I get emails from Congresswoman Nita Lowey whose capacity to repudiate her prior votes never ceases to amaze me. Last month, I posted about an email she sent out containing a pretentious attack on the constitutionality of the Defense of Marriage Act (a law she had voted in favor of). Today, I got another email, this one with a heading: "Flight Delays and the Senseless, Across-the-Board Budget Cuts". In the body of the email, twice again, she calls the budget cuts effected by the sequestration "senseless". So I went back and checked her vote on the sequester, the Budget Control Act of 2011, and, no surprise, she voted "yea". In fact, not only did she vote to impose those "senseless" cuts, she contemporaneously issued a statement titled "Statement Supporting Debt Limit Deal". Somehow the word "senseless" was missing from her description of the law back then.
You know those credit card commercials that end with the word "Priceless"? I think someone should do a similar commercial listing all the times Nita Lowey was for something before she was against it, and end with the word "Senseless".
Monday, April 29, 2013
Pass-Through Entities, Tax Payments and Fraudulent Transfer Law
In the latest ABI Journal, I came across an article by Karen Cordry entitled "Paying the Owner's Taxes as a Fraudulent Conveyance? Maybe Not". It discusses two recent decisions, In re Kenrob Info. Tech. Solutions, Inc. 474 B.R. 799 (Bankr. E.D. Va. 2012) and In re Northlake Foods, Inc., 483 B.R. 247 (M.D. Fla. 2012) , each of which held that a subchapter S corporation's payment of a shareholder's pass-through tax liability on the S corp's income was not a fraudulent transfer, because the S corps and their creditors were no worse off than if the corporation had been a C corp. More precisely, they hold that the election to be an S corp eliminated the debtor's independent tax liability and this provided "reasonably equivalent value" for it to pick up the tax liability incurred by its owner by virtue of the pass-through.
I think it is very strange that both decisions explicitly disregard a much simpler route to the same result, even though the opinions reflect that the more direct reasoning was presented to them.
In each case, there was a pre-petition agreement in place between the debtor corporation and its shareholders that obliged the debtor to pay, or reimburse its owner for paying directly, the tax liability the owner incurred by virtue of the pass-through rules. Those agreements created, the defendants argued in each case, an antecedent debt. Strangely, the opinions both pass over this argument and go right to the benefit the corporation received by being an S corp. (It appears that the lower court in Northlake Foods did adopt that argument, but the opinion on appeal explicitly chooses to ignore it). Section 548(d)(2)(A) defines "value" to include "satisfying or securing an antecedent debt". Section 3 of the UFTA contains similar language. And paying a dollar to reduce a dollar of debt is obviously "equivalent" -- so equivalent that it's obviously "reasonably equivalent".
So finding a payment that merely satisfies a liability under a pre-existing contract answers the fraudulent transfer inquiry itself without further inquiry. It appears that neither plaintiff sought to avoid the agreement in question (in the Northlake case, it is clear that the agreement fell outside the clawback period of the fraudulent transfer statute), so the debt was clearly a valid antecedent debt for analytic purposes. Thus, every dollar of payment of taxes simply reduced a corresponding dollar of valid debt under the contract. That dollar-for-dollar equivalence is clearly "reasonably equivalent debt".
What amount of tax liability the debtor would or would not have incurred in some alternative universe in which it was a C corp seems unnecessary to examine. That sort of "alternate universe comparison" seems to create a very big opening for defendants. For example, imagine a case where a shareholder incurs a debt related to her business in her own name. Then she has the corporation pay it off. The logic of the Kenrob and Northlake courts seems to suggest that, because the corporation's creditors are no worse than if the corporation had undertaken the debt in the first place, there is no fraudulent transfer. It's hard to distinguish that fact pattern from the fact pattern blessed by those two opinions, unless labeling the liability "tax" somehow determines the outcome by itself, although neither of the opinions so states. But that transaction has always been thought of as a quintessential fraudulent transfer, which leads me to think the reasoning of these opinions is overbroad, and the results should have been based on the clearer statutory foundation upholding satisfactions of antecedent debts.
I think it is very strange that both decisions explicitly disregard a much simpler route to the same result, even though the opinions reflect that the more direct reasoning was presented to them.
In each case, there was a pre-petition agreement in place between the debtor corporation and its shareholders that obliged the debtor to pay, or reimburse its owner for paying directly, the tax liability the owner incurred by virtue of the pass-through rules. Those agreements created, the defendants argued in each case, an antecedent debt. Strangely, the opinions both pass over this argument and go right to the benefit the corporation received by being an S corp. (It appears that the lower court in Northlake Foods did adopt that argument, but the opinion on appeal explicitly chooses to ignore it). Section 548(d)(2)(A) defines "value" to include "satisfying or securing an antecedent debt". Section 3 of the UFTA contains similar language. And paying a dollar to reduce a dollar of debt is obviously "equivalent" -- so equivalent that it's obviously "reasonably equivalent".
So finding a payment that merely satisfies a liability under a pre-existing contract answers the fraudulent transfer inquiry itself without further inquiry. It appears that neither plaintiff sought to avoid the agreement in question (in the Northlake case, it is clear that the agreement fell outside the clawback period of the fraudulent transfer statute), so the debt was clearly a valid antecedent debt for analytic purposes. Thus, every dollar of payment of taxes simply reduced a corresponding dollar of valid debt under the contract. That dollar-for-dollar equivalence is clearly "reasonably equivalent debt".
What amount of tax liability the debtor would or would not have incurred in some alternative universe in which it was a C corp seems unnecessary to examine. That sort of "alternate universe comparison" seems to create a very big opening for defendants. For example, imagine a case where a shareholder incurs a debt related to her business in her own name. Then she has the corporation pay it off. The logic of the Kenrob and Northlake courts seems to suggest that, because the corporation's creditors are no worse than if the corporation had undertaken the debt in the first place, there is no fraudulent transfer. It's hard to distinguish that fact pattern from the fact pattern blessed by those two opinions, unless labeling the liability "tax" somehow determines the outcome by itself, although neither of the opinions so states. But that transaction has always been thought of as a quintessential fraudulent transfer, which leads me to think the reasoning of these opinions is overbroad, and the results should have been based on the clearer statutory foundation upholding satisfactions of antecedent debts.
