In my last post, "Illinois is #1 in Underfunded Pensions", I ended with the newly enacted two tier pension system which will apply to future hires starting in 2011 and indicated there are actuarial and accounting questions with respect to how the long term savings from the adoption of a two tiered system were applied. This has come as a surprise and I know of only one Illinois newspaper (Champaign-Urbana) which has mentioned the New York Times article entitled, "The Illusion of Pension Savings". We have previously commented in detail on the failure of Illinois mainstream media to discuss Illinois pension systems risky investment policies.
While we have been a public proponent of a two tiered pension system as economically necessary, however distasteful or unfair, given the growing underfunded liabilities of the Illinois pension systems, Illinois officials have apparently taken a concept designed to create future cost savings and used grey areas of actuarial language and governmental accounting standards to purposefully calculate the savings by including all current employees (not just future employees to whom the calculation should apply) in the actuarial cost methods calculation and then applied the "future" savings to the current State budget reducing the required pension funding amount.
This does not pay down principal; it does not keep up with interest; and it actually increases debt annually. It is not a responsible funding method. It is particularly not responsible and, in fact, very risky for an underfunded pension system to adopt such a cost methods calculation.
When the State of Illinois issued public documents this year, which stated the cost method used did not permit the cost of future benefits to be factored into the current year contributions, it caught the attention of actuaries who questioned the disclosure and the cost methods used as well as discourage Illinois from adopting the deceptive method. One actuarial consultant to the State recommended they clarify the disclosures and also said the funding method "may not be an appropriate one."
This has caused the Actuarial Standards Board to begin a review of necessary standards revision, particularly since Texas, Rhode Island, Ohio, and Arkansas use similar methods.
Recently, New Jersey signed a SEC consent order acknowledging that New Jersey had engaged in misleading and incomplete disclosures (to improve the perception of their credit risk) to investors with respect to pension system funding. The investigation had taken three years and no one was charged. According to the State of Illinois Office of Management and Budget, the SEC has not contacted them and they are confidant the disclosures were complete and accurate.
It appears that the State of Illinois officials were aware of the grey interpretation and purposefully chose to use it as a plug in the current deficit budget.
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Tuesday, September 21, 2010
Illinois is #1 in Underfunded Pensions
We have repeatedly spoken and written publicly about the horrible underfunding of Illinois pension systems, including here. Illinois now ranks as having the worse underfunded pension systems out of all fifty states according to recent data accumulated by the Bloomberg Cities and Debt Briefing in the U. S Pensions Funds Ranking by Bloomberg News at 50.6% underfunded for all Illinois pension systems.
Part of Illinois' funding problem (2005 study) was the adoption in 1995 of a RAMP funding program that would increase State funding payments in future years to reach 90% funding by 2045. The increasing funding amounts are impractical (2007 study) and often suspended by the General Assembly.
This has contributed to the Teacher's Retirement System and, to a lesser degree, the State Universities Retirement System to engage in risky investing policies involving securitized derivatives. With the Illinois State Board of Investment, all three have high domestic and international equity exposure and low hedge fund direct investment. Illinois pension systems do not have adequate staff to individually investigate due diligence on investments and rely on third party investment managers. While the Illinois State Board of Investment has posted 8.9% investment return for FY2010 and the SURS has reported 16.7% for FY2010, the Teacher's Retirement System has yet to post their FY2010 return. In June, the spokes person for TRS was estimating 19% but has made statements in September that it was 13%.
The sad fact is that benefit payments from the Illinois State Board of Investment were 10% in FY2010 and the benefits paid by the TRS were supposedly 12%. Although employee and employer contributions continue to be made, the failure to make the required actuarial funding of liabilities will escalate the under funding with the percentage of benefits paid increasing to levels which cannot be sustained by investment return and employee/employer contributions. Here is a video on how the more conservative Illinois State Board of Investment could run out of money in ten years or slightly more. While this is extremely serious and must be addressed immediately, it is not a "death spiral" yet.
In a Chicago Federal Reserve paper, Lance Weiss provides an overview of the Illinois pension problems and funding and provides two gross solution alternatives: 1) reducing costs by reducing benefits, increasing invest return, reducing administrative costs, and finding alternative funding sources or 2) deferring costs by changing funding policy, changing actuarial assumptions, changing actuarial funding method, and changing actuarial asset valuation method. It should be noted that the 2003 Pension Obligation Bonds of $10 billion mentioned in his paper were not fully deposited in the pension funds but partially used for other States expenditures.
In another Chicago Federal Reserve paper by Laurence Msall again details the current Illinois budget problem and the necessity to institute pension reforms. He references the recently enacted legislation to raise retirement ages, limit pension double dipping, and limit pension wages which applies only to future participants. He continues his argument, with which I am in general agreement although we might disagree on some details, that cutting State expenses cannot achieve enough savings without significantly damaging essential social safety services and a tax increase is necessary which includes specific funding for pensions.
In "Coping with Unfunded Pension Liabilities", Howard Cure delineates the general causes, current situation, and competing political pressures. He also lists revenue streams, special purpose revenue, defined contribution plans, and the use of tiered pension systems as possible funding solutions. He mentions that Illinois in the recently enacted pension reform legislation adopted a two tiered pension system applicable to future participants hired after January 1, 2011. Unfortunately, it has since been disclosed that there are actuarial and accounting problems with how the two tiered pension system was used in the current FY2011 budget. I will cover this in more detail in my next post
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Part of Illinois' funding problem (2005 study) was the adoption in 1995 of a RAMP funding program that would increase State funding payments in future years to reach 90% funding by 2045. The increasing funding amounts are impractical (2007 study) and often suspended by the General Assembly.
This has contributed to the Teacher's Retirement System and, to a lesser degree, the State Universities Retirement System to engage in risky investing policies involving securitized derivatives. With the Illinois State Board of Investment, all three have high domestic and international equity exposure and low hedge fund direct investment. Illinois pension systems do not have adequate staff to individually investigate due diligence on investments and rely on third party investment managers. While the Illinois State Board of Investment has posted 8.9% investment return for FY2010 and the SURS has reported 16.7% for FY2010, the Teacher's Retirement System has yet to post their FY2010 return. In June, the spokes person for TRS was estimating 19% but has made statements in September that it was 13%.
The sad fact is that benefit payments from the Illinois State Board of Investment were 10% in FY2010 and the benefits paid by the TRS were supposedly 12%. Although employee and employer contributions continue to be made, the failure to make the required actuarial funding of liabilities will escalate the under funding with the percentage of benefits paid increasing to levels which cannot be sustained by investment return and employee/employer contributions. Here is a video on how the more conservative Illinois State Board of Investment could run out of money in ten years or slightly more. While this is extremely serious and must be addressed immediately, it is not a "death spiral" yet.
