Another Taxation Gem from Washington

Why should banks that were forced to take TARP money, even though they didn’t need it and then paid it back as fast as they were allowed, be penalized for running efficiently and generating profits?  If they are going to be on the hook forever for TARP, even if the acutal obligation for most of them doesn’t exist anymore, let’s apply the same standard in reverse – investment banks and employees never again have to pay city and state taxes in New York because they bailed the city out of bankruptcy in 1975.  Better yet, let’s not let shallow, populist, politically motiviated efforts supplant sound fact and logic based policy making.  Why are GM and Chysler excluded?  Because they make things?  Because they’re not “Wall Street”?  Restrict AIG bonuses until they pay back the loans – definitely.  Screw Goldman and Morgan Stanley even though they’ve made good on the loans – that makes no sense whatsoever.

I’ve said it before and I’ll say it again…we need to insist on smarter decisions and policy making from our elected officials.

Paying the Bill

I wonder how much support the House’s version of the health care bill would have if the cost was to be paid by all taxpayers in proportion to their share of annual tax revenues?  I’m guessing that popular support would wane, particularly with those earning more than a $100k/year.  Everyone likes to spend someone elses money, especially on a moral cause.  It feels a bit different when your required contribution is more than just talk and support.

I generally subscribe to the argument that high earners should carry a greater share of the burden because they stand to gain more by keeping things running smoothly, but that isn’t always the case.  Health care is one of those exceptions.   As an example, the wealthiest people will end up paying to support or (hopefully) pay down the deficit.  They will lose the most if interest rates spike, the dollar is displaced as the reserve currency, or our trading partners get pissed if we inflate our way out of the national debt (all of which will happen if we don’t stop spending money and reduce the deficit).  They have the most to lose, and the curve isn’t linear, so they will ultimately need to suck it up and bail everyone else out.  This is not the case with healthcare.  The only people who benefit are people who don’t have health insurance right now; roughly 17% of the population.  This is a moral issue, not an economic one.  Essentially, 95% of the people are voting “yes” to spend the money of the other 5% of the population to solve a problem that affects 17% of the populace.  If you feel so badly about people not having insurance, step up and pay your share to make it right.  If you’re not prepared to do that, keep still and keep your hands out of the other guy’s pocket. 

Maybe we should try the inverse of the way things work right now and see how people like it.  How do you think it would go over if, on all economic matters, your vote counted in proportion to the amount of taxes you paid in the prior year.  When  you’re putting pennies in the jar, you can have a say in how it’s spent.  I can hear the screams now…Not fair!  We’re not represented!  I actually think that suggestion is a terrible idea, but it’s the mirror image of what we have now.  The distribution of wealth will always be normal, in the statistical sense.  That means that most people (by number) will be lumped in the middle and the tails (wealth and poverty) will encompass a relatively small number of people.  It also means that the wealthy will always be underrepresented when it comes to voting, especially when the options that are being voted on lump all the costs on the wealthy tail.  Who wouldn’t vote for something that helps other people, makes you feel better, and has a cost that they don’t need to pay?  Very few.

Let’s be honest with ourselves.  This country was birthed and raised in an economic construct.  Economics was the basis of our fight for independence, the civil war, the Louisiana Purchase and its subsequent exploration, the push Westward…nearly every notable and broadly meaningful innovation and development throughout history has been in pursuit of economic gain.  Let’s not pretend that money doesn’t matter.  More importantly, let’s not pretend that the other guy’s money doesn’t matter to him.

Universal healthcare is a worthy and attainable goal.  I support it.  I don’t support the thoughtless approach to the debate or the lazy, weak-minded solutions with which we’ve been presented.  Why does it always need to be about sucking more money out of the system and heaping more financial responsibility on the top 10% of the country.  There was never any consideration given to a true top-to-bottom reform that actually reduces costs at the source and improves outcomes, because that solution is hard, takes longer to implement, and will require a change in behavior from everyone.  It’s so much easier to just stick the bill with someone else, make it someone else’s problem, and then call them selfish when they protest.  The joke, ultimately, will be on the 95% when the costs of the “fix” ripple through the entire economy and reduce jobs, wages, growth, and opportunity.  And you know what?  These repercussions will affect the bottom 90% a lot harder than they will affect the top 10%.  Be careful what you wish for, you might get it.

What’s the point to all this?  Simple…if the government has an irrevocable call on income exercisable at its whim, it should be held to a standard of care ensuring that it spends that money in the most efficient manner possible in the achievement of the goals determined through the democratic process.  We should be looking for the best long-term solutions, not the most expedient ones.  Right now, that’s not happening.  How about some decision-making reform?

The Skinny on the Healthcare Reform Proposals

One of the perks of my job is that I get exposed to some very interesting people.  I recently had the pleasure of eating dinner with the Chief Financial Officer of the Memorial Sloan Kettering Cancer Center (“MSKCC”), Ted Kennedy Jr., founder of the Marwood Group and the late Senator’s son, and one of Ted Jr.’s partners at Marwood.

MSKCC is one of, if not the, premier cancer treatment and research center in the world.  It is a non-profit institution dedicated to the treatment of cancer patients and the eradication of all forms of this terrible disease.  It treats thousands of patients from all socio-economic strata every year.  It spends hundreds of millions of dollars every year on research, facilities, equipment, doctors and other medical personnel, and therapeutics.  As such, the CFO of this institution is squarely in the middle of the healthcare issue and has a unique window on the both the system and debate.

