All Things in Moderation

Form the WSJ this morning, A Short History of the Income Tax:

Unfortunately the corporate income tax, originally intended as only a stopgap measure, was left in place unchanged. As a result, for the last 98 years we have had two completely separate and uncoordinated income taxes. It’s a bit as if corporations were owned by Martians, otherwise untaxed, instead of by their very earthly—and taxed—stockholders.

This has had two deeply pernicious effects. One, it allowed the very rich to avoid taxes by playing the two systems against each other. When the top personal income tax rate soared to 75% in World War I, for instance, thousands of the rich simply incorporated their holdings in order to pay the much lower corporate tax rate.

There has since been a sort of evolutionary arms race, as tax lawyers and accountants came up with ever new ways to game the system, and Congress endlessly added to the tax code to forbid or regulate the new strategies. The income tax act of 1913 had been 14 pages long. The Revenue Act of 1942 was 208 pages long, 78% of them devoted to closing or defining loopholes. It has only gotten worse.

The other pernicious consequence of the separate corporate and personal income taxes has been a field day for demagogues and the misguided to claim that the rich are not paying their “fair share.” Warren Buffett recently claimed that he had paid only $6.9 million in taxes last year. But Berkshire Hathaway, of which Mr. Buffett owns 30%, paid $5.6 billion in corporate income taxes. Were Berkshire Hathaway a Subchapter S corporation and exempt from corporate income taxes, Mr. Buffett’s personal tax bill would have been 231 times higher, at $1.6 billion.

So which is Buffet…misguided or a demagogue?

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Apologies for the length of this post.

Since 2008, the term “derivative” with regard to the finance industry has become much maligned and has been regularly used, both in the press (which loves a simple story) and among politicians (who love to see someone else blamed for problems) as the all purpose villain in the story of our economic collapse of that year.  And this notion of “derivatives” as somehow to blame for our troubles has largely been absorbed by a public that in fact knows next to nothing about what a derivative actually is, much less the part they might have played in fueling the crisis which came in 2008.  So perhaps an explanation of what derivatives are and the role they play might serve to dispel some of the misinformation that our politicians and the press are happy to leave lingering in the public mind. 

First of all, the term “derivative” is a generic term that refers to any product or contract the value of which is based upon, or derived from, the value of another product.  What does this mean?  Well, consider perhaps the easiest to explain, a simple commodity derivative, or what is more commonly know as a commodity swap.  The current price of a barrel of oil is about $85, but we have no idea what the price will be in 6 months. Imagine a contract between you and I in which I agree to pay you $85 a barrel for 100 barrels of oil in 6 months, and you agree to pay me whatever the actual price is in that day, also for 100 barrels.  Now since we are each buying and selling the same number of barrels of oil to each other, there is no actual exchange of oil.  All that will be exchanged, or “swapped”, in 6 months is a cash flow.  I pay you $8,500 (85 times 100) and you pay me X  times 100 where X equals the price in 6 months.   The value of our contract is derived from the price of oil, even though neither of us is actually buying oil.  Hence, it is a derivative.  

How, you might be wondering, could such a contract have precipitated the demise of the housing market in 2008?  It couldn’t. And didn’t. In fact there are all kinds of different derivative markets…fixed income derivatives, equity derivatives, credit derivatives, commodity derivatives, etc.  These are all very distinct  markets, and most of them had nothing whatsoever to do with the collapse in the market in 2008.  

There was one financial innovation in particular which did contribute to the problems in 2008, the CDO, or collateralized debt obligation.  These were groups of mortgages packaged together as a single security and sold to investors. How did this contribute to the problems of 2008?  The demand for CDO’s greatly increased the amount of money available to mortgage borrowers, resulting in easy borrowing and thus helped fuel the buildup of the housing bubble.  The thing is, CDO’s are not derivatives.  They are securities. 

