Carl from Chicago

Business executive interested in history, economics, taxation and energy policy.

The Onion On State Government

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Recently I received a proposed amendment to the Illinois State Constitution in the mail. The purpose of the amendment is to require a 3/5 majority before pension increases can be passed for state employees.

In short, the amendment to the constitution is required because our elected representatives refuse to do any basic “governing”. Illinois recently implemented a massive tax increase (after all, that’s what “Blue State” governors usually do when they must choose between cutting state expenditures and raising revenues) on the revenue side of the ledger but kicked the can for the umpteenth year in a row for SERIOUS reform of our pension crisis in Illinois.

It made me reflect on the giant overhead and general incompetence of our state’s government. We have a state senate, house, a governor, and an amazing array of local authorities. According to this article, Illinois leads the nation in governmental entities, with almost 7000 of them.

On the other hand, the Onion summarized state and local government with a brilliant and pithy line.

Alabama State Constitution changed to “Roll Tide”.

Perhaps Illinois should do something simpler and just change our state constitution to the famous line

We don’t want nobody nobody sent

Cross posted at LITGM

Market Timing on Debt

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The historical “rule of thumb” is that markets are rational. This is likely true over some period of time, but not in the short run.

A recent article in the WSJ (more like a blurb, on the back page) called “The Big Number” described the current situation with junk bonds.

Yield hungry investors are making the bond market a welcoming place for even the lowest rated borrowers. The average yield paid by new triple-C rated issuers (i.e. “junk”) of corporate bonds in the third quarter hit a record low.

The current yield on new CCC bonds is 9.05%, down from 10.65% in the second quarter of last year. This is a decline of 18% in about a year, which is a giant decrease for a company considering re-financing.

In addition to being able to sell debt at the lowest rates in years, these highly leveraged firms are also able to find buyers for their debt (i.e. the market is liquid).

When the market freezes up, as it did in 2008, there are two main impacts – 1) the rates that everyone pays for financing in the short term move up sharply 2) there is little financing available for those that don’t have the strongest credit. In practical terms, #2 means that if you need money, it will cost you very dearly such as when Goldman Sachs had to borrow from Warren Buffet at a 10% preferred stock issuance.

While it is very difficult to determine the right time to buy and sell, there is no doubt that “market timing” is of incredible importance. If you have a highly leveraged company, these low rates and many yield hungry buyers willing to lend to you means that you can retire very high cost debt, load up on lower cost debt, and roll out maturities for many years, buying your company valuable time in case there is a recession or business downturn.

Today is literally the opposite point of time in terms of market timing from when Goldman Sachs was forced to pay 10% rates to Buffett; today even the lousiest company (in terms of credit ratings) can get funding cheaper than that (9.05%, per this article). This doesn’t mean that rates won’t still fall – if I could predict that I’d be on an island somewhere – but it does show the amazing difference in market conditions that just a few years made, without the economy itself changing in any substantive manner.

Who is buying all of this? Right now your bank account and CD’s effectively pay almost zero, and US government debt 10 years out is 1.6%. Thus for someone who wants income, an investment that pays 9.05% LOOKS a lot better than under 2%.

The flip side of loaning to the most highly leveraged, lowest rated companies, is risk. Risk can be business risk or their continued ability to find low rate financing (liquidity).

On a market timing basis, this is the best time for these sorts of companies.

Cross posted at Trust Funds for Kids

Spain and History

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As a history buff it was interesting to see “saber rattling” in Spain as regions consider leaving the central state, under pressure of an immense fiscal crisis. This article describes comments made by current or retired Spanish officers regarding potential independence for Catalonia:

First we have the robust comments of Colonel Francisco Alaman comparing the crisis to 1936 and vowing to crush Catalan nationalists, described as “vultures”.
“Independence for Catalonia? Over my dead body. Spain is not Yugoslavia or Belgium. Even if the lion is sleeping, don’t provoke the lion, because he will show the ferocity proven over centuries,” he said.

The Spanish civil war of course began in 1936. While in the popular imagination of the world it featured a battle between the power of the Catholic Church and those demanding reform, and was a proxy war for the Germans and Soviets (both true), it also was a battle of the Spanish regions against Madrid. This third narrative is now on full display as Catalonia is calling an election, tied perhaps to a renewed independence drive.

