2012 vs. 1984: Comparing the costs of tuition and housing

One of Canada’s best finance journalists, Rob Carrick, wrote this piece in response to the furious protests being held by students in Quebec regarding skyrocketing tuition fees and living expenses.

The Globe And Mail – 2012 vs. 1984: Young adults really do have it harder today

All young adults who think they’re getting a raw deal in today’s economy, let me tell you about how it was back in my day.

In 1984, my final undergraduate year of university, tuition cost more or less $1,000. I earned that much in a summer without breaking a sweat.

When I went looking for a new car in 1986, the average cost was roughly half of what it is now. It was totally affordable.

The average price of a house in Toronto back in 1984 was just over $96,000. I wasn’t buying just then, but it’s worth noting that the average family after-tax income back then was close to $50,000. Buy a first home? Easy to imagine for new graduates of the day.

Read More

The Jane Jacobs theory of “import replacement”

In previous days I’ve argued that having a strong industrial/manufacturing base isn’t as important to a nation as it once was. But lately I’ve wondered if a loss of that base has greater implications than we think. I’m not a Jacobs devotee like many urban-minded Torontonians are, but I did think that this summation of her theory of “import replacement” is a very good explanation for why we may want manufacturing to stick around.

The Millions – Fifty Years On: Jane Jacobs and the Rebirth of New York

Why did a city like New York recover when a city like Detroit, which had a more durable industrial base, fell into blight and decay? The answer, Jacobs argues in The Economy of Cities, turns on the ability of a city’s inhabitants to innovate. Cities grow, she says, through a process she calls “import replacement.” This occurs when local tradesmen produce for themselves the goods and services they had previously been importing and then use the skills learned from this local production to create new products, which they can then export in great bulk.

Detroit, she notes, began as a port for shipping flour across the Great Lakes. Soon, local manufacturers were building their own steamships to make the lake crossings and got so good at it they began making ocean-going ships for use in other cities. This not only put money into local coffers, but supported the dozens of local engine-parts makers Henry Ford drew upon when he founded the Ford Motor Company.

But here’s the rub: the auto industry was so successful that once Ford arrived at his greatest innovation, the assembly line, the industry so dominated Detroit’s economy that there was no local market for further innovation, and, as Jacobs points out, it was only a matter of time before another city – in this case, cities in Japan – improved upon Ford’s ideas and made better, cheaper cars.

The Economy of Cities came out four years before the gas crisis that set Detroit’s long tailspin in motion, but it eerily predicts the dilemma the city faces today, in which a moribund auto industry, out-innovated by foreign competitors, had to be bailed out by the U.S. taxpayer to avoid collapse.

Like Detroit, New York began as a port city, but in New York’s case a principal byproduct of its shipping trade was a robust banking industry, which survived the city’s manufacturing collapse. Even as New York was begging for a bailout from the federal government in the mid-1970s, young hotshots like Ivan Boesky and Michael Milken, many of them children and grandchildren of immigrants who had filled the ghettos earlier in the century, were inventing new ways to own and finance large companies. Think of all the financial innovations of the last thirty years: junk bonds, hedge funds, leveraged buyouts, asset-backed securities, credit derivatives, subprime mortgage markets, and on and on.

Yes, bankers are evil, and, yes, the banking industry required a federal bailout even larger than that of the auto industry’s, but like it or not, New York is the safest large city in America, with a vital private sector and a buoyant real estate market, largely because the living, breathing organism we call Wall Street has spent the last thirty years innovating its way out of obsolescence.

Amazing Forbes article on manufacturing: “Why Amazon Can’t Make A Kindle In the USA?”

I found this article incredibly interesting for illustrating how a series of seemingly reasonable business decisions can be made by North American corporations that ultimately lead to entire industries being moved offshore. Even better, it talks about repair measures we can take, starting with a shift in our way of thinking at every decision-making level.

The article also links to the Harvard Business Review paper Restoring American Competitiveness, which is worth the twenty minutes it’ll take you to read it in its entirety.

Lastly, there’s a sequel to the article called Does It Really Matter That Amazon Can’t Manufacture A Kindle In the USA? which addresses reader comments on the article and is also a good read.

