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HOW HARRY BROWNE FOUND FREEDOM IN AN UNFREE WORLD
Next year will mark the 35th anniversary of the publication of Harry Browne’s self-help classic, How I Found Freedom in an Unfree World. While I do not agree with everything in the book, I regard it as the best book I have ever read, and I have read it and reread it so many times that I literally almost have it memorized. It is one of those books that had such a profound effect on my thinking that I felt like a completely different (and much improved) person after reading it. Except for the Bible, never have I read something that is so full of wisdom and so clear about life, people, and how the world really works.
Harry wrote the book to explain how most of life’s restrictions and problems are self-imposed, and to shake people awake from the unquestioned assumptions that they make in life that cause them to blindly follow what others expect of them, rather than realizing that their lives are theirs to do with whatever they want. In most cases, other people are in no position to force their demands on them.
Harry calls these unquestioned assumptions “Rraps”, and they are the core of the book’s three sections. The first section identifies the 14 basic Traps that Harry saw people falling into, although he acknowledges that life has many other Traps. The second section contains his advice for freeing yourself from these Traps. And the third section contains his instructions for implementing his advice. Let us look at Harry’s 14 Traps.
Identity, Intellectual and Emotional, and Morality Traps
The first is the Identity Trap, which is pretending to be something you are not or expecting others to be like you. Both Traps have severe consequences. If you pretend to be something you are not, it is impossible to experience one of the greatest joys life has to offer, which is to be liked, and even loved, for who and what you really are. That is an integral part of the bond of genuine intimacy. Expecting others to act as you would is a common trap that everyone has been guilty of at times. Harry advises accepting people as they are and focusing on what you control, which is your response to how others treat you. This attitude is one of the marks of a mature person, and adopting it not just intellectually, but emotionally, will save you a lot of grief in life.
Harry Browne’s next two traps are the Intellectual and Emotional Traps, the Intellectual being the expectation that your emotions should conform to what your intellect knows, and the Emotional being the belief that it is okay to make a decision – especially an important one – when your emotions are dominating your mind and you cannot see all of the consequences clearly. The Intellectual Trap is to deny your emotions, which are the clearest indications of pleasure or pain in your life. However, accepting your emotions rarely means that it is a good idea to act on them in an emotional state, instead of first planning your response calmly and rationally, after the emotions have passed. To do so is to fall into the Emotional Trap. In my view, this is one of the most important lessons to learn in life.
The next trap is the Morality Trap, which is living by a moral code dictated by someone else. Harry posited three types of morality: (1) Personal Morality, which is a code of conduct you devise yourself, only for yourself, based on the consequences of your actions to you. (2) Universal Morality, which is a code of conduct that will bring happiness to anyone who follows it. And (3) Absolute Morality, which is a moral code dictated from someone wiser or better than you, such as God or a human guru. Harry did not believe that Universal Morality exists, because people are too different to all receive happiness from the same code of conduct. And he believed the weakness in Absolute Morality is that it requires total obedience, even if you believe that certain required conduct would bring you unhappiness. So he advocates following a Personal Morality, which he defines as a code of conduct created by you, based only on the consequences of your actions to you.
In my view, this definition of Personal Morality is one of the weaknesses of the book, and it seems to be something he did not think completely through. A more complete starting point for defining personal morality would be to incorporate the libertarian non-aggression axiom, and forbid yourself from doing anything that you believe would bring bad consequences to you or that would violate anyone else’s body or property. The bigger lesson to take from this chapter is that, if you choose to follow a moral code derived from someone or something else, you are still the one who made the decision to follow it. You are deciding for yourself even when you try not to decide.
Unselfishness and Group Traps
The Unselfishness Trap is the belief that you should put others’ interests ahead of your own. His point is that different things motivate different people, and no one does anything unless they believe that they will either gain from it or prevent some kind of loss. That was as true for Mother Theresa as it was for Hitler. The gain may just be a warm feeling for doing something nice for someone else or believing you are storing riches for the afterlife. But altruism is, at its core, really selfishness. No one would engage in altruism if they literally saw no benefit whatsoever for themselves in doing so.
The Group Trap is the belief that you can accomplish more by acting in groups than you can by acting on your own. There is nothing inherently wrong with participating in groups. You may enjoy the social aspect or something else about it. But you should be consciously aware that, if you just want to accomplish something, it s actually easier to act on your own.
The heart of this Trap is what Harry states is one of the most important keys to finding freedom in life, which is understanding the difference between what he called Direct and Indirect Alternatives. An Indirect Alternative is one that requires you to go through others to get what you want. A Direct Alternative involves you acting by yourself to get what you want, without having to convince anyone else that you are right. There is not necessarily anything wrong with trying to improve the world or with wanting to be apart of a movement that is bigger than yourself. But you should be consciously aware that you do not have to do that to get what you want out of life – if you do it anyway, it should be for other reasons. There are easier, more direct ways to keep an issue from adversely affecting you, whichever side you are on, than spending your life fighting for or against something that is never going away.
Government Traps are the beliefs that governments perform socially useful functions that you should support, that you have a duty to obey laws, and that government can be counted on to enact a social reform you favor. Not much more has to be said about these points to libertarians.
The belief that you have a duty to obey laws is legal positivism, the belief that the law should always be obeyed, regardless of its morality. Nothing more has to be said about this to anyone with a pulse, except that Harry is not necessarily advising you to break the law. He is advising that your concern should be the consequences to you – not to an amorphous, ill-defined “society”. Moreover, there are now so many laws in the U.S. that it is literally impossible to just go about your life, minding your own business, without constantly breaking laws.
Harry elaborated on the idea of looking to government to enact your social reforms in his 1996 campaign book, Why Government Doesn’t Work. There he defined it as “The Dictator Syndrome”, which is the idea that something you want the government to do will be enacted and applied exactly as you envision it. This mentality reflects an incredibly naïve, unrealistic view of the world and of government. Even if you believe in the idea of government, it is the least efficient way possible to get what you want.
He discusses numerous sensible alternatives for doing what you want without running afoul of the law, and the biggest point here is that, contrary to how it is often portrayed, governments are not omniscient. In fact, what little they accomplish is usually done via the voluntary cooperation of their citizens. Just do not flaunt what you are doing and you probably have little to worry about.
Despair, Rights, Utopia, and Burning-Issue Traps
The Despair Trap is the belief that others can stop you from being free or from having the kind of life you want. Harry advises that there is a way out of almost any situation, no matter how bleak it seems, if you use your imagination.
The Rights Trap is expecting your rights to make you free. No sensible person would rely on their rights to get what they want or protect them from harm, no matter how strongly they believe in rights in theory.
You probably believe that you have a right to keep your property and that no one else has a right to steal it. But you do not leave your front door hanging open when you go out and expect those rights to protect you. You recognize the world for how it really is, regardless of how you think it “should” be, and you concentrate on what you control, such as locking your doors and windows. And if you suffer a theft anyway and you are an extraordinarily mature person, you ask yourself if there is a lesson you can learn from it for the future. If there is, you apply it. If there is not and you took every precaution and it happened anyway, you calmly accept the fact that the odds finally went against you, pay the damages and move on to better things.
As another example, the government probably taxes you more than you think it has a right to, depriving you of property you believe you have a right to keep. It probably abuses you in other ways that you feel violate your theoretical rights. But that does not stop it, does it?
The Utopia Trap is the belief that you must create a better world as a precondition to having the life you want. The essence is the idea of Direct vs. Indirect Alternatives that we have already discussed. The Burning-Issue Trap is the belief that there are compelling social or political issues that require your support, and that it is more important to join such causes than to make the most of your own life. We have already covered the essence of this too.
The Previous-Investment Trap
The Previous-Investment Trap is the belief that any resource spent in the past must be considered when making a decision in the present. This is a Trap that has affected everyone, and it can be subtle.
For example, an investor holds onto a stock that is in a loss position because he feels he has to at least break even – and he probably loses more by holding onto it. Or a doctor finds that he hates medicine, but will not quit because he does not want to “throw away” the years he spent in medical school. As Ron Paul often says about Iraq, it makes no sense to attempt to justify past mistakes by perpetuating them. Whether resources spent in the past were spent wisely or not is irrelevant, because they are gone forever. What matters is what you have left in the present that can be applied to improving your future.
As Harry writes at the end of the chapter, “There is a bright, glorious, free future ahead – if you keep looking forward.”
Box and Certainty Traps
The next Trap is the Box Trap. Harry defines a “box” as any uncomfortable situation, and the Trap as the belief that the cost of getting out is too horrible to even consider. A box can be big, like an unhappy marriage, or small, like a boring dinner every Sunday with your relatives. The principle of this chapter is to avoid getting stuck in a rut simply because you cannot think of anything better to do, or because you think the price of getting out is too fearful to even consider. He advises examining your life, making a note of everything you are unhappy with, and to getting tough with yourself and figuring out why you are letting any uncomfortable situations continue. You may decide that the price required to get out of a situation really is worse than staying in. But at least then you will have made a conscious decision to tolerate it.