Now, there are, derivatives on CDOs, called synthetic CDOs, and as you might have guessed, are contracts that derive their value from underlying packages of mortgages.  They are essentially a form of credit derivative, wherein one party buys protection from the other contracting party regarding some underlying credit event. In a typical credit derivative, the underlying credit event is usually the default of a given company on a given piece of debt.  The buyer of protection will pay a monthly or quarterly premium to the seller, and the seller agrees to pay the difference between par and value of the referenced debt in the event of default.  In a synthetic CDO, the referenced credit event is the default on a package of referenced mortgages.  

It was these synthetic CDOs that were the subject of the infamous congressional inquiries which featured testimony from several Goldman Sachs employees, including Lloyd Blankfein.  Now, there are definitely some interesting ethical issues involved in creating these synthetic CDOs, because if the buyer of protection does not actually own the referenced credit risks, his purchase is little more than a bet that the referenced credits will default, and the sooner the defaults occur, the bigger the payoff for the buyer. So in a synthetic CDO, the buyer has an incentive to include the riskiest possible mortgages.  The seller, of course, wants the safest ones.  Generally speaking, this wouldn’t be a problem, as both sides have to do their own analysis of the mortgages involved, and they both must agree for a deal to get done.  But what if the seller is relying on the advice of the arranger, Goldman Sachs, and GS fails to advise them that the buyer does not actually own the underlying credit risks, and is therefore selecting the underlying credits based on the likelihood of default?  This was the nub of the criticism aimed at GS during it’s congressional testimony.  

But whatever you think of the ethical issues involved, these types of derivatives did not really contribute to the underlying conditions that led to the collapse of 2008.  Remember that, as derivatives, they weren’t actually adding money to the mortgage market, as regular CDOs did.  They were nothing more than either hedges as protection against the default of mortgages that were already owned, or they were bets against the performance of already written loans. And there is even a reasonable argument to be made that, had more people been willing to buy naked protection sooner (ie bet against the performance of mortgages), it would have been a signal that the real estate market was over heating and may have burst the bubble sooner.   

The one way in which derivatives can be said to have contributed to events is that they compounded the liquidity issues faced by financial institutions in the fall of 2008.  Most derivative contracts between market participants are collateralized, which means that, as the value of the contract changes, collateral must be posted on a daily basis to cover that value.  As markets became tumultuous in 2008, a lot of these contracts required larger and larger postings of collateral, at exactly the time that it was becoming more and more expensive, and in some cases impossible, to borrow short term money.  This is precisely what happened to AIG. It couldn’t borrow the money to meet its increasing  margin and collateral obligations. 

In any event, the point here is basically that the demonization of derivatives is much too overblown. While there are certainly legitimate questions to be raised regarding the structuring of certain kinds of derivatives, most derivatives played virtually no role in the collapse of the economy in 2008, and certainly were not responsible for the wider economic conditions in the nation, the consequences of which we are are still living with today. 

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Saw this over the weekend. Basically, this billionaire wants to move beyond simple charity to put his money to use in efforts that will lead to job creation and a more lasting effort. I think it’s kind of a “teach a man” vs. “give a man” idea.

But, he’s got an email address and is soliciting ideas. Perhaps a group letter is in order?

See the column here

Late edit: Obviously he should pay us to post on this blog.

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I originally blogged this on my own blog in January of 2004 (back when I blogged regularly).

Here it is, for posterity:

Finally, Republicans control it all, so it’s back to smaller government, right? Wrong! It’s back to Big Government–in fact, the Biggest Government ever!

From Deroy Murdock in National Review (read the article here):

A forthcoming Cato Institute study rates American presidents on real domestic discretionary spending. Lyndon Johnson hiked such outlays by 4.3 percent before they grew 6.8 percent under Richard Nixon. Jimmy Carter’s 2-percent increase preceded Ronald Reagan’s 1.3-percent reduction. Clinton’s expenditures advanced 2.5 percent, but Bush’s spending boom more than triples that figure to 8.2 percent. Most of this is beyond the war on terror.

