Sunday, December 28, 2008

Lane Community College and the PERS bond

About five or six years ago, when the Public Employees Retirement System (PERS)crisis in Oregon was at its worst, a number of public agencies floated bonds, took the proceeds and sent them to PERS to reduce their Unfunded Actuarial Liability (UAL). Lane Community College was one such entity. The theory was simple. Bonds could be sold for rates between 5 and 6 percent. PERS has an actuarially assumed rate of return of 8% on the funds it manages. Uncorrected, a UAL grows by 8% annually, so giving the money to PERS reduced that cost. It also allowed LCC to fund the UAL over 20 years, a much longer period than PERS would require otherwise.

In one regard, it worked great. The bond spreads that pain over a long period of time and shifts the burden to the next generation. This is particularly true since the bond was back-end loaded, so that initial payments are low and increase over time. Starting at $2 million and change, they pass $7 million in the final year.

Overlooking the immorality of this, it still only worked if PERS produced the 8% return. But that was never a guarantee, it was an actuarial assumption used to calculate the fund's ability to cover future liabilities. PERS may have earned 8% over carefully selected timeframes, more in some, but in the last 14 months they've been losing their shirts.

This includes their investment of the $55 million that LCC sent them. The college was lucky to time the bottom pretty closely and earned a good return over the first four years. But PERS has been hammered and I doubt that today the "side account" for LCC contains more than the $55 million it began with.

So after five years, the college

a) Has a greater UAL than it started with,
b) Still owes just about the full $55 million, since it has hardly been covering accrued interest,
c) Has a steadily increasing bond repayment schedule in the years ahead,
d) Faces a sharp decline in state funding, as Oregon, dependent as ever on income taxes, goes into a sharp recession.

Not all of this will become apparent at once. But there's no doubt it will come into full view over the next four years and budget making for LCC will be gruesome. The college is fortunate to now have available the abilities of Greg Morgan, who replaced the catastrophically incompetent vice-president Marie Matsen in 2007, but it takes more than administrative skills to get out of this mess. It will take a fundamental rethink of the mission of the college.

The difference between Madoff and the Oregon PERS

Bernie Madoff differs from the managers of the Oregon Public Employees Retirement System investments in one crucial aspect. Madoff pretended to be doing something brilliant to produce steady gains when he was not. The PERS managers are doing it in full view of the public. Amazingly, nobody seems to care.

At the end of October, they were deeply in the hole for the year, but they still were able to brag about doing better than the market. This is straight horse pucky. They are doing better because, for a very large portion (perhaps 20%) of their investments, they know they have lost money but not how much. Their investments in real estate and "private equity" are so illiquid that they don't know what value to assign.

So they are continuing to assign the last value they could come up with. In reality, based on what others in the same asset class have done in the past year, they have likely lost 80% of their value.

There's no great secret to making extra money in an up market. You simply use leverage, borrow at fixed rates, invest at higher returns, and the difference accrues to the small equity base rather than being spread over the whole investment. But as Galbraith wrote in "The Great Crash of 1929," when the market goes down, people discover that the magic of leverage works in both directions. Thus the spectacular gains the PERS enjoyed for several years are quickly turning into massive losses.

The source of all this woe is that the Oregon legislature has declined to fix PERS. It has permitted the managers to make risky investments that, during the good years, went a long way towards backfilling the Unfunded Actuarial Liability (UAL). It was never a sound, long-term strategy and the consequences are coming back to haunt the state.

Putting Mumbai in Perspective

The violence in Mumbai last month was terrible, but also illustrated the fact that what captures the attention of Westerners is not people in India being killed by terrorists, which happens frequently, but people in India in expensive hotels being killed by terrorists. Nevertheless, it's a problem and India needs to take security mesaures.

On the other hand, before we hyperventilate over this, let's think about what the Santa Claus killer in Covina did. In one evening, one disgruntled ex-husband killed nine people. Adjusted for population, that's like 36 people in India. Less than Mumbai, but it happens here all the time. We only see it in the news when there's something quirky, like the guy dressed up like Santa or the victims in Jennifer Hudson's family in Chicago. But if you add them up, there's no doubt that the United States has as big a problem with angry ex-husbands with handguns as India does with terrorists.

