Ravengate
Partners - Stock market, economic and political commentary by Patricia Chadwick

The Federal budget deficit cannot be brought under control or meaningfully reduced without addressing the looming insolvency of Social Security.
The heart of the problem lies in demographics. More than seventy five million baby boomers will be retiring over the next eighteen years. That is approximately one quarter of the entire U.S. population today. As they depart the workforce, they will immediately go from contributing to the funding of the program to taking from it. And thanks to medical technology, life expectancies continue to improve. Since the first baby boomer was born in 1946, life expectancy at age sixty-five has risen by nearly five full years. Good news to be sure, but it up-ends the arithmetic of funding. It is both logical and essential to raise the eligible retirement age for social security, even more that what has been done to date.
Most major corporate and government pension/retirement plans in this country are required by law to be safeguarded and managed separately from the operating finances of the company or government entity. The Social Security taxes received by the Federal Government, by contrast, are not segregated. There is no “lock box” into which Social Security payments are made and invested for future retirees. The system is truly “pay as you go” which means that the burden of funding the growing liability associated with the baby boomer generation will increasingly fall on their children and grandchildren.
Social Security legislation was signed into law by President Franklin Roosevelt in 1935 as part of the New Deal in the midst of the Great Depression. The law’s intent was to provide a social insurance program during a period of massive unemployment and poverty in this country. It certainly wasn’t intended as supplemental income for the wealthy.
Forty years ago, when I was hired for my first “real” job (which I define as one with a salary and not an hourly wage), I was excited at the offer of an annual salary of $10,800. I remember believing I was on the path to a career that would allow me to make enough money to forego Social Security when I retired. That was my goal.
Today, with the magical age of “retirement” and Social Security within sneezing range, I am pleased to have attained that objective. I neither need Social Security nor should I receive it. However, the system will not let me even opt out, much less allow me to register that I do not need it. And therein lies a big part of the problem. Social Security should be provided on the basis of need. The money withheld to fund social security is a tax pure and simple; it is not a savings plan. It is not my money, despite much rhetoric to the contrary. Means testing would be complicated no doubt. There are many who might appear to have adequate retirement income but in fact may be caring for children and grandchildren. But simply because the solution might be complex does not mean it should be eschewed.
I realize that I have already uttered what is heresy to many, so let me add more fuel to the fire. If a portion of the 6.2% of gross income that an employee pays into the Social Security system were instead put into a private personal savings account and invested over the forty years of her working life, it would generate a level of assets by retirement that would be able to supplement and possibly even exceed the social security benefits provided today. And most important of all, that money would belong to the person who saved it, not to the Federal Government. That means it could be passed on to the family in the event of death before retirement. It is a ”no lose” solution for workers. You can do the arithmetic yourself. Even if you use a conservative 4% annual growth rate for investment return, you will be amazed at the power of compounding. For minimum wage earners or those making too little money during their working years to build up a sizable private savings pool, they could still be provided social security through the contributions made by the employer.
The fiduciary oversight of those assets would need to be addressed. In the wake of the decimation of many 401(k) plans during the stock market decline of 2008/2009, there is much skepticism about private savings as a secure means of generating retirement income. But even if the private accounts invested only in Government bonds, they would be far ahead of the system today.
Social Security has been tagged as the “third rail of politics”: touch it and die. And since the “courage deficit” exceeds our budget shortfall, this growing fiscal crisis has been shunned and cast aside for some other lawmakers to address some other day. And now we face the next twenty years of having to pay the piper – well seventy five million baby boomer pipers lining up to be paid back after having contributed for forty years.
Here is the good news – it is not too late to solve this problem so long as there is a will to do it. Social Security can be fixed. It will take courage to change. The solution will almost certainly include raising the age of retirement, means testing and partial privatization. Let’s fix it for our children’s children.
Patricia W Chadwick
President
Ravengate Partners LLC
February 3, 2011

In last week’s blog, I asked that question and then provided the issues facing a buyer, without supplying a firm answer. So let me directly answer my own question this week.

