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By Walter Borden

“Everything… is very simple, but the simplest thing is difficult… things do not turn out as we expect. Nearby they do not appear as they did from a distance” — Karl von Clausewitz

ONE hears little talk of a potential carbon bubble in financial media and the role of policymakers in its potential formation. Yet, a broad array of business and economic institutions along with professional investors such as Tom Steyer maintain carbon-free portfolios in response to negative long-term trends for carbon-derived asset values.  Asset bubbles typically refer to cases where a group of widely held assets are overvalued as evidenced by appreciation rates and valuation ratios far above their historic on trend averages. This overvaluation then implies sudden, acute drops in value for both the holder of the assets. This effects the broader market as a function of the assets default presence in keystone funds and indices that must reflect markets in composite. Yet, definitions of asset bubbles exist primarily in the vernacular.  Many scholars and technicians argue that buubles can only be recognized post ante. Setting this debate aside, potential equity and real estate asset bubbles discussions appear frequently in the media while the possibility of a carbon bubble is largely ignored. Why? Of these three possible bubbles, which of them present the graver threat to shared prosperity?

Goldman Sachs reported, “the window to invest profitably in new [coal] mining capacity is closing” this past July. According to Bloomberg: “The top 100 coal and 100 oil-and-gas companies had a combined value in 2011 of $7.42 trillion, much of which was based on reserves that can never be used, according to a Carbon Tracker report that first made the case for “unburnable carbon.”

Yet, clean coal programs continue as policy makers prop-up the sector — even as the market sells off. Will this soon-to-be-past be prologue for oil? Statoil, a sustainability leader that Fund Balance has followed from some time, quoted in Bloomberg:

Statoil considers climate change a key corporate risk which will have industry-wide impact,” the company wrote to investors. ‘We consider our portfolio of assets to be fairly robust with respect to climate regulations.’

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As we see above fuel consumption is flat in the US and growing in the BRICs. Given that China and India in particular are investing heavily in renewables, how likely are their rates of consumption to accelerate? Looking out, prospects for revenue growth curves for Big Oil flatten at best due to higher projected carbon prices.

A carbon bubble and its twin risk vector climate change represent serious long term risk to a great many more citizens and their wealth, well being, and security than putative stimulus from Quantitative Easing (QE) and any attendant bubbles. So, what to make of the talk of equity asset bubbles? Currently, ~20% of US citizens own ~80% of the stock market and wages over the last 20 years have been flat to declining. This coupled with the decreasing  share of productivity to 90 percent plus of US workers beg the question: for whom are potential asset bubbles so dangerous?

Certainly many households are dependent on their comparatively minimal stakes in equity markets. For example, billionaires can buy low and sell when bubbles burst, but those living off dividends and capital gains to pay for food, medicine, and shelter cannot. Further, income inequality, long-term under- and unemployment mean fewer and fewer labor force participants accumulate enough monthly income to set aside sufficient savings through asset market participation. The great complexity and increasing lack of transparency as typified by LIBOR and ISDAfix insider trading shuts out the majority of non-professional investors and even many smaller scale professional ones. The ranks of Wal Mart associates and pizza-deliverers swells. Consequently, large swaths of laborers lack both the information and capital  to gain access to the phenomenal growth and opportunities afforded to the shrinking few within the hedge fund and luxury class.

Moreover, when QE ends this will signal uptrending inflation which in turn will mean rising demand, congruent with stronger earnings and prospects for large components of blue-chip indices. And, even if over-bought, new iwill arise in a sell off, long term positions won’t need to change all that much. After all, as superstar investor Henry Kravis points out consumer spending is 70% of the US economy which is the world’s largest. So very plausible demand-side scenarios exist whereby QE does not usher in a long-term bear market.

Are Major US Real Estate Markets Becoming Overvalued?

Housing Affordability Index. Source National Association of Realtors.

Housing Affordability Index. Source National Association of Realtors.

Looking at real estate, some see a bubble inflating among certain major urban markets. In aggregate though the real estate market has mostly trended sideways. Existing home sales are still below 2007 levels as are new home starts. More people are renting. So while property owners can command handsome rent appreciation the market for new homes is flat on a broad basis, so concerns of pockets of bubbles in real estate are basically marginalia.