Israel's Purpose is ... what?

Israel has shown once again that its military machine, financed heavily by the United States, can wreak havoc on any military opponent in the Middle East. The pertinent question, is why prove it again?

An editorial writer for the Times of London opined that a military conflict with Hamas was inevitable. But that's to give Hamas much too much credit. They have been able to lob a few missiles into Israel, but they can't hit anything. They had recently stepped up a bit, but the casualties consisted of no deaths and not many injuries. The Israeli response produced a hundred times the death and destruction that they has sustained.

Skip the morality of this, the "right to defend" and all that crap. Does Israel ever want a solution? It's been demonstrated that the effect of bombing, from World War II on, has not had the effect of "breaking the spirit" of the bombees. In general, it strengthens their resolve. The Jews are proud of hanging together through a couple millenia of persecution. The Palestinians have maintained their identiy and their enmity through six decades. This will only redouble the hostility of both sides.

America can't bring peace to the Middle East, but we can stop financing violence. Times are now tough in this country and the federal budget must be reviewed, in every program, to see if we're getting value for our money. Subsidies to the Israeli military looks like a good candidate for elimination.

Huckabee the Magic Honky

The point about the silly CD sent out by Mike Huckabee's former campaign manager, now hoping to head the Republican Party aparatus in the country, is not whether it rises to the level of indictable offense. It's simply a mirror on the Republican Party.

Imagine a Democrat, trying to distance himself from Joe Lieberman, writing a song that made fund of the senator becauser he's Jewish and sending it to the Democratic Party power structure in America. Hard to imagine? Of course, because he'd know that he'd be on tricky ground with a large number of Jews with influence in the Democratic Party.

That Huckabee's guy had no such concern about writing about Obama the Magic Negro says a little about his taste, but it speaks volumes about the Republican Party. He could distribute his ditty with almost no fear that an influential black Republican would object. If you're scrambling for the top in the Republican Party in 2008, you don't need to worry a lot about losing the black vote.

Thursday, December 25, 2008

Opportunity Knocks

After 9/11, my opinion of Thomas Friedman was pretty low.  His support for the Iraq invasion and the even dumber remarks he initially made about Afghanistan turned me off.  But his observations about America's relative position in the world have been insightful and his latest opinion piece, Time to Reboot America, is well worth reading.I'm pessimistic about America's economic future because, although as Friedman rightly point out, we have many advantages, we also seem so committed to a series of structural problems that I'm doubtful that we'll achieve our potential. 


Compared with other countries, we overspend with little effect on health care, which cripples the competitiveness of some of our large, unionized industries. We allow lawyers to run wild, with little net benefit to the population. We keep energy taxes low, creating a huge national security problem, while we spend billions on the almost immaterial threat from Islamic terrorists. We allow our education system to be run by unions that insist that no teacher can ever be paid according to ability, only seniority and farcical "education" credits.

We've lost the momentum and it won't be easy to regain it. I wonder where we'd be today if in 2000, we'd elected someone like Obama instead of George W. Bush. It's asking a lot to thrust Obama into the current mess and expect him to fix it, but OK, we're asking.

Sunday, December 14, 2008

Wall Street may bring Peace to the Middle East

It may seem odd, but the Wall Street debacle of the past eighteen months may provide the impetus for peace in our time. I don't think this was intentional, although I'd be prepared to thank them if it turns out that this was planned and it proves successful.

The first stage was the destruction of demand for oil, which has brought the price of a barrel of crude down by $100. Without high priced petroleum, the leading sponsor of anti-American and anti-Israeli activities in the region, Iran, will not be in a position to do nearly as much. I rather doubt they will continue active pursuit of nuclear weapons. When you need all your money to buy rice, or whatever Iranians eat, you may have to give up on plutonium for a while. And Hezbollah may need to go on a financial diet as well.

On the flip side, the general decline of wealth and income among Wall Street types had affected their ability to fund Zionism with the same esprit, even before the events of the past week. To this, Bernie Madoff may have added the coup de grace. The $50 billion he seems to have stolen came disproportionately from Jews, and perhaps even more so from Jews with a special fondness for letting another Jew manage their money. Some of them were definitely among Israel's best friends.