Marwood is a Washington D.C.-based public policy consultancy specializing in healthcare.  It is staffed by very senior people with extensive backgrounds in the executive and legislative branches of our federal government.  These are people who have worked as senior staffers for high-ranking senators and representatives, counsel for major congressional committees, and folks that have held senior roles in administrations going back several presidential election cycles.  It is a non-partisan organization with senior partners and associates from both parties.  Marwood provides clients with its expert view on what legislation is being considered and debated in all corners of the federal government.  It opines on the likelihood of passage and the form and substance of what will pass.  What it does not do is provide its opinion of the merits of the proposed legislation.  That is left up to the client.

Our discussion was disheartening, to say the least.  They provided some fantastic insight into what is being proposed and considered in Washington.  Things have morphed a bit since the dinner, including a public option (now euphemistically being called the “consumer option” by that Master Bullshit Artist, Nancy Pelosi), but the fundamentals remain the same.

It’s best to think about the proposals in two parts: the Big Bill and the Little Bill.  While the two parts are being sold to the public and presented in the media as one, they are actually being considered by the Congress independently.  Little Bill is easy to understand.  It is merely an expansion of the current Medicare/Medicaid program to include an additional 9MM people, plus or minus.  This piece of legislation will cost roughly $300BB over the next ten years.  It will be financed through a combination of Medicare taxes and surcharges on “high value” health insurance plans.  When you hear that the American Medical Association is supporting the current proposals, they are talking specifically about Little Bill and not the entire proposal.  What they are not telling you is that the AMA’s support was bought and paid for by rescinding $250BB of Medicare reimbursement cuts that would have come directly out of the pockets of AMA members.  The passage of Little Bill is a near certainty.

Big Bill aims to cover most of the remaining 26MM that fill out the census indicating that they don’t have health insurance (this is different from actually not having coverage and important to remember when you hear about 35+MM uninsured citizens).  Big Bill was originally comprised of four parts:  a requirement for everyone to purchase health insurance and a penalty for those that don’t purchase insurance, a requirement that insurance companies accept anyone who applies for health insurance (and not charge sick or less healthy people more for the same coverage), the establishment of a non-profit co-operative consisted of the private health insurance providers in each state, and health insurance subsidies for individuals and families falling under a certain income level.  People could choose between any one of the providers in their state or the co-op.  There has been much less activity recently on the cop-op, which seems to have been supplanted by government-run health insurer.  In its original incarnation, Big Bill was estimated (very conservatively, according to the dinner attendees) to cost $550BB over the next 10 years.  Recent Big Bill proposals that include a public option range from $550BB to over $700BB over the next 10 years.  Marwood thinks that there is a 50/50 chance that some version of Big Bill will be passed.  They were pretty blunt about this, saying “Despite what you read in the paper, if they had the votes for it, it would have been passed by now.  They don’t have the votes.” 

Some interesting things to note:

1. Marwood and the CFO stated unequivocally, and I agree, that there is absolutely nothing in either Big or Little Bill to address the cost of healthcare.  They address the cost of insurance, but this is not the same thing as the cost of healthcare.  Making someone else pay for something isn’t the same as making that something more affordable.  When I (apparently naively) stated, “I thought the whole point was reducing the cost of healthcare and the upward march of that cost.  Isn’t that what all the rhetoric was about?”, everyone laughed and said, and I quote, “It was never about cost and healthcare inflation.  It has always been about garnering votes for the next presidential election and the party.”.  This is from highly experienced and bi-partisan Beltway insiders that are intimately familiar with the process and the discussions.  Save your breath doubters and Obama supporters…we all know this is how it works, but it was depressing to hear this about something that is so important to fix and will cost so much money.  The President is no more moral, smarter, or differently motivated than anyone that has come before or will come after, he’s just a better public speaker.

2.  Little Bill, the most likely to pass, is not universal coverage.  Neither is Big Bill.  The requirement to have healthcare doesn’t mean everyone will comply.  In fact, given the low financial penalty for non-compliance, most of the 10 to 15MM voluntarily uninsured (mostly young, male professionals that absolutely can afford it but choose not to) will gladly pay a light annual penalty to avoid paying for much more expensive healthcare premiums.  Since insurers won’t be able to either reject applicants with pre-existing conditions or charge them premiums commensurate with their health profiles, there is absolutely no incentive for them to sign up with a plan and every incentive to game the system, getting insurance only once they are sick.

3.  High value health insurance plans aren’t limited to huge earners.  They are actually very prevalent in middle-class jobs in urban areas and with unionized workers (note labor’s reaction to the high value plan surcharge).  This has implications for who is footing the bill for these proposals.  As an aside, there is a very interesting reason for the prevalence of high value health insurance which is fundamental to why the healthcare and insurance system is set up the way it is in this country (to be addressed in a subsequent post).

4.  None of this takes effect for 3 years, so all of the coverage gains start in 3 years and all of the costs are crammed into 7 years, although we’ll all start paying in 2010.