The final trap is the Certainty Trap, which Harry describes as being so certain that what you know is true that it causes you to take unnecessary, foolish risks because it never even occurs to you that you might be wrong. It is impossible to accomplish anything significant in life without taking risks. But you should never lose sight of the fact that your information is inherently uncertain, and that there may be factors you cannot see now. So take risks with that in mind, and be prepared for the fact that you might be wrong – and, if you are, that the consequences may be different, or even worse, than what you imagined.
The Uncertainty Trap
The corollary to the previous Trap, which Harry left out of the book, is what could be called the Uncertainty Trap, which is the state of being so consciously aware that what you know is uncertain that it makes you afraid to do anything. The fear of failure is a perfect example of this trap. You have to take risks in life. But do not take stupid risks without considering the consequences or the idea that you might be wrong, but also do not let the knowledge that you cannot know for certain beforehand how something will work out cause you to be too afraid to do anything.
So there are Harry’s 14 Traps, plus one of mine as a bonus. If you would like to read about the Traps in more detail, as well as Harry’s thorough advice for how to free yourself from them, and how he ties all of this together to explain how he found freedom in an unfree world – and how you can too, the book is well, well worth your time and money, and it would be a bargain even for $500. Hard copies can be found online in the usual places, like Amazon, eBay and Bookfinder.com, but they have become rare and fairly expensive.
However, a downloadable e-book is available at HarryBrowne.org for $9.75, and Harry’s widow, Pamela, intends to have it republished as a hardcopy someday. I have given away numerous copies over the years, recently to two friends for their wedding. As Richard Bach, author of Jonathan Livingston Seagull, states on the back cover of Harry’s book, How I Found Freedom in an Unfree World is “a gift of power and of joy for whoever yearns to be free.”Link here.
CAN WE HAVE INFLATION AND DEFLATION ALL AT THE SAME TIME?
Very few people understand the “continental drift” that threatens with a fracture of the U.S. (and hence, the world) monetary system. There are two tectonic plates: one, the supply of Federal Reserve notes, and the other, the supply of electronic dollars in the form of an inverted pyramid that rests on the supply of FR deposits. The fault line between the two tectonic plates is a worrisome source of unpredictable earthquakes that could cause massive and permanent damage to the U.S. and world economy. The monetary fault line exists because of the different statutory requirements the Fed has to meet in order to increase the supply of “high-powered money”:
Thus there is a serious obstacle in the way of increasing the money supply by increasing the volume of FR notes in circulation, giving the lie to Chairman Ben Bernanke’s promise to air drop them from helicopters: falling interest rates. For example, if the T-Bill rate dips into negative territory, then the market value of T-Bills exceeds their face value and the Federal Reserve “cannot afford” to buy them in the open market. The shortage of eligible collateral will restrict the inflation of FR notes in circulation. By contrast, FR deposits can be created out of the thin air in unlimited quantities at the click of the mouse.
Herein lies the danger of monetary earthquake along the fault line. The outstanding issue of FR notes as of September 20, 2007 was a paltry $760 billion, which is less than 0.2% of the notional value of derivatives. Just a drop in the ocean of potential bad debt. It is possible for the tectonic plate of hand-to-hand money, the FR notes to deflate, while that of electronic dollars to go into hyperinflation. The decoupling has frightening consequences for the financial and economic future of the world.Link here.
CLASH OF THE PARADIGMS
“History’s Greatest Credit Bubble” framework explained.
David Tice (PrudentBear.com), banking analyst Charlie Peabody (Portales Partners), and I (Doug Noland, PrudentBear.com) led a panel discussion, “End Game for Credit Bubble: Implications for Financial Markets & Wall Street Finance”, at an Argyle Executive Forum (“Alternative Thinking About Investments” in NYC). It was moderated by the wonderfully talented Kate Welling. The following is certainly not an official transcript of David and my comments but, rather, Q&A expanded in hope of providing more complete responses.
Question: For starters, why don’t you provide us a framework for the analysis behind your provocative title, “The End Game for the Credit Bubble.”?
It is our view that we are in the midst of history’s greatest credit bubble. History and sound economic theory have taught us that unconstrained credit systems are inherently unstable – and the longer excesses and imbalances are accommodated the more serious the consequences from the impairment of underlying financial and economic structures. We will begin by presenting two slides that contrast between the current conventional view and our own. We see this very much as the Clash of Incompatible Paradigms – and it is this “clash” that will remain at the epicenter of unfolding credit system instability.Link here (scroll down).
PANAMA CITY, BEYOND THE MYTH
Boomers, your attention, please! Panama offers a real estate’s ball and you are its special guests. The dreams factory is very busy organizing the feast, counting on you to populate the numerous waterfront resorts and towering condominiums aiming to the clouds. Don’t worry about etiquette. Tuxedos are not required. Local weather is H2, meaning too hot and humid for formal dressing. All you need is some available cash, prime credit history and good will to relocate.
In addition to quick buck condo flippers, Panama is also attracting those retired on a modest fixed income. Traditional destinies have become either very expensive (Florida), extremely insecure (Mexico) or crime prone and chronically affected by inflation (Costa Rica). Tropical weather, public security and first world class services in the Sunshine State are unaffordable for many retirees and although the real estate bubble is finally deflating and housing prices are starting to draw back, they will not retreat to where they were five years ago.
However, when considering expatriation, security is one main factor. America is a much more secure place to live than any country south of the border. Although relatively safer than its neighbors, Panama is not a safety haven. Forget about what some unscrupulous promoters have published about Pinkerton praising Panama’s security. It is a shameless deceit.
Panama’s capital has two faces. One reigns with beauty and splendor. The other lies in the twilight zone. Economically, socially and architecturally speaking, the city is sharply divided between two main sections – upscale and downscale. Tourists are encouraged to avoid the last one. While a dense forest of new condominium towers, mostly owned by well-off foreigners, grows up steadily, 40% Panamanians are struggling against poverty, pariahs in their homeland. Inequality causes anger and social disengagement, rooting criminal attitudes early in life. Authorities actually have a huge problem with juvenile delinquency which often turns deadly violent. Narcotics and weapons trafficking, as well as money laundering, are primary concerns. Panama is a major cocaine transshipment point and money-laundering center for narcotics revenue. Official corruption remains a major problem. A healthy society cannot afford to have half of the population living below the poverty line. Misery feeds the lawless armies. Panamanians are constantly complaining about insecurity and widespread corruption.
Fast-paced tourists may not notice these contrasts, but residents do. Foreigners living in poor countries are often preferred targets to resented outlaws. It is possible to live caged in the protected environment of a luxury condominium, but what is the point? However, Panama’s upscale neighborhoods are safer than its Costa Rica’s counterparts. We have walked unharmed throughout these areas very late at night. No one with a sound mind would dare to do the same in Costa Rica. Panamanian police seem better prepared to deal with crime.
Nevertheless, public security cannot be determined by how successfully the state could repress illegal activities, but by how well a society provides opportunities for its citizens to socially and economically advance while abiding the Law. Latin American governments tend much more to punish crime than to supply hopes to those less fortunate. Panama is no exception.
Before taking the life changing decision to relocate abroad, do an extensive investigation of cultural differences. Can you readapt to the new environment? Panamanians speak Spanish. If you want to interact, learn their language. Those claiming that anyone can do well in Panama speaking in English might be referring to professionals trained to work with foreigners. Promoters stating that life in Panama is very similar to America are notoriously misguiding readers. The Panamanian’s society is quite different.
Metro areas are extremely noisy. Traffic horns, loud music and all kind of high-decibel pitches pollute the city. Infrastructure, although unquestionably better than its neighbors, does not come close to American standards. Once you leave the well-protected premises of your condo, the real Panama comes up to chase you. Peddlers and beggars knocking on your car windows are vivid reminders that, skyscrapers and shopping malls apart, Panama is still a third world country. Therefore, if you have your mind set on Panama, make several trips to get acquainted. Life is much bigger than biased promotions. To perform a reality check, lease a furnished apartment ($700-$2500 monthly).
Beware the “Wizards of REA”.
Considering living standards and building costs, suitable properties are actually over-valued. Prices have increased 3-fold within the last two years. Avid for profits, condo flippers are betting hard on advertising. The “Wizards of REA” (real estate advertising) have shamelessly proclaimed that properties in Panama are not overpriced when compared to similar dwellings in North America and Europe. REA alchemy works by overlooking the huge gap in living standards, income, infrastructure and safety between first and third worlds. Profiteers are trying to convince foreigners that it is possible to own a share of “paradise” for a bargain. Compared to what? Pasadena? Miami Beach? Côte d’Azur? Low purchasing power keeps most Panamanians out of this deceptive equation, while the wealthy among them are just too smart. Considering the huge income gap between USA and Panama, real estate properties are overpriced and totally out of touch with Panama’s living standards.
How many retirees would be willing to relocate to Panama if housing prices and crime rates keep their upward trend? Big question! Also it remains to be seen how, and to what extent, the local housing market could be affected by the recent downturn of that industry and the economic slowdown in USA.