One of the benefit of the Dot Com bubble was quite literally its network effect: the US economy developed its internet infrastructure which subsequently laid the foundation for Google, Facebook, Twitter along with an entire generation’s worth of capital formation for savers and investors. Its legacies include cloud computing, social media, big data, etc. And, even amid the irrational exuberance driven carnage of the Dot Con Bubble burst much essential research and development was performed weeding out many shibbolleths and flawed business models.

Housing prices have only now returned to historical levels. Click to Enlarge.

Housing prices have only now returned to historical levels. Click to Enlarge.

Are all bubbles are alike? Probably not.

On the other hand, what of the legacy of bursting of the housing bubble? So far, all we have is enormous gains for a handful of rentiers, the continued grind of the Lesser Depression and interest rates that remain low at the Zero Lower Bound, which will simply will not co-operate with those that would argue primarily from authority that they must be inflationary; consider again existing home sales:

z-existing1

Lastly, what were reality-based economists calling for to bring us out of the Lesser Depression: fiscal stimulus aimed at upgrading US infrastructure into an era of greater efficiency via renewable energy and less pollution, a pernicious form of inefficiency. Regulatory capture allows for its cost to be shifted onto the public accounts and thus obscured accounting of publicly trade firms.

For evidence of the inefficiencies wrought by pollution, just look at firms leaving China due to rampant pollution or at the points shaved off its GDP by endemic air and water pollution. On the positive side, China’s future generations will reap benefits from its investments in the clean and renewable energy now. The US needs to focus on those benefits for its future generations by borrowing cheaply while there is still time to build infrastructure and cultivate a new breed of social institutions. These steps will lead to a healthier and more prosperous future than cuts to food programs for those living in poverty now.

Comparison of the  GDP deflator (unused for policy indication by the Fed  Because it contains  grain and oil prices, which fluctuate a lot, making it an unstable measure that is highly unreliable as an indicator of underlying inflation vs. the consumption deflator excluding food and energy.  Click to enlarge.

Comparison of the GDP deflator (unused for policy indication by the Fed as it contains grain and oil prices, which fluctuate a lot, making it an unstable, unreliable measure  of underlying inflation) vs. the consumption deflator -excluding food and energy. Click to enlarge.

So again, for whom are equity and real estate bubbles forming? Put another way, are bubbles relative? Where is the inflation from QE thats been predicted for the last 5 years? Last word to economist and former treasury official Brad DeLong:

I see an economy in which the share of American adults who were employed was 63% in the mid-2000s, fell to 58.5% in 2009, and is still 58.5% today. We would have expected the natural aging of America’s population to have carried the share of adults at work from 63% down to 62% over

the past seven years or so–not to 58.5%. And we would have expected the collapse of people’s retirement savings either in housing or in stocks in 2008 to have led many Americans to postpone retirement. Given the collapse in the value of retirement savings and their impact on desired retirements, I see a healthy American economy today as one that would still have the same adult employment-to-population ratio of 63% as the economy of the mid-2000s.

From that perspective, we are not halfway back to health. We had a gap of 4.5% points between actual employment and full employment at the end of 2009. We have a gap of 4.5% points between actual employment and full employment today. We are flatlining. It is true that in late 2009 there were still real and rational fears that things might become worse very quickly, and that that possibility is no longer on the menu. But in my view our “recovery” has taken the form not of things getting better but of having successfully guarded against the possibility that things would get even worse. And that is a very feeble recovery indeed.

(h/t econintersect for the housing graphs)

October 21 2013

FUND BALANCE Quarterly Report

Overview:

AT the close of 2012, some analysts saw the mix of retrenchment of regulatory programs in the EU and lack of a co-ordinated clean energy strategy in the US combined with China’s burgeoning carbon footprint as a gun to the head of Environmental, Social, Governance (ESG) and related (CSR, SRI) investment theses. Many saw it more as a water pistol. We were in the latter group.

