Another Play
College and professional football games offer new twists in both offense and defense practically every week. These efforts are designed to produce winners. However, in many cases, the Xs and Os on the chalkboard and on the practice turf do not move as anticipated in a game setting. As a result, changes have to be made continually in order to produce the desired results.
Similarly, because of the myriad problems continuing to press down and hold back the forward momentum of the nation’s economy, several steps have been taken over the past few days and weeks to mitigate the difficulties. All of them have been designed to help Americans and, indeed, citizens of the entire globe, better maneuver the daunting waves of uncertainty and thus reach the shores of greater financial stability and security.
To accomplish these goals and allow credit to flow more freely, the Treasury Department approved the doling out of $125 billion to purchase stock in nine of the nation’s largest banks. This investment was the first official distribution of funds from the federal government’s $700 billion financial rescue program approved on October 3.
To bolster balance sheets and stop the economic drain, the Treasury Department is taking the preliminary steps to give approval for using another $125 billion to purchase stock in key regional banks, hopefully by the end of the year. The logic behind this plan is simply that, if the problem is liquidity, why not provide liquidity? The rationale stemmed from a similar approach which seemed to be working in Europe (better than the original idea of using all of the funds to buy distressed assets), so why not try it here? I would like to say there was more to it than that, but there wasn’t.
The plan now underway to relieve the credit crisis by using public funds to invest in banks is not without precedent. During the financial chaos at the height of the Great Depression in the 1930s, the Reconstruction Finance Corporation (RFC) was created to enable the government to become a shareholder in thousands of banks across the country. This measure was eventually vindicated as the economy improved, and the $1.1 billion the government had invested in the nearly 6,800 banks was repaid. (The $250 billion the government is now investing is equal to about $1.6 billion in 1933 dollars.)
The purpose of the infusion of money into the major and regional banks is basically to help boost capital ratios and ease the flow of loans. Unfortunately, according to the Senate Banking Committee hearing last week, these monies are not being made readily available to the public.
The reason perhaps lies in the fact that the Treasury Department authorized stronger banks to use a portion of the funds to acquire weaker banks, and thus much of the money is being held or used for this purpose. The modest increase now being experienced in lending seems to be coming from firms drawing down lines of credit instead of financial institutions creating new loans.
The Treasury’s approval for such use of taxpayer investment has led to some criticism because it has opened the door to acquisitions and mergers that will not necessarily make additional funds available to those seeking loans. Furthermore, this caveat has created a perception that the government is stepping in to determine winners and losers. Additionally, some major banks are reluctant to release their purse strings out of fear that the financial situation will get worse and they may need the money for themselves.
The nine major banks that received the public investments did not have a choice regarding participation in this plan. They were basically required to accept it because the Treasury Secretary requested them to lend more money, to both customers and to each other. If one or two had been allowed to opt out, it would have sent a signal that the others were weaker, thus risking more market panic and chaos. The smaller institutions do have a choice, and some strong Texas banks are opting not to participate. Others that are equally strong see it as a vehicle to obtain low-cost capital and earn greater profits.
While the government’s purchase of stock may eventually prove beneficial in slowing the financial slide, many business leaders believe that more is required. Thus, several other industries, ranging from automobile manufacturers to insurance companies, are looking to get in on the act. Some consideration is being given by federal authorities to these desires.
Moreover, to help ease the flow of funds and relieve the pain being felt by many Americans, the Federal Reserve this week ratcheted down interest rates yet again, as did other banks around the world. For reasons that will require another column to explain, this is not likely to be the most effective part of the effort, but we have to try it nonetheless.
Just as football teams normally adjust their plans to better meet the anticipated challenges as the game continues, extra fine tuning will no doubt be required in the coming weeks to stabilize the banking system and encourage additional lending. We will get there!
posted @ 08:02 AM CST [link]
Friday, October 24, 2008
How Big Becomes Huge!!
One of the main topics of interest from the water cooler to the halls of Congress is the current US economic situation. Several times a week and at practically all the presentations I have been making across the state and nation, the main questions asked are “What’s going on with the economy?” and “How did we get into this mess?”
Most people know of the difficulties, especially when they examine their portfolios or check their 401(k) plans. However, because things had been rocking along so well for such a long time, few people had really noticed what was happening. The problems we are now experiencing have brought the situation to our attention, and we want to know why it has occurred.
Our economy, of course, did not falter suddenly; it has been a slow process and can be traced back to financial and credit problems that began more than a year ago. In fact, the roots of the current situation can be traced back to the boom-and-bust high-tech bubble in the 1990s.