This past March, commodities guru Jim Rogers predicted a real estate crash that would trigger defaults and spread troubles to emerging markets. “You can’t believe how bad it is going to get before it gets any better,” the respected fund manager told Reuters, “It is going to be a disaster for many people who don’t have a clue about what happens when a real estate bubble pops. It is going to be a huge mess.” Mr. Rogers declared that the crisis would spread to emerging markets. “When you have a financial crisis, it reverberates in other financial markets, especially in those with speculative excess,” he said. “This is the end of the liquidity party. Some emerging markets will go down 80 percent, some will go down 50 percent. Some will most probably collapse.”
Considering Panamanian authorities’ ill-fated decisions and the current housing and economic woes in America, it is advisable to be skeptical of optimistic forecasts about Panama’s “great values”. Go there. If you think that you have found it in there, then prepare to stay for a prolonged period of time. Informed decisions need time to mature, but save money and mishaps in the long run.
Do not follow the beaten path. Like Odysseus, refuse to be charmed by Sirens songs. Inexperienced, wannabe get-rich-quick investors, are regularly herded toward masked shearing-houses. Boomers, your attention again, please! As special guests to Panama’s real estate ball, you are totally entitled to leave or stay, so don’t rush to pay for the bill!Link here.
WHEN THE MUSIC STOPS
Take advantage of the wise guys’ ignorance while you still can.
“When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance. We’re still dancing.” ~~ Charles Prince, CEO, Citigroup
That retroactively juicy statement appeared in an interview in London’s Financial Times on July 9. It was immediately picked up and posted all over the Web. There were many skeptics, but mostly in the hard-money crowd. Then came August’s collapse of the secondary market for subprime mortgages. In that market, the music ended abruptly.
Just before the New York Stock Exchange closed on Friday, September 28, Mr. Prince announced that Citigroup’s expected earnings will be down in the third quarter by 60%. But not to worry, he assured the media: “[W]e expect to return to a normal earnings environment in the fourth quarter.” ... “But,” the FT reported, “in an audio message on Citi’s website on Wednesday, Mr Prince said: ‘We are one of the largest providers of leveraged financing to clients around the world. When the leveraged loan market severely dislocated this summer, it had a significant impact on us, resulting in large write-downs.’”
Mr. Prince was a confident man in late July. Very confident. He was quoted in an August 2 article in the International Herald Tribune: “We see a lot of people on the Street who are scared. We are not scared. Our team has been through this before.” Scared? Not Mr. Prince. Then, over the next month, Citigroup lost $1.4 billion. The decline “was driven primarily by weak performance in fixed-income credit-market activities, write-downs in leveraged loan commitments, and increases in consumer-credit costs,” reported Prince.
Frankly, he should have been scared back in July 2006, when he could have unloaded this junk at face value. There is a lesson here: when you can unload future junk at face value, do so.
Citigroup is not alone. The reality is that the best and the brightest in the financial world entered into high-risk ventures and then got caught by market realities. They did not see it coming.
The investment world assumes that central banks can, and will, always paper over any liquidity crisis in the financial markets. But what if the problem is not liquidity in general but insolvency in a capital market? It is not that there is not sufficient fiat money in general. The problem is that in a highly leveraged market there are no buyers at yesterday’s prices, when yesterday’s prices were the basis of the existence of a flow of new funds into this market.
Prince saw in general what was coming, just not when: “The depth of the pools of liquidity is so much larger than it used to be that a disruptive event now needs to be much more disruptive than it used to be,” he said. “At some point, the disruptive event will be so significant that instead of liquidity filling in, the liquidity will go the other way. I don’t think we’re at that point.”
We may not be at that point, but it is surely coming. When it does, the smart guys who run the pools of capital will be seen as wise guys looking for escape hatches.
When liquidity moves out of a market, the problem is then insolvency, not liquidity. Liquidity is the product of confidence. A market is liquid because investors think it is priced rationally by the best and the brightest, and therefore other investors stand ready to buy a capital asset when the seller is ready to sell. But then, without warning, other investors learn that this market had been way overpriced, and so they move to the sidelines. Liquidity is restored at (say) 50% of the previous price.
The world of the smart guys of the world – the fund managers, multinational bank boards, and economic forecasters – is one in which years of inflation, declining thrift, increasing trade deficits, and the demise of subprime mortgages means nothing significant. The dependence of the U.S. government on Chinese central bank purchases of its debt does not raise red flags to these people. They really do believe that the possibility of Federal Reserve intervention into one narrow financial market – the overnight bank loan market – is sufficient to keep the American economy recession-free and inflation-free at the same time.
For as long as America’s investors believe this, they will not prepare an exit strategy, just as U.S. Treasury officials have not prepared an exit strategy for the time that China ceases to buy T-bills, let alone starts selling them. Of course, if China were to sell dollars, the yuan would appreciate even more. The smart guys assume that China, an exporting nation, will not sell dollars, ever. They forget about such things as politicians’ pride, their desire to put Americans in their place, and the universal desire of investors to get out of a bad investment while there is still time.
Today, Americans who are in bad investments have time to get out. The smart guys and the smart money continue to believe the old phrase, “I’m from the Federal Reserve, and I’m here to help you.” They continue to believe that legalized counterfeiting is still productive. They still believe that timely intervention by the FOMC will keep recession at bay.
Their faith is based on a premise that bad money produces rational prices. This leads to a conclusion that there will be no need to reprice and reallocate capital when the original fiat money conditions no longer exist.
I say, take advantage of the smart guys’ ignorance while you still can.Link here.
THE “NEW AND IMPROVED” BIG BROTHER
It is time to wake up.
Not that long ago, it was easy to know when you were in a police state. But not anymore. Indeed, in just the last 12 months, the U.S. has quietly brought into existence several initiatives that resurrect some of the worst aspects of a Nazi or Soviet-style police state. But they have done it in such a way that almost no one noticed.
In the old big brother police states, you knew your place. And you acted accordingly. Phones were tapped – often badly. You also knew – immediately – when you had crossed the line from acceptable to unacceptable behavior. The police would come out, kill a few members of the opposition party, and then retreat behind the barricades. This still occurs in some police states like Myanmar. Naturally, mail is read in an old-style police state. Nor were these efforts particularly sophisticated.
Another example of a classic police state is the use of internal passports. In the Soviet Union, you could not travel outside your own village unless you received the appropriate stamp on your internal passport. Naturally, permission was often forged, or purchased in exchange for a small bribe.
The new big brother is much more subtle, yet far more intrusive. Especially if you live in the U.S., you are under a pervasive and continuous surveillance of which the likes of Stalin, Hitler and Castro could only dream. Thanks to a new law from Congress, enacted in July, the so-called “Protect America Act”, it is perfectly legal for the government to wiretap U.S. citizens without a warrant. The wiretapping takes place at the telephone company switch, not at your home or office, so you will never know whether your conversations are being monitored or not. No annoying clicks or hums.
Then there is the matter of political protest. For instance, plenty of Americans oppose the Iraq war. The Bush administration is not very happy about this domestic opposition. But instead of sending out goon squads armed with night sticks, clubs and machine guns, the Bush administration’s response was much more subtle. On July 17, President Bush simply signed an executive order that essentially outlaws all opposition to his Iraq war policy. If you breach this order’s provisions, you could lose everything you own – your home, your car, your retirement account, your bank accounts, etc. – all based on a secret determination by the Treasury Department that you have no right to contest in court.
U.S. law has long required a search warrant to open first-class mail unless postal inspectors suspect it contains something dangerous, like a bomb, or contraband like narcotics. But last December, President Bush quietly asserted a new government prerogative to open domestic mail without a warrant, probable cause, or even suspicion that it contains dangerous materials or contraband. Bush did this through a mechanism known as a “signing statement” – a statement issued when a bill is signed into law, stipulating that the president has the authority to ignore certain of its provisions. Bush has issued at least 750 signing statements during his presidency, more than all other presidents combined.
Finally, there is the internal passport. In a “free” country like the U.S., it would never do to issue such an obvious reminder of government oppression. People might complain. Even the Fox Network might start complaining about our eroding civil liberties. Once again, though, the U.S. government came up with a much more subtle, high-tech, replacement for the internal passport. It is called the “Advance Passenger Information System”. With the APIS, you will need to obtain permission from the Transportation Security Administration to travel on any commercial airliner or ship that goes to or from the U.S. Until APIS clears you, you will not receive your boarding pass. You will also need permission to travel through the U.S., e.g., if you are changing planes at a U.S. airport on a trip between two foreign countries).
Naturally, the entire process – for both domestic and international travel – will occur in total secrecy. If you are denied permission to travel, you will not be able to appeal the decision to any court. Your only recourse will be through the TSA bureaucracy.
Fighting back against the new Big Brother.
Indicating displeasure with the old big brother was relatively simple, albeit dangerous. But with the new, warm and fuzzy big brother, police state machinations are so subtle that it is impossible to know if you are being watched. You cannot tell your telephone calls are monitored, or see if your mail has been opened, or know if you are on a terrorist watch list. Your first clue that a problem exists might be when you are denied the right to board a plane, or more ominously, when your bank account is frozen.
What is more, the vast majority of Americans seem to like being monitored. However, if you do not like the idea of having your telephone calls, letters, political activities, and travel habits continuously monitored, there are steps you can take to avoid this type of surveillance. Here are a few suggestions.