In general and in context, Fund Balance sustainable investing advisory continued its strong market out-performance for 2013. While the Equilibrer broader mid to large cap market portfolio has essentially tracked the S&P’s ~22.4% YTD and 5.4% Q3 performance for 2013, the LED specific Leading The LED ETF/portfolio outperformed its peers as has the Here Comes The Sun solar based ETF/portfolio with returns of 43.3% and 267.3% for Q3 2013 respectively.

Important global and international developments merit brief discussion with three general developments of note.

Firstly, China is still enigmatic in terms of its role in the sustainability story. It has both helped drive price points down for solar power so as to allow for competitiveness all the while ramping up its coal consumption and continuing to generate headlines reporting local ecological collapses: entire cities shut down by pollution; whole stretches of rivers toxified beyond life-support thresholds and entire aquifers rendered unfit for human consumption. Hence rapid scale back of its coal consumption becomes even more critical as the World Health Organization announced its findings of definitive links between air pollution and cancer.

Secondly, United States based endeavors, particularly those based in our Western states, continue to surprise on the upside, whether via advances in solar storage, LED innovation, or other clean economy initiatives enacted by California, whose economic mass and dynamism compels neighbors and salesman to bring clean economy wares to its market.

Thirdly, even as the US has surpassed Russia as the world’s largest exporter of refined petroleum product thanks to shale gas and even as fracked natural gas diminishes coal based power generation, the reality of negative implications of a carbon bubble for traditional hydrocarbon marketers continue to sink into the thinking of the populace and fund managers alike. The IPCC in its 5th Assessment of Climate Change avers of the necessity of leaving 2/3 of known carbon reserves in the ground to secure our future. The Fund Balance view is that the risk of carbon dioxide driven climate change portends of a sub-prime like collapse of carbon-based asset values and such represents a significantly graver threat to intergenerational prosperity moving forward than US public debt and deficit spending.

Specific guidance for the solar power sector:

After severe buffeting by regulatory retrenchment and policymaker recalcitrance in 2012, our solar plays as well as those of our peers significantly outperformed the S&P 500 and the small cap weighted Russell 2000 (10.21% return for Q3) both on YTD and Q3 bases.

Solar power usage continues to expand its role in mainstream residential markets as well as commercial ones. Wal Mart for example now has almost twice as much capacity as second-place Costco. Wal-Mart is converting more sun into power than 38 U.S. states.

For market participants that took positions at the beginning of 2012, the question now is: to take profits or not? We recommend those interested in playing the psychology and cycles of the market take a hard look at realizing some gains by selling with an eye to build reserves for coming troughs. Those with long views should still consider some intra- and inter- asset class reallocations, by building positions in sub-sectors like solar storage, maintenance, and microgrid in combination with more early stage private ventures with an eye towards gaining exposure to high risk/reward stewardship. Volatility will continue to feature prominently in the solar equity market as solar power generation increasingly closes on parity with conventional generation on a $/megawatt basis.

In sum, we have no doubts on the long view, robust growth story for the solar sector and consider decisions about exposure a question of one’s investment time frame and goals. But now would be a good time to take some profits if so inclined.

Specific guidance for the LED power sector:

LEDs are lighting the way in Buenos Aires to Dubai to the shelves of Home Depot. Research from economists at Yale show that civilization and prosperity correlate with the amount of artificial light output. Indeed light rendered a 20th century of progress. The clean economics of LEDs portend well for a 21st century of sustainable, equitable, smart growth driven prosperity.

From a macro perspective the Dutch industrial giant Philips serves as good bellweather for the LED market. Salient facts for Philips at the end of the Q3 2013:

  • Philips soaring third-quarter earnings show its continuing leadership in the world’s LED market. It reported its Q3 sales revealing LED sales growth of 33% from a year ago and now representing 30% of Philips’ total US$2.85 billion lighting sales.

  • The company now offers US consumers LEDs for US$5 at the Home Depot, as well as in partnerships with large utilities companies. Further, while all Philips’ divisions reported greater operating profits, the lighting unit saw the biggest improvement, which it’s management crediting strong LED sales and lower restructuring charges.

