For People Who Live Their Work

Voters love easy solutions to their problems, so the idea of drilling domestically for more oil is an incredibly appealing solution to high gas prices.  Slogans like “Drill Baby Drill” provide great sound bites - especially when they come from the incredibly cute lips of Sarah Palin.  But if you scratch even slightly below the surface you realize that increased domestic drilling is a sound bite that does not make any sense.  Here are the problems:

• Offshore drilling is not environmentally safe.  Proponents spend a lot of time talking about how new drilling technologies have made offshore drilling much safer and cleaner than earlier attempts, and perhaps it it true that we have better techniques. But one of the main problems is that drilling releases huge amounts of methane gas - one of the main causes of global warming.  There is no way around this - so even if we don’t have oil leaks - we do release toxins into the air when we drill.  Another huge environmental concern around offshore drilling is the issue of storms.  Offshore rigs are incredibly exposed to the massive storms that are hitting more frequently as a result of global warming (there is an irony there). When these rigs are damaged huge dangerous leaks can occur.
• Even if we find more oil there is no guarantee the oil companies will use it to ease domestic supply issues.   Here’s an important point.  “We the people” don’t control the oil supplies - the oil companies do.  Giving the oil companies more access to oil does not necessarily mean they will sell that oil here. They will do as they are currently doing - sell the oil where they can derive the most profit.  Right now oil companies in the US are hoarding oil in hopes the price will go up.  If we allow them to drill and China is willing to pay more money, our oil gets shipped to China, and we have to pay the environmental price.
• This is not an immediate solution - and it distracts us from the real solution.  Even the advocates for drilling agree that if we start now new drilling will not produce any meaningful results for ten years.  In a decade if we are still as reliant on fossil fuels as we are now we have a lot bigger problem.  If we concentrate on green technologies right now, in ten years we could eliminate the need for additional oil.  This new green effort would also bolster our economy, help save our planet, and again make us a world economic and social leader.  Continuing our addiction to oil is dangerous old thinking. As Thomas Friedman often points out, it is like investing in typewriters after we discover the computer.

So what do we do if we need an immediate oil fix?  Well, here’s an idea.  Lets quit exporting oil.  Strip away all the hype and you discover that the US is and always has been one of the world’s largest oil producers, and we currently export a huge amount of oil.  Which begs the question - if we are in such short supply that we need to drill, why are we exporting?  Lets look at the stats.  Last week the US imported 13,671,000 barrells of crude oil and petroleum products.  That’s a lot!  But, we exported 1,511,000 barrells.  If you look at the historical trend of imports and exports (available at http://tonto.eia.doe.gov/dnav/pet/pet_move_wkly_dc_NUS-Z00_mbblpd_w.htm) you discover that on average we export about 10% of our imports.  So you want a 10% increase in domestic oil capacity?  Quit exporting.  You want even lower prices on oil? Stop the oil companies from hoarding and driving up the price.

The brilliant investor Warren Buffett now seems to have taken center stage in America as the one financial expert people trust.  In fact, in many ways I suspect Buffett will be one of the saviours of our current economic crisis, either as investor, advisor, or perhaps as a part of the Obama cabinet (he is supporting Obama for President).  Accordingly, people are curious about how the notoriously conservative investor is approaching the current economic situation.  Perhaps not suprisingly, Buffett sees opportunity in the stock market crash.  Of course, unlike most of us he had the foresight not to get caught in the downturn (he was invested in treasuries), so he is picking up bargains with his money intact and a lot of upside.  And I doubt Warren has an adjustable rate mortgage on his mansion.  Still, he is a smart man to follow.  Buffett publicly expressed his opinions this week in an op-ed in The New York Times.  His approach is interesting -  http://www.nytimes.com/2008/10/17/opinion/17buffett.html?_r=1&scp=2&sq=warren%20buffet&st=cse&oref=slogin

My brother-in-law Don called this weekend to express his thanks for The Bizzy Life.  A couple months ago after reading guest blogger Ray Link’s entry - Why Investing In Stocks Might Be A Bad Idea - he decided to move his savings from the market into cash, and of course now he could not be happier.

Ray, Don sends his thanks for your sage advice!