A few years later, when the nation underwent a mild recession, the Federal Reserve lowered interest rates, an action designed to mitigate the severity of the economic downturn. The lower interest rates naturally created an opportunity for cheaper mortgage rates, which in turn rapidly increased the desire for home ownership. The lower rates also widely expanded the practice of refinancing existing mortgages.
With the ramping up of the housing industry and diminished government oversight, the quality of mortgages fell dramatically. Unfortunately, credit was granted to new homeowners who eventually were unable to meet their mortgage obligations. As a result, default and delinquency rates soared, and by 2006, they seemed to be on an unstoppable upward spiral.
Despite this negative rampage, major banks and financial institutions continued to provide unsubstantiated loans and failed to respond by enforcing limitations. Investors and lending partners assumed the quasi-government-backed system that had been in place for so long would continue to be supportive, so they sliced and diced through a complex financial system to strengthen and improve their profit margins.
This situation was also impacted by laws designed to provide more equitable and fair access to credit. It was an excellent concept that initially allowed many worthy individuals and families to purchase homes for the first time. However, driven by political pressure to let even unworthy borrowers into the game, Fannie Mae and Freddie Mac (and then private underwriters) issued larger and larger volumes of mortgage-backed securities which pumped more money into the system to support weaker and weaker loans. In many instances, so-called “credit default swaps” were used to translate a portfolio of weak mortgages into AAA-rated financial instruments.
Credit default swaps are similar to insurance contracts designed to pay off if those assets default. Congress had decided in 2000 not to regulate credit default swaps, believing that investors would abide by their natural desire to keep their own risks at a minimum (or at least at a reasonable level). However, in the aftermath of the corporate accounting scandals that made investors skittish of the equity markets, these seemingly safe securities were gobbled up with a vengeance.
This phenomenon in and of itself wouldn’t tank the entire system because mortgage lending is only a small part of the vast international financial system. However, more problems occurred when major investment houses, unleashed from reserve limitations by a fresh round of deregulation in 2004, began to issue huge amounts of derivative securities.
Basically, these instruments are not backed by mortgages, but are designed to mimic the performance of their secured counterparts. In other words, if a group of bad mortgages are transformed into a highly rated bond through the hocus-pocus of credit default swaps, the potential loss is still no more than the presumed value of the underlying assets, and the investment can only be held by one entity at a time.
Through derivatives, however, a virtually unlimited number of eager buyers can bet on whether or not those mortgages get repaid. Thus, a relatively small (by the standards of a multi-trillion dollar market) amount of “mortgage-backed” securities can generate an enormous volume of “mortgage-related” securities, and much of this brouhaha can occur outside the realm of public disclosure.
The initial round of failures of large mortgage lenders and write-downs by major purchasers of their assets was only the tip of the iceberg of what was to come. The growing weakness of the mortgage-related investments would, over a period of several months, lead to the collapse, purchase, merger, and realignment of various financial institutions. Government rescue plans were put into place, interest rates were lowered, more money was made available by the Fed, and major banks took on government partnership. Similar phenomena occurred all around the world.
Additional plans for strengthening the economy and quelling the economic damage are now on the drawing board. They will take a while to implement, of course, and even longer to stem the tide. Still, credit is already beginning to flow, and there is little doubt that the nation’s economy has the resilience required to make a rebound over time.
posted @ 07:55 AM CST [link]
Friday, October 17, 2008
Cheers!!!
Since the end of Prohibition, voters in Texas communities have considered the question of whether to elect to be “wet” and allow alcoholic beverage sales or “dry” and prohibit sales of beer, wine, and distilled spirits. Counties, justice of the peace precincts, and municipalities all qualify to exercise local option elections, making the current liquor laws in Texas confusing and extensive. Not only can the political subdivision vote on whether to allow liquor sales, but also what types of liquor will be allowed to be sold and whether it can be sold for on or off premises consumption.
A key issue in such elections is often the likely effect on the economy and local tax receipts. The economic and fiscal implications of wet/dry status are notable. My firm, The Perryman Group (TPG), recently released a study of the overall effects of the alcoholic beverages industry on business activity in the state of Texas. In addition, we looked at the effect on representative communities of switching from dry to wet.
The numbers are big. We found that the alcoholic beverage industry supports some $36.6 billion in total annual spending and more than 300,000 jobs in Texas. It is also a notable source of tax receipts, generating $2.067 billion per annum to the State and $0.622 billion each year to local governments stemming from the total alcoholic beverages industry.