  • Philips is the exclusive supplier to the Dubai Municipality’s buildings with its intelligent LED solutions. They claim their lighting solutions are saving 50% in electricity usage. Dubai for its part states that its mission is to become the most sustainable city in the world.

Other key factors:

  • Thousands of municipalities have adopted LED streetlighting and millions of households have switched on LED systems and fixtures.

  • LED generated luminance is not only brighter and more efficient but saves citizens money in the long-term making LEDs are a common-sense purchase in economically challenging time.

Fund Balance ETFs/Portfolios YTD and Q3 Results:

1. Here Comes The Sun, the fund balance solar portfolio:

YTD: 267.3%

Q3: 62%

On a 5 point scale for volatility: 5 => maximal volatility

On a 5 pt scale for valuation: 5 => historically high valuation relative to other sectors.Note: Reversion to mean historic broader market valuation levels of 3 coupled with price decreases, if only for a few quarters, should not be unexpected.

 

2. Leading The LED

YTD: 43.3%

Q3: -6.7%

On a five point scale for volatility: 3

5 pt scale for valuation: 3

3. Equilbrer

YTD: 22.1%

Q3: 10.0%

On a five point scale for volatility: 3

5 pt scale for valuation: 3

PE ratio: 20.39

Equilbrer has the potential, pending close of year and backtesting results, of serving a good fit for a SRI proxy for the S&P. For example, consider its PE ratio of 20.39, compared to the those of the S&P:

● S&P 500 TTM (trailing twelve month average) P/E ratio = 17.85 (Equilibrer TTM comparable will not be available until Jan 2014)

  • Mean 15.50

  • Median 14.51

  • Min 5.31(Dec. 1970/Max 123.7 (2009)

Equilibrer YTD performance:

Conclusion

Q4 2013 will require preparation for a measured rebalancing from broad, mid- and large-cap concerns towards a focused, sub-sector driven approach with a long view, looking at funds and early stage ventures with acceptably low levels of technology risk. Further, heightened attention will be paid to the private equity asset class as we see it poised to outperform over the next 5 years.

Investments in energy efficiency alone can create 1.5 million jobs in America by 2030 — so at Fund Balance we see participating in building the clean economy as an important part of good corporate citizenship as well. We will seek out for opportunities in subsectors in the solar market in terms of storage such as Solana and automated systems for cleaning solar panels like Serbot and QBotix, both of which are not publically traded.

Leaders of 70 the largest pension funds in the U.S. are calling on fossil fuel companies to detail their management plans the switch to cleaner energy. These concern is that their portfolio companies’ profitability in the future will slow and disappear as the world shifts away from oil and coal and towards clean energy. These 70 funds are asking 45 of the world’s largest oil, gas, coal and electric companies to conduct detailed studies of how policies to curb climate change will impact the fossil fuel business.

The above is but one reason why the Fund Balance outlook for Outlook for Q4 2013 and into 2014 is that clean energy is will one of the main high return sectors for the coming decade. With this is mind we will continue to bring private equity further to the fore in pursuit of our mission to build wealth by investing and contributing to sustainable economics and culture. Continue to work with solar industry leaders at the individual level such as Jigar Shah and at the institutional level such as The Credit Suisse Impact Investment Group amongst others, to identify opportunities in the private equity asset class. In the public equity markets plan to undertake coverage of a wider and deeper range  to sustainability leaders with a such as Philips, which we have added to Equilibrer.

We conclude with an excerpt from Paul Krugman’s review of William Nordhaus’s The Climate Casino: Risk, Uncertainty, and Economics for a Warming World:

 

So the future is uncertain, a reality acknowledged in the title of Nordhaus’s new book, The Climate Casino: Risk, Uncertainty, and Economics for a Warming World. Yet decisions must be made taking the future—and sometimes the very long-term future—into account. This is true when it comes to exhaustible resources, where every barrel of oil we burn today is a barrel that won’t be available for future generations. It is all the more true for global warming, where every ton of carbon dioxide we emit today will remain in the atmosphere, changing the world’s climate, for generations to come. And as Nordhaus emphasizes, although perhaps not as strongly as some would like, when it comes to climate change uncertainty strengthens, not weakens, the case for action now.

