Monday, November 29, 2010

Municipal Bond Update 1

The good news is that the municipal bond market has somewhat stabilized, but I've only made .1% on my investment to date. Fortunately the brokerage I am buying through does not charge for purchases of internal mutual funds. Bonds are difficult/expensive to buy for the average investor given the average size ($1000) and transaction costs ($10 and up at many online brokerages). If you are purchasing less than $100K in bonds, it makes much more sense to purchase shares of a mutual fund. Achieving diversification and keeping transaction costs low is incredibly difficult otherwise.

Thursday, November 18, 2010

Municipal Bond Market

This may bore most, if not all, of the few people who regularly read this blog, but an interesting event occurred earlier this week. The municipal bond market has tanked in the last 3 weeks. There are a variety of reasons such as the poor condition of municipal finances, Republicans were elected so the Build America bond program will likely end, and the prospect of future inflation. As an example, iShares Tax-Free Municipal Bond ETF, MUB, fell from $106 a share in October to $99 on Tuesday. This may not seem like a significant drop to those who don't follow the market closely, but to give some perspective, the last time the municipal bond market fell this much was October 2008 during the height of the financial crisis.

In a few previous posts I've mentioned that I don't truly believe that the market is efficient in the short term. In other words, I do not think the market price accurately reflects future cash flows at all times. The latest example is the municipal bond market. While I would not speak highly of the long term prospects for many issues, I do not think that the probability of default or debt restructuring (lowering the principal or interest associated with the bonds) increased over the weekend. Of all debt holders who should be worried, it's Treasury holders. They are accepting absurdly low returns while ignoring the certain pricing change that will occur as the bond market wises up. Much like other investments I've made such as BP, GS, GE (during the flash crash), and others, this is a good opportunity to enter the municipal bond market with the intention of selling after a more realistic price level returns in the near term. The municipal bond market is not very liquid, so a minor movement can affect the fair value of others' holdings. This is what I believed has happened in the last few days. Sanity will likely return and I should make a decent return, 2-5% for about 4-6 wks of investment.

With this investment I intend to publish an update every week with the returns I receive. With any luck, I will not be embarrassed by thought process outlined above.

Wednesday, November 10, 2010

Don't ask, don't tell

I have been besieged over the course of the past 6 months with Pentagon surveys requesting me to catalog my feelings about serving with homosexual military members.

First and foremost, let me say that I support the idea that homosexual Americans should have the exact same rights and opportunities as every other American. It strikes me as peculiar that we can pride ourselves on being a land of liberty for all yet decide that there is a class of citizens who are entitled to fewer liberties than others. In my opinion, the current debate will be viewed by Americans in 50 years in the same way that we now think of woman's suffrage and civil rights.

Having grown up in a very conservative Christian community, I can understand (but not agree with) the anger that homosexuality induces in some. I cannot, however, find in the Bible where I have been authorized  to impose (share, yes) my own religious beliefs on those around me.

With that said, the current policy is terrible. I have served with openly gay individuals and never did I doubt their commitment to their country or feel threatened by their sexuality. I have shared living quarters with gay people and been oblivious to their orientation.  The notion that the Joint Chiefs of Staff could agree in principle with the equal rights of homosexuals yet request time to take surveys to decide a course of action strikes me as incredible. Since when did we decide that popular opinion was the American method of apportioning rights? Either homosexuals deserve the same rights as all of us, or they don't. There's no morally defensible position whereby the general says, "Sure they have rights, but my soldiers are against it, so I'll pass." I would have been completely understanding if they had dropped DADT, but requested time to put in place policies for actual implementation (does the partner get access to Tricare and military housing, how must living quarters be adjusted.....). What the military's leadership actually did was disgraceful. 

A legitimate plan? That's not what we hired you for!

On February 18, 2010, President Obama created a panel called the National Commission on Fiscal Responsibility. It's billed as a bi-partisan panel, but the self-imposed rules governing the appointment of members meant that the Democrats would appoint 12 of the 18 members, though at a minimum 2 of those 12 can not be "Democrats". The other 6 members were appointed by Republican leadership in the Senate and House. In the end the panel is 10 overtly Democratic members, 6 Republican politicians, and 2 CEOs.