In a Chicago Federal Reserve paper, Lance Weiss provides an overview of the Illinois pension problems and funding and provides two gross solution alternatives: 1) reducing costs by reducing benefits, increasing invest return, reducing administrative costs, and finding alternative funding sources or 2) deferring costs by changing funding policy, changing actuarial assumptions, changing actuarial funding method, and changing actuarial asset valuation method. It should be noted that the 2003 Pension Obligation Bonds of $10 billion mentioned in his paper were not fully deposited in the pension funds but partially used for other States expenditures.
In another Chicago Federal Reserve paper by Laurence Msall again details the current Illinois budget problem and the necessity to institute pension reforms. He references the recently enacted legislation to raise retirement ages, limit pension double dipping, and limit pension wages which applies only to future participants. He continues his argument, with which I am in general agreement although we might disagree on some details, that cutting State expenses cannot achieve enough savings without significantly damaging essential social safety services and a tax increase is necessary which includes specific funding for pensions.
In "Coping with Unfunded Pension Liabilities", Howard Cure delineates the general causes, current situation, and competing political pressures. He also lists revenue streams, special purpose revenue, defined contribution plans, and the use of tiered pension systems as possible funding solutions. He mentions that Illinois in the recently enacted pension reform legislation adopted a two tiered pension system applicable to future participants hired after January 1, 2011. Unfortunately, it has since been disclosed that there are actuarial and accounting problems with how the two tiered pension system was used in the current FY2011 budget. I will cover this in more detail in my next post
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Friday, September 17, 2010
Can Risky Illinois Pension Fund Investments Be Made Invisible?
After we published "How Risky Are Illinois Pension Funds?" as a follow-up to a segment on our radio show, a spokesperson for the Illinois Teacher's Retirement System wrote a rather long op-ed piece entitled "Facts about pension system alleviate uncertainty for teachers" in the State Journal-Register on September 8th in which the pensions funds are assured to be safe, that pension payments of $2.7 billion paid in 2008-2009 created a $4 billion stimulus in the economy, and assets are being sold in 2010 as they were in 2009, because the State of Illinois in the General Assembly has failed this year and over the years to adequately fund Illinois pension funds as required. We have previously had Laurence Msall of the Civic Federation of Chicago on our radio show in the past to discuss the underfunding of Illinois pensions and what the State must do if it is avert disaster in the future. We have also written on the need of the State to properly fund pensions and address many years of poor government which may leave no choice but a tax increase, despite a slow economic recovery from a recession which is flirting with a double dip, which is normally a time in which a tax increase is not economically desirable or prudent, because the cuts, without a revenue increase, necessary to balance the budget going forward would be destructive of public safety and welfare.
Our article had discussed the proposed 2010 asset sales by the Teacher's Retirement System (possibly $3 billion), the State Universities Retirement System (possible $1.2 billion), and of the Illinois State Board of Investment (possibly $840 million), which invests for the other Illinois pension funds, as reported by Crain's Chicago Business and other news sources..
Our article had also discussed Alexandra Harris' Medill Reports article "Illinois pension fund use OTC derivatives to recoup returns, jeopardizes pensions", which was published in June but has gotten no main stream media attention in Chicago or Springfield, which we can find. When the Teacher's Retirement System spoke person's op-ed appeared in the State Journal-Register, we immediately emailed the editor with a link to our article. We did not get even the courtesy of a response; just silence. Such an unprofessional lack of response got us wondering why and we did some research to see if there had been other posts on blogs and found two on Pension Pulse. The first referenced a zero hedge post which accused the Teacher's Retirement System of being dangerously risky and the second referenced a demand by the Teacher's Retirement System spokesperson to remove the zero hedge comments. I had both zero hedge posts on the subject of the Teacher's Retirement System, including an earlier zero hedge post on the Medill Reports article, which I had missed when it was published. I concentrated on Harris' article and the Illinois Auditor General's audit report of the Teacher's Retirement System.
Further research led me to the disparagement of current economic research still in process by Joshua Rauh at Northwestern University on state pensions. Rauh's research is still in the form of working papers and a continuing project. Earlier in May we had discussed his research on the underfunding of state pensions on the radio show. The Teacher's Retirement System disparagement was part of an Issues Update in which the TRS defended itself on many issues, even asserting that the fiscal year ending June 30, 2010, will have a return of 19% and defended it's use of derivatives. The disparagement of Rauh concentrated on a NPR very brief condensation of state pension systems ranking the Teacher's Retirement System as the fourth riskiest in the country and the classification of investments as risky if they were not fixed income or cash. The TRS argues that all investments are risky to one degree or another, no analysis of individual category risk was made, and the TRS manages risk. To me it appears that the general finance classification of risk was used, because fixed income bonds were not classified as risky, although they can be risky and lose money. Bottom line, the disparagement is smoke exhaled as a screen to obfuscate rather than enlighten with specific risk management procedures and substantiation of acceptable fiduciary risk.
To demand removal of comments, to disparage in general, and to benefit from media silent refusal to print or comment on the issue of investment risk is pretty heavy weight political magic. It made me even more curious. It caused me to re-read the Medill Reports article two more times, review the TRS audit report investment category by category, review the audit report of the Illinois State Board of Investment, review the audit report of the State Universities Retirement System, review the Teacher's Retirement System website information, review the State Universities Retirement System website, and review the Illinois State Board of Investment website information.
On the websites, I found investment information as of 6/30/2010 for the Illinois State Board of Investment showing a FY2010 return of 8.9%; investment information as of 7/31/2010 for the State Universities Retirement System showing July return and FY 2010 return of 16.7%; and investment information as of 3/31/2010 for the Teacher's Retirement System (the information used in the Medill Reports article) with no FY 2010 as of fiscal year end 6/30/2010 investment return information. In the Medill reports article the TRS spokes person stated there would be a $158 million gain in the derivatives category by June 30, 2010 with $5 million from CDS, swaps, and swaptions out of a projected return of $627 million. The other pension systems could post their FY 2010 (ending June 30) investment return, but the Teacher's Retirement System has not been able to do so as of this day in September. Why?
