tag:blogger.com,1999:blog-66928447838189513282024-02-19T00:51:40.845-08:00Viewpoint by Chuck MartinChuck Martinhttp://www.blogger.com/profile/01165029253566700876noreply@blogger.comBlogger13125tag:blogger.com,1999:blog-6692844783818951328.post-23315922065201267972013-07-19T14:23:00.001-07:002013-07-19T14:23:16.218-07:00The Future of Higher Education<br />
<div class="MsoNoSpacing" style="margin: 0in 0in 0pt;">
<i style="mso-bidi-font-style: normal;"><span style="font-family: "Times New Roman","serif"; font-size: 12pt;">If you think the
world is coming to an end in two weeks, go to a college campus…it will take at
least two years.<o:p></o:p></span></i></div>
<span style="font-family: "Times New Roman","serif"; font-size: 12pt;">---Mark
Twain<o:p></o:p></span><br />
<br />
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<span style="font-family: "Times New Roman","serif"; font-size: 12pt;">Innovation has touched every aspect of
our lives…except education. There is no aspect of the human experience that has
been more vacant of innovation than education, especially higher education.
Innovation in education offers more opportunity for the advancement of society than
any other endeavor that could be pursued by mankind. Colleges and universities
continue to deliver their service in the same manner as they have for
centuries: A professor stands before a class of students delivers a lecture and
students read a text book. This is an archaic system that is on the threshold
of a massive transition. Certainly, established institutions will resist the
change as they always have throughout history. The concept of efficiency,
productivity and efficacy in the delivery of knowledge and skill has had no
place in the world of academia. We are now entering an agonizing period whereby
the educational delivery system will be completely restructured by innovation
and enabling technologies. The landscape in higher education is about to change
dramatically.<o:p></o:p></span></div>
<br />
<div class="MsoNoSpacing" style="margin: 0in 0in 0pt; text-align: justify;">
<b style="mso-bidi-font-weight: normal;"><u><span style="font-family: "Times New Roman","serif"; font-size: 12pt;">Today’s
education delivery system: <o:p></o:p></span></u></b></div>
<br />
<div class="MsoNoSpacing" style="margin: 0in 0in 0pt; text-align: justify;">
<span style="font-family: "Times New Roman","serif"; font-size: 12pt;">The educational delivery system
throughout history has been characterized by:<o:p></o:p></span></div>
<br />
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<span style="font-family: "Times New Roman","serif"; font-size: 12pt; mso-fareast-font-family: "Times New Roman";"><span style="mso-list: Ignore;">1.<span style="font-size-adjust: none; font-stretch: normal; font: 7pt/normal "Times New Roman";">
</span></span></span><span style="font-family: "Times New Roman","serif"; font-size: 12pt;">Students
show up to classrooms where professors deliver lectures.<o:p></o:p></span></div>
<br />
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<span style="font-family: "Times New Roman","serif"; font-size: 12pt; mso-fareast-font-family: "Times New Roman";"><span style="mso-list: Ignore;">2.<span style="font-size-adjust: none; font-stretch: normal; font: 7pt/normal "Times New Roman";">
</span></span></span><span style="font-family: "Times New Roman","serif"; font-size: 12pt;">Students
read textbooks<o:p></o:p></span></div>
<br />
<div class="MsoNoSpacing" style="margin: 0in 0in 0pt 0.5in; mso-list: l0 level1 lfo1; text-align: justify; text-indent: -0.25in;">
<span style="font-family: "Times New Roman","serif"; font-size: 12pt; mso-fareast-font-family: "Times New Roman";"><span style="mso-list: Ignore;">3.<span style="font-size-adjust: none; font-stretch: normal; font: 7pt/normal "Times New Roman";">
</span></span></span><span style="font-family: "Times New Roman","serif"; font-size: 12pt;">All
students, fast learners and slow learners are delivered the same instruction.<o:p></o:p></span></div>
<br />
<div class="MsoNoSpacing" style="margin: 0in 0in 0pt 0.5in; mso-list: l0 level1 lfo1; text-align: justify; text-indent: -0.25in;">
<span style="font-family: "Times New Roman","serif"; font-size: 12pt; mso-fareast-font-family: "Times New Roman";"><span style="mso-list: Ignore;">4.<span style="font-size-adjust: none; font-stretch: normal; font: 7pt/normal "Times New Roman";">
</span></span></span><span style="font-family: "Times New Roman","serif"; font-size: 12pt;">All
courses are the same length (a semester or quarter) regardless of the amount or
complexity of the content <o:p></o:p></span></div>
<br />
<div class="MsoNoSpacing" style="margin: 0in 0in 0pt 0.5in; mso-list: l0 level1 lfo1; text-align: justify; text-indent: -0.25in;">
<span style="font-family: "Times New Roman","serif"; font-size: 12pt; mso-fareast-font-family: "Times New Roman";"><span style="mso-list: Ignore;">5.<span style="font-size-adjust: none; font-stretch: normal; font: 7pt/normal "Times New Roman";">
</span></span></span><span style="font-family: "Times New Roman","serif"; font-size: 12pt;">All
classes operate on one hour cycles (45 minutes of lecture, 15 minutes to change
classes) and are delivered at a specific time and place convenient for the
professor and university. <o:p></o:p></span></div>
<br />
<div class="MsoNoSpacing" style="margin: 0in 0in 0pt 0.5in; mso-list: l0 level1 lfo1; text-align: justify; text-indent: -0.25in;">
<span style="font-family: "Times New Roman","serif"; font-size: 12pt; mso-fareast-font-family: "Times New Roman";"><span style="mso-list: Ignore;">6.<span style="font-size-adjust: none; font-stretch: normal; font: 7pt/normal "Times New Roman";">
</span></span></span><span style="font-family: "Times New Roman","serif"; font-size: 12pt;">Class
sizes are limited to 25-30 students and the physical plant is geared to that
sizing criteria. <o:p></o:p></span></div>
<br />
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<span style="font-family: "Times New Roman","serif"; font-size: 12pt; mso-fareast-font-family: "Times New Roman";"><span style="mso-list: Ignore;">7.<span style="font-size-adjust: none; font-stretch: normal; font: 7pt/normal "Times New Roman";">
</span></span></span><span style="font-family: "Times New Roman","serif"; font-size: 12pt;">Degree
programs are structured to graduate students in four, or five, years, assuming
class availability and reasonable student progress. <o:p></o:p></span></div>
<br />
<div class="MsoNoSpacing" style="margin: 0in 0in 0pt; text-align: justify;">
<span style="font-family: "Times New Roman","serif"; font-size: 12pt;">This is the “straight jacket” in which
higher education has lived for centuries. <o:p></o:p></span></div>
<b style="mso-bidi-font-weight: normal;"><u><span style="font-family: "Times New Roman","serif"; font-size: 12pt;"></span></u></b><br />
<b style="mso-bidi-font-weight: normal;"><u><span style="font-family: "Times New Roman","serif"; font-size: 12pt;">Innovation
Transforms Education:<o:p></o:p></span></u></b><br />
<br />
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<span style="font-family: "Times New Roman","serif"; font-size: 12pt;">Enabling technologies have emerged that
provide the power to transform the delivery of education. While in its infancy,
it is clear that we are at the doorstep of enormous changes in higher
education, if not indeed in the entire educational delivery system. This is
being brought on by the emergence of on-line courses and programs. These were
pioneered by for-profit enterprises, but are now rapidly proliferating
throughout the non-profit institutional space. Emerging companies, such as
Coursera, Udacity and EdX have led the way by providing an infrastructure for
the delivery of what are known as MOOCs or Massive Open On-line Courses. But
this is just the “tip of the iceberg”.<o:p></o:p></span></div>
<br />
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<i style="mso-bidi-font-style: normal;"><span style="font-family: "Times New Roman","serif"; font-size: 12pt;">We
can best understand this through an example. <o:p></o:p></span></i></div>
<br />
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<span style="font-family: "Times New Roman","serif"; font-size: 12pt;">A Stanford professor of mathematics
recently posted his course on differential equations on Coursera’s on-line
site. He put considerable effort into making the course interesting and an
effective learning presentation supplemented by good graphic illustrations,
video and other learning materials. He built in student progress assessment mechanisms
that permit the course program to triage learners into fast-forward or remedial
instruction tracks. In a course, such as differential equations, like majority
of others, there is little, or no, benefit to student interaction. 120,000
students took his course. As he puts it, “I have spent many man-hours every
semester for years teaching this course to only twenty students at a time.
Through the Coursera program I have taught more students in three months than
otherwise in my lifetime. It would have taken 1,000 professors six years to
teach the course to that many students.” In this example, we have seen a
glimpse of the future.<span style="mso-spacerun: yes;"> </span><o:p></o:p></span></div>
<br />
<div class="MsoNoSpacing" style="margin: 0in 0in 0pt; text-align: justify;">
<i style="mso-bidi-font-style: normal;"><span style="font-family: "Times New Roman","serif"; font-size: 12pt;">But
more is happening…much more.<o:p></o:p></span></i></div>
<br />
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<span style="font-family: "Times New Roman","serif"; font-size: 12pt;">Most MOOC courses are free and not for
credit and therefore do not apply toward a degree. That is beginning to change.
The first MOOC courses offered for credit were introduced in January, 2013 and
in May, 2013, Georgia Tech launched an entirely MOOC-based Master’s Degree for
$7,000.<span style="mso-spacerun: yes;"> </span>Students anywhere can take this
Master’s Degree program without ever setting foot in Georgia. This dramatically
expands the market for this Georgia Tech product.<o:p></o:p></span></div>
<br />
<div class="MsoNoSpacing" style="margin: 0in 0in 0pt; text-align: justify;">
<span style="font-family: "Times New Roman","serif"; font-size: 12pt;">A small university in New Hampshire
offers a number of on-line degree programs. These degree programs generated
over $130 million in revenue for the university during the last academic year
and produced an operating surplus of $29 million. While their brick &
mortar campus served 2,750 students, the on-line program enrollment was 25,000.
Students on campus paid an average of $112,000 in tuition, plus room, board,
books and other expenses for their degree. The cost of the same degree on-line
is about $38,000. Only twenty-five faculty members are required to provide the
instruction on-line.<o:p></o:p></span></div>
<br />
<div class="MsoNoSpacing" style="margin: 0in 0in 0pt; text-align: justify;">
<i style="mso-bidi-font-style: normal;"><span style="font-family: "Times New Roman","serif"; font-size: 12pt;">This
is a tidal wave that is forming and will transform higher education.<o:p></o:p></span></i></div>
<br />
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<span style="font-family: "Times New Roman","serif"; font-size: 12pt;">There will be vigorous resistance to
this change by faculty and administrators. They will argue that there is no
substitute for the classroom experience, the interaction between students and
the teacher. This is just so much B.S. and will ultimately give way to the
power of competition and economics.<o:p></o:p></span></div>
<br />
<div class="MsoNoSpacing" style="margin: 0in 0in 0pt; text-align: justify;">
<span style="font-family: "Times New Roman","serif"; font-size: 12pt;">While not all courses are well-suited to
on-line instruction, a huge portion are and can be delivered more effectively
through that modality. They will not be delivered by TAs or average faculty
members. Students will learn from the best.<o:p></o:p></span></div>
<br />
<div class="MsoNoSpacing" style="margin: 0in 0in 0pt; text-align: justify;">
<i style="mso-bidi-font-style: normal;"><span style="font-family: "Times New Roman","serif"; font-size: 12pt;">So,
what will change?<o:p></o:p></span></i></div>
<br />
<div class="MsoNoSpacing" style="margin: 0in 0in 0pt; text-align: justify;">
<span style="font-family: "Times New Roman","serif"; font-size: 12pt;">At the most fundamental level we can
expect important transformations in the way education is delivered. <o:p></o:p></span></div>
<br />
<div class="MsoListParagraphCxSpFirst" style="margin: 0in 0in 0pt 0.5in; mso-list: l1 level1 lfo2; text-align: justify; text-indent: -0.25in;">
<b style="mso-bidi-font-weight: normal;"><span style="font-family: "Times New Roman","serif"; font-size: 12pt; line-height: 115%; mso-fareast-font-family: "Times New Roman";"><span style="mso-list: Ignore;">1.<span style="font-size-adjust: none; font-stretch: normal; font: 7pt/normal "Times New Roman";"> </span></span></span></b><b style="mso-bidi-font-weight: normal;"><span style="font-family: "Times New Roman","serif"; font-size: 12pt; line-height: 115%;">Courses will become “productized”. </span></b><span style="font-family: "Times New Roman","serif"; font-size: 12pt; line-height: 115%;">Many
courses are commodity-like and can be structured into well-designed instructional
“products.” Top professors and universities are developing these on-line format
courses in a way that facilitates the learning of the content material and
makes it more interesting for students. These courses will not just be videos
of “talking heads’, they will be well-designed courses that deliver the
material in a compelling, easy-to-learn way.<b style="mso-bidi-font-weight: normal;"><o:p></o:p></b></span></div>
<br />
<div class="MsoListParagraphCxSpMiddle" style="margin: 0in 0in 0pt 0.5in; text-align: justify;">
<i style="mso-bidi-font-style: normal;"><span style="font-family: "Times New Roman","serif"; font-size: 12pt; line-height: 115%;">Examples of well-suited courses
include: accounting, chemistry, physics, biology, mathematics (algebra, statistics,
calculus, geometry, etc.), psychology, economics, astronomy, language studies
and more.<o:p></o:p></span></i></div>
<i style="mso-bidi-font-style: normal;"><span style="font-family: "Times New Roman","serif"; font-size: 12pt; line-height: 115%;"><span style="mso-spacerun: yes;">
</span></span></i><br />
<div class="MsoListParagraphCxSpLast" style="margin: 0in 0in 10pt 0.5in; mso-list: l1 level1 lfo2; text-align: justify; text-indent: -0.25in;">
<b style="mso-bidi-font-weight: normal;"><span style="font-family: "Times New Roman","serif"; font-size: 12pt; line-height: 115%; mso-fareast-font-family: "Times New Roman";"><span style="mso-list: Ignore;">2.<span style="font-size-adjust: none; font-stretch: normal; font: 7pt/normal "Times New Roman";"> </span></span></span></b><b style="mso-bidi-font-weight: normal;"><span style="font-family: "Times New Roman","serif"; font-size: 12pt; line-height: 115%;">Competency-based degree and course
credit programs</span></b><span style="font-family: "Times New Roman","serif"; font-size: 12pt; line-height: 115%;"> will replace time period based
instruction. The empowering character of MOOC, MOOC-variant programs and other
on-line technologies will empower the implementation of, and drive the demand
for, competency-based education. While largely in an experimental and
developmental stage, this approach to education is set to expand rapidly,
fueled in part by innovations in the application of technology.