Yes, big brother is back. Warm and fuzzy, or not, the initiatives taken in just the last 12 months by the Bush administration invade your privacy in ways you scarcely could have imagined. It is time to wake up.Link here.
MEDICAL TOURISM IN INDIA – A HEALTHCARE REVOLUTION?
“Medical tourism” is the act of traveling to foreign locales in search of high-quality, affordable healthcare. India, for example, is currently trying to figure out how to best advertise and support a growing medical tourism industry. Resort-like hospitals that cater to medical tourists are raking in clients by providing a level of care and comfort that is ... well ... foreign to some Americans. The kicker is that it is also insanely cheap.
For example, say John Q. Public elects to have a back surgery but his insurance is balking at covering it. In the U.S., his out-of-pocket cost might be $30,000 if he chooses to pursue the procedure without insurance clearance. If he does not have the cash to make it happen John is usually out of luck. But wait ... For the price of a plane ticket to and accommodations in India – say $10,000 – John can save up to 80% on the surgery itself by getting it half a world away. Bottom line, instead of paying $30,000 in the U.S., John Q. Public might be able to get the same surgery in India plus flights, lodging and the surgery for a hypothetical total of $16,000 – a nearly 50% total savings.
There is a burgeoning medical tourism “travel agency” business in the U.S. They offer all-inclusive packages at hospitals worldwide, depending on exactly what procedure a patient requires. That can lower costs even further. Studies suggest that 150,000 Americans left the country last year to have a medical procedure. Other sources put the number closer to 500,000 – presumably including such “travel” as having a root canal performed in Tijuana or tooth veneers installed in Juarez.
Medical tourism may be the brightest example yet of Americans, albeit out of extreme necessity, embracing a true global economy and spending their dollars in such a way that maximizes return on medical investment. When you look at it like that, traveling a great distance to receive priority treatment and save money seems downright ... smart.
While researching this issue, I expected to find tons of information on the things that would prevent an American from engaging in medical tourism. For example, I expected to find articles and blog posts shouting about under-trained and unprofessional doctors, substandard facilities and arcane witch doctor practices. I knew I would come across at least one post-op horror story about bandages, scissors and exotic bacteria being found inside patients once they returned to the States.
Evidently, those expectations amounted to nothing more than my own prejudices. While the medical tourist does have to be sublimely careful and diligent in their research and planning, there most certainly are high-quality and cost-effective doctors around the world who can perform most procedures for just a fraction of the cost a patient would encounter in America.
Medical tourism is yet another industry in which Indian expansion is helping to break new ground. In time, opportunities for investors will emerge, and the issue of medical tourism will surely break into the consciousness of the mainstream press. As a start, simply enter “Medical Tourism India” in your search engine of choice and sift through the results. Just be careful to avoid the websites written in broken English.
This much is certainly clear: Regardless of who wins the White House in 2008, it appears as if a revolution in how we access our healthcare may be on the horizon.Link here.
THE “SUBPRIME” MENTALITY IS A METAPHOR FOR THE WHOLE U.S. FINANCIAL CULTURE
Too many people think that the issue of subprime lending is a local problem that will be contained. In the unlikely event that you are in this camp, think again. First of all, the fallout from subprime lending will be bad enough as it stands. But the real problem is that “subprime” is a metaphor for the whole U.S. financial culture.
At its worst, subprime lending consisted of giving loans to people that probably could not pay, on low- (or no-) “doc” terms (because lenders did not want to ask). They were initially targeted at people on the economic margins of society, precisely the kind of people that could not qualify for mortgages or other loans on conventional terms. (The latest “hot” market is illegal immigrants, who often live and work “off the books”, and therefore cannot document their income or assets.) “Alt-A” loans are aimed at higher paid people with similarly variable incomes who are otherwise very much in the economic mainstream, e.g., commission salespeople, or investment bankers whose base salaries are low relative to bonus-driven total compensation.
Because subprime loans, by definition, are made to borrowers who are unqualified, lenders demand higher interest rates, which supposedly compensate for the risk. Except that they don’t. When a borrower who is already on financially shaky ground is charged an above-market rate, the excess payment means that s/he becomes an even greater risk than before. In short, the act of subprime lending itself creates the very problem it is supposed to solve. Subprime lending was about finding someone stupid enough to borrow (on such terms), and honest and solvent enough to repay. Barring such rare birds, subprime products were fit for “only crooks and deadbeats,” in the words of wise underwriter named Jack Ringwalt (who sold his company to Warren Buffett in the 1960s).
The supposed cure for payment problems was another monstrosity – adjustable rate mortgages (many of which are “prime”). The whole point of such mortgages and low “teaser” rates was to “qualify” people for loans they really could not afford. This incentive consisted of submarket rates for a period of time, typically two or three years, enough time for a loan to get “seasoned”, with a monthly payment that was temporarily affordable. Until the recent resets, beneficiaries of such loans had an artificial incentive to pay on time to keep the low rates. After the resets, however, the incentives run the other way, which explains the recent hockey-stick rise in foreclosure rates. In essence, overextended home borrowers were made to appear as better credits (during the “teaser” period) than they actually were. It was an artifact of the “lend now, collect later”, mentality that pervades today’s banking system. Such practices violate the old J.P. Morgan dictum of a “first class business done in a first class way.”
If only the problems of such stupid lending could be confined to the lenders and the soc-called “investors” that act as their backers. ... But the abnormal spending that was made possible by the “housing ATM” effect of home equity loans is now coming to a screeching halt. More to the point, “normal” consumer spending – that which would have occurred if the consumer were not severely loaded down with debt, will soon be severely crimped. Such borrowers probably will not end up going hungry or unclothed. But they might end up eating Sloppy Joes, and wearing secondhand clothes purchased at garage sales for the two or three decades that it will take to pay off their homes – as their grandparents did 70 or 80 years ago. (What is more, many of them live in housing developments that threaten to turn into modern “Hoovervilles”.) Slavery has been abolished, but not “indentured servitude” in what Warren Buffett recently termed a “sharecropper society”.
Nor are any solutions likely to provide relief. One idea is to penalize the lenders. Suppose, for instance, that a political consensus formed around the proposition that loans with “teaser” rates for the first 2 years and market rates for the remaining 28 years were “deceptive” to the average consumer. (Individual lawmakers already feel this way.) In this case, legislators or judges might rule that those low teaser rates should remain in effect for the life of the loan. That would certainly provide the consumer – or selected consumers – relief, in the form of an interest subsidy. But lenders and investors who foolishly bought such loans would suffer as a result, meaning that a large number of banks and/or hedge funds would go bust.
Many of these bad loans were packaged and sold to foreign investors, meaning that they now contaminate the banking systems of our major trading partners. German banks for instance, whose staples are fixed income products, were “shocked ... shocked!” to find that their “tranches” of loan packages carried properties more characteristic of options, a much riskier security. Such shaky paper is now often treated as nearly equivalent to Treasury paper at the Federal Reserve borrowing window. And this comes at a time when the Fed is lowering its benchmark rates toward “teaser” levels. What happens when foreign investors wake up to the fact that they are being paid “teaser rates” to hold paper of a very questionable quality. Will the U.S. Treasury then be able to roll over its debt (of which 40% or so is held by foreigners)? Or will there be a “default event” that is allowed to occur about once in the lifetime of a nation before others wise up? Although their grandparents presided over steadily improving U.S. credit, Baby Boomers and their immediate predecessors and successors may end up insuring that their children and grandchildren will have impaired credit in global markets for at least a century.
The U.S. government cannot prevent someone from taking losses on the foolish lending/borrowing discussed above, because those are losses on loans that have already been booked. What the government can do is to determine who gets to eat the losses – borrower, lender, U.S. taxpayer, or foreign investor. There is no question that the piper is about to be paid, and in a big way.Link here.
FISHING WITH THE BEAR
Discounting near perfection, both domestic and foreign stock markets could crack at any moment. The smallest problem threatens to send them down, as we have seen this past summer. At best that makes staying invested like angling for landlocked salmon in northern Maine, which I like to do whenever I can. The fishing is wonderful there, but every once in a while you see black bear tracks right underfoot.
The market’s bearish signs, from a growing subprime mess to the fretting over whether somebody should bomb Iran’s nuke labs, lead many to suggest that now is the time to cut bait and run for safety. Not me. I think what makes more sense is learning to fish with the inevitable bears that will cross our paths.
Today the market has rebounded and we are back to setting records (Dow Jones Industrials) or near there (S&P 500). This year the Dow has had more record closes than you could fit into a 31-day month. Now we are armed with a Federal Reserve aiming to fend off the bear with rate cuts and a savaged dollar that benefits our multinationals, whose products have rarely been cheaper overseas.
Still, thus far in 2007 the bear has attacked us twice, first in late February and then in mid-July – more than enough to dissuade a reasonable person from staying in the river. Swipe one saw the S&P 500 lose 5.9% of its value in 10 trading days last winter, as it appeared that Asian markets were on the verge of collapse. Swipe two tore into a midsummer’s dream of a rally (the S&P had risen 13.5% since the previous attack), sending the broad-market index down 9.1% between July 13 and August 16.