In the investments of the Illinois Board of Investment, they use puts, calls, futures, and foreign currency contracts but they do not use collateralized mortgage obligations (CMO), credit default swaps (CDS), swaps, or swaptions. While collateralized mortgage obligations are on the balance sheet, none were listed as remaining as of 6/30/2009. In the investments of the State Universities Retirement System, derivatives are thrown into fixed income but listed currency, CMO, swaps, swaptions, and CDS (both buy and sell protection). Currency forward contract positions, futures, puts, and calls are more traditional, older derivatives. CDO (collateralized debt obligations), CMO, CDS, swaps, and swaptions are securitized derivatives that date from approximately 1997-98 with J. P. Morgan for all practical purposes, although some limited but marginal use existed in the early 1990's, and are far more risky and dangerous. The Teacher's Retirement System uses puts, calls, futures, currency contract both buy and sell, CDS buy and sell, CMO, CDO (other two systems do not use), swaps, and swaptions, which make them look more like an unfocused trading hedge fund. The derivatives loss in 2009 for the TRS was $381, 367, 366 with a net derivatives category loss of $6,848,438 which means they had approximately $755,886,294 invested in derivatives in FY2009, which was a year (July 2008 - June 30, 2009) in which they lost $4.4 billion. One derivatives trader was quoted in the Medill reports article saying, " TRS basically sold insurance and now it has an enormous short volatility position." They are making bets on long term Treasury yield curves and global interest rates. In the Medill Reports article Dale Rosenthal, a former hedge fund strategist, characterized the TRS portfolio as primed for speculation, because, if they were hedging investments or mitigating risky investments, they would be on one side of the swaptions and CDS rather than buying and selling. They even buy and sell within the same currency forward contracts. Yet, the TRS spokes person said TRS the derivatives are spread across each asset class as complimentary positions, which means that no one manager or separate group of managers are directly responsible for derivatives investing. Frank Partnoy, a law and finance professor who worked as a derivatives structurer on Wall Street, said TRS is not investing smart but chasing returns and not maintaining prudent, effective internal controls. Rosentahl is also quoted in the Medill Reports article as comparing the TRS portfolio with the disastrous hedge fund Magnetar.
The Yale Endowment has often been characterized as aggressive with its use of illiquid investments for higher return but there investment allocation is actually more conservative than the TRS and other two Illinois pension systems with respect to domestic and foreign equity exposure. If you look at actual Yale allocations in 2009 (on PDF page 7), you will see only 7.5% for domestic equity, 9.8% for foreign equity, 4.0% for fixed income, absolute return 24.3%, private equity 24.3%, real assets 32.0% and cash <1.9%>. Obviously, Yale is not taking substantial risks in domestic or foreign equity and has chosen to forgo less risky fixed income which is itself a material risk. TRS has 30.5% for domestic equity, 20.3% for foreign equity, 17.5% for fixed income, 3.6% for absolute return, 8.3% for private equity, 9.6% for real assets, and .9% for short term investments. This would appear to be risky with such high allocations for domestic and foreign equities. The Illinois State Board of Investment is very similar equity allocations but with more fixed income (appears to be too much). The State Universities Retirement System also has similar equity ( PDF page 4) allocations and a fixed income allocation which is perhaps at the top of an appropriate range, but it also has 24.8% of its allocations in passive investments. In chasing returns, the Illinois pension funds have chosen to chase returns in the equity markets with higher allocations which are consequently more risky however liquid. All three systems have target returns of 8.5%. Yale has chosen more sophisticated, albeit more illiquid, investments for higher return (they got burnt in 2008 with the global financial crisis seizing up liquidity).
We ask again where are the Teacher's Retirement System FY2010 returns, both total and by category? When will the main stream media start picking at the pungent facts? How long will this story remain suppressed? Are the investment policies of the Teacher's Retirement System too risky in the performance of its prudent fiduciary duty? If the staff is not concerned, should the Board, in the performance of its fiduciary duty, be concerned?
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Our article had discussed the proposed 2010 asset sales by the Teacher's Retirement System (possibly $3 billion), the State Universities Retirement System (possible $1.2 billion), and of the Illinois State Board of Investment (possibly $840 million), which invests for the other Illinois pension funds, as reported by Crain's Chicago Business and other news sources..
Our article had also discussed Alexandra Harris' Medill Reports article "Illinois pension fund use OTC derivatives to recoup returns, jeopardizes pensions", which was published in June but has gotten no main stream media attention in Chicago or Springfield, which we can find. When the Teacher's Retirement System spoke person's op-ed appeared in the State Journal-Register, we immediately emailed the editor with a link to our article. We did not get even the courtesy of a response; just silence. Such an unprofessional lack of response got us wondering why and we did some research to see if there had been other posts on blogs and found two on Pension Pulse. The first referenced a zero hedge post which accused the Teacher's Retirement System of being dangerously risky and the second referenced a demand by the Teacher's Retirement System spokesperson to remove the zero hedge comments. I had both zero hedge posts on the subject of the Teacher's Retirement System, including an earlier zero hedge post on the Medill Reports article, which I had missed when it was published. I concentrated on Harris' article and the Illinois Auditor General's audit report of the Teacher's Retirement System.
Further research led me to the disparagement of current economic research still in process by Joshua Rauh at Northwestern University on state pensions. Rauh's research is still in the form of working papers and a continuing project. Earlier in May we had discussed his research on the underfunding of state pensions on the radio show. The Teacher's Retirement System disparagement was part of an Issues Update in which the TRS defended itself on many issues, even asserting that the fiscal year ending June 30, 2010, will have a return of 19% and defended it's use of derivatives. The disparagement of Rauh concentrated on a NPR very brief condensation of state pension systems ranking the Teacher's Retirement System as the fourth riskiest in the country and the classification of investments as risky if they were not fixed income or cash. The TRS argues that all investments are risky to one degree or another, no analysis of individual category risk was made, and the TRS manages risk. To me it appears that the general finance classification of risk was used, because fixed income bonds were not classified as risky, although they can be risky and lose money. Bottom line, the disparagement is smoke exhaled as a screen to obfuscate rather than enlighten with specific risk management procedures and substantiation of acceptable fiduciary risk.
To demand removal of comments, to disparage in general, and to benefit from media silent refusal to print or comment on the issue of investment risk is pretty heavy weight political magic. It made me even more curious. It caused me to re-read the Medill Reports article two more times, review the TRS audit report investment category by category, review the audit report of the Illinois State Board of Investment, review the audit report of the State Universities Retirement System, review the Teacher's Retirement System website information, review the State Universities Retirement System website, and review the Illinois State Board of Investment website information.
