Going Postal

I’ve got nothing against postal workers. But I do have a bone to pick with their union (American Postal Workers Union, "APWU"). Have you seen the APWU ads on TV and print lately? I think the ads are a lie.

The background is that as many as 3,700 post offices are going to be closed. The union hates that. The union is spending big bucks on a slick ad campaign in an effort to stave off the inevitable.

APWU President Cliff Guffey had this to say recently:

“We must dispel the persistent myth that our work is funded by taxpayers.”

The ads show happy postal workers and all that mail they drive around. The heart of the UPWU message is:

"The post office is funded solely by the sale of stamps and postage."

By what magic does the PO do all that good stuff they do without sucking at the taxpayer teat? Easy. They borrow billions at near zero interest rates from good old Tim Geithner. Tim is responsible for the Federal Financing Bank. This is an off balance sheet funding vehicle (“SPIV”). Take a look at the balance sheet as of June 30, 2011.

So the PO has wracked up 12 large. What’s the Vig on this? Nothing! The debt is being rolled over at less than 20 basis points.

This is a perfect example of what is wrong with America. When faced with a problem what do we do?

(I) Lend money to the problem in the hope it will go away.

(II) Hide the debt in SPIVs.

(III) Burry the problem with zero cost debt.

(IV) Lie to the public and say there is no cost.

(V) Kick the can down the road and declare success.

The PO issue is small potatoes. But in a much bigger way all of D.C. is following the lead of the PO. Steps I through V are being played out as I write. It may take a few days for the markets to figure this out. But they will.

On More QE and the Recession that won’t end

Boy does the economy stink! The GDP report from the BEA was about as bad as it could get. I think the economy is rapidly approaching stall speed. The insanity in D.C. has already put an additional damper on the prospects for the future.

Many places that I read jumped on the BEA data and concluded that QE3 is imminent. I think that is all wrong. From the BEA report:

The price index for gross domestic purchases increased 3.2 percent in the second quarter, following an increase of 4.0 percent in the first. Excluding food and energy, the price index for gross domestic purchases increased 2.6 percent in the second quarter, following an increase of 2.4 percent in the first.

In the past six months core inflation has been rising at an annual rate GREATER than 2%. What does Ben Bernanke say about core inflation? When does the Fed get nervous about this measure of price change?

Bernanke has said a half dozen times that he felt that core inflation “around 2%” would be the upper bounds the Fed would tolerate. Anything beyond the 2% level and easy monetary policy would no longer be justified.

In his June 22 press conference he underscored that with this:

We do have to pay adequate attention to our dual mandate.

And this:

It's not clear we can get substantial improvement without inflation risk.

Yes, it’s correct that Bernanke’s definition of inflation covers a longer period of time than six months, and yes, the last six months is not what he is focusing on. But it is also correct that neither he not his cohorts can ignore what is happening on the inflation front. We are already running a rate of core inflation that is hotter than Bernanke has promised to deliver.


My conclusion is that monetary policy is on hold. The economy would have to be evidencing negative growth for the Fed to act. That is unlikely to happen before 2012. If you’re waiting for a QE3 miracle, you’ll be disappointed.



Change direction back to how very bad the economy is. It’s worse than we thought it was. (At least it’s worse than those who believe in the MSM spin)

Economists try to define things. (It makes them feel better) One big definition these economists use is Recession. A recession has three parts to it. The first leg is a decline in GDP from a peak to a trough. (This is the actual “Recession” part of the cycle) The second leg is called Recovery. This is the time it takes for the economy to recover output so that it equals the prior GDP peak. The third leg is called Expansion. This would mark a recovery from the recession. A typical recession would look like:

With that definition in mind consider the (significantly) revised GDP results for the past few years. The revisions by the BEA yesterday make for some interesting conclusions. Consider the quarterly GDP numbers since 2007.

Note that the peak in the most recent economic cycle occurred in the first quarter of 2008 when GDP was growing at an annual rate of 13.310 Trillion. As of the end of June there has been a recovery (13.270T), but we are still below the peak. ($61B shy).

So if you’re out there feeling and seeing that the economy is a piece of crap; that it has been a piece of crap for nearly four years now. You’re right. The media has been telling you that the recession cycle has ended and we are back to growth, well, they’re lying.

On UBS and the FHFA Lawsuit

The Federal Housing and Finance Authority announced this week that it was suing UBS for mortgage fraud. (I'm shocked!) This is a big deal. The damages being claimed start at $900mm. I find this lawsuit interesting. Some background.