5.  Be wary of claims of revenue/cost neutrality.  Throughout these proposals, and very common in all “cost neutral” bills, is language that states that if it costs more than it is supposed to than the shortfall will get made up by raising taxes.  When the CBO and other budget scorekeepers opine on these bills, they treat this situation as a wash, when in fact, it removes any incentive for paying attention to costs.  Some costs, even if not offset by tax increases, are counted as zero in the scorekeeping because of the nature of the expenditure.  The rollback of the Medicare fee schedule reduction is such a case.  Because it isn’t in force yet, getting rid of it isn’t counted against the cost of Little Bill.  This is the type of bizarre accounting that goes on inside the negotiation of these deals that makes it near impossible for the regular Joe (or Josephine) to really know the true budgetary impact of government programs.

Not everything is what it seems and if you are relying on others to tell you the truth and act in your best interest, prepare to be disappointed.

I plan to follow-up shortly with a discussion of why I think the healthcare debate has completely missed the mark, the myths of the debate, and what I would propose we do to truly reform healthcare, making it more affordable for everyone and enhancing the quality of outcomes (ignored in the current debate) without adding a crushing burden to the national economy.

Ten Perfect Songs

Somewhere over the last 16 years, music has lost its place in my life.  I used to be obsessed with music.  I used to be obsessed with stereo equipment.  In college, I would drop classes during the first week of the semester and use the refund check to buy speakers and CDs for my burgeoning collection (don’t tell my dad – there is no statute of limitation in my family for stupid behavior).  My dorm room and apartments in college and grad school used to pulse with beyond-loud tunes cranking from my ill-gotten Boston Acoustic tower speakers and midnight issue Adcom separates.  I had a wall of sound in my car, when I was writing term papers, when I was just hanging out in my room decompressing from a hard day of skipping class and wasting time with my similarly unmotivated crew of friends.  I was pretty passionate about the bands I loved and equally passionate about the music I hated.  As life became more structured and complicated, I slowly began to migrate from music to sports talk radio.  Why?  I don’t know.  I just wasn’t getting the same kick out of the music, and in my sour state driving for the 500th time from NYC I could pass the time arguing with Mike and the Mad Dog as they blathered on about the Yankees and Giants.  With two young kids in the house, I can’t fire up the stereo like I used to (I’m told I’ll damage their hearing).

Enter the iPod.  My wife (aka Santa) bought me an iPod Touch for Christmas a couple years ago.  I travel a lot and don’t like to fly and thought immersing myself in music would calm me down sans Lorazapam.  I loaded up every disc I own onto the thing and still amazingly had room for more (apparently I have 12 days of music).  Slowly, I’ve been refamiliarizing myself with all the music that was such a huge part of my life.  I’m rediscovering all of the things about music that got me hooked in the first place. More importantly, I’m rediscovering old favorites.  I’m very pleasantly surprised to find that they move me every bit as much as they did 20 years ago.

I decided to take a page from the movie High Fidelity and create a list; a list of my Ten Perfect Songs.  These aren’t just songs that I like a lot.  I like a thousand songs.  They aren’t just songs that make me play the air drums in my car or sing in my office even though the door is open. There are hundreds of those, too.  These are songs that resonate with my psyche, my history, my experience, my missed opportunities, my beliefs, my desires, what I have, and what I don’t have.  I don’t know why I love them so much, and I know exactly why I love them as soon as the first note is played.  They fit.  They’re songs I can listen to on repeat for an hour and not get tired of hearing.  They’re songs that I can’t get out of my head.  Sometimes it’s the music, sometimes it’s the lyrics; most of the time, it’s both and how they work together.

This is completely self indulgent, but here is my list, in no particular order.  What are your Ten Perfect Songs?

1.  Little Time Bomb – Billy Bragg

2.  Hold You – Orchestral Manoeuvres In the Dark

3.  Under Pressure – Queen with David Bowie

4.  There is a Light That Never Goes Out – The Smiths

5.  I Know It’s Over – The Smiths

6.  The Marriage – Billy Bragg

7.  St. Swithin’s Day – Billy Bragg

8.  The Short Answer – Billy Bragg

9.  Three Little Birds – Bob Marley and the Wailers

10.  Country Feedback – R.E.M.

Honorable Mention (because Ten is really too few!)

1. Texarkana – R.E.M.

2.  Hollow Display – Taj Weekes

3.  Paralyzed – Bob Mould

4. Bizarre Love Triangle – New Order

5. Mr. Disco – New Order

6.  New Boy – The Connells

7.  Down on the Corner – Creedence Clearwater Revival

8.  Oh l’Amour – Erasure

9.  Weight of the World – The Samples

If Not Oil, What?

Matt at http://think.fernsehtek.com issued a challenge to auto manufacturers.  He wants more choices, real alternatives, when it comes to personal transportation.  He’s got a legitimate beef.  Oil is expensive, it beholds us to countries that have more of it than we do, and it will run out.  We’re not close to running out right now.  Despite the Chicken Little cries of “The sky is falling!”, the fact is we haven’t even reached peak production, which is the theoretical point at which production will decline irrespective of what new technologies are applied to all proven and probable reserves.  In my research, I’ve discovered that nearly all credible estimates put the running-out-of-oil risk at between 80 and 120 years.  This is interesting, but it misses the point, I think.

For all practical puposes, oil is a finite resource.  Technically, it gets produced through extreme pressure and and heat combined with the decomposition of carbon based compounds.  Live stuff that dies can get turned into oil, but the time it takes to go from dead dinosaur to barrel of oil is so long that we can only count on what exists in the ground right now.  Matt is the geologist, so I’ll leave the specifics to him.  The important point is that we are using it faster than it can be created.  Classical economic theory dictates that as supply decreases, price increases; as demand increases, price increases.  In fact, the expectation of an increase in demand or a decrease in supply is more than enough to push up the price of something as critical to modern life as oil.  This is the crux of the problem.