On the websites, I found investment information as of 6/30/2010 for the Illinois State Board of Investment showing a FY2010 return of 8.9%; investment information as of 7/31/2010 for the State Universities Retirement System showing July return and FY 2010 return of 16.7%; and investment information as of 3/31/2010 for the Teacher's Retirement System (the information used in the Medill Reports article) with no FY 2010 as of fiscal year end 6/30/2010 investment return information. In the Medill reports article the TRS spokes person stated there would be a $158 million gain in the derivatives category by June 30, 2010 with $5 million from CDS, swaps, and swaptions out of a projected return of $627 million. The other pension systems could post their FY 2010 (ending June 30) investment return, but the Teacher's Retirement System has not been able to do so as of this day in September. Why?
In the investments of the Illinois Board of Investment, they use puts, calls, futures, and foreign currency contracts but they do not use collateralized mortgage obligations (CMO), credit default swaps (CDS), swaps, or swaptions. While collateralized mortgage obligations are on the balance sheet, none were listed as remaining as of 6/30/2009. In the investments of the State Universities Retirement System, derivatives are thrown into fixed income but listed currency, CMO, swaps, swaptions, and CDS (both buy and sell protection). Currency forward contract positions, futures, puts, and calls are more traditional, older derivatives. CDO (collateralized debt obligations), CMO, CDS, swaps, and swaptions are securitized derivatives that date from approximately 1997-98 with J. P. Morgan for all practical purposes, although some limited but marginal use existed in the early 1990's, and are far more risky and dangerous. The Teacher's Retirement System uses puts, calls, futures, currency contract both buy and sell, CDS buy and sell, CMO, CDO (other two systems do not use), swaps, and swaptions, which make them look more like an unfocused trading hedge fund. The derivatives loss in 2009 for the TRS was $381, 367, 366 with a net derivatives category loss of $6,848,438 which means they had approximately $755,886,294 invested in derivatives in FY2009, which was a year (July 2008 - June 30, 2009) in which they lost $4.4 billion. One derivatives trader was quoted in the Medill reports article saying, " TRS basically sold insurance and now it has an enormous short volatility position." They are making bets on long term Treasury yield curves and global interest rates. In the Medill Reports article Dale Rosenthal, a former hedge fund strategist, characterized the TRS portfolio as primed for speculation, because, if they were hedging investments or mitigating risky investments, they would be on one side of the swaptions and CDS rather than buying and selling. They even buy and sell within the same currency forward contracts. Yet, the TRS spokes person said TRS the derivatives are spread across each asset class as complimentary positions, which means that no one manager or separate group of managers are directly responsible for derivatives investing. Frank Partnoy, a law and finance professor who worked as a derivatives structurer on Wall Street, said TRS is not investing smart but chasing returns and not maintaining prudent, effective internal controls. Rosentahl is also quoted in the Medill Reports article as comparing the TRS portfolio with the disastrous hedge fund Magnetar.
The Yale Endowment has often been characterized as aggressive with its use of illiquid investments for higher return but there investment allocation is actually more conservative than the TRS and other two Illinois pension systems with respect to domestic and foreign equity exposure. If you look at actual Yale allocations in 2009 (on PDF page 7), you will see only 7.5% for domestic equity, 9.8% for foreign equity, 4.0% for fixed income, absolute return 24.3%, private equity 24.3%, real assets 32.0% and cash <1.9%>. Obviously, Yale is not taking substantial risks in domestic or foreign equity and has chosen to forgo less risky fixed income which is itself a material risk. TRS has 30.5% for domestic equity, 20.3% for foreign equity, 17.5% for fixed income, 3.6% for absolute return, 8.3% for private equity, 9.6% for real assets, and .9% for short term investments. This would appear to be risky with such high allocations for domestic and foreign equities. The Illinois State Board of Investment is very similar equity allocations but with more fixed income (appears to be too much). The State Universities Retirement System also has similar equity ( PDF page 4) allocations and a fixed income allocation which is perhaps at the top of an appropriate range, but it also has 24.8% of its allocations in passive investments. In chasing returns, the Illinois pension funds have chosen to chase returns in the equity markets with higher allocations which are consequently more risky however liquid. All three systems have target returns of 8.5%. Yale has chosen more sophisticated, albeit more illiquid, investments for higher return (they got burnt in 2008 with the global financial crisis seizing up liquidity).
We ask again where are the Teacher's Retirement System FY2010 returns, both total and by category? When will the main stream media start picking at the pungent facts? How long will this story remain suppressed? Are the investment policies of the Teacher's Retirement System too risky in the performance of its prudent fiduciary duty? If the staff is not concerned, should the Board, in the performance of its fiduciary duty, be concerned?
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Wednesday, September 15, 2010
What Small Business Wants
Following up on my recent post on business tax cuts, here is an Economist's View comment on an Economix article on what's holding small business back. As we said below, it is sales, lack of customers, demand. Jobs create demand.
The Economix article also includes a link to the most recent National Federation of Independent Business small business survey. The NFIB also has a new credit survey out.
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The Economix article also includes a link to the most recent National Federation of Independent Business small business survey. The NFIB also has a new credit survey out.
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Wealthy Tax Cuts Slow Growth & Increase Deficit
As A follow-up to may last post, Econbrowser has an excellent graphic explanation of how the extension of the Bush Tax cuts for those making more than $200,000 and $250,000 would actually slow growth while increasing the deficit and keeping unemployment elevated.
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Tuesday, September 14, 2010
Do Business Tax Cuts Mean Less Food Stamps?
In recent proposals, President Obama has pushed a $50 billion infrastructure program for roads, railways, and runways as well as a $200 billion permanent extension of the research and development tax credit, allowing businesses to expense capital improvements in 2010 and 2011 rather than depreciate over several years. He is pushing a Small Business Jobs Act which would provide $30 billion to community banks to lend to small businesses, $12 billion in tax incentives and tweaks to small businesses, and $1.5 billion for state small business programs. Numerous attempts have been made to cut SNAP (food stamps) to make the small business tax cuts budget neutral. He has also continued his push for an extension of the Bush tax cuts except for those making more than $200,000 (individuals) or $250,000 (families).
Unfortunately, Austan Goolsbee, the new chairman of the Council of Economic Advisers to the President, knows from his early published work that tax incentives do not work in stimulating an economy. His "Investment Tax Incentives, Prices, and the Supply of Capital Goods" and other papers can be found here. These tax cuts and incentives are political in nature, although they will achieve some longer term economic improvement. But it will not create jobs now and cannot stimulate the economy into sustained recovery. Real jobs creation requires government spending which creates jobs now and in the near future, but there is no political consensus in the U. S. Congress concerned about continued high unemployment which is growing and strangling the economy. Families are saving and businesses are saving. Tax credits and cuts do not create sales when the consumers have no jobs or fear losing a job or fear the uncertainty fostered and nurtured by both political parties in their maneuvering for the temporary bread and circus applause. Sustainable economic recovery is directly dependent on job growth. Without creating jobs as quickly as possible, the economy will go forward slowly at best with continued high employment, a general diminishment of the middle class, and even more rapid income inequality than has already occurred since 1960.