On July 10, 2010 FHFA issued a total of 64 subpoenas to various financial institutions. All of these lawsuits were related to losses that either Fannie or Freddie had incurred as a result of improper mortgages that were sold to the Agencies. UBS is the first formal legal action related to those subpoenas.

Two questions come to my mind. (I) Why UBS? And (II) what are the broader implications of this?

On the why UBS:

Federal prosecutors often push for a trial when the opposition is being uncooperative regarding a settlement. I don’t think this is the case with UBS. While I’m sure that UBS is pushing as hard as they can, I doubt they are the only ones doing so. It is "Un-Swiss" to fight, better to settle.

Federal prosecutors only go to trial when they have a very good case. I think this is the issue. FHFA’s lawyers have drafted a 102-page complaint that has been filed in Federal Court. The brief is very detailed. This is a summary of the charges against UBS.

Note that there are three claims of violations of the 1933 securities act (a big deal). There are also numerous allegations that UBS provided materially false information (also a big deal).


I think UBS is a soft target. This outfit has been ripped to shreds by the Feds over the past few years. In each case UBS’s lawyers folded and UBS paid big mega bucks. So if you were a hotshot federal prosecutor you might tee up UBS first knowing from prior experience that when they are pushed, they crater.

That still does not fully explain why UBS. FHFA’s lawyers have to have a broad battle plan. UBS is the first salvo in that plan. So my guess on why UBS, is that this bank is representative of the other lawsuits that are to follow. When UBS is smashed to pieces in court the other 63 names that got subpoenas will crap in their pants, throw in the towel and write big checks to the FHFA. That would be a good plan to win this war.

So if I’m right and UBS is a stalking horse to get to other big players, where might this lead?

I actually don’t know exactly where this might lead. I tried to find out by contacting the FHFA. I asked if they would provide the other 63 names that are facing big lawsuits. “Nix” was the answer from FHFA. There is no public source of information as to who got the subpoenas. I find that interesting. We have 64 of the biggest names in finance that are being sued for tens of billions of dollars and we have no idea who they are. I think this is material information for investors; it is material information to the public. Why the secrecy?

It’s actually not that hard to figure out who is on the FHFA “target list”. Who are the 64? Everyone, is the answer. It’s hard to miss anyone big when there are so many names involved.

I think that UBS was chosen first in part because they were a middle of the road “bad boy”. They were neither small nor large. Most of the dreck that UBS originated and sold to F/F was originated in 2005 and 2006. The following is a league table for mortgage origination during this period. UBS is mentioned, but note that they are 10% of some of the other players.

This table does not prove much. We will have to see how this works out. My guess is that UBS is the tip of an iceberg. What is behind the UBS suit are monster suits against some of the biggest financial names on the globe.

The press has reported that the UBS suit is about $900mm. That’s only partly correct. FHFA is claiming that they have already suffered losses of  $900mm. But that is not a cap on the damages that may be awarded. This is the PRAYER FOR RELIEF section of the court document. (Why do they call it a Prayer?)

Note that FHFA is asking to be compensated for its losses. They want UBS to pay for the legal expenses (astronomical) they want penalty interest at the highest rate the law allows and they also want the dreaded punitive penalties. I’m sure that the UBS lawyers are worried about the $900mm claim, but they have to be very worried about this:

Such other and further relief as the Court may deem just and proper.

If the case goes against UBS the Judge could award anything. A $1.5b total award is not out of the question. Should this happen and we see a big penalty as well as loss compensation, it will scare the life out of the other bankers. One after the other they will fold on this should UBS lose the case.

The UBS/FHFA suit brings another big cloud over the financial players of the world. The question of who is involved and to what extent is a bit of a mystery at this point. The answer is “they” are all dirty, and “they” will be paying big bucks to settle these claims. Just another reason why not to own the financial stocks.

Is Social Security Obama's secret piggy bank?

Zero Hedge is reporting that Treasury has determine it will prioritize debt payments over other obligations in the event no deal is reached. That probably is the right thing to do. It does raise the question of what is going to happen to all of the other obligations the government has.

I thought it was interesting that this afternoon Social Security updated their web site and provided the details of the payments due in August.