Modern society cannot exist without oil.  Take away petroleum and you turn back the clock 100 years.  Everything, and I mean everything, rotates around oil:  transportation, power and electricity, agriculture, specialty chemicals (including pharmaceuticals)…the list goes on.  Can you even imagine a world without something as simple as plastic?  This gives those gifted with vast reserves of oil an extraordinary amount of influence on those who use oil.  In an added twist, and as a cruel joke by God, most of the world’s most easily tapped reserves of oil and natural gas are located in the most sociopolitically unstable areas on the planet:  the Middle East, Russia and the former Soviet republics, Mexico, and Venezuela.  These are not the countries that you want pulling the strings.  Oil is the biggest string of all and it’s tied to everyone.  If any of these countries were able to get their shit together at all, or worse yet, get their collective shits together, they would wield incredible influence over national and global economies.  Oil is so incredibly important to the functioning of the modern world that even the implied threat of a decrease in supply or an increase in demand sends shockwaves through the spot and future pricing of oil and natural gas. 

A shitty situation, to be sure.  What are the options?  There are actually a lot of options, but physics and chemistry limit most of their practical applications.  Ethanol has gotten a lot of play lately because it can be created from renewable foodstock; typically corn in the U.S. and cane in Brazil.  There are a lot of problems with ethanol, both as an energy source and from an environmental perspective.  Ethanol has about 50% of the energy density of gas, so you have to burn twice as much for the same power output.  This completely eliminates the cost benefit versus oil.  It accelerates corrosion of metal and eats away at many types of rubbers, making it a challenge for existing powerplants.  In the U.S., the ethanol boom diverted huge portions of corn crops away from foodstock and into fuelstock.  Farmers converted from other types of crops to corn because of the demand for and subsidized economics of ethanol.  This drove up the price of not just corn but of all foods, which disproportionately impacts the less fortunate.  Finally, when you consider all of the gas burned in the farming of corn, plus the environmental impact of increased water usage and fertilizer usage, suddenly ethanol doesn’t look so good.  Through subsidies and poorly considered legislation, the government, once again, created a case study for unintended consequences.  Without the subsidies and other mandates, ethanol as a business could not exist.

What about wind?  Wind power has been around for a while and is pretty well understood.  So are the economics of wind, and they suck.  Again, even with substantial subsidies, the marginal cost of wind is greater than that of gas, oil, or coal.  As a result, commercialization is unlikely until carbon based fuels become much, much more expensive.  The problems with wind are pretty simple.  The energy density is very low, some of the best places to generate wind power are furthest away from the greatest electricity needs, and wind is not terribly consistent ant or predictable, creating a timing  mismatch between production and usage.  Right now, wind accounts for about 0.1% of  our electricity production.  Our President has been vocal about doubling this in the near term.  Big deal…0.2% of the electricity produced.  I believe the Texans refer to this as  ”Big hat but no cattle”.  Wind farms are HUGE (ever driven through the Central Valley in CA or the Mojave Desert?) but produce very little power and the power is not reliably available.  Wind farms boast about 35% efficiency, mostly because wind doesn’t always blow.  When it does blow, it is often during off-peak usage hours and battery storage is still in the dark ages, relatively speaking.  None of this was factored into the equation when the administration crafted its energy plan.  It will pour billions of taxpayer dollars into an energy black hole that will have essentially no impact on our power needs or the environment, but is politcally saleable and expedient.

Surely hybrid and electric cars are the answer, based on all the commercial and government sponsored hype.  Sadly, no.  Battery technology is still terrible.  The energy density of even the most sophisticated battery is way, way to low for electric cars to be a viable alternative for most drivers.  Even cutting edge battery companies like A123 (disclosure: financed by my firm) are introducing batteries that are better marginally, not by the order of magnitude needed to make electric cars a real alternative.  Electric cars simply can’t go far enough on a charge and take too long to charge up to be practical.  The physical and chemical limits on batteries are well known are very real.  It is very unlikely that in our lifetime we will see this change.  Another problem with batteries is that they need to be charged and that electricity needs to come from somewhere.  Right now, most of it comes from coal and gas.  Unless we start charging electric cars with solar and wind, not much, if anything, is gained.  The one real advantage is that energy generated on a large scale centrally and then distributed is much, much more efficient than energy generated locally (in a car engine, for instance).  This is a clue to the potential solution to our energy conundrum.

Hybrids are a bit like fools gold…shiny and enticing but not really worth shit.  The battery issue is a big part of this failing.  They restrict the practical advantage of a hybrid system and they are very expensive.  In real world driving tests, not the completely unrealistic EPA methodology for determining fuel efficiency, time and again it has been shown that hybrids are barely superior to high efficiency gas engines in like-sized cars.  Hybrid cars are much more expensive than their gas-only counterparts and, again, can only exist commercially with government subsidies in the form of tax breaks.  The discriminating buyer will do the math and discover that even with the tax break, the breakeven point on a hybrid will not be achieved by most owners, especially on a time-value-of money basis.  Once more, we will piss away money on something that will not have an impact on either oil consumption or the environment.  Not smart.