Monday, April 22, 2013
Further insights on the Reinhart & Rogoff Research Controversy
James Hamilton at Econbrowser has written a nice summary of the major difference in opinion between the UMass students who challenged the Reinhart & Rogoff paper "Growth in a Time of Debt". Simply put, if you have a handful of nations that persistently run debt > .9GDP, they will make up a large proportion of the sample. How to weight them? Do you weight the sample by incident or by nation? The students argue by incident; Reinhart - Rogoff did it by nation. Is that clear? Maybe using specific nations will help (quoting Hamilton):
"Now let's take a look at the details by which [the UMass students] come to their numbers. First, they found a dumb error in Reinhart and Rogoff's spreadsheet-- Reinhart and Rogoff left the first 5 countries in the alphabet (Australia, Austria, Belgium, Canada, and Denmark) out of the set of cells selected for averaging. This is a numbskull error, but it turns out it would only have changed the estimate they reported by a few tenths of a percent.
"The major differences come from a difference of opinion about how one should summarize the mean for these data. For example, the U.S. spent 4 years in this sample with debt levels above 90% of GDP, while Greece spent 19 years. How should we combine these two sets of observations?
"One view one could take is that the expected growth rate when a country has a high debt level is a single number across all countries, that is, you expect the real growth rate for Greece when its debt is 90% to be exactly the same number as the real growth rate expected for the U.S. when its debt is 90%. ... the correct thing to do would be to act as if you have 19 observations ... from Greece and 4 observations from the U.S., and take a simple average of those 23 numbers. In other words, you should base most of your inference on the data from Greece, because that is where you have the most observations. This is the approach that [the UMass students] insist is the correct one to use.
"Another view you could take is that the expected growth rates for the U.S. and Greece would be different even if the two countries had the same debt levels. From that perspective, there is a different expected growth rate for each particular country when it gets to the 90% debt level, and our goal is to estimate what that number is for a typical country. That view seems to underlie the method chosen by Reinhart and Rogoff, which was to estimate an average growth rate when debt is greater than 90% for the U.S., a separate average growth rate when debt is greater than 90% for Greece, and then take the average of those averages across different countries."
Seems like a pretty obvious choice to me.
"Now let's take a look at the details by which [the UMass students] come to their numbers. First, they found a dumb error in Reinhart and Rogoff's spreadsheet-- Reinhart and Rogoff left the first 5 countries in the alphabet (Australia, Austria, Belgium, Canada, and Denmark) out of the set of cells selected for averaging. This is a numbskull error, but it turns out it would only have changed the estimate they reported by a few tenths of a percent.
"The major differences come from a difference of opinion about how one should summarize the mean for these data. For example, the U.S. spent 4 years in this sample with debt levels above 90% of GDP, while Greece spent 19 years. How should we combine these two sets of observations?
"One view one could take is that the expected growth rate when a country has a high debt level is a single number across all countries, that is, you expect the real growth rate for Greece when its debt is 90% to be exactly the same number as the real growth rate expected for the U.S. when its debt is 90%. ... the correct thing to do would be to act as if you have 19 observations ... from Greece and 4 observations from the U.S., and take a simple average of those 23 numbers. In other words, you should base most of your inference on the data from Greece, because that is where you have the most observations. This is the approach that [the UMass students] insist is the correct one to use.
"Another view you could take is that the expected growth rates for the U.S. and Greece would be different even if the two countries had the same debt levels. From that perspective, there is a different expected growth rate for each particular country when it gets to the 90% debt level, and our goal is to estimate what that number is for a typical country. That view seems to underlie the method chosen by Reinhart and Rogoff, which was to estimate an average growth rate when debt is greater than 90% for the U.S., a separate average growth rate when debt is greater than 90% for Greece, and then take the average of those averages across different countries."
Seems like a pretty obvious choice to me.
Basketball IQ at Work
Saturday night, I had the pleasure of watching the Brooklyn Nets decimate the (admittedly short-handed) Chicago Bulls in the first game of their playoff series. Afterwards, on SBNation, a very astute analyst broke down three or four plays that show Deron Williams's basketball IQ at work, leaving the vaunted Bull defense in tatters. Working very much like an NFL QB reading the defense, DWill totally ignores the man guarding him and focuses instead on the help defender away from him, keying off that defender's position and lapses in attention to decide how best to score.
The author explains: "Williams is watching Boozer because he knows Boozer is Hinrich's primary help. It's Boozer, and not Hinrich, that would play the biggest role in thwarting a drive to the basket."
I've copied another one of the analyses in full below but there are several more at the link above and they're all worth reading if you are into hoops.
The author explains: "Williams is watching Boozer because he knows Boozer is Hinrich's primary help. It's Boozer, and not Hinrich, that would play the biggest role in thwarting a drive to the basket."
I've copied another one of the analyses in full below but there are several more at the link above and they're all worth reading if you are into hoops.
"Once again, note the timing of Williams' move. He throws in a number of high dribbles and even crosses up Belinelli once, but he never has any intention of acting on those moves. All he's doing is offering a distraction until he sees how Boozer and Mohammad react to Evans' cut. Once he notices Boozer pick him up, Williams makes his move.
"As Williams makes his move, Brook Lopez comes charging down the lane. Again: this is timed on purpose. Williams' decision to shoot or pass will be determined by how Mohammad reacts to his right-handed drive. And sure enough:"
Very impressive (both DWill's bbiq & the author's analysis of it).
