Last Friday’s employment figures sounded like good news. Total employment increased by 295,000 during February, and the U.S. unemployment rate declined to 5.5%. But there’s another side to the employment story, and it has to do with middle-class workers’ wages.

During the Great Recession of 2008 and in the several years following, many corporations — large and small, public and private — found it necessary to pare their employment costs through layoffs, as well as by cutting benefits to their remaining workforce. For some companies, the measures taken were essential to survive; for others, it helped to alleviate significant declines in profits. That’s the real world of business.

The cost-cutting measures included slashing or eliminating bonuses. I’m not referring to C-suite bonuses that run in the seven figures, but the small ones — the $500, $1000 and maybe $2,500 given to the rank and file employees as a goodwill gesture.

Another money-saving tactic utilized during that period was to reduce, or even do away with, the corporate match for employees’ retirement plans. That “free” return on employees’ 401(k) plans was a valuable asset in building a nest egg for later years.

Health care costs also came under sharp scrutiny. Companies were able to negotiate lower premiums with insurers by raising deductibles and co-pays for employees. In many cases, both the employer and the insurer benefited from reduced costs, while the employee was saddled with higher out-of-pocket expenses.

Now, nearly eight years later, the economy has improved significantly. GDP is at an all-time high, as are corporate profits. That should be great news for workers — solid, profitable growth ought to imply that salaries are increasing, previously cut benefits have been restored and bonuses are once again being paid.

But in fact, it seems that many companies have conveniently forgotten the fact that they took benefits away from their employees when times were tough.

From 2000 through 2013, (a period that includes both a robust economy and the Great Recession) corporate profits increased by 132% (a 6.7% annualized growth rate), while wages and salaries grew by only 47%, or the equivalent of 3% per year. The graph below shows how profits (blue line) are becoming a larger share of the economic pie at the expense of wages (red line).

Source: U.S. Bureau of Economic Analysis

To some extent, the divergence in those two lines is a function of cheap capital replacing more expensive labor. But importantly, it is also the result of productivity gains, and one of the advantages of productivity is that it allows employers to increase wages and benefits without an inflationary impact. Unfortunately, that doesn’t seem to be happening to any major degree in the U.S.

With a mere 3% annual increase in salaries and wages barely outpacing inflation, together with rising out-of-pocket expenditures for health care, it is no wonder that the middle class feels trapped.

Good corporate stewardship entails dealing fairly with all stakeholders — owners, employees, customers and vendors. Many companies in this country embrace that responsibility; however, many more tend to act as though the only stakeholder that matters is the owner (private or public).

Now is the time for companies that are thriving to restore to their employees the benefits that were curtailed or eliminated during the recession. The goodwill created among the workforce should be reward enough, but we all know that the reason for the anemic recovery from the Great Recession has been weak consumer spending. A robust expansion depends on strong consumer expenditures. We need higher real wages to take the economy to the next level.

The Great Reformer: Francis and the Making of a Radical Pope (by Austen Ivereigh)

Pope Francis has been invited by Speaker of the House John Boehner to address a joint session of Congress in September when he visits this country.

The pope has been criticized by many “talking heads” and pundits, most particularly on the right, for his statements about issues relating to the economy, profits and employment. Rush Limbaugh has gone so far as to tag him as “a Marxist”, which is patently false. Pope Francis, as Ivereigh points out in The Great Reformer, was highly critical of Marxist ideology and of those (including Jesuit priests) who supported it during his tenure as bishop and cardinal in Argentina.

There is an uninformed point of view by many that the pope has no real comprehension or understanding of capitalism and is guided solely by the crony capitalism of Argentina, where he spent most of his life prior to becoming pope.

But before heaping criticism on the pontiff for phrases, clauses or statements that, in many cases, have been extruded from long and thoughtful writings, his critics would be well-advised to read the eminently researched book by the English author and journalist, Austen Ivereigh, entitled, The Great Reformer: Francis and the Making of a Radical Pope.

The book, reviewed in the New York Times by James Martin, is not a quick read. But it is packed with research and information that give great insight into the thoughtful, pragmatic and intelligent man who is now pope. It seems evident to me, after reading the book, that Jorge Bergoglio, as the pope was known before his election to the papacy, is hardly naïve or uneducated on issues of economics and politics. He does indeed rail against what he calls “unfettered” capitalism as “a new tyranny.” Indeed, the antitrust laws that were enacted in this country one hundred years ago were designed precisely to counter the economic ills of unfettered capitalism, also referred to as robber baronism.