With respect to the Bush tax cuts extension, it has been well documented that lower income people are more likely to spend a tax cut, although this would be an extension of current taxes, and higher income people are more likely to save. When there is so much effort to cut food stamps to budget neutral business tax cuts, why is it so important to extend the Bush tax cuts for those making more than $200,000/$250,000 when 55% of those tax cuts will go to .1% or 120,000 people for over $3,000,000 each over a ten year period? Those who are liquidity constrained are more likely to spend and stimulate the economy.
Families cannot spend if they do not have jobs. Families cannot spend is they are reducing debt in preparation for whatever may happen. Businesses cannot spend if they do not have sales. If businesses use tax incentives to purchase new equipment, how many jobs will be lost from the new equipment operation? If new equipment and other capital expenditures increase the opportunity of increased productivity, of what use is that increased productivity in underutilized capacity economy? Capital expenditures do not create sales.
Jobs create sales. Jobs solve vacant housing inventories. Jobs increases income for the wealthy. Jobs stimulate an economy. Jobs buy food and clothing and shelter and medical care.
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Unfortunately, Austan Goolsbee, the new chairman of the Council of Economic Advisers to the President, knows from his early published work that tax incentives do not work in stimulating an economy. His "Investment Tax Incentives, Prices, and the Supply of Capital Goods" and other papers can be found here. These tax cuts and incentives are political in nature, although they will achieve some longer term economic improvement. But it will not create jobs now and cannot stimulate the economy into sustained recovery. Real jobs creation requires government spending which creates jobs now and in the near future, but there is no political consensus in the U. S. Congress concerned about continued high unemployment which is growing and strangling the economy. Families are saving and businesses are saving. Tax credits and cuts do not create sales when the consumers have no jobs or fear losing a job or fear the uncertainty fostered and nurtured by both political parties in their maneuvering for the temporary bread and circus applause. Sustainable economic recovery is directly dependent on job growth. Without creating jobs as quickly as possible, the economy will go forward slowly at best with continued high employment, a general diminishment of the middle class, and even more rapid income inequality than has already occurred since 1960.
With respect to the Bush tax cuts extension, it has been well documented that lower income people are more likely to spend a tax cut, although this would be an extension of current taxes, and higher income people are more likely to save. When there is so much effort to cut food stamps to budget neutral business tax cuts, why is it so important to extend the Bush tax cuts for those making more than $200,000/$250,000 when 55% of those tax cuts will go to .1% or 120,000 people for over $3,000,000 each over a ten year period? Those who are liquidity constrained are more likely to spend and stimulate the economy.
Families cannot spend if they do not have jobs. Families cannot spend is they are reducing debt in preparation for whatever may happen. Businesses cannot spend if they do not have sales. If businesses use tax incentives to purchase new equipment, how many jobs will be lost from the new equipment operation? If new equipment and other capital expenditures increase the opportunity of increased productivity, of what use is that increased productivity in underutilized capacity economy? Capital expenditures do not create sales.
Jobs create sales. Jobs solve vacant housing inventories. Jobs increases income for the wealthy. Jobs stimulate an economy. Jobs buy food and clothing and shelter and medical care.
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Wednesday, September 8, 2010
401(K) Auto Enrollment: Who Benefits"
In recent years 401(k) retirement plans, 403(b), and 457 plans) were allowed to adopt auto enrollment of employees. As of June 30, 2010, approximately 38% of 401(k) plans have adopted auto enrollment; that number is even less if you consider 403(b) and 457 plans. Large companies have been more likely to adopt auto enrollment than small companies and workers who had not previously saved for retirement increased by approximately 25% in large companies and 9% in small companies. In that workers who had not been saving towards retirement now are, that is good; however, the default funds into which they must be placed are such that they will not be properly diversified and are unlikely to achieve enough money for a quality retirement during their retirement life time. It does, however, create captive investors for the plan salespeople.
U.S. Department of Labor regulations are very specific as to what the default choices must be:
investment product or fund designed to preserve principal;
provide a rate of return generally consistent with that
earned on intermediate investment grade bonds; and provide
liquidity for withdrawals by participants and beneficiaries,
including transfers to other investment alternatives. Such
investment product or fund shall, for purposes of this
paragraph (e)(4)(v), meet the following requirements:
(1) There are no fees or surrender charges imposed in
connection with withdrawals initiated by a participant or
beneficiary; and
(2) Such investment product or fund invests primarily
in investment products that are backed by State or federally
regulated financial institutions."
The employee is sent an auto enrollment notice which specifically informs the employee they have the right to opt out, to actively choose their own investments within the retirement plan, or accept the default investment fund or funds which are specifically named in the notice. The employee knows exactly in what funds the retirement contributions are invested. The employer makes no choices for the employee; the plan administrator has chosen a default fund or funds meeting the regulations of the Department of Labor. The employee may elect at a future date to change the investments within the plan or opt out.
Many employees do not want to make choices, lack investment knowledge, or face the choices of retirement and they ignore the notice. The plan administrator's duty is to the company and cannot give fiduciary advice to participants. Some companies make investment advice available, but it is from advisers who have conflicts of interest, although there are proposed regulations which would require participant advisers to be conflict free fiduciary advisers. Participants need impartial, conflict free, professional advice, but it is still very much a sales person's game. The same employees who pay no attention to their auto enrollment notices and options also have no idea who is a fee only fiduciary advisor with no conflicts of interest as opposed to those who are not fiduciary duty bound and have conflicts of interest but can still legally call themselves fee only advisers, because the SEC makes it very difficult for even a knowledgeable investor to ferret out the distinctions.
Employees need to take responsibility for their retirement investments and seek out an affordable fee only, fiduciary duty to the client only, impartial professional advisor. This requires they take action and ask questions. How many do that? How many employers provide conflict free help? Not very many.