Forbes – Why Amazon Can’t Make A Kindle In the USA

How whole industries disappear

Take the story of Dell Computer and its Taiwanese electronics manufacturer. The story is told in the brilliant book by Clayton Christensen, Jerome Grossman and Jason Hwang, The Innovator’s Prescription:

ASUSTeK started out making the simple circuit boards within a Dell computer. Then ASUSTeK came to Dell with an interesting value proposition: ‘We’ve been doing a good job making these little boards. Why don’t you let us make the motherboard for you? Circuit manufacturing isn’t your core competence anyway and we could do it for 20% less.’

Dell accepted the proposal because from a perspective of making money, it made sense: Dell’s revenues were unaffected and its profits improved significantly. On successive occasions, ASUSTeK came back and took over the motherboard, the assembly of the computer, the management of the supply chain and the design of the computer.

In each case Dell accepted the proposal because from a perspective of making money, it made sense: Dell’s revenues were unaffected and its profits improved significantly. However the next time, ASUSTeK came back, it wasn’t to talk to Dell. It was to talk to Best Buy and other retailers to tell them that they could offer them their own brand or any brand PC for 20% lower cost. As The Innovator’s Prescription concludes:

Bingo. One company gone, another has taken its place. There’s no stupidity in the story. The managers in both companies did exactly what business school professors and the best management consultants would tell them to do—improve profitability by focuson on those activities that are profitable and by getting out of activities that are less profitable.

Read More

Ideas for how to put the unemployed back to work

On my commute to the office yesterday I saw a link to a feature being run by The Atlantic called The Great Jobs Debate: Ideas for how to put the unemployed back to work. In their words, they’ve “brought together some of the top minds in business, government, and the world of ideas, each to answer the same question: What is the single best thing Washington can do to jumpstart job creation?”

There are some good ideas and some bad ideas, mostly depending on what your personal ideology is. Personally, I thought these two were great:

Megan McArdle: Create a Special Job Credit for the Long-Term Unemployed

How to get employers to hire people who have already been out of work for too long? Traditional government solutions like job training have an absolutely dismal record. The only government solution to long-term unemployment we’ve ever found was to have World War II, and for various reasons, we’re probably not going to reauthorize that particular program.

One suggestion is to give them direct incentives to choose the long-term unemployed over those who are already in work, or out of work for only a short time. How? We could exempt new hires from both the employee and the employer sides of the payroll tax, one month for every month that they were unemployed.

The result is a direct wage subsidy of more than 10%. But it is a time-limited subsidy, and one carefully targeted to those who need it the most. By the time the tax relief expires, these workers will have been reintegrated into the labor force. This will cost the government something of course–but not nearly as much as supporting them on welfare, disability, or early retirement–or the prison system.

Mike Haynie: Unlock Capital for Small Business

The United States should create a national microlending program positioned to provide ready access to capital to small business. It is widely acknowledged that small business represents the engine of job creation in this country. Small business accounts for approximately 50 percent of all private-sector jobs, and roughly 70 percent of all new jobs created in the past decade.

In today’s environment, banks have much less incentive to extend a traditional small-business loan ($5,000 to $25,000), because the relationship between the transaction costs associated with processing that loan and the return on that investment to the bank often doesn’t make economic sense. It’s all about opportunity cost.

For example, consider that the transaction costs associated with processing a $10,000 loan to a small business and a $5 million loan to a large business are roughly the same. Also recognize that the return on investment to the bank (that is, the interest paid on the loan) increases proportionally with the size of the loan–the larger the loan, the more interest income generated relative to the “cost” of issuing and servicing the loan. Therefore, whether you are a large public bank with a fiduciary responsibility to shareholders or a small credit union responsible to its membership, there is an incentive to focus on larger and thus more profitable loans. Banks are in business to make a profit.

Research highlights that most small businesses, especially over the first five years of operation, require only small and incremental infusions of capital to sustain positive growth. A national microlending program positioned to provide capital infusions of $1,000-$20,000 to small business–created as a partnership between government and community-based lenders–would represent an compelling channel for small businesses to access start-up and growth capital.