Practical solar is so incredibly far away it’s not even worth talking about.  It is incredibly inefficient and would require millions of acres of photovoltaic cells to have any impact whatsoever.  This will have environmental implications.  In addition, the timing mismatch/storage problem exists for solar.  Even the most bleeding edge solar technology is a decade away from being efficient enough in converting sunlight to electricity to be considered a real alternative.  The cost per watt issue here is worse than wind and ethanol.  Another option that can’t survive without subsidies and won’t make a difference in the near or mid-term (or the long term, most likely).

Water is very well understood and actually stacks up well, cost per kilowatt.  I know much less about water power than the rest because water is usually an infrastructure play versus a technology play, so I and my firm have much less exposure to innovators in this field.  My rough understanding, though, is that pretty much every river in the U.S. that can be dammed has been dammed.  The environmental impact of damming a big river should also be considered.  The Three Gorges Dam in China is an environmental and social tragedy (but it is an engineering marvel).

After reading through 1,500 words, you’re probably saying, “What’s the point of all this?”.  I started off by saying that Matt was right.  We are much too beholden to oil for a bunch of different environmental, political, and economic reasons, and we need to address this now.  It will come as no surprise to anyone that I support a market based solution.  For any option to catch fire, it needs to produce energy at or below the cost of carbon based fuels, the energy needs to be reliable, scalable, and producible on-demand and without the timing mismatch of wind or solar.  If these conditions don’t exist, no amount of subsidies will force the issue, but these subsidies will drain valuable capital and resources away from better uses  in the quest to find power that isn’t subject to the Three Laws of Thermodynamics (not going to happen).

There are a lot of very interesting things going on right now on the technology front to address our energy concerns.  All of the best stuff is focused on centrally produced and distributed power since it is so much more efficient than locally generated energy.  Companies like Silver Spring (disclosure: financed by my firm) are technology based infrastructure plays that tie together usage and production, allowing producers to quantify usage and charge more during peak hours and allowing users to understand usage at the level of the appliance, as well as pricing, so that they can tailor usage to need and cost efficiency.  The system provides market feedback to both the producer and the user to incent conservation and efficiency (Congress, are you taking notes for application in healthcare reform?).  None of this requires tax dollars.  In fact, the ROI on this technology is so clear and compelling that utilities are falling over each other to both purchase the technology and invest in the company.  Better for the taxpayer, better for the consumer, better for the environment, plus it creates jobs, advances the state of technology, and will create wealth for the investors.

Nuclear power is an option that should be getting much more attention, but  isn’t.  Some of the slight is earned but a lot is irrational, in my view.  What to do with the waste is a very real and big problem.  It’s nasty and it lasts a very long time.  The state, local, and federal governments put the kibosh on the Yucca Mountain underground storage facility in Nevada.  There was a lot of technical stuff that factored into the decision, but it really was a clear case of NIMBY.  The problem is, the proposed facility really wasn’t in anyone’s back yard.  Everyone supports sacrifice for the greater good as long as it isn’t them being asked to sacrifice.  Short sighted, I think.   I get it, though.  I wouldn’t want that shit in my town either.  But as a friend of mine once said, places like Northern New Jersey need to exist so places like Connecticut can exist.

Nuclear still suffers from the stigma of Three Mile Island.  In fact, this one event basically killed the construction of all new nuclear facilities.  I was pretty young when that went down, but I still remember the headlines and the fear.  The fact is, the radioactive release was extremely minor and there has been no statistically identifiable health or environmental impact from the incident.  New plant designs are generations ahead of the Three Mile Island facility, in terms of safety.  What happened then (which was a perfect concatenation of a series of small errors that would probably happen once in a thousand years) almost certainly couldn’t happen with these new plants.  They are so much safer, and yet the odds of ever getting the necessary permitting to build one are so long that no firms are willing to put up the risk capital.  The current administration has basically shut the door on nuclear fission.  Given the clear advantage of centrally generated power, the incredible energy density of uranium, and what I understand to be an abundance of uranium in the U.S. (Matt, is this true?), I think we have made it our nation’s policy to ignore an important and viable alternative to carbon based energy.

If the government does absolutely feel the need to spend our money on energy, they should forgo wind and electric cars and pour it into investments in private companies trying to untie the Gordian Knot of nuclear fusion.  Fusion is the Holy Grail of energy generation (Thermodynamics tells us that we can neither create nor destroy energy, but merely change its form).  The power created from fusion is relatively clean and basically limitless, as it is fueled by the most abundant element in the universe, hydrogen.  Unfortunately, right now, fusion is still very much a science project.  To induce a controllable fusion reaction that is self-sustaining (that is, generates as much power as it takes to maintain the reaction) is a very difficult problem to solve and we are only at the very beginning of finding a solution.  I probably won’t live to see it happen.  But, and this is important, we know that it is a solvable problem.  It’s basically an engineering puzzle at this point.  The physics are completely understood..   Once we solve the puzzle, the answer will be completely game changing.  This is the type of innovation that is worthy of public finance:  a clear end-point with a result that will have a significant and meaningful impact.  It will end our dependency on oil and, if we solve the problem first, will cement the U.S.’s economic leadership for generations to come.  Compare this to the money being spent on technologies that aren’t commercially viable and won’t make a meaningful impact on usage, carbon footprint, or any other metric.