FAA Cutbacks are "Bogus" per Aviation Expert
On CNBC this morning, Mike Boyd of Boyd Group International delivered a brutally and beautifully frank assessment of the Department of Transportation's implementation of the sequester in a manner designed to inflict pain on the traveling public. It's a four minute video very much worth watching.
http://video.cnbc.com/gallery/?video=3000163110
I hope that link worked; if not, you can get the substance from his blog post this morning on his website. This sentence tells what you need to know to evaluate the good faith of the Administration on this front: "after the cuts, the FAA will still have a bigger budget than in 2008, and today, there are one million fewer airline departures."
http://video.cnbc.com/gallery/?video=3000163110
I hope that link worked; if not, you can get the substance from his blog post this morning on his website. This sentence tells what you need to know to evaluate the good faith of the Administration on this front: "after the cuts, the FAA will still have a bigger budget than in 2008, and today, there are one million fewer airline departures."
Wednesday, April 17, 2013
Reinhart & Rogoff's Thesis that High Debt Levels Retard Economic Growth Appear to be Confirmed by Revised Calculations
All over the business
and financial media the past 24 hours, and apparently in economics blogs prior
to that, there have been stories about a
new paper published by three University of Massachusetts (Amherst) economists
who found errors in a 2010 paper by Carmen Reinhart and Kenneth Rogoff which supported a thesis that, once a nation's public debt exceeded 90% of GDP, its
economy tends to stall. The R&R paper has
been cited as justification for opposing Keynesian-style deficit spending over
the past few years, providing evidence that the Keynesian approach won't
stimulate the economy as its proponents expect when implemented by a country
that is already highly indebted.
The UMass paper found
three errors in the composition and calculation of data behind R&R's 2010
paper that depressed the growth rates of the nations in their study. R&R
responded and acknowledged the errors, while pointing out that in
subsequent papers, they had updated and expanded their analyses. They also point out that the UMass paper, while
deriving different specific numbers, does in fact prove that growth declines as
debt increases, so it may not really
support a different bottom line. This Business Insider link contains their response and a fair
summary of the errors found by the UMass researchers. The New York Times also had a well thought out article on
it, albeit with very little in the way of numbers.
The table below, which
I've simplified from one prepared by R&R, summarizes the differences
between their 2010 study and the UMass corrections.
Debt / GDP ratio
|
Mean GDP growth, per R&R
|
Mean GDP growth, per UMass
|
0 - 30
|
4.1
|
4.2
|
30 - 60
|
2.8
|
3.1
|
60 - 90
|
2.8
|
3.2
|
> 90
|
-0.1
|
2.2
|
Proponents of
aggressive government spending are euphoric over the difference that the
corrections make at the ">90% debt / GDP " level. They engage in the sophomoric chain of reasoning that
"a part of your argument has an error; therefore your argument fails
entirely; therefore, my argument, opposite to yours, is correct". That is obviously fallacious, like arguing
that, if it can be shown that a mapmaker who drew a map showing the world was
round made an error about the size of the Pacific Ocean, the world is in fact
flat.
First, it's clear
that the UMass study confirms that increased debt is correlated with slower
growth. There may not be a clear tipping
point at 90%, but the trend is unmistakable.
It's argued in response that this doesn't prove causation. I find that response a little superficial. Two variables have a correlation. You can control one of them. So you should control it in the manner that
gives you the better result if the correlation holds.
Second, and more
important from a policy perspective, the
UMass paper shows something very important.
It's very unlikely that a government with a 90% or greater debt / GDP
ratio can service that out of a 2.2% growth rate. First, interest has to be
paid on all of that debt. Second, governments do not have a 100% marginal tax
rate; they can only capture some of that
growth and apply it to debt
service. Third, a government that has run up a 90% debt / GDP ratio is likely not to be in fiscal balance, but rather is likely running annual deficits that are going to ensure the ratio keeps rising.
For example, let's
imagine a realistic environment in which real GDP growth of 2.2% - the
rate calculated by the UMass paper - might arise, and see whether it suffices to service the
corresponding 90% debt level. Real GDP growth
of 2.2% will arise if, for instance, nominal growth is at 5% and the deflator
is 2.8%; those numbers are reasonably
similar to the numbers the US economy has thrown off over the past decade or
so when it was functioning normally. Next, plug in a nominal interest rate - say 3%
- for that government debt at 90% of GDP, and
you need 2.7% of GDP just for interest. Further, let's say the government runs a primary fiscal deficit of 3% of GDP (actually less than what the US federal government has been running recently), so now you need 5.71% of GDP to cover the sum of interest plus deficit spending. Then, specify the rate at which that
government extracts taxes from the economy - say 20% % of GDP, if you want to
mirror what the federal government historically tends to extract. 20% of
the 5% nominal GDP growth is 1.0%; that's how much new revenue is extracted by
the government, so the net increase in federal debt over the year is 4.71%. Now GDP rose 5%, so the debt balance for that nation grows to 94.71/ 105 or 90.2% of GDP as of year end. Repeat for a few years and you see
the hole gets bigger every year through compounding. Were one to specify tax rates at a Eurozone-like 40% of GDP, you would get a slight decrease in the ratio, assuming the economy grew at nominal 5%. At nominal 4%, however, the debt / GDP ratio would continue to climb; of course, the
Eurozone isn't growing at a 4 or 5% either.
The UMass paper
confirms that high government debt is not sustainable under normal, realistic
assumptions. Eventually the sovereign
has to default. Alternative to a formal
default, it can pursue some combination of (1) inflation to goose up the tax base, (2) financial repression to keep the sovereign's interest
rates down below the rate of inflation, (3) confiscation of private savings, which are
outside of GDP, or (4) higher taxes on GDP, which are likely to stunt the
growth rate further. Those are distorting policies and problematic over the
long run. There is one more solution - cut back on other components of government spending to free up money for debt service, or so-called austerity.
It may be fallacious
to infer that, once a nation reaches the 90% threshold, austerity will produce
growth. Please do not infer that that is
my view. Rather, it may be the case that a high debt burden simply eliminates
any chance for growth under any policy and
the right policy is to avoid getting into a high debt position in the first
place. But once a nation gets itself
into the debt trap, austerity is likely a necessary part of returning an
economy to a healthier condition, if not sufficient by itself. Austerity is just part of the restructuring, part of the default. And certainly and most importantly, the UMass corrections
of Reinhart and Rogoff give no comfort whatsoever that a debt-financed Keynesian
stimulus at high debt levels would render the public debt any more serviceable.