Note the amount due is $60.7 billion. This amount is comprised of Old Age ($49.5b) and Disability ($11b). The President has mentioned a few times that the $49b of retirement payments may not be made. I have to assume that he was excluding the DI number. It’s possible that someone thinks that DI has a preference over OAI. But I doubt that. This an all or nothing deal.

So the question is, “Where’s $61b coming from?”. SS has no cash at all. They do receive cash every day. Tons of it. In the month of July they will take in ~$53b. All cash receipts at SS are immediately returned to Treasury. Treasury, in turn, issues SS a Special Issue Note.

At the beginning of the month payments to beneficiaries are made. Checks are issued and electronic banking transfers are sent out. SS must have cash in the bank(s) to honor this. They get the cash from Treasury. To accomplish that they redeem the Special Issue Notes. This happens every month.


This chart shows the components of the debt. Note how big SS (and other Trust Funds) are – Blue)

The following slide is the debt as of today. The two components, Debt to Public + Government Series Equal the Debt Subject to Limit. We can’t exceed the limit. But there is nothing in the laws that would prohibit the NORMAL monthly operations between Treasury and SS.

BUT.....

Where would Treasury get the cash? Easy! They would sell securities to the public. Just like they always do. Who would buy these short-term government notes? Easy! The big banks would do it. They would take the same paper back to the Fed who would Repo it with a 0% haircut. Just like they always do. Could this be done for $500b? Easy! Just like it's always done.

I am absolutely convinced that Geithner has called the Fed and the big shots at the money center banks. Everyone will play ball. I’m willing to bet that Obama has called Dimon over at JPM and put it on the line. 

O: “Jamie, I may need you to sign up for $200b of low yielding paper, are you in?

J: “Count on me. I’m good for up to 500 large if you need it. And put me on the short list for the T Sec.”

O: “Okay, thanks. You’re on the top of the list.”

Add some more info:

-Treasury has being doing exactly this pattern of transaction with another Trust Fund for the past two months. They have been playing with the debt ceiling by running down the balance of FERS (Federal Employee Retirement – a clone of SS)

-It is not at all unusual for the SSTF to dip into its holdings of Treasury IOU’s. They do it nine months each year. The monthly shortfall ranges from 3 to 15 billion. There is absolutely no reason why this number could not be raised to 50 to 70 billion on a monthly basis.

What does this mean?

It means Obama misled us on the technical issue of whether SS checks can be sent in the event of default. He never said that they would not be made. He said they “might” not be made. So he was using the fear factor to sway opinion in his direction. In my view he had the money “in his pocket” when he said it was not available. (Didn't we once go to war over that fear factor thing? Are we doing this again?)


The entire FICA receipts ($52 billion a month) could be used by Treasury to make debt service and other payments. This would dramatically improve the liquidity picture. It could buy some time.


As of tonight we have a standoff. The House plan will be defeated in the Senate. The Senate plan will be defeated in the house. Obama has said that he would veto Boehner’s plan. To me, the possibility of a 'no deal' and a blown deadline is staring us in the face.

I’m just wondering if this is not the Obama script. Let the situation blowup. But have the consequences contained.

There would be tons of fallout. The markets would take it on the chin and the rating agencies would threaten action. My guess is that 500 federal parks might close, but the roof will not fall in.

In that scenario the White House would "look" good. They would be able to say that they were creative and avoided a crisis. They could blame the Republicans for the failure. It would strengthen Obama’s hand in the post August 2 debate. The end result would be that Obama gets a deal that takes him past the election. Which he wins.

A story like this is what gets people (re) elected to office. But if this is being orchestrated to that end, then it is a very sad story indeed. We’re being used.

Big Boys Duke It Out

.
Faye Dunaway had a great line in the movie Chinatown. She said:

I don’t get tough. My lawyers do.

Some of the biggest titans of industry are currently in brawl over a ton of money. As is usual in America, when powerful forces get into a fight they turn to their lawyers (and lobbyists) to do the actual punching. While this may appear to be civil, it’s not. There’s too much at stake.

The issue is the $1 trillion of earnings that corporate America has piled up outside of our borders. This money represents the profits from foreign activities that have not been repatriated back home. This loot has already been taxed in the foreign jurisdiction where the profits have been made. The average tax on this pile of money is only 12%. To bring the money home would trigger an additional tax liability to the IRS equal to ~23% (35% marginal tax minus 12%, foreign taxes paid).

What’s at stake is $250 billion. With that much money on the table the big hitters get the best lawyers and lobbyists to “Get tough”.