That Pope Francis lived in Argentina (through both good economic times and bad), as opposed to having spent years in the US, is not what guides him today in his statements about capitalism. Rather his concerns are the effect of unbridled capitalism at the expense of the greater good.

I would hope that every member of the US Congress would take the time necessary to read this book before the pope’s arrival in September. It will be hard to come away without at least a great measure of respect for the man.

The housing market, while still under water and providing little contribution to economic growth, is at least seeing light at the end of the tunnel. That is because mortgage rates are now at a fifty year low, providing significant economic incentive for buyers to enter the marketplace. The excess supply of homes is slowly dwindling.

However, just as the housing market appears to be coming out of its depression, the country faces another threat. It is an insidious economic cancer that threatens to sap potential growth for decades to come. This cancer is none other than STUDENT LOANS!

An entire generation of twenty somethings who were not privileged enough to be provided higher education by their parents is entering the work force with a giant noose around its collective neck. And that noose is in the form of huge student loans they were required to take out in order to get an education that would give them a competitive entrée in the work place. It is the magnitude of the debt that is frightening. In many cases, their middle class parents are broke and now they are starting their careers broke as well. By some measures, the total student debt outstanding is over $1 trillion, according to an article in the Wall Street Journal on March 23, 2012.

The economic impact of this scenario is scary. Today’s young college graduates should be the trailblazers for the continuation of the American dream. Their energy, stamina, creativity and appetite for risk are the ingredients for entrepreneurship. It has been that way in this country for decades and even centuries. But now suddenly that ability to dream big and take risk is being choked off by the crushingly high level of debt they must repay. They cannot afford to take risk or to invest. They can barely afford to spend on discretionary items because they have so little money left each month after paying their student loans.

Student loans have long been a part of the American way of life. I had such a loan myself for seven or eight years. But there is a huge difference today. When I paid my student loan, it was in the late 1970s, a period of extraordinarily high inflation and consequently high interest rates. However, the interest on my student loan was a manageable 5.5% and the loan carried simple interest.

Today, with interest rates under 2% on the 10 year Government note, student loans carry rates of 6% at a minimum and as high as 11%, most of them under a Federal Government program. And to add insult to injury, the interest on many of these loans is amortized. The newly minted graduate, assuming he/she gets that far, is racing just to service the debt without paying down the principal.

I recently spoke to a young woman who put herself through college and graduate school with no financial support from her family. Upon graduation, her eleven separate Federal loans totaled $135,000. She currently earns nearly $65,000 annually by working a full week and one day on the weekend. Since she started working, she has paid more than the monthly minimum required on her loans and after nearly two years of payments that have totaled $26,000 her balance today has grown to $141,560! She is deeper in debt than at graduation because some of the loans are paying down no principal at all. She is caught in a vise that will make home ownership an impossible dream for decades. She called Sallie Mae, the company that services the vast majority of Federal student loans, to inquire about consolidating her many loans the possibility of getting a lower rate. The Sallie Mae employee said that the company was willing to consolidate but would give her no break on the interest rate. And when she inquired as to why no one at Sallie Mae reached out to her, she was told that policy prohibits such action. If that is true, that policy is criminally negligent.

Another young woman, the daughter of a friend of mine, has a $42,000 private student loan with Discover carrying an 11% interest rate. When her father contacted Discover in an attempt to negotiate a lower interest rate, the (evidently naïve) employee said there was nothing that could be done. In further conversation, she admitted that the student loan business was Discover’s most profitable and that employees were provided incentive compensation based on how successful they were in ‘selling’ loans to students. Again, if true, such a corporate ethic is moral turpitude. And Discover’s website advertises student loans for “as low as 6.79% APR”.

These stories are far from unique. They are repeated hundreds of thousands of times in this country. The lenders decry the fact that student default rates are high. Well of course they are high when the interest rates are so onerous. The system is downright Dickensian.