Tuesday, April 16, 2013
What, Exactly, Are the Qualifications to Head Up FHFA?
The Wall Street Journal has been following a story that Mark Zandi, an economist at "economy.com, which is owned by Moody's, is going to be appointed to replace Edward DeMarco as head of the FHFA, the current regulator of Fannie Mae & Freddie Mac. I have been a big fan of DeMarco for maintaining strict discipline over F & F since his appointment to protect taxpayers against losses; DeMarco is, I believe, the first and only regulator of F & F to have done so in their sordid history.
Zandi has been a very active figure in recent years, always willing to testify on Capitol Hill in favor of stimulus and other legislation sponsored by the Democratic Party, and also very available to journalists and admirably willing to be quoted on the record. Firedoglake calls him a "court jester economist for power".
There's a false narrative that has been spun around him by Democrats that, despite being a registered Democrat, he "served as an advisor to the McCain Presidential campaign in 2008" which is supposed to make him look open-minded or bipartisan or something. For example, here you see Jared Bernstein writing in 2010 on the White House website itself, characterizing Zandi as one of McCain's "top advisors".
But those who have looked into it have found that it's not quite so. You can find the CBS chief White House correspondent debunking the myth here: it quotes Zandi as saying he is a Democrat and his role was "quite modest"; John Taylor writes on his blog that "McCain Campaign Adviser Doug Holtz-Eakin did ask Zandi and many other economists for their forecasts during the 2008 campaign, but Zandi did not advise McCain on policy."
But in any case, as a result of his willingness to testify and be quoted, there is a substantial record built up regarding his views, with which I have been tremendously unimpressed.
In particular, in relation to housing, Zandi has called a housing bottom every year since the housing market rolled over in 2007:
Here is just a sampling of his bad forecasts (all of these quotes come from this link at The Big Picture, unless otherwise indicated; sorry I could not get rid of the underlining when pasting them into this post):
Marketwatch - March 26, 2007
"Zandi sees a bottom for sales in spring ..."
AP – May 27, 2008
“I think we are at the beginning of the end of the housing downturn ....
CNN Money – Sept 18, 2008
“The bottom of the housing market is coming into view....”
Bloomberg February 2009: “Notwithstanding the intensifying economic gloom, the bottom of the housing downturn is within sight,” chief economist Mark Zandi said in a statement today.
CNN – April 25, 2009
“I spoke with Mark Zandi this week ... Zandi says we are at the bottom in the housing market,
New York Times – Feb 19, 2010
“Mr. Zandi of Economy.com said he expected the nation’s housing prices to fall another 8 percent during 2010 and bottom out by the end of the year“
And here is his presentation "Housing Hits Bottom in 2011."
Well, he finally got it right in 2012, after being wrong for 2007, 2008, 2009, 2010 & 2011, five straight years.
And this wasn't just empty talk. According to one of the reports, Zandi went out in 2007 and bought a house in Vero Beach. He put his money where his mouth was. You do wonder if that influenced his bullish forecasts.
Zandi's inability to predict the future accurately wasn't just limited to housing. In July 2007: I think it is fair to say the economy isn't going to weaken any further." |In September 2007, he was "fundamentally optimistic we won't see any job loss". He said on September 20, 2008 that there would be "a very, very sharp recovery."
The WSJ articles on his prospective appointment never mention any of these blunders. They're pretty easy to find - the Big Picture compendium of them was the top link when I did a Google search on his housing forecasts. I suspect that he bought himself a lot of goodwill with journalists by giving them quotes for their stories so readily over the years, and he can count on them not to show him up now.
But I don't get it -- what exactly are the qualifications to become the regulator of Fannie & Freddie? It doesn't appear to require any ability to read the housing market. As far as I can tell, the driving factor seems to me the same one that led him to be called to testify so often on Capitol Hill. He can be trusted to say what the party in power wants to hear.
Zandi has been a very active figure in recent years, always willing to testify on Capitol Hill in favor of stimulus and other legislation sponsored by the Democratic Party, and also very available to journalists and admirably willing to be quoted on the record. Firedoglake calls him a "court jester economist for power".
There's a false narrative that has been spun around him by Democrats that, despite being a registered Democrat, he "served as an advisor to the McCain Presidential campaign in 2008" which is supposed to make him look open-minded or bipartisan or something. For example, here you see Jared Bernstein writing in 2010 on the White House website itself, characterizing Zandi as one of McCain's "top advisors".
But those who have looked into it have found that it's not quite so. You can find the CBS chief White House correspondent debunking the myth here: it quotes Zandi as saying he is a Democrat and his role was "quite modest"; John Taylor writes on his blog that "McCain Campaign Adviser Doug Holtz-Eakin did ask Zandi and many other economists for their forecasts during the 2008 campaign, but Zandi did not advise McCain on policy."
But in any case, as a result of his willingness to testify and be quoted, there is a substantial record built up regarding his views, with which I have been tremendously unimpressed.
In particular, in relation to housing, Zandi has called a housing bottom every year since the housing market rolled over in 2007:
Here is just a sampling of his bad forecasts (all of these quotes come from this link at The Big Picture, unless otherwise indicated; sorry I could not get rid of the underlining when pasting them into this post):
Marketwatch - March 26, 2007
"Zandi sees a bottom for sales in spring ..."
AP – May 27, 2008
“I think we are at the beginning of the end of the housing downturn ....
CNN Money – Sept 18, 2008
“The bottom of the housing market is coming into view....”
Bloomberg February 2009: “Notwithstanding the intensifying economic gloom, the bottom of the housing downturn is within sight,” chief economist Mark Zandi said in a statement today.
CNN – April 25, 2009
“I spoke with Mark Zandi this week ... Zandi says we are at the bottom in the housing market,
New York Times – Feb 19, 2010
“Mr. Zandi of Economy.com said he expected the nation’s housing prices to fall another 8 percent during 2010 and bottom out by the end of the year“
And here is his presentation "Housing Hits Bottom in 2011."