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U.S. Department of Labor regulations are very specific as to what the default choices must be:
"(A) Subject to paragraph (e)(4)(v)(B) of this section, an
investment product or fund designed to preserve principal;
provide a rate of return generally consistent with that
earned on intermediate investment grade bonds; and provide
liquidity for withdrawals by participants and beneficiaries,
including transfers to other investment alternatives. Such
investment product or fund shall, for purposes of this
paragraph (e)(4)(v), meet the following requirements:
(1) There are no fees or surrender charges imposed in
connection with withdrawals initiated by a participant or
beneficiary; and
(2) Such investment product or fund invests primarily
in investment products that are backed by State or federally
regulated financial institutions."
These are usually a money market or stable value fund, a lifecycle or target date fund, a balanced fund, or a managed account such as a variable annuity. Target date and lifecycle funds are under SEC scrutiny, because the same date funds from different companies are not similarly invested and disclosure to investors is less than desirable. Stable value funds may have contractual problems that make them unacceptable or problematic in a qualified plan. Money market funds are currently very low interest and have no principal guarantee like a money market at a bank. A variable annuity can have internal costs and may or may not guarantee (for additional costs) principal or provide a lifetime income (however small).
The employee is sent an auto enrollment notice which specifically informs the employee they have the right to opt out, to actively choose their own investments within the retirement plan, or accept the default investment fund or funds which are specifically named in the notice. The employee knows exactly in what funds the retirement contributions are invested. The employer makes no choices for the employee; the plan administrator has chosen a default fund or funds meeting the regulations of the Department of Labor. The employee may elect at a future date to change the investments within the plan or opt out.
Many employees do not want to make choices, lack investment knowledge, or face the choices of retirement and they ignore the notice. The plan administrator's duty is to the company and cannot give fiduciary advice to participants. Some companies make investment advice available, but it is from advisers who have conflicts of interest, although there are proposed regulations which would require participant advisers to be conflict free fiduciary advisers. Participants need impartial, conflict free, professional advice, but it is still very much a sales person's game. The same employees who pay no attention to their auto enrollment notices and options also have no idea who is a fee only fiduciary advisor with no conflicts of interest as opposed to those who are not fiduciary duty bound and have conflicts of interest but can still legally call themselves fee only advisers, because the SEC makes it very difficult for even a knowledgeable investor to ferret out the distinctions.
Employees need to take responsibility for their retirement investments and seek out an affordable fee only, fiduciary duty to the client only, impartial professional advisor. This requires they take action and ask questions. How many do that? How many employers provide conflict free help? Not very many.
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Thursday, September 2, 2010
How Risky Are Illinois Pension Funds?
On the 8/28/2010 Radio Show, we used the June 11th article in the Medill Reports by Alexandra Harris on the Illinois Teacher's Retirement System use of derivatives and investment diversification methodology which has made it the fourth riskiest pension fund in the Untied States. We did not spend a lot of time on the subject given the amount of information we try to cover during the show and after we had researched the information earlier in the week, an article by Doug Finke was published in the State Journal-Register on the pension system and the fact they are selling $3 billion of assets to make pension payments and the State University Retirement System was selling $1.2 billion. The Illinois Investment Board may also sell $840 million of assets to pay benefits for the state employee's, General Assembly, and Judge's retirement systems. In the S J-R article, the Teacher's Retirement System spokesperson attributed the need to sell assets to the failure of the State to make its required contributions to the retirement system and the lost opportunity from not having the money to invest.
In the Medill Reports article, Alexandra Harris not only details the prior year losses in 2008 ($4.4 billion or 5%) and 2009 (22.3% loss) of which in 2009 the derivatives loss alone was $381, 367, 366. Harris had a list of investments as of March 31, 2010, received under a Freedom of Information request and the Illinois Auditor General's audit report for Fiscal Year 2009 to obtain information on the investments and had them reviewed by professionals knowledgeable about derivatives and pension fund investing. On page 52 of that audit report, you can see the projected allocations for investment for 2009 and what they were in 2008. Harris indicates that the pension system has adopted a riskier investment allocation beginning in the 1990's, which would have been approximately the time the State adopted a ramped tier system of increasing payments by the State to reduce underfunding of State pension funds. However, this funding formula has been delayed or suspended more than once in the intervening years and even the issuance of pension bonds in 2010 was denied by the General Assembly. Consequently, the Teacher's Retirement System is 60.9% underfunded.
In the Medill Reports article, Teacher's Retirement System spokespeople indicated there would be a profit in 2010 from using derivatives, but the author's professional reviewers of the investment balance sheet and listing of investments were seeing a loss of approximately $515 million.
The Medill Reports article also attributes the risky investing style to a methodology of the Yale Endowment, which got itself in trouble in 2008 with its illiquid style of investing. However, if you look at the allocation in 2009 of the Yale Endowment on page 7, you will see that the Illinois Teacher's Retirement System allocation of investments is quite divergent from the Yale Endowment and far riskier, even without considering its dependence on derivatives. The Teacher's Retirement System has eight (8) pages of derivative investments, far more U.S. and international equities and far less Absolute Return, Real Return (only 6 investments), and Real Assets. They are not comparable. What is clear is that the Teacher's Retirement System is engaged, and has been engaged, for several years in risky catch-up investing that paid off through 2007 and is now clearly dangerous.
Derivatives were a primarily cause of the current financial crisis. The use of derivatives and the type of derivatives being used by the Teacher's Retirement Fund are not marginal hedging of other investments. They are substantial bets of inflation in regional parts of the world, long term Treasury yields, and CDS on corporate and sovereign debt of foreign nations. This is more appropriate for a major bank trading desk and we have seen the destruction that can bring and the cost to society. It is not appropriate for a pension fund.
To see how the other pension funds are invested and doing, go to the Illinois Auditor General and look at the audit reports under Retirement Systems.
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In the Medill Reports article, Alexandra Harris not only details the prior year losses in 2008 ($4.4 billion or 5%) and 2009 (22.3% loss) of which in 2009 the derivatives loss alone was $381, 367, 366. Harris had a list of investments as of March 31, 2010, received under a Freedom of Information request and the Illinois Auditor General's audit report for Fiscal Year 2009 to obtain information on the investments and had them reviewed by professionals knowledgeable about derivatives and pension fund investing. On page 52 of that audit report, you can see the projected allocations for investment for 2009 and what they were in 2008. Harris indicates that the pension system has adopted a riskier investment allocation beginning in the 1990's, which would have been approximately the time the State adopted a ramped tier system of increasing payments by the State to reduce underfunding of State pension funds. However, this funding formula has been delayed or suspended more than once in the intervening years and even the issuance of pension bonds in 2010 was denied by the General Assembly. Consequently, the Teacher's Retirement System is 60.9% underfunded.