The recently passed bill signed by President Obama unfortunately will not relieve the interest rate burden on the generation of young graduates who are drowning in debt, although it does alleviate conditions from getting even worse for some students. In response to the new law, Sallie Mae and other student debt servicing companies have bemoaned the fact that they will be forced to lay off employees. But I argue that those layoffs are nothing compared to the negative impact on the economy from a generation of workers who have diminished resources to buy basic goods and services, much less to take on economic risk.
So what is to be done? How can this cancer be cured?

A complete overhaul of the student loan industry is essential. For one, the business should be tightly regulated, in much the same way that utilities are. I am sure this concept is anathema to many, and I myself abhor overregulation, but the abuse that is being heaped on the vulnerable (i.e. young, desperate students) warrants such a response.

And something must be done about the cost of higher education, which has spiraled out of control. There are many studies that show that the cost of college tuition has increased at multiples of the rate of inflation. When an asset (college education) is priced to become a liability (it bankrupts the buyer) the price must fall. That is simply an economic fact of life.

Ruminate on these statistics for a moment or two.
CONFISCATORY STUDENT LOANS
Tuition Per Annum 1960 1960 (in 2008 $) 2008 Actual
Harvard $1,520 $10,147 $33,709
University of Texas $100 $695 $7,530
Michigan State $279 $1,939 $8,843
Source: ClearPictureOnline.com

Is it no wonder that parents can no longer afford to provide a college education for their children? But without such higher education, the outlook for gainful and fulfilling employment is miserable.

The debt being incurred by the young in this country has reached the level of a national crisis. We had better address it now before this it takes on the proportion of our Federal Government’s debt.

Patricia W Chadwick
President
Ravengate Partners LLC

It is not often that low mortgage rates coincide with low house prices – the condition that exists today in this country. When mortgage rates are high, they tend to keep house prices from rising because it becomes too financially onerous to finance the house. When interest rates are low, it tends to stimulate demand for houses, pushing up the prices.

But we are in an unusual situation today. The housing bubble which burst in 2008 caused not only a massive oversupply of homes across nearly the entire country, but it also precipitated the worst recession in over fifty years. The Federal Reserve, in response, cut interest rates sharply and despite the fact that the recession has officially been over for two years, it continues to keep rates low. It is trying to allow homeowners to refinance their mortgages at more favorable rates. However, the issue is complicated by the fact that many homeowners now have mortgages that exceed the value of their homes.

The Fed has stated that it will keep rates low for at least another 18 – 24 months, hoping that time as well as a resolution to thorny banking regulation issues will result in existing mortgage owners lowering the carrying costs of their debt.

Regarding the prices for homes, you can see from the chart below (courtesy of JP’s Real Estate Charts) that the price bubble in housing has truly been burst. Both the nominal and the inflation-adjusted house price in the United States has returned to its long term trend line. That is good news over all, but I hasten to point out that the data show an average for the country as whole. There are still significant pockets of oversupply and prices in those areas are likely to remain under pressure for some time. But the shape of the graph is very good news.

All of which gets me to the point of my title. If you are in the market to buy a house, this is as good a time as you may find in the next twenty years to do so. Mortgage rates are lower than they have been in well over fifty years. House prices appear to have ceased falling (for the most part) but have not yet started to regain any significant momentum.

This window of opportunity will not likely be around for more than a year or two. That may seem a long time, but once rates start to creep up again, this golden moment will be gone for years, maybe even decades. And while it may seem counterintuitive, when rates start to rise again in the next two years, so will house prices. The bursting of the housing inflation bubble resulted in damaging deflation, but as the economy rights itself, and employment improves, so too will house prices.

On a thirty year mortgage of $200,000, the difference between an interest rate of 3.5% (what one can get today) and 6.0% (the rate that is more like what it would be without the Fed’s intervention) is a total of $108,364!!! That is more than 50% of the value of the house.

The saying goes, “Don’t look a gift horse in the mouth”. But in this case, I would not only look this gift horse in the eye, I would saddle it up and gallop into the future with the gift of a lifetime. I am particularly thinking of you twenty somethings and thirty somethings who may be thinking that real estate prices still have a long way to fall or that the current mortgage rates might be the new norm. Neither is the case.

Happy Shopping.

January 22, 2012

Since returning a day ago from a trip to Prague and Krakow, I have been pondering the stark contrasts between our country and the countries in Europe. The differences say everything about the drivers of our respective economies. I admit that I am oversimplifying the case, but I am trying to provide a little food for thought.