Well, he finally got it right in 2012, after being wrong for 2007, 2008, 2009, 2010 & 2011, five straight years.
And this wasn't just empty talk. According to one of the reports, Zandi went out in 2007 and bought a house in Vero Beach. He put his money where his mouth was. You do wonder if that influenced his bullish forecasts.
Zandi's inability to predict the future accurately wasn't just limited to housing. In July 2007: I think it is fair to say the economy isn't going to weaken any further." |In September 2007, he was "fundamentally optimistic we won't see any job loss". He said on September 20, 2008 that there would be "a very, very sharp recovery."
The WSJ articles on his prospective appointment never mention any of these blunders. They're pretty easy to find - the Big Picture compendium of them was the top link when I did a Google search on his housing forecasts. I suspect that he bought himself a lot of goodwill with journalists by giving them quotes for their stories so readily over the years, and he can count on them not to show him up now.
But I don't get it -- what exactly are the qualifications to become the regulator of Fannie & Freddie? It doesn't appear to require any ability to read the housing market. As far as I can tell, the driving factor seems to me the same one that led him to be called to testify so often on Capitol Hill. He can be trusted to say what the party in power wants to hear.
Monday, April 15, 2013
Wine Country Conference Presentations
I spent the first weekend in April at the inaugural Wine Country Conference in Sonoma, which was organized by economics blogger Mish Shedlock to raise money for the Les Turner ALS Foundation; Mish had lost his wife to ALS a couple of years ago.
Interesting presentations on a variety of economic and financial topics were delivered by Mish and by John Hussman of the Hussman funds, John Mauldin whose newsletters are widely distributed, and Chris Martenson of the Peak Prosperity blog. The presentations are supposed to be posted online sometime, but as of now, I haven't seen them available, so I will write up some of my notes. Yahoo! Finance covered the conference and has posted 5-minute video interviews with each of the speakers.
Hussman's presentation, well reviewed by Yahoo! here, has generated a lot of secondary attention on sites like Advisor Perspectives and Business Insider for his thesis that corporate profits in the US have risen to a historically anomalous 11% share of US GDP and should be expected to revert to the mean of about 6%. He contends that there are basically three sectors in any economy - the individual consumer, government and the corporate sector - and their respective deficits and surpluses must balance out; thus, when consumers and government increase their deficits, the corporate sector's profits will increase and conversely.
I have a lot of issues with his thesis which I will briefly touch on: first, GDP is not a static or zero-sum measure, such that the growth of one component must come at the expense of another. GDP is a periodic measure that is analogous to an income statement for a corporation. Just as all the y/y growth in a corporation's revenues can in some cases fall to the bottom line, so too all the y/y growth in GDP can go into one sector. But because total GDP has grown, the one sector's doesn't necessarily come at the expense of another sector. Second, there are aspects of how GDP and corporate profits are defined by the agency that keeps them that, in my opinion, make them not wholly reflective of the economy. Mainly, they are defined to exclude much of the financial activity in the economy and do not, for example, capture directly changes in balance sheets or wealth, people can draw down on savings, or borrow, and the changes in their net worth don't show up in GDP or corporate profits, although the spending that is thereby funded will increase GDP. So profits can go up without a corresponding offset occurring in the individual or government sector - that increase comes out of the incremental GDP. Thirdly, the experience of Japan shows that corporate profits can stay well above 6% of GDP for an extended period of time; as this chart from Credit Suisse shows (in Exhibit 5), the mean share of that economy's GDP attributed to corporate profits has risen steadily over the past 40 years and now stands about 9% (faint red line rising from left to right). So short-term mean reversion is not a given.
Hussman made an excellent point about QE's failure to impact economic activity with this chart:
Simply put, the chart shows that, as the monetary base has increased, the turnover of that money -- its velocity -- has been declining. In other words, much more money is being created but economic activity is not going up commensurately, so the stock of money just moves around more slowly. It's not doing much of anything for economic activity; by creating more money than the economy is really going to use, it drives up financial asset prices. In the case of financial assets in the form of debt, it drives down yield, as this chart shows:
In the case of financial asset prices, they have maintained or increased yield despite price appreciation due to the rise in corporate profits. One way to describe what's been going on is the interest income being lost annually by savers due to QE's financial repression has just found its way into corporate profits instead, increasing equity returns but just moving money from one form of savings to another. You can read a good summary of Hussman's presentation at Advisor Perspectives.
John Mauldin made some very good points about Japan's pursuit of inflation to stimulate its economy. In addition to endorsing a strategy of long Japanese stocks (due to increased exports) / short the Japanese yen (which can be implemented through the ETF symbol DXY, which is up about 50% the past 6 months), he also observed, as did Mish, that industrial sectors in other countries will experience deflationary pressures when they have to compete with companies whose costs are paid in a depreciated yen. They advised focusing on Japanese high-tech stocks that are not much affected by commodity prices, which will rise in yen if the central bank achieves the anticipated inflation. He also pointed out that Japan's export growth would probably make things harder for South Korean competitors.
Chris Martensen presentation substantially tracked this blog post of his, which lays out many of his concerns about natural resources and central bank policy. In his Yahoo! interview, he predicts a 40% or worse fall in the S&P 500.
Additionally, Michael Pettis and Jim Chanos delivered very bearish presentations on China's economy. It was made clear by other speakers that Pettis, who teaches in Beijing, could not speak with full candor on the record because negative views could impact his status in China. The implication was that he was soft-pedaling how bad things are ( to the extent that was true, Chanos cleaned up for it later). Pettis doesn't believe the country can sustain another decade of investment-driven growth. One interesting point he made was that the annual cost of pollution in China is estimated at roughly 3.5% of GDP. He also said the economic gap between Beijing / Shanghai and the interior of the country is enormous and growing; no one seeking economic success wants to "go west". is massive. His Yahoo! interview is here.