Competency-based systems allow all learners to progress at their own pace, yet
assure that the student has adequately mastered the subject to merit the award
of the course credit and ultimately the degree.<b style="mso-bidi-font-weight: normal;"><o:p></o:p></b></span></div>
<span style="font-family: "Times New Roman","serif"; font-size: 12pt; mso-fareast-font-family: "Times New Roman";"><span style="mso-list: Ignore;">3.<span style="font-size-adjust: none; font-stretch: normal; font: 7pt/normal "Times New Roman";">
</span></span></span><b style="mso-bidi-font-weight: normal;"><span style="font-family: "Times New Roman","serif"; font-size: 12pt;">The pace of
learning will become variable; linked to the individual.</span></b><span style="font-family: "Times New Roman","serif"; font-size: 12pt;"> Fast learners,
and those that work harder, will progress through the learning experience at an
accelerated pace, not held back by those of average or sub-par learning
abilities. Slower learners will progress at a pace geared to their abilities
and work ethic. <o:p></o:p></span><br />
<span style="font-family: "Times New Roman","serif"; font-size: 12pt;"><o:p> </o:p></span><br />
<br />
<div class="MsoNoSpacing" style="margin: 0in 0in 0pt 0.5in; mso-list: l1 level1 lfo2; text-align: justify; text-indent: -0.25in;">
<span style="font-family: "Times New Roman","serif"; font-size: 12pt; mso-fareast-font-family: "Times New Roman";"><span style="mso-list: Ignore;">4.<span style="font-size-adjust: none; font-stretch: normal; font: 7pt/normal "Times New Roman";">
</span></span></span><b style="mso-bidi-font-weight: normal;"><span style="font-family: "Times New Roman","serif"; font-size: 12pt;">The rigid
structure of class periods, semesters and degree timelines will break down.</span></b><span style="font-family: "Times New Roman","serif"; font-size: 12pt;"> There is no
good reason why all courses should take exactly one semester. There is no
reason why class cycles should all run one hour. There is no reason why all
students should take four years (or more) to graduate.<o:p></o:p></span></div>
<span style="font-family: "Times New Roman","serif"; font-size: 12pt;"><o:p> </o:p></span><br />
<br />
<div class="MsoNoSpacing" style="margin: 0in 0in 0pt 0.5in; mso-list: l1 level1 lfo2; text-align: justify; text-indent: -0.25in;">
<span style="font-family: "Times New Roman","serif"; font-size: 12pt; mso-fareast-font-family: "Times New Roman";"><span style="mso-list: Ignore;">5.<span style="font-size-adjust: none; font-stretch: normal; font: 7pt/normal "Times New Roman";">
</span></span></span><b style="mso-bidi-font-weight: normal;"><span style="font-family: "Times New Roman","serif"; font-size: 12pt;">Instruction will
cease to be linked to the academic year schedule</span></b><span style="font-family: "Times New Roman","serif"; font-size: 12pt;">. There is no
good reason why students must begin their classes, all at the same time, in the
fall or at the beginning of a semester. They will be able to commence their
study at any time of the year.<o:p></o:p></span></div>
<span style="font-family: "Times New Roman","serif"; font-size: 12pt;"><o:p> </o:p></span><br />
<br />
<div class="MsoNoSpacing" style="margin: 0in 0in 0pt 0.5in; mso-list: l1 level1 lfo2; text-align: justify; text-indent: -0.25in;">
<b style="mso-bidi-font-weight: normal;"><span style="font-family: "Times New Roman","serif"; font-size: 12pt; mso-fareast-font-family: "Times New Roman";"><span style="mso-list: Ignore;">6.<span style="font-size-adjust: none; font-stretch: normal; font: 7pt/normal "Times New Roman";"> </span></span></span></b><b style="mso-bidi-font-weight: normal;"><span style="font-family: "Times New Roman","serif"; font-size: 12pt;">The physical classroom will become obsolete for
many/most courses. <o:p></o:p></span></b></div>
<br />
<div class="MsoNoSpacing" style="margin: 0in 0in 0pt 0.5in; text-align: justify;">
<span style="font-family: "Times New Roman","serif"; font-size: 12pt;">Universities
will need to rethink the structure and function of their physical plant.<o:p></o:p></span></div>
<b style="mso-bidi-font-weight: normal;"><span style="font-family: "Times New Roman","serif"; font-size: 12pt;"><o:p> </o:p></span></b><br />
<br />
<div class="MsoNoSpacing" style="margin: 0in 0in 0pt 0.5in; mso-list: l1 level1 lfo2; text-align: justify; text-indent: -0.25in;">
<span style="font-family: "Times New Roman","serif"; font-size: 12pt; mso-fareast-font-family: "Times New Roman";"><span style="mso-list: Ignore;">7.<span style="font-size-adjust: none; font-stretch: normal; font: 7pt/normal "Times New Roman";">
</span></span></span><b style="mso-bidi-font-weight: normal;"><span style="font-family: "Times New Roman","serif"; font-size: 12pt;">Much of the
curriculum becomes <i style="mso-bidi-font-style: normal;">commoditized</i></span></b><span style="font-family: "Times New Roman","serif"; font-size: 12pt;">. When we
examine the typical undergraduate college curriculum we discover that a
majority of the courses can be delivered better through well-designed internet-based
programs than through the terrestrial classroom format. These courses are
basically those that benefit very little by the interaction between a teacher
and students or between students.<o:p></o:p></span></div>
<span style="font-family: "Times New Roman","serif"; font-size: 12pt;"><o:p> </o:p></span><br />
<br />
<div class="MsoNoSpacing" style="margin: 0in 0in 0pt 0.5in; mso-list: l1 level1 lfo2; text-align: justify; text-indent: -0.25in;">
<span style="font-family: "Times New Roman","serif"; font-size: 12pt; mso-fareast-font-family: "Times New Roman";"><span style="mso-list: Ignore;">8.<span style="font-size-adjust: none; font-stretch: normal; font: 7pt/normal "Times New Roman";">
</span></span></span><b style="mso-bidi-font-weight: normal;"><span style="font-family: "Times New Roman","serif"; font-size: 12pt;">Social Media
will play an increasing role in education</span></b><span style="font-family: "Times New Roman","serif"; font-size: 12pt;">. The interaction between
students and teachers and the interaction between students has long been a
vital part of the educational process. Young people coming of age now are much
more into interaction through social media. Companies like Piazza are providing
an on-line gathering place for students to interact with university faculty and
other students in much the same way that they might in a classroom. However,
through this platform, interaction is available 24/7, not just during classroom
of office hours. Through platforms such as this, students will have social
interaction with classmates all over the country and the world. It is a growing
new medium for student interaction focused around their learning experience.<o:p></o:p></span></div>
<span style="font-family: "Times New Roman","serif"; font-size: 12pt;"><o:p> </o:p></span><br />
<br />
<div class="MsoNoSpacing" style="margin: 0in 0in 0pt 0.5in; mso-list: l1 level1 lfo2; text-align: justify; text-indent: -0.25in;">
<span style="font-family: "Times New Roman","serif"; font-size: 12pt; mso-fareast-font-family: "Times New Roman";"><span style="mso-list: Ignore;">9.<span style="font-size-adjust: none; font-stretch: normal; font: 7pt/normal "Times New Roman";">
</span></span></span><b style="mso-bidi-font-weight: normal;"><span style="font-family: "Times New Roman","serif"; font-size: 12pt;">Textbooks will
become obsolete.</span></b><span style="font-family: "Times New Roman","serif"; font-size: 12pt;">
Courses developed for on-line delivery will increasingly use excellent
graphics, audio and video with text presentations and will be programmed like a
computer. Tests, or built-in progress assignment mechanisms, will allow fast
learners to skip forward while rerouting others into remedial channels. This
will be far more powerful than textbooks which are linear in nature and have no
way to know how well the student understands what is presented. The on-line
course <u>will become the textbook in the future</u>.<o:p></o:p></span></div>
<span style="font-family: "Times New Roman","serif"; font-size: 12pt;"><o:p> </o:p></span><br />
<br />
<div class="MsoNoSpacing" style="margin: 0in 0in 0pt 0.5in; mso-list: l1 level1 lfo2; text-align: justify; text-indent: -0.25in;">
<b style="mso-bidi-font-weight: normal;"><span style="font-family: "Times New Roman","serif"; font-size: 12pt; mso-fareast-font-family: "Times New Roman";"><span style="mso-list: Ignore;">10.<span style="font-size-adjust: none; font-stretch: normal; font: 7pt/normal "Times New Roman";"> </span></span></span></b><b style="mso-bidi-font-weight: normal;"><span style="font-family: "Times New Roman","serif"; font-size: 12pt;">Degree Programs will be formed from a composite of
courses offered by multiple universities. </span></b><span style="font-family: "Times New Roman","serif"; font-size: 12pt;">Universities will begin
constructing degree programs that select, bring together and bundle courses
from other institutions to construct better academic offerings. Through this, a
student might take an approved course in mathematics from Stanford or the
University of Michigan, and economics course from a prominent faculty member at
the University of Chicago, a science class from MIT and a cluster of core
courses from the degree-granting university.<b style="mso-bidi-font-weight: normal;"><o:p></o:p></b></span></div>
<span style="font-family: "Times New Roman","serif"; font-size: 12pt;"><o:p> </o:p></span><br />
<br />
<div class="MsoNoSpacing" style="margin: 0in 0in 0pt 0.5in; mso-list: l1 level1 lfo2; text-align: justify; text-indent: -0.25in;">
<span style="font-family: "Times New Roman","serif"; font-size: 12pt; mso-fareast-font-family: "Times New Roman";"><span style="mso-list: Ignore;">11.<span style="font-size-adjust: none; font-stretch: normal; font: 7pt/normal "Times New Roman";"> </span></span></span><b style="mso-bidi-font-weight: normal;"><span style="font-family: "Times New Roman","serif"; font-size: 12pt;">Prices will come down.</span></b><span style="font-family: "Times New Roman","serif"; font-size: 12pt;"> For decades,
the cost of a college education has been rising. It has been rising faster than
any other product or service that consumers purchase (including healthcare).
The will soon come to an end. Ferocious competition is arriving at the doorstep
of higher education. Historically, universities have competed within fairly
narrow market segments, characterized by price, brand, geography, academic
offering and other factors. With the onset of course “products” and internet
delivery modalities, any university can compete anywhere anytime.<o:p></o:p></span></div>
<span style="font-family: "Times New Roman","serif"; font-size: 12pt;"><o:p> </o:p></span><br />
<br />
<div class="MsoNoSpacing" style="margin: 0in 0in 0pt 0.5in; mso-list: l1 level1 lfo2; text-align: justify; text-indent: -0.25in;">
<span style="font-family: "Times New Roman","serif"; font-size: 12pt; mso-fareast-font-family: "Times New Roman";"><span style="mso-list: Ignore;">12.<span style="font-size-adjust: none; font-stretch: normal; font: 7pt/normal "Times New Roman";"> </span></span></span><b style="mso-bidi-font-weight: normal;"><span style="font-family: "Times New Roman","serif"; font-size: 12pt;">Large populations of faculty will become obsolete,
unneeded.</span></b><span style="font-family: "Times New Roman","serif"; font-size: 12pt;">
The transformative in commodity type courses is likely to result in at least
half of all faculty positions at universities becoming unnecessary. Because of
the tenure system, universities will struggle to reduce their “headcount”
consistent with the decline in need for these employees. <o:p></o:p></span></div>
<span style="font-family: "Times New Roman","serif"; font-size: 12pt;"><o:p> </o:p></span><br />
<br />
<div class="MsoNoSpacing" style="margin: 0in 0in 0pt 0.5in; mso-list: l1 level1 lfo2; text-align: justify; text-indent: -0.25in;">
<span style="font-family: "Times New Roman","serif"; font-size: 12pt; mso-fareast-font-family: "Times New Roman";"><span style="mso-list: Ignore;">13.<span style="font-size-adjust: none; font-stretch: normal; font: 7pt/normal "Times New Roman";"> </span></span></span><b style="mso-bidi-font-weight: normal;"><span style="font-family: "Times New Roman","serif"; font-size: 12pt;">The Economic Model of Higher Education will change. </span></b><span style="font-family: "Times New Roman","serif"; font-size: 12pt;">The amount of
labor (faculty and administration time) to deliver on-line instruction is
small, especially when spread across a large number of students and multiple
years. Up-front there are capital costs to develop the courses, but all the
repetitive costs of professor lesson plan preparation and classroom delivery of
material will be eliminated. Thus, the costs per student will drop enormously
in this business model.<o:p></o:p></span></div>
<span style="font-family: "Times New Roman","serif"; font-size: 12pt;"><o:p> </o:p></span><br />
<br />
<div class="MsoNoSpacing" style="margin: 0in 0in 0pt 0.5in; mso-list: l1 level1 lfo2; text-align: justify; text-indent: -0.25in;">
<b style="mso-bidi-font-weight: normal;"><span style="font-family: "Times New Roman","serif"; font-size: 12pt; mso-fareast-font-family: "Times New Roman";"><span style="mso-list: Ignore;">14.<span style="font-size-adjust: none; font-stretch: normal; font: 7pt/normal "Times New Roman";"> </span></span></span></b><b style="mso-bidi-font-weight: normal;"><span style="font-family: "Times New Roman","serif"; font-size: 12pt;">Competition will intensify…significantly. </span></b><span style="font-family: "Times New Roman","serif"; font-size: 12pt;">The ability of
any university or professor to deliver courses anywhere, any time at a
competitive price (not burdened by labor or facilities costs) will transform
the markets for higher education. A university in New England will go after
students in the “backyard’ of a university in California (and vice versa). With
gross margins near 90 percent in the on-line offerings, price competition will
flourish. Universities with strong programs and strong brand equity in certain
academic specialties will do well in diverse geographic markets, while those
without distinction will struggle. Universities will need to learn how to
become effective at marketing. They can learn a great deal from the for-profit
sector regarding those strategies. The days of charging big tuition prices will
come to an end.<b style="mso-bidi-font-weight: normal;"><o:p></o:p></b></span></div>
<b style="mso-bidi-font-weight: normal;"><span style="font-family: "Times New Roman","serif"; font-size: 12pt;"><o:p> </o:p></span></b><br />
<br />
<div class="MsoNoSpacing" style="margin: 0in 0in 0pt 0.5in; mso-list: l1 level1 lfo2; text-align: justify; text-indent: -0.25in;">
<b style="mso-bidi-font-weight: normal;"><span style="font-family: "Times New Roman","serif"; font-size: 12pt; mso-fareast-font-family: "Times New Roman";"><span style="mso-list: Ignore;">15.<span style="font-size-adjust: none; font-stretch: normal; font: 7pt/normal "Times New Roman";"> </span></span></span></b><b style="mso-bidi-font-weight: normal;"><span style="font-family: "Times New Roman","serif"; font-size: 12pt;">An opportunity to improve educational efficacy.</span></b><span style="font-family: Calibri;">
</span><span style="font-family: "Times New Roman","serif"; font-size: 12pt;">When we
look on the bright side of what technology and innovation will bring to
education, the picture is exciting, but challenging. It offers to free
educators from the “mundane” instruction that they deliver in the traditional
format of today’s system. That will be empowered to focus on more valuable
learning experiences for students. There is much that technology cannot do
well. Many areas benefit from interaction with the teacher and other students.
