Return on Investment

July 11, 2010

This is Tony Hayward, a man who combines the ruthlessness of Mao Zedong with the sheer genocidal glee of Hitler. Add the economic scorched-earth policy of General Ne Win, and a dash of Saddam Hussein’s disdain for the environment, and in the BP chairman we have a thoroughly contemporary supervillain. In some circles, he’s almost as hated as George W. Bush.

BP has lost $102.7 billion in 10 weeks. That’s the GDP of Poland, the country with the 18^th-largest economy in the world. All because Hayward wouldn’t ensure that the series of valves used to prevent a blowout on the Deepwater Horizon rig included a trigger with a “deadman’s switch” that only stays inactive when the rig is manned. It would have cost an extra $500,000. The law didn’t require a deadman’s switch on Deepwater Horizon, and still doesn’t, but surely someone as diabolical as Tony Hayward should be able to predict the future. The populist wisdom is that Hayward ought to be keelhauled for the unspeakable atrocities he’s committed in the lubeless anal rape of Mother Gaia.

This is Franklin Delano Raines, former chairman of Fannie Mae.

(This always needs to come with an explanation, because so few people understand what this famed but mysterious entity does. Same with Freddie Mac. This particular explanation involves only Fannie Mae, but the two are close to interchangeable.)

You get a mortgage through a standard lender. But that lender can only lend out so much, relative to its assets. So the lender sells the rights to your loan to Fannie Mae, then takes that money and can loan it out. Multiply that by all the lenders in the nation, and Fannie Mae is essentially a bank with limitless funds. The argument for Fannie Mae’s existence is that it gives more people a chance to own homes, leaving open the question of why this is so important that it needs to be achieved artificially.

Now Fannie Mae has all these loans on hand – yours, and millions of others. Fannie Mae then packages the loans and sells them to investors. It promises the investors a decent return, and…

WAIT. How can Fannie Mae promise any kind of return? That’s not how investments work.

Private investments, no. But Fannie Mae is a government entity.

No it isn’t. Its own website says it’s a private corporation.
Yes, and the Hell’s Angels are a motorcycle club that gives toys to kids every Christmas.

You’d have to agree that if, say, a bunch of people default on the underlying mortgages, Fannie Mae would have to lower its returns. Except Fannie Mae has access to something that Microsoft, Geico and Cargill don’t: your tax dollars.

If Fannie Mae isn’t a government organization, then why doesn’t it pay state or local taxes? Why is it exempt from Securities & Exchange Commission regulations? Why did it enjoy a AAA credit rating when its debt-to-equity ratio would suggest a D rating?

For the first 30 years (1938-68), Fannie Mae was blatantly and officially a government operation. The only reason it switched to a “private” corporation was to keep its dismal numbers off the federal balance sheet. From that point on, you know the story: Fannie Mae leaned on lenders to hand out mortgages to people who didn’t earn enough money to justify the payments. (Thanks to 1977’s Community Reinvestment Act, an attempt to circumvent classical economics.) Thus Fannie Mae’s returns to investors should have decreased, but didn’t. And why not? After all, ultimately it was someone else who had to pick up the check.

There’s a reason why Fannie Mae goes through chairmen like the Oakland Raiders go through head coaches.

The worse the economy gets, the more harm Fannie Mae and Freddie Mac’s unassailability does to the economy. People can’t pay their mortgages, Fannie Mae and Freddie Mac continue to sell investments, and the implicit government backing becomes explicit, with no end in sight.

BP produces something tangible: without what they offer, our cars would be nothing more than stationary status symbols. Trucks move freight, and need gas to do so. The importance of BP’s role in the economy is obvious. Fannie Mae and Freddie Mac? Not even close. Their very purpose is to thwart economic movement, under the guise of democratizing the way people buy homes. But selling homes, like anything else, has nothing to do with how many people would enjoy the product and everything to do with whether they can afford it.

The cleanup estimates for Deepwater Horizon have ranged from $3 billion (BP’s own, presumably conservative estimate) to $20 billion (the amount the White House “suggested” BP fork over) to $63 billion (a recent estimate by a Raymond James analyst.) Let’s go with $20 billion, which is not just the median but close enough to the geometric mean. This will be paid exclusively by BP’s owners: its shareholders. Which primarily means the pension fund holders throughout the United Kingdom who watch every drop in BP’s stock price (it’s down 57% since the accident) with trepidation. American taxpayers won’t be out a nickel. (Check that. Obviously the oil leak impacts a lot of people economically, just like other unrelated events impact those same people both positively and negatively – just not in their capacity as taxpayers.)