Chanos's short thesis was impressive. As he says in his interview here,China's GDP has quadrupled this century but its stock market has not budged. There is an ongoing credit bubble and their economy is increasingly dependent on credit creation, but the marginal impact of new credit is declining and quality is poor. Capital flows out of the country are enormous. He had some remarkable tales of how party, business and military elite circumvent capital controls in Macau and HK. He pointed out that GDP measure reported by China does not account for depreciation (capital consumption), so if a building is thrown up, it adds to GDP, but if it falls down, it doesn't reduce GDP.
Mish Shedlock spoke a little less than some of the other speakers. He covered a number of topics. The one point he made that stayed with me the most was when he showed that, contrary to popular thinking, the corporate sector is not really awash in cash; as this chart shows, if you take into account corporate debt, the corporate sector is in fact a net debtor as you would expect it to be.
So basically everyone was quite bearish on financial conditions.
Afterwards, a number of attendees went to Nicholson Ranch, a magnificent winery in Sonoma with a number of 90+ rated wines, where owner Deepak Gulrajani gave us a tour of his caves - yes, real caves underground where he stores wines - and fed us a terrific dinner. I definitely recommend including it on a tour of the Sonoma wine country.
Interesting presentations on a variety of economic and financial topics were delivered by Mish and by John Hussman of the Hussman funds, John Mauldin whose newsletters are widely distributed, and Chris Martenson of the Peak Prosperity blog. The presentations are supposed to be posted online sometime, but as of now, I haven't seen them available, so I will write up some of my notes. Yahoo! Finance covered the conference and has posted 5-minute video interviews with each of the speakers.
Hussman's presentation, well reviewed by Yahoo! here, has generated a lot of secondary attention on sites like Advisor Perspectives and Business Insider for his thesis that corporate profits in the US have risen to a historically anomalous 11% share of US GDP and should be expected to revert to the mean of about 6%. He contends that there are basically three sectors in any economy - the individual consumer, government and the corporate sector - and their respective deficits and surpluses must balance out; thus, when consumers and government increase their deficits, the corporate sector's profits will increase and conversely.
I have a lot of issues with his thesis which I will briefly touch on: first, GDP is not a static or zero-sum measure, such that the growth of one component must come at the expense of another. GDP is a periodic measure that is analogous to an income statement for a corporation. Just as all the y/y growth in a corporation's revenues can in some cases fall to the bottom line, so too all the y/y growth in GDP can go into one sector. But because total GDP has grown, the one sector's doesn't necessarily come at the expense of another sector. Second, there are aspects of how GDP and corporate profits are defined by the agency that keeps them that, in my opinion, make them not wholly reflective of the economy. Mainly, they are defined to exclude much of the financial activity in the economy and do not, for example, capture directly changes in balance sheets or wealth, people can draw down on savings, or borrow, and the changes in their net worth don't show up in GDP or corporate profits, although the spending that is thereby funded will increase GDP. So profits can go up without a corresponding offset occurring in the individual or government sector - that increase comes out of the incremental GDP. Thirdly, the experience of Japan shows that corporate profits can stay well above 6% of GDP for an extended period of time; as this chart from Credit Suisse shows (in Exhibit 5), the mean share of that economy's GDP attributed to corporate profits has risen steadily over the past 40 years and now stands about 9% (faint red line rising from left to right). So short-term mean reversion is not a given.
Hussman made an excellent point about QE's failure to impact economic activity with this chart:
Simply put, the chart shows that, as the monetary base has increased, the turnover of that money -- its velocity -- has been declining. In other words, much more money is being created but economic activity is not going up commensurately, so the stock of money just moves around more slowly. It's not doing much of anything for economic activity; by creating more money than the economy is really going to use, it drives up financial asset prices. In the case of financial assets in the form of debt, it drives down yield, as this chart shows:
In the case of financial asset prices, they have maintained or increased yield despite price appreciation due to the rise in corporate profits. One way to describe what's been going on is the interest income being lost annually by savers due to QE's financial repression has just found its way into corporate profits instead, increasing equity returns but just moving money from one form of savings to another. You can read a good summary of Hussman's presentation at Advisor Perspectives.
John Mauldin made some very good points about Japan's pursuit of inflation to stimulate its economy. In addition to endorsing a strategy of long Japanese stocks (due to increased exports) / short the Japanese yen (which can be implemented through the ETF symbol DXY, which is up about 50% the past 6 months), he also observed, as did Mish, that industrial sectors in other countries will experience deflationary pressures when they have to compete with companies whose costs are paid in a depreciated yen. They advised focusing on Japanese high-tech stocks that are not much affected by commodity prices, which will rise in yen if the central bank achieves the anticipated inflation. He also pointed out that Japan's export growth would probably make things harder for South Korean competitors.
Chris Martensen presentation substantially tracked this blog post of his, which lays out many of his concerns about natural resources and central bank policy. In his Yahoo! interview, he predicts a 40% or worse fall in the S&P 500.
Additionally, Michael Pettis and Jim Chanos delivered very bearish presentations on China's economy. It was made clear by other speakers that Pettis, who teaches in Beijing, could not speak with full candor on the record because negative views could impact his status in China. The implication was that he was soft-pedaling how bad things are ( to the extent that was true, Chanos cleaned up for it later). Pettis doesn't believe the country can sustain another decade of investment-driven growth. One interesting point he made was that the annual cost of pollution in China is estimated at roughly 3.5% of GDP. He also said the economic gap between Beijing / Shanghai and the interior of the country is enormous and growing; no one seeking economic success wants to "go west". is massive. His Yahoo! interview is here.
Chanos's short thesis was impressive. As he says in his interview here,China's GDP has quadrupled this century but its stock market has not budged. There is an ongoing credit bubble and their economy is increasingly dependent on credit creation, but the marginal impact of new credit is declining and quality is poor. Capital flows out of the country are enormous. He had some remarkable tales of how party, business and military elite circumvent capital controls in Macau and HK. He pointed out that GDP measure reported by China does not account for depreciation (capital consumption), so if a building is thrown up, it adds to GDP, but if it falls down, it doesn't reduce GDP.