Communication and thinking skills are among these. The social and philosophic
development of young people also requires beneficial interactivity. How do you
teach critical thinking, analytical processes, and problem solving? How do you
teach a student to persuasively convey his or her ideas? How do they harness
the power of interrogative means to get to the bottom of an issue? <span style="mso-spacerun: yes;"> </span>In the new world, educators will be challenged
to step up to the full intellectual and personal development of the whole
person.<b style="mso-bidi-font-weight: normal;"><o:p></o:p></b></span></div>
<br />
<div class="MsoNoSpacing" style="margin: 0in 0in 0pt 0.5in; text-align: justify;">
<span style="font-family: "Times New Roman","serif"; font-size: 12pt;">Innovations enabled
by technology need not spell the demise of (all) universities. But certainly
big adjustments must be made. With compellingly more efficient, more effective,
less costly means to deliver a large part of college education coming soon, it
is imperative that academic leaders rethink their business models and their
strategy. <o:p></o:p></span></div>
<br />
<div class="MsoNoSpacing" style="margin: 0in 0in 0pt 0.5in; text-align: justify;">
<span style="font-family: "Times New Roman","serif"; font-size: 12pt;">University
leaders always put down for profit education companies, yet they are soon to
enter their domain. For-profits education companies have advantages. They do
not carry the heavy costs of athletic programs, bloated bureaucracies and
expensive facilities. They also focus on delivering customer value, i.e.
education and placement instead of “research”. They have also developed a core
competency in marketing; in recruiting customers (students). They are
unburdened with the baggage of tenure and are free to hire the best faculty and
get rid of weak performers. Non-profits are wise to learn from these
competitors.<o:p></o:p></span></div>
<span style="font-family: "Times New Roman","serif"; font-size: 12pt;"><span style="mso-tab-count: 1;"> </span><o:p></o:p></span><br />
<span style="font-family: "Times New Roman","serif"; font-size: 12pt;"><span style="mso-tab-count: 1;"> </span><b style="mso-bidi-font-weight: normal;">In pursuit of the provision of value<o:p></o:p></b></span><br />
<br />
<div class="MsoNoSpacing" style="margin: 0in 0in 0pt 0.5in; text-align: justify;">
<span style="font-family: "Times New Roman","serif"; font-size: 12pt;">All goods and
services are measured by consumers by the value they deliver (i.e. what one
procures, divided by its cost). Strangely, neither producers nor consumers of
higher education have focused on this concept. The title wave of intense
competition that is coming will change that. Universities have benefited,
especially recently, from the strong demand for their services, giving them the
opportunity to increase prices aggressively, in lock-step. This has been fueled
by a weak job market. High school graduates cannot find employment, so they opt
to go to college. Also, college education promises better jobs when they
graduate, a promise that many are finding vacant. Also, fueling this demand is
the excessive availability of student loans with lenient borrowing standards. This
is another factor driving prices up at an unsustainable and unreasonable rate.
Because of the unwise public policy making such loans easily available, many
young people will ultimately suffer under the burden of the ill-advised
acquisition of debt they accumulated to get their education. A huge portion of
young people pursue academic majors that offer little prospect of gainful employment.
They simply have a good time in college studying fun subjects that interest
them, but have little value in preparing them for a viable career or for any
meaningful employment. They graduate with a mountain of debt, but without the
economic ability to live independently. This is just plain wrong.<o:p></o:p></span></div>
<br />
<div class="MsoNoSpacing" style="margin: 0in 0in 0pt 0.5in; text-align: justify;">
<span style="font-family: "Times New Roman","serif"; font-size: 12pt;">Educators must
change this equation. The concepts of educational productivity and efficacy
must become imperatives in their profession. They must embrace the idea of
delivering more educational efficacy through innovation and enabling
technologies. They must be willing to let go of the old ways of doing things
and aggressively look at new modalities for the delivery of education. They
must focus on the comprehensive intellectual and personal development of
students. Moreover, priority must be given to providing young people with the
skills and knowledge to become employed as productive members of society.<o:p></o:p></span></div>
<br />
<div class="MsoNoSpacing" style="margin: 0in 0in 0pt; text-align: justify;">
<span style="font-family: "Times New Roman","serif"; font-size: 12pt;"><o:p> </o:p></span><b style="mso-bidi-font-weight: normal;"><span style="font-family: "Times New Roman","serif"; font-size: 12pt;">Evolution and Revolution<o:p></o:p></span></b></div>
<br />
<div class="MsoNoSpacing" style="margin: 0in 0in 0pt 0.5in; text-align: justify;">
<span style="font-family: "Times New Roman","serif"; font-size: 12pt;">Early
adopters/innovators will benefit from the massive transitions that are
beginning. Like the progressive university in New Hampshire, incremental
revenue and operating surplus can be generated from the extension of their
business model into cyberspace. Such offerings will dramatically extend their
market reach. On-line programs will also expand the market to include
“customers” that are geographically “challenged” such as those in military
service or others in families employed overseas where access to college
education is limited. American Public Education (APEI) has made a very
successful business serving this market and has current enrollment of 130,000
students. Working adults have always been a good market for these programs, but
there is no reason that they need to be limited to the adult education market.
Soon the lines will become blurred between adult and traditional campus
programs offered to high school graduates.<o:p></o:p></span></div>
<br />
<div class="MsoNoSpacing" style="margin: 0in 0in 0pt 0.5in; text-align: justify;">
<span style="font-family: "Times New Roman","serif"; font-size: 12pt;">However, while
initially the market will expand and first movers will prosper, the advent of
elevated competition, price pressure and the conversion of campus-based
enrollment to on-line will pose a very serious challenge for most universities.
Traditional, high-tuition-paying enrollment will drop significantly as students
increasingly choose a less costly and better educational experience on a
cyber-campus. For those laggard institutions that do not seize the moment to
transform their operating models, revenues will decline sharply and many
universities will face extinction. <o:p></o:p></span></div>
<span style="font-family: "Times New Roman","serif"; font-size: 12pt;"><o:p> </o:p></span><br />
<div class="MsoNoSpacing" style="margin: 0in 0in 0pt 0.5in; text-align: justify;">
<i style="mso-bidi-font-style: normal;"><span style="font-family: "Times New Roman","serif"; font-size: 12pt;">Within 15 years, half of the universities in America
will become insolvent.</span></i></div>
Chuck Martinhttp://www.blogger.com/profile/01165029253566700876noreply@blogger.com1tag:blogger.com,1999:blog-6692844783818951328.post-43311915530752559982011-04-15T09:33:00.000-07:002011-04-30T11:43:12.566-07:00Looking over the Horizon - US Economic Challenges beyond the Near TermAs our political leaders gather to raise the debt ceiling and debate yet another profligate budget, many now increasingly ask “Where does this lead?”; How will this all end?” It is a worrisome consideration for all of us.<br />
<br />
<strong><em>America’s Financial Situation</em></strong><br />
<br />
The national debt (Federal only) now exceeds $14 trillion (putting that painful number on paper, it is $14,000,000,000,000). Over the last decade that number has been soaring. Historically, the US debt load has been about 35% of GDP where it was just 12 years ago. The IMF projects that by 2015 it will reach 100% of the GDP (about the level of Greece today). America has an addiction to debt. It will come to an end. If we do not deal with it through our own (painful) public policy initiatives, it will be imposed upon us by the global capital markets.<br />
<br />
Federal spending now exceeds tax revenues by 42% and was 12% of GDP in 2009 and 10%+ in 2010. There is no end in sight for the spending binge by our political leaders. If one thinks about this in the context of a business, it would be like a company that was losing 42% on revenues every year. It would be like a family that spends 42% more each year than they earn. For any such company or family, it could only be accomplished by borrowing from the future to have a better life today. But some day the future comes around…and it is approaching us today. <br />
<br />
Another troubling way to look at our financial plight is to examine the growth of government as a fraction of the US economy. Government spending (federal, state & local), as a fraction of the economy, stood at about 12% a century ago. By the 1930s it had grown to 22%; by 1960 it grew to 28%. Then it began to accelerate especially in the last decade, reaching the 47% level currently. Think about that. Government spending is now almost the same size as the private economy. This is scary, since the government produces nothing, uses the nation’s wealth rather than creating it and is not the source of tax revenues. The burden of carrying the economy falls exclusively on the private sector.<br />
<br />
When we think about a nation’s currency, it is useful to think about it like the stock of a company. Would you want to own the shares of a company that was running such big losses, experiencing very little growth and deep in debt? Furthermore, printing money is like issuing a lot more stock. It dilutes the value of the currency…in the same way that issuing more shares in a company dilutes the ownership of shareholders.<br />
<br />
<strong><em>Next 2-3 Years</em></strong><br />
<br />
We are currently in a relative period of calm. The US economy is showing signs of improvement, albeit tepid. Inflation and interest rates are low in America. The US Dollar is gradually weakening, but trading calmly, helped by its reserve currency status. As the world’s reserve currency, US dollars are used to trade oil and other commodities. Therefore, foreign governments and companies must buy our currency to affect their transactions. According to the Bank for International Settlements, the US dollar was used in nearly 87 percent of all international currency transactions during 2010. Central banks around the world, especially in emerging nations, continue to purchase large amounts of US Treasuries (keeping interest rates low). <br />
<br />
But increasingly our nation’s creditworthiness is coming into question. By the beginning of this year, many other nations had credit ratings better than the US (among them Finland, Sweden, Singapore and Norway). In coming years our nation’s creditworthiness is certain to slide further, increasing our borrowing costs. It is noteworthy that PIMCO, the world’s largest bond investor, sold all of its US Treasuries in April this year. The global financial markets are already sorting out the differences between those nations that have low debt burdens and low government deficits and those that do not. In addition to being reflected in the credit rating of nations, it also shows up in the value of their currencies. One can see the effect of this in the chart showing the two-year appreciation of currencies of a sample of nations that exhibit solid growth but are comparatively unlevered with debt and operate with low government deficits. <br />
<br />
This is a serious problem and our nation’s political leaders must find the courage to deal with it. The political debate has heated up, talking about the nation’s debt and deficits…but it is doubtful that anything meaningful will be done. In their Panglossian way they will ultimately push the problem down the road into the future.<br />
<br />
Also, propping up our economy these days is an unprecedented accommodative monetary policy. With the Fed at a near zero interest rate policy level and printing money like it is “going out of style” (as it may), it is no wonder that things have (superficially) improved a little.. But this cannot go on forever and what happens when the stimulus is withdrawn? The headlines say that the US GDP is growing in the 3 ½ percent range. But if one were to subtract out the 10 percent of GDP that the government is spending in excess of its revenues (the deficit), the nation’s growth would be negative. Can the private sector, that has been “jump started on hormones”, keep growing and begin carrying the nation forward?<br />
<br />
<strong><em>Where does this lead us?</em></strong><br />
<br />
This leads us to the question “What happens over the horizon, beyond the next 3-5 years?” To assess this, we must ask some tough “What if?” questions. What if foreign buyers of our national debt (mostly emerging market central banks) lose faith in our government’s creditworthiness; our political will to manage our country’s financial affairs in a conservative, responsible way? Or what if they simply want to repatriate those funds for their own domestic purposes…or they decide to diversify away from holding almost exclusively US dollars as foreign currency reserves? Under any of these scenarios, the US dollar drops sharply, interest rates move up and inflation accelerates as the cost of imports rise sharply. This is not a pretty picture.<br />
<br />
As we look out beyond 2020, the costs of embedded entitlements, defense spending and debt service become untenable, consuming most of our national resources. It is often said that the national debt is a burden that we place “on the next generation”. It now appears that the storm is approaching faster and will probable set in in sooner, rather than later. <br />
<br />
What it means is that America must live within its means and begin doing so soon. Austerity is tough medicine as the people of Greece and Ireland are learning. This will come at a price. It will lower the standard of living in this country and slow the progress in developing nations around the world, since we are their biggest customer. But it must be done to avoid catastrophe. However, many nations have gone through the process moving from socialistic excess to responsible fiscal management, and have gone on to more prosperous times. Think about the turnaround that Margret Thatcher engineered in the UK during the early 1980s.<br />
<br />
An American transition to “living within its means” also has significant foreign policy implications as our nation pulls back from being the world’s policeman and providing many nations with economic aid.<br />
<br />
America remains the greatest nation on the planet earth, but has lost its way. It can regain its strength and prosperity only by returning to the principles that made it great in the first place (individual freedom, rewarding hard work, risk taking and investment, promoting/nurturing private sector enterprise, shrinking the size & spending of government). Those principles created our national wealth. No country can be generous that does not first achieve and sustain its national wealth.<br />
<br />
The growth of government and tax policy began to change that, decades ago. The nation’s tax system was created to cover the cost & investment in those things that were in the common good (infrastructure, education, defense, law enforcement and public safety). At some point it became a system for the redistribution of wealth, to take from the producers and to give to the users in our society. This has been accelerating as politicians see their opportunity to give away benefits to a larger cohort of voters, instead of advancing public policies that make our economy more efficient, innovative, and enterprising on the world’s competitive stage. In the end, we live in a competitive world, where labor, capital, and prosperity migrate to the strongest player. <br />
<br />
<em>Post note: This essay was written originally on April 15, 2011. On the following Monday, Standard & Poor’s downgraded the US credit outlook to “negative” the lowest level since the Pearl Harbor invasion in 1941.</em>Chuck Martinhttp://www.blogger.com/profile/01165029253566700876noreply@blogger.com1tag:blogger.com,1999:blog-6692844783818951328.post-73574246971905600512010-12-14T18:09:00.000-08:002010-12-15T12:02:50.720-08:00The Investment Landscape: 2011+ - Opportunities and HazardsWhile the “great black swan” event of 2008 has past, the aftermath has left us in a changed world. The investment landscape is more heterogeneous than in the past. From a global macro point-of-view, some economies are prospering, some are failing and some are struggling with the new realities. This presents a more complex set of opportunities and risks than we experienced historically. Indeed as we look forward "there are many wild cards in the deck" for 2011 and beyond which present challenges for even the most sophisticated investor. While we may form a position on the likely scenario going forward, we must keep in mind that these "wild cards" can show up at any time.<br />
<br />
<br />
<strong>Inflation: A Contrarian View?</strong><br />
<br />
At least 90% of all investors polled expect inflation to emerge in the US economy. One only needs to look at a recent auction of treasury inflation-protected securities (TIPS) which sold at a negative yield to know where investor sentiment is on this issue. Imagine that, paying someone to hold your money and give it back later. It is easy to understand why most might hold this view. The monetarists' theory asserts that when the US prints money (particularly the high quantities that the Fed is today) then inflation follows. <br />
<br />
I hold a contrarian view. In the US, deflation is a bigger risk and a much more frightening scenario to contemplate. We know how to deal with inflation and it’s not so bad in modest doses. On the other hand, if deflation gets entrenched, it is very difficult to contain (as Japan, ravaged by deflation for two decades, has learned) and can be devastating as asset values drop, family wealth disappears and leveraged assets (such as real estate) go underwater. Our current circumstances demand that we look beyond the simple monetarist theory. I believe that the Fed is very worried about this and it is one of the unstated reasons that they are printing so much money. If deflation gets traction, it can be very “sticky”; it acts like a spiral down.<br />
<br />
In order to examine the contrarian argument one must look at the fundamental forces that influence the inflation rate. Such observations reveal many potent deflationary drivers in the US economy:<br />
<br />
<strong>Unwinding The Credit Binge</strong><br />
<br />
The US economy is undergoing a massive deleveraging in the aftermath of a decades-long credit “binge” (consumers, banks/lending entities, investors & businesses: virtually all components of the private sector). Why are banks stingy with lending? It is because they are reducing the ratio of their loan portfolio assets to their capital (deleveraging). Consumers are paying down their credit cards and walking away from underwater mortgages. <br />
<br />
In deleveraging economies there are more sellers than buyers; causing asset values to fall and final demand to decline. As aggregate credit contracts the economy shrinks. This is a very deflationary force. Seeing asset prices fall (real estate is, of course, the big one) buyers tend to delay their purchases, waiting on a lower price and not wanting to own something that will decrease in value. The purchase of a new home is typically accompanied by a surge in other consumer purchases (household appliances, tableware, furniture, insurance, etc.). So delayed asset purchases also decrease other consumer spending and this slack demand leads to a loss of pricing power by producers. All of this is a closely linked, integrated syndrome.<br />
