Coffee heat rising

Integrity, Confidence, and Trust: A financial manager’s view of the economy and the future

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This is a guest post by Stephen Taddie, managing partner of Stellar Capital Management, LLC, located in Phoenix, Arizona. Stellar, which manages my vast fortune, has contrived to keep my shirt and my IRA more or less intact as the economy has crumbled around our ears. The essay, which provides some insight into what capital managers and financial advisors think of the events leading up to the current recession and offers some prognostication about the near-term economic future, was Mr. Taddie’s New Year’s message to the firm’s clients.

People in positions of power often claim to have integrity, and the public needs to have confidence in those people in order to trust the system. The sheer number of “ethically challenged” individuals who have surfaced lately makes it increasingly difficult to see through the haze of hypocrisy and to trust anything. At present, we are seeing a crisis in confidence so great that many investors are willing to accept a zero return just to have the U.S. government hold their funds.

If you take a quick glance around the country, you’ll find a governor who attempted to sell a senate seat, a self-anointed savior of the masses (also a governor) patronizing a prostitution ring, a senator convicted of several felonies almost winning an election, and numerous other government officials taking liberties, receiving special treatment or deals. Those in professional sports also continue to be ethically challenged, from athletes doping to referees influencing games for personal benefit. Hollywood and the music industry provide enough content year-in and year-out to keep thousands of magazines, newspapers, and web sites in business. Remarkably, we allow this type of behavior to continue by giving candidates our votes and contributions, as we buy tickets, magazines and memorabilia for morally bankrupt celebrities. Integrity has been all but lost in political maneuvering, convenient omissions, and downright deceit.

I left the financial industry out of the previous paragraph only because its problems have been so plentiful it needed its own paragraph! Bigger, better, more complex has been the cry from Wall Street for the last decade, and that has produced overpaid, ethically challenged executives; programs and products like hedge funds and subprime loans; and fund-of-funds and credit default swaps. The list goes on and on. As things grew more complex, investors found themselves further removed from their money and the people actually responsible for its well being. Although stockholders could always vote on the tenure and compensation of a company’s management, most investors are not in a position to do so in a meaningful way. When twice removed from the actual investment, as is the case when investing in a manager of managers program or in mutual funds, investors must rely on highly paid executives to vote on the tenure and high salary of other executives, in a more or less self-perpetuating cycle. for most individual investors, exerting shareholder control has become a thing of the past.

As Warren Buffet said, “It’s only when the tide goes out that you learn who’s been swimming naked.” Growth hides many structural problems and 2008 was a year of revelations. Take the case of hard-money lenders. In many parts of the country these firms were lending money directly to developers and builders and offering steady 12 percent returns to investors. A few years ago, Stellar interviewed two such local firms and, after substantial due diligence, decided to wait out the brewing storm. In general, we saw that these programs were losing sustainability because of lack of appreciation and new buyer interest in development projects. One firm, now in the headlines, lacked enough internal controls for our comfort, and we eliminated them from consideration. I’m sure other firms like ours made similar decisions;but some did not. More recently, Bernie Madoff’s complex “Ponzi” scheme made the headlines, leaving a mess for investors and regulators. In both cases, integrity was lacking and trust was betrayed. Other firms misrepresented the scope of their services, appearing to be sophisticated money managers on the outside, but when the tide went out, were found to be nothing more than high-priced marketers or “feeders” for the real manager of the assets, offering no real value to their clients.

To recover from the present economic ills, massive stimulus programs are being worked into the system. This has effectively put a safety net under the economy in an effort to restore confidence. As confidence replaces fear, a valid case can be made for either a “¾ V-shaped” recovery, where the economy recovers into a less leveraged, slower-growth version of itself; or a “W-shaped” recovery with a double-dip recession beginning near the end of 2010. Due to decreased leverage in the global economic system, a more typical “V-shaped,” or complete, recovery does not seem likely in this cycle.