Maybe it won't work out, but if it turned out that peace could come from the antagonists running out of the funds necessary to remain obstinate, it would be an elegant and symmetrical solution, as mathematicians would say.

Euphemism of the day

The Wall Street journal has an article on Bernie Madoff that may set a new standard for euphemism. The quote is:

Colleagues of Mr. Madoff said he was fair to those he dealt with and generous to charities including the Special Olympics. Mr. Madoff treated employees well and loved to take friends and colleagues on his 55-foot fishing boat, called Bull, said Frank Christensen, a retired New York Stock Exchange broker. "I really think very highly of him," said Mr. Christensen. "People make mistakes."

The people that Mr. Madoff dealt with have been taken for about $50 billion. That doesn't strike me as particularly fair.

And if somebody gives me $50 for safekeeping and I misplace it, that's a mistake. And people might still think highly of me. But $50 billion? I don't think the word "mistake" is adequate. Mr. Christensen is understanding to a fault.

I think we will learn more about David Friehling in the coming week as well. Friehling's CPA firm, Friehling & Horowitz of New City, New York, had the task of doing a (wink, wink, nudge, nudge) "audit" of Madoff, if you know what I mean. Done without staff, it would seem.

A Google search for "David G. Friehling" shows that Cornell University had listed him on their Honor Roll of donors from the class of 1981. If you check out the URL that Google directs you to, the Cornell site responds with "Sorry, a problem has occurred." Another euphemism. They mean an error 404, but it seems more broadly applicable. Although Cornell has removed the page, you can still find it in Google's cache. Not long ago, Cornell grouped him on a list of honor. They are now maybe having second thoughts about associating him with that word, or for that matter Cornell.

Saturday, December 13, 2008

Madoff -- Where was the New York State Society of CPAs?

The firm of Friehling & Horowitz, auditors of sorts for Bernard Madoff's financial empire, belonged to the New York State Society of CPAs. You can go to their Web site and search for Mr. Friehling yourself. He's right there, a member, apparently in good standing. More than in good standing. A July 15 newsletter from NYSSCPA shows board members of their various chapters. David G. Friehling is shown as a board member for the Rockland chapter. Earlier in the year, on April 15, he has an article in the newspaper of the NYSSCPA and is identified as the president of the Rockland chapter. The newspaper is, ironically, named The Trusted Professional.

CPAs perform three levels of services on annual statements. They render compilations, reviews, and audits. A single person would have trouble doing a compilation on financials as complex as Madoff's. A proper compilation would have been impossible without a team of CPAs, and Friehling is reported to have worked alone.

But an audit?! It can't have been a secret in Rockland, or at the HQ of NYSSPCA, that Friehling & Horowitz audited Madoff. Any sensible CPA must have realized that he could not either (a) conduct an audit that would meet AICPA standards or (b) remain independent when clearly, he can't have had any other clients. He has no Web page and he runs from essentially a storefront. No alarms bells anywhere?

The NYSSCPA has noticed the Madoff scandal and published an article on it. The article does not note, as other journalists have, the peculiarity of Madoff's outside auditor.

Clean water or rising waters

A number of things have started me thinking again about global warming and the analysis of Bjorn Lomborg, the Danish "skeptical environmentalist," that if we're going to address the world's ills, it makes sense to choose the ones with the greatest possible benefit for the least cost.

So despite Al Gore, I don't see anybody being swamped by rising oceans. Subsiding land is a problem, especially in deltas, but this has nothing to do with global warming. Stopping the rise in CO2, which thus far actually hasn't had a measurable effect on the rate of rise, would cost trillions, if it were possible at all. Moving people out of the fringe regions would cost a fraction. Having fewer people there in the first place, by producing and distributing a trillion condoms, is probably more economical yet.

Contrast this with clean water. There are definitely people dying, millions of them every year, because they don't have access to clean water. I don't know how much it cost per thousand people now, but putting this problem on a high priority list and developing high volume technologies would make the solution a lot cheaper. Certainly not more than a few hundred dollars per person.

