Saturday, March 31, 2012

Warren Buffett should pay a lower tax rate than his secretary

President Obama has renewed his call for the so-called Buffett Rule, under which a person earning more than $1 million in income would have to pay a minimum 30% tax rate, suggesting that this somehow about "fairness" and that persons with high incomes are not paying "their fair share." There are a couple of problems with this claim.
First, although the "marginal rate" may be lower for people with an income mix such as Mr. Buffett's (or Mr. Romney's), their "total" tax payment are significantly higher, and it is "total" tax, not "marginal rate" which really matters.
Second, for the first portion of Mr. Buffett's income that matches his secretary's income he pays exactly the SAME tax rate. That sounds awfully fair to me.
Third, if someone has income over $1 million that is strictly or mostly salary/wage income they will in fact be paying a significantly higher marginal tax rate than his secretary for every dollar of that non-investment income, once again due to progressive tax rates. Again, nobody talks about this. That hardly seems "fair" for him, but nobody says anything about that and if he doesn't want to complain, that's that. But, to put it simply and bluntly, there is zero truth to the claim that people with non-investment income greater than Mr. Buffett's secretary are paying a lower rate for that non-investment income. Zero truth. The story should be about the relative value of salary and wage income vs. investment income, but oddly that important distinction has been lost in the noise of all the political theater.
Fourth, our tax system deliberately places a higher value on investment income since capital and investment is the very lifeblood of our economy. Without ongoing investment, the economy would quickly grind to a halt. For this reason, we intentionally and mindfully assign a significantly lower tax rate to "investment income." This is the incentive for people to invest money rather than to merely spend money. And, to be fair, we do in fact offer that same identical lower tax rate to both Mr. Buffett and his secretary for their investment income.
Fifth, my apologies to his secretary but Mr. Buffett deliver far greater economic value to society than she does. I am sure he compensates her "fairly." I am also sure that if she had a ROTH retirement account or some modest investments from savings that she would in fact pay a much lower tax rate than she pays on her salary and wage income, which is how it should be. If she wants to go back to school or teach herself investment skills and go out and raise capital to be an investment manager comparable to Mr. Buffett or Mr. Romney, all power to her, and then she will deserve a lower marginal tax rate for her investment income.
It may not seem fair to some, but working "smarter" is and should be more highly values than merely working "harder." Yes, hard work is needed, but it is only smart work that grows the economy in a leveraged manner.
So, in short, President Obama is completely misguided in his call for higher tax rates for investment income. If someone has more than $1 million in non-investment income they will already be paying a much higher tax rate (for that non-investment portion of their income) than Warren Buffett's secretary, so no change is needed on that front to achieve so-called "fairness" for taxation of entertainers, star athletes, et al whose income in primarily from their own labor as opposed to investment income.
It may not seem "fair" that capital has higher "value" than labor, but capital is more like a fuel and labor is more like water. Both have great value, but fuel is more scarce and has greater leveraged economic value and must be protected and promoted with much greater vigilance, especially since it can be so easily squandered if used in a misguided manner.

-- Jack Krupansky

Thursday, March 29, 2012

So, which direction is the market headed now, over the next six months?

Of course the stock market bounces around on a daily or weekly basis, but what direction is it headed over, say, the next six months? I can honestly say that I really don't know. I am fairly confident that the stock market will continue to grind its way higher over a two-year and longer timeframe, but there are so many hedge funds and in-house proprietary ("principal") trading desks at the big banks "playing" (and manipulating) the markets on a short-term basis, that there simply isn't enough public information on their thoughts and intentions to discern the likely direction of the market. These people have collectively taken a "risk on" position for the past several months, but they could decide to either maintain that posture or flip over and reverse it to a "risk off" position without a moment's notice and on whatever internal criteria they may be using but are not going public with.
In the old days, the brokerage firms told clients which direction they "thought" the market was headed and clients followed, but these days with all the hedge fund and prop/principal trading the firms have a vested interest in profiting from whatever causes losses for the customer. Oh, sure, let the customers "win" occasionally or frequently enough to keep them in the game, but bleed them slowly the rest of the time. Kind of like the lottery, with just enough people  winning big to keep up the interest even though most people only lose money – and count on the fact that the "losers" will be too embarrassed to publically admit their losses.
In the old days, prop/principal trading could "manipulate" the market direction for only days, weeks, and only occasionally a couple of months at a time, but now with all the hedge funds and their "hot money" (profiting from short-term trading rather than long-term investment), the direction of the market can be artificially "influenced" for six to nine months and sometimes even a year to eighteen months before underlying economic and business fundamentals build up or decline enough to overwhelm the artificial influences.
In short, the nice rally since the beginning of the year is much more likely to be "fake" than real and sustainable. Lucky for me, I am not "playing" the market for short-term profit, so I am less vulnerable to whether the "swing" continues or reverses.
Personally, I think we need to split the stock market, a la Glass-Steagall, into a "casino" (derivatives) market for the short-term traders and an "investment market" for the long-term, true investors. Let people "bet" on stocks, but not "with" stocks. Stocks should be reserved for income and long-term appreciation.
But, that kind of reform is not likely to happen any time soon.
Meanwhile, we have to read any advance or decline of the stock market with a rather large grain of salt. A major rise or decline over a year or even eighteen months is just as likely or even more likely to be the result of the "artificial influence" of hedge fund and big bank prop/principal trading as the result of actual movement in economic and business fundamentals. And if even a one-year market "trend" is suspect, you know that a three-month "trend" is a completely unreliable indicator of where the market or the economy is headed next.
In short, the current "rally" of 2012 could simply be taking a breather here before continuing higher, or it could be running out of steam and faltering and on its last legs and about to flip over and run right back down for the entire distance it ran up. Flip a coin as to which will happen next.
For me personally, I am still sitting on the cash for my 2011 retirement contributions. I simply do not see any compelling investments and am a little worried about the "intentions" of the hedge funds and prop/principal traders. For now, my intention is to invest 25% of the cash after six months or when the market declines 10%, whichever comes first, and to invest the remaining three "tranches" with the same formula. Having a little cash (10% to 20% of total assets) is actually a good idea and the profit to be made by buying on any sharp market pullbacks would easily compensate for the tiny money market fund interest and inflation loss. Exactly what I invest in is open, with a default of investing more in my 2025 target date fund, or maybe some Verizon (VZ) or Priceline (PCLN). Verizon pays a healthy dividend and Priceline is the only company whose product/service I am really passionate about.