As the election heats up there is a lot of focus on which potential President will raise taxes.  McCain say Obama will raise taxes - Obama admits he will raise taxes on the rich, but versus the McCain plan will lower taxes for the middle class.  One could argue that given the fact our country is going broke we probably all need to pay more taxes, but according to the Tax Policy Center here is how the candidates really compare:

If you make        you would save under Obama          under McCain

Less than $19,000                $567                                      $21

$19,000 - $36,600               $892                                      $118

$36,600 - $66,400               $1118                                     $325

$66,400 - $111,600             $1264                                     $994

$111,600 - $161,000           $2135                                     $2584

$161,000 - $227,000           $2796                                     $4437

So the clear fact is that if you make less than $111,600 per year (as most of America does), and you vote strictly based on which candidate will hit you with the lowest taxes (or on the surface what appears to be the lowest taxes), then you should vote for Obama.  However, wealthier Americans only concerned with Federal taxes will clearly like McCain more.  Take a look at how the tax rates compare if you are among the top 5% of earners in the US:

If you make                      pay more under Obama       save under McCain

$227,000 - $603,400             $121                                          $8159

$603,400 - $2.87 million       $93,709                                     $48,862

More than $2.87 million         $542,882                                    $290,708

So, if you make $1 million a year, under Obama your taxes will increase as much as $94,000, but under McCain you will get a tax break of $48,000.  This is all very confusing to me, as McCain’s supposed base - the straight-talking heartland of America - typically does not make huge amounts of money, so financially you would assume they would be in Obama’s camp.  They are also justifiably upset by greedy Wall Street “big wigs” - the people that make millions per year and tank our economy.  But these are the folks that would benefit most by a McCain Presidency.

Personally if Obama wins my taxes go up.  But I agree with an earlier post by Ray Link that there is more to making money than the tax rate.  The value of my investments has plummeted under an administration that believes in little or no regulation and tiny tax rates for the rich.  I’m hopeful that by paying more in taxes my asset base will grow, and I will sleep a little better at night.

If you are a Warrior in the workplace, you care more about getting things done than your popularity level in the company.  But unfortunately, there are seldom enough Warriors in the workplace, and a high percentage of non-Warrior managers prefer to “run a community” as opposed to “run a business”. 

Of course, there are exceptions -  ”community companies” that operate efficiently, but they are almost always small, frequently family-run organizations that have made the choice for a variety of different reasons.  A high performance company must operate like a company.

In a community, everyone has their say.  Decisions are made by consensus, and the community leaders are dependent on the community members to maintain their status, so they are careful to be inclusive and not offend anyone.  Community members are typically only ejected from the community for really heinous behaviour.  Community leaders will often choose not to make the tough choices for fear of alienating the community. 

A successful business almost never operates this way.  Decisions in a business are made by Warriors or teams of Warriors and trusted advisors, and are based on what is best for the business, not what would make them the most popular with the employees.  Managing by consensus or by popularity contest does not work in a business.  Certainly a successful business should have an industry-appropriate culture that fosters talent, and encourages success and innovation, but maintaining that kind of culture also requires tough standards. Good managers understand that they can’t be friends with everyone in their department, and holding people to standards (and firing those that can’t perform) is their duty as the manager.  Otherwise they foster mediocrity, which threatens the entire company.

Communities are great places to live, but I would not want to work there.

Guest blogger Ray Link joins us again today with a very concise and interesting analysis of the relationship between maximum tax rates and the GDP - and whether it makes financial sense to pay more taxes. Ray is a big-brained finance guy, and a good example of what the Republican Party once stood for long, long, long ago; small government and fiscal restraint.

Should High Income People Want to Pay More Income Tax?

Senator Joe Biden recently made some comments that I thought were out in left field when he stated that “wealthy Americans must pay more taxes to show patriotism”. I have no real issue with high income people paying more in tax and to some degree even paying disproportionately more, but I never felt it was my patriotic duty to want to pay more. But am I better off with a higher tax rate or a lower one? So, being an accountant, I crunched some numbers to flesh out the facts.