In the Medill Reports article, Teacher's Retirement System spokespeople indicated there would be a profit in 2010 from using derivatives, but the author's professional reviewers of the investment balance sheet and listing of investments were seeing a loss of approximately $515 million.
The Medill Reports article also attributes the risky investing style to a methodology of the Yale Endowment, which got itself in trouble in 2008 with its illiquid style of investing. However, if you look at the allocation in 2009 of the Yale Endowment on page 7, you will see that the Illinois Teacher's Retirement System allocation of investments is quite divergent from the Yale Endowment and far riskier, even without considering its dependence on derivatives. The Teacher's Retirement System has eight (8) pages of derivative investments, far more U.S. and international equities and far less Absolute Return, Real Return (only 6 investments), and Real Assets. They are not comparable. What is clear is that the Teacher's Retirement System is engaged, and has been engaged, for several years in risky catch-up investing that paid off through 2007 and is now clearly dangerous.
Derivatives were a primarily cause of the current financial crisis. The use of derivatives and the type of derivatives being used by the Teacher's Retirement Fund are not marginal hedging of other investments. They are substantial bets of inflation in regional parts of the world, long term Treasury yields, and CDS on corporate and sovereign debt of foreign nations. This is more appropriate for a major bank trading desk and we have seen the destruction that can bring and the cost to society. It is not appropriate for a pension fund.
To see how the other pension funds are invested and doing, go to the Illinois Auditor General and look at the audit reports under Retirement Systems.
Print Page
How Far Is Too Low?
On Wednesday, we saw the stock market surge moderately on Increased Chinese PMI, Australian Q2 GDP growth, and ISM better than expected numbers.
Today, Bloomberg tells us the U. S. has avoided recession because the economic data cannot get much worse. When you read commentary like this, you need to fall back on your macroeconimic framework and deal with the data in analytical terms.
Chinese PMI was up only one-half percent, but there had been speculation it might fall . Consequently, the Western commentators saw this as meaning increased future exports to China. The Chinese stock market fell despite the Chinese PMI going up. China was been taking steps to moderate inflation and a real estate bubble. It has been taking steps to promote the use of the yuan in trade and equity markets to decrease the use of foreign currencies. It has been emphasizing and growing internal production for internal consumption. Too much is being made of a modest increase with mixed data, which surprised analyst expectations. Of eleven categories, ten fell: new export orders, imports, output, backlogs of orders, stocks of finished goods, stocks of purchases were all down. Four of the categories were below the expansionary level of 50.
Australian Q2 GDP was up 1.2% beating the expectation of .9%. This was hailed as proof that exports, of which Australia is heavily dependent on China, would expand, because this GDP number included a 5.6% increase in export volume. Unfortunately, the trade effects which have encouraged exports will not last much longer and the Australian economy is being driven by increased personal consumption in which private debt is increasing and savings decreasing. Additionally, the Australian political scene is very uncertain as the recent election was, for all practical purposes, was a tie and any coalition government will dependent on obtaining at least 3-4 of five independent members of parliament, none of whom have any close affinity with either choice of government. It is doubtful any coalition will last for any significant length of time.
U.S. Institute of Supply Management Manufacturing Index was up eight tenths to 56.3, while expectations had been a possible decline of 2.5. However, new orders declined and inventory increased. One should reasonably expect this index to decline going forward.
Just as economists can get lost in models which do not listen to the streets and limit data or the analysis of data and information, the public commentators often fail to utilize a macroeconomic framework to provide consistency and methodology.
The above reports and the reactions to them at this time could well be the anxious grasping for hope. The reality is that lagging economic indicators will catch up with current indicators starting at the end of September and particularly in October and November. There is every reason to believe unemployment will increase, housing prices will decrease and housing inventory increase, earnings reports will start to confirm and second half slow down as will GDP reports from countries around the world. As an example, Spain was up two tenths on sales tax increases (VAT) and Germany is acknowledged to have lower (perhaps significantly) Q3 growth than its export driven 2.2% Q2.
Do not just read the news reports; dig into the data and the information and context behind it.
Print Page
Today, Bloomberg tells us the U. S. has avoided recession because the economic data cannot get much worse. When you read commentary like this, you need to fall back on your macroeconimic framework and deal with the data in analytical terms.
Chinese PMI was up only one-half percent, but there had been speculation it might fall . Consequently, the Western commentators saw this as meaning increased future exports to China. The Chinese stock market fell despite the Chinese PMI going up. China was been taking steps to moderate inflation and a real estate bubble. It has been taking steps to promote the use of the yuan in trade and equity markets to decrease the use of foreign currencies. It has been emphasizing and growing internal production for internal consumption. Too much is being made of a modest increase with mixed data, which surprised analyst expectations. Of eleven categories, ten fell: new export orders, imports, output, backlogs of orders, stocks of finished goods, stocks of purchases were all down. Four of the categories were below the expansionary level of 50.
Australian Q2 GDP was up 1.2% beating the expectation of .9%. This was hailed as proof that exports, of which Australia is heavily dependent on China, would expand, because this GDP number included a 5.6% increase in export volume. Unfortunately, the trade effects which have encouraged exports will not last much longer and the Australian economy is being driven by increased personal consumption in which private debt is increasing and savings decreasing. Additionally, the Australian political scene is very uncertain as the recent election was, for all practical purposes, was a tie and any coalition government will dependent on obtaining at least 3-4 of five independent members of parliament, none of whom have any close affinity with either choice of government. It is doubtful any coalition will last for any significant length of time.
U.S. Institute of Supply Management Manufacturing Index was up eight tenths to 56.3, while expectations had been a possible decline of 2.5. However, new orders declined and inventory increased. One should reasonably expect this index to decline going forward.
Just as economists can get lost in models which do not listen to the streets and limit data or the analysis of data and information, the public commentators often fail to utilize a macroeconomic framework to provide consistency and methodology.
The above reports and the reactions to them at this time could well be the anxious grasping for hope. The reality is that lagging economic indicators will catch up with current indicators starting at the end of September and particularly in October and November. There is every reason to believe unemployment will increase, housing prices will decrease and housing inventory increase, earnings reports will start to confirm and second half slow down as will GDP reports from countries around the world. As an example, Spain was up two tenths on sales tax increases (VAT) and Germany is acknowledged to have lower (perhaps significantly) Q3 growth than its export driven 2.2% Q2.
Do not just read the news reports; dig into the data and the information and context behind it.
Print Page
Friday, August 27, 2010
Beware Earnings as F.O.E.
