?

Last week BlackRock Inc’s institutional asset management chief, Andrew Dyson resigned. The resignation came after a reorganization eliminated his position, and negotiations over a new position broke down, according to news reports and company spokesperson Bobbie Collins.

Dyson will likely take his experience and some of his connections to a competitor. (In June, BlackRock lost another highly regarded employee, when Michael O’Brien former head of institutional business for Europe, the Middle East and Africa joined J.P. Morgan Asset Management.)

News reports indicate Dyson had been instrumental in building the firm’s presence in Europe among liability driven institutional investors. He came to BlackRock from the Merrill Lynch Investment Managers acquisition in 2006, where he’d been head of institutional investing.

His departure comes as BlackRock sees continuing outflows from its actively managed funds. As of the second quarter of this year, BlackRock had experienced seven consecutive quarters of outflows totaling $30 billion. It reversed that trend in the third quarter taking-in over $15 billion. But those inflows were primarily attributed to its ETFs and other passive investment vehicles. Trends seem to be turning against high cost ratio actively managed hedge funds.

Unfortunately for Blackrock, while passively managed ETF inflows increase its total for assets under management, they provide far lower fee income than its actively managed hedge funds. More worrisome: those inflows are getting smaller. BlackRock’s iShares ETF empire is under threat from aggressive competitors with lower cost-ratios. BlackRock is losing market share, to low-cost competitors like Vanguard and Charles Schwab.

Vanguard has rolled out 17 new funds that mimic iShare funds just in the last month. Vanguard funds have cost ratios of around 22 basis points as compared to BlackRock’s iShares 72 basis point cost ratios. In the past iShares market dominance had ensured its ETFs greater liquidity, but Vanguard seems to be catching up. Four years ago iShares had almost 60% of the ETF market as of last summer its share was down to 47%. In the same period Vanguard’s market share has risen from 5% to 15%. With larger market share comes increased fund liquidity. With Vanguard increasingly offering equivalent liquidity, BlackRock may be forced to lower fees to maintain market share. It’s least profitable, but most popular product may be getting even less profitable.

Faced with such destructive competition in the past, Blackrock CEO Larry Fink might have tried simply to acquire the competition to avoid a price war, but Vanguard has a singular corporate structure where the funds themselves are the shareholders of the parent company, much like a mutual insurance company. It’s a sort of nonprofit with no responsibility to pay shareholders, and no avenue for being purchased. It can’t be bought off…

In the end the world’s largest asset manager may have no choice but to let go of respected but expensive employees to streamline operations and lower costs.

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