On one side of this slug fest are 50 big companies including Apple, Cisco Systems, Devon Energy, Google, Microsoft, Oracle, and Pfizer. They are jointly represented by a slick lobbying outfit called WinAmerica. (link) This is the mission statement of WinA:

Congress should pass legislation to offer an immediate reduction of taxation on income earned overseas by innovative American businesses to allow that money to be brought home and invested in the United States.

Gee! That sounds smart doesn’t it? Some details from WinAmerica:

Currently, there is over $1 trillion earned by American businesses trapped overseas. An essential first step would be to allow these worldwide American businesses the freedom to bring up to $1 trillion in global earnings home to invest it now into our still fragile economy.

Let’s be very clear on this. GOOG/AAPL/MSFT/GE etc. are pushing for a tax holiday. They want to bring all of their foreign profits back home and pay no US tax. This has been done before and there is very little evidence that those companies who benefited in the past actually invested in the US and created jobs. They paid dividends and reduced debt with most of the money.

On the other side of the tax holiday being pushed by WinAmerica are Kimberly-Clark, Zimmer, United Technologies and Caterpillar. Corporate officers of these big hitters testified on this matter to Congress. This group is arguing against a holiday. From a Newsweek report:

"The four chief financial officers testifying at the hearing said they oppose a one-time repatriation holiday that would allow companies to bring back overseas profits at a reduced rate."

So what’s this really about? Why are the titans of American industry spending big bucks and beating each other up? Enlightened self-interest is the answer.

Apple, Cisco Systems, Devon Energy, Google, Microsoft, Oracle, and Pfizer had a total of $164 billion in accumulated undistributed foreign profits. They want that money in their pockets and they don’t want to pay a penny in taxes. This group is prepared to make concessions regarding future tax benefits (deductions economically related to foreign earnings) in exchange for the cash.

Those apposed to a one-time holiday don’t have the big stash of foreign cash, so a holiday does them no good. In some cases a holiday would create a competitive disadvantage. This group is more interested in maintaining the existing tax structure as it is. They want to keep credits for US located activities of R&D, workforce training, and manufacturing.

So the pissing match between the titans (and their lawyers) is about money. It’s about greed and tax avoidance. Surprised?

I think the scale is going to tip in favor of the nice folks at WinAmerica. This is the argument they are selling:

The likelihood of another stimulus, additional tax cuts, or action by the Federal Reserve is low, and unemployment is still too high.

Providing American businesses with incentives to invest at home is a common sense solution that will immediately inject up to $1 trillion into our economy and provide businesses with the certainty they need to help get Americans back to work.

The first part of this is true. There is no stimulus coming from the monetary or fiscal side. The second part is bullshit. There is a ¼ Trillion of tax revenue at stake. That will be traded for a promise of some jobs in the US. There will be some jobs created as a result. But the cost of a $60,000 job will be $500,000 in the final analysis.

Either way this plays out Corporate America will win, the average American will be the loser.

Some cracks in the sidewalk

Paul Krugman is crapping in his pants. Some cut and pastes from his blog(s) today. (Link and Link)

Boehner’s reply was as vile and dishonest as you might have expected.

If the government is forced to slash spending when the money runs out. — We’ll be doing a 1937 squared.

I hope and pray that Obama’s lawyers discover that the 14th amendment solution is valid after all. Because otherwise we’ll be looking at very dire things, even if the markets stay calm.

It sounds to me that PK wants the markets to crash. (He’s ‘praying’ for a lawyer to find a loophole?) Maybe he thinks a 1,000 point DOW drop would get those “vile and dishonest” Republicans to cave in.

The fact is that the market’s collective response to the possibility of a US default has been extremely muted.

Ten-year treasuries are not showing any signs of stress. The current yield of 2.95% is significantly lower than just five months ago.

Stocks are doing just fine. The S&P is 5% higher than a month ago. We are back to the levels seen in May.

I don’t see any significant stress in the Muni market either. MUB (index) is just a tad off recent highs.

How are these results possible? Easy.  

The Smart Money on Wall Street is 99.5% convinced there will be a deal.

I’ve never been so sure about that “smart money’ thing, (having spent a lot of time there) but I agree with this thinking. There will be a deal and there won’t be a default. But the deal that is going to be struck is going to stink. It will put the issue of default back on the table in less than eight months.