So we might redirect the money we spend on Iraq and Afghanistan, provide clean water to a half billion people in the Third World and save a couple million lives annually. Or we could try to reduce CO2 emissions, or at least make them stop rising quite as fast, and delay but not stop global warming. And the consequent rise in ocean levels which have cost the lives to date, rounded off to the nearest whole person, of nobody.

Pick one.

Metric System -- the Best Infrastructure Investment

At present, there are three countries worldwide that have not adopted the metric system (SI). Besides the United States, they are Liberia and Burma. Not the greatest company for the world's preeminent economy.

Barack Obama is calling for a stimulus package that will have immediate impact on employment and a long-term impact on the competitiveness of the country. I can't think of anything better than to begin the conversion to metric. There are a million small expenses. We need to begin with highway signs that display both systems. You could have people at work doing that in a month.

Some things are going to be difficult and expensive to convert. Buildings that have studs spaced in inches are going to be a challenge for decades. Nevertheless, this must be done eventually and there's no better time than when the economy is slow and much of the productive capacity is idle anyway.

Making life easier for India and Pakistan

It seems that India wants to keep the consequences of the Mumbai attacks to a reasonable level and avoid war. We should applaud that. It would also be nice if we would put our trouble in this part of the world in perspective and make things easier for the parties to stay peaceful.

The death toll in Mumbai was significant, and clearly tragic for those directly involved. But every day in India, about 2,000 children under the age of six die of diarrhea. That replicates the Mumbai death toll every two hours, and if not addressed, will do so forever.

But however insignificant in the big picture, Mumbai is a political issue of great importance and Pakistan has problems. Muslims everywhere feel threatened and for Pakistanis, Kashmir is a permanent sore point. A government that tries to be reasonable about Kashmir, however, is compromised if required to support the U.S. war against the Pashtun ethnic group that straddles the Pak/Afghan border and opposes the current regime in Kabul.

For many, many reasons we should get out of Afghanistan. This just adds another. Pakistan's government is close to civil war against a segment of its own population because they are our ally and we're fighting in Afghanistan. Tensions would fall in Pakistan if the Afghan war were to end.

It would be nice to bring democracy and prosperity to Afghanistan, but the prospects have never been good and haven't gotten better since 2001. On the other hand, India is the world's largest democracy and Pakistan has a semblance of one. They have 25 times the combined populations of Afghanistan and Iraq. For what we're pissing away in Afghanistan and Iraq, we could bring clean water and basic sanitation to everyone on the Indian subcontinent and become relatively beloved.

Iraq and Afghanistan run by people we don't like isn't a disaster. Much of the world is run by people we don't like. This would have been a better proposal in years past when the United States actually had the wherewithal to be internationally generous, but we should start by ending the wars ASAP and then, after the depression, start to do something constructive.

Silly Economics

Perhaps the dumbest suggestion I've read about curing the current financial crisis was published by Forbes on their Web site. It's by one Frank Beck and advocates a 30% devaluation. Not just by the USA, but by every other country in the world as well. There are a lot of comments attached and I haven't read them all in detail, but scanning through I only found two that raised the question, what does this mean? Neither suggested an explanation.

Since we're not on the gold standard, we can't devalue the currency relative to gold. If every country "devalues," then they aren't devaluing relative to each other. It's mathematically impossible to devalue the dollar relative to the dollar.

Mr. Beck seems to be confusing the fact that a rising CPI "devalues" the purchasing power of the dollar, but this has nothing at all to do with "currency devaluation," which he seems to advocate in some puzzling form.

And for historical accuracy, FDR eliminated convertibility between gold and the dollar, but not the peg. Nixon took us off the gold standard. And the economy did not recover much after 1934 before crashing again in 1937.

This is a good example of why the blogosphere will not ultimately replace serious reporting. Almost all of the 50-odd comments presented a strongly felt opinion -- ranging from support to denunciation as Keynesian and communistic. Nobody observed that "good" and "bad" cannot be applied to a concept that is self-contradictory. If you want to read about economics, check out Robert Samuelson, who has qualifications and is paid to write. Amateurs writing blogs are usually idiots. Present company excepted, of course.

Mr. Beck evidently earns a living giving investment advice. Caveat emptor.