Comments on economics, mystery fiction, drama, and art.

Monday, April 25, 2005

Why worry about a budget crisis when you can build a football stadium?

That is perhaps the question facing the governor, legislators, and the citizens of Indiana right now, as the state moves toward passing a budget and paying for a new pleasure dome.

The state currently projects a $600 million budget deficit in a state government budget that totals about $24 billion for the next two years. Constitutionally, the state must adopt a (planned) balanced budget. The governor (Mitch Daniels) proposed a surcharge of one percentage point on the state's 3.4% gross income tax, a proposal that has been rejected by the state legislature, Republicans and Democrats alike. The Democrats have proposed raising the cigarette tax (by $0.19 per pack) and capturing $70 million in casino revenue that currently goes to local governments. The Republicans in the legislature oppose any tax inxreases.

The governor and the Republicans in the legislature plan to reduce spending by, in part, not paying $750 million in state financing for local governments and for elementary, secondary, and higher education that was not released in this budget cycle and by reducing Medicaid spending. The Democarat want to pay about half of that.

The Republicans control both houses of the legislature, so their proposal is the one most likely to be enacted.

But just so you don't think that fiscal sanity has been restored, the state has moved to take control over a plan to build a new, $900 million stadium for the Indianapolis Colts (NFL), a team which, despite strong performances the last few years (including Peyton Manning's record-setting year in2004) has not been able consistently to sell out its existing facility. The stadium will be financed by a small contribution from the team (apparently about $50 million, net) and from increases in local-option taxes on sales of reataurant (and other prepared) food and sales of alcoholic beverages.

So we can raise taxes to provide huge benefits to a private, for-profit firm that apparently can't do well on its own, but reduce spending (on education, Medicaid, and other state government services) rather than raise taxes.

Who says that Indiana doesn't have its priorities straight?

Sunday, April 17, 2005

"Just Cut The Checks"

On SportsCenter tonight (April 17), one of their NBA analysts (whose name I did not catch) talked about how the owner of the Clland Cavaliers needs to "clean up the mess" there, and his solution was to hire "basketball people" and let them run the team. "Just cut the checks. That's all he needs to do. Just cut the checks."

I was struck by the assumption that the owner of a professional sports franchise is assumed to be incompetent at running the business. Imagine if this were the universal assumption about small businesses (and, yes, most pro sports franchises, whatever their alleged values, are still basically small busineses). Hard to do? Yes, it is.

Yet it is clearly a widespread attitude about the sports business. The separation of ownership and control is assumes to be a virtue in this business, if not anywhere else.

I just find that interesting, and faintly bizarre.

Wednesday, April 13, 2005

How Long Is A Long-Term Investment? Longer Than You May Think

An interesting and important article in the Economic Review , First Quarter 2005, Vol. 90, No. 1, published by the Federal Reserve Bank of Kansas City:

How Long is a Long-Term Investment?By Pu Shen

Conventional wisdom tells us that stocks tend to outperform government bonds in the long term. That is, if stocks are held long enough, they are usually better investments because their total return is likely to be higher than the return on bonds. While this view may be correct in principle, in practice a crucial question remains: How long is long enough?

The answer is important to every investor, not just the wealthy few. With employers relying increasingly on defined-contribution retirement plans, employees must make their own saving and investment decisions.

Shen reviews historical patterns to show investors how the riskiness of stocks and bonds can change as an investor’s holding period lengthens. First, she explains why stocks are generally considered riskier than government bonds and thus, on average, should pay higher rates of return to attract investors. She then shows why stocks, with their higher average rates of return, tend to perform better over sufficiently long holding periods. Next, she examines the historical patterns of stock and bond returns in the United States. She shows that sufficiently long has been very long relative to most people’s holding periods. Finally, she examines various holding periods in detail. She finds that, for many investors whose holding periods were not sufficiently long, risks for both stocks and bonds were quite high. She concludes that, historically, longer holding periods may have reduced the riskiness of stock investments but not bond investments. Further, for most individual investors, feasible holding periods have seldom been long enough to take full advantage of long-term stock investments.

What does this seem to mean? It suggests that the time horizon required to feel confident that returns to stock ownership will actually exceed returns to bond ownership are longer than the (economic) lifetimes of many--or most--investors. I leave the implications of this for replacing part or all of Social Security with stocks as retirement savings as an exercise for the reader.

Tuesday, April 05, 2005

Still More IOUs

Apparently President Bush believes that financial assets (I generalize from his claim about one class of financial assets--U.S. Treasury Bonds held by the Social Security Trust Fund--to all classes of financial assets) are "just IUOs." He also wants us to use part of what would otherwise be contributions to Social Security to acquire savings held in the form of corporate stocks.

Which are financial assets, giving the owner no claim to any real productive assets, no claim to any output, no claim to any income. They are, in other words "just IOUs."

"Just IOUs"

I may be forced to rant at some length about this.

Consider your checking account. What does it consist of? A promise by your bank to pay, on demand, funds you have deposited in the bank to a payee named by you. Your checking account is an IOU. Consider your savings account or your certificate of deposit. What do they consist of. A promise to pay you interest and to pay to you those funds (at a time and on terms to which you have agreed). Your savings account and your CDs are IOUs. Consider those corporate bonds you own. What do they consist of? A promise to pay you periodic interest and to redeem the bond on a specified date. Your corporate bonds are IOUs. Consider that money market mutual fund you have at Fidelity Investments. What does it consist of? A promise to pay you interest and to redeem the principal value. Your money market mutual fund deposits are

. If those IOUs have no value, then virtually all the wealth of people in the United States has no value.

Do you believe that? Does George W. Bush believe that? Does he believe that for the assets to have value, they must have little piles of Federal Reserve Notes somewhere in vaults? Or piles of gold bars? Wait. What's a Federal Reserve Note? It's an IOU. There's no stash of gold behind it.

If George Bush believes what he has been saying about the bonds in the Social Security Trust Fund, he's a fool.

If he doesn't believe it, he's a liar.

What Is A Trust Fund?

Speaking today in Parkersburg, West Virginia, President Bush said: “A lot of people in America think there is a trust — that we take your money in payroll taxes and then we hold it for you and then when you retire, we give it back to you. But that’s not the way it works. There is no trust ‘fund’ — just IOUs that I saw firsthand”

Suppose I had inherited a trust fund from my great-grandfather, and suppose that the trust fund were composed entirely of U.S. Treasury Bonds--IOUs from the Federal Government to the "owner" of the trust fund. In what sense can it be said that there is no trust fund? Only in the sense that the U.S. Treasury plans to default on its promise to pay me the interest and principal represented by those bonds.

So, when the President of the United States says, "There is no trust fund," what he's really saying is that it's his belief or plan or intention that the U.S. Treasury will default on those bonds. If that's his intention, and if he carries that intention out (but fortunately for the rest of us, he won't be president by then), I believe that would be an impeachable offense. Hell, I'm ready to believe that planning to default is an impeachable offense.

I repeat myself. Someone in Congress should introduce a "sense of the Congress" resolution stating that U.S. Treasury bonds--whether in the Social Security Trust Fund or not, carry the full faith and credit of the United States Government and demanding that the President pledge that the interest on those bonds will be paid as due and that those bonds will be redeemed as they mature.

Force the privatizers to vote on default. Do it now.