Barring more surprises, the economy should transition from stimulus-driven economic activity to organically driven growth late in 2009, leading to a ¾ V-recovery. As we approach 2011, the prospects of higher tax rates due to “sunset” provisions in the current tax code could cause economic activity to accelerate. This would create an after-the-fact lull in economic activity, pushing it back to recessionary levels in 2011, leading to more of a W-shaped recovery. The eventual shape of the recovery depends on how and how much stimulus is deployed, the extent and timing of its removal, and other policies established to smooth the transition both here and abroad.

At some point, the investment markets will turn around. Since mid-November, the S&P 500 has risen about 20 percent, rebounding from “technical support” and building a potential “bottom” around the 900 level. Volatility has calmed down a bit, and liquidity seems to be returning to the markets. However, that has not stopped the yield on 10-year U.S. Treasury bonds from falling to levels not seen since 1955, and coming close to the lows experienced during World War II. The economy is still trying to find a stable footing, and economic data in the next few months will probably continue to be ugly, but the markets may have already discounted the expected data and may be beginning to look beyond the present abyss.

While we believe that world affairs are in better shape than they were during World War II, the bigger issue facing capitalistic societies today is “trust.” Without it, the economy will stumble; with it, it will thrive. When trust comes back to the system, investors will be less willing to park money in essentially noninterest-bearing Treasury bonds and more interested in making educated, longer-term investments.

Here’s to trust…Happy New Year!

January 1, 2009

The perqs of pinching pennies

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Spent some time this morning updating the Excel and Quicken books and realized things didn’t look nearly as dark as one might expect, given the current brouhaha over the economy.

On the other hand, we do recognize that any time now, the layoff ax, sharpened to a fine edge by a legislature in full Mme. LaFarge mode, may fall. So, I took a little more time to look over the current state of the safety net.

Four things have helped to weave that net:
1. I set up a “pool” account to hold my paychecks, from which I disbursed enough cash into one credit union account to cover my monthly recurring expenses, such as utility bills, insurance premiums, and workmen into one checking account and then, into a different account, enough to cover all my other expenses, which are charged on American Express and paid off at the end of each billing cycle. The disbursements are monthly. But my paychecks are biweekly.

The effect of this has been to turn those so-called “extra” biweekly paychecks into real-life, de jure extra income: the money to cover regular expenses comes out of two checks a month, and so a month with a third paycheck pours two weeks of net income into my “pool” account, where it sits and accrues.
2. I based the amount needed for monthly recurring bills on the maximumamounts those bills reach. My electric bill, for example, has reached $225 in the summer, but in December it was $63.52. Then I pinched pennies: this winter I’ve not run the central heating more than six hours, grand total, pushing each month’s bill well below what they were in 2007. I also cut my “all other expenses” budget by $300, even though I had enough income to cover the old, more generous budget.

Here, too, the net effect was to leave cash sitting in those “piggy-bank” accounts. This money has accrued by dribs and drabs over the past several months.
3. After I’d accrued enough cash to pay off the small 30-year fixed-rate second mortgage I took out to pay for renovations on the Investment House (the house my son and I are coinvesting in, part of whose mortgage is covered by rental income), I continued to put the monthly contribution into savings. I had been saving $200 a month for emergencies and indulgences. Reaching the loan payoff goal meant that I could start saving $404 a month.

Even though that doesn’t sound like much, it’s amazing how fast it adds up. Especially because…
4. My associate editor and I started a small side business, which has created a small but steady second income. All of the after-tax revenues from this activity went directly into savings.

The result: my emergency and indulgence savings quickly jumped from $600 to almost $4,000. Even after I paid $670 to insulate the Investment House and $330 for the Talbot’s clothing frenzy, I still have around $3,000 in that savings account.

When I surveyed my credit union accounts and added up the overage in each account, the total extra amount that has quietly built up over just a few months is $6,797!

That is 2.26 months’ worth of my present take-home pay: over two months of living expenses, and we’re not talkin’ Depression mode there. If I’m not putting $404 a month into savings and not buying booze and not shopping at my favorite gourmet emporium, that amount will stretch a great deal further.

