Leftovers -- Radio Show 4/3/2010

We continued the discussion on the new Health Reform Bill and confirm that children's pre-existing conditions coverage has been questioned by the insurance industry as not being covered in the language of the legislation, but supposedly the insurance industry group AHIP has compromised with the Administration, who threatened to cover the issue in rules and regulations, to allow pre-existing coverage for children, starting September 23, if their families already have an existing policy.  We also discussed that existing group plans are exempt from this legislation and there is conflicting information from the different experts analyzing this legislation as to whether the exemption ends with a new plan as some iterate and others do not mention.

We covered the unemployment numbers and what they really mean.  We emphasized the tax facts, contrary to popular myth, that the average American with $50,000 in income does not pay 20-25% of gross income in federal taxes, that the actual amount is less than 7% in federal income taxes and less than 15% in federal income taxes and social security taxes, and taxation revenues are not equal to about 40% of GDP but are in fact less than 10%.  While many people believe taxes increased under the current Administration, taxes, as a whole, actually went down as the result of the economic stimulus package.

We also commented on the fact that, although the Illinois General Assembly, suddenly passed the Illinois pension reform bill, as we have pushed for over a year, in order to prevent a credit rating downgrade, the credit rating was still downgraded one notch to A- by Fitch because Illinois has failed to make any credible effort to to address the operating deficit which is at least $13 billion.  We found it interesting that there had been no known Illinois or Springfield media coverage of the credit downgrade.

At the very end of the show we tried to cover research on asset allocation.  In the past we have extensively covered the myths of Modern Portfolio Theory, specifically with respect to allocation and efficient market theory and how it is taught improperly and misapplied, and Capital Asset Pricing Model.  These myths are deeply entrenched and resilient to factual education.  For over twenty years people have been told that asset allocation is responsible for over 90% of investment returns.  This is wrong and new research has shown that the returns are not from asset allocation but from the actual market movement of the different asset classes without respect to "proper" allocation for a given period.  This is very similar to recent attempts by William Sharpe, who won the Nobel Prize for MPT and CAPM contributions, to devise an investment methodology based on re-balancing as asset classes move in the market.

We got through all of the economic data during the show.

While some mysterious, unspecified agreement between the EU and the IMF has supposedly been agreed upon, no apparent help has been forthcoming to Greece.  Roubini joined the deficit chorus insisting the budget deficit be slashed further to avoid a refinancing crisis.  The credibility of the Southern euozone countries to pay debt has been under attack by the financial markets and economic commentators without respect actual ability to pay as opposed to the draconian negative effects of the imposed EU austerity programs on the potential for economic growth in those countries, which they could solve if they had their own national currencies.  Any analysis of the eurozone current trade balances show that it is in the best interest of Germany to assist in the formation of an effective EU assistance program.  Germany needs to urgently foster internal consumer consumption and German banks have large exposure to Spanish mortgage and public debt.  If Greece is thrown to the deficit wolves and forced to restructure or default on debt, Spain will be next.  Not to be forgotten, Italy's debt is 25% of all EU debt.  Greece has no reason to default, although some argue otherwise, on debt unless it is imprudently and politically forced to do so rather than exit the euro.

Paul Krugman does not believe breaking up big banks will solve any problems, because a financial crisis can still emanate from a run on smaller institutions.  He wants to update and extend old fashion bank regulation and include "shadow banking" in the regulated.  While I continue to have concerns about size, I have consistently asserted that the real question is not size but whether the financial entity, of whatever size, is systemically dangerous.  Regulation, as it has existed in the United States, is not enough without effective risk management policies in place and rigorously enforced.

Paul Volcker said that proprietary trading was not central to the financial crisis, but a ban is necessary because it could distract banks from their fiduciary responsibilities.  He finds no need for commercial banks to be involved in proprietary trading and arguments that liquidity requires proprietary trading are over blown.

The Baseline Scenario argued that capital requirements are not enough to regulate big banks and that they must be broken up.  They argue for asset caps on financial institutions and, if they want to take on risk, they need to be smaller.  Again, the need for proper risk management is essentially ignored.

The Aleph Blog wants banks reformed by encouraging liquid assets, limiting derivative transactions, fixing the accounting to become transparent, raise capital requirements disproportionately to the rise in assets, and fix the risk-based capital formula to emulate the risk management policies of insurance companies.

China is expected to report a trade deficit in march for the first time in recent memory.  We have previously published articles on China's spending bubble and China's real estate bubble and growing leverage problem.  We have also published an article on Chinese and United States publications on the practice and use of economic warfare.  Pressure continues to mount on China to allow the yuan to appreciate against the US dollar.  This international pressure will only delay the 2-4% appreciation China needs to allow slowly in order to respond to internal wage and inflationary pressures requiring monetary policy action.  New analysis reports are detailing China's debt bubble and internal needs from different perspectives, but coming to similar conclusions that China will not address its internal needs soon enough to avoid a hard economic landing.  If this were to occur, it would have massive global repercussions as even a soft landing will cause global contraction.

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