How losing your job affects your long-term earning potential

Via Ezra Klein comes a graph from an International Monetary Fund discussion paper illustrating the effect of long-term unemployment on the average male’s overall earning potential:

International Monetary Fund – The Challenges of Growth, Employment and Social Cohesion

Loss of earnings: There is empirical evidence that layoffs are associated with substantial loss of earnings both over the short and long run. That is, even when workers are re-employed shortly after displacement, they suffer a decline in wages compared to the pre-displacement job and compared to similar workers that were not displaced.

The decline in earnings is on average observed for job losers in any period, but is most pronounced for job losers during a recession (see Farber, 2005). Studies for the US show that these earnings losses persist even in the long run: 15-20 years after a job loss in a recession, the earnings loss amounts on average to 20% (see e.g. Jacobson et al., 1993; von Wachter et al., 2009).

Short sellers as the fall guy

The Globe & Mail – Short-selling isn’t that bad

A recently published study by researchers at the University of Chicago and the University of Toronto examined 216 corporate fraud cases between 1996 and 2004. Shorts uncovered 14.5% of those frauds, not far behind the 17% that were exposed by whistleblowers within companies. And what about the SEC? It uncovered just 6.6% of the frauds.

Looking back, it’s also now clear just how right the shorts were about the poor condition of U.S. banks and investment dealers before the 2008 financial crisis. A recent bankruptcy examiner’s report shows that officials at Lehman Brothers created an off-balance sheet mechanism to shift liabilities off the books, concealing weaknesses caused by Lehman’s own recklessness. As Michael Lewis correctly points out in his latest book, The Big Short, the problem is not that regulators allowed Lehman to fail, but that it was allowed to succeed.

In the months before Lehman collapsed in September, 2008, Fuld complained that the firm was being targeted by so-called naked shorting, in which traders put in sell orders for shares without even borrowing them first. A study by three University of Oklahoma researchers published in May, 2009, examined trading in several major U.S. financial stocks—including Lehman—before and after the SEC imposed a ban on naked shorting of those issues in late July and early August in 2008. It found “no evidence that stock price declines were caused by naked shorting.”

The trouble was that U.S. regulators took the complaints from Lehman and other companies far too seriously. In fact, that SEC order actually hurt investors. A study by Arturo Bris, a professor at IMD business school in Switzerland, concluded that the order dampened trading in the stocks, which widened the spread between market bid and ask prices—a spread that investors have to cover. Erik R. Sirri, who ran the SEC’s division of trading and markets during the crisis, recently conceded that the decision to restrict short selling was based on political considerations.

Using bond yields to predict where the market is going next

The Globe & Mail – In economic forecasting, it’s hard to beat the yield curve

Since 1970, every time short rates have been higher than long rates – a condition called an inversion – the Standard & Poor’s 500 composite and the S&P/TSX composite index (formerly the TSE 300) have had negative or flat earnings growth. The curve showed relatively high short rates before the dot-com bust in 2000. Investors who heeded these warnings could have sold off their stocks ahead of the collapse.

The yield curve predicted the present economic malaise. In the 15 months leading up to the subprime housing that began last August, the U.S. Treasury curve was showing relatively high short-term rates. Says Anthony Crecenzi, author of the 2002 bestseller (in fixed income analysis circles, that is), The Strategic Bond Investor, “few indicators with such a stellar forecasting record have the yield curve’s simplicity.”

Its ability to predict economic growth or contraction 12 to 18 months ahead far exceeds the power of other analytical tools, including the analysis of far more esoteric macroeconomic indicators that track things like orders for tools that make other tools. As well, the yield curve beats folk tales about hemlines and Super Bowl winners.

Read More

Inside the Dodd-Frank financial reform bill

TIME Magazine’s excellent finance-focused blog The Curious Capitalist pointed me the way of this interactive Wall Street Journal graphic on what’s found inside the Dodd-Frank financial reform bill. I highly recommend giving it a read.

