Author: ken

BETA WEALTH

Now You Have it – Now You Don’t

Preoccupied as we are with the 1% at the top, we lose sight of how volatile all wealth today has become – and “beta” is the measure of change, relative to the market.  Technology and gambling stocks can have betas of 1.5 or more, since they tend to overshoot the market in cyclical ups and downs, while utilities hardly move at all.  The problem, of course, is that high “beta’s” don’t last.

As The Wall Street Journal put it recently:  “The new rich have become the high-betas of our economy. With their dependence on financial markets, their leverage and their hyperspending, the top 1% have income swings that now are more than twice as high as those of the rest of the population.” (See, “The Truth About Wealth.”)

A November Federal Reserve study found that “a third of the people in the top 1% in 2007 . . . were no longer in the top 1% in 2009.”  A report commissioned by J.P. Morgan Private Bank, found that only 15% of the Forbes 400 stayed on the list over a 21-year period.

But even the little guys suffer huge swings in the value of their assets, as mortgaged homes sink underwater and stock prices gyrate wildly.  The total amounts may be less, but the volatility can be the same. The rich may be more prone to these dangers than the rest of us.  Not used to worrying about paying the bills, they can more easily neglect the bottom line.  But the dangers apply to everyone.

The Journal went on to list the underlying causes of this volatility, none of them surprising to any who have given more than a moment’s thought to guarding their investments against excessive risk.

Overconcentration in one asset or class of assets.

Leveraging debt to support speculation or lavish lifestyles.

Spending based on false assumptions or paper profits.

These dangers boil down to matters of common sense and self-delusion, psychological factors that could be corrected if we paid more conscious attention to our behavior.  Most of us tend to put too high a valuation on our assets in order to give ourselves an emotional boost.  Extra money not only feeds our fantasies about what we can buy, but it also makes us feel more important and successful.  On the other hand, we are reluctant to accept lower valuations and the lesser status they entail.

Behavioral economists have been familiar for sometime with the fact that we all tend to be “loss averse.”  That is, we put off accepting that our investments have declined in value, often to the point that profits turn into losses.  Or we succumb to the “money illusion,” the belief that the price tag accurately reflects the value of what we own, neglecting to correct for inflation, for taxes, for fees.

Rich or poor, we all struggle to hold on to a realistic and reliable grasp of what we have.  Our minds continually flirt with “beta” values — and frequently succumb to unnecessary loss.

 

 

 

 

Less Than They Think

What justifies the bloated expenses of the finance industry, the exorbitant salaries, percentages taken off the top, the finder’s fees, the bonuses?  We have to wonder what do bankers do that justifies the added cost of their services?

The cynical view is that they “take money from one pot, skim some off the top, and put it into another pot.”  But that can be actually useful, argues Thomas Philippon, professor at N.Y.U.’s Stern School, as that money is often needed to finance start-ups or expand existing enterprises.  And since there is a real service performed and some risk in performing it, they should be compensated.

Moreover, there has been genuine innovation in designing ways to measure risk and leverage resources.  As a result, less money can stretch further and do more, and that is an increase in productivity that deserves to be rewarded.

On the other hand, of course, is the fact that all too frequently those innovations led to a reckless denial of risk.  It wasn’t so much that assets were leveraged to an alarming degree, which they were during the credit bubble.  The more serious problem was that the original assets were over-valued to begin with and repackaged to conceal the real risk they held.  Driven by frenzied competition for investors, banks failed to question their decisions and, in many cases, the risk-management procedures they put in place were circumvented or just ignored.

As Kim Stephenson has pointed out on Mindful Money, new rules are not likely to work.  “Apart from anything else, you simply start an ‘arms race’ to see who can subvert the rules most effectively.”  But just as legitimate innovation can and should be rewarded, failures and lapses can and should be punished. (See, “Tough on Pay, Tough on the Causes of Pay.”)  And the banks that are too big to fail can be broken up.