<br />
Real estate prices will be under long term pressure for other reasons: a big pipeline of forclosues, a large shadow inventory of sellers that have not yet put homes on the market, an increasing practice of homebuyers simply walking away from their underwater mortgages/homes leaving them vacant and owned by lenders and a huge inventory of unoccupied homes resulting from years of overbuilding (2nd homes and spec homes). Approximately 11 million homes in America are unoccupied at this time. <br />
<br />
The situation is only slightly better in the commercial, retail and industrial sectors of the real estate market where a long period of overbuilding has left the US with excess capacity and a flat to negative absorption rate trend. We simply have too many stores, too much office space and too much industrial space. This surplus in real estate assets must be worked off over time, a process that is likely to take years.<br />
<br />
<strong>Idle/Slack Capacity</strong><br />
<br />
The economy is flush with idle capacity (labor markets and industry) and weak final demand. This leaves producers without pricing power at the point-of-sale and backward through the supply chain (wages, facilities, suppliers, etc.). Unemployment is, perhaps, the biggest negative catalyst in our economic system. It is not likely to get better for a long time. <br />
<br />
Commodities are the only area where prices are firm because they are portable between economies and elsewhere (emerging markets) on the planet demand is strong. However, the commodities component in the US inflation picture is overwhelmed by the other, larger forces. <br />
<br />
<strong>Mindset</strong><br />
<br />
Consumers are worried about the economy and businesses are cautious about expansion. Both are saving at unprecedented rates, rather than spending. Consumers in mainstream America are reigning in their spending and moving down market on item price points. This is not necessarily a bad thing, except that it means that the economy will not grow. Nothing will change on this in any substantial way until/unless there is an improvement in the unemployment situation, a scenario that looks quite unlikely. However, we can expect a modest improvement in spending in some of the better-off consumer categories as people have become a little less concerned about losing their jobs and are a little more optimistic about the future.<br />
<br />
<strong>A Mixed Landscape</strong><br />
<br />
While America and the EuroZone may face deflation, those nations that have growing economies (China, India, Brazil and other Emerging Nations) face inflation pressures. Even in the US it will be a mixed issue since we are likely to see prices firm or up in some categories (energy, agricultural commodities and industrial metals (iron ore & copper). On the other hand… housing, labor, consumer & industrial goods and other items are likely to see falling prices.<br />
<br />
<strong>Currencies: a Growing Issue</strong><br />
<br />
What will happen to the US dollar? What will happen to the Euro, the Yen and others?<br />
<br />
To be sure, this is a growing issue between nations. There is growing talk of “currency wars” as some endeavor to keep their currencies from rising or to lower their value in order to help them compete in the world markets…so that they can keep their own domestic economies healthy. <br />
<br />
Except for the rare economies that have capital controls and/or fixed exchange rates (China, Saudi Arabia and a few others) this is a futile effort. The world’s markets will move the exchange rates as they wish. <br />
<br />
If the USD was not the world’s reserve currency, it would decline severely. There is little to support its value from a fundamental stand point (profligate government spending, public debt, weak economy, unfavorable trade balance, etc.) Offsetting this is the international demand for US dollars. Oil is bought and sold in dollars across the world. The same is true for most other commodities. When mines in Australia sell/ship iron ore and other industrial metals to China, Japan and Korea they are paid in US dollars. This creates a demand for US dollars and our Fed is happy to print more to serve the needs in the growing parts of the world.<br />
<br />
Perhaps the biggest driver of the dollar’s direction is the level of fear and uncertainty in the world. When fear rises, money flows into the USD. When fear wanes, the dollar falls (as it is driven by unfavorable fundamentals). If there is a break out of war on the Korean peninsula, the dollar will move up. If more European nations (Portugal, Spain, and Italy) fall into financial jeopardy, the dollar will rise. In the absence of these, the dollar will fall…particularly against <br />
<br />
Emerging Market currencies of nations that have political stability. Near term, that is the most likely case.<br />
<br />
When one contemplates the direction of the US dollar, it is essential that we ask “versus what?” With currencies, it is a relativity issue. The US dollar may hold its own or strengthen against the Euro, Pound and Yen…but weaken against the Asian currencies (e.g. Singapore, Indonesia, Korea) and natural resources-rich nations such as Australia, Brazil, Norway, Chile and Canada. <br />
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In an economic paradox Germany, the world’s second largest exporter (only last year passed by China) is benefitting greatly from a weak Euro, dragged down by other troubled European countries. The favorable exchange rate has boosted the competitive position and profitability of its industries (autos, industrial/equipment, chemicals, pharmaceuticals, etc.).<br />
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A huge amount of the support for the US dollar also comes from the economic fear that is widespread across the planet…largely resulting from the credit/liquidity crisis of 2008, but now exacerbated by the financial crisis facing Europe. This fear drives capital into “safe havens” and the US is the primary beneficiary. If fear wanes and an appetite for risk returns, capital will flow out of the USD and its value will decline.<br />
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<strong>The Euro is doomed!</strong><br />
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The biggest risk to the world’s economy is Europe and the Euro. In my opinion it is highly unlikely that the euro will survive as a currency. The economies, political conditions, financial strength, and values of the different nations that make up the union are simply too different. The huge public debt load of the Club Med countries, Ireland and others is an overwhelming burden that cannot be solved without massive restructuring. Currently, member countries are happy to “kick the can” down the road and implement austerity measures in an effort to solve the problem. It will not work and eventually they must face the fact that the debt cannot be repaid. In Ireland, the public debt load is about 170,000 euros ($220,000) for every man, woman and child. There is no chance that bond holders will get paid in full. In Greece, the austerity measures, high taxes and declining economy are causing a massive exodus of businesses, wealthy families and investment capital. The problems of Greece and Ireland, with Portugal, Spain and Italy at risk promise contagion across the region as European banks are forced to write off sovereign and other debt, leaving their balance sheets wasted in the process. If they had their own currency, they would devalue it, but they are lock stepped together which limits their individual options. The EU will vigorously defend the euro, because unwinding it would be traumatic. However, ultimately the huge challenges of defending it by the few strong nations may mark the demise of the currency.<br />
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This is not a good scenario for the world as we are all interdependent to some degree.<br />
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<strong>Bond Market/ Interest Rates</strong><br />
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In most of the world’s markets interest rates are determined largely by market conditions (credit quality, duration, currency risk). Rates in the US have been pushed down artificially by public policy initiatives of the Fed. While this is an effort to stimulate the economy, it is also self-serving in that the Fed’s big brother, the US Treasury, is the biggest borrower on the planet. So the Fed & Treasury want to keep borrowing costs low in order to feed the huge deficit spending activities of our government. <br />
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The other motivation is to avoid exacerbating the mortgage and banking crisis. If interest rates were to rise, more mortgages would go under, foreclosures would accelerate and the hit to bank balance sheets would be devastating. Even now, if these mortgage assets were marked to market values, perhaps all bank capital would disappear. Therefore, we can expect that monetary policy will continue to be “accommodative” for years to come. Also holding down rates is the fact that there is little private demand for credit, due to sluggish economic growth and the deleveraging of the consumer sector and lending institutions. <br />
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The mood of the Fed may be changing, however. Many members are becoming more conservative and the three new members expected in 2011 will probably be conservative leaning, thus Bernanke strategy may come under pressure. Furthermore, QE2 may be his last instrument for holding down rates. Then the market, a much more powerful force, will take over.<br />
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Investors are now confronted with a dilemma: US Bonds with investment grade credit quality pay very little yield. To get yield, investors must go out on the maturity curve to longer durations. That territory is loaded with risk since rates are near decade-old lows. If rates go up, bond prices will drop like a rock. If they invest in short duration instruments, the yield is paltry. Bonds with lower credit quality have had a good run as the economy has improved and liquidity has returned to the capital markets. However, it is likely that such gains have come to an end. The great bull market for bonds is likely to be near its peak.<br />
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A cautionary consideration regarding this belief is that, if deflation becomes entrenched for an extended period of time, bonds could appreciate, even from this elevated point.<br />
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One possible answer to this dilemma is to invest in foreign bonds that trade at market rates without excessive public policy manipulation. While one must have the “stomach” for currency risks, intelligently placed bets offer a currency attribution opportunity that can add to the returns of those international bonds…and provide diversification away from the US dollar. However, one must be very selective in the selection and vetting of such foreign bonds.<br />
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<strong>Will The European Union Implode?</strong><br />
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Perhaps the biggest risk facing the markets and the world economy in the near term is the financial instability of the Eurozone. In that arena there is a lot to be concerned about. Earlier we addressed the euro’s risks, but the region’s economic challenges go well beyond its currency. For the most part the economies of old Europe are inefficient, uncompetitive and burdened by restrictive labor laws, a profligate welfare system, declining fertility rate and a population that values leisure more than work effort and entrepreneurial initiative. It must be a huge concern that the contagion of this economic disaster spreads from Greece to Ireland, to Portugal to Spain, to Italy…and brings down “the Union”. There can be no question that this leads to a bad outcome.<br />
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Germany is the lone exception. They make good products, work hard, have conservative economic values and are one of the most amazing exporters on the planet. Think of a nation only one third larger than the size of Ohio that is so productive and competitive that they out-export the United States, Japan and stand equal to China. The time will come when they grow weary of propping up retirees in Greece and the other people enjoying the good life in the club med countries of the European Union. If the “sugar daddy” pulls out, the euro sinks. Eventually, they will want the deutschmark back.<br />
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<strong>Is China a “Bubble”?</strong><br />
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Many say “China is a bubble.” I have a contrasting view. My opinion is that the growth of China will continue for decades. Perhaps not at the same rate but certainly at a very high rate compared to the nations of the developed world. <br />
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The reasons for this are simple and powerful:<br />
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1. China has a strong balance sheet. It has no sovereign debt, a huge trove of foreign reserves and substantial natural resources (although it has little in the way of oil reserves).<br />
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2. Its people are hard-working, industrious, self-reliant and entrepreneurial. <br />
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3. The middle class is growing rapidly. According to the IMF about 300 million in China can be classified as in the middle class. Their way of life is getting better and they have an optimistic view of the future.<br />
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4. Chinese consumers are unleveraged, most have zero debt. They rarely use mortgages when purchasing real estate and most do not have credit cards. On the rare occasions when they purchase a home with mortgage financing, they must put down a minimum of 30 percent.<br />
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5. The consumer economy is beginning to “boom” in China. Retail sales are growing at the impressive rate of 18% annually and every major retailer across the planet is opening stores there. Demand is very strong. China auto sales this year were 16 million units vs. 10.5 million in the US and they are not just buying small inexpensive cars. <br />
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6. Government policy action is very constructive for the economy. In America, stimulus to fight the downturn flowed mostly into unemployment benefits, bail-outs and other spending type uses of the funds. China also deployed a “stimulus” but it was an “investment” type of expenditure…putting funds into infrastructure, modernizing the power grid and building power generation facilities, expanding the school system (and building new universities), upgrading the communications network…and many other things to make the China economy more efficient and more competitive. China has a long term view and it’s recently announced 5-year Plan is a very thoughtful roadmap for the future. <br />
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7. In spite of its communist political system, the Chinese government is very business-friendly. It will often support or partner with private enterprise on development activities and, for the most part, will allow companies a great deal of freedom from burdensome regulation. Things tend to get done fairly quickly without a huge debate. <br />
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Despite these positives, any investor in China or business entering that market should be aware that you are “playing on their home court…by their rules”. A Western investor or business man would be naïve to approach their endeavors without understanding the differences in the cultural, business practices and the political/legal system.<br />
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Certainly, China is not without risk considerations also. The rapid construction rate is not sustainable over the long term and will surely slow. Real estate prices could decline, but because buyers typically do not finance their purchases, there is virtually no chance of a mortgage market driven collapse such as occurred in the US and some other developed nations. There is also a legitimate concern over the aggressive lending practices of China’s regional banks. This could lead to a problem, but because they are state owned, a collapse is unlikely. The government recognizes these risks and is in the process of tightening controls on speculative activity while moving forward with infrastructure investment at the same time (95 new airports, 200 new universities, a fast rail system to interconnect key parts of the country, power generation and grid, etc.).<br />
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China is not alone in this track to prosperity. Much of Asia (ex Japan) is on a similar trajectory. Also, other developing/emerging nations are also on a very positive track (Brazil, India, Israel and others). Even some “Frontier Nations” are showing good economic growth. What they have going for them is that they are relatively unleveraged with consumer or public debt, have strong growing middle classes, people with a strong entrepreneurial work ethic, have little legacy entitlement social welfare programs and supportive governments. The emerging story of these countries is less today their export dependency (and competitiveness) but the strong growth of their internal, domestic economies.<br />
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<strong>The Equity Market Outlook</strong><br />
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My general opinion is that the equity markets will move up in 2011. A key consideration is investor’s appetite for risk. We have been in a period where that appetite has been low for a few years now. Investors have been “hunkered down” primarily focused on capital preservation strategies. That is beginning to change. There is a huge amount of money on the sidelines, earning essentially nothing. The flood of money into the bond market has caused it to be overbought. If bond prices start to fall, there will be a “stampede for the door” which will accelerate the decline. We may look back on this as a “bond bubble” in the future. A significant portion of those funds will move into the equity markets…which now look comparatively inexpensive.<br />
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While there is trouble brewing in Europe, the US economy is showing a few signs of firming. Economic data is showing a positive trend. No one reasonably expects a strong recovery, but likewise the threat of a “double dip” seems to be waning. This makes investors more comfortable moving into risk assets. <br />
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We are also seeing volatility decline. The VIX (volatility index) has dropped from a peak of 60+ to 17.25 over the last two years. This signals a drop in the anxiety level of investors and therefore, a move to equity exposure. <br />
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While many companies are stuck in neutral, many are financially strong and beginning to show top line growth. Among the vast number of public companies there is a cohort that is doing incredibly well. So some observers look at the correlation of S&P stocks at 80% and say, there is no way to add alpha by stock selection (which has been true for large funds limited to S&P market cap size companies). However, it is not true across the wider spectrum where many excellent companies are prospering, while others struggle. Share prices are now making this distinction. Furthermore, within the large cap sector, it seems likely that the correlation trend will reverse going forward as fundamentals are beginning to drive market prices once more.<br />