In Continental Europe there seems often to be a grand sense of calm, as though a higher being is overseeing and managing the place. (Of course this excludes all those strikes and demonstrations we have witnessed of late against the Governments. But I told you I was oversimplifying the case, so bear with me, please.) Europe is rule bound. There is order. The trolleys run on time; you can count on them to show up at exactly 11:05 and then at 11:11 and then at 11:17. The electronic clock on the trolley tells the exact time as the mechanical clock in the square. In Prague, the Astronomical Clock in the Old Town Square which dates back to 1410 strikes the months, days, hours and minutes to perfection.
Prague is an overwhelmingly secular city of 1.2 million people, more than 75% of whom say they are atheists. However, there is no hue and cry over the fact that a giant Christmas scene is erected on Government property. Political correctness doesn’t seem to be an issue. Tradition is important. It provides security. Change is not a good thing.

In Krakow, the streets are immaculately clean. There are people whose full time job it is to keep them that way. It gives one a sense of security to walk around in a tidy place. The Christmas market hums with hundreds of vendors selling everything from Italian gloves to kielbasa. The weather is frigid but no one is shivering for lack of warm clothes. Vendors sell their wares in a quiet and peaceful atmosphere; it is impolite to insult them by trying to bargain. The prices are reasonable and the experience is hassle free. There are a few beggars, but they are far outnumbered by street musicians whose talents are a pleasure to support.

Coal is still the fuel of preference in the countryside of Poland. It’s far cheaper than electricity. Despite the frigid weather while I was in the country, there was no sign of air pollution from the coal.

The invisible hand in all this calm and order is the Government. It is the overlord. And how does it achieve this apparent state of perpetual calm and equanimity? By taxing its citizens and redistributing that money into services for the benefit of all.

It sounds so wonderful. So what is the downside, one might ask. There is a downside and it is economic growth. The larger the Government’s piece of the economic pie (i.e. GDP) the less there is for the private sector. That is an economic truism. In the Czech Republic, the tax burden (i.e. Government’s share of the economic pie) is 36% of GDP and in Poland it is 35%. Contrast that with the U.S. where it is 27%. That is a vast difference.
Which brings me to the contrasting part of my rambling. When I landed at Newark Airport, I headed out into the balmy evening. As I waited for the WALK light to come on, I had to laugh as I observed that the two lights providing the countdown to zero for the WALK light were not even in synch. One was three seconds ahead of the other.

That’s the way it is in America. Our country is a messy place (at least compared to Europe). Americans chafe at too many rules. We are still young as a country – at least by European standards. The entrepreneurial spirit is the driving economic force in this country. That’s why high unemployment is such a loathsome blight. People want to be working. They don’t want Government support. They tolerate Government only to the extent needed because too much Government gets in the way of achieving their dreams.

And there is a price to be paid for living in the land of opportunity. The price is the uneven distribution of wealth. There are the very rich, the rich, the not rich and the poor. And the differences are vast. But before castigating the system, it is worth observing that Americans themselves are engaged in redistributing their own wealth. Of all the major countries in the world, the people in this country are by far the most generous. They give back without Government redistribution. Last year, charitable donations in this country reached $300 billion. That’s not a misprint – it’s $300 BILLION! And of that amount, more than 75% came from individuals. They supported their places of worship, hospitals, the arts, the poor, education.

The system is not perfect. No economic system is perfect. No political system is perfect. But for all the faults in our own economic system, its strengths seem to outweigh its weaknesses. That is why so many people want to emigrate from their own countries and live here.

Postscript: I was in Prague when the news came of the death of Vaclav Havel. It was evident how much the people of the Czech Republic revered him. And in Krakow, my hotel was directly across the street from the house where Pope John Paul II lived for a number of years. I felt close to two very great people.

Leaving aside the issue of influence via political contributions and lobbyists (as they are as yet unproven) the moral of the Solyndra debacle seems simple to me. The Federal Government should stay out of the investment business.

Solyndra was an accident waiting to happen. The company couldn’t get funding from the private sector. A hoped for public offering had been cancelled. It was apparently obvious to analysts and lenders that the company was, at a minimum, not an attractive investment and possibly not even viable. They chose to avoid providing either equity or debt capital to the company. The macro factors were compelling – in an industry where the competitors’ raw material costs were falling, Solyndra was a classic case of a company with variable costs that were simply too high.