These problems are made worse by the fact that 1) Spain is broke and needs to go to the ECB for funding 2) much of the money and bills are handled by the regions. This BBC article summarizes many of the key elements of the current situation.

Thus the Spanish central government effectively quieted the restive regions over the years by either crushing the revolt (the ETA) or by granting the regions fiscal autonomy (Catalonia). However, the buy-off was essentially done with borrowed money and now the regions need to come to terms with being part of the Spanish state and collectively work to solve their daunting problems or attempt to go out on their own.

While Spain was a critical part of the world’s geography in the years prior to WW2, today Spain and Portugal are far on the periphery of the world’s economy, with a great tourist industry, agriculture, and a few competitive companies, but mostly an uncompetitive place with an over valued currency and massive structural unemployment broken only by “infrastructure” projects such as underused airports, ports, and the like.

In other countries, the regions that have boiled and chafed under central government eventually left and found their own way. Look at the USSR, the Czechs, and many others. Spain was able to buy off their restive regions with EU largess over the years, but now the gravy train has halted dead in its tracks. It will be interesting to see how events play out in Spain, and whether the military really has the stomach for the types of events that are necessary to bring a restive region to heel. I highly doubt it.

Cross posted at LITGM

History and Demography

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History has always been a fascinating topic for me. Growing up, I read all I could on a variety of topics, typically military history, although branched out in later years. Many of the posts and opinions that I have are formed by an understanding of nineteenth and (mostly) twentieth century history.

While the Western countries (and China) mostly got older on a median level (median being the age at which half the population are above and half below the line, a better metric than “average” age which is skewed by outliers), for much of the rest of the world the opposite trend occurred. The most dramatic example of this occurs in Africa.

The “African World War(s)” in the 1990’s and early 2000’s were sparked by events near Rwanda and ultimately inflamed the entire region, home to over a hundred million people and where key natural resources (coltan) were mined. For a high level synopsis of these events go to the wikipedia sites for the Rwandan Genocide of 1994, The First Congo War, and The Second Congo War.

Other than the Rwandan Genocide, which spurred a film and a bit of international soul-searching due to the inability of Western powers to inhibit the massacre, most of the rest of these events are poorly referenced in the world today given the number of deaths and the geo-political impact. I’m not aware of much discussion on this topic other than occasional articles from the BBC and / or ties to the mining of materials and sanctions on companies that violate new US laws (still being written) on “conflict minerals“.

If events such as these had happened recently in the United States, they would dominate media and the culture. Even today America is fascinated by our civil war, which occurred one hundred and fifty years ago (there is a Ken Burns’ brother documentary on death and dying in the civil war that sounds interesting).

While I haven’t researched the local culture in Rwanda and the Democratic Republic of the Congo to understand the impact, a brief look at the median age of countries per this wikipedia page shows some statistics that I find remarkable. The median age in the Democratic Republic of the Congo is 16.5 and for Rwanda it is 18.6. Thus about 50% of Rwanda’s population was not even born when the genocide in 1994 occurred, and a much larger population would remember it only sparingly as they were very young.

For the Democratic Republic of the Congo, not only does the low median age mean that many would not remember much of the first and only some of the second wars, the country’s incredible demography in terms of child bearing resulted in the country’s population increasing massively DESPITE THE WAR (per Wikipedia):

The United Nations 2009 estimated the population at 66 million people, having increased rapidly despite the war from 39.1 million in 1992.

What is history? In the West it is a long tide, taught to millions (albeit often poorly), and to some extent linked into our daily lives. I don’t think it has the same impact on these other countries where 1) education is poor and literacy is low 2) there is a massive demography change towards the young who would be more consumed with “current” problems rather than issues that arose before their time.

I think many of these same conceptual issues toppled many of the authoritarian regimes in the middle east as the colonialist themes that propped up many of the governments withered in the face of the new generation seeing them for their entire lifetime as just brutal dictators propped up by crony economic partners. With low median ages and a limited appreciation for history (based on poor schooling and literacy), their rage was a match waiting to be struck.