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With stock prices trading at reasonable levels (most estimates put the S&P 500 at a 13.4X multiple), the aversion to risk showing some signs of waning and capital beginning to move back into the market from the sidelines, there is good reason to expect equities to move up in 2011. <br />
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As a prognosticator, I would expect the stock market to be up at least 15% by the end of the year.<br />
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<strong>Risk Factors</strong><br />
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Most investors share a common view of the principle risk factors that form part of the landscape as we move forward in 2011. Bear with me to list them.<br />
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1. Expansion of the financial trauma in the Eurozone.<br />
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2. Deceleration of the growth engine in China, lessens its effect of lifting the world economy<br />
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3. Financial problems of US State & Local governments may magnify<br />
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4. Fed policy of accommodation may shift with the likely addition of three new conservative members to the Board (filling vacancies).<br />
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5. Unemployment may move back up over 10%<br />
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6. Geopolitical risks from rogue nation actions (N. Korea, Iran, etc.) or a growing realization that we will not succeed in Afghanistan.<br />
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7. Terrorist attacks<br />
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8. Public policy changes arising out of political power shifts.<br />
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Even though the credit crisis has past, we are reminded that we live in a world with many dangers.<br />
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<strong>Investment Themes and Strategies</strong><br />
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Reflecting on the landscape conditions discussed above, the question becomes “What action should an investor pursue in this environment?” The following are a few thoughts on that matter.<br />
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1. In an environment that presents a higher degree of uncertainty, it is best to maintain a higher degree of flexibility (less illiquid exposures). It is also a good idea in the actively managed part of portfolios to place funds with skilled managers in structures that provide those managers with decision making flexibility. Obviously long-only funds in equities, bonds or other asset classes do not have this attribute, since they are pure directional “bets” that cannot dynamically adjust market exposures when conditions change. The hedge fund structure does provide this flexibility.<br />
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2. Currency exposures have become increasingly important in investment strategies. It seems wise to diversify away from the USD, Euro, Pound and Yen (currencies of nations with very high sovereign, consumer and bank debt) and gain exposure to currencies of economies that have low debt, solid growth, abundant natural resources and are competitive in the world markets. One could also trade weak currencies short, or pair-trade them against more favorable currencies.<br />
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3. Investors should lower their interest rate exposure. With treasuries selling at decade long highs the risk is elevated that long bonds could steeply decline in value if interest rates rise. With bonds being massively over bought any movement of capital away from this asset category (as we have seen in the last week or so) would bring prices down quickly. So it is time to be cautious about longer duration bonds.<br />
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4. As an alternative to fixed income exposure (that has interest rate risk), seek exposure to absolute return-type hedge fund strategies with low equity beta characteristics (low market correlation). There are a wide range of hedge fund strategies; some which are correlated to markets to varying degrees and some that offer little or no equity or bond market exposure. The latter offers a portfolio alternative, which is a proxy for bonds, but without exposure to interest rate cycle risk. Such strategies seem attractive in market conditions such as is likely to exist in 2011. <br />
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5. The likelihood that equities will move higher in 2011 implies that investors should maintain some good degree of equity exposure during the year. While there are a number of “wild cards” out there that could “spook” the market, the trend seems toward more stability and therefor more accommodative for risk (the VIX has been on a trend down for the last two years). This should favor equities as investors move away from low yielding “safe” assets.<br />
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6. While there are a good many “bottom fishers’ in the real estate category, I believe that it is unlikely that there will be any rebound in prices for many years to come. So, keep exposures low and heavily targeted in this asset class. Investors should select investments in real estate for income purposes, not appreciation and should have a long term investment horizon.<br />
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7. In the private equity sector favor buyout funds over venture capital, unless you are able to gain access to top quartile funds. As always, in this asset class, manager selection is critical since performance spreads are very high in this industry.<br />
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<strong>Final Thoughts</strong><br />
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When forming a view on the direction of the economy or the markets, an investor must always ask themselves “What if I am wrong?”. For that reason it is important to examine multiple scenarios, even those that one believes are less likely. It is a part of good investment discipline.<br />
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On the downside, there is a measurable risk that the sovereign debt crisis in Europe accelerates during the year, reaching crisis proportions. This would drag down the world economy and adversely impact the markets. Austerity action by troubled countries may not work. In fact it may have the pejorative effect of exacerbating the problem by throwing those economies into a downward spiral. <br />
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The mood of US and EU investors (particularly individuals) remains quite pessimistic. The evidence of this is everywhere you look. There is an unprecedented amount of investment capital on the sidelines (earning nearly nothing). The bond market for the highest credit quality securities (US Treasuries) is at a decades-long peak. It is an extremely crowded trade. Any negative event (skirmish in Korea, financial troubles in Ireland, etc.) leads to a big rush into “safe haven” instruments such as treasuries or gold. Projections for the US economy are very weak and worries are high that the economy will sputter once the stimulus winds down. No one believes that a recovery might be poised to perform better than expected. <br />
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That might be wrong. It is possible that the recovery might go better than expected. Even if it follows a weaker track than other post-recession recoveries, it could surprise many investors and observers. Perhaps the biggest driver of investor psychology is unemployment. If unemployment improves more than expected, the stock market will take off. Retail sales during the upcoming holidays may surprise the markets on the upside. Consumer confidence has been steadily improving. If this scenario unfolds, investors will be fearful of getting left behind. All that capital on the sidelines, earning near nothing will get tired paltry yields and move toward equities boosting the markets unexpectedly.<br />
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Nevertheless, we are navigating through “uncharted waters” where there will be a much higher variability in performance among asset classes and strategies. The macroeconomic landscape is more complex and demanding for investors.<br />
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Perhaps 2011 will show some improvement in the US economy, but our obdurate political leaders have not faced up to the longer range, fundamental issue that public sector spending is simply out of control and not sustainable. We are putting off the pain of doing the right thing today to push our problems down the road into the future. As John Henry Boetcheu said in 1016 “A nation cannot spend its way to prosperity”.Chuck Martinhttp://www.blogger.com/profile/01165029253566700876noreply@blogger.com0tag:blogger.com,1999:blog-6692844783818951328.post-15412011873412642772010-08-11T12:31:00.000-07:002010-08-11T12:39:59.172-07:00Rethinking Modern Portfolio TheoryThe world of institutional Chief Investment Officers and Risk Managers was a very orderly place until the credit crisis of 2008. As the correlation between asset classes went to 1.0, all asset values declined at the same time and risk metrics proved worthless…the defects in the application of “Modern Portfolio Theory” became highly visible and leading investment professionals began the search for better methodologies. In this paper I endeavor to explore some of those important issues.<br />
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Firstly, the basic principle of Modern Portfolio Theory appears sound; its frailties show up in its application, more particularly in the effort to apply quantitative methods. The basic concept is that an investor can optimize the risk adjusted returns of a multi-asset class portfolio by configuring the mix of asset performance characteristics. The application of this principle is far more complex than has previously been practiced. How often have I seen the seductive charts showing the “Efficient Frontier”, as if one could simply compute the best mix of investable assets. If only life were that simple.<br />
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The Fatal Flaw: Risk and Volatility are not the same<br />
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A fatal flaw in the application of the principle was the assumption that risk and volatility were the same thing. The formulation of Modern Portfolio Theory required data to be inserted in equations. Leading economists and academics struggled with this fact and, so, decided that volatility (for which they had ex-post data) was the measure of risk. Further they assumed that the historical volatility of each asset group would be predictive of the forward volatility/risk. From a macro point-of-view, much of the volatility data used in today’s models relates to historical periods that are not relevant looking forward. For the five year leading up to 2008, volatility was low and markets were stable. Then in late 2008 and early 2009 volatility went through the roof. Going forward which data do you use? Perhaps neither characterizes the forward risk situation.. <br />
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A practical example of the frailty of the assumption (that volatility and risk are the same) came in 2007 with the notorious collapse of the Bear Stearns’ High Grade Structured Credit Strategies Fund which exhibited very low volatility statistics until it completely collapsed to near zero value (in a couple of months) with no warning. Even the title of the fund implied quality and low risk. Contributing to this insidious development was the fact that there was no underlying trading of the fund’s assets, therefor the manager (Bear Sterns) was marking the value on investors’ monthly statements to a model, not to an actively traded market (because there was none).<br />
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The Bear Sterns fiasco points to another flaw in the use of volatility statistics, namely that they can be misleading when applied to illiquid asset categories, such as real estate, private equity and some hedge fund strategies. Furthermore, if a security or portfolio trades with high volatility through a wide range, but experiences more “up days” than “down days”, moving higher over time, does that imply that it is high risk? To a pragmatic investor, risk is the likelihood of losing money…not the range of price variation over relatively short periods of time. Such variations do not reflect the investor’s holding period or the fact that he/she has the choice of exit timing. While there certainly is a wide range of risk characteristics of different asset classes and individual investments, risk cannot be quantified with any degree of precision. It therefore must lie in the domain of business judgment. <br />
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The fundamental issue here is that it is pure folly to think that one can mathematically determine risk to a couple of decimal points using statistical ex-post volatility data to project ex-ante outcomes. The assessment of risk must consider a range of issues and scenarios…but ultimately requires a high level of investment judgment. Within any asset class, investment strategy or fund, the range of risk characteristics must be evaluated by the investor on a prospective basis. Such risks might include the stability of a fund’s investment leadership, its team, the degree of liquidity of its assets, its net market exposure and the amount of leverage it uses or does not use.<br />
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Efficient Frontier<br />
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The efficient frontier has been described by a line plot on a graph that presents risk vs. reward (expected returns). It is used to create a collection of assets that optimize the overall risk-return characteristics of an investment portfolio. Since it is not possible to reasonably quantify risk or the returns that will be realized, one might question the application of this type of analysis. So, is there an “efficient frontier” and where is it? The principle is sound, but the challenge comes in its application. One cannot draw a line on a two-dimensional piece of paper that describes it. <br />
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For the efficient frontier methodology to work, it must rely on a few key assumptions; namely that the markets are rationale, that it prices securities in an efficient manner and that forward risk can be quantified with some degree of precision using historical volatility data. Increasingly, investors are coming to the realization that none of these assumptions are true. Another assumption intrinsic to this methodology is that the distribution of expected outcomes (returns) may be characterized by a Gaussian curve. In fact, many asymmetric or by-modal curves may describe expected returns on an ex-ante basis.<br />
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Diversification <br />
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In spite of the fact that diversification offered no safe “hiding place” during the 2008 credit crisis, it continues to be an important discipline in constructing portfolios that manage the two strange “bedfellows” of risk and opportunity. However, it is not a two dimensional phenomenon as has been historically displayed on risk-return charts. Missing from the picture is the consideration that many asset classes are cross correlated to the same risk drivers, so the benefits of diversification in such cases can be minimal. A weakening economy may put downward pressure on equity prices, but also would cause commodities and real estate to drop in value. Thus, in such a case, diversification across these asset classes offers little risk mitigation value. One must look at the correlations between asset classes to understand whether diversification can deliver risk abatement value or not.<br />
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Also, diversification should not lead an investor to buy some of everything. Portfolio construction should reflect a carefully constructed mix of asset classes and investment strategy types should consider correlations, lack of correlations and counter-correlations. The mix of these should reflect the scenarios that the investor believes are most likely to develop. As important as the risk considerations are, it is even more important that the portfolio mix reflect the investor’s judgment of the profile of opportunities that are expected during the time horizon. <br />
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Another important consideration is the risk parameters and capital market assumptions that one puts into the asset allocation process. The validity of outcomes can only be as good as the quality of the inputs. Here also it is easy to fall into the trap of characterizing a situation with single numbers. The risk profile of any asset class can be better described through a probability distribution rather than a single number. The shape of that risk profile curve varies depending on future scenarios of events not known at the time the asset allocation strategy is formed. The same can be said for the capital markets assumptions (ex-ante return projections). In an environment with many unknowns and unknowable’s, the investor’s judgment comes seriously into play. Historical data can only be a small guide to future expectations. To rely upon it exclusively, is foolhardy.<br />
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The Skill Factor<br />
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Economists all neglect the effects of skill on investment risk and outcomes. Helicopters may be unsafe when flown by an amateur pilot, but may be very safe when operated by a Marine copter pilot with thousands of hours of experience. It is the same with investment managers. This shows up, in particular, in those areas where managers have a high degree of discretion and ability to affect the course of events. When one looks at the investment categories of venture capital, private equity, hedge funds, real estate and some others, one observes a wide range of performance outcomes. The dispersion of return performances from the top quartile performers to the bottom quartile is substantial. On the other hand for managers of traditional long-only equity funds, mutual funds and bonds, the variations (from market benchmarks) are narrow.<br />
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Since economists deal with statistical methods, it is necessary to have a big sample which lumps good, bad and average managers together. In this the attribute of skill is lost. This principle also comes into play on a fund-specific level. Many fund managers seeking to avoid risk or variance from benchmarks build large diversified portfolios with sector allocations that track closely to their benchmarks. I call these “benchmark huggers”. In doing so, they dilute to positive effects of skill in the performance of their portfolios. In the hands of a skilled investment manager, a sensible level of concentration and directionality is a good thing.<br />
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Liquidity<br />
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A basic economic principle is that one must pay a higher price for liquid assets than illiquid assets. While, in general, this may be true, investors overlook the advantages of flexibility offered by liquid assets. Most investors look at the need for liquidity to be a use-of-funds or spending requirement. They overlook the value that it has in providing the ability to quickly adapt to changing conditions or unforeseen events. Harvard Management learned this lesson the hard way during the recent credit crisis when they found their investment portfolio to be substantially committed to illiquid holdings at a time when rapid change put a premium of flexibility. In addition to causing distress, this lack of capital flexibility presents an opportunity cost since such portfolios cannot seize the opportunities that emerge during such periods. In many situations, the flexibility to easily sell an asset and re-deploy one’s capital in order to re-align investment exposures can be very valuable…worth the extra price. In portfolios with a mix of liquid and illiquid assets, one must be aware of the tradeoffs and intelligently weigh the benefits of an illiquid investment against the cost of compromising flexibility. It is not always the case that the illiquid investment offers a better return opportunity.<br />