One has to assume that the Federal Government employees responsible for doing the research on Solyndra simply lacked the technical skills to do a thorough analysis of the company’s long term (or even short term as it turns out) viability. That is the most charitable thing that can be said.

It is hard to imagine that they were so dimwitted that they were willing to risk the embarrassment of a default on a loan of over $500 million. So it is fair to say that they didn’t really believe the company would go into bankruptcy. Common sense tells me that the powers that be who were making the final decision about which ‘green’ company would receive Federal Government backing most assuredly wanted it to be a success story.

Of course, it is possible that Solyndra’s management lied to the Government. That is not uncommon in the investment world, and that is what tried and true analysts are paid to figure out. The Government was in over its head. If an analyst in the private sector had recommended a loan or an investment in Solyndra and within two years the company had gone kaput, you can be assured that the yearend bonus for that analyst would also have gone kaput. In the investment world, there is a real incentive to be hardnosed, to get the facts right and to make a decision that creates a positive return. There is no such incentive system in the Federal Government. I doubt that anyone will lose his/her job over the annihilation of $535 million of taxpayers’ hard earned money being lent to Solyndra.

So assuming that there was no sinister under-story here, the problem must lie in the fact that the Federal Government employees charged with researching the case were simply not up to the task.

And therein lies the true moral of the story. Let the Federal Government stick to its appointed knitting, and for the benefit of all the people it serves, let it stay out of the sophisticated and specialized business of investing in and lending to corporations in the private sector.

Why is there no job growth in the U.S. Economy?

Depending upon whom you ask, you can get any number of different answers. Political demagoguery is the easy response, particularly when we are less than fourteen months away from the presidential election.

But I am confident that had John McCain won the election in 2008, the unemployment rate today would not be much lower than it currently is.

Contrary to what many Republicans say, the stimulus plan did indeed help the economy and certainly provided for jobs. And for the most part the money that was spent was used for long overdue infrastructure spending that the Government should have been doing all along. But there is no way the stimulus plan could be a long term solution for economic growth. That is the responsibility of the private sector.

The real problem underlying the dearth of new jobs today is twofold.

On the one hand, it reflects the fact that the consumer is paying for the sins of the past. For two decades, consumers in this country went on a spending spree. With the aid of banks and other lending institutions, they used the equity in their homes to borrow money, over and above what they were earning, and then they spent that money. Such behavior acted as a stimulus to the economy, that is, until the music stopped.

The recession that started in 2007 brought an end to the profligate borrowing, as the decline in home values eviscerated many homeowners’ equity. Banks turned off the lending spigot and consumers were forced to alter their lifestyles. Instead of turning to a new line of credit in order to pay off the old one, they found themselves forced to repay their loans, often as their own income was diminished. Their response was quick and logical. They cut back on spending and started to save, and savings rates, which had plummeted over the past twenty years of excessive spending, began a sharp reversal, rising dramatically over the last four years. All of that sounds like good news, and in one way it is because it means that the consumer’s balance sheet is improving.

However, savings increases are coming at the expense of spending and therein lies one of the big problems for job growth and the economy in the short run. Savings by definition is money NOT spent. Savings in the long run will be very beneficial and will allow consumers to replenish their balance sheets but the process is painful. And because the consumer had so much debt at the time of the recession, it is likely that it will take a number of years still before consumer spending becomes robust again. And without robust demand, it is difficult to create new jobs.
On that score, it is not fair to blame the current administration for the lack of jobs. Consumers brought this state of affairs on themselves, and they are slowly rectifying it.

On the business side of the economic equation, which is the investment part of the economy, the issue of job creation is also a problem. In part, it is the result of slow final demand by consumers who are unable to spend as freely as they could when borrowing was at their beck and call. However, the problem is bigger and more dire than that.
Businesses spend their capital and/or expand their labor force based on the profits they expect to generate from those investments. Entrepreneurs make decisions about starting new businesses (and more than half of the job creation in this country comes from new and small companies) on the basis of the long term outlook for growth and profitability.

