Caffeinated Simpleton

The nice thing about a bubble bursting is that you know you’re not in a bubble. Now is the time to look at how we should be investing for the long term, both on personal and governmental levels.

Who Can Help

The recently passed stimulus bill (not the currently debated spending bill) focused on a few main areas. The first was “shovel ready” government projects. These projects are mere stopgaps. They employ people for a short time and then they are finished. Building a bridge or a road, while nice, creates a minimum amount of additional value. Coming up with a single idea that transforms our energy industry, on the other hand, potentially creates huge amounts of additional value. It is these types of innovations that need to be funded, and that was what a part of the stimulus bill was aimed at. Funding “green” technology and IT companies that would transform healthcare by making it efficient.

The problem with these investments is that the markets are artificial, or at least unproven. The market for energy efficient vehicles and other appliances will be created, in large part, by another part of the stimulus bill. Raw incentives and tax cuts are being handed out to those who will purchase the products the stimulus funded the development of. It’s a market, perhaps, but the value is all what the government put into it. If there is actual demand for these energy solutions, they will succeed wihout subsidies (and be extraordinarily lucrative with the government subsidies).

Determining what energy solutions will actually create new markets with obscene profits and goodness for all mankind is not an easy task. Luckily, we have professionals that do this on a day to day basis. These people are called “investors”. There are many types of investors, but they all have one goal: to invest in securities that will increase in value. Since they share this common goal, they have come up with numerous ways of determining whether something will make money or not. They are not always right, but they are way better at it than anybody else.

Fixing Societies Woes

The ideal situation, then, is to somehow get these investors the capital and time necessary to find the corners of the market that will flourish given enough time and capital and allow the investors to give these markets time and capital. As you can see, this all requires time and capital. There is an institution in this country that has plenty of both, and that is the Social Security Administration.

The Social Security Administrations currently looks over a fund of nearly 2.5 trillion dollars. That is enough money to fund just about everything. What’s more, people don’t need it until they are at least 62. This gives approximately 40 years from the time people start investing until the fund needs to reach maturity. There has never, ever been a 20 year period, let alone a 40 year period, in which the stock market on average has not returned a better return on investment than any other security.

It is my feeling that privatizing social security provides us with the capital necessary to bust out of any economic crunch, this one included. However, capital alone is not sufficient.

Privatizing Social Security, Responsibly

When the housing bubble burst a year ago, people were stunned to learn that their retirement savings had been slashed by huge percentages. I can’t even imagine the emotional impact of helplessly watching your grand retirement being washed away in a matter of weeks. This cannot be allowed to happen to Social Security, and it’s my belief that it needn’t happen to either Social Security or 401k’s.

As Cass Sunstein and Richard Thaler argue in Nudge, people are very unlikely to change from default choices. By following some of the recommendations there, we can make privatizing Social Security safer than the 401k’s people use today.

An ideal system would offer a very good default with a limited number of good alternatives, while also allowing the reckless individual to invest however he pleases. The default option for a person’s Social Security should be a private fund that invests heavily in index funds with a small percentage set aside for risky venture and low risk bond investments. It should also be age aware. By the time the individual reaches age 55 (or whatever is deemed appropriate), they should be exposed to the minimum amount of risk. A stock market crash on your 62nd birthday should ruin your day, not your retirement.

Investing in the Game Changers

The final piece of the puzzle that is necessary for true economic stimulus is investing in the potentially explosive markets. Getting in on the next Google or Microsoft: the next big thing. These are the companies that will employ vast numbers of people in short periods of time, provided they have the capital to grow. Currently, this niche is filled almost exclusively by Venture Capitalists. I feel that while these players certainly have a role to fill, current legislation practically prohibits the American public from taking advantage of these opportunities.

Sarbanes-Oxley was a bill passed shortly after the Enron scandal. It imposes very strict accounting requirements on public companies which end up costing these companies millions of dollars a year. Before these regulations existed, having an IPO (Initial Public Offering) was a good way to raise a round of capital to expand. After Sarbanes-Oxley, only companies that have enough money to offset the prohibitive costs of entry have an IPO. This means no regular Americans get to invest in the little guys that are steadily hiring and trying to grow with as little money as possible. The irony is that Enron was successfully prosecuted on laws that were already on the books, not Sarbanes-Oxley. These laws had just been poorly enforced until the scandal broke.

Now I do not mean to suggest that we should throw our Social Security into the venture capital arena. What I do mean to suggest is that a well balanced fund should invest a small percentage in risky investments, and that small companies should be able to benefit from these investments. Two percent of 2.5 trillion is still 50 billion dollars, and that is enough to fund whatever the next big thing may be. If we are careful, it could pay back in spades.

Stimulus Through Prudent Investment

With the index funds at ten year lows, this is a buyers market. The only way to bring the markets up, along with the economy, is to invest in those companies that are poised for expansion. Nothing is more about investing in the future than Social Security, and it seems obvious that these two identical goals should be combined. By removing the obstacles to investment, providing the capital for investment, and putting it in the hands of professionals, we can get America’s economy back on track.

There has been a lot of debate in the past few months about what the government should do about all these “toxic assets” that various financial institutions have on their books. My less than educated opinion is that it doesn’t matter, but the government has to make its intentions clear, and it has to make them clear fast.

These “toxic assets”, which are largely comprised of bad mortgages to people who will never be able to pay them back, have an undefined value. Nobody is really sure how much they are worth, if they’re worth anything at all. Once people realized that these assets were of questionable value, and certainly worth a lot less than previously thought, the total value of the financial institution plummets down. This is an overly simplified version of what makes these institutions “insolvent”.

The customary thing for a bank to do when a mortgage cannot be paid back is to foreclose on the home. This allows the bank to sell it for something close to its actual value and recoup the money they lost on the bad loan. This is what happened en mass at the beginning of the financial crisis. However, it’s my belief that this is only continuing because of governmental indecision.

Houses are as close to worthless now as they have been in anybody’s lifetime. We suddenly find ourselves in a situation where there are far more houses than there are people with the means to purchase them. This means that foreclosure no longer makes sense. If a bank cannot sell the property they foreclose on, then it is in their best interest, by far, to renegotiate the mortgage. In many cases, the people most willing to pay for a house are the people who don’t want to lose their home, and they’ll pay what they can.

The government sees this, of course, which is why they want to help. By purchasing all these bad assets, or so the argument goes, they can get what value is there without throwing people out on the streets. However, they have not made their intentions clear. The government’s failure to do something or say that they will not do anything is the single worst thing they could do. As it is now, financial institutions have no incentive to renegotiate mortgages because there is a sporting chance they will get a better deal from the government. If the bad mortgages look worthless, so much the better, the government has to act to save these institutions that appear insolvent and are “too big to fail”, and the government will look at those “worthless” assets, see that they are not worthless, and see a potential money making opportunity (especially after the savings and loan crisis). In essence, the financial institutions can’t lose, as long as they keep these toxic assets looking worthless.

I have my personal opinions about what the government should do, but anything is better than straddling the fence, debating whether or not to do something or not. These institutions will be forced to work out their problems, or they will have them taken off their hands. Either outcome is preferable to the current  predicament of millions of people in default. This isn’t the banks’ fault, it’s the government’s, and it’s crucial that they do something about it.