Mish Shedlock spoke a little less than some of the other speakers. He covered a number of topics. The one point he made that stayed with me the most was when he showed that, contrary to popular thinking, the corporate sector is not really awash in cash; as this chart shows, if you take into account corporate debt, the corporate sector is in fact a net debtor as you would expect it to be.
So basically everyone was quite bearish on financial conditions.
Afterwards, a number of attendees went to Nicholson Ranch, a magnificent winery in Sonoma with a number of 90+ rated wines, where owner Deepak Gulrajani gave us a tour of his caves - yes, real caves underground where he stores wines - and fed us a terrific dinner. I definitely recommend including it on a tour of the Sonoma wine country.
Sunday, April 14, 2013
Camp Bowie
Sheppard Mullin's bankruptcy law blog alerted me to an interesting Fifth Circuit opinion dealing with several closely related chapter 11 plan confirmation issues. The February 26 opinion in Matter of Village at Camp Bowie, L.L.P. allowed a chapter 11 debtor to "cram up" a "new value" plan on its secured lender, holding that the plan satisfied the "one accepting class of impaired creditors" requirement of section 1129(a)(10) when the class of general unsecured creditors, which received only de minimis impairment of (full payment in 90 days without interest), voted to accept. The Fifth Circuit is not traditionally associated with such a "pro-debtor" / anti-secured-lender stance, so I looked at the opinion closely to see if this was a major shift in its approach to chapter 11 battles. I found that the case presented some fairly unusual - and appealing - facts (which aren't fully captured by the Sheppard blog post) and the opinion ultimately struck me as a fairly sensible approach to those unusual facts. But I think the fact pattern was sufficiently different from the Circuit's prior chapter 11 precedents, like Greystone and Sandy Ridge, that the decision is more sui generis than any kind of a doctrinal shift. Its facts actually resemble the Second Circuit's vote designation opinion in In re DBSD North America, Inc. more than the gerrymandering case law.
Village at Camp Bowie is an operating commercial real estate property in Fort Worth, Texas. Its owners acquired and improved it in 2004, investing approximately $10 million of equity and financing the rest with a typical commercial mortgage. The mortgage matured in 2008 and apparently was not re-financeable. The mortgage lender and borrower spent approximately 2-1/2 years in a workout / modification mode. In July 2010, the mortgage lender sold the debt to the appellant, Western Real Estate Equities, L.P., who, according to the opinion "purchased the Notes with an eue toward displacing the Village as the owner of the underlying real estate". (The bankruptcy court opinion states that the buyer admitted this on the witness stand at confirmation and further found that the buyer "had no interest in negotiating plan treatment acceptable to it with the debtor"). The court goes on to note that Western "posted the Village for a non-judicial foreclosure immediately after acquiring the Notes". Village filed chapter 11 to stay the foreclosure.
At the time of filing, the debtor owed a little more than $32 million on its mortgage and also owed trade creditors about $59,000. The bankruptcy court, at some point prior to plan confirmation, found that the value of the real estate was $34 million, meaning that the mortgage was over-secured and the estate was solvent. The opinion does not contain any indication that the valuation was appealed.
The debtor proposed one new value plan that the bankruptcy court rejected. After modifications, the bankruptcy court confirmed a plan that provided for:
(1) the mortgage to be restructured as a five-year balloon with full cash pay interest using an interest rate of at least 6.4%, which, the bankruptcy court opinion reports, was about 470 bps over comparable Treasuries at the time of confirmation (the Fifth Circuit opinion quotes the rate as 5.84% but a reading of the bankruptcy court opinion shows that that court rejected the 5.84% interest rate and required the debtor increase it to "at least 6.4%" which the Fifth Circuit does not mention);
(2) the owners to infuse $1.5 million of cash; and
(3) the general unsecureds to be repaid in 90 days without interest.
The unsecureds voted to accept, but the mortgage holder voted against the plan and objected to considering the general unsecureds as impaired for purposes of satisfying 1129(a)(10).
So the case presented someone with an oversecured note trying to take away the debtor' s equity, by voting
against a full payout plan, while the debtor's owners were willing to infuse a meaningful amount of money to hold on to their property and further to make multiple enhancements of the secured creditor's treatment under their plan to win confirmation. I think the court was influenced by the relative sympathies the parties' objectives evoke, although it does not say so explicitly. Just as the opinion does not show any appeal of valuation, it shows no feasibility issue being raised on appeal either. So the case looks just like a blatant attempt by the distressed mortgage buyer to own something worth more than its claim at the prejudice of someone willing to put up real money to enable full repayment. The case resembles DBSD quite a bit in that respect: as the bankruptcy judge wrote "If any party has a questionable motive in this case, it is Western." However, neither the bankruptcy court nor the appellate court address the case under section 1126, and presumably the debtor did not frame its confirmation case in that fashion.
But, in gauging the precedential value of Camp Bowie, it is essential to understand these key facts. It is thus very different from cases like Greystone and Sandy Ridge which involved an opposite fact pattern: under-secured mortgage lenders fighting efforts by the equity to hold on to properties by writing off the lenders' deficiency claims and imposing substantial losses on them, and solving the 1129(a)(10) hurdle with clever artificial impairment. Here, in contrast, there was an over-secured lender trying not to achieve repayment in full, but something better than that. In Greystone and Sandy Ridge, there were unsecured deficiency claims receiving dramatically inferior treatment to the general unsecureds, whereas in Camp Bowie, there was no deficiency claim. In each of these cases, then, the legal battles brought to the appellate level were over issues of classifying and treating the small unsecured creditor class, but the good faith objectives of the litigating parties were completely different one to the other and really, I think, drive the results in all of them.