Fuel cells are another very interesting technology with great promise but with big engineering challenges to overcome.  Right now, it appears that fuel cell technology may be very useful on a small scale (phones, computers, small cars) but may be tougher to implement for centrally generated power.  Stay tuned.  There are a lot of very sharp minds and smart money focused here.

What to do in the meantime?  Good old fashioned conservation.  Carpool, buy smaller cars and drive less, turn down your thermostat, shut off lights, convert to mini-flourescents, insulate your house and install better windows, WebX conference or telecommute instead of hopping on a plane; these are things we can all do that will stave off oil dependency and help the environment.  Don’t be suckered in by pie in the sky promises of abundant energy with no environmental impact at a low cost.  It doesn’t exist.  In physics, there is no free lunch, and it is a zero sum game.

Modern Manners (With Apologies to P.J. O’Rourke)

I never cease to be amazed by the general population’s lack of basic manners and sense of situationally appropriate behavior.  I don’t know if it’s just me getting older or stiffer or more uptight and crotchety, but it seems to me that the general public’s ignorance of appropriate social interaction has increased, and it is manifesting itself as rudeness.  We went out to dinner on Saturday evening.  The restaurant was a pretty nice joint; not Le Cirque or Babbo, but it wasn’t Applebees either.  There were guys there wearing shorts, untucked golf shorts, and, my personal favorite, baseball hats.  At my grandmother’s funeral, some shithead was wearing jeans and a baseball hat on backwards.  At least he was wearing a oxford cloth button down shirt (untucked).  Look, I get it.  People want to be comfortable.  I’m probably the shittiest looking guy going when I’m just running around town, but there is a time and a place for ubercasual dress and a nice restaurant isn’t it.  Put on a pair of trousers, for Christ’s sake, and take off the hat.  To quote Mrs. Smails in Caddyshack, “You two look like a couple of boobies”.

What’s worse, though, is how we interact with each other when we’re strangers.  I can’t tell you how many times I’ve gone out of my way to hold an open door for someone, only to have them pass right through without a “thank you”.  I’m not looking for a big brass band and a heartfelt hug, but not even “thanks a lot”?  How fucking lazy and inconsiderate can you be.  I’m in NYC all the time for work, and the subway is the easiest way to get around the city.  I have never, ever seen anyone give their precious subway seat up for a woman, a elderly person, or a woman with a baby.  When I have done it, I get looked at like I have two heads.  It’s not just New York.  People are pushy in lines, they can’t wait two seconds for an elevator to unload before they try to push their way in, they are rude and disrespectful to service people.  “Please” and “Thank You” are becoming endangered.  Kids are the worst, but they learn this behavior from adults.  I don’t know if people aren’t brought up with manners anymore, if they just think that they’re too important/busy/cool, or they simply don’t give a shit.  It’s just not that hard to be polite.

We certainly have more important things to worry about, with all that is going on domestically and globally.  Still, to me, this is not a positive trend.  I can see where folks could see these manufactured trappings of interaction as superficial and/or insincere.   I have a different view.  In an increasingly crowded, complex, and stressful world, basic manners are a critical social lubricant, allowing people to interact closely with a minimum of friction.  I liken a society with an absence of manners to gears meshing at high speed without oil, eventually overheating and grinding themselves to filings.  It’s really not that hard to be polite and courteous.  It takes the edge off of personalities and the master/subordinate roles inherent in almost every social interaction.  In a world where the thing most people have in common is that you don’t want them around, manners and a sense of appropriateness make forced interaction that much more bearable.

For a much more humorous look at societal norms, you should read Modern Manners by P.J. O’Rourke.  Very funny stuff.

Thankful

All of us should thank God that we were born in the United States.  It should be the first thing we do when we wake up and the last thing we do before we go to bed.  I haven’t been everywhere, but I’ve been a lot of places…U.K., Spain, France, Netherlands, Canada, Japan, S. Korea, Israel, etc. and there isn’t anyplace I’d rather live.  Every time I see some incredibly screwed up situation in another country, like the current deal in Iran, my appreciation for the U.S. is reinforced.  They’re actually beating the shit out of each other and shooting people over an election.  God forbid you supported the opposition party.

The current administration isn’t for me.  While the goals are worthy and should be pursued, I’m opposed to its ideology, its methods, its rhetoric.  I genuinely believe that if the President gets what he wants, we’ll be on the wrong path for long term success.  That notwithstanding, I have an incredible amount of faith in the system we have, the ideals that govern, and the document that guides us (the Constitution, of course).  I’m so happy and proud that we live in a nation where these things are nearly universally loved and appreciated even by people with diametric views.  We may disagree, but we typically don’t maim and kill over our political differences, at least not on the wholesale basis that seems to occur in so many other nations.  I may not love the guy, but I love the fact that we can basically do a 180 degree turn on ideology without violence, no matter how much some people may disagree with the new administration.  We are soooooo lucky and I think we take it for granted sometimes.

For sure, we’re not perfect.  We have suffered lots of self inflicted wounds and will continue to do so.  Of that I’m certain.  We have a long way to go to get it all right and we probably never will.   Even so, the system works marvelously and we all buy into it even if we don’t care for the tactical approach of whatever group is in power.  We respect the system.  Maybe that’s the critical ingredient lacking in so many other countries.  I’m stunned by the shit show in Iran.  I hope they get it figured out, but I doubt they will.

I am so happy I am here and not there.