YES, I say emphatically, now is indeed an excellent time to buy a house in this country. Seldom in the last fifty years has a potential homebuyer been given the opportunity to take advantage simultaneously of both low prices in houses and low mortgage rates.

Under “normal” conditions, when housing prices are weak, it is generally during periods of high interest rates. This is logical because the mortgage interest rate is the key variable in determining the monthly mortgage payment. As interest rates rise, a buyer is forced to “trade down” i.e. find a less expensive house because of the cost of financing. The other side of that coin is true also – during periods of low interest rates, the buyers of houses can afford to pay up somewhat because the cost of financing is advantageous.

However, as I noted last week, these are not “normal” times. The glut of housing is keeping prices exceptionally low despite the extremely favorable interest rates that mortgage seekers can obtain.

But fair warning – interest rates will not stay at this level forever. In fact, I believe it would actually benefit the economy to have rates rise somewhat. (But that’s a discussion for another blog.) That won’t happen just yet, but the process of finding the right house and getting the paperwork done to get a mortgage can take months and months. The sweet spot for homebuyers is now and it may not last that long.

Getting one’s foot in the door (pun intended) of home ownership is still a worthwhile long term goal. The unfortunate experience of too many homeowners over the last several years is the exception, not the rule. Owning one’s own home is still a legitimate part of the American dream, and the equity built up over twenty to thirty to forty years can be of great value in retirement.

Even if the home available today is not one’s dream house, it can still be a good investment. The “average” home is sold every seven years – we are a country on the move, scaling up and scaling back, depending on our circumstances. In that way, we are different from many other cultures. We are a mobile country. And under normal conditions, and normal conditions will come back again, selling a house is not a difficult transaction.

There is always the “caveat emptor” aspect. Do your homework! Some real estate markets may be so overbuilt that prices are still too high. Shop around and don’t be forced into anything. But get out there and hoof it; drive and walk and talk. Put energy into a search. You are making a long term investment that should serve you well.

That is the question for many potential homebuyers. (Apologies to William Shakespeare) But it is complicated by two other questions that must be answered by two other related parties – (1) the seller: To sell (at a distressed price) or not to sell (and wait till the market improves) and (2) the bank: To finance or not to finance.

In “normal” times (i.e. such as existed for most of the last half century) when interest rates were low, it was an opportune time for eager homebuyers to fulfill their dreams. In “normal” times, prevailing mortgage interest rates are the critical element in determining the price a buyer is willing to pay, because the interest rate is the fulcrum in the transaction.

In “normal” times, low interest rates give house prices an upward boost that sellers are happy to meet and that buyers know they can afford. In “normal” times, banks’ mortgage business thrives when interest rates are low and the arithmetic for approving a mortgage is straightforward and logical.

But we are not living in normal times. Interest rates are as low as they have ever been in the lifetime of this country’s baby-boomers. Even most of our parents never had a mortgage at rates as low as can be realized today. So why isn’t the mortgage business booming? Why is there still such a glut of housing inventory aching to be bought and hoping to be sold? Why does it take a Federal Government tax credit to move the inventory?

I have been pondering those questions for some months and not coming up with a truly intelligent conclusion in my own mind. But a very recent encounter with refinancing a mortgage myself has opened my eyes. Getting a mortgage has now become hugely complex and banks have been maneuvered into making it difficult.

The old rule of “monthly take-home pay of three times your mortgage payment” is no longer applicable. The old rule of providing statements proving the value of all your financial assets to the bank is no longer sufficient to satisfy the mortgage lenders. Now that statement is given a 30% haircut by the bank as it tallies up your assets. Given the volatility in the stock market, I can understand that application to a portfolio of stocks. But triple AAA rated bonds, yes, even Federal Government bonds, are being given the same 30% haircut. Who made that edict – the Federal Government itself or the banks? In either case, it says something about the state of fear in lending. Banks appear unwilling to take any risk at all – two earners are deemed no more secure than one earner (or so it seems).