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Strategy <br />
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In an environment of uncertainty, with tools of limited value, what is an investor to do? It gets down to a matter of practical judgment. Often investment managers set asset allocations for the long term. Investment environments change. They are dynamic. It is not a good idea to fix asset allocations, to let them become “straight jackets” over a long time horizon. There is much opportunity in getting tactical allocations right and, conversely, a lot to be lost in getting them wrong. Therefore, it is important to bring the best thinking to the process of dynamically allocating assets from a tactical standpoint. ”Tactical” implies time horizons of 1-2 years whereas strategic implies a longer timeline from an asset allocation standpoint. In making such tactical allocations, one must recognize the uncertainty of the decision making environment and the imperfection of even the best investor’s ability to judge the future. For this reason it is important for every investor, in setting tactics and strategy, to ask themselves “What if I am wrong?”. Good investors deal with this by factoring into their decisions the prospect of less likely scenarios.<br />
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The look forward is perhaps the most important determination that an investor will make. <br />
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The process of asset allocation is best accomplished by carefully thinking through and researching the various high probability scenarios that are likely to develop. In doing so an investor must anticipate changes that are likely to develop and their impact on the various asset types and strategies in their portfolio. Only then can one consider the mix that presents the best composite return potential and the lowest risk profile.<br />
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The degree of concentration in cross-correlated assets depends on the investor’s level of conviction on his/her primary scenarios. If there is a high degree of uncertainty about the catalytic drivers of the scenarios, then a more uncorrelated asset mix (diversification) is warranted. Conversely, when uncertainty is low and conviction is high, more concentrated, directional strategies can be employed. At the end of the day, it is a matter of optimizing the probability of successful outcomes while assuming the level of risk that fits an investor’ tolerance level and objectives. <br />
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Investors live in a world characterized by uncertainty and change. As they continue in the challenge to manage the two strange “bedfellows” of risk and opportunity, it is important to constantly re-examine the validity of the tools and theories practiced in the investment industry and look for better methodologies.Chuck Martinhttp://www.blogger.com/profile/01165029253566700876noreply@blogger.com0tag:blogger.com,1999:blog-6692844783818951328.post-67169331114145259952010-04-27T13:14:00.000-07:002010-05-21T11:30:01.879-07:00American Democracy at a Crossroads<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhXjXjEtpw2qre4XSgpRYAoERtF5u04ZxxYrB_YI_tnDzC70pkBWXrWEi4tGfd-9bNonSehE-NG2LV5OPEyg9dge_btenQ7D5_rS819c2b20F4lvw8wuFcEicpu3aozWOYKwx67ruSIp1I/s1600/aapl.png"></a><br /><div align="justify">Most people in America are growing increasingly concerned about the direction of the country and, particularly, its political leadership.<br /><br />When we reflect on the values that made America a great and prosperous nation, we see those principles eroding. Our nation is comprised of a generous and principled people. When helpless European nations were invaded by Hitler’s Germany, the US put the blood of its young men and its balance sheet on the line to save the people from tyranny. The same can be said for South Korea, the Philippines, Eastern European nations of the Soviet block, Kuwait, and others. We have devoted extraordinary funds and effort to help mitigate AIDS and corruption in Africa and rushed to help when disasters struck in Haiti, Indonesia and other places. America is a nation that has sent its young people into struggling parts of the world to help through the Peace Corps.<br /><br />The democratic principles on which our nation was founded have been an inspiration to freedom seeking people across the planet; to all that search for a better way of life.<br /><br />At home also, we have been a generous nation, providing a social security benefit for the elderly, healthcare for the poor and public education that affords opportunity for all citizens without regard to their economic, ethnic or gender status.<br /><br />However America now stands at a crossroads. The principles that made it great are: an independent thinking, self-reliant people; an innovative, entrepreneurial society; a small, efficient government; an absence of bureaucratic obstacles that discourage individual initiative, a value system that rewards and celebrates hard work and achievement…and a tax system that did not transfer wealth from the nation’s most productive individuals and distribute resources to those that rely on society’s generous welfare system.<br /><br />No nation can be generous that is not prosperous.<br /><br />Thus, America must return to, and stay true to, those fundamental principles that made our nation prosperous. However, we all see our country increasingly moving away from those principles.<br /><br />In America it has become politically “fashionable” to demonize business leaders. These are the individuals in a society that create employment, generate national wealth and tax revenues. Yet instead of nurturing business enterprises or supporting their leaders with good public policy… we abuse them. A top business executive that earns as much as a top athlete, a musician or film star…is chastised for it, in spite of the fact that his/her effort does more to generate prosperity in the nations economy. It has become politically popular to take the rewards from those that have worked hard, taken risks, created successful enterprises and redistribute their economic earnings to others with less. <a title="blocked::http://console.mxlogic.com/redir/?arX2r5XI6QTXLIc9Tdw0y4tB0IbdRD_bUbdRDZc5CWP-CjOpeGKQ4vtthjjuuhU76XZuWrWrwVNx4TsTgwT650k8XqF2DMJm59NrJelosKrjvuvupdEFICzB5BMsUOrj76Ns1kzh05WC3h0x90Qg0hXHLNFm1EwaMGo96V-7PNo_pgdFCPhOrjvK-MOeudzeEr http://console.mx" href="http://console.mxlogic.com/redir/?arX2r5XI6QTXLIc9Tdw0y4tB0IbdRD_bUbdRDZc5CWP-CjOpeGKQ4vtthjjuuhU76XZuWrWrwVNx4TsTgwT650k8XqF2DMJm59NrJelosKrjvuvupdEFICzB5BMsUOrj76Ns1kzh05WC3h0x90Qg0hXHLNFm1EwaMGo96V-7PNo_pgdFCPhOrjvK-MOeudzeEr" target="_blank">Thomas Jefferson</a> once said “Democracy will cease to exist when you take away from those who are willing to work and give to those who would not”.<br /><br />A core issue that will determine our nation’s future lies in its political domain. Historically Americans voted for what they believed to be in the best interest of the nation. As more and more entitlement programs proliferated across the political landscape, Americans began voting more for their self-interest. This pernicious shift in the political process leads a nation down the path where public policy is redirected from the generation of national wealth to the redistribution of it. Ultimately, the “pie” begins to shrink as the creation of output is penalized and the idle in society are rewarded.<br /><br />Unfortunately, this leads to a less efficient and less competitive economy. We live in an increasingly competitive world. When our government increases the cost of doing business for American companies by supporting unions, increasing the tax burden on investment and business enterprises, adds restrictive bureaucracy & regulation, it makes American companies less competitive…and foreign companies “beat us out” for business, resulting in lost jobs in the US. The insidiously titled “Employee Free Choice Act” (working its way though Congress) is a perverse example of this. It eliminates the secret ballot for union organizing, regressing back to the days when intimidation and coercion were used to form a union shop. It would also put government bureaucrats, not employers, in the loop in determining worker’s pay. It is convoluted thinking to believe that raising worker pay and benefits above market rates through organized labor or legislative initiatives will make them better off. The ephemeral benefits of this soon give way to the ultimate power of competitive displacement by more cost efficient alternatives overseas…and again politicians would complain about the outsourcing of jobs to foreign companies. It is inevitable.<br /><br />There is another insidious trap that continues to develop. It is an easy political process to borrow from the future to make things better today. The ballooning public debt should concern all Americans. The US government is pursuing a profligate spending binge and an extraordinary expansion of (unfunded) entitlement programs. It seems that our political leaders and voters are all too happy to “party today” and “kick the can down the road” for future generations to deal with. The absence of a prescient perspective of where this leads us and the courage to do the right thing in the face of adversity reflects the temerity of human behavior. The challenge here is aggravated by the high degree of economic illiteracy in our society.<br /><br />No nation, business or family can spend its way to prosperity.<br /><br />We, the American voters, now stand at the crossroads. Do we have the backbone, the courage to redirect this great nation back to its core principles… or will we take the easy path and gradually descend into mediocrity? On this small planet no course of events is assured. The bright star that has lifted the hopes of people around the world could one day fade. What would the world be like then?<br /><br />I cannot help recall the ending of the movie classic “Planet of the Apes” when Charlton Heston, walking down the beach of that strange land comes across the fallen structure of the Stature of Liberty and realizes the errant history of mankind that has gone before him, he exclaims… “Oh my god, what have we done!”<br /><br />Let’s not let that happen to our great nation.</div>Chuck Martinhttp://www.blogger.com/profile/01165029253566700876noreply@blogger.com1tag:blogger.com,1999:blog-6692844783818951328.post-6649598879461833652010-03-17T10:02:00.000-07:002010-05-20T14:08:38.344-07:00UniverCity<div align="justify">Universities occupy a unique and important venue in society. It is at such institutions that young lives begin their transformation to adulthood and accelerate their development as human beings. These are also places where faculties seek to create new knowledge and to dispense knowledge to the young people that come there as students and to others that will apply that knowledge to productive application in the private and public sectors of an economy. There is no “engine” in a society that is more potent in advancing its human potential, and therefore its prosperity, values and ethics. It is in universities that all this is shaped.<br /><br />Because young individuals arrive at universities at the threshold of adulthood, they are at a nascent stage in the development of their views, ethical standards, knowledge, and values. It is in this setting that they must learn critical and independent thinking. It is in this theater that they learn about civil discourse, fairness, freedom of speech, freedom of descent, respect for others and activism. Thus, it is important that universities provide an environment that nurtures their growth as human beings. While good scholarship in learning content/information is important, the challenge for universities presents a bigger calling than simply preparing students for careers or educating them.<br /><br />These developmental attributes are not likely to be learned in a classroom. However, the institution’s core values, how it conducts its affairs and the environment that it creates provides an influential framework for this developmental process. Thus it is extremely important that the leadership of universities carefully architect their institutional environment and implement it with the steady hand of conviction.<br /><br />Throughout history, the young have been inclined toward idealistic activism and the university has been a common setting for the expression of such strongly held views. Suppressing such passions through censorship is not a constructive policy for a free society. Rather, a wise strategy is to view such situations as an opportunity to explore the issues and caste some light on the truth. Often this is a challenging undertaking, since activists have only an advocate agenda and are closed-minded about the search for enlightenment. In real life the extremists are one percent of the equation. While others may have an affinity for the extremist views, they are within the realm of persuasion, whereas it is wasted effort to attempt to influence the extremist coterie.<br /><br />Debate is a civil process through which all participants develop deeper understanding of issues. Activists need to learn that the “louder they shout” their message, the less effective it is in persuading anyone of their cause. In fact it often has a pejorative effect in promoting an understanding of their agenda. Universities and their leadership have an important role in cultivating the attitudes and civilized behavior of students, as those young people ponder society’s issues. Often concepts and beliefs formed in this early stage of life get traction as young individuals evolve to adulthood.<br /><br />Certainly there have been times in history where protest movements have gained sufficient force to effect the course of public policy. Such initiatives have not been the sole purview of idealistic youth, but often have had a broader base of individuals sharing a common, contrarian view. This has served a constructive purpose in a modern democracy.<br /><br />Activism and protests have always been a part of campus life, particularly in California. At the UC Irvine campus there was a recent disruptive protest by a small boisterous group of Muslim students at a speech by the Israeli Ambassador to the US. These students clearly crossed the line of acceptable dissident behavior and invaded the free speech rights of others. This has been a polarizing event in our community. At the extremes, some would have them hanged and others would lionize them. This exemplifies the emotion that surrounds this geopolitical issue. In my view, Chancellor Drake and the university are handling this sensitive matter firmly and appropriately. The students were arrested and the university is proceeding with the due process that is likely to lead to disciplinary action.<br /><br />UC Irvine is not alone in recent student misconduct experiences. At UC San Diego a group of fraternity students staged a “Compton Cookout” where they dressed as African-Americans and ate watermelon. A KKK-style noose was hung in the student library. Following this incident the UC San Diego Chancellor handled the matter poorly. While there were many protests on campuses regarding the tuition increase, at UC Berkeley, student protests got out of hand resulting in some significant property damage on the campus.<br /><br />I find it strangely ironic to see student protests over the rise of tuition at the University of California to the $10,000 level, but no protests at comparable private institutions where tuition is in the $35-45,000 range. There is no mention by protestors or the media about the fact that 1/3rd of the increase is being channeled back into need-based scholarships. Also, there is no mention of the fact that students in families with annual incomes of up to $75,000 pay no tuition at all at any UC campus. This is one of the greatest bargains on the planet, particularly considering the fact that the academic standing of the UC System is very high. Several campuses rank in the top one percent of all colleges & universities in America.<br /><br />While a few express dissatisfaction, the demand for education at UC campuses is strong. Applications were up substantially this year in spite of the tuition increase. When the nation’s 3,000 universities are ranked by the volume of applicants, five of the ten most applied to universities happen to be UC campuses. Californians are fortunate indeed to have an institution of higher learning of this caliber.</div>Chuck Martinhttp://www.blogger.com/profile/01165029253566700876noreply@blogger.com0tag:blogger.com,1999:blog-6692844783818951328.post-4612090856816038702009-12-22T13:39:00.000-08:002010-05-21T12:09:42.591-07:00John Maynard Keynes vs. Friedrich August von Hayek<div align="justify">The tortuous times of the past two years when nations have been embroiled in economic crisis has revived an old battle between macroeconomic theories. Huge differences have evolved between political leaders and economists on matters of public policy to deal with the challenges. The root of these philosophical differences lies in the macroeconomic theory of the last century. It is the dilemma of whether free markets create a more prosperous economy or whether government management of an economy is best.<br /><br />In the 1930s the idea of government managed or planned economies emerged in the classic “General Theory of Employment, Interest and Money” by John Maynard Keynes. This dominated economic theory until the concept of market economics gained favor, championed by the Austrian economist, Friedrich Hayek. His book “The Road to Serfdom” challenged the merit of socialism and the negatives of government intervention in private sector. It argued the merits of free market capitalism and individual liberty. Hayek’s philosophies were embedded in the thinking of other economists and world leaders, namely Milton Friedman and Margaret Thatcher. A young Milton Friedman attended a series of salons on macroeconomic theory run by Hayek at a resort in Switzerland, known as Mont Pelerin. Hayek was awarded the Nobel Prize in 1974 and Milton Friedman followed in 1976.<br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi1tZy9d4dklX4MnqP-UIGr1UACaQd_UakfoACB4R6U7_2gwjqD4ldvi3oRBC_J0lGDEWVGmGTx0pH4yrgUsWQRKxQCPjpduHEZpkzNwSKJxiGNA6wmI8N8P4YZ6ZhjJd4tyIuhhRRDbYc/s1600/Keynes.jpg"><img id="BLOGGER_PHOTO_ID_5473802361575733042" style="FLOAT: right; MARGIN: 0px 0px 10px 10px; WIDTH: 215px; CURSOR: hand; HEIGHT: 263px" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi1tZy9d4dklX4MnqP-UIGr1UACaQd_UakfoACB4R6U7_2gwjqD4ldvi3oRBC_J0lGDEWVGmGTx0pH4yrgUsWQRKxQCPjpduHEZpkzNwSKJxiGNA6wmI8N8P4YZ6ZhjJd4tyIuhhRRDbYc/s320/Keynes.jpg" border="0" /></a><br />Now, it seems that Keynesian ways are back as governments overdose on “stimulus packages” (spending like drunken sailors) and endeavor to aggressively manage economies. Too often political leaders neglect to recognize that it was errant public policy that got us into this mess in the first place. Forgotten is the fact that congress aggressively pushed home ownership for all Americans…regardless of their economic status or their ability to pay the mortgage when the “teaser rate” term ended. Washington encouraged families to use credit (mortgages) to purchase homes they could not afford through low interest rates, low down payments and flooded the mortgage markets with capital through Freddie Mac and Fannie Mae. Keynes never imagined that political leaders could be so reckless and unwise in the economic policies that they pursued.