Now, I say again: Bush –> Nixon. I keep on seeing it. And 98% of the Republicans (supposedly our beloved ’94 sweep, contract with America types) in congress are going: “Sure, let’s spend more. And more. And even more.”

But, as Roger Hedgcock, a conservative talkshow host and former congressman often points out, it’s hard to understand how intoxicating it is to spend Other People’s Money to a politician, unless you’ve been there. They’re all addicts. I haven’t been there. But I can imagine. There’s just so much tax payer revenue concentrated on one place. How much good could you do? How popular could you become in your district back home?

Never mind that spending is out of control.

And shame on the Democrats who, in the face of such bald-faced hypocrisy and utter fiscal irresponsibility, can only say deficits are up because of “tax cuts to the rich” and, simultaneously, demand more money for education (despite the highest outlay ever) and other social spending, and say that not enough is being done. They won’t say that $500 billion is “not enough” for the prescription drug benefit, but they have all complained that it doesn’t cover enough, that seniors are left to pay for too much on their own . . . what is one left to conclude, except that they think that the largest growth in real government spending is not enough and we should, instead, be spending more and make up the difference with what one would have to imagine for zero-based thinkers the highest tax hikes in history (because, if the only way to raise revenues is to increase taxes, then how else can you pay for even more spending than has come from the spendiest administration in history?).

I doubt I’ll do it myself, but I understand why conservatives are proclaiming their going to vote for a libertarian candidate. I can’t—there is a happy medium between “no government” and “all government” somewhere—but I understand it. I also understand why a lot of Democrats would vote for Nader. At least McGovern had some consistency. Carter had some consistency.

Although, for the most part, Bush has been very consistent for a politician—he promised outrageous social spending and the opening of the borders and, dammit, if he ain’t delivering. And, he promised tax cuts and constructionist judicial appointments, and he’s doing that, too.

And I understand certain “message” spending—increasing the budgets for the National Endowment of the Arts or being the biggest spender on AIDS in Africa and what have you, but the prescription drug benefit is a massive social spending boondoggle that will be rife with waste and fraud and essentially burn taxpayer money forever, without really providing a tangible benefit to society as a whole . . .

On the plus side, the liberalism of Richard Nixon and Gerald Ford provoked the “Reagan Revolution”, so maybe the compassionate conservatism of George Bush will provoke a response–an actual Reagan conservative who might, say, reduce government rather than just taxes.

Oh, well. Speaking of taxes, back to paying mine.

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Speaking of the economy. Investors dumping equities in favor of cash and bonds (I’m a cash man, now, myself).

The rich get richer, but everybody else mostly gets poorer. Is it class warfare if it’s kinda true?

We invented the internet, but compared to many other places, our average broadband speed sucks.

This should tell you something about the current Republican field: 56% of registered Republicans don’t have a preferred candidate.

Troy Davis executed.

ashot, here, throwing in a link from The Economist about taxing the rich.

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Joint Statement From Governor Cuomo, Christie, Corbett and Perdue Urging Congress to Put Aside Politics on Disaster Assistance

Albany, NY (September 23, 2011)

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The WSJ reports:

Nonprofits across the state are campaigning against a provision in President Barack Obama’s jobs bill that would limit itemized deductions, including charitable deductions, for individuals with an annual income of $200,000 or more.

The federal proposal, which would cap itemized deductions at 28% from the current 35%, has provoked particular concern in New York, where nonprofits last year lost a fight against a state bill that reduced deductions from 50% for individuals earning $10 million or more.

While that policy ensnared an influential but limited portion of the oppulation, New York charities fear that the federal proposal will curb charitable giving among a much broader swath of potential donors, possibly compounding the impact of the state law.

Why is it that discriminatory laws that would be deemed outrageously abusive (and certainly unconstitutional) if targetting any other demographic of the country are considered perfectly acceptable when targetting a group defined arbitrarily by their income?

