Saturday, March 27, 2010

Elizabeth Warren on the Collapse of the Middle Class

Elizabeth Warren is a law professor at Harvard and has become a public figure recently due to her leadership role on the TARP Congressional Oversight Panel. She's also an expert on trends concerning the middle class. In this lecture at U.C. Berkeley in 2007, Ms. Warren discussed why the quality of life and financial security of the middle class has diminished year after year for the past 30 years. Not a pleasant subject, but it's an important topic. I hope you find it informative.

Credit Default Swaps Explained

Finally, someone has done a pretty straightforward video on how credit default swaps work. The punchline, if you will, is the part near the end about how someone can buy this type of insurance without actually owning the asset that's being insured. That was the magic ingredient that multiplied all of the problems in the meltdown and sent everyone into a panic. Also, take note that these swaps only cost about 2% per year of the insured value. So, when our government made good on AIG's contracts, they were providing Goldman Sachs and others with nice little 50:1 payoffs in many cases.

Barney Frank has it all under control

Good grief. I caught this interview on CNBC on March 24th. It's of Barney Frank and Chris Dodd talking about their financial reform agenda following their meeting with the President.

Frank's comments are particularly shocking. Fairly early in the video, he says that we've "dealt with" all of the problems that led to the collapse of the likes of AIG and Lehman. Oh really? How have we dealt with them, Mr. Frank? If any new regulations or government powers have been implemented, please cite them.

Then, about 80% of the way through the video, he says that we'll only pay down bank debts (in future bailouts) that threaten a "total spiraling downward" (i.e., a systemic meltdown of the financial system). Mr Frank, isn't systemic risk what we need to prevent by implementing too-big-to-fail measures and Mr. Volcker's ideas regarding the segregation of high-risk, non-banking activities? The whole idea is that we need to refocus banking and Wall Street on "boring" customer-focused activities, rather than high-risk proprietary activities, so that we don't create enormous risks in the first place.

I have to say, I feel like absolutely nothing has been learned, and that the American people are in very poor hands.

Gretchen Morgenson on why no progress on financial reform

Wonderful interview on Bill Moyers Journal last night with Gretchen Morgenson of the NY Times: "Eighteen months after the economic meltdown, why has Washington been unable rein in Wall Street with serious regulation? Bill Moyers speaks with financial journalist Gretchen Morgenson for a candid look at the obstacles facing substantive reform and what Congress' proposed legislation would — and wouldn't — accomplish."

Click here to watch the video on PBS' site.

Tuesday, March 23, 2010

Health Care Reform Implementation Timeline

As everyone knows by now, sweeping health care reforms were approved by the House of Representatives Sunday night. President Obama signed the health care legislation this morning at The White House.

The Senate will now begin considering a package of House changes to the Senate measure in a process known as "reconciliation." The Senate needs a simple majority of 51 votes to approve the changes. Once this process is complete, President Obama will then sign the reconciliation bill and the changes will be incorporated into the measures listed below.

The health care reforms will unfold slowly. Below, I have provided a detailed timeline highlighting the major changes that would take place year-by-year.

Timeline for Implementation:

Sets up a high-risk health insurance pool to provide affordable coverage for uninsured people with medical problems.

Requires all health insurance plans to maintain dependent coverage for children until they turn 26. Prohibits insurers from denying coverage to children because of pre-existing health conditions.

Prohibits insurance companies from imposing lifetime dollar limits on coverage and canceling policies, except in the case of fraud.

Provides tax credits to help small businesses with up to 25 employees obtain and keep coverage.

Begins narrowing the Medicare prescription coverage gap by providing a $250 rebate to seniors in the gap, which starts this year once they have spent $2,830. The gap would be fully closed by 2020.

Reduces projected Medicare payments to hospitals, home health agencies, nursing homes, hospices and other providers.

Bans health plans from dropping people from coverage when they get sick.

Imposes 10% sales tax on indoor tanning.

Creates a voluntary long-term care insurance program to provide a modest cash benefit helping disabled people stay in their homes, or cover nursing home costs. Benefits can begin five years after people start paying a fee for the coverage.

Imposes a $2.3 billion annual fee on drug makers, increasing over time.

Requires employers to report the value of health care benefits on employees' W-2 tax statements.

Provides Medicare recipients in the prescription coverage gap with a 50 percent discount on brand-name drugs; begins phasing in additional drug discounts to close the gap by 2020.

Provides 10% Medicare bonus to primary care doctors and general surgeons practicing in underserved areas, such as inner cities and rural communities.

Freezes payments to Medicare Advantage Plans. The first step in reducing payments to the private insurers who serve about one-fourth of seniors. The reductions would be phased in over three to seven years.

Sets up a program to create nonprofit insurance co-ops that would compete with commercial insurers.