<br /><br />This caused an “asset bubble” as home prices surged and our nation overbuilt the stock of homes to an excessive level. Homeowners began to use their new home equity as an ATM, tapping it for cash to buy boats, RVs and upgrade their homes. There was an enormous growth in consumer spending and the economy was fueled by the expansion of credit. Certainly Wall Street got on board with this by the expansion of the securitization of mortgage portfolios and the creation of new derivative instruments. It started with bad public policy and was amplified by financial engineering.<br /><br />The credit “binge”, engendered by bad public policy, caused the US economy to grow at a rate above its natural rate (without the meddling of government in the economy). Oddly, now political leaders are attempting to get the economy going by encouraging consumers to borrow and spend (cash-for-clunkers, mortgage incentive programs, etc.) and, of course, the government is a huge borrower and spender itself. It seems that we are trying to get out of the recession by doing more of what put us into it in the first place.<br /><br />What must follow is a period of de-leveraging, where the economy will grow below its natural rate until balance sheets are repaired. Without the Keynesian public policy initiatives, the economy would not have become supercharged in the 2002-2007 period, the credit crisis would not have occurred and the nation’s growth during the next decade would be higher and more stable. You will never hear this discussed in our congressional hearings…they will be busy “bashing” business leaders in the private sector. Hayek would say “Just leave it alone and the economy will do fine”. Keynes would say “Intervention by government is essential to avoid disasters”. The “Achilles’ heal” in Keynes’s thinking was the assumption of wise governance.<br /><br />The pejorative effect of errant public policy during challenging times can be huge. Regardless of who is right, it would benefit us all if members of congress would be required to pass an Economics 101 test. </div>Chuck Martinhttp://www.blogger.com/profile/01165029253566700876noreply@blogger.com0tag:blogger.com,1999:blog-6692844783818951328.post-49159756268300504252009-12-20T16:55:00.000-08:002010-05-22T16:56:05.172-07:00Compensation Plan for Obama<div align="justify">The compensation plan for the President of the United States has remained unchanged for a long period of time. It is overdue for an overhaul. I look at it in much the same way that I would for any Chief Executive of an enterprise, in this case the “enterprise” is our nation. The shareholders of our nation are its taxpayers. They have bought their shares with tax dollars and are paying for the benefits received by all its inhabitants.<br /><br />Over the last 30 years I have chaired many compensation committees for companies big and small, public and private. In structuring any compensation plan for a Chief Executive, it is important that it align his/her interest with those of the shareholders of the enterprise. Sadly, the President’s pay plan does not do that and is severely out of date. There is much room for improvement. So it is that I propose the following compensation plan; one that has both contemporary and appropriate features.<br /><br />Firstly, I propose that we should raise his salary from $400,000 to $1 million per year. His current salary is too low and has not kept pace with his responsibilities.<br /><br />Secondly, all top executives have an incentive compensation component to their pay which is based on performance. He should have a bonus plan that provides an opportunity for him to earn up to 100% of his salary based on the results that he is able to achieve.<br /><br />The President is the only American wage earner that does not pay taxes. This seriously misaligns his interest with those of his “shareholders”. Like all other Americans, he should pay Federal and State income taxes and be subject to the Alternative Minimum Tax.<br /><br />The President gets many other benefits that misaligns his interest with those of taxpayers, among those is free housing. How can he relate to the issues of homeowners with mortgages if he is not in the same “boat”? He should pay a fair market rate of rent for the housing provided to him by tax payers. His rent should reflect the size, location and quality for the housing provided to him and his family.<br /><br />In order to align his interest with ordinary Americans, his rent should be characterized as mortgage interest and be deductible in the same manner as other homeowners in his tax bracket.<br /><br />Any benefits that he receives from the government, such as food, personal travel, healthcare benefits, etc. should be placed on his W-2 in the same manner that it is for other tax payers. As the nation’s Chief Executive, he should have the use of the corporate jet, so long as it is for legitimate business purposes. This makes his valuable time more productive, as it does for any leader. If he uses it for personal travel or campaign travel, he should be charged the standard first class airline rate.<br /><br />He should be entitled to a 401K or other retirement plan, to which he should contribute, like the rest of us. A matching contribution by his employer would also be appropriate. The amount of his retirement fund should be based on his years of service, as it is for other executives.<br /><br />Now back to that bonus. Good incentive compensation plans for executives are performance based and his should be also. The bonus payout should include the following criteria:<br /><br />(a) Executives are not paid bonuses for running businesses that lose money or acquire bad assets on their balance sheet and neither should he. So his bonus should be conditioned on operating his enterprise (the US Government) without losses.<br /><br />(b) Also, he should be rewarded for running a government that causes the nation to be prosperous (and the citizens to benefit thereby). Accordingly, I propose that his bonus be awarded on a sliding scale between zero and 4 percent in GDP growth at which he would receive his full 100% bonus, conditioned on item (a).<br /><br />(c) In order to avoid gaming the system (as many Wall Street execs did) the bonus award should be a multi-year program tied to a few years that follow, even if they are on a successor’s administration. The plan should have a claw back and carry forward provisions to assure that good performance in one year is offset/averaged-out by any losses or benefits in the following years.<br /><br />(d) In regard to item (a) above, if he comes into his job inheriting a loss, he should be given credit for improvement above that level (i.e. reducing the loss).<br /><br />Such a compensation plan would align the President’s interests with those of his citizen tax payers and reward him for good behavior and good performance. Individuals that are not shareholders (i.e. not taxpayers) should not be entitled to vote, just as people that have no investment in a company’s shares are not entitled to vote on the affairs of the enterprise. If they are entitled to vote, they will always vote for something that provides them with benefits that someone else will have to pay for.</div>Chuck Martinhttp://www.blogger.com/profile/01165029253566700876noreply@blogger.com0tag:blogger.com,1999:blog-6692844783818951328.post-30014907159067655912009-11-07T13:42:00.000-08:002010-05-21T12:07:19.187-07:00Global Warming: How much do we really know?<div align="justify"><br /></div><div align="justify"><br /><br /></div><div align="justify">It seems these days that everyone has bought into the idea of “global warming. Congress is busy debating a ‘cap & trade” bill and the “Kyoto Protocol” has become the international standard for dealing with greenhouse gasses. Environmentalists are predicting the end of life on the planet, if we do not do anything about it.<br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEibyckUcbZWtr4f0J5duF2MKjNlHufZT95HHyN9DXzSJm33SUAhHKVuuBJLdBVDZHPvWifh9c4ZY9jb_NK9rnXVR0sGii684PJ4qydzMyjvIVC0_Xcqrjq-a5azI6LjYDwjIYhDJJ9Gseo/s1600/Global+Warming.jpg"></a><br />So, perhaps the lone voice in the darkness should ask the question “Is it true?”<br /><br />There is a lot of “hype” over CO2 content in the atmosphere and its effect on the planet’s temperature. Scientists are talking it up in hyperbolic terms because it draws more attention to them and more research dollars to their projects. If global warming was not a concern, they would be relegated to jobs as weathermen. They seize on anecdotal evidence to support their assertions (this is advocacy, not science). </div><div align="justify"> </div><img id="BLOGGER_PHOTO_ID_5473801237097383922" style="DISPLAY: block; MARGIN: 0px auto 10px; WIDTH: 320px; CURSOR: hand; HEIGHT: 242px; TEXT-ALIGN: center" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh0igk5N9xqk0tvEanNVDIFRfo-LjOauCrWa4lhgTB_N2nwHjsXwBAVIDnuLtb218F0nKSP9txNejIuGoyg6NIPvW1S-We7AdKcHiBN1A2j6-RW7qBBXh63w-Gs5p-rEJjeM2buloMT5ig/s320/Global+Warming.jpg" border="0" /> <p align="justify"><br />It is important to separate fact from fiction and what we know from what we do not know. To help with this, let me make some observations. First, examine this chart. The chart traces the history of the earth’s temperature for the last 500 thousand years, along with the concentration of atmospheric CO2 and dust. It should be read left to right: the left side being the current day and time-past being to the right. The current day temperature variation is “zero” and historical variations are plotted backward from that point.<br /><br /><br />It is clear that there is a causal relationship between atmospheric CO2 gas composition and the temperature of the earth. While scientists jump to the conclusion that CO2, a “greenhouse gas” causes the temperature to rise, when we examine the chart closely, we see that the earth’s temperature appears to rise in advance of CO2 content in the atmosphere. That should raise a question: Why? Could there be a more powerful force in the planet’s eco system? Which is the “cause” and which is the “effect”? Another big question that arises once we look at the history of the planet’s temperature and CO2 content is “Since these cycles have occurred before human’s had cars, before the industrial revolution, what causes the temperature and CO2 gas content to rise and fall?”<br /><br />It is clearly the case that the planet is warmer today than it generally has been. It is also true that the planet’s temperature has peaked at about the present level many times in history…then declined. Once again, that has happened hundreds of thousand years before humans contributed to its “carbon footprint”.<br /><br />One can make a case for any conclusion that they want by simply selecting the timeframe for the data. During the last 10-12 years, the temperature of the earth has cooled; during the last hundred years the temperature of the earth has warmed; during the last 5,000 years the earth has cooled; during the last 20,000 years the earth has warmed.<br /><br />Scientists (with a stake in the race) argue that the polar ice cap is receding. This is true, but only for the northern hemisphere; the southern ice cap is growing. They argue that industrialization over the last 150 years has caused the temperature of the planet to warm. At the same time the temperature of Mars has also warmed by about the same (percentage) amount. But there obviously are no people on Mars. Could it be that some more powerful exogenous force has caused it: perhaps flair-ups on the sun?<br /><br />An important principle to understand is that scientists, activists and political leaders can make any case they want by presenting selected data that supports their advocacy, and leaving out data that refutes it.<br /><br />Research in this area is important, but it must be done with an objective mind. The drivers for global warming and cooling are very complex and dynamic. Our planet’s eco system is very complex and changing. The study of this needs to be an interdisciplinary pursuit. Atmospheric sciences must consider the interaction of the atmosphere with the ocean (it absorbs about 50% of the CO2) and the interaction with the earth’s surface and its biomaterials (plants, biomass decomposition, etc.) as these are as big a factor (and perhaps overwhelmingly dominant) as the effect of humans and animals.<br /><br />If these forces are as profoundly causal as they have been in the past, the planet earth may have past the warming peak…and we should worry more about the return of a cooling cycle and another ice age. Mankind may be simply a passenger on the train of the swings warm and cool of our eco system. What we do, or don’t do, may have little effect. We actually know very little about these processes, but we should push on to understand them.<br /><br />But one thing is sure, these temperature changes are more glacial than the polar ice flows themselves and significant changes will take thousands of years.</p>Chuck Martinhttp://www.blogger.com/profile/01165029253566700876noreply@blogger.com0tag:blogger.com,1999:blog-6692844783818951328.post-86602068076955230192009-10-06T16:51:00.000-07:002010-05-22T16:53:54.760-07:00Healthcare Reform<div align="justify">America is engaged in a vigorous debate over reforming our healthcare system. That debate has been politicized and dominated by sound bite arguments to the point that no one seems to be thinking clearly about it.<br /><br />Certainly there is significant opportunity to improve the system. The delivery of health care has become costly and some in our society have inadequate access to care. In this article I seek to address some of the issues and inefficiencies that are critical that would promise to improve the complex economics, access means and quality of care.<br /><br />Firstly, we should recognize that the huge majority of Americans are relatively happy with the medical care that they get under the current system. Let’s not fix the part of the system that is not broken. This very large majority, particularly seniors, are terrified about changes that might deny them the medical benefits that they now receive. Although it is a costly, bureaucratic and inefficient delivery system; much can be done to improve it.<br /><br />More government involvement in people’s healthcare is a bad idea. Virtually everything the government runs operates badly and is much more costly to operate than comparable activities in the private sector. Think about the Post Office. Think about the bureaucratic operation of Medicare and the fact that it is “going broke.” Furthermore, do we really want to embark on a path that involves more public service workers in our personal medical decisions?<br /><br />Myths & Misconceptions<br />Advocates of healthcare reform often point to statistics such as life expectancy where the US lags many other countries. They argue that, for all that we spend, our system does not deliver better results. Nothing could be further from the truth. Many factors, other than the quality of medical care, drive mortality statistics. Iceland has the highest male life expectancy of any nation, yet they have virtually no deaths from auto accidents, their young men never go to war and cardiovascular disease is very low due to their diet that is dominated by fish. Japan has the best life expectancy statistics for a large nation, but again for reasons that are obvious: a diet rich in fish, a very low crime rate, an absence of military deaths and a population where obesity is, by far, the lowest in the developed world. Poor infant mortality rates for the US are also sometimes quoted as a critique of our healthcare system. The infant mortality problem is largely a result of socioeconomic factors and access to prenatal care by the poor. On this matter, we can do better.<br /><br />A better test is survivability of patients that enter the health care system and the quality of outcomes for those that receive treatment. On that front Americans do well. Outcomes for patients with cancer, heart disease, diabetes, orthopedic degeneration and other maladies are very good in the US. The rest of the world knows it and individuals, that have the means to be treated anywhere, overwhelmingly choose medical centers in America.<br /><br />Health Care Economics 101<br /><br />Our political leaders are promising that the huge expansion on health care coverage to 40-50 million more people will not increase the deficit. This is a naïve and dangerous proposition. Washington claims that they can pay for it through savings from a reduction in “waste and abuse”. Our government does not have a competency in such undertakings and tends, instead, to add on more bureaucracy and waste. If we, as a society, wish to add this entitlement on top of Social Security, Medicare, Welfare and other such social programs, we must realistically be prepared to pay for it. Our elected officials are good at giving away “other people’s money” (taxpayers). According to the impartial Congressional Budget Office, the ambitious expansion of healthcare coverage being proposed will add significantly to the already huge federal deficit. Unfortunately, the burden of paying for this will fall on young people for decades to come.<br /><br />Our leaders in Washington are also promoting a “public option” as a way to expand coverage and create a competitor for private sector insurance companies. Their proposition is that competition from the lower cost public healthcare insurance option would bring down the cost of private sector premiums. Here again the logic is flawed. Medicare, the biggest government healthcare benefit program pays only about 78% of hospital’s average costs. In order to remain financially viable, hospitals must charge more to private insurance providers. In other words, the private insurers (and their insured population of consumers) subsidize the care of the elderly on Medicare. If another low paying public program is launched, hospitals, doctors and other providers with need to raise their prices to private insurers in order to make ends meet.<br /><br />There are some things, however that can be done.<br /><br />Administrative Inefficiencies<br />The paperwork cycle in healthcare is an extremely inefficient process. Innovations can be made that improve the efficiency and quality of care and also the payment processing system. Why is it that we need to fill out the same forms and produce insurance information every time we go to a new doctor or hospital? In a more efficient system, each person could maintain their medical history on a private online site that is password protected and patient controlled. With each visit to a doctor, hospital, diagnostic lab, imaging center or change in insurance coverage, new information could be added to the site which would be available when needed.<br /><br />Preventative Health<br />Many, perhaps most, Americans lead an unhealthy lifestyle. This is exhibited mostly in their diet and exercise habits. The highest cost impact area lies simply in the area of obesity. Obesity leads to many costly diseases (cardiovascular, diabetes, cancer and others) that weigh on the economic equation of healthcare. The obesity problem in the US, and the economic burden that it places on our system, is huge. Americans lead the world in obesity at 32.2% while obesity in Japan is a mere 3%. Even in France, the frequency of obesity in their population is less than one third of the rate for the US. The frequency of obesity in America is significantly more than double that of Germany (think beer & Bratwurst). Economic implications: since 32.2% of Americans are obese and obese people cost 36% more than individuals of normal weight, the obese population in America are responsible for about 40% for the nation’s health care expenditures.<br /><br />To deal with the obesity problem, there need to be strong economic incentives for behavioral change and a well-conceived public communications program like the campaign against cigarette smoking. On the economic front, healthcare insurance should reflect the higher cost of obese patients by charging higher premiums for individuals who are overweight. There could be other incentives such as airlines charging passengers by the pound. Higher sales taxes could be levied on junk food and beverages with high caloric and fat content. As hefty cigarette taxes dissuaded smokers, this could discourage excessive, unhealthy food consumption in the same way.