“Houses, houses, everywhere, Nor any one to buy.” (Apologies – this time to Samuel Taylor Coleridge) So what can be done to end this logjam?

As a machinery analyst for years, I watched the inventories at major capital goods manufacturers. When they got too high, there was only one thing to do – give incentives to potential buyers to get rid of the inventory. The same is true every January in the retail industry. And today, that is what is needed in the glutted housing industry – a major incentive to get rid of the inventory. Without that, there will be no new housing built, and the industry will remain endlessly morbid.

My solution may sound like blasphemy to fiscal conservatives (of whom I consider myself one) but I would bring back the Federal Government’s tax credit for first time home-buyers and keep it in place until the inventory of housing is down to a level that will allow for new homebuilding. Like extending unemployment benefits, this is a temporary solution that will have benefits for the private sector and ultimately for the government.

A tax credit may give the buyer that extra edge to accept a slightly higher bid, and coax the seller into parting with an illiquid asset. Financing will still be a problem, but one can only hope that if the demand for mortgages starts to pick up, the banks will see green (there is no doubt that they make nice money in the process) and will figure that the odds of every new mortgagee defaulting are mighty slim.

The Government will really not be out money in the long run because the increased economic activity will ultimately generate revenues – something it dearly needs to count on. It is a bit of a supply side argument – and I don’t mind that at all.

It seems that some days all news is good news to the stock market and the next day all news is bad news. And other times it seems as though the stock market extrapolates one single economic indicator as though it alone matters.

No doubt the May 6 “Flash Crash” has spooked many investors, most particularly individual investors who were just getting their sea legs after watching their life savings decimated in 2008 and early 2009.

It is evident that the economy is improving. But the momentum is too slow. What the market wants to see is substantive job growth – not public sector jobs but private sector jobs. Over the next several quarters, as the Federal Government’s stimulus program winds down, we will experience a decline in jobs that were funded by that program. I, for one, would be happy to see Congress forfeit all the pork it packed into the back end of the stimulus package (which is not stimulus at all) and spend that money now finishing what was some way overdue spending on roads and bridges across this country. That would be money well spent.

What we need now is new private sector jobs. Since the onset of the recession and so far through the first phase of the recovery, the corporate sector of the U. S. economy has done a masterful job of reducing costs, enhancing productivity, maintaining a pristine balance sheet and fortifying cash flow. But as a country and as an economy, we cannot be prosperous with an unemployment rate of anything close to 9% – 10%.

The US economy differs from economies in Europe in many ways, but most particularly in the fact that the primary driving force in our economy is capitalism, whereas in Europe, the role of Government is far more pervasive on economics and growth. As an example, for decades now the Government has provided the vast majority of the job growth in France.

Despite the increasing encroachment into the private sector of the U.S. economy by Government, through regulation, taxation or outright confiscation of authority, there is still a vast opportunity for private entrepreneurship, job creation and wealth in this country. It is a well known economic fact that in the U.S. job creation is derived from new, small companies. That will and aspiration has not died or even gone dormant. What it needs is some fuel.

Unfortunately, SBA (the Federal Government’s Small Business Administration) has sharply curtailed its spending. So too have private sector banks, as they try to get their overleveraged balance sheets back in shape.

But the corporate sector does indeed have cash and cash to lend. And so do credit unions. And it is encouraging to see that those non-traditional lending sources are opening up their spigots and providing funding for growth.

In the next few months, we will witness the shedding of Government jobs – seasonal census workers are already being dismissed and many state and municipal employees are likely to lose their jobs as state and local governments work to close their budget deficits. Those jobs should indeed be shed.

The U.S. economy is in far better shape than it was just two years ago – consumers have pared down their bloated balance sheets, have added to their savings and have started living within their means. That is good. On the production side on the economy, corporations have cut costs and have reaped the rewards in giant sized productivity gains as demand has slowly improved.