So in a wild landscape where the bear roams, which investments have the most staying power? I have looked at the past two maulings to find what recovered the best from its lows. Plus I factored in how different markets, whether domestic or foreign, commodities or currencies, had fared throughout the year, to get a context for individual picks.
Extending our wildlife metaphor, my research shows that individual stocks are the equivalent of a .22 rifle. They do not pack enough firepower to stop the bear. Small things can hurt their performance. And buying into a wide index such as the S&P 500, via a mutual or ETF, has the opposite problem. They are clumsy instruments that, like a shotgun, can miss a fast-moving target. The wider-ranging S&P is more susceptible to the bear than is the Dow, the oldest measure of the U.S. stock market, made up of 30 global leaders you can name in your sleep. The Dow fell less than the S&P in the late-summer slump.
The way to play the Dow is with an ETF called Diamonds Trust (DIA, 140), which mimics it. If the world economy, or just our own, stumbles, then the big blue chips in this index do not have to outrun the bear, but merely the mid- and small-cap stocks that tend to be hurt the worst in a bad market.
China has the ability to emerge as the world’s largest economy by 2030. You should be buying there today. Consider either the iShares FTSE/Xinhua China 25 (FXI, 193) or the SPDR S&P China (GXC, 93) as the best way to put the yin in that market’s volatile yang.
Thanks to hedge fund proliferation, the wildest market around is foreign exchange. The BIS estimates that forex trading has increased to $3.2 trillion a day. The PowerSharesDB G10 Currency Harvest Fund (DBV, 29) is the ETF I like for this. The dollar, which has suffered a lot lately, is one of 10 currencies covered by the ETF, which follows the Deutsche Bank G10 Currency Future Harvest Index. The other nine denominations, including the yen, the pound and the euro (but not China’s yuan), are what you are after for diversification. If there are no further changes in exchange rates, your return from this basket would be flat, minus overhead (0.75%). If the dollar weakens further, you will outperform a dollar-only money market fund.
Gold, the best bear-proof investment, can be efficiently owned through the iShares Comex Gold Trust (IAU, 73), an ETF that in effect owns bullion and runs up an annual overhead of 0.40%. Gold has doubled over the past four years to $732 per troy ounce.
A hypothetical portfolio that bought equal amounts of the four securities recommended here would have earned 27% so far this year, to the S&P 500’s 11%. If the market sinks, the four should continue to outperform.Link here.
THAT WHICH IS ABOUT TO FALL DESERVES TO BE PUSHED. THE NATION-STATE IS WOBBLING
Empowering Ron Paul’s grassroots army.
We are seeing a political phenomenon like no other in history. We are seeing the creation of an army of volunteers who have not been actively recruited. This is as close to Hayek’s concept of the spontaneous order as politics has ever provided.
Back in 1937, Albert Jay Nock wrote an essay titled “Isaiah’s Job”. It dealt with the strategic error of starting a political movement to save America. It will not work, Nock said. The kind of people who you need in order to change America cannot be attracted by active political recruiting. Such people will seek out those leaders who they approve of. He called them the Remnant. We are now seeing what Nock did not foresee, the coming together of a grass roots army. It is assembling itself. The internet’s technology is making this possible. The Remnant is forming.
What if Ron Paul does not get the Republican Party’s nomination. What will his newly self-assembled army do then? If it disbands, that would be a tragedy. If it is given the digital tools to work with, free of charge, this really could change America.
There will come a day when the checks from Washington will stop coming, or – more likely – the money delivered by Washington’s checks will not buy much. On that day, Americans will look locally for leadership. Almost no one with a long-run perspective sees this coming. No one is preparing politically. No local politician has sat down with Jacques Barzun’s From Dawn To Decadence and Martin van Creveld’s The Rise and Decline of the State and read the final chapter in each, where each scholar discusses the looming failure of the nation-state to provide either protection or welfare.
No one has said, “What will fill this coming vacuum?” No one has developed a strategy for the transition from Washington to localism. Such thoughts are not common in today’s world of Federal power and Federal money. It takes a specific worldview even to ask such a seemingly utopian question. Ron Paul has such a worldview. So do his followers.
The grass roots army that has spontaneously assembled itself around Ron Paul’s candidacy is motivated by one powerful idea: shrink the state. There is an old rule – “When you see something wobble, push it.” For all its braggadocio, the modern nation-state is wobbling. It has issued more promises than it can possibly deliver. As this reality becomes apparent to millions of voters, there will be a search for local alternatives. There will be local power-seekers who will offer one set of alternatives. That is when we will need power-shrinkers in positions of local influence. Remember, we cannot beat something with nothing.Link here.
ONE WORLD, TAKING RISKS TOGETHER
Huge financial losses in the U.S. spark fears in Europe. A credit crisis ensues. Soon the fear spreads to Wall Street, where the biggest banks fight off rumors of insolvency amid a broader economic panic, and Washington is forced to step in. The market swoons. If this sounds familiar, it should. Except we are not talking about the subprime mortgage crisis, or the deal brokered by the Treasury Department last week with three American banking giants to cough up $75 billion for a fund aimed at stabilizing the global credit market, or this past Friday’s 366-point drop in the stock market.
It is a brief history of the Panic of 1907, which culminated exactly 100 years ago. Back then, losses stemming from the San Francisco earthquake the year before hammered British insurers and eventually forced government officials on this side of the Atlantic and none other than J. P. Morgan himself to come to the rescue. On the night of October 21, 1907, the legendary tycoon summoned the country’s leading financiers to his Murray Hill mansion to help finance a bailout. “This is where the trouble stops,” Mr. Morgan famously declared. He succeeded. By early 1908, the panic had passed.
Today, it is J. P. Morgan again – the firm, not the man – along with Citigroup and Bank of America that are trying to fix things, with prodding from Henry M. Paulson Jr., the secretary of the Treasury, and, as the former head of Goldman Sachs, something of a latter-day tycoon. Given the historical echo – as well as the 20th anniversary of the crash of October 19, 1987 – it is appropriate that the plan to ease the credit crunch is high on the agenda as the finance ministers of the Group of 7 leading industrial countries confer in Washington.
But this time around, it may take much longer to repair the damage and restore confidence than it did a century ago. It is not only that the sums are larger now, even adjusting for a century of inflation. Losses from the San Francisco earthquake totaled only about $18 billion in today’s dollars, according to Marc Weidenmier, an associate professor of economics at Claremont McKenna College, compared with the likely loss of hundreds of billions dollars related to subprime mortgages.
It is also that the breadth and complexity of today’s global markets create risks so great that no group of business leaders – or even a single country – can control them. When it comes to the valuing of the mortgage-backed securities that are at the heart of the subprime meltdown, no less an expert that Ben Bernanke, the chairman of the Federal Reserve, admits he is at a loss. “I’d like to know what those damn things are worth,” Mr. Bernanke said during the question-and-answer period after a speech in New York.
So would many ordinary homeowners who normally do not concern themselves with the inner workings of the Fed. Unlike past panics, or even the crash of 1987, the current credit turmoil has affected ordinary consumers who merely want to secure a mortgage or refinance a loan. Rates have spiked for even the best-qualified borrowers, and home buyers with less than stellar credit histories now find themselves locked out.
This phenomenon goes both ways. Not only are people without a dime in stocks affected by market gyrations, but in an era when United States mortgage defaults can move markets from London to Mumbai to Shanghai, it seems as if bad decisions by a lender in Cleveland or a borrower in Miami can have worldwide implications. On a trip last week to New Zealand to meet with investors, Byron R. Wien, chief investment strategist of Pequot Capital and a 40-year Wall Street veteran, noted, “Every place I go they ask about subprime and climate change — those are the two big issues.”
It was not supposed to work this way. Interconnected global markets should make the world economy more stable, according to traditional economic theory, with risk spread more widely and strength in one region offsetting weakness in another. “In practice, we are not seeing that happening,” says Richard Bookstaber, a veteran hedge fund manager and author of a new book, A Demon of Our Own Design: Markets, Hedge Funds and the Perils of Financial Innovation.
Although international financial links are nothing new, as the Panic of 1907 shows, what is different now is how closely international markets are correlated with one another. “Everybody tends to invest in the same assets and employ the same strategies,” Mr. Bookstaber says, noting how just as Citigroup and Merrill Lynch suffered billions in losses from subprime loans, so did banks in France, Germany and Britain.
The trend extends into stock exchanges in Asia, where shares in India and China are experiencing a parabolic rise. “You have speculative American money invested in India, just as you have speculative Indian money invested in India,” he says. “As markets become more linked, diversification does not work as well.” As a result, Mr. Bookstaber argues that today’s global financial markets may actually be more risky than in the past. The same types of investors are taking on the risky bets and then simultaneously heading for the exits when trouble comes, even if they’re on opposite sides of the world.
Historically, adds Mr. Bookstaber, there are two characteristics that precipitate financial crises – complexity and leverage. And the current subprime mess, in which risky mortgages were bundled together by Wall Street and then sold to investors who borrowed heavily to buy them and who may not have understood exactly what they were getting, pretty much fits this pattern.