Meanwhile, the amount that I’ve stashed to pay off the loan represents another seven months of take-home pay. Because the payments are so small as to be almost negligible, I’ve kept the money in savings instead of paying it off, figuring that if I need to cut expenses drastically I can use the money to get rid of the monthly payments. Or not: in a real emergency, I’ll have the choice of using some or all of the cash for survival.

If I had to do that and I were really in desperation gear, that 9.26 months’ of my current net income would go much further: it would support me for well over a year. Remember, that’s not counting freelance income and whatever part-time teaching I can scrounge from the community colleges. It doesn’t count Social Security, and it doesn’t count the $17,000 the state owes me for back sick leave, or the month’s worth of accrued vacation time for which the state will owe me.

So. Un-American though it may be, frugality has saved this worker’s little tail. If I’m laid off within the next few weeks or months, a threat that again looks very credible, I have a safety net that will keep me from falling to the ground and breaking into a million little sherds—because I’ve been living within my means. Well within my means: I’ve been spending enough less than I earn to stash a substantial amount of beat-back-the-wolf cash in savings.

Call me unpatriotic and call me naïve. But I still think this is not a bad thing. I still think if most Americans understood what simple frugality means—and that it does not mean living like Scrooge McDuck—we would all be in a lot better shape.

Well…all of us except a few zillionaires who took advantage of our late, great free-spending times.

McDuck portrait(link) by Carl Barks

The devastation of higher education in Arizona

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Here’s the University of Arizona president’s statement on the Draconian cuts our legislators propose to inflict on the state’s already constricted higher education system:

Earlier today legislative leadership put forward figures on possible cuts to higher education in the State of Arizona. They have suggested mid-year cuts to the university system that could total $243 million, approximately one-quarter of the entire budget, with a total reduction of $388 million into fiscal year 2010.

Mid-year cuts to the University of Arizona would total $103 million under this scenario.

These figures are so extreme that they would absolutely cripple higher education in our state. At the very time that our state needs to stimulate the economy, the Legislature is talking about absolutely devastating cuts to the most powerful economic engine in our state. If enacted, these cuts would compound the current economic challenges in our state and make it harder for Arizona to recover from the recession. This is simply irresponsible.

The state needs to protect its universities, not dismantle them, if it has any hope of building an economy for the future or aspiring to more than mediocrity.

We are very conscious of the difficult deficit challenge facing the state, and all three universities are prepared to do their part to cut budgets. But cuts of this magnitude wouldbring irreparable damage. It would force the closure of colleges, increase the costs for attendance, and ultimately cut access to the best hope of a better way of life for our young people.

Compounding the budget cuts are proposals to micro-manage the universities. This is simply unacceptable.

We plan to continue conversations with the governor and key legislators, and to focus on helping them understand the key role that The University of Arizona plays in spurring theeconomy, improving the quality of life in the state and affording access to upward mobility.

And we encourage every citizen of this state who cares about their quality of life, who wants their children or grandchildren to have an opportunity to attend a quality university, to speak up now and to speak loudly.

It is wrong to balance the state’s budget on the backs of its citizens’ children. That is what the massive budget cuts proposed for the state’s university system will do: penalize our young people for the crimes and stupidity of our country’s political and financial leadership. This is unfair and simplywrong.
The proposed Arizona State University budget cuts for 2009 and 2010 would be the largest higher education budget reduction in the state’s history. Cuts of this magnitude would require ASU to reduce costs by up to $126 million and $194 million next fiscal year.
If every student at ASU decided, voluntarily, to donate an equal portion to the State of Arizona to make up for these slashes, each student would have to cough up $1,880.59 this year and $2,895.52 next year. To survive, clearly ASU will have to raise its tuition by about those amounts.
These are not students who can afford private colleges or universities in other states. Most attend ASU because it’s what they can afford to pay for, and for many, the existing inflated tuition is a hardship. [If you have a relevant personal experience, insert it here; in any event, delete the following, which I’m leaving as a for-instance: My son wants to pursue a master’s degree at ASU but is given pause by the prospect of student loans that could put him in hock for decades.Not years:decades.Any increase will be a hardship for him. You can be certain that spikes in tuition of that size will keep him out of graduate school. He won’t be alone.] These proposed funding cuts and the tuition increases that will inevitably follow will bar many of Arizona’s young people from four-year degree programs, period.
ASU is prepared to do its fair share to help our state out of the budget crisis; however, these proposed disproportionate cuts are simply impossible to institute without gutting the university.
Seven hundred jobs have already been lost at ASU. The proposed drastic cuts to ASU’s budget will mean large numbers of university staff and faculty will lose their jobs. More programs will be dismantled, more course sections will be combined to make impossibly huge classes, and more classes will be eliminated. This will demolish the quality of higher education that our state has so desperately needed and for which legislative and educational leaders have worked so hard. It will set the state back two generations.