The “life settlement” bond market

This is one of the odder reads I’ve had lately, though it makes perfect sense that a market would have sprung up in this space: It allows the elderly and otherwise gravely ill to get cash now and ease their last days on Earth, and an “investor” gets a substantial payoff somewhere down the road. The topic arose due to a discussion in my province of whether these types of transactions should be made legal here: Serious concerns about preying on the old and ill, whether or not life insurance in general would shoot up as a result of this new market.

Canadian Business – Insurance: Dead set against it?

Right now, somewhere in Toronto, someone is dying. He has congestive heart failure and diabetes. He has spent time in the hospital, and almost passed away last year. It seems he is not long for this world.

That’s sad, of course. But for someone else in Toronto, his death will mean a windfall because this man has a $350,000 life insurance policy. Or, at least, he had it. He sold the policy some time ago for a fraction of its value. Now the buyer of the policy is in need of some quick cash and is looking to sell it again. Don Jones, an insurance broker in Seattle, is trying to facilitate the sale — asking price: $175,000.

If he can swing a deal, Jones will collect a handsome finder’s fee. The seller will get a quick, six-figure payout. And whoever buys the policy will double their money, just as soon as the insured man passes away. It would seem to be a win-win transaction — if a pesky ethical quagmire, and some thorny legal questions, didn’t come along with it.

Life settlements, a booming, if somewhat misunderstood, multi-billion-dollar business in the U.S., are illegal in most Canadian provinces. All but four (Quebec, Saskatchewan, New Brunswick and Nova Scotia) have laws explicitly prohibiting trafficking in second-hand life insurance policies. And even in provinces where there are no laws expressly against life settlements, securities regulators are suspicious of them, which makes finding seed capital tricky.

Critics — with insurance companies being foremost among them — say such a market is ripe for exploiting the old, the frail and the desperate. Not only that, many warn a secondary market would drive up insurance premiums for everybody else, since current rates are based on the fact that some policies will default.

Proponents, however, point out that life settlements provide insurance policy owners with financial options they wouldn’t otherwise have. Although most insurance companies already provide people the option of buying the policy back, life settlement advocates claim that people often get 400% more cash for their policy through life settlements than they would get from their insurers.

It’s a three page article that I’ve cut down to the little shown above. Click through for a full viewing.

Commodities (gold, oil) are a poor strategy for portfolio diversification

Interestingly, what’s written below doesn’t recommend never investing in commodities – but that one should do so for the right reasons (you have good intel on where the price is going, or you wish to invest in a specific commodity producer).

Financial Post – Another culprit in the big hurt: Commodities hardly a strategy for diversification

It was an idea inspired by Ivy League research. The research said that enhancing your portfolio with a splash of commodities — things such as gold, oil and pork bellies — could allow you to reap stock-like profits while providing a safe harbour during market downturns.

It sounded lovely in theory. But commodity investing flopped in practice. Despite a mild recovery, broad commodity indexes are still below their levels of 2008. Rather than being a counterbalance to equities, commodities have bounced up and down in tandem with Wall Street.

To understand how important the fine print is, go back to 2006, when two Yale professors published one of the most influential finance papers in years.

Gary Gorton and Geert Rouwenhorst examined 45 years of market history and concluded that investing in commodity futures, while using U.S. treasury bills as collateral, produced returns just as good as putting money into stocks. Even more enticing was their conclusion that commodities tended to do well when stocks did badly.

To institutional investors, this was catnip. Putting money into commodity futures –contracts for the delivery of commodities in months to come — looked like the perfect way to balance the risks in the stock market.

Within months of the paper’s publication, money managers were searching for easy ways to invest in commodity futures. Fund companies obliged them by creating specialized exchange-traded funds (ETFs).

The new ETFs got off to a roaring start as money poured into what appeared to be a sure bet. Then the stock market sank in mid-2008. This was when the Yale professors had predicted that commodities should shine.

Commodities did no such thing. They plunged in line with the stock market, then struggled to recover only part of their losses. So much for big gains and reducing risk. What went wrong? One theory blames the global recession. Another theory is that the flood of money into commodities changed the nature of the market.

Read More