UMF Scholarship Challenge Grant

MEET MY CHALLENGE! I’m a proud graduate (class of 1990) of UMF’s Business Economics Program, and I feel passionately that financial difficulties shouldn’t prevent someone from receiving a good education. I have always believed that education is the key component to personal growth and success. Last year, my wife and I set up an endowed scholarship at UMF to help support the tuition for a student in need of financial assistance and enrolled in the Business/Economics program. At the time of its inception, we committed to continued support of this endowment. This year, I’m issuing a challenge grant! I will match your contribution dollar for dollar until the first $10,000 dollars in new scholarship gifts is raised. Your gift may be designated to either a new Business Economics Scholarship or to the general UMF Scholarship Fund. The choice in yours! Increasing scholarship funds is UMF’s highest and most urgent priority. Over 85% of UMF students apply for financial aid each year, yet UMF only has enough scholarship funds to award to 10% of those in need. We must change that – now more than ever! Please join me in supporting UMF’s Leadership Starts Here! Scholarship Campaign to increase the university’s scholarship resources by reaching the goal of $20,000 by June 30, 2009. Together we will meet this challenge! Online giving is easy at www.umf.maine.edu/giving or contact Ms. Pat Carpenter at patc@maine.edu or 207/778-7091. Thank you so much for any support that you can provide. Your contribution will have a direct and lasting impact on the lives of the fortunate scholarship recipients.

A Good Move

The administration has made a move that I think makes a ton of sense.  It has vowed to continue unemployment benefits to people who decide to go back to school.  Currently, if you are unemployed and you decide to go back to school, your benefits are terminated.  To me, this new policy is just good business.  They have introduced the concept of Return on Investment into the world of entitlements.  Good on them.  I strongly believe that education is paramount to economic growth, job growth, innovation, and broadening the middle class by giving people the tools to enhance or reinvent themselves professionally and personally.  This is a short term cost that I am happy to pay because I think it will generate huge dividends over the long term.  Let’s encourage more of this type of thinking as we look to cut costs and set ourselves up for continued global economic leadership.

The Sanctity of Contracts

The administration made a very aggressive and (I believe) unprecedented play in its pursuit of a resolution for Chrysler’s tenuous position.  In doing so, it broke new, and in my view, dangerous ground in how commerce is conducted in this country.  It could possibly have global repercussions in how both private and public institutions bind their actions and intentions to counterparties.  I do not believe that these repercussions will be positive.  I’m not sounding the alarm bells.  I am hopeful that our system of checks and balances, inside and outside of the government, will keep this from becoming too destructive.  I do think it is a good (and not encouraging) barometer of where this administration is headed.

In one stroke, the administration’s actions diluted the value and power of the contract.  It ignored hundreds of years of contract law.  Its actions are rippling through the legal world and have given all who participate in commerce the shivers.  I’m not just talking about financial types like me.  This effects anyone or any institution that trades goods or services with a counterparty.  This isn’t picking around the edges with legal technicalities.  This is chipping away at the foundation of what makes everything work in an economic system.  And I mean any economic system, not just a market based economy.  This isn’t about free markets versus socialism or that most overused, under defined term “fairness”.  This isn’t about the viability of Chrysler or the domestic auto industry as going concerns.  My opinions on government intervention are well documented, but this isn’t about that, either.  This is about acting in good faith, expectations, meeting obligations, and the pricing of risk and reward.

Clear, enforceable contracts and property rights are the the two most important components of commerce and are indispensable to free markets.  I don’t think I overstate this when I say that they are the Constitution and Bill of Rights of trade.  Without them, widespread, productive, growth-promoting trade and commerce cannot exist.  What remains is typically concentrated in the hands of those that can exert the most illicit force on its “partners”.

Why are contracts and their enforceability so important?  It’s pretty simple, really.  It’s all about expectations.  They set the rules of the game.  In actions involving multiple parties, contracts clearly and accurately delineate the relevant terms of any transaction:  responsibilities, assets, consideration for same (the price paid for assets or actions), ownership, representations and warranties (transparency of information, ownership, title free of encumbrance, legal action, etc.), remedies in the case of breach, and one hundred other details.  These details allow both parties to know clearly what is expected of them and their counterparty.  The unquestioned belief in their enforcement enables commerce because it stipulates performance and provides protection against breach, malfeasance, or fraud.  One of the biggest impediments to the development of emerging nations is the absence of clear and enforceable contract law and property rights.  Contracts protect both sides of a transaction.  Without this protection, no one is willing to conduct legitimate business and put resources at risk.

Russia’s economic development is instructive.  When post-Soviet Russia decided to move towards a more open, market based economy, one of the first things it did was address a complete absence of property rights and contract law and enforcement.  In the absence of these things, oligarchs, typically with strong ties to the local and national governments, controlled commerce by force.  They resisted, often violently, the intrusion of these rights into the status quo because it shifted the balance of influence away from them and towards broader commerce that could involve everyone.  It was not until these rights started to take root that significant foreign and non-governmental domestic investment was made into the country.  Even today, though, Russia struggles with adherence to and enforcement of its own contracts with domestic and foreign investors and business partners.  One of the key reasons that Russian resources, such as oil, are so underdeveloped is that foreign business partners have been burned by contract non-compliance and are loath to put resources at risk in partnership with Russian entities.  Everyone loses.  The Russians don’t have the capital or skill set to maximize exploration and production, and this impacts commerce, growth, and sorely needed cash flow to the country.  The world, including Russia, is denied full use and benefit of the resources.