If you're the President, you expected the panel to come back with some sort of rubber stamp of your economic policy. Unfortunately, the 18 panel members are capable of simple math and determined that spending cuts and tax increases are required to restore the American economy. This was met by stunned lawmakers, notably the Democrats who put this thing together and schedule the proposal to be delivered after the election (no politics there of course). The proposal from the co-chairs which was released today is far from earth shattering. This is not the final deliverable as that must be approved by a vote from the entire commission. I outlined some of the items below which I found to be fairly good proposals.

1) Social Security: Raise the eligibility age, index benefits to inflation not wage growth, expand the tax base to include state/local government workers, and expand the tax to higher income levels. All of these are necessary in some form or another; it is impossible to fix Social Security without either raising taxes or cutting benefits. The Social Security eligibility age was initially 65 when the program was first introduced in 1935 and life expectancy was between 60-64 at the time (see page 6 here). The eligibility age is now 67 and life expectancy has increased to just over 78. (By the way, life expectancy means how long a child born in that year is expected to live...example: a child born today is expected to live to 78). Social security was meant to keep the elderly out of destitution, so indexing to inflation provides the individual to access the goods which are required to live.

2) Fix the tax system: Use just 3 tax rates, reduce the availability of deductions (including the mortgage deduction), and tax no income under $30,000. I really like this plan. Raising the standard deduction to $30,000 codifies what is already the case, that low income individuals pay no taxes right now. Whenever a Democrat says, "They're trying to raise taxes on the poor to give tax breaks to the rich," I laugh. The poor don't pay taxes and what the Democrat should say but can't is, "They're trying to cut benefits to the poor so they lower taxes for the rich." I like reducing the number of tax deductions available, especially those related to housing. Tell me, why exactly should the interest on a mortgage of greater than $500K be tax deductible? I disagree in general with the mortgage interest tax deduction, but subsidizing the purchases of large homes doesn't seem like smart public policy. I would also suggest that the deduction should be indexed to geographical areas, but in general the principle seems correct.

3) Cut federal budgets: Freeze federal wages/benefits, reduce farm subsidies, make civil servants contribute to their retirement plan, and so on. Again most of these options seem to be reasonable. The gap between public and private sector pay has disappeared, so there's no reason for Federal employees to enjoy hirer pay and lower career risk. Farm subsidies are just plain ridiculous, subsidizing the manufacture of ethanol which requires more energy to produce that it provides simply highlights what happens when a politician tries to solve a market problem. I also like the proposal to increase the premiums for the military's health care plan, Tricare. As discussed here, this alone costs the Pentagon tens of billions each year. The premiums could be substantially raised and still be lower than the market price of a comparable plan.

There are quite of few excellent ideas in their report, most of which will never make it out the committee since the final report requires a vote by the 18 members to be approved. The trouble is that the co-chairs were right, we are in a bad place economically and fixing it requires pain in the form of cuts to federal budgets and increased taxes.

Having recently received an offer for employment, I calculated my expected yearly tax bill and was horrified to learn it will be significantly larger than my salary when I first joined the Army as a 2nd Lieutenant. The upside to this is my purchasing power now is significantly better that of an individual who was born to a lower middle class family anywhere else in the world. So why don't we just buck up and accept that the Ponzi scheme we have allowed our politicians to put in place can't continue?

P.s. Having read this post before hitting the "publish button," I appear to have assigned far more blame to Democrats than Republicans. That is certainly not my intent, indeed were you to simultaneously start two wars and cut taxes you shouldn't even be allowed to utter the words "fiscal responsibility." I will also add that I find Tea Party members to be in the same intelligence league as the beauty pageant member (What do you want? World Peace!). If you pay attention to all the candidates that the Tea Party has put forward, they all recommend cutting taxes. Asked how they'll pay for this, they reply with some inane combination of cut earmarks and reduce waste. I have news for you, earmarks are a pitifully small portion of the federal budget (less than 1% percent) and there is not exactly a Federal program which comprises of people burning $100 bills all day long. Waste in government means ineffective policies and expensive regulations, it's not exactly easy to find or fix.