<br /><br />Needless to say, there are many other preventative medicine strategies that can reduce the cost of care (e.g. regular check ups that provide early detection of the onset of disease and the pre-emptive treatments that are available).<br /><br />Over Utilization:<br />Many factors contribute to the over utilization of healthcare facilities and services. Primary among these is the fact that healthcare is paid for by a third party (government or insurance). Thus, consumers are incentivized to overuse the system. They do not need to make a “buy or not buy” decision like everything else in life (a car, house, food, vacation, etc.). The method of payment should be overhauled to provide a first-dollar participation in the cost of every healthcare service. Consumers would then think about whether or not to use the system on each occasion, weighing the merits and costs. Some economists also believe that the tax benefits applied to healthcare insurance may also lead indirectly to over utilization of the system. <br /><br />The same faulty incentive exists with healthcare providers. The payment system is mostly one based on units of service. Thus, providers (doctors, hospitals, labs, etc.) get paid more for each unit of service provided. Higher utilization of the system generates more revenue for the provider. This system needs to be overhauled to pay for good outcomes. Certainly, the threat of medical malpractice liability, in our litigious society, leads to the practice of defensive medicine…which is costly and does not necessarily lead to quality care.<br /><br />Insurance:<br />For some reason that few can explain, health care insurers are restricted from offering plans across state lines. This severely restricts competition and is awkward since many employers have employees in multiple states. Rather than create a “public option” adding to the tax burden, we should simply eliminate the restriction on health care insurers and let the free market work.<br /><br />Indigent Care:<br />Mostly, poor people are locked out of the formal healthcare system. However, most people in this category find a way to be treated for illnesses. Unpaid care is provided through emergency rooms and hospitals (mostly charity and public hospitals). However, this system is very inefficient and costly. A patient with the flu shows up at the same “doorstep” as an accident victim or an individual suffering a heart attack. The primary care provided to indigents from emergency rooms is very costly and interferes with the provision of care to those that need it.<br /><br />This problem could be solved by creating a network of clinics that would provide free primary care to the poor, and triage those in need of complex intervention to appropriate medical centers that are equipped to care for those patients and compensated for it. The cost relief of the burden on emergency rooms would help offset the costs of these clinics and it would be far more efficient than setting up a new Medicare-like system for the uninsured.<br /><br />Tort Reform:<br />Heavy political contributions by trial lawyers make legislation in the area of tort reform nearly impossible. Certainly, when there is malpractice, the system should be able to make well-informed and effective judgments and then provide appropriate penalties and awards. The problem is that the defenders of the status quo appeal to public sympathy by raising examples of persons that suffered due to medical malpractice without recognizing the abuses of the system. Unfortunately, all-to-often frivolous lawsuits claiming malpractice are simply opportunistic grabs for money. Insurance companies facing significant legal costs and the possibility of a large award following a jury trial are quick to settle, even when the case is clearly without merit. Awards often are excessive and drive malpractice insurance premiums higher to reflect this cost. This cost alone can be so high as to force many physicians out of the practice of medicine.<br /><br />This is a complex issue since we would not like to deny a rightful claim, but also frivolous lawsuits and excessive awards need to be curtailed. It must be attacked from both directions: the compensation of trial attorneys and the excessive plaintiff awards. Excessive litigation also drives up costs by causing doctors to over prescribe tests and treatments in the practice of defensive medicine. No one knows how much this really costs, but it is likely to be a big number.<br /><br />Access vs. Capacity:<br />A serious problem exists in the capacity of our healthcare system to deliver more care. If we expand coverage to a large new population, and if the number of doctors or hospital beds remains static, the overall quality of care and access to care for everyone will go down. Any expansion of “access” must be accompanied by an expansion of the “capacity” of the system.<br /><br />Increasingly we find ourselves in a time when fewer talented young people are motivated to pursue careers in the profession of medicine. Also, doctors are retiring early from the practice because of the administrative burden, increased malpractice insurance costs, and lower payment/reimbursement for their services. There is a particularly short supply of general practitioners which perform a vital function in the healthcare system. They provide primary care and are the “gate keepers” that triage patients to the specialty care treatment providers. A high payoff solution to this would be to offer low-interest, forgivable loans to medical students who agree to serve as primary care physicians in rural areas or urban clinics that provide care for indigent populations. They could “work off” their debt obligations through such community service.<br /><br />Preserving Innovation:<br />The great engine of innovation in medicine that is contributing measurably to the quality of care is facing a threat by public policy leaders that do not understand the economics equation of innovation.<br /><br />Nowhere is this more obvious than in the debate about reducing the number of years of proprietary protection under US patent laws for new drugs. Also, there is continued pressure on the pricing of these new drugs. New drugs are extremely expensive and risky to develop. During long safety and efficiency trials many fail to deliver the anticipated results and get FDA approval. There must be an attractive incentive to invest in these and other medical innovations.<br /><br />Basic Principles:<br />When we examine the means to improve the healthcare system in America and make it more cost effective, the basic principles mostly relate to realigning the incentive system and removing bureaucracy. At the top of the list is to motivate and empower the consumer (patient) to make intelligent decisions on the use of the healthcare system. Consumers should pay a percentage of the cost, starting at dollar one. They should be incentivized to decide: whether or not to use it, how much to spend and to shop for the best value for the best price. Remove the incentive for doctors to practice defensive medicine and reward them for the achievement of desirable outcomes (instead of simply providing units of service). We must provide incentives for people to pursue healthy lifestyles. Also, we must promote innovation that leads to breakthroughs in medicine; incentives for entrepreneurs, companies, and healthcare providers that develop diagnostic methods, pharmaceuticals, therapeutic means and healthcare delivery modalities that improve medical outcomes, reduce costs and improve the efficiency of the healthcare delivery system. Also, we certainly need to increase competition in the healthcare insurance industry by eliminating the restrictions on doing business across state lines. In all of this, we need to simplify the payment and information handling system and the immense bureaucracy that burdens the process of our healthcare delivery system.</div>Chuck Martinhttp://www.blogger.com/profile/01165029253566700876noreply@blogger.com0tag:blogger.com,1999:blog-6692844783818951328.post-6165358104959764992009-07-15T16:37:00.000-07:002010-05-22T16:39:22.872-07:00Fixing California<div align="justify">We are all aware that the State of California is in a financial mess. What is needed does not require deep intellectual insight…it simply requires common sense.<br /><br />For almost two centuries, the “golden state” has been the land of opportunity that has drawn people from all over America and elsewhere in the world, seeking a better way of life. Now, even with substantial immigration from Latin America into the state, it is experiencing a net loss in population as its citizens decide to move out. It is not difficult to understand why. As the state with the most unfriendly disposition toward business, jobs are moving out of California to other states. The state’s tax rate is the second highest in America. Its school system, once admired as among the best in the nation has declined to become one of the worst, rivaling Deep South states such a Mississippi. The credit rating of the state has been downgraded to near junk bond status.<br /><br />All this derives from a totally dysfunctional state government. Our political leaders do not seem to have the wisdom, or the will, to take the actions needed to put the state on a sound financial footing. What is needed is public policy and action that increases tax revenues by making the state, once again, to be an attractive place to live and for businesses to locate and grow…and to reign in its legislature’s excessive spending binge on social programs.<br /><br />So here is my list of the “tough love” that we need to put our state back in order:<br /><br /><br />1. Pay cut for all public employees<br /><br />Firstly, for a very long time the compensation level for public employees has been rising faster than that in the private sector. The Governor’s office has been attempting to deal with these rising cost of labor in public service jobs through a “furlough” system, i.e. employees working less days. This reduces public services without solving the problem. I suggest a pay cut of 10% across the board for all public service employees. That way service levels could be maintained and no one needs to lose their job. They just “tighten their belt” like everyone else. The problem here is that a large number of our public employees are subject to union contracts. Thus, as with the Detroit auto industry, the unions must give back some of the excessive gains that they have obtained over the years.<br /><br />2. Increase the retirement age<br /><br />People are living longer and are more productive than decades ago when the retirement age was set. Also, many public service workers become entitled to retirement pay after 20 years of service. They then “retire” (at a young age) and move on to another pubic service job, thus drawing double pay. This is very costly to the public and the under-funded public employees’ retirement funds represent a huge financial liability “time bomb”. California taxpayers will foot the bill for the shortfall in these funds in future years. The retirement age should be increased to 70 for men and 73 for women and indexed to longevity statistics. This would have a huge impact on relieving the financial stress on our public finances.<br /><br /><br />3. Fix the illegal alien problem<br /><br />California and, to a lesser extent, other border states (Texas & Arizona) carry a disproportionate economic burden because of the migration of Hispanics across the boarder from Mexico. California taxpayers bear a great deal of this load. There is much debate about this at the Federal level, but no solution is on the horizon. The Federal government should solve this problem and/or compensate California for its disproportionate share of the burden.<br /><br />I think it is best to create a new class of semi-permanent resident. Do not grant citizenship, but make them legal residents. Currently, these immigrants mostly reside here peacefully, work and contribute in our economy, even vote in our elections (since proof of citizenship is not required). Yet they do not pay taxes and live in a shadow economy. California taxpayers pay for their healthcare, welfare, police & fire protection and the education of their children. They should be permitted to register for this new class of residency, be subject to the payment of taxes (perhaps on a simple flat-rate basis), but not entitled to vote or enjoy other privileges of citizenship. If they do not sign up, they should be fined and deported…and serve jail time if there is a second offence.<br /><br /><br />4. Break the unions’ stranglehold on public service jobs.<br /><br />Require that all new public employees be hired as “at will” non-union employees. Continue this until the share of public employees is less than 50% of the workforce. At that point forward make the joining of the union voluntary, truly voluntary and pay less for union workers than non-union employees (because of the additional cost and lack of flexibility of union workers). Also, eliminate the requirement that contracts awarded by the state’s agencies be let to companies with union shops.<br /><br /><br />5. Make California attractive to employers<br /><br />California is widely known as one of the most difficult and most costly venues in America to do business. This drives companies, jobs and tax revenues out of the state. There is a mass migration of companies and plants/divisions to friendlier states. We must reverse this aggressively by lowering taxes, severe labor laws and bureaucratic regulations on businesses. By keeping more jobs here and helping companies grow and prosper, the state’s tax revenues will rise.<br /><br /><br />6. Reduce/restructure taxes on individuals<br /><br />California has one of the highest tax rates in the nation. Individuals in the highest brackets spend enormous effort avoiding exposure to state taxes (buying California tax exempt bonds, avoiding taxable income, etc.). A large number of them simply move out of the state. The state loses a huge amount of tax revenue that would stay here if rates were more moderate. Also, the Federal capital gains rate is lower than the ordinary income rate, but not so in California. Our tax policy should provide a lower rate of tax on capital invested in California businesses, projects and other state-based activities to encourage investment to stay focused here.<br /><br /><br />7. Restructure public education<br /><br />The biggest part of the state’s budget is education. While the K-through-12 system in California is one of the nation’s worst, its higher education system (the University of California, Cal State system and the community colleges) is clearly the best in the nation (and probably the world). However, the higher education system in California is at risk of losing its greatness. This is because the state is cutting its subsidy (with no hope of reversal) while continuing to put a lid on the tuition it can charge students. The “access” part of the institutional mission in education is of high value to the California society and must be preserved. “Access” simply means that every individual with the academic ability, but not the economic means should be able to obtain a top quality university education. However, the economic model is broken now that state subsidies are fading. Currently, the UC system charges a little over $8,000 per year for an in-state resident student. The quality of education delivered by UC Berkeley, UCLA and other campuses is clearly on parity, or superior to leading private universities where tuition is above $35,000. There is no good reason for this disparity in price, except for the “accessibility” issue. This can be easily solved by freeing UC campuses to charge a fair market price for the education they deliver, conditioned on the fact that they carve out a large block of scholarship funds to apply to those that need financial support. If one “runs the numbers” you can see that this works amazingly well.<br /><br />The K-through-12 challenge is an area that commands our best thinking. The answer is not money, but a new way of doing things. On this matter my thinking is not yet developed.<br /><br />Over the years, the California legislature has increased spending at an unconscionable rate, doubling outlays in the last decade. At the same time, revenue growth has been weak…and will continue to be weak over the next decade. Fixing this year’s budget deficit is simply an ephemeral solution. We must address the inherent problem of our “business model”. We must increase tax revenues by improving the prosperity of our state (not by increased taxes) and must cut the excessive spending spiral.</div>Chuck Martinhttp://www.blogger.com/profile/01165029253566700876noreply@blogger.com0tag:blogger.com,1999:blog-6692844783818951328.post-74041744053340056872009-06-05T16:42:00.000-07:002010-05-22T16:44:48.488-07:00The Fading American Dream<div align="justify">Years ago, I was having dinner with two young men, one from an affluent American family and one from Holland. I asked the young man from Holland, “Why did you leave your family and friends and come here?” He replied, “To pursue the American Dream.” The other young man responded asking, “What’s the American Dream?”<br /><br />It was a sobering look into the shifting values of America and the declining appreciation for what has made our nation great…and prosperous. It seems, of late, that there is an accelerating transformation of social values in our nation.<br /><br />It is important that we all take a thoughtful look back at the basic principles that have made America a prosperous nation. To be sure, our nation is a generous and principled society. To afford continued generosity, a nation must be prosperous. Only when the economic engine of a nation is powerful, can it afford to do good things for its people and others.<br /><br />Economic value in a society comes from the private sector. It makes things, creates jobs and income for employees and provides tax revenue to the government. Government adds no value to a nation’s economy. It is like overhead in a business; necessary for certain essential functions, infrastructure and shared services. But, it does not contribute to the welfare of its people since it does not create anything of economic value. A society prospers when public policy supports and nurtures the private sector…and declines when it intrudes too much on that territory. In the 1800s, the author, Thoreau said “Government is best when it governs the least.”<br /><br />So what did make America great?<br /><br />Our forefathers and immigrants migrating to this country often referred to it as the “land of opportunity,” that is, a place where one’s hard work, individual initiative and creativity could lead to a better life for them and their family.<br /><br />Now it seems that America has become the “land of entitlements” and rights. There has been a gradual, pejorative shift of orientation from those that produce (create economic value) in our society, to those that consume economic resources. This is not a sustainable equation. So, if there is a battle between those that want to “take” resources from society and those that want to create resources for a society, who will win?<br /><br />The pendulum has swung too far to one side. It is a challenge in a democratic society when voters are presented with a choice between self interest and the greater good of society itself. For a democracy to prosper, its people must vote without self interest for what makes that society better. They must also have the level of knowledge to know what makes for a better society for all of its people.<br /><br />What is going on now that should raise one’s concern? Government activism is on the rise…invading the private sector. It is deeply troubling when we see the long arm of government reaching into the private domain; including a frightening disregard for the rule of law by public officials. I recommend that we all go back and read the