Now, let’s contrast the havoc BP hath wrought with the similar numbers for Fannie Mae and Freddie Mac.

On October 4, 2007, Fannie Mae traded at 67.39. Within 11 months it had fallen to 33¢, a penny or two from where it remains. That’s a loss of $79 billion.

On June 9, 2008, Freddie Mac stock traded at 41. Within 9 months, it sank to where Fannie Mae is today. A mere $26.5 billion loss.

That’s $105 billion evaporated. The companies’ corpses are now the property of…well, you and me, whether you like it or not. We’ve already given Fannie Mae and Freddie Mac $145 billion from a line of “unlimited” government credit, although presumably it’s limited by how much you and I can earn.

The Congressional Budget Office, which has an interest in keeping government numbers as conservative as BP keeps its, estimates that ultimately Fannie Mae and Freddie Mac will cost us $389 billion. Barclays Capital says $500 billion ($1500 per capita.) Other estimates are twice that.

Janet Jackson exposes a nipple, Mark McGwire injects dianabol, an idiot woman conjures up a story about the accelerator and the brake in her Lexus switching places, and Congress can’t wait to publicize the hearings. Yet an entity created by Congress does what government entities do – destroy wealth, but profoundly in this case – and the quiet is deafening.

That quiet is also tampered by the obfuscation of institutionalization. The people who ran, and run, Fannie Mae and Freddie Mac took our money and torched it. They have names.

Daniel Mudd, who replaced Franklin Raines.

Herb Allison, who replaced Mudd and is now the White House’s bank bailout czar.

Congressman Barney Frank and

Senator Chris Dodd, who received sweetheart mortgages of their own from Fannie Mae and Freddie Mac’s biggest clients.

Richard Syron, Freddie Mac’s chairman when the government took it over.
And others too numerous to mention. May God have mercy on their souls.

**This post was featured in Financial Highway’s Best of Money Carnival #60-Best World Cup Goals Edition**

**Named on of July’s top 10 articles at Balance Junkie**

Yip yip yip yip yip yip yip yip/Mum mum mum mum mum mum/Get a job

February 7, 2010

The Silhouettes broke up in 1968. Color photography was still many years away

Meet us back here on Election Day 2012, and tell us that “the college crisis” didn’t become an issue in the 33 months since this post appeared.

We’ve already heard how the domestic automotive industry is the unseverable spinal cord of the American economy, and that it’s our duty to our fellow man (if he’s a UAW member) to spend $50 billion propping up this radiant pulsar of American commerce.

In 2008, you had to go all the way down to the presidential candidate with the 5^th-most votes (the Constitution Party’s Chuck Baldwin) before finding one who didn’t spout off some variation on how crucial it was to “keep Americans in their homes”, even if those Americans borrowed too much money and assumed that a steady increase in their homes’ values was a cosmological constant.

And as we heard from a prior presidential administration, doling out 700 billion taxpayer dollars (that’s $233 for each of us) was necessary to keep some of the nation’s largest investment banks in the business of lending money, otherwise “the whole system would collapse”, which presumably means we’d be reduced to collecting animal pelts in exchange for our mp3s and bedroom linens. “I’ve abandoned free-market principles to save the free market” was the quote. To paraphrase a ‘60s-era t-shirt and bumper sticker, that’s like (having sex) for virginity.

Meet the next bubble – post-secondary education.

The problem is this: despite the recession, our society has gotten so absurdly rich that today, young adults loaded with potential can postpone any worthwhile work and ring up debts in the process, all in the name of getting an education. How “education” became more important than “productivity” or “fulfillment” or “not being a drain on society” is unclear.

Yes, we’ve all seen the studies say that college graduates make more money than high school graduates – somewhere around $15,000 annually. This is a mantra people take to heart without examining in any detail. It sounds logical, as many jobs require applicants to have college degrees. But like many bromides that attempt to persuade you of a fact in as pithy a fashion as possible, the $15,000 allegation tells only a minute part of the story.

The median salary for petroleum engineers is around $108,000. For a physician who’s been out of school for a couple of years, it’s reasonable to assume he’ll make anywhere from $170,000 or so for a pediatrician to more than $500,000 for a neurosurgeon.