A brief history is in order. The United States adopted an income tax in 1913 with the passage of the 16th amendment to the constitution. Prior to that time the government funded itself largely from tariffs on imports. Once it became law Congress gradually increased the rates from 1% in 1913 to a top rate, also known as the maximum marginal rate of 94% during World War II and then set the top rate at 91% for many years. The maximum marginal rate is the rate paid on income above a stated level, which usually impacts a small percentage of taxpayers. But because these few people earn so much it contributes a fairly large percentage of all income tax paid. It is also a source of debate when Congress raises or lowers the top rate as it only impacts high income taxpayers. These high rates prompted many tax shelters and schemes to avoid taxes and Congress eventually lowered the rate and the threshold and eliminated many tax shelters. A table of this rate since 1960 follows:

Now that I am enjoying some of the lowest top tax rates in the past 50 years, I ask the question, am I better off and is the country better off?

I want to know if my investments do better in high tax periods or in lower tax periods. I also want to know the impact of tax policy on the deficit and the growth in our national debt as well as the overall growth in our gross domestic product or GDP. The GDP is the sum of all goods and services produced by Americans and it is an important gauge of the health of the country. The deficit and total growth in our debt impacts inflation and the value of the dollar which impacts our world purchasing power. After all, aren’t high income tax payers those people with all the money so they shouldn’t they be more concerned over the growth in their net worth and the value of their money than the tax on their income?

Let’s investigate the facts. Fact one, the U.S. has run a budget deficit every year since 1957. Fact two, since 1960 the government spends about 18% more per year than it takes in taxes and fees. Sorry Bill, despite the popular belief that you ran a surplus; you too in fact were 0 for 8 in your ability to generate a surplus. You did have the single lowest deficit since 1960 in the year 2000 with a paltry, by Washington standards, deficit of just $18 billion. Here are some alarming data on deficits and the size of our national debt:

The above data are alarming but one that is really scary is that our total debt is 3.8 times the size of the government’s gross receipts. That would be like saying a company doing $1 billion in revenue would have debt of almost $4 billion which is highly leveraged and very risky. In addition, the fact that it would take every man, woman and child, all 300 million of us, to pony up some $30k each to extinguish the debt is dreadful. The interest cost alone on the debt is now approaching $300 billion or about 10% of the total budget. This is one of the main causes that the dollar has depreciated over 60% since 2000 compared with the euro and why it is so hard to keep inflation in check. We just continue to print money. Let’s look at what the deficit and growth in the national debt are doing to the value of the dollar since 2000:

The large depreciation in the value of the dollar compared to other world currencies such as the euro, Canadian dollar and pound sterling is also a huge underlying “tax” on our savings. It is a significant contributing factor to the increase in our national debt and deficit, especially compared to our slowing growth in GDP. If one wonders if this has any real impact I suggest you look at the price of oil or imported goods from Europe and you will find significant price increases since last year. If a few percentage points in tax rates can close that deficit, perhaps the dollar would be stronger and prices lower.

So what happens to the deficit, GDP and investment returns in periods after a major tax increase or tax cut?

Lots of data but what comes out is that some of our best returns in the S&P 500 were earned in periods of higher tax rates, often after a tax rate increase was enacted. The growth rate of the GDP has been on a rather steady decline but the budget deficit as a percentage of the GDP increased in the Reagan and both Bush administrations when tax rates were lower. Real growth as measured by GDP minus inflation suffered under Carter and both Bush administrations yet the tax rates were vastly different. On balance some of our best years were during the Clinton administration where we had a relatively low top tax rate (but higher than the previous administration) yet had smaller relative budget deficits, above average real growth and far superior investment returns. The key then seems to be a combination of modest tax rates coupled with modest deficits and it’s hard to have a modest deficit with really low tax rates.

As one of those “fat cat” Republicans in the maximum marginal tax rate I would gladly pay another 4-5% in income tax on my income above $300,000 and have much higher returns on my invested assets and the benefit of a lower deficit that otherwise is eroding the purchasing power of my money. So sorry Joe, I’ll pay more taxes if it is good for my country and also good for me financially, but it is not my patriotic duty to do so. It’s just good business.

Ray Link is a CPA and has an MBA from the Wharton School and is CFO of FEI Company, the world’s leader in electron microscopes. He is a former city councilman from Florida and a 30 year member of the Republican Party.