This reality will push the hand of Standard and Poor’s. They have said that the political will of the country to tackle tough problems was central to their decision to put the USA on their watch list. The US will fail on this if there is a short-term patch on the debt limit. S&P will have to follow through. They will drop the US by year end (or they have no balls).

Krugman is not looking in the right places for evidence of the stress that is building. Some places I see as signs of problems:

-Gold is reacting.

-The safe havens of Swiss Francs and Yen are being sought after.

The Swissie is about to break an important barrier. By the end of the week a lousy 80 Centimes will buy a Dollar. The Yen is not at a record, but it might as well be. We are at the panic levels of March 2011 and way back in 1994.

-Some stocks like AAPL are trading as if they are safe havens. (That’s crazy!)

-The most significant evidence of trouble brewing is an issue that I do not have a chart to show you. It is something that is not (now) being reflected in the markets.

I stay in touch with a number of folks who push money for a living. I am repeatedly hearing that there is stress in the funding market. There is plenty of liquidity and the cost is zero, but financing to fund assets (positions) is drying up. It’s becoming increasingly difficult to finance large liabilities. Where funding is available, it’s only for very short maturities. These issues are showing up in the repo market, euro dollar deposit market, money market funds, swaps markets and interbank lending.


I’m very concerned that the "smart" money on Wall Street is positioned very poorly for what is coming. We are setting ourselves up for a big disappointment. It’s as if the Street is set up for a Non Farm Payroll of +600,000 and we get a -200,000 print. The reaction will be swift and bloody.

Cash is definitely Trash these days. This investor is long as much cash as I can. I’m convinced that big volatility is in front of us. Being cash rich gives me a chance to play in markets where values are being presented.

I may miss out on what could be a soft landing and a happy ending. I never did believe in fairy tales.


Update:
In the hour and a half since I wrote this the President has came out with a threat of a veto. That would be an immediate default and downgrade. Like I said, I’m worried about that “smart money” thinking. Also, the USDCHF broke the 80 barrier. Gulp!

Inflation “Bend” points

One part of the debt ceiling debacle debate that has been agreed to a long time ago is that there will be changes made to inflation calculations. The result will be bracket creep (higher taxes) and a slowing of the rate of benefit payments. I am concerned with this type of thinking. I don’t think it addresses the fundamental problem.

The raging argument in D.C. is about something called Long Term Fiscal Solvency. The apparent goal is to slowly reverse the direction of the big ship and ultimately turn it around. Sounds great. The time frame that is being measured is at least 25 years. (It takes a long time to turn a big ship).

Social Security is a micro component of the budget picture. The “Financial Health” of SS is something that is looked at over a 75-year time period. Some even look at SS based on something called “the Infinite Horizon”.


This is crazy thinking. We have no idea what will happen over this time span. The operating assumptions behind all this long-term thinking are that the economy grows at a steady and predictable rate, inflation will remain modest and well below the growth rate. FOR EVER! Call that economic utopia. It will not happen.


I am much more concerned about the short-term. I think the US has to make very substantial changes over the next ten years. We can’t wait for adjustments to take effect a decade from now. But that is what we are going to get. The following looks at Social Security and what changes to inflation calculations would mean to benefit payouts from 2012-2021. (all data from SSTF Annual Report to Congress, Link)

These charts show the anticipated SS benefit payments (by year and cumulative). This data is from the SSA Intermediate or base case assumption:

Note that benefits rise by 70% over this time frame. That increase is a result of two components; A) Net new beneficiaries and B) Inflation adjustments.

SS has a range of expectations for inflation. They start with the 2011 number and they all increase over the ten-year period. These are the numbers that are built into the SS calculations for inflation. This chart covers the Low Cost, High Cost and Intermediate projections for inflation.

 This chart of data looks at what the inflation component is in actual dollars.

Now let’s put our D.C. thinking caps on. If they are going to mess with this inflation adjustment how much can they actually do? They can’t eliminate it. That would be politically impossible. It would also be flat out unfair. So less than 100% is the answer. IMHO it will be impossible to achieve even a 50% claw back in inflation adjustments. If that were to happen the results would look like this:

A more modest (but still significant) result would be a 25% reduction over the next ten years. If that were the case (it’s likely to be less than this) these would be the savings:

Consider the conclusions. Depending on the actual rate of inflation the savings of a 25% cutback plan would result in very small changes to actual payouts. In the SS Intermediate Case the savings would amount to a measly $54 billion over the period. That comes to ½% of total benefits. This is a meaningless result in our big economy.