Crippling cuts will also severely compromise our state’s future, so much so it may never recover. Our legislators must realize the long-term consequences that are not easily reversible, such as lost business, workforce and related revenues. To fail to acknowledge this is not only poor public policy, it’s irresponsible and unconscionable.

Don’t wait. If you live in Arizona, write to your legislators now. If you have friends or relatives who live in Arizona, urge them to write. If you give a damn about young people, write to Arizona’s congressional leaders and governor. Our future depends on it. Our children’s future depends on it. Our grandchildren’s future depends on it.

Bye, Little TV Set; Bye, Evening NewsHour

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Speaking, as we were yesterday, of Evan Mecham, Arizona’s late great moronic governor—a man who could whip W in an Olympic-level stupidity contest, hands-down—in just a few weeks now I will lose the TV set that allows me to watch the PBS Evening NewsHour. This is the only source of in-depth national news that’s easily and consistently available to me.

NPR does run some news, but most of it is commentary and yak. The actual news reports are short and perfunctory. And because I listen to NPR mostly in the car, getting the news this way is a catch-as-catch-can process.I try to read a national newspaper in the morning—the local metropolitan paper has been converted to a tabloid and no longer carries much news at all—but there just isn’t enough time to do more than skim the front page. Often I can’t even get that much read.

What does ole’ Evan have to do with a television set, and why is it about to go away?

Evan Mecham’s tenure in the Governor’s mansion was a nonstop sideshow. Every day he would open his mouth and something ludicrous would come out. It soon got to be so outrageous and so hilarious that everyone went out and bought a small, cheap television set for their office so as to catch the latest antics as they happened. I picked up one at Smitty’s, the now-defunct supermarket chain, for about $40 (can you imagine?).

Mecham was thrown out of office in 1988. But my little Evan Mecham television set still runs cheerfully, after more than 21 years of faithful service.

dcp_2326These days the Evan Mecham television resides on top of the refrigerator. I’m usually fixing dinner right about the time Jim Lehrer comes on, and so that’s when I turn the TV on to watch the news. The little television set is so old it probably doesn’t have a connection for the new HDTV box that we’re being made to purchase if we want to keep watching TV off the air, nor is there room on the fridge for the box and special HDTV rabbit-ears: two new dust-catchers.

[Oh, lovely: 4:22 in the morning and the locals are shooting at each other. That sounded like a semiautomatic pistol, rather than the usual streetsweeper. Close enough to set the dog off…jerks!]

Where were we? Oh yes, the television: Our beloved government’s enforced changeover to something many of us don’t especially want or care about will render my old friend unusable. And in doing so, it will bring a stop to my watching the evening news. It will close off a major source of news for me.

The local PBS station does rerun the NewsHour on one of its new ancillary HDTV channels later in the evening, but by the time I’m ready to sit down in front of the bigger television, I’m so tired I can barely keep my eyes open. I usually fall asleep within a half-hour after I turn the thing on.

To my mind, a TV set is no decorator item. I do not want a battleship-gray eye staring at me in my living room, and I consider it rude to have the thing nattering on and on while guests are here. The main TV resides in one of the back bedrooms (so designated “the TV room”), and there is noooo way I’m bringing that thing and its ugly HDTV rabbit ears and its dust-catching HDTV box into the front of the house. Even the smallest of new TV sets, at least as far as I can tell, are so absurdly expensive that I can’t afford to replace the little guy.