I like to work with stock and real estate brokers that have been through a recession or two and have experienced deep dives in pricing.  It gives them a certain perspective that the young and fresh don’t share.  They are typically much more resistant to panic.  They know from experience that the certainty of the market is that it eventually always goes up, and if you have built your portfolio correctly, avoid panic, and keep your debt levels in check, you will profit.

A 777 point drop in the market is painful - perhaps devastating if you are close to retirement.  But if you have a longer horizon, and have money to invest, this is a great time to go shopping.  There is a huge sale going on right now.  Great companies trading at deep discounts for no real reason.  For those with decade or two before retirement, this will be a blip in most people’s financial memory, and the smart money will have prospered.  Take advantage of this limited-time sale.

In the most recent episode of HBO’s terrific show “Entourage”, fallen movie star Vincent Chase is confronted by his angry financial advisor.  “You’re broke”, he screams at him, and encourages him to declare bankruptcy.  Instead, Chase decides to take any possible gig to raise money, and ultimately ends up swallowing his pride and appearing at a lavish sweet 16 party for a lot of quick cash.

Even in the fictional world of movie stars that is how things work.  Ultimately if you are tapped out and want to avoid bankruptcy, you have to cut expenses and raise cash.  Work more, sell something, cut expenses; that’s how you dig out of a financial hole. But in the more surrealistic world of American politics, the normal rules of cash flow do not apply.  Politicians deal with debt by simply borrowing more money, primarily from other countries.  At least that is how it has worked for the last administration.  Whether or not the rest of the world will continue to loan us boatloads of dough during this current crisis is yet to be determined.

Perhaps there are other options that the Washington braintrust have not considered.  When Vincent Chase is first confronted with his dire financial situation his reaction is to “sell something”.  Unfortunately, he had nothing to sell, but that is not the case with the government.  They have plenty of assets, and since they seem to have no issues with getting into bed with corporate America, the options are almost limitless.  Here’s an idea -

• Sell the corporate naming rights to Washington DC.  It would not only be a great way to raise cash, but would also be a constant reminder to our elected officials of the consequences of bad financial management.  Microsoft just spent $300 million on their new ad campaign.  Perhaps they would pony up $500 million to change the name of our seat of Government to “Microsoft City”.  Or how about “stop by and see the Smithsonian in Yahoo Town!”  They could use a PR boost.  Or Googleville.  That one just rolls off your tongue.

Of course, just like Vincent Chase, our elected officials could raise more money by working more.  Most of them already make a ton of extra cash giving lectures and making public appearances.  Perhaps that money should go into federal coffers, since they are doing it on federal time.  And if fake movie star Vincent can appear at a birthday party, perhaps our politicians can lower their pride level a bit and really do something special to raise some money.  Here is an interesting idea -

• A travelling road show of “Mamma Mia” featuring politicos.  Nancy Pelosi could be the horny mother, with the young-looking Sarah Palin appearing as her daughter. Pelosi’s aging suitors would include Dick Cheney, Karl Rove, and Barney Frank.  I would personally pay $1000 per seat to see Rove in a Speedo crooning Abba music! And we all know that Palin looks great in a bikini (and I am so curious about her tattoo)!  This could be big - really big.  Forget the Streisand Comes-Out-Of-Retirement-Again concerts - this would be the hot ticket! 

Finally, our government could go on a diet, and spend less than they bring in.  What a novel concept!  In the corporate world there would be lay-offs to cut expenses.  Perhaps Washington should do a little house cleaning.  Does everyone need all those aides and assistants? How about an across the board cut of 20%? We could consider getting out of Iraq right away which would save us $10 billion a month - and since Iraq has an $80 billion surplus they could afford to hire Blackwater!  And dare I suggest…. salary cuts?  Seems the powers in Washington have done a pretty dismal job of managing things.  In the real business world when things go badly sometimes people have to take less money.  Perhaps Washington should live in the real world. 

The average Americans’ head is now spinning with incomprehensibly big numbers!  Numbers for bailouts, bankruptcies, wars, deficits, CEO salaries, and various government interventions.  Not to add to the confusion - but here are a few of the more interesting big numbers.  Lets start with the really big one….