What has emerged over the last several years is an environment of Government regulation that is truly crushing the entrepreneurial spirit in this country. Companies large and small are facing an array of rules, restrictions, and profit-destroying constraints that have immobilized capital. The threat of higher taxes for corporations and small owner-operated business is a powerful deterrent to capital formation.

Until and unless there is a major reprieve from such stultifying over-regulation, our economy will not make forward progress and unemployment will remain unnecessarily high. The blame for this state of affairs can indeed be laid at the feet of the current administration. President Obama is either getting bad advice from his inner circle of advisors or not heeding them, but he ignores the problems facing business and employment at his own peril.
There is not much time between now and Election Day in 2012 to remedy the unemployment rate. However, massive elimination of regulation and an equalization of corporate tax rates that allows the U.S. to be competitive with other countries would be a major start. A bold move such as that would send the message that the President understands how the economy works and what it needs to get it turned around. But as of now, people don’t think he gets it and they will be looking for someone for President who does.

The volatility in the markets this past week may be reminiscent of what took place in August and September of 2008, but this summer of our discontent is a far cry from what the world faced three years ago. Thank goodness!

That is not to say that the issues roiling the markets today are insignificant or of little consequence. To the contrary, the recent sharp decline in equity markets around the world reflects the host of global challenges that face economies and governments. And the equity market will likely continue to be volatile for a number of reasons.

For one thing, the banks remain under stress. The good news is that the entire banking system is not as leveraged as it was in 2007/2008. However, the largest banks still have far too many distressed loans on their balance sheets. That puts them in the unenviable position of being a reluctant lender, preferring to hoard cash.

Perhaps most important, consumers, the driving force for growth in our economy, are both underemployed and over-indebted. Such a condition severely crimps discretionary spending. Consumers, like the banks, are being forced to reduce their own debt and downsize their balance sheets. This process takes a long time and is the reason that economic growth is likely to remain sub-par for a number of years into the future. And lest we blame the young for profligate spending, it should be noted that it is the 40 and 50 and 60 somethings who have perpetrated this overindulgence. It is refreshing to see how many of the 20 and 30 somethings are choosing to live within their means, utilizing debit cards rather than the potentially bottomless pit of credit cards. And they seem to understand the need to save for their own retirement.

What they are entitled to expect is credible, prudent leadership from Washington. Our political system is choking on rhetoric – all talk and no action, or maybe better put – all shouting and irresponsible, self-centered brinksmanship. I wonder sometimes if the shrillest of the voices in our national legislature don’t reflect the views of but a small percentage of the population. Where is the representation for the nearly silent vast majority that is centrist in its politics and its values? Where is the leadership that can bring both sides together as President Reagan, working with Speaker of the House, Tip O’Neil, was able to do? I am willing to wager that, come the next election, the most secure seats in Congress will be held by those who have been willing to meet in the center over major issues.

Our challenges are daunting but not insurmountable. They will require major restructuring of long term retirement programs currently provided by the Government. Social Security must and will be means tested – the sooner the better. We will also need to overhaul our tax system. A good start is the elimination of all loopholes, those secretly agreed upon ‘deals’ that get slipped into legislation in the dead of night. (I sometimes wonder if the only way to get rid of tax loopholes is to outlaw lobbyists. The only bad news from that would be that the unemployment rate would likely sky-rocket – at least in Washington, D.C.)

The stock market reflects the outlook for corporations to generate profits and pay dividends. Profit growth in the U.S. has been excellent since the recession bottomed out in 2008. Today, nearly 40% of the stocks in the S&P 500 yield more than the current 10-year Treasury rate. The list includes such household names as PepsiCo, Merck, Kimberly Clark, Johnson & Johnson, Proctor & Gamble, Staples, Sysco, McDonalds – all companies that are sound, growing and most likely will be raising their dividends for years to come. Of course corporate earnings are not immune from economic activity, but today’s valuation of the S&P500 seems attractive, particularly when compared to the returns available on fixed income securities.

Three years ago, our economy as well as those of much of the rest of the world came close to hurtling over a precipice. The invaluable and too much maligned support from the Government did in fact save the day. We went through a serious recession and are still clawing our way back to prosperity. The challenges facing us today are long term structural issues. They must be confronted and resolved before they mushroom out of control. But they do not compare in urgency or magnitude to the events in the summer of 2008.