I’m not going to bore you (further) with more charts. I will just tell you that after ten years or so the miracle of compounding comes into play. With each additional year the difference between actual inflation and the COLA adjustments will widen. When you extend this type of thinking over long periods of time it does make a very big difference. After 25 to 30 years this would be significant.

This "logic" will be presented to us in the next few days. Leaders on both sides will say that they have set a path toward long-term fiscal solvency. They will show graphs produced by the CBO that support the claim that after fifteen years (or longer) the bend point on benefits is reached. They will be able to show dramatically improved debt to GDP ratios as a result. But all of that “good stuff” will be far into the future.


My concern is that we don’t make it through the first ten years. The absence of any significant improvement in the foreseeable future (versus the infinite future) is going to trip us up. It won’t take all that long for the markets to recognize these implications. Any relief rally in bonds or stocks is likely to be short lived.

The stock market looks out (at best) six months. The bond market looks longer (not of late); two years is as far as the bond boys can see. Macro economic policy starts with ten years and looks beyond that. The two groups are looking at entirely different playbooks.

It’s quite possible that we will see the D.C. crowd showing us one set of graphs and claiming success. At the same time Wall Street will be producing another set of numbers on the visible supply of government debt for the next 48 months.  D.C. will be crowing about long-term solvency, while the markets will fret about short-term insolvency. Ten-years is forever on Wall Street.

The term “Voodoo Economics” was a popular term that was used to describe "Reaganomics" back in the 80s. I wouldn’t be surprised if that term comes back into vogue.

Man it’s hot!

Something like 200 million people are sweltering in the US today. Where I am we have had four short power outages. Every time it happens I think, “Is this the big one?”

It’s not just hot on land. It’s hot in the ocean. In particular, the Gulf of Mexico is getting very hot.

For years I monitored ocean water temperature at buoy #42001. Not any longer. When I checked today I found this. R.I.P. 42001.

I did get some partial data from a nearby buoy #4204. A comparison of water temperatures over the past eight years:

The conditions today have not been seen since 2004. A question to ask it what kind of hurricane season was 04? Bad, is the answer:

The 2004 season had 16 tropical depressions, 15 named storms, nine hurricanes, and six major hurricanes (Category 3 or higher on the Saffir-Simpson Hurricane Scale). The Accumulated Cyclone Energy figure of 225 ranks this as the fourth most active season since 1950.

August 2004 was incredibly active, with eight named storms forming during the month despite a weak El Niño emerging during the summer. In an average year, only three or four storms would be named in August. The formation of eight named storms in August breaks the old record of seven for the month, set in the 1933 and 1995 seasons.

Note that a condition that existed in 2004 was a weak El Nino. What do we have today? A weak La Nina. It is predicted that the cycle will complete sometime in July. We will revert to a weak El Nino (we may have already achieved that)

The odds point to big storms in the Gulf over the next 60 days. Here’s hoping we beat the odds, and the heat.

Whoopie! We got a Greek Deal!

So we got a Greek deal. That’s great news! (I think, I hope, maybe, we’ll see)

After all the hoopla over the last week where Trichet basically said that Euro sovereign debt was money good, we find that the same people have caved and debt relief has been granted.

But I ask the question, “Has debt relief really been granted?” Yes, there have been some haircuts on some Greek bonds, and yes there is interest relief involved. But my read of this deal takes Greek Debt to GDP from an impossible 175% to an (almost) impossible 130%. So I am left wondering if this is a half loaf; one that does not get the job done. We shall see.

The Council of the European Union released a long statement on this. I ran it through Wordle. This is what you get:

The full statement(s) can be read at this Zero Hedge link. Here is the one comment that I think is the crux of the matter:

All other euro countries solemnly reaffirm their inflexible determination to honor fully their own individual sovereign signature and all their commitments to sustainable fiscal conditions and structural reforms. The euro area Heads of State or Government fully support this determination as the credibility of all their sovereign signatures is a decisive element for ensuring financial stability in the euro area as a whole.

From this one must conclude that the ECB has put up a big fence around Greece. They are the only exception in all of Europe that will ever see debt relief as an option. There will not be a default for Ireland, Spain and Portugal (and don’t even mention Italy). I say to that:

You wanna bet?