Investors who were hurt by the catastrophic collapse of financial markets and the continuing weakness of the economy are rightfully upset that the punishment never happened.  The banks, in fact, are bigger than before.  The public is upset as well.  Enormous amounts of tax money were used to bail out the industry.  That amounts to a subsidy of failure, or what has been called “moral hazard.”  There has been no lesson to learn.

So it is time to look at our underlying assumptions about the finance industry, and that is what Philoppon has done in research reported in The Wall Street Journal.  Last year, finance accounted for 8.4% of our GDP in the U.S. – compared to 2.8% in 1950.  That’s a huge increase, but Philippon argues that the value finance adds to our GDP today is 2% below its current share.  In other words, it should be a bit over 6%.  That would be a reduction of almost 300 trillion dollars for the U.S., 45 trillion for the UK, using World Bank estimates.  (See, “Number of the Week: Finance’s Share of Economy Continues to Grow.”)

Those are sobering figures.  And they provide a hint about how much of a correction would be warranted if we could think rationally about what we were getting from bankers for the money they are getting from us.

 

 

 

Here Comes Not Quite Everybody

It is a cliché that the Internet connects everyone, so it probably has escaped consciousness that many actually cannot afford the high-speed service the rest of us now take for granted.  They are being bypassed.

Susan Crawford, a professor at New York’s Cardozo law school, recently called attention to our “digital divide.”  “If you were white, middle-class and urban, the Internet was opening untold doors of information and opportunity. If you were poor, rural or a member of a minority group, you were fast being left behind.”

The U.S. Department of Commerce pointed out, for example, “a mere 4 out of every 10 households with annual household incomes below $25,000 in 2010 reported having wired Internet access at home.”  Moreover, “only slightly more than half of all African-American and Hispanic households (55 percent and 57 percent, respectively)” have it, compared with 72 percent of whites.  (See The New York Times, “The New Digital Divide.”)

It’s not just a question of convenient, quick shopping or entertainment – though it is also about that.  Increasingly medical services, employment information and job interviews, education, and access to vital career information depend on high speed Internet connectivity.  In the future more and more essential services will depend on it.

Most of us just absorb the increasing expense, but America is 12^th among developed nations for wired Internet access, held down by monopolistic practices, the lack of incentive to wire rural markets, and the virtual absence of regulation – all hallmarks of the political and economic policies that discount the role of government and favor the wealthy.  The poor rely more and more on smart phones, but their capacity to carry large amounts of data is restricted.  They may tell you where your kids are, but they’re not equivalent to computers.

In the nineteenth and earlier twentieth centuries, the U.S. government heavily subsidized postal rates so that newspapers and magazines vital to the development of democracy could be cheaply distributed.  Those services are now being cut back, partly of course because the Internet is a more efficient way to do those jobs.  But it is not doing the same job if it doesn’t reach more citizens.

Democracy depends on economic opportunity or it will atrophy.  This is yet another way in which the poor are dropping out of our collective consciousness, no longer able to participate in our economy and, as a result, disenfranchised.

Mesmerized by out technological marvels and gargets, we are in danger of failing to notice that fewer and fewer among us are still playing.

 

 

“Anyone But Mitt”

Democratic politics, in theory, is about people choosing leaders to guide the country.  But lately it has come to seem in the U.S. that the process has become vindictive and charged with hatred.  The question has become not “What do we want?” but “Whom do we despise and fear the most?”

This phase began with conservatives deciding that their most important goal was brining down President Obama.  That single-minded obsession has produced legislative gridlock and rendered Congress impotent to deal with the jobless Great Recession.  Democrats, in turn, seem to have been reduced to scoring points against their adversaries.  Several times this has led the country to the brink of fiscal crisis.

There are legitimate differences of opinion, of course, about the policies we need.  But that’s not what the discussions are about – now all the more apparent as the Republicans are competing with each other for the nomination.  A succession of candidates has arisen, each presenting himself (or herself) as an alternative to Mitt Romney, but each has crashed and burned as the new front-runner shows himself to be politically inept or morally compromised.  Liberal leaning commentators are amused and contemptuous, while conservatives are aghast and anxious – if not actively joining in the fray. (See, “Republican Leaders Still Seem Torn About Romney.”)