Microgrid

A local microgrid in Sendai, Japan. Source: NTT Facilities, Tokyo, 2006

By Walter Borden

ON the way to closing out 2013, renewable energy sectors quietly outperform the broader market. Notably, solar power and LED systems have entered prime-time in a big way.

Wal Mart has deployed, and is profiting on, the largest portfolio of solar panels of any retailer in the nation, just ahead of Apple. Costco runs 2nd  in the retail sector. Wal Mart’s implementation alone exceeds that of 38 US States combined. Meanwhile Dutch conglomerate Philips reports 33% profitability growth in its LED sales along with a presence in Home Depot stores. And residential solar has gone mainstream while distributed generation projects continue to increase exponentially, even as regulatory support scales down. Another intriguing development is Sunpower’s un-subsidized 70 MW plant in Chile that will sell solar directly on the spot market. This may well be the model of the future.

Corporate America profits on solar. Key facts:

  • GTM Research and SEIA report solar system costs decreases of 40% since the start of 2011 and 50% from 2010.
  • Commercial installation costs dropped 14.7% to $3.71 per watt for 2013.
  • Assuming a 10% return on investment and a 20% capacity factor, projected cost of this electricity are 8.5 cents per kW-hr, below grid prices  ex-ante tax benefits. 

The outlook grows ever brighter when one factors in twinned developments in microgrid and microfinance. In the case of microgrids, or distributed generation, both Connecticut and New York are deploying microgrids in the aftermath of Hurricane Sandy. New firms like Mosaic lead the way with cash flow generation for retail investors via interest rate income from solar projects over its crowdsourcing platform.

For Dutch Design week 2013 Lucid created a base frame where visitors can add to, and manipulate, light formations.

For Dutch Design week 2013 Lucid created a base frame where visitors can add to, and manipulate, light formations.

So what is the signal here? Basically, its that in the US, clean and sustainable economic advancement presents with wide variability around the state by state valence, with the balance now tipping to uptake in a majority of US States. Some of the sunniest states are in the late adopter category, there is still a large pool of untapped markets. While plenty of noise was generated around the predictable yet minor growing pains in US green energy public programs, these programs has spurned free market opportunities for sustainable value creation — even as subsidies are scaled back far more sharply than they were for other sectors like fossil fuel extraction and industrial agriculture.

Investors then, should look past efforts to define complex problems from a single datapoint (Solyndra perhaps is the best known and most overstated example). Given these developments, which are strongly indicative of an upward sloping trend line, we think investors are well advised to focus on mid and long term possibilities. Additionally, investors would be wise to monitor the growing concern of asset managers about overvaluation in petroleum assets: 70 of the largest pension funds are already inquiring as to risk exposure to a Carbon-based Asset Bubble to the petro-product majors.

One thing is certain, extemporizing around the economic inefficiencies of pollution on the part of petroleum producers has long since outlived its persuasiveness for many institutional and individual market participants. More analysis on this is in the works at Fund Balance.

By Walter Borden

Copyright: Cartoon Network

Copyright: Cartoon Network

Building an equitable work environment in our nation is not about ensuring equal outcomes for all, as often claimed. Its purpose is to create equal opportunities for all citizens. The financial press makes frequent note of the slow, steady increase in employment in the US as ex ante proof of a recovery and thus cautious optimism. Yet looking at the matter simply as aggregate jobs created is downright myopic. Attention to the low and stagnant wages paid to almost all of these new work force participants and taxpayers. Further, even in an era of low inflation, these low wages represent income losses when adjusted for inflation. Is this the context and function of a truly recovering, resilient and sustainable economy for all but rather only a precious few? For the vast majority of US labor force participants, here are the salient realities:

  • If the $7.25 federal minimum were had simply been adjusted with inflation since 1968, it would be  ~$10 an hour.
  • If linked to average U.S. productivity growth, it would be over $18 an hour.
  • Between 1948 and 1973, the productivity of U.S. workers  rose 96.8 percent and wages rose 93.7 percent.
  • Between 1973 and 2011, productivity rose 80.1 percent but wages rose only 4.2 percent.
  • Median household income today, adjusted for inflation, is at 1989 levels.
  • During that same time, union membership dropped from about 1/3 of the private sector workforce to about 6.5 percent today.
  • The majority of gains in our economy have thus almost all of the growth in income, has gone to the top 2 percent, and especially the top .1 percent.
  • We are richer as a country than ever — with these riches concentrated in amongst a .1% of us and to an extent not seen in a century or more.