This, too, has implications for ordinary consumers as well as the Masters of the Universe. Homeowners having trouble coming up with their mortgage payment can no longer call their local bank to renegotiate because their mortgage is being held by an investor thousands of miles away. At the same time, foreigners seem to be emulating the American appetite for risk-taking and speculation, rather than learning from its dangers.
“We’re still the big spenders, but there’s evidence that’s starting to change,” says Mr. Weidenmier, citing China as one example. Not only is consumer spending there booming, but local investors have bid up shares on the Shanghai Stock Exchange by 432% over the last two years – many going into debt to get a piece of the action.
Now, just as problems in the U.S. have caused ripples in Europe, there are fears that a bursting of the Asian bubble could soon be felt in New York. A brief sell-off in Shanghai prompted a 400-point decline in the Dow last February, but both markets quickly bounced back. A prolonged plunge now in Chinese stocks might not be so easy to shake off, especially given the turmoil in credit markets in the United States and Europe, says David Malpass, chief economist at Bear Stearns.
Of course, taking risks, even speculative ones, has always been a driving force behind economic growth and the dynamism of the capitalist system. John Maynard Keynes called these urges “animal spirits”, and experts like Mr. Wien disagree with the notion that globalization has made things more risky. He argues that the newly rich in places like the Middle East can actually smooth things out by having the money to buy when everyone else is selling.Link here.
SEYCHELLES COMPANY LAUNCHES “MY LEGACY, MY WAY” TRUST
For those worried about the effects of unearned wealth on would-be beneficiaries.
Maritime International Ltd. has designed a new Trust product for those who wish to pass on their values and not just their assets. This trust structure allows clients to specify the distribution of trust assets to children and others, on the basis of meeting specified criteria.
As the lifespan of the global population continues to increase and many parents are having children much later in life, this new Legacy Trust is designed for clients who wish to provide parental guidance to their children, even after death. Parents can now have the final word, “My Legacy, My Way”. According to Laura Mouck, Maritime International’s Director of Wealth Management, “Sometimes the free and unfettered acquisition of wealth by children upon the demise of their parents, can have disastrous results. The newspapers are full of such examples.”
Specific incentives, however, can be included in the wealth distribution process, to increase the likelihood of children achieving goals and showing initiative, teaching them that hard work and personal achievement are the standards you want them to have. The new “My Legacy, My Way” trust structure does not, for example, simply provide funds for the children’s education. Instead, on the client’s instructions, it provides distributions depending upon the level of the children’s achievement in higher education, plus other criteria, in order to give them the incentive to excel.
In other cases, a client may wish to encourage hard work and entrepreneurial skills. They could then include an annual distribution from the trust equal to or double that of his or her earned income for the previous year. If encouraging philanthropy and generosity to others is important to a client, each child could receive an annual distribution equal to or double the charitable contributions reported on their tax returns for the previous year. Other like provisions can be added to the client’s Letter Of Wishes, as limited only by the imagination of the individual and how he or she wants his or her legacy to live on.
Clients might also wish to restrict payments for what might be considered frivolous items, e.g., expensive sports cars, parties, or a ski chalet in the Alps. Ms. Mouck advises, “We have found that many clients do not wish their hard earned money frittered away, unnecessarily, in only one generation.”
Malcolm Nickerson, Managing Director of Maritime, says, “It sounds complicated, but it is not. ... It is just as crucial for people to determine what to do with their wealth, as it was deciding to save, accumulate and invest it. They can leave a real, lasting and useful legacy to their heirs. The choice is theirs. Even if parents are no longer physically there, they can still help shape the future of their children and instill the values that will ultimately guide them to becoming self sufficient independent individuals who can find their own successful path in life.”Link here.
HOW TO SPOT WEAK ACCOUNTING BEFORE THERE IS AN EMBARRASSING RESTATEMENT
Fabulous earnings and a goodwill-rich balance sheet are a good place to start.
Petrohawk Energy has been a winner for investors this year, its shares up 46% on a combination of rising energy prices and rapid-fire acquisitions. Revenue climbed to $443 million in the first half, compared with $588 million for all of 2006.
On that basis Petrohawk looks like a solid growth company. But an innovative statistical analysis of financial statements flashes a yellow light on this Houston outfit. The pattern in its numbers is too much like that exhibited by companies later shown to have padded their earnings. Investors in Petrohawk have a higher-than-average risk of suffering a big disappointment in the next few years, in the form of a writedown or an earnings restatement.
This new way of looking at financial statements comes from University of California, Berkeley accounting professor Patricia Dechow and three colleagues. Their algorithm collects data on such things as sales, receivables and employee count, and spits out a number that Dechow calls the F-score. F is for fudging. A high score is not proof that a company is doing anything wrong – Petrohawk says its accounting follows the rules – but rather just a good reason to worry.
At our request, Dechow’s colleague and coauthor, Weili Ge of the University of Washington, found the U.S.-listed companies with market capitalizations above $1 billion that get the highest fudge scores. The list includes lots of fast-growing midcaps like Petrohawk, which uses a Pollyannaish method of accounting for the costs of acquiring oil and gas assets. It also has volatile technology firms such as Abraxis Bioscience and Tessera Technologies, as well as blue chips like Procter & Gamble and Google (see box).
Dechow’s test is especially sensitive to companies that add lots of assets from year to year, like P&G’s $57 billion acquisition of Gillette. It also snares companies whose assets are increasing faster than employees, such as BlackRock (BLK), where assets increased 10-fold after it took on Merrill Lynch’s investment management business last year. That sounds like efficiency, and in the money management business it is. But when Enron piled up hard assets like power plants faster than employees to manage them, it spelled disaster.
Ms. Dechow’s research does not purport to show that any of these companies are manipulating earnings. It just suggests that they deserve a closer look. One key signal is the simultaneous occurrence of rising cash sales and a cash margin rate that is falling. “Cash sales” means revenue minus the increase in accounts receivable. For “cash margin” you subtract from cash sales the sum of the cost of goods sold and the increase in inventory, and divide the result by cash sales. A confluence of these two trends could mean the company is extending credit to customers to make sales and building excess inventory. Enron displayed this combination in 2000.
The F-formula also penalizes companies with fast-rising stock prices that trade at high multiples of book value, perhaps because managers of such companies feel pressed to continue their winning streak. It penalizes them for goodwill that rises faster than cash revenue.
Skechers USA shares doubled last year as kids made a fad of its Airators and Cali Gear shoes. But Skechers also earned an F-score of 1.8 – roughly the same as Enron would have got in 2000, the year before it collapsed – because the cash margin fell as sales rose. Sure enough, Skechers shares fell 40% in August after the company reported lower earnings on higher-than-expected costs. Other companies with high F-scores because of diverging cash sales and margins include fast-growing underwear manufacturer Gildan Activewear. Shares are up more than 20% this year on soaring sales, but margins could come under pressure sooner or later. Gildan says its F-score is misleading because of a merger that skewed cash margins.
Petrohawk earns a closer look because of an old red flag in the oilfield – full-cost accounting. Under this system, which the SEC tried, and failed, to ban in the early 1980s, companies lump all the expenses of finding and buying reserves into one big account and amortize it over time, instead of charging costs against earnings as they are incurred. That lets fast-growing companies like Petrohawk put off recognizing the effects of bad acquisitions and dry holes because recent moneylosing projects can be mixed in with earlier ones. Petrohawk also has $938 million in goodwill, or the excess of what it paid for reserves and what it thinks they are worth. Goodwill is essentially a bet that management can wring more oil and gas out of the ground than previous owners could, and management decides when that bet has not paid off. With oil companies, RiskMetric’s Hilt Hannink says, “There is no real disclosure of why or when goodwill is written down.”
Thermo Fisher Scientific (TMO) generated a score of 5 – five times the average risk of manipulation – because of the $6.4 billion in goodwill it picked up when Fisher and Thermo merged in 2006. Thermo Fisher has another $7.5 billion in non-goodwill intangibles, including $4.7 billion attributed to “customer relationships”, $1 billion in “product technology” and $696 million in trademarks. Intangibles and goodwill are vulnerable to a sudden writedown if management decides the merger was not such a good idea. Such accounts are also vulnerable to manipulation, as managers push an earnings hit into the future or execute a “kitchen sink” writedown, wiping out asset values in one swoop to make future earnings and return on capital look better. When companies have lots of such hard-to-value assets, “their accounting is more fuzzy,” Ms. Dechow says. “Their earnings are not going to be as stable.”
Ms. Dechow got her Ph.D. in accounting and finance at the University of Rochester in 1993. But her education in fuzzy accounting really began back in Kalgoorlie, Australia, where her father, a geologist, taught her how to tell the difference between a promising mining stock and a scam. “He could tell just by looking at who the directors were,” she recalls. “Where the assets are underground, a lot of games can go on.”Link here.
JIM ROGERS SHIFTS ASSETS OUT OF DOLLAR TO BUY YUAN
He is also buying yen, Swiss francs. Says bull market in stocks, bonds is “over”.