What is going on?  What are the underlying reasons for this polarization and frenzy?  Why have our politics come to look like war?

The reason is that it actually is a form of war.  The underlying issue, thinly disguised, is who will profit the most from the restructuring of our tax codes, entitlement programs, subsidies and regulatory policies.  The competing political and economic agendas offered by the candidates are not about finding the best policies to move the country forward into economic recovery, as they are presented as being, but about who stands to gain the most — and who can best disguise the real underlying conflict.  The problem with Romney is that he has shown himself to be all too willing to compromise and betray the conservative agenda.  They want someone they can trust.

In general, we deal with these issues naively, unconsciously — and “optimistically.”  We do not want to see the clash of self-interests that underlies the idealized “land of opportunity” we still think we are.  We have been reluctant to face the fact that the country is split between those whose wealth is growing, aided by government policies, and the increasing ranks of the poor, who face further cuts to our already frayed safety nets.

But the Occupy Movement has forced the wealth gap to the surface of our minds, and the 99 percent are looking around and beginning to stir.  The Republicans mock the movement’s lack of a political agenda, but it has succeeded in placing the issue squarely in the minds of the public, and the conservatives don’t have a strong way to deflect attention away from it or a compelling, charismatic leader to distract us.

But they keep hoping something better will come along.

 

 

 

The Benefits of Work

Retirement used to be thought of as an ideal goal, almost a right.  After 30 or 40 years of productive work, people expected to be able to take it easy.  But that idea has now become obsolete – and maybe it is undesirable as well.

Partly, the shift is the result of necessity.  As The New York Times put it recently:  “Retirement seems out of the question for increasing numbers of Americans who are saddled with debt and whose savings evaporated during the recent bust.” (See, “Goodbye, Golden Years.”)

But economists are also coming to think of retirement as a drag on the economy.  Older workers who keep working continue to buy more goods and pay more taxes.  Moreover, they depend less on the earnings of others.  As the baby boomers reach retirement age, can society afford the “entitlements” we have come to take for granted?

Finally, on a personal level, those who keep working also often feel more useful and relevant.  Unless retirees find stimulating and socially valuable activities, they undergo a kind of marginalization that makes it more difficult to maintain self-esteem and overcome depression.  They more easily withdraw from engagement with others.

Conventional wisdom in the past held that the threat of unemployment hastened workers’ decision to retire. But The Times noted, “recent increases in unemployment haven’t encouraged many older Americans into retirement.”  One reason is that workers now keep their social security benefits when they continue to work.  Another is that, as our economy is less focused on heavy industry and manufacturing, work for most people has become less physically strenuous.

It is a big issue, and it is getting bigger.  As The Times put it:  “Between 2007 and 2010, the number of working Americans over 65 years old jumped 16 percent; the number of under-65’s in the labor force shrank.”  These trends are likely to continue.

Declining health and age, on the other hand, often require substantial cutbacks in activity, and it can be cruel to force people to work when their jobs are stressful.  Moreover, not all jobs are good jobs, offering decent pay and emotional rewards.  But it is probably a good thing to dismantle rigid expectations about retirement.  Even better would be the creation of a range of part-time jobs allowing people to supplement their income while continuing to engage with others and feel productive.

The Old Testament taught us to view work as a curse, mankind’s punishment for sin.  And for centuries work has often been painful and harsh.  Since the Reformation, however, we have tended to view work as a source of human dignity.  Today, it has become the most important thing we do, providing us with our identities, the esteem that comes from competence, and allowing us to take our place in the world.

Work has eclipsed virtually all of our other meaningful activities.  As a result, we need to shift our expectations about retirement.  But we also need jobs, and the opportunities to find the work that suits us as we complete the life cycle.