Penalizes hospitals with high rates of preventable readmissions by reducing Medicare payments.

Initiates Medicare payment reforms by encouraging hospitals and doctors to band together in
"accountable care organizations" along the lines of the Mayo Clinic. Sets up a pilot program to test more efficient ways of paying hospitals, doctors, nursing homes and other providers who care for Medicare patients from admission through discharge. Successful experiments would be widely adopted.

Standardizes insurance company paperwork, first in a series of steps to reduce administrative costs.

Limits medical expense contributions to tax-sheltered flexible spending accounts (FSA's) to $2,500 a year, indexed for inflation. Raises threshold for claiming itemized tax deduction for medical expenses from 7.5% of income to 10%. People over 65 can still deduct medical expenses above 7.5% of income through 2016.

Imposes a 2.3% sales tax on medical devices. Eyeglasses, contact lenses, hearing aids and many
everyday items bought at the drug store are exempt.

Increases Medicare payroll tax on couples making more than $250,000 and individuals making more than $200,000. The tax rate on wages above those thresholds would rise to 2.35% from the current 1.45%. Also adds a new tax of 3.8% on income from investments.

Prohibits insurers from denying coverage to people with medical problems or refusing to renew their policy. Health plans cannot limit coverage based on pre-existing conditions or charge higher rates to those in poor health. Premiums can only vary by age, place of residence, family size and tobacco use.

Coverage expansion goes into high gear as states create new health insurance exchanges – supermarkets for individuals and small businesses to buy coverage.
Medicaid expanded to cover low- income people up to 133% of the federal poverty line, about $28,300 for a family of four. Low-income childless adults covered for the first time.

Requires citizens and legal residents to have health insurance, except in cases of financial hardship, or pay a fine to the IRS. Penalty starts at $95 per person in 2014, rising to $695 in 2016. Family penalty capped at $2,250. Penalties indexed for inflation after 2016.

Penalizes employers with more than 50 employees if any of their workers get coverage through the exchange and receive a tax credit. The penalty is $2,000 times the total number of workers employed at the company. However, employers get to deduct the first 30 workers.

Provides income-based tax credits for most consumers in the exchanges, substantially reducing costs for many. Sliding-scale credits phase out completely for households above four times the federal poverty level, about $88,000 for a family of four.

Imposes a tax on employer-sponsored health insurance worth more than $10,200 for individual
coverage, $27,500 for a family plan. The tax is 40% of the value of the plan above the thresholds, indexed for inflation.

Coverage gap in Medicare prescription benefit is phased out. Seniors continue to pay the standard 25 percent of their drug costs until they reach the threshold for Medicare catastrophic coverage, when their co-payments drop to 5 percent.

Sunday, March 21, 2010

A History of Medicare and Social Security Tax Increases

Medicare was legislated in 1965, and a new payroll tax was implemented in 1966 to cover the expense of the new entitlement program. The initial tax was 0.35%, payable by both the employee and employer on the first $6,600 of the employee's wages. The $6,600 upper wage limit rose by about 50% in total over the first 8 years, and then dramatically increased thereafter, until reaching $135,000 in 1993. That represents about an 11.40% annual increase between 1966 and 1993, whereas inflation increased at an annual rate of 5.38% during that time. The upper wage limit was eliminated in 1994, meaning that the tax began to be charged on all wages at that time.

While the Medicare wage limit was being increased, the tax rate was increased continuously as well. It approximately tripled in the first 8 years from 0.35% to 1.0%, and eventually hit the current level of 1.45% in 1986. In dollar terms, the amount collected on the wage limit maximum from both the employee and employer increased from $23.10 in 1966 to $1,957.50 on the $135,000 limit that was in place in 1993. That represents a 17.2% annual increase, whereas, as noted above, inflation increased at 5.38% over that period. Hence, the maximum tax was increased at over 3 times the rate of inflation, and again, there has been no maximum tax since 1994.

Changes in the Social Security tax are equally staggering. The tax was implemented in 1937 at 1.0% of the first $3,000 of wages. It stands today at 6.20% on the first $106,800 of wages. Inflation between 1937 and 2010 was 3.76% annually, whereas the wage limit has risen at 4.95%. Hence, even if the original 1.0% tax had remained constant, the amount collected on the limit would have increased substantially more than the rate of inflation due to the more rapidly increasing wage limit. However, with increases in both the limit and the rate, the tax in dollar terms has increased on the wage limit from $30 to $6,622, a 7.57% annual increase, which is double the rate of inflation between 1937 and 2010.