The reality of this type of labor whether its temporary, part-time, or full time is that one can start minimum wage and work a decade to even gain an $1 more per hour. In the warehouses where Amazon and Wal-Mart fulfill their online sales employees are mostly temp, allowing these firms, that do not contribute to the communities in which the operate, to nonetheless take advantage of the local infrastructure and  the means-tested/public services most of the employees at these operations require.

What if more people earned wages that allowed them to live a bit beyond subsistence? Would these wages be more likely to spent in the community? Or would they export most their earnings to offshore investments as management does? Would the local and state tax bases not grow, enabling public funds for desperately needed infrastructure improvements and transitions to clean economies that don’t compromise air and water quality for its inhabitants? Many of these jobs are not easily easily replaced with automation and algorithms. One other thing we know, states and nations with higher minimum wages and unions have stronger economies and better health and education outcomes.

Corporate Profits as a share GDP. Grey bars indicate recessions. Source: St. Louis Fed.

Corporate Profits as a share GDP. Grey bars indicate recessions. Source: St. Louis Federal Reserve.

By Walter Borden

MANY US cities like Detroit face pension and general service funding shortfalls. Yet for over 5 years the corporate sector has recorded historic profits as a share of GDP. In none of these years however, did they choose to undertake the simple, incremental steps that would have met pension reserve requirements. Even the debt ratings, presented as legitimate third party analysis in support of more pain for retirees and the working poor, are in fact made by firms owned and beholden to Wall Street titans, and as such are dubious. For example, some downgrades appear suspiciously right after a heavyweight firm has taken a position which would gain on a downgrade. Other cities in the US may soon follow as targets for the Model-Detroit. How to help main street? continue reading…

By Walter Borden

Does it make sense to tell someone that doesn’t have health insurance to go to the doctor? Does it make sense to expect jobless and underemployed citizens to save more? Many of the most profitable corporations across the US perennially underfund their pensions while simultaneously funding campaigns for privatization of social security paired with cuts to the program.

Pension shortfalls. Click to enlarge.

Pension shortfalls. Click to enlarge.

Yet, these same corporations oppose raising the cap on payroll taxes or asking Wall Street financiers to sacrifice via minimal financial transaction taxes common in the US during many a bull market and still common in the EU and Asia. All of this set against a backdrop of historically high corporate profits, S&P record highs, and stratospheric ratios of CEO pay to that of middle management and wage earners.  The term generational theft is popular argot for corporate bureaucrats and their funding recipients in Washington, DC. Many of the CEO’s and hedge fund managers recommend pain of the majority and none for themselves. Yet, US taxpayers currently fund corporations at an historical scale via low interest rate loans and subsidies. This is the real generational theft: draining the the US middle class so financial speculators can ship away jobs, keep cash in tax havens, and speculate on Asian markets.

Gillian Tett writing in the Financial Times makes notes of a statement by a top executive of a consumer goods conglomerate:

We see a pronounced difference between how people are shopping today and before the recession,” the executive explained. “Consumers are living pay cheque by pay cheque, and they tend to spend accordingly. Then you have 50 million people on food stamps and that has cycles too. So for our business it has become critical to understand the cycle –when pay [and benefit] cheques are arriving.

Hence, the mostly austerity driven so-called recovery further reveals another deteriorating economic indicator for the middle class. Compare and contrast this with austerity champion the Walton Family and its Walmart. Without accounting for its massive local and federal tax breaks and subsidies, Walmart receives even more welfare from US taxpayers by paying its workers so little that they cannot afford healthcare and so must utilize social programs funded by their neighbors and fellow Walmart customers. In short, the world’s largest employer, after the US Department of Defense and the Chinese Military, relies on taxpayers rather than participation in the general welfare of the communities in which it operates and generates huge profits for its small group of majority shareholders (5% of of its owners possess 50% of its shares). Is this an example of good corporate citizenship?