• $3,000,000,000,000.  That’s three trillion dollars - the final price many experts are estimating for the Iraq war.
• $60,000,000,000.  Sixty billion - the original estimate from the Bush administration for the Iraq war.
• $80,000,000,000.  That’s eighty billion dollars, the current budget surplus the Iraq government recently reported.  (Yes - I did mean surplus - as in “we have way too much money!”)
• $407,000,000,000. Four hundred and seven hundred billion. The upcoming estimate of the Federal Deficit.
• $700,000,000,000.  The Bush Administration is requesting seven hundred billion from congress to stabilize the economy.

So, what to make of all these big numbers?  Well, since I am not an economist I’m not qualified to comment on the government’s increasing role as regulator and “Uncle Moneybags” to Wall Street.  But, as a businessman who has some experience borrowing money and granting credit to customers, if they were borrowing money from me I would question the credit qualification of the current administration.

Imagine someone comes to you to borrow money - perhaps to build a new building.  They initially request sixty billion - but the budget ultimately comes in at three trillion.  (OK - it’s a really, really big building! Lots of glass and gold plated elevators!) And after all the cost overuns, you learn that one of the partners in the project has abscounded with eighty billion.

If that same borrower then wanted to borrow another $700 billion after running up another $407 billion in debt - would you give them the money?

Probably not.

Though we might want to consider letting the Iraqi government run this show.  They seem to be pretty good with money!

A few more unrelated but interesting numbers to consider:

• $91,000,000.  Ninety one million dollars - the 2006 compensation for Merrill Lynch CEO Stanley O’Neal.  O’Neal received more than $160 million in compensation despite the fact that stockholders lost 41% of their value during the same period. Three other Merrill executives will share a $200 million dollar payment for tanking the company and turning it over to Bank of America.  Makes you wonder how much they would have made if he had managed to take the value of the company to zero!
• $68,000,000. AIG’s former CEO Martin Sullivan’s contract entitled him to compensation of $68 million while the company reported losses for two quarters of $13 billion!

As the CEO of a mid-size company, the above numbers obviously indicate I am doing something wrong!  I receive bonuses based on achieving profit goals, not for running up huge losses and tanking my company.  I suspect it is much easier to lose money than make money, so I really need to renegotiate my contract!

These are frightening times when it comes to investing and and holding on to your money! As I write this the DOW seems hell-bent on going retro - retreating to ugly places we have not seen for years!  And we all just sit and wait with baited breath for the next bad news!

Of course, the optimistic investor with the proper long-term horizon might be saying “wow, I see a major buying opportunity right around the corner!”  There is definitely a big liquidation sale going on right now, and you can buy some really great quality companies at a fraction of their value!

But I’m not going to go out on a limb here and tender investment advice in this entry. I would encourage people to do a little basic safe house keeping -

1. Check your FDIC insurance limits.  Keep in mind that depending on your account, you are typically insured to $100k per institution (trusts and joint accounts carry bigger limits), yet many people are running balances in excess of this number.  Also, you might be invested in money market accounts that are not insured.  Double check the status of all your cash, and shift accordingly to maintain proper FDIC insurance!
2. How are your securities being held in your investment accounts? Here is a little-known fact I just discovered.  Some brokerage houses hold your assets in a street name as opposed to your name.  This could be dangerous if your brokerage house were to collapse, as your ownership might be questioned, and your assets could get thrown into a big bucket parceled out via bankruptcy.  It’s not a bad idea to verify with your broker that your assets are held in your name, so no matter what happens to the brokerage house you get to keep your assets.

Though my portfolio is pretty ugly compared to a couple months ago, I am taking some solace in the fact that I have been playing it pretty conservative lately.  I have been buying 30 day to Two Year FDIC insured CDs for the last few months, being careful to observe the FDIC limits per institution.  While there might be good rates floating around in your home town, I have found the easiest way to manage a lot of CD trades is through Charles Schwab.  They have a CD trading section that changes constantly, and makes it very easy to buy from many institutions to maintain your FDIC limits.  Schwab manages the process and the rates tend to be very good.

Good luck, remember the one sure thing about the market is that it eventually goes up, and avoid open windows!  It’s only money!