That said, the Fifth Circuit seems, to me, to get the 1129(a)(10) analysis right. The delayed repayment of the general unsecureds was clearly impairment, and it clearly voted to accept. So 1129(a)(1) was clearly satisfied as a formal matter. The substantive inquiry into whether the amount of impairment was "good enough" or done for the right motive is better handled under 1129(a)(3)'s "good faith" test, where the varying goals of the parties involved can be assessed both more directly and more flexibly; as the above shows, those goals can differ enormously from one case to another. The court correctly observed that Greystone did not turn on 1129(a)(10) but was an 1122 classification holding, and correctly notes that other decisions prohibiting "gerrymandering" plan classes to get one accepting impaired class are not applicable because there was only one class of unsecureds (because of the unusual fact that the mortgage lender was over-secured, the debtor did not have to gerrymander unsecureds to create an accepting impaired class).
The opinion rejects a stricter reading of 1129(a)(10) from the 8th Circuit about 20 years ago, creating the potential for Supreme Court review to resolve a circuit conflict. But, because litigants and courts can frame this kind of dispute as an 1129(a)(3) issue, and are not required to litigate under 1129(a)(10), I don't see the circuit conflict as being significant enough to require Supreme Court involvement. But we'll see.
Village at Camp Bowie is an operating commercial real estate property in Fort Worth, Texas. Its owners acquired and improved it in 2004, investing approximately $10 million of equity and financing the rest with a typical commercial mortgage. The mortgage matured in 2008 and apparently was not re-financeable. The mortgage lender and borrower spent approximately 2-1/2 years in a workout / modification mode. In July 2010, the mortgage lender sold the debt to the appellant, Western Real Estate Equities, L.P., who, according to the opinion "purchased the Notes with an eue toward displacing the Village as the owner of the underlying real estate". (The bankruptcy court opinion states that the buyer admitted this on the witness stand at confirmation and further found that the buyer "had no interest in negotiating plan treatment acceptable to it with the debtor"). The court goes on to note that Western "posted the Village for a non-judicial foreclosure immediately after acquiring the Notes". Village filed chapter 11 to stay the foreclosure.
At the time of filing, the debtor owed a little more than $32 million on its mortgage and also owed trade creditors about $59,000. The bankruptcy court, at some point prior to plan confirmation, found that the value of the real estate was $34 million, meaning that the mortgage was over-secured and the estate was solvent. The opinion does not contain any indication that the valuation was appealed.
The debtor proposed one new value plan that the bankruptcy court rejected. After modifications, the bankruptcy court confirmed a plan that provided for:
(1) the mortgage to be restructured as a five-year balloon with full cash pay interest using an interest rate of at least 6.4%, which, the bankruptcy court opinion reports, was about 470 bps over comparable Treasuries at the time of confirmation (the Fifth Circuit opinion quotes the rate as 5.84% but a reading of the bankruptcy court opinion shows that that court rejected the 5.84% interest rate and required the debtor increase it to "at least 6.4%" which the Fifth Circuit does not mention);
(2) the owners to infuse $1.5 million of cash; and
(3) the general unsecureds to be repaid in 90 days without interest.
The unsecureds voted to accept, but the mortgage holder voted against the plan and objected to considering the general unsecureds as impaired for purposes of satisfying 1129(a)(10).
So the case presented someone with an oversecured note trying to take away the debtor' s equity, by voting
against a full payout plan, while the debtor's owners were willing to infuse a meaningful amount of money to hold on to their property and further to make multiple enhancements of the secured creditor's treatment under their plan to win confirmation. I think the court was influenced by the relative sympathies the parties' objectives evoke, although it does not say so explicitly. Just as the opinion does not show any appeal of valuation, it shows no feasibility issue being raised on appeal either. So the case looks just like a blatant attempt by the distressed mortgage buyer to own something worth more than its claim at the prejudice of someone willing to put up real money to enable full repayment. The case resembles DBSD quite a bit in that respect: as the bankruptcy judge wrote "If any party has a questionable motive in this case, it is Western." However, neither the bankruptcy court nor the appellate court address the case under section 1126, and presumably the debtor did not frame its confirmation case in that fashion.
But, in gauging the precedential value of Camp Bowie, it is essential to understand these key facts. It is thus very different from cases like Greystone and Sandy Ridge which involved an opposite fact pattern: under-secured mortgage lenders fighting efforts by the equity to hold on to properties by writing off the lenders' deficiency claims and imposing substantial losses on them, and solving the 1129(a)(10) hurdle with clever artificial impairment. Here, in contrast, there was an over-secured lender trying not to achieve repayment in full, but something better than that. In Greystone and Sandy Ridge, there were unsecured deficiency claims receiving dramatically inferior treatment to the general unsecureds, whereas in Camp Bowie, there was no deficiency claim. In each of these cases, then, the legal battles brought to the appellate level were over issues of classifying and treating the small unsecured creditor class, but the good faith objectives of the litigating parties were completely different one to the other and really, I think, drive the results in all of them.
That said, the Fifth Circuit seems, to me, to get the 1129(a)(10) analysis right. The delayed repayment of the general unsecureds was clearly impairment, and it clearly voted to accept. So 1129(a)(1) was clearly satisfied as a formal matter. The substantive inquiry into whether the amount of impairment was "good enough" or done for the right motive is better handled under 1129(a)(3)'s "good faith" test, where the varying goals of the parties involved can be assessed both more directly and more flexibly; as the above shows, those goals can differ enormously from one case to another. The court correctly observed that Greystone did not turn on 1129(a)(10) but was an 1122 classification holding, and correctly notes that other decisions prohibiting "gerrymandering" plan classes to get one accepting impaired class are not applicable because there was only one class of unsecureds (because of the unusual fact that the mortgage lender was over-secured, the debtor did not have to gerrymander unsecureds to create an accepting impaired class).
The opinion rejects a stricter reading of 1129(a)(10) from the 8th Circuit about 20 years ago, creating the potential for Supreme Court review to resolve a circuit conflict. But, because litigants and courts can frame this kind of dispute as an 1129(a)(3) issue, and are not required to litigate under 1129(a)(10), I don't see the circuit conflict as being significant enough to require Supreme Court involvement. But we'll see.
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