Jim Rogers said he is shifting all his assets out of the dollar and buying Chinese yuan because the Federal Reserve has eroded the value of the U.S. currency. “I’m in the process of – I hope in the next few months – getting all of my assets out of U.S. dollars,” said Rogers, 65, who correctly predicted the commodities rally in 1999. “I am that pessimistic about what is happening in the U.S.”
Rogers, delivering a presentation late yesterday at an investor’q meeting organized by ABN Amro Markets in Amsterdam, said he expects the Chinese currency to quadruple in the next decade and that he is holding on to commodities such as platinum, gold, silver and palladium.
The dollar has dropped against all the 16 most actively traded currencies except the Mexican peso this year. Since the Fed lowered U.S. interest rates on September 18, the first cut in four years, the dollar has fallen 2.8% against the euro. Gold has risen to a 27-year high and platinum jumped to a record. “It’s the official policy of the central bank and the U.S. to debase the currency,” said Rogers, a former partner of George Soros.
“The U.S. dollar is and has been the world’s reserve currency, the world’s medium of exchange,” he said. “That’s in the process of changing. The pound sterling, which used to be the world’s reserve currency, lost 80 percent of its value, top to bottom, as it went through the whole period of losing its status as the world’s reserve currency.”
The Chinese currency, known as the renminbi, or yuan, is “the best currency to buy right now,” Rogers said. “I don’t see how one can really lose on the renminbi in the next decade or so. It’s gotta go. It’s gotta triple. It’s gotta quadruple.”
The yuan strengthened past 7.5 to the dollar today for the first since the central bank ended a fixed exchange rate in July 2005. The currency has gained 10.5% since the dollar link was abandoned. China, growing faster than any other major economy, is “going to be the most important country in the 21st century,” he said. China’s GDP expanded 11.9% in the second quarter.
Rogers also is buying Swiss francs and Japanese yen, which he said have been “pounded down” because of the so-called carry trades – where investors borrow in countries with low interest rates, such as Japan, and invest the proceeds where rates are higher. Japan’s benchmark overnight lending rate is 0.5%, compared with 6.5% in Australia and 8.25% in New Zealand. The carry trades in yen and francs will “unwind someday,” which will send the currencies “straight up,” Rogers said. “I’m buying the yen.”
The bull markets in bonds and stocks are “over,” he said. “Bonds will be a terrible place to be for many years and will in fact be going down for many years.” Rogers said he remains bullish on commodities because “that’s where the big fortunes are going to be made in the world in the next five, or 10 or 15 years. The current bull market is going to last until sometime between 2014 and 2022.”
Commodity prices have surged as demand for raw materials, especially from China, rose faster than producers were able to increase output. Agricultural prices have led recent gains, including a record high for wheat last month and a three-year high in soybeans. “The number of hectares devoted to wheat farming has been declining for 30 years, the inventory levels of food are at the lowest level since 1972,” Rogers said. “Suppose we start having droughts again. God knows how high the price of agriculture is going to go, so that’s where I’m putting more of my money now than in other things. ... I think I’m going to make more money in agriculture than I make in precious metals.” Platinum, gold, silver and palladium will “be much, much higher during the course of the bull market.”Link here.
SEND IN THE CLOWNS
Nattering naboobs of positivism.
Four leading members of the Bush administration’s economic team, including Ed Lazear, Chairman of the Council of Economic Advisors, Commerce Secretary Carlos Gutierrez, Al Hubbard, director of the National Economic Council, and Jim Nussle, director of the Office of Management and Budget, convened on a CNBC panel earlier this week and confidently forecast that the economy would avoid a recession. As they uttered their platitudes, we learned that housing sales plunged again, with national inventories of unsold homes hitting a new record high, and that Merrill Lynch disclosed nearly $8 billion in losses. Set against this backdrop of deteriorating economic news, it would have been more honest, and perhaps more effective, if the Administration team came on stage in clown makeup and oversize shoes.
The group’s most entertaining routine could be described as the “falling dollar hot potato”. It is a testament to the professionalism of CNBC host Dylan Ratigan that he was able to suppress howls of laughter while the economists scrambled to avoid any discussion of the dollar by claiming that only the President and the Secretary of the Treasury were allowed to comment. (Of course the only thing Bush or Paulson will utter on the subject is the all too familiar mantra “a strong dollar is in our national interest.”) How can the leading economic policy makers in government refuse to discuss the value of our money, which is arguably the single most important part of the economy? Why is the subject taboo? Perhaps they feel that anything they say will only inspire less confidence in the dollar? In reality, the Administration is perusing a policy of benign neglect. Break-outs in the prices of gold and silver show that the policy is not going over too well!
In addition to the dollar dance, the wacky economists also provided some laughs on a variety of other subjects. Regarding the California wildfires, the panel reassured us that the resilient U.S. economy would weather the storm, much as it did with hurricane Katrina. However, as state and federal officials promise unlimited funds to rebuild thousands of burned homes, they conveniently ignore the fact that we must put the tab on our national charge card. The ability to postpone pain by borrowing from abroad is not evidence of economic resilience but vulnerability. A truly resilient economy has ample domestic savings to cover these vicissitudes itself. America has yet to pay the costs associated with a string of natural disasters, the bills for which will likely come due much sooner than anyone seems to realize.
The Administration gang also told us that the American economy will benefit once China moves to an economy based on consumption rather than savings (in other words, more like our economy) as they will finally begin buying more of our products. Although it is true to expect that the Chinese will inevitably start spending more, it is ridiculous to assume that it will benefit the U.S. When the Chinese begin spending they will simply snap up their own abundant production and send fewer goods to America. As the Chinese reduce their savings to begin enjoying the fruits of their labor, American borrowers will lose access to their largest source of credit. The two-pronged effect on the American economy will be substantial increases in both consumer prices and interest rates – hardly the benign outcome all the President’s men expect.
None seemed too concerned about the cost of funding the war in Iraq, which on the day of this “summit” we learned is now projected to be almost $2 trillion. Their lack of concern likely reflects their belief that Americans are not the ones picking up the tab. I am sure there is a different reaction among our foreign creditors, as they contemplate the prospects of “loaning” us that much more money knowing that a declining dollar guarantees they will never be repaid in full. Perhaps the thought of loaning us endless sums to cope with natural disaster at home and man-made ones abroad will shock foreigners to their collective senses, prompting them to finally cut us off.
On housing we were once again told the problems would be contained. Such upbeat pronouncements should be wearing thin in the face of mounting evidence to the contrary. When will people begin to grasp that the trillions of dollars of mortgage loans financed by Wall Street will never be repaid in full and that the losses for lenders will be staggering?
Homeowners have lenders over a barrel, and soon all will know it. Once the government exempts forgiven mortgage debt from being treated as taxable income, defaults will become a national trend. Under normal circumstances, lenders have all the power, as 20% down payments and an ample supply of qualified buyers makes foreclosure a real threat. However, under current circumstances, it is completely empty. Lenders can not foreclose as there are no buyers and no equity. If homeowners choose not to pay, lenders really have no choice but to renegotiate the loans. Once homeowners understand this no one will make a mortgage payment until their loan is reduced to an amount more consistent with the actual value of their home.
While homeowners themselves will experience mere paper losses, those of the lenders will be all too real. However, even with less mortgage debt, homeowners will finally wake up to the fact that their home equity is gone. Without it, much like the Chinese today, Americans will consumer a whole lot less and hopefully save a whole lot more.
For a more in depth analysis of the tenuous position of the Americana economy and U.S. dollar denominated investments, read my book Crash Proof: How to Profit from the Coming Economic Collapse.Link here.
WHERE THERE IS NO WILL OR TRUST ...
Your mother-in-law could inherit your house. Your family could get stuck paying unnecessary taxes.
Do you have a will? In a recent PNC Wealth Management survey, 30% of adults with investable assets of $500,000 or more admitted they did not have this basic document. A Harris Interactive survey of the general population, done for lawyers.com, found 55% had no will.
If you die intestate – meaning without a proper will or living trust – your assets will be divvied up according to the law in the state where you live. To see how your estate would be distributed, based on your residence, relatives and net worth, go here and look for the retirement section. There you can try the intestacy calculator created by Pennsylvania estate lawyer Kurt R. Nilson. You might be shocked.
Example: Married couples with kids typically write “I love you” wills leaving everything to each other, with the idea that the survivor will take care of the kids. And since 1991 the National Conference of Commissioners on Uniform State Laws, a group dedicated to rationalizing and harmonizing state laws, has urged states to make this the default for a married person with kids (but no children from a previous marriage) who dies intestate. “A lot of people think their spouse gets everything,” says Nilson.
Yet only 16 states have made that the law. Some states have stuck to the traditional approach of giving a 1/3 share to the spouse, with the kids dividing the rest. Other states give spouses half. Mississippi gives an equal share to the surviving spouse and each child.
If your kids are young, your spouse will have the hassle of accounting for the kids’ funds separately and the worry of what the darlings will do with the money when they come of legal age. If your kids are grown, your spouse may have to beg them for help to maintain his or her current lifestyle. Even if you leave behind no kids, your surviving spouse may not get all your assets. In some states the deceased spouse’s parents, siblings, nieces or nephews and even more distant relatives receive a cut.