Revolutions are often sparked by hordes of young, jobless males with few prospects. These are those with little to lose and the type of rage and fearlessness upon which the backbones of mobs are forged. While we may look at history on a broad scale, in a population dominated by the middle-aged and elderly, it is a completely different picture in most of the world, and our prism for viewing their perceptions and determining their actions, obsolete.

Cross posted at LITGM

India Power Market Article Shows NY Times Doesn’t Understand Capitalism

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This post is an intersection of my research on the power industry around the world and a lack of understanding of the power of capitalism that I see reflected around me in Chicago and in many news outlets.

India’s Power Industry

The NY Times recently had an article titled “Scandal Posts a Question: Will India Ever Be Able to Tackle Corruption?“. The article described a scandal about India’s coal mining industry, a critical element of their power generation since India has heavy reliance on locally sourced coal.

Coalgate, as the scandal is now known here, is centered on the opaque government allotment process that enabled well-connected businessmen and politicians to obtain rights to undeveloped coal fields.

Why is this important? Per the article, 57% of India’s power is generated by coal. The industry is hobbled for lack of coal. 300 million Indians are without electricity, and a recent blackout effected huge areas of the country.

The Indian government used a bureaucratic process to assign out rights to these coal fields, instead of an overt capitalistic auction process (a fact that the NY Times article fails to mention), and many politicians and their cronies of course received the rights, likely due to overt or covert bribery and connections.

(the) $34 billion coal mining scandal that has exposed the ugly underside of Indian politics and economic life: a brazen style of crony capitalism that has enabled politicians and their friends to reap huge profits by gaining control of vast swaths of the country’s natural resources, often for nothing.

Why does this matter? When property rights are doled out in this manner, the people who receive them aren’t the BEST POSITIONED to develop the assets. If a profit seeking company paid for an asset in a public auction, they would be paying cash from investors (or out of their own pocket) and would need to “monetize” the asset in order to achieve a proper return back to investors. You don’t go into the auction without a plan to develop the asset, since you would be bidding against actual competitors who were motivated to do so and they’d likely pay more than you would. Per the article on India, this is the type of behavior that you see, instead:

Investigators now say that some of the favored applicants, having acquired the coal fields free, quickly sold them for tens of millions of dollars to steel or power companies. Others simply kept them as an asset and have not yet developed them, even as the country faces blackouts and coal shortages.

The NY Times treats this as some sort of “scandal” rather than as a FEATURE of socialistic systems. Politicians in these systems are exactly like capitalists in a capitalist society, using their role to obtain power and riches rather than for some sort of utopian “betterment of mankind” which the NY Times would likely expect them to do. In fact, these sorts of behaviors are modeled as successful and drive out would-be capitalists since the politicians in socialist societies hold the cards in terms of laws and processes and will use them against those trying to open up the process to a fair and transparent capitalist alternative.

India has no power for 300 million people, an unreliable system with rolling blackouts, and is crippling growth BECAUSE IT RUNS POWER AS A SOCIALIST SYSTEM RATHER THAN A CAPITALIST ONE. The answer is absolutely as simple as that. The scandal and the failures are product of a socialist system as doomed to fail as the USSR’s five year plans.

The answers to this problem of inadequate power are simple and can be found in any text from Smith to Hayek.

1. Sell state owned coal fields to qualified bidders (have the capital and means to develop the fields) in an open and transparent auction process
2. Protect the property rights of power developers by ensuring that they are able to build and site transmission lines and power stations appropriately
3. Protect the property rights of power companies by ensuring that they are able to charge and collect from customers and eliminate illegal connections to their systems
4. For areas that are a local monopoly (distribution), the state should ensure that performance and reliability are monitored via clear criteria and that entities that don’t comply should be fined or the franchise put up for auction to another qualified entity

Since the NY Times fundamentally doesn’t understand how capitalism works and that it is a BETTER solution that top down central planning or socialistic bureaucratic “queuing” models” (of which this is a primitive variant) they don’t make any of these recommendations. Scandals aren’t a problem – they are a direct result of the SYSTEM and will always be present in these sorts of political environments.

Cross posted at LITGM