The CEU statement makes it pretty clear that the Euro folks are going to do everything they can (including direct intervention in the bond market) to stop the spread of contagion. I think they will succeed in maintaining market peace for a few months. But sometime this fall the issue of default by some Euro members will rise up again. It has to. I think the leaders in Europe are dreaming.

Note: The Greek deal will have an IMF component. A portion of that will be funded by the good old US of A. There are no details at this point but I would suggest that the US portion of this will come to $15-20 billion. In the scheme of things that is not a big deal. But in the summer of 2011 a bailout of this amount for a country that has little connection to the US is not going to be such an easy sale. I think this will happen, but that will be the end of it. The US will not take part in the next Euro bailout. And yes, the next Euro bailout will happen before year-end. 

CBO Report: We have three options, only one is viable – A different plan to consider?

This piece runs on a bit and gets wonkish toward the end. Sorry on both counts. BK

The Congressional Budget Office may have done the country a big favor. It put into blunt words what choices we face. In the report dated July 19th CBO had this to say:

I) Raise federal revenues significantly above their average share of GDP;

II) Make considerable changes to the sorts of federal benefits we provide for older Americans;

III) Substantially reduce the role of the rest of the federal government—that is, defense (the largest single piece), Food Stamps, unemployment compensation, other income security programs, veterans’ benefits, federal civilian and military retirement benefits, transportation, health research, education and training, and other programs—in our economy and society.

‘I’ is necessary and it’s going to happen. While this may sound easy it is not. Increased taxes from workers are just a drag on the economy. If there must be new taxes, the money raised has to support more than just the rapidly growing aging population. The country is in desperate need of new investments (energy, infrastructure, education); it would be a mistake to channel more scarce financial resources to one segment of the population.

‘III” is also going to happen. Cut backs in defense are critical. The other programs in the “rest of the government” will also be part of the mix. But let’s get real about this. The US can’t cut these programs by an amount that would move the needle. Do we really want to eliminate a substantial portion of the defense budget? It’s true that the US can no longer afford its huge bases in Asia and Europe. And we certainly can’t afford to go off to wars that last ten years. We don’t need a huge standing Army. There can be cuts in the Navy’s carrier fleets. The Air Force doesn’t need new combat fighters. But it would be the dumbest mistake we ever made to degrade the military so they could not react if and when needed.

So that leaves ‘II’. The baby boomers are the real problem. This chart from the CBO says it all:

Note that of the significant components in the budget there is the assumption that they all remain about the same as a percentage of GDP for the next ten years. The exceptions are Social Security and Medicare. These two programs gobble up a greater and greater share of the pie. It's simply not possible to change the direction of the deficit in the USA unless spending for the older population is reduced.


There is no plan from any side of the budget debate that is addressing this simple reality. I have a plan. It goes like this:

Objectives:


-Decrease the number of those covered by Medicare by 20% (now and in the future).

-Maintain existing revenues sources for Medicare at their current (and projected future) levels.

-Provide a major economic stimulus to the health care industry.

It is very tempting to say that a means test is the mechanism to achieve these objectives. IMHO it's necessary that well off seniors have to take a sizable hit. That may sound like an easy solution, but it is not. The tax codes only address income, so there is no effective “means test” measuring system. There would have to be an “asset test”; this is something that does not exist and would be very unpopular. (Note: If one had $10mm in the bank it would be very easy to make $500k a year tax free. This very wealthy person would not be hit with a means test based on income.)

Probably the most significant factor against a means test is that it is confiscation. While the results may be considered fair by a broad segment of the population the fact is that this is stealing. I think the courts would not look favorably toward this type of approach. A means test is a very tough political sell.

So the question are:  

How do we steal old rich people’s money?  

How do we do it in a way that actually has some fairness (to all) attached to it? 

And can we do it in a manner that would also act as a broad economic stimulus?

I think it might be possible to achieve these things. Rather than confiscate rich old people's money I want to sell that group something they desperately want. I want to sell them what they want at a very high price.

If those rich older folks don’t want to buy what I want to offer them, there will be a price to pay. Those with significant resources will have two choices in my plan. Either they can sign up for what I’m offering or they have to pay a tax on the SS and Medicare benefits they receive.

Here is a brief description of the new health care plan that I would offer to high net worth seniors. I call this the Gold Plan. Assume a 65 year old got this in the mail from Uncle Sam:

Your government is offering you a new health plan called the Gold Plan. Here are the features you will like:

-It will cost you nothing out of pocket to get this insurance.