Under the proposed health care reform act, to pay for the changes, the legislation includes more than $400 billion in higher taxes over a decade, roughly half of it from a new Medicare payroll tax on individuals with incomes over $200,000 ($250,000 for couples). From an article on MSNBC, here's how the tax hike would work:

"Under Obama's plan, individuals with incomes of more than $200,000 — including both wages and investment returns -would pay a 2.9 percent tax on interest, dividends, royalties and other unearned income that exceeds that threshold. Couples with total incomes over $250,000 would face the tax, too.

The proposal would also increase the 1.45 percent Medicare payroll tax on workers' wages to 2.35 percent on earnings that exceed $200,000 for an individual and $250,000 for a couple. The portion of the Medicare payroll tax paid by the employer would remain at 1.45 percent.

Under this plan, a couple that earns $275,000 in salaries and $150,000 from investments would pay the normal 1.45 percent on the first $250,000 of their wages. They would pay 2.35 percent on the last $25,000 of wages. And, because their total income tops $250,000, they would face the 2.9 percent tax on all $150,000 of their investment income.

Right now, that couple would pay $3,987.50 in Medicare taxes each year. Under the proposal, they would pay $4,212 on their wages and $4,350 on their investment income, $8,562, assuming all of that income is taxable. Congressional estimators predict any final policy would include some exemptions, such as the costs of generating investment income."

Note that in addition to the above Medicare tax hike, the House's revisions to the Senate's bill also include a 0.5% Hospital tax on high-income individuals and couples; i.e., those with incomes over $200,000 and $250,000, respectively.

Clearly, the new taxes are intended to shift the burden to the supposed rich. However, after analyzing the government's past record for increasing the Medicare and Social Security taxes, how long can we honestly expect it to be before that $200,000 floor starts to creep down, or the tax rate starts to creep up, or both?

Inflation data:

Historical tax rates:

MSNBC article on the new tax:

Thursday, March 18, 2010

Michael Lewis: Inside the Collapse

Michael Lewis, author of the new book The Big Short (click for Amazon), gave a great interview on 60 Minutes this week. It's a must see for anyone who wants more of the scoop behind the mortgage meltdown, Wall Street's bad behavior, and the U.S. government's sell-out of the taxpayer to buck-up the busted investment banks.

Part 1:

Part 2:

Short "extras" (about a minute each)

More from Michael Lewis on the bailouts:

Michael Lewis on Wall Street pay:

Michael Lewis on how Wall Street is subsidized by the Fed:

More from Michael Burry on being a misfit:

Michael Burry on the size of his bet against mortgages:

Saturday, March 13, 2010

Tips from Dr. Doom, and Understanding His Doomsday Scenario

This is a pretty gloomy, yet surprisingly lighthearted interview with Marc Faber, otherwise known as Dr. Doom. I'm glad he can keep his spirits up in light of how he feels about our future!

Faber (and the other fellow in this interview) is obviously as contrarian as one can get. However, in the ten years I've been following him, unfortunately, his opinions have been on the mark. I give him a lot of credit for being able to look at things objectively and for being willing to go on record with unpopular opinions. From my perspective, I like to gather all points of view. Blinders off, so to speak. I then try to form my own ideas based on all of the inputs.

In this video, Faber shares a few ideas on how people can protect themselves financially in the face of what he believes is a coming high-inflation environment. Faber is an advocate of buying "hard assets" that benefit from inflation, such as gold, farm land, and other real estate. This then raises the question of why he believes we'll have high inflation.

The situation is that we will about double our national debt in the next decade. Obama has been very up-front about this. Since this will be during a time when America is doing everything it can just to get back on its feet, there is no expectation that Americans will somehow become wealthier in that time frame, and therefore more capable of paying down that debt. Hence, the likely scenario is that the government will simply print money to do what's known as "infalting away" the debt. In other words, if $200 billion in bonds that China is holding come due, we would simply print the money to retire the bonds. Naturally, that would devalue our currency, which would then make everything we buy from other countries more expensive; i.e., inflation. In addition, it would make issuing additional debt in the future more expensive, as our international lenders got burned last time by getting a devalued currency in return for their bonds. After all, who wants to lend a dollar and get the equivalent of, say, 80 cents in return?

With everything then being more expensive, people would have to cut back on spending, which would create a recession and increase unemployment. With higher unemployment, the government would have to increase entitlements and deficit spending, thus exacerbating the debt problem by having to borrow more at ever-increasing interest rates. This perpetuates the cycle and accelerates our trek towards ruin, which is the doomsday scenario these guys are talking about.

Essentially, people, companies, and countries reach a tipping point when they take on too much debt, and it inevitably takes them down. This is the problem many Latin American countries ran into in past decades, and this is where the so-called "PIIGS" countries (Portugal, Ireland, Italy, Greece, and Spain) are headed today. These two gents are saying we're probably looking at the same fate in about 10 years. Frankly, I'm looking for reasons to refute what they're saying, and I'm having a hard time finding any. Fun, huh?