Of those amounts, the distilled spirits segment accounts for an estimated $10.7 billion in annual spending and in excess of 90,000 jobs as well as a significant portion of tax receipts ($596.7 million to the State and $181.5 million to local governments each year).
The substantial benefits of allowing alcoholic beverage sales are available to communities of all sizes and income levels. We found that retail sales in wet regions are higher than in dry locales (after adjusting for other factors such as income). Moreover, even when factors such as income patterns, general economic conditions, and overall retail trends are accounted for, our analysis indicates a statistically significant increase in retail sales following a change from dry to wet.
To get an idea of the range of these benefits, we measured the likely economic impact of the alcoholic beverage and distilled spirits segments on a representative community. This allows for an approximation of current effects or likely gains for a locale electing to change from dry to wet. TPG developed three representative examples.
Results for a representative small, 25,000-person community with per-capita income 10% below the state average indicate that the net impact of sales of alcoholic beverages totals almost $19.0 million in annual spending in the local economy, $10.8 million in output, and 185 jobs. The distilled spirits component of these effects is more than $5.8 million in annual spending, nearly $3.3 million in output, and 55 jobs.
For a town with a population of 100,000 with average incomes equal to the state as a whole, the impact of alcoholic beverage sales includes $90.1 million in annual spending, $50.8 million in output, and 863 jobs. Distilled spirits account for $27.8 million in yearly spending, $15.5 million in output, and 264 jobs.
A community with a population of 150,000 and per-capita income levels 20% above the Texas average generates even larger effects on annual business activity of $134.1 million in spending, $79.7 million in output, and 1,366 jobs. For distilled spirits, these effects are $43.2 million in spending each year, $25.3 million in output, and 440 jobs.
In those areas which preclude alcoholic beverage sales, the prevailing reason tends to be concern over the associated social costs. It should be noted, however, that while dry areas do not permit the sale of alcohol, they have little or no ability to impact the consumption of alcohol. Residents of dry areas simply have to drive to a neighboring wet area to buy alcohol. Also, many cities within partly wet counties are dry, and residents can drive outside the city limits or to a neighboring city to buy alcohol.
Thus, although some may see restricting sales as protecting the area from the legitimate social problems that can occur from abuse, the economic reality is that it is only an inconvenience for residents. In essence, “dry” areas tend to incur the social costs, but deny themselves the offsetting benefits.
posted @ 07:58 PM CST [link]
Friday, October 10, 2008
Texas Tax System Among the Best
Almost from the first days of civilized societies, taxes have been of intense interest to the majority of the human race. As was evident in the Presidential debate Tuesday evening, it appears that the subject is still attracting a lot of attention.
While most of us today do not relish paying taxes, we normally realize their importance and do not begrudge the requirement too severely unless they become excessive. We accept it as just something we live with. After all, we all want national defense, highways, education, and other public services. Of course, depending on where you reside in the US determines just how much of your money you are able to live with.
It has been estimated that Americans worked about 74 days this year to afford to pay their federal taxes and another 39 days to pay state and local taxes. For 2008, the traditional arrival of the so-called Tax Freedom Day®, when workers are able to pocket all their income for the remainder of the year, occurred on April 23rd. Over the past two decades, this special day has moved anywhere between April 16 to May 3, depending on government tax requirements.
A report that came out this week from the nonprofit, Washington, DC-based Tax Foundation indicates Texas has one of the nation’s least-burdensome tax climates. Founded in 1937, the organization regularly disseminates information about government finances to the general public. The objective is to make taxes more visible so that people understand what they are paying and why. The report focuses on state and local taxes.
Thirty years ago, Texans put approximately 8.1% of their income into local and state coffers and were third from the bottom among all states in these kinds of payments. Today, residents are paying 8.4%, which represents a ranking of 43rd, with 1st being the worst (highest tax burden).
For 2008, the average American is expected to direct about 9.7% of their income to pay state and local taxes, down from 9.9% last year. The reduction was due to the fact that in fiscal year 2007, income grew faster than tax requirements. According to the Tax Foundation, residents of New Jersey are paying the highest percent of their income for state and local taxes—11.8%, while Alaskans are paying the least—6.4%.
In Texas, per-capita income for fiscal year 2008 (which ended in June) was $42,796. Of that amount, state and local taxes took about $3,580. The Foundation’s data differs from that provided by the US Census Bureau in that the Bureau includes taxes paid in the state by non-residents (tourists, commuters, businesses, and non-resident property owners) while the Foundation identifies those taxes with the home state of the individual or business.