What about philosophy graduates? English majors? People who think a sociology degree is worth anything? We don’t have figures for them, because the Bureau of Labor Statistics doesn’t list “barista” and “street musician” as employment categories. Sure, the average college graduate makes a better salary than the average high school graduate. But the average college graduate is part doctor and part engineer. The students who major in the hard sciences are dragging the political science and journalism majors up with them.

This statistic puts the cart before the horse, and puts passivity ahead of activity. For many college graduates who inherently know, just know, that the last 4 or 5 years were worth it, they assume that that diploma is the negotiable equivalent of a $15,000 annuity. God forbid they actually go to the trouble of applying it.

The University of Hawai’i’s spring semester enrollment is up 9.4% over last year. Instead of working harder than ever to find jobs in a weak economy, people are willfully deferring life – and paying money they don’t have for the privilege. And it’s not like UH is creating more engineers and scientists. A college vice president says “They tend to be all over the place. We have graduate students seeking their master’s, students in areas where there’s a shortage, such as teaching, nursing and social work, and business is popular, but so is psychology.”

And parents, don’t leave the room. We’re not done with you, either. The following is your financial obligation to your kids: food, clothing and shelter until they reach the age of majority. That’s it. No one owes anybody a college education, just like no one owes anyone a house or regular doctor visits. Your kid is far better off becoming a welding technician straight out of high school than wasting four years earning a degree in gender & women’s studies and beginning the income-earning years tens of thousands of dollars in debt. Economically speaking it’s better yet that he become a neurosurgeon, of course, but the world still needs welding technicians.

On the macro level, everyone from your neighbor to the president is talking up post-secondary education. The neighbor does it because he doesn’t know any better, the president for the same reason any elected official advocates anything.* The talking points are familiar: the next generation of Americans needs to be prepared in an ever more competitive world, education is a fundamental right, do you really want America to be a nation of blathering idiots, etc., etc.
This obscures the truth by shrouding it in catchphrases. This may be indelicate, but that doesn’t make it false: things cost money.

An investment, even in one’s own education, is a deferment of resources for an expected return. The majority of college kids don’t know a damn thing about what they’ll do when they get out of college. Therefore for them college isn’t an investment, it’s an expense.

That’s not to say that finishing high school is all you need to do to enter the workforce with a minimum of debt. There’s still a thing called motivation. Completing school, at whatever level, shows that you had the diligence to sit quietly and take some tests. There are a million ways to earn a respectable living out of high school – carpentry apprentice, garbageman, junior lab technician – but taking a random selection of undemanding college courses is not one of them.

Yet the government, true to its misguided principles, subsidizes education. President Obama proposes, in public and behind a live microphone, that no college graduate should have to fork over more than 10% of his income in student loan payments. This is what commerce has come to in 2010 – the terms of an agreement are dictated by future occurrences. Of course no one wants to pay 10% of his income on debt obligations, or on anything else for that matter. Not that 10% is an insurmountable number, but if the government mandates that it’s too high, pretty soon people will agree that it is too high, and that no $40,000-a-year junior account executive should suffer the inconvenience of paying more than $333 a month toward her student loans.

It gets better. (Or worse, if this kind of thing bothers you, which it should.) The president adds that student loans should be forgiven after 20 years – 10 if the borrower “enters into a life of public service.”

His definition of public service goes beyond Green Berets and SEALs. Say you want to take your forestry degree and be a National Park Service ranger, which offers room and board and pays $35,000 annually. Thanks to the time value of money, you’d be getting close to a complimentary education while doing nothing that makes a measurable impact on America’s gross national product.

But after the 10 (or 20) years, the unpaid part of your education doesn’t suddenly become “free”. Services were still rendered, the college still paid its professors and maintained its classrooms and grounds. Who makes up the difference? (Hint: the same generous soul who already bailed out Chrysler, GM, AIG, Lehman, your deadbeat neighbor who didn’t know how to sign a loan document, etc.)

People respond to incentives. If the government declares that the price you pay for your education will be arbitrarily lowered, more people will go to college. And earn useless degrees. And take their sweet time paying them back, if at all. But at least our elected officials can brag that a higher percentage of Americans go to college than do the Irish or the Icelandic.

*To get elected. (And in this particular case, to distract attention from more pressing matters, such as the ever-closer destruction of Social Security.)

**This article is an Editor’s Pick at The Best of the Best in Money and Personal Finance #12**