-- Jack Krupansky

Wednesday, March 28, 2012

Update on the morality of short-selling

A commenter reasonably asks "What rights you have to ask other person not to call the bluff of a moron (or group of morons!) by the process of betting?" Thanks for asking!
I have absolutely no objection to "betting" against a stock per se, and there are options, futures, and other derivatives for doing so. But "betting" using the underlying stock, which is intended for investment and which we want to be safe for retail investors needs to be strictly off limits. Maybe we do need additional marketplaces for people seeking only to "bet" for or against stocks, but let us try to do a much better of making the core stock market safe for investment. Shortselling makes stocks much less safe for investment, not more safe. Yes, it is true that pump-and-dump buying is also harmful to everyday investors, but to put it as simply as possible: two wrongs don't make a right.
By all means, let us discourage all forms of short-term trading of raw stocks. For example, we do need to have a steep excise tax on stock transactions of less than two years. Not to raise revenue for the government, but to strongly dissuade people from using stocks themselves for their so-called "betting."
To be honest, there are two distinct forms of "betting": short term and long term. Short-term betting is for casinos. Long-term betting is for true investment for financing of the productive capacity of society. If companies want to "make a buck" off the former, fine, this is still a free country, but as socially acceptable as a "weekend in Vegas" might be, safeguarding our "seed corn" is a deep social obligation. We need to do everything we can to discourage betting on the short-term, and do everything we can to encourage betting on the long-term.
The idea that shortsellers are increasing liquidity and "normalizing" the market is an excuse rather than a reason for tolerating the practice. The good news is that most of the time the shorts get hosed by their own greed and poor timing. The problem is that there are too many times when shortsellers act as predators rather than protectors of the common investor.
By all means, let people "bet", but let us place short-term betting with stocks (and bonds) strictly off limits.

-- Jack Krupansky

Tuesday, March 20, 2012

We need an Investor Bill of Rights

There is no question that investing these days is very tricky business. In fact, any dealing with Wall Street is quite treacherous these days. It is caveat emptor, let the buyer beware, every step of the way. Sure, it has always been that way, to some extent, and us diehard investors are quite used to it and have all sorts or tricks to navigate through the investment minefields, but it is plain and simply dysfunctional and  unacceptable for the average investor. What we need is an Investor Bill of Rights that makes it once and for all relatively safe for the average American to invest in anything other than a simple bank savings account or CD. Even money market funds are far more risky and tricky (and less profitable) these days than once thought.
I don't have even a preliminary draft for an Investor Bill of Rights yet, but it is something to start thinking about.
The point is not to eliminate all risk or guarantee a high rate of return, but simply to assure that average investors are protected from severe predatory behavior on the part of the denizens of Wall Street. Once it was only a bunch of hedge funds and due to their limited size they could be tolerated, but now every big bank is trying to run itself like a hedge fund, so what in the past was marginally tolerable is now definitively intolerable.
The goal will not be to eliminate all conflicts of interest, but to render them manageable, to assure that there are very clear limits to how far banks are allowed to go in acting against the interests of their customers. We need to restore the meaning and value of the term fiduciary duty.
The goal will not be to eliminate speculation and short-term trading, but simply to assure that speculators and traders cannot attack the assets of average investors. In the past, speculation and trading was simply "noise" and little concern to serious investors, but now it is the speculation and trading "tail" that is wagging the once-mighty investment "dog." Put simply, we need a solid firewall between investments and the casino betting of speculators and traders.

-- Jack Krupansky

Wednesday, March 07, 2012

Wall Street DOES have an interest in your future!