The Tax Foundation report also noted that Texas continues to rank as one of the best states in the nation in which to do business based on required tax payments. In its annual State Business Tax Climate Index, Texas was in seventh place, up one from last year. Wyoming ranked at the top for having the most business-friendly tax climate.
The report gathers information on the role a state’s tax system has in encouraging investment by measuring the tax base and level of rates. Over the past few years, Texas has been frequently cited by various national organizations for its friendly business atmosphere and identified as among the top places in the nation to work. Evidence of this categorization of the Lone Star State is demonstrated by the ongoing increase in jobs, while employment levels in much of the country is going in the opposite direction. According to the Texas Workforce Commission, businesses in the state added 252,000 workers over the past 12 months.
Since paying taxes is one of the certainties of life (like it or not), it is good to know that we seem to be getting a good return on investment in terms of national recognition and economic competitiveness.
posted @ 07:59 PM CST [link]
Friday, October 3, 2008
How High’s the Water
Although the late Johnny Cash was no economist or even an economic prognosticator, he certainly knew how to get your attention and get his point across. The “Man in Black’s” rendition of “How High’s the Water, Mamma” in which he learns that his home is flooding and realizes there’s no end in sight paints a vivid picture that requires no expert interpretation.
Such might have been the feeling of many Americans over the past several days. Reports from myriad quarters kept coming in labeling the financial crisis the nation has recently been experiencing as the worst in most people’s lifetimes; some say since The Great Depression.
Almost daily, news of the failures of major banks and other historic financial institutions have flooded over the landscape tearing apart the hopes of people reminiscent of the onslaught of the waves of Hurricanes Gustav and Ike that invaded our shores only days earlier.
Although the nation did not panic, there was undoubtedly great anxiety, and perhaps even some fear that the situation was doomed to keep getting deeper with each sunset. But just when it looked like gloom and doom would prevail, things turned around (at least in the stock market), leaving many investors feeling whipsawed as a result. Of course, this burst of relative optimism was based on the notion that Congress would surely end up doing what it couldn’t manage to do the first time around.
The degree of attention to economic matters on such a wide scale was quite unusual. People were seeking answers to both the causes and remedies. The media tried to assuage the situation by enlisting financial analysts and economists to explain what was happening and what might be the end result. I was inundated with calls from radio, television, and print media to share my take on the matters.
Both elected and appointed officials got into the act. Plans were proffered from various fronts ranging from the White House to Capital Hill. Presidential campaigns were adjusted so that the contenders could play a role. Wall Street responded both negatively and positively depending on rumors and anticipated solutions.
Was it time to take money out of bank accounts and put it in a sock or hide it under the mattress? How high was the “water” going to rise?
I pictured in my mind the scenes that blanketed our television screens of people being rescued by boats and helicopters during the recent storms. Was this turmoil going to cause similar financial rescues, and, if so, by whom?
We didn’t have to wait long before motor boats and helicopters arrived on the scene in terms of avenues of approach for rescue, or as it became known, the government, aka, taxpayer “bailout.” The first and biggest (among many) marketing mistake in the whole process was probably that name. The actual proposal is an asset purchase that may ultimately even make a profit for federal coffers and certainly will cost nowhere near the initial outlays. Also, although the initial purchases will be with government dollars, nobody is talking about raising anybody’s taxes to pay for it. There will be consequences to all of us no doubt, but they are much less severe than the alternatives.
Deadlines were given and then extended. Warnings came that if the situation was not fixed over the past weekend, it might not ever be accomplished. Working agreements were announced and hope looked to the House of Representatives to be the first step on the course of resolution.
Monday was the line in the sand for moving forward with the Senate to take up the matter a few days later. However, something happened as noted by the famous English poet Robert Burns who wrote, “The best laid plans of mice and men go oft astray.”
The bipartisan bill, hammered out over long hours of discussions was narrowly rejected by House members. The President and his advisors were disappointed. Wall Street experienced its deepest drop in history. Politicians began to point fingers. The public quickly changed from adamantly opposed to realizing that the situation couldn’t go on. And the water continued to rise.
So what now?
There is no doubt that a solution must be found. Liquidity is being drained from the financial system, and small businesses and consumers will not be able to function without credit availability.
As I write this column, our national lawmakers are back at the drawing table. We await what they will produce. By the time you read it, I suspect something will have happened. It won’t be perfect, but most solutions passed by Congress are not. However, almost any workable and realistic plan will free up some funds and allow us to get about the business of consuming, investing, and growing.
posted @ 08:02 PM CST [link]