So, come February and the mandated switch to HDTV broadcasting, it’s good-bye to Jim Lehrer.

Amazing,isn’t it,how these technological advances enrich our lives?

Legislators propose to shoot us all in the foot

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More scary news from the Great Desert University: Our beloved president sends an announcement that our ever-astonishing legislators yesterday recommended cutting the university systems’ funding by $243 million in what remains of FY 2009 and then by another $388 million in 2010. That is huge: the largest cuts in higher education in the state’s entire history. And this is not a state known for its support of education.

Arizona has only three public universities, and you can count the private institutions of higher education on the fingers of one hand. None of these are exactly world-class institutions. A few departments are excellent: the University of Arizona, for example, has one of the world’s leading astrophysics programs, and Arizona State University has cultivated a good business school and a research emphasis in bioengineering. But by and large the universities reflect the general quality of education in this state, which as we have seen before, is not high. In an Arizona university classroom, it’s possible to guess with some accuracy which students grew up in the Midwestern states where citizens invest in education, simply by observing the students’ basic writing and logical thinking skills. Nine times out of ten, I can identify a kid who came from Ohio, Minnesota, or Iowa just by reading a paper or two.

This is the direct result of Arizona’s chronic underfunding and neglect of education.

“Budget reductions of this magnitude,” says Arizona State University President Michael Crow, “would have a serious and immediate impact on university operations.” The $39 million that had already been cut in the 18 months leading up to FY 2009 have so far resulted in the elimination of almost 500 staff positions and more 200 faculty associates, the dismantling of two schools, and a reduction in the number of nursing students.

Arizona State University serves 67,000 students. It graduates 14,000 a year, and its president claims it pumps $3.2 billion a year into the state’s economy. The planned cuts, Crow reports, will require additional layoffs, furloughs, and reduction of programs that already have enrolled students for 2009.”The fact that the legislature has known about the state budget problems for months and failed to take appropriate and effective action to minimize harm to Arizona’s families and economy is unconscionable,” he adds.

Unconscionable, yes. But surprising or anything new? No. This kind of thing is standard operating practice, historically, for the state’s legislative leadership.

With Governor Janet Napolitano leaving to head up Homeland Security, the state loses its strongest advocate for intelligence and commonsense, one whom our legislators have resisted and fought every step of the way. Her replacement will, according to the state’s constitution, be the present secretary of state, a dim light whose politics and retrograde thinking echo those of the blessedly exiting presidential administration.

Our new governor, heaven help us, is the woman who is responsible for state employees losing all choice in health-care plans: her husband, an executive of a large insurance company, was involved in submitting a bid for the contract to insure state employees that was below the break-even point, so that Blue Cross/Blue Shield, at the time the only decent insurer we had, pulled out in protest of the blatant conflict of interest. For a time, we had just one insurer, the one for which our new governor’s husband worked. This company was so roundly hated by the medical profession that many doctors (including most of mine) would not accept it. If you wanted to go to your doctor, you had to pay in cash and then try to extract the money yourself from the insurer, a process that at best required three to six months. My dermatologist would not let me set foot in his office, even after I said I would pay in cash! To get care from the doctors I knew were reasonably competent,I had to buy my own insurance on the open market. Today the state has to self-insure its employees, thanks to that fiasco.

And she’s pretty typical, this new governor. Remember, this is the state that once elected Evan Mecham, the stupidest holder of elected office in the nation’s history. After Mecham made a laughingstock of Arizona, his predecessor, an affably muddle-headed fellow, looked smart: he was the one who announced that he had never read a book from cover to cover except the Bible and had finished school with a junior college diploma—and he didn’t see why anyone else needed to do anything any different. After all, look how far he’d gone!

That one’s favorite byword was (I kid you not!) “It’s a beautiful day in Arizona. Leave us all enjoy it.”

You can see where all this is going: straight back to the Dark Ages.

So, to personalize, it appears that the danger of a layoff where I’m concerned is still very real and very immediate. The university’s administrators are already firing library staff, and I’m sure they soon will move beyond that.

Related Posts:
The Devastation of Higher Education in Arizona
The Perqs of Penny-Pinching