I was reading Harry Newton's blog post today where he says "Wall Street is a product machine. It creates what it can sell you. It has NO interest in the future of what it sold you" and while I superficially agree with that, after a little thought I realized that something was missing from Harry's formulation, something very important. I realized that "It has NO interest in the future of what it sold you" is not an accurate assessment of Wall Street's mentality at all. The rest of this post is a near replica of an email that I sent to Harry.
There is plenty of evidence in the financial media since the financial crisis that Wall Street all too frequently DOES have a very deep and passionate interest in your future and the future of what it sold you – namely, to profit handsomely from your downside. So, for example, they will sell you stocks, and then short them, profiting from your loss. Or sell you "dogs" of bonds and then buy them back at a steep discount when you want to dump them. Or, one of the big GS scandals where they sold customers mortgage securities that they intended to short or bet against or had hedge fund clients intending to do so. The list goes on. They have a very intense "interest" in how things go for the future of what they sell you. Maybe the particular salesman/broker doesn't because he just wants his commissions, but I can assure you that there are plenty of others at the firm who do have an interest.
The real point is that the primary interest of Wall Street is collecting fees, commissions, and other payments based on the flow of transactions. You say cash is king, but on Wall Street transaction flow is king.
The secondary point is that as long as transaction flow is maintained, Wall Street is more than happy to profit from any downside you the customer experience.
The "prop trade" desks on Wall Street have two functions: 1) to "support" the flow of transactions – that is what they were doing with ARS, until they stopped, and 2) to bet against the customer and profit from the downside.
The real point of ARS was to provide a steady flow of Muni underwriting transaction flow, unlike the situation we saw later with the mortgage market.
Wall Street firms have something called "inventory" which is a combination of the stocks and bonds that they are selling as a result of underwriting "support" and "cheap" stocks and bonds they speculate on when you dump them in bear markets or due to other fear-based emotion (you can be sure that they were big buyers of BP while the oil spill was in progress.) They buy the stuff cheap, and then sell it back to you (or your neighbor or friend) at a nice profit on balmy days when the sun comes out again. In any case, this "inventory" is a very clear interest in the future of what they sell you, either to continue selling it to you in a rising market or to buy it up cheap in a down market. Note: There is currently a lot of Wall Street interest in buying up "distressed" mortgage securities, proving that Wall Street does have an "interest" in anything and everything that they sell you.
Wall Street caters to a lot of different types of interests, ranging from hard-core value investors to hot-tip casino speculators and twitchy day traders. Just like Vegas, they have a very deep and passionate interest not just in taking as much of your money as possible, but just as much interest in having you return again, again, and again – as you yourself do! So, it is rather misleading to say that they have "NO" interest in the future of what they sell. It's much more complex that that. Half of the time they have a "NEGATIVE" interest (selling you crappy offerings like ARS or overpriced IPOs or other so-called "products"), but just as importantly they, like Vegas, offer a implied promise that if you are willing to gamble and take on enough risk, that sometimes you can "beat the house", at least for a short period or maybe only for a single transaction. And, most importantly to us "true" investors, if you are willing to do your homework and be much more dispassionately calm and prudent in how you choose risk and extremely patient in your outlook, you can identify bargains and opportunities that slip by under the radar of Wall Street since they have so many bigger (and more gullible) fish to go after.
On the muni front, the sad thing is that all too often Wall Street sells local governments exactly what they ask for, a little lower cost (which government officials and bureaucrats are FORCED to ask and beg for due to the intense pressure to keep expenses and hence local taxes down), even if in exchange for confusing fine print that can have serious downside. If the local governments weren't so desperate to save "just a few shekels" to hold taxpayer activists at bay, Wall Street wouldn't have such a slam-dunk, shooting fish in the barrel market for complicated munis, the likes of which brought you and your friends the "innovation" of ARS.
I wouldn't for one moment let Wall Street off the hook for any of the many egregious practices that they do engage in, but accuracy in how we characterize their FULL activities is still important. I think you just got a little sloppy with this point. A decent correction is in order.
The guidance for investors should not be "Wall Street has NO interest", but for us to ask the question "What are the particular interests of Wall Street in this specific offering and how do they mesh or conflict with my own interests?"
I learned the hard way to stay away from convertible debentures – they seem appealing, but Wall Street's interest besides the upfront fees is that they collect commissions from the hedge funds that immediately turn around and short the stock on the expectation that any company feeling desperate for a convertible debenture is "headed down." Or maybe more to the point, the stock is likely to be a rollercoaster leading to repeated shorting and covering that just fills the pipeline with a commission revenue stream. And once the stock goes down, the debenture goes down and then they can buy them back at a steep discount and earn a huge yield on them. My personal example involved... yes, you guessed it – Goldman Sachs. That's another example of how Wall Street does have an "interest" in the future of what they sell you.
There are no "perfect" investments; it is all a matter of identifying, managing, and balancing potential upsides with potential downsides, and, as importantly, understanding that both upsides and downsides will evolve over time in unpredictable ways.