For digestibility, let’s break the details and the enforcement of the details into two separate parts, beginning with the details.  Let’s say that I’m selling a house and you’ve decided that you want to buy it.  You’ve conducted due diligence on the property and the structure.  This due diligence was based, in large part, on specific disclosures that I was required to make about the property and the warranty that these representations are true and accurate:  no water in the basement, wiring and plumbing up to code, no material defects that I’m aware of, radon below certain levels, and so forth.  In addition, you entered into a contract with a home inspector to perform an inspection of a specific nature at a specific level of invasion and investigation, with the results of the inspection to be relayed to you in good faith.  The price you’re willing to pay is based not just on the market value of similar homes proximal to the one you want to buy but also on the results of your diligence.  A house that has no radon, doesn’t need a new roof, doesn’t have water in the basement, with plumbing and wiring that is up to code, and is free of material defects is worth more than the exact same house with all of those things opposite.  Your price is directly a function of your assessment of the value of the asset, which is the sum of the base value plus your assessment of the upside potential minus your assessment of the risks and costs of owning the asset.  These assessments are based on information either referred to or represented and warrantied in the contracts.  The contract is the basis for the price.  It tells you what asset in what condition for a set price.  Furthermore, the contract between you and the inspector defines roles, responsibilities, and reps/warranties.

What if that contract isn’t enforceable, or is selectively enforceable?  This creates an environment in which neither party has an incentive (or has less incentive) to be truthful or follow through with the satisfaction of the contract and neither party has reason to believe that the other will act appropriately.  Why on Earth would you enter into a potential transaction in this circumstance?  If you did decide to transact, would you bid the same price for the house?  Of course you wouldn’t.  Your assessment of the risks (in this case, transaction risk) would increase significantly, resulting in your willingness to put much less capital at risk (in case I decided to renege on the contract).   This devalues the asset independent of any change in its intrinsic value.  It is clear that contracts with no or less enforceability result in both less commerce and asset (physical or intangible) devaluation.

Precedent is an important component of law, and this is exactly the precedent set by the actions taken in the Chrysler bankruptcy.  Lenders priced loans and debentures to Chrysler based on their assessment of the sum total of risks of all types:  economic, market, business, transaction, financing, competitive, and many others.  In the financing contract, known as a debenture, they set clear terms for the securities they purchased from Chrysler:  priority of cash flow from operations and financing activities, security, default covenants and provisions, default cures, equity conversion.  While the specific terms may vary, all of these rights, the rights of creditors, are well established in corporate, contract, security, and bankruptcy law.  Creditors get more preference, have more safety, and get more consideration in a restructuring than equity holders because they own more of the capital structure, price it more cheaply, and have no claim to upside.  The entire financing industry and all of bankruptcy law is founded on this principal.  The administration chose to ignore this, throw the contract out the window, and apply pressure of the sort only the government can to flip this on its head and force lenders to approve a deal that is certainly sub-optimal for their stakeholders and may or may not be beneficial to the country as a whole (this is an entirely separate issue and one that people should understand fully before they pick sides).  Additional risks are introduced, pricing becomes much less certain, and assets are worth less because people are not willing to pay the same amount to take on more risk.  What is certain is that if selective enforcement is the order of the day, contracts are no longer the bedrock of commerce. 

In the hope of heading some replies off at the pass, Chrysler asked for and took the loans from the government ($4BB from the Bush administration), not the lenders that just got squashed.  Senior lenders have the right to restrict a borrower’s ability to take on additional debt.  They generally have the absolute right to block the borrower’s ability to take on debt senior to their own.  While the lenders probably were required to approve, in some measure, Chrysler’s loans from the government, thereby agreeing to take the money, there is no way that they would have approved the financing or subordinated themselves to the new money if they thought that their rights as creditors as per the debenture contract would be nullified and/or ignored.  The government did just that.  They completely ignored the contract and the established rights of the creditors. 

 In normal situations, the lenders would voluntarily reduce the debt, reset the covenants, sometimes provide additional financing, and would convert some meaningful portion of the debt into an equity stake in the company.  Equity is received in compensation for agreeing to reduce the debt and take a less senior, protected position in the capital structure. Fiat, which wasn’t even a creditor, ended up with 35% of the company (the merits of this merger is an interesting and future post).  In this case, the creditors ended up with 29 cents on the dollar and no equity.  It’s bad enough when you lose money because you just got it wrong.  This happens all the time. It’s unacceptable when it happens because your contractual rights were violated by the government.

In my opinion, this is a problem.  With Chrysler, the admistration forced the lenders to give up their rights because they felt that the end result was desirable.  This is the same as saying that selective enforcement of the Bill of Rights is ok because current circumstances dictate that course of action.  The stakes may not be as dire (arguable, but again, a different discussion), but the principal is the same.  There is certainly precedent for this in our history:   suspension of habeas corpus during the Civil War and current invasions of our privacy through government actions (monitoring of communications and flow of funds, etc).  That doesn’t make it right.  I believe you risk fucking with the fundamentals of our nation at everyone’s peril.  I don’t necessarily subscribe to the Slippery Slope (one of the basic Fallacies of Logic).  I believe (and hope) that private and public sector checks and balances will smooth out these transgressions over the long haul, but I am very concerned about the mindset of an administration that will upend something as basic and important as the contract.