Without a will even a modest estate can get hit by unnecessary tax. You can leave any amount to a spouse free of federal and state estate taxes. You can also leave $2 million to nonspouse heirs without federal estate taxes kicking in. But some states tax far smaller amounts left to nonspouse heirs. Say you die intestate in Pennsylvania with a $2 million estate, a spouse and two kids. The state collects $44,325, since each child gets $492,500 (the spouse gets $30,000 off the top and half of what is left), taxed at a 4.5% inheritance rate.
What if you die intestate with a second spouse and kids from a first marriage? Your kids could end up with a lot less than you would want. In the “I love you” states, the second spouse typically gets a minimum of $100,000 and splits the rest 50/50 with your kids. But federal law gives 401(k) and other pension plans at work to the spouse, unless he or she has waived rights to them. The spouse gets the house, too, if you own it as joint tenants. The same goes for a jointly owned brokerage account. Your IRAs? They pass separately to whomever you have named as the beneficiaries.
Most states’ intestacy laws are brutal on unmarried couples. Your live-in partner of 20 years could get nothing and be forced from your shared home. “I’ve seen people come in and say, ‘We’re not really married, but for all intents and purposes we are,’” says Rebecca Manicone, an estate lawyer in Virginia. “Well, that doesn’t cut it.”
California, the District of Columbia, Maine, New Jersey and Washington give intestacy standing equal to that of a spouse to both surviving heterosexual and homosexual partners, but only if the couple has signed up for a state partners registry. In those states that still recognize “common law marriage”, a long-standing heterosexual partner might be able to claim the spouse’s share of your estate, but it could mean a lot of lawyer’s fees.
What if you die intestate leaving no spouse (common law or otherwise) and no kids? Your parents and siblings are usually next in line to inherit. In nine states the parents of your late spouse are in line, too, albeit toward the rear. In Colorado a natural parent who gave you away for adoption can be an intestacy heir.
Do not put if off. Get a will written and sign it. “We have some clients with very well-traveled, unsigned wills,” laments Timothy Speiss, a CPA in charge of Eisner LLP’s wealth advisory group in New York.Link here.
FOR GOLDEN YEARS, INVEST ABROAD
How are you planning to spend your retirement? If your dreams include exotic adventures, you cannot afford to wait until retirement to start exploring the world. It is time to pack your bags now – at least as far as your portfolio is concerned.
When your grandparents started saving for retirement, international investing was not much of an option. Their choices, if any, were limited to a handful of international mutual funds and big global companies with shares trading in New York. And back then, brokers and other financial advisers did not have decades of academic research to draw upon to make the case for going global.
International investing has come a long way in recent years. In 1985, there were fewer than 50 global mutual funds to choose from, with combined assets of about $8 billion, according to the Investment Company Institute. Now there are more than 800 funds, representing closer to $1 trillion. Your grandfather’s plain-vanilla global mutual fund has been replaced by a dizzying array of ETFs, ADRs, closed-end funds and specialized regional or single-country mutual funds. Getting exposure to global markets from Stockholm to Shanghai is as easy as buying shares of IBM, and as time goes by even more offerings are sure to be on the way. Discount brokers are already experimenting with ways to trade stocks listed on foreign exchanges directly from your laptop.
Trouble is, even though the current generation of investors is spoiled for choice when it comes to international markets, most folks still keep the vast majority of their money at home, just like Grandma and Grandpa did. Lots of Americans have dabbled in foreign stocks or funds, but how many have actually built truly global portfolios? My guess is very few. And during a market panic like the one we saw this summer, I would not be surprised to see more investors cutting back on international exposure, especially when it comes to “serious money” like 401(k) plans and other retirement accounts.
There are a few problems with this view. For starters, most Americans are already way too dependent on the U.S. economy. We own homes here and we work for companies that are based here. Before we invest a single dime of our savings, we are 100% exposed to the U.S. market. So if you only had 10% or 15% of your stock portfolio invested overseas before the subprime mess started to unfold and you start cutting back now, chances are you will end up with almost negligible international exposure in a holistic sense.
So how much is enough? The answer will vary depending on your circumstances, but I think you need at least 20% in international stocks to even begin making a difference. Jeremy Siegel, a professor of finance at the Wharton School, argues that at least 40% of your stock portfolio should be allocated overseas. I think you can go as high as 50% if you are not planning to retire for another 20 years or more. This is not as far-fetched as it may seem. The U.S. represents about half of the world’s market capitalization, so by that measure, a 50% allocation overseas would be just about right.
Somewhere along the line we learned to associate “foreign” with “risky”. The real risk is keeping too much of your money at home. I am not one of those gloom and doom conspiracy theorists who think America is about to go the way of the Roman Empire. But when I look overseas, I see too many opportunities to ignore.
International stocks have performed well in recent years, but they still offer one of the best combinations of value and growth that you can find in any asset class. U.S. stocks are trading at 16 times 2007 estimated earnings, with expected earnings growth in the 7% neighborhood. Compare this with emerging markets, where stocks trade for about 14 times earnings and offer 15% growth. Even stodgy old Europe is on course to deliver better earnings growth than the U.S. – and it is cheaper too, at 14 times earnings.
Planning for retirement involves making a lot of assumptions about the future. It is tough enough predicting what the economy and markets will do next quarter, let alone several decades from now. But there is one thing I can almost guarantee. The forces of globalization will continue to boost the importance of international markets, particularly emerging economic powers like China and India. Now is the time to make sure your retirement portfolio has a meaningful stake in these markets of the future.Link here.
WARREN BUFFETT COMPLAINS HIS TAXES ARE TOO LOW
President can expect small thanks from billionaire investor Warren Buffett for cutting his taxes, after the Berkshire Hathaway chairman once again publicly criticized Bush’s tax policies for favoring the wealthy over low- and middle-income workers.
In an interview with CNBC, Buffett, thought to be worth about $52 billion, revealed that he had conducted an informal survey of his office staff, and found that his income tax rate was almost half that of his employees. According to Buffett, his office staff on average paid a combined income and payroll tax rate of 32.9%, while, without any help from tax advisors, his own tax rate is about 17%.
“The taxation system has tilted towards the rich and away from the middle class in the last 10 years. It is dramatic. I don’t think it is appreciated. I think it should be addressed,” he remarked. “There wasn’t anyone in the office, from the receptionist up, who paid as low a tax rate and I have no tax planning. I don’t have an accountant or use tax shelters. I just follow what the U.S. Congress tells me to do.”
Buffett made similar remarks to a fund-raising dinner for the Hilary Clinton presidential campaign, where he attempted to prick the consciences of the 600 Wall Street investors in attendance. “(We) pay a lower part of our income in taxes than our receptionists do, or our cleaning ladies, for that matter,” he observed. “If you are in the luckiest 1% of humanity, you owe it to the rest of humanity to think about the other 99%.”Link here.
“TITANIC” TACTICS WHEN THE FED HITS AN ICEBERG
Fifty years ago, I read Walter Lord’s book on the sinking of the Titanic, A Night to Remember. Frankly, the only fact I can remember about that book is this: the lifeboats were only a little over half full. That grim fact has never left my memory. It was shocking to me then. It is shocking to me now.
I am not sure what I would have done, had I been a passenger on that ship. But as an entrepreneur, I know one thing: I would have been the first person to line up at a lifeboat. If I had been refused access to that lifeboat – “Women and children first!” – I would have headed rapidly to another lifeboat, on the assumption that the same rule did not hold for every lifeboat. That was in fact the case that night. A lot of men got into lifeboats. I would have been prepared to offer my seat to a woman or child, but once the crewman said “lower it!” I would have sat tight.
From the groaning sound, I have concluded that the Good Ship Bubble Economy has hit a monetary iceberg. The question now is this: Is the scrape long enough so that it has punched a gaping hole in all of the watertight bulkheads?
The Fed under Greenspan lured lenders and home buyers into what have now become visible disasters. But for most of this period, 1991–2005, the policy seemed to create great wealth, in the form of rising home prices. That is a long period of success. So, when signs appeared in mid-2005 that the housing market had peaked, and some of us hard-money writers began warning about this, nobody paid attention. But the reality is here.
In every mania, a few emotion-driven people buy at the top. This now-deflating housing mania was debt-funded. You could still get jumbo loans (above $417,000) last July at fairly low rates. Today, you can’t. There is no indication that anyone will be able to do so in time for these now debt-burdened people to get out from under their upside-down mortgages. They must now make mostly interest payments for the next 15 years just to pay off the equity that they have lost in one year. They are prisoners in their McMansions.
This is the price of central bank policies designed by very smart people. They are very smart people who think that they are wiser than free markets. They aren’t.
In a year, there will be real fear. Sellers will not be able to sell. Inventories will be much higher. Sellers will be stuck in their homes, or worse, paying the mortgage on their now-empty houses and rent on the one in the new location. Reality will set in. Some sellers will run out of bargaining room. That is when you should be there with cash.
If you are seller, think “Titanic”. Lower your price now and get out while the ship is still afloat. The water will be just as cold next year. Put on a life vest and jump, before the lifeboats float out of swimming distance.Link here.
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