As growth continues, and I admit that the growth will be gradual, that stupendous improvement in productivity needs to be converted into new jobs. Only in that way will the growth feed on itself and be self sustaining. When the first inkling of solid new job creation is evident, I believe the stock market will break out on the upside.

Patricia W. Chadwick
President
Ravengate Partners LLC

July 19, 2010

It is good news that the Senate Banking Committee yesterday approved Ben Bernanke’s nomination for a second term as Chairman of the Federal Reserve. But it is disappointing that the 16 – 7 vote did not include a single Republican. For once, I am happy that Republicans are in the minority in the Senate, which will now require a full 60 votes to confirm Mr. Bernanke. Let’s hope there are at least a few Republican Senators who see the wisdom of keeping Mr. Bernanke.

It is disconcerting to observe how yesterday’s hero can morph into today’s villain. A year ago at this time, Ben Bernanke was truly engaged in saving the world from financial collapse. His comprehensive understanding of the financial markets and his knowledge of the causes and catastrophic decisions leading up to the Depression served the U.S. and the world well.

Because last year’s financial crisis did not culminate in a global financial catastrophe, (thank goodness) the world has forgotten how close we came to the brink of disaster. It is ironic that both Houses of Congress can find no cause to blame themselves for any of the events that led to the financial crisis and the ensuing recession. All they can do is heap blame on Wall Street and the Fed Chairman. Ironically the most outspoken critics of Wall Street and Mr. Bernanke, Senator Christopher Dodd and Congressman Barney Frank, were the most aggressive proponents of the Government policies that led directly to the crisis. It seems a bit like a case of “The lady doth protest too much, methinks.”

Unlike Congress, Mr. Bernanke has admitted to errors. But to be fair, most of the issues that led to the crisis were in place well before he became chairman.

The Federal Reserve has a dual role. It is charged with safeguarding the purchasing power of the dollar, i.e. managing inflation, and promoting full employment. However, it cannot singlehandedly guarantee these two objectives. What the U. S. economy has needed throughout this financial crisis is liquidity and the Fed has and continues to provide that. Today deflation is a far greater risk than inflation. With the economy in a recession, the velocity of money had declined putting little upward pressure on prices. The time will come for rates to rise and money policy to tighten, but now is not the time when unemployment is high and asset prices are low.

If the Senate has the best interests of the U.S. at heart, it will vote to retain Mr. Bernanke for a second term as Chairman of the Federal Reserve.

I was flummoxed, bowled over and plain stupefied as I read the article by Eric Dash and Jack Healy on the front page of the business section of the New York Times this past Saturday.   On the surface, the story simply defies belief.

Beleaguered Citigroup has been forced to execute a fire sale of its prize-winning entity, Phibro, because the Federal Government’s ‘pay czar’, Kenneth Feinberg, has ruled that the compensation contract with top level employees at Phibro “promoted excessive risk-taking and ran counter to the public interest”.  (A quote from the article.)

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Or put another way – Saving is the new spending in the United States.

After several decades of Americans being the world’s consummate and most profligate spenders, we appear to have developed (all of a sudden in just the last few months) a serious fancy for saving. This phenomenon is most evident in the Baby Boomer generation, those of us who were reared by frugal parents who themselves were reared during the Great Depression by parents, many of whom themselves were truly struggling to survive.

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I never thought I would find myself in the same camp as the self-acclaimed “democrat socialist” Senator Bernie Sanders of Vermont. But last evening on the Kudlow Report he made a very legitimate case for Government capping interest rates on credit card balances.

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On the surface, JPMorgan Chase’s first quarter 2009 earnings look auspicious, reversing the red ink of the last few quarters and exceeding what was expected by investors. But a simple read-through of the press release paints a different picture.

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The housing industry is finally just starting to get a bit of life, thanks to mortgage rates that are at the lowest levels in nearly 50 years. Combined with falling house prices, home affordability is the best level in years. Wise homebuyers will take out a fixed rate mortgage, NOT a variable one, however long the term might be, and budget to pay that fixed amount every month.

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