Earnings reports and earnings season every quarter are times when the market responds to impressions rather than researched information. Too a large extent the public cannot be entirely blamed, because they are relying on news reports and financial information from the companies. In as much as these do not reflect the underlying tax accounting manipulations, real cash flow, the types of cash, and other legal legerdemain that constitute forward operating earnings (FOE), the information being publicly passed and digested does not give a reliable value of the security or the market as a whole.
John Hussman has written about the problem of forward operating earnings on many occasions in his weekly commentaries. On July 19, he discussed how dividends are not properly taxed and this leads to companies to report earnings and then waste the "...retained earnings on speculative acquisitions and incentive compensation to insiders...". He then went on to discuss how he warns investors to be skeptical of valuation metrics built on forward operating earnings as they are estimates of next year earnings but omit a whole range of charges such as bad investments, loan losses, restructuring charges, etc. This generates statistically distorted and overly optimistic projections as substantiated by historical data. He then illustrates how Tobin's q ratio, which is based on comparing market value to replacement cost, as advocated by Andrew Smithers and Schiller's CAPE, which is based on the ten year average of actual net (not operating) earnings provide consistently comparable valuations. "Ultimately, the value of any security is the properly discounted stream of cash flows that the security will deliver into the hands of the investor over time." Net earnings not operating earnings are the important and more accurate information. "...net earnings represent the only amounts that investors can hope to obtain, and then only if the net earnings are distributed as dividends or invested in productive activities that don't get written off later."
On August 2, 2010, Hussman continued his concern with the increasingly careless use of operating earnings as a misleading measure of stock valuation. "The two main failures of standard FOE analysis are that 1) analysts assume a long-term norm for the P/E ratio that properly applies to trailing net, not forward operating earnings, and; 2) analysts fail to model the variation in prospective earnings growth induced by changes in the level of profit margins, and therefore wildly over- or underestimate long-term cash flows that are relevant to proper valuation. By dealing directly with those two issues, we can obtain useful implications about market valuation." Analysts tend to treat these hypothetical operating earnings to create forecasts "... as if they are distributable cash flows. Unfortunately, operating earnings exclude a whole range of charges that may not occur on an annual basis, but are legitimate costs and losses incurred as part of the ordinary course of business. Meanwhile, operating earnings often include a benefit from those very same "extraordinary" sources - provided they make positive contributions (witness the large boost to the operating earnings of major banks this quarter, resulting from the reduction in reserves for future loan losses)."
On August 9th, Hussman repeated the importance to the investor of being able to properly assess stock valuations. He then continues with warning investors to not believe that cash on the balance sheet could "... suddenly be used, in aggregate, for new investments and capital spending." Often, this cash is in the form of loans to the government or private companies in the form of T bills and commercial paper. Consequently, these investment savings are not available to spend. These marketable securities are someone's liabilities. Often, cash is the result of the issuance of corporate debt. You cannot look at cash assets and ignore liabilities in national and global balance sheet of all assets and liabilities; what affects one side of the balance sheet effects the other side of the economic balance sheet of all corporations, individuals, and government.
When you look at market valuation and the value of a security, you need to dig into the actual detailed financial information and historical data and use that data in a rigorous model that yields information and not forecasts. Too many market pundits will cry earnings and pronounce them as positive or negative based on summaries and estimates of forward operating earnings when they should be focused on net earnings, in what form cash is held, liabilities, and the use of earnings. Too often market talk about earnings is the shot used to stampede the herd. Often, market commentators have vested positions in how the market moves or, worse, political motives in forming public opinion.
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John Hussman has written about the problem of forward operating earnings on many occasions in his weekly commentaries. On July 19, he discussed how dividends are not properly taxed and this leads to companies to report earnings and then waste the "...retained earnings on speculative acquisitions and incentive compensation to insiders...". He then went on to discuss how he warns investors to be skeptical of valuation metrics built on forward operating earnings as they are estimates of next year earnings but omit a whole range of charges such as bad investments, loan losses, restructuring charges, etc. This generates statistically distorted and overly optimistic projections as substantiated by historical data. He then illustrates how Tobin's q ratio, which is based on comparing market value to replacement cost, as advocated by Andrew Smithers and Schiller's CAPE, which is based on the ten year average of actual net (not operating) earnings provide consistently comparable valuations. "Ultimately, the value of any security is the properly discounted stream of cash flows that the security will deliver into the hands of the investor over time." Net earnings not operating earnings are the important and more accurate information. "...net earnings represent the only amounts that investors can hope to obtain, and then only if the net earnings are distributed as dividends or invested in productive activities that don't get written off later."
On August 2, 2010, Hussman continued his concern with the increasingly careless use of operating earnings as a misleading measure of stock valuation. "The two main failures of standard FOE analysis are that 1) analysts assume a long-term norm for the P/E ratio that properly applies to trailing net, not forward operating earnings, and; 2) analysts fail to model the variation in prospective earnings growth induced by changes in the level of profit margins, and therefore wildly over- or underestimate long-term cash flows that are relevant to proper valuation. By dealing directly with those two issues, we can obtain useful implications about market valuation." Analysts tend to treat these hypothetical operating earnings to create forecasts "... as if they are distributable cash flows. Unfortunately, operating earnings exclude a whole range of charges that may not occur on an annual basis, but are legitimate costs and losses incurred as part of the ordinary course of business. Meanwhile, operating earnings often include a benefit from those very same "extraordinary" sources - provided they make positive contributions (witness the large boost to the operating earnings of major banks this quarter, resulting from the reduction in reserves for future loan losses)."
On August 9th, Hussman repeated the importance to the investor of being able to properly assess stock valuations. He then continues with warning investors to not believe that cash on the balance sheet could "... suddenly be used, in aggregate, for new investments and capital spending." Often, this cash is in the form of loans to the government or private companies in the form of T bills and commercial paper. Consequently, these investment savings are not available to spend. These marketable securities are someone's liabilities. Often, cash is the result of the issuance of corporate debt. You cannot look at cash assets and ignore liabilities in national and global balance sheet of all assets and liabilities; what affects one side of the balance sheet effects the other side of the economic balance sheet of all corporations, individuals, and government.
When you look at market valuation and the value of a security, you need to dig into the actual detailed financial information and historical data and use that data in a rigorous model that yields information and not forecasts. Too many market pundits will cry earnings and pronounce them as positive or negative based on summaries and estimates of forward operating earnings when they should be focused on net earnings, in what form cash is held, liabilities, and the use of earnings. Too often market talk about earnings is the shot used to stampede the herd. Often, market commentators have vested positions in how the market moves or, worse, political motives in forming public opinion.
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