Click to Enlarge.

US Profits and Investment 1929 — 2012. Click to Enlarge.

Nevertheless, the most economically secure in our society mostly talk of deficits and are enabled by our nation’s highly consolidated media to dominate the public debate thereby granting them disproportionate exposure. Yet, their arguments that austerity and fiscal contraction will resolve the unemployment crisis fail logical and evidentiary tests time and again. Sequestration is projected to shave a point off GDP this year. As GDP shrinks consumers have less money to spend and consequently labor demands falls. Further, low-paying and low-to-no benefit jobs, which are the bulk of jobs now being created in the US, threaten a generation’s retirement security and access healthcare (health services as opposed to health insurance need disintermediation). Furthermore, corporations and the super affluent pay lower taxes than ever.  Supporters for this program argue that it frees up capital to be reinvested in the economy. But, this not the pattern of the past 30 years. In the last decade the pace of reinvesting these perquisites into the economy or funding pensions has all but completely lapsed. Rather, these windfalls are shipped to hedge funds and tax havens. Additional study finds deeper problems.

From a recent blog post by James Kwak:

That was my goal in my first law review article, “Improving Retirement Options for Employees”, which recently came out in the University of Pennsylvania Journal of Business Law. The general problem is one I’ve touched on several times: many Americans are woefully underprepared for retirement, in part because of a deeply flawed “system” of employment-based retirement plans that shifts risk onto individuals and brings out the worse of everyone’s behavioral irrationalities. The specific problem I address in the article is the fact that most defined-contribution retirement plans (of which the 401(k) is the most prominent example) are stocked with expensive, actively managed mutual funds that, depending on your viewpoint, either (a) logically cannot beat the market on an expected, risk-adjusted basis or (b) overwhelmingly fail to beat the market on a risk-adjusted basis.

Furthermore, how can someone that works full time outside of Wall Street understand the complexity of 21st century markets? For example, this animation shows what happens inside of the one half-second of trading in Johnson and Johnson shares: more than 1,200 orders and 215 actual trades occur again, in a half a second. (The colored boxes in the video represent exchanges, and the dots that go flying represent individual orders.) Such behavior takes place roughly 100,000 times a day according the animation’s creator, Nanex. Many professionals in the industry within the financial industry understand its mushrooming supercomplexity:

Could this meltdown have been avoided? Should rating agencies have spotted it? Well, this is how it would work with the rating agencies when we were building a new CDO. They would tell us their parameters and criteria; if you meet this requirement, you get that rating and so on. And they gave out a free model so we could test our product and tweak our portfolio for the CDO until it fit, I mean get the rating that we wanted. We would do a lot of stress-testing ourselves too, of course we would. We’d pretend the market changed and run the models to see how our products would hold.

But what happened during the financial crisis was like a perfect storm. In our tests we would assume the market moved, say, 10% – while in reality it rarely moved more than 1%. Now the crisis happens and suddenly the market moves 30%. Our models were based on what we saw as normal. Now we saw numbers behave in ways barely conceived possible.

Consequentially, a quartet of corporate sector driven storm clouds hang on the horizon:

 Nanex ~ Order Routing Animation ~ 02-May-2013 ~ JNJ .Click to Enlarge.

Nanex ~ Order Routing Animation ~ 02-May-2013 ~ JNJ .Click to Enlarge.

  • Underfunded pensions from corporations with record amounts of cash and an investment climate skewed towards insiders and Wall Street
  • Their ongoing failure to hire new employees and consistent blockage of publicly funded programs to fund infrastructure investment
  • A largely fossil fuel derived economy that requires large scale degradation of  our present and next generations air and water resources
  • Over-priced/under-performing privatized healthcare drives healthcare inflation at unsustainable rates all the while forcing the good neighbors in US society to pick up the tab for the uninsured, many of whom are employed by highly profitable firms

Whats going on?

Why are record profits and CEO pay more and more divergent from the economic well being of the society’s whose labor and resources they use?

continue reading…