-It will provide the best possible care with no deductions or co-pays.

-You can go to any Dr. you like, whenever you want.

-Your prescriptions are covered at no cost to you.

-There is no part A,B,C or any of that. No paper work at all. You get a Gold card and everything is covered.

-This is the same level of coverage that a President would get.

-This is lifetime coverage, regardless of health outcome. It will never cost a dime out of pocket to get.

That sounds good doesn’t it?

Medicare has an out of pocket monthly cost of $500 (including supplemental). There are co-pays, tons of forms and deductibles for prescriptions. Not all doctors or treatments are covered. Medicare is not cheap and it does not provide for the best level of care. Therefore if someone 65 got that letter in the mail they would whoop for joy.

What does the new health insurance actually cost? 100% of ones monthly social security check. Sign that payment away and you have a Gold Plan.

Very quick numbers:

*The average cost per Medicare beneficiary is $11,000 per year. (Medicare annual report)

*The average SS check for high life time earners is $1,800 per month or $21,600 a year. (A range of monthly SS income from $1,400-2,200+ would be accepted as full payment. This is a progressive feature of the Gold Plan.)

The math on this looks good from the government’s perspective. A beneficiary would be "paying" $22k per year. That is more than double the average cost of a Medicare beneficiary. A portion (approximately $3,000) would go back to Medicare. The balance of $19,000 a year is available to cover the benefits under the Gold Plan.

This is the "carrot" part of the plan. There has to be a "stick" to get one's attention. The stick would be a new tax. Those that are high lifetime earners would be subject to a new tax on their SS benefits (a flat tax of about 15%) if they don't go for the Gold. There would be two doors to choose. Yes, either door is costly. But at least one door has something valuable on the other side.


On the economics: Assuming a 20% participation rate, the Gold Plan initial revenue pool would be ~$190 billion a year and rise with annual COLA + 750,000 new enrollees every year (increasing by $20b or 10% PA). The objective would be for the Gold Plan to breakeven. This is a bailout of Medicare. That would be the "prize".

This would also be a huge boost to the medical industry. In my example Medicare expenditures would go down by $140 billion (20%) while Gold Plan medical expenditures would rise to ~$200 billion. The net gain of +$50 billion (and growing) would be very supportive of the health care industry. I am not a fan of Big Pharma or Big (private) Hospital, but if you want to create jobs in America, health care is the place to do it. If you think that CAT, CSCO, INTL, GM are going to create the jobs we need, think again. Healthcare is the only growth industry the country has got.

Yes, this is a "backdoor" means test. I'm sorry, but something like a means test has to happen.

Note: If you’ve read me before on this topic you know I am apposed to an economic plan that entails a huge inter generational wealth transfer. Unfortunately, that is the plan we are currently following. My thinking is that we need a different plan. A plan that shifts the burden (substantially) to the generation where the problems reside. The foregoing was my effort to turn the arrow in a different direction.

A Trillion of revenue is on the plate

We’re coming down to the wire on the debt limit. “Hard” deals are now being put on the table. The Republicans have said all along they don’t want any new taxes. But only a fool could think this can be done without a significant amount of revenue increase. So if we’re to get a deal what has to give? Easy. Rather than increase taxes the government can phase out deductions.

This data looks at individual deductions. This come to a whopping $950 billion. You tell me, are you on this list? Have a mortgage? Pay state or property taxes? School debt? Health care costs? Charity? Kids? Veterans? At one point or another every American is on this hit list.

Consider the deductions at the corporate level in America. It’s only $65b. Peanuts compared to the tax breaks of individuals.

Now think of yourself in a room trying to negotiate this big deal. It’s all well and good to say that the end result will be more taxes for corporations. But at a ratio of 15 to 1 you have to hit individuals pretty hard in order to raise any serious money. At this point everyone understands that. Cutting personal deductions in a very big way is the only possible outcome where all sides can save some face.

The way that these cuts in deductions will be phased out will hit high incomes the hardest. But don’t kid yourself; this will end up in three to four years as a very middle class tax increase. Should something like this come about you have to look askance at owning real estate. You’ll get hit with a tax from employer 401 contributions. You might think twice about having a child. Those charitable deductions are just that, charity.

I guess this is what has to happen when you need to raise a trillion in revenue to sell a deal. We’re going to hate it a few years from now when all this kicks in.