Pension Problems?
Posted by Jody Eisenman | Filed under Uncategorized
In a fascinating article in todays’ New York Times http://www.nytimes.com/2010/06/20/business/20pension.html?scp=1&sq=pension&st=cse
it seems that many states are finally coming to the realization that their budgets are not close to being balanced. Some states have promised pensions that they cannot afford, and as people retire, these states face a crisis in figuring out what to do. According to Eden Martin of the Commercial Club of Chicago, we are within a few years of several pension funds running out of money. According to federal law, a state is still obligated to make pension payments even if they run out of money. The problem is, where will they get the money? The most obvious choice is from general revenues, i.e. taxes. However, as most of these states are not only in debt but also run continuing yearly deficits, this is sort of like robbing Peter to pay Paul. On Wall Street, we sometimes call it “shuffling the deck chairs on the Titanic”. In other words, you are funding one deficit by adding to another. This is sort of like someone with several credit card bills that he can’t pay. Therefore, he pays off one by increasing the credit line of another. Of course, the interest charges just get bigger.
This is the same scenario the US government has with social security. Many people misunderstand this system. They think that the money deducted from their paychecks is being held in reserve for them till retirement. The reality is quite different. To understand this, think of when social security first became a law in 1935. Retirees received money immediately, without ever having to pay into the system. Where did this money come from? From the then current worker pool. Who paid those workers? The new workers, and so on and so forth. Now, this system only works if the social security tax rises at least as people retire. In 2009, over 50 million American received over $650 billion in benefits. Even though social security taxes are now over 15% (equally split between employers and employees), the system has not kept pace. This is especially due to the beginning of the “baby boomers” retirement age. Some people, like Thomas Sowell, refer to this as just a pyramid scheme. How this will play out over the next decade may prove to be a challenge.
British Petroleum
Posted by Jody Eisenman | Filed under Uncategorized
BP is the largest company in the United Kingdom. It has been around for over a century, when they began as the Anglo-Persian Oil Company. Since then, they have merged with Amoco and Atlantic Richfield, also known as ARCO. BP has been steadily profitable, with revenues in excess of $250BB, and earnings of about $20BB. Helped by a huge dividend, their stock had risen from the mid-30s at the depth of the market decline in March of last year to over 60 in April of this year. Then came April 20.
On that day, an explosion on a oil rig led to 11 deaths and a massive oil spill in the Gulf of Mexico. Since that date, estimates of the amount of oil released and the potential clean up costs have increased constantly. As such, BP stock lost about half of their value. The devastation has effected the shipping industry and negatively effected a huge portion of the US marine environment. In a bid to show leadership, you even had President Obama involved in castigating the company on national television.
Today, BP finally announced that they were setting up a $20BB fund. This may not be enough. In addition, they suspended their dividend, which will save them another $10BB. The question is, what’s next? I can see three possible scenarios:
1. BP finally gets a handle on the problem and takes steps to resolve it. The stock will probably increase under this scenario, depending on the eventual cost.
2. BP gets taken over by one of its’ competitors. There are rumors of Exxon and Shell being interested, but these are only rumors. A takeover could mean a $50+ stock price.
3. The costs and political pressure become so great that BP decides to seek protection under the bankruptcy code. This would have the biggest negative effect on the stock price.
Although the situation is still ongoing, I think scenario 1 is most likely. Bankruptcy is a final resort, and even Obama would not like to see this, as it will limit BO’s ability to pay claims. As far as scenario 2, a takeover is always tough to predict. Even if someone was interested, it would be an incredibly complex deal subject to heavy regulatory approval. Therefore, I believe BP will finally get a handle on the costs. However, this situation is still changing every day, and as such, anything could happen.
The Jobs/Inflation Conundrum
Posted by Jody Eisenman | Filed under Uncategorized
When Fridays’ unemployment numbers showed scant month to month improvement, the stock market reacted swiftly. When the dust settled, the DJIA had fallen over 300 points. What added fuel to the fire was a surprising announcement that Hungary could be facing bankruptcy. While Hungary is a relatively small country, this announcement, coming the heels of the Greek bailout and the Spain credit downgrade, has led many to believe that the European debt crisis is spreading. The market is now clearly nervous, which is almost a 180 degree turn from where we were a month ago, when the market seemingly shrugged off every bit of negative news with a wave of fresh buying. While I do think that the situation will probably get sorted out over time, there is a slight chance in my opinion of this crisis becoming so large as to completely overwhelm the stock and bond markets. I prefer not to dwell on this nightmare scenario at the present.
The main issue, of course, is debt. It is rather outrageous that almost every industrialized nation has spent more than they take in. If a sovereign country were a corporation, they would realize that you cannot continually spend three dollars for every two dollars in revenue. Sooner or later, you are to have to turn a “profit”. In the case of most European countries, they haven’t turned that profit in years. Their solution has been to borrow ever increasing sums in order to finance their yearly shortages, as well as buying the interest on their debt. This is true in the United States as well. OK, then why did the market react so negatively to a seemingly benign jobs number on Friday?
In order to stimulate the economy, the US government has been spending huge amounts of money (via treasury bond sales).Interest rates are already around zero. They have already bailed out the banks and the auto industry. Now, all this might have been worth it if the economy was truly improving. However, based on the latest unemployment numbers (which are currently 9.7% nationally),it is apparent that it is not. Most of the new hires have come from the government incentives, and not from private industry. How long can the US continue to spend without bringing the Euro crisis here? I don’t know, but one thing I learned in business school was that if you borrow money, you have to repay it sooner or later. Unfortunately, the US, like most countries, really have no idea how they are going to repay this. You want to know what their plan is?
1. Leave it to the next guy
2. Hope that investors will continue to buy bonds forever
3.Pray
There is only one real way to address this, and that is to balance the budget. One would accomplish by either cutting expenses (meaning unemployment, bailouts, subsidies, etc.) or by increasing revenues (meaning taxes). Needless to say, neither path is politically popular. The one thing every elected official understands is that you remain popular in order to get reelected. As such, there are very few people who will be willing to sacrifice their political career for the sake of balancing the budget. Until this happens, we will constantly be behind the eight ball.