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Liam Neeson crashes in a plane and punches a wolf with razor knuckles in The Grey. Dude just won’t stop working.

In March of this year, Steve Gibson on Security Now (with Leo Laporte) discussed the anatomy of the Stuxnet worm. This is a lengthy commitment to listen to (over an hour–might skip the news at the top of the show), but Stuxnet was a virus (weaponized malware), designed by the Israeli’s to disrupt the Iranian nuclear program by reprogramming the industrial controllers on the centrifuges being used to enrich uranium for their “nuclear plant” (wink-wink, nudge-nudge). To do this would have involved the Israelis breaking into more than one American company, and purposely infecting more than one vendor who sold to, or vendors who sold to vendors who sold to, Iran.

That it worked is amazing and scary. Here is a lower quality MP3 version for folks who can’t do the video.

Anybody here remember Pianosaurus, the band from the late 80s that played everything on nothing but toy instruments? My favorite was always Something Funny Happened on the Way to the Toystore.

Don’t rent out your place out on AirBnB. Not unless you want it trashed. Because AirBnB will want you to take down your blog post complaining that your apartment trashed, but will refer to their ToS if you want them to do anything to help assist you with the criminals they sent to your apartment or house.

Nostalgic for time spent watching HBO’s Video Jukebox before the debut of MTV? Well, here ya go: Robert Palmer’s video for Johnny and Mary. I can’t get to YouTube, so I’m just hoping that’s the right one.

There are ghost writers for Twitter accounts for people who aren’t that particularly well known? How do I get a job like that?

It’s the end of the world as we know it! R.E.M. retires. What will the Furry, Happy Monsters do?

Remembering Braniff Airlines. Rest in peace, Big Orange!

Five million books spend more time talking about Texas than Tennessee. Or California. Put in any terms you want, and find out that “betwixt” and “thou” were more popular words, in books, in 1800 than in 2000. “Thou” much more than “betwixt”.

This post brought to you by you rebels out there. You know who you are. — KW

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I know I harp on the middle class and jobs, probably too much for some of you, but without a thriving middle class I don’t think American business succeeds in the long run. Not to mention the misery of lost wages. Here’s a chart linking education to wages. Wow, even that Master’s Degree may not protect you in the future. I better have my daughter revisit that PhD scholarship.

CHART: Only Advanced Degree-Holders Saw Wage Gains In Last Decade The only group of Americans whose average wages increased over the last decade were the 3 percent with advanced college degrees (other than a master’s degree), according to data released by the Census Bureau. The 1.5 percent of Americans with an M.D., J.D., or M.B.A. saw wage gains of about 5 percent, while the 1.5 percent with a Ph.D saw gains of slightly more than 5 percent. Among those with a four-year college or master’s degree — more than a quarter of the American workforce — average wages dropped by about 7 percent, and wages dropped even more for those who haven’t completed college:

lmsinca……..click on chart link for a visual

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Having seen and heard this suddenly famous video class-warfare rant by Elizabeth Warren several times, I boldly predict that, in addition to the ideological reaction she will provoke, she will turn off many, primarily men, with her persona, her voice, her body language. I’ve seen her and heard her in person, but on the stump she is going to be quite unappealing and indeed repellant to many.—QB

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Senators are grilling Google over where certain things come up in search results. “You’re cooking the books!” Of course, it’s (a) mostly nonsense and (b) not really the frickin’ senate’s business, in my humble opinion, even if they knew what they were talking about when it comes to post-19th century technology, which they mostly do not appear to.

Franken railed against him, “We are trying to have hearing here about whether you favor your own stuff, and you admittedly don’t know the answer.”

I mean, called me crazy, but I would kind of expect Google to favor their own stuff. On their search engine, which they make available to the general public. For free. With no promises to never promote themselves in any way. Good grief. — KW

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Anybody watching? Or have comments after-the-fact?

Update: This is nothing more than okie solo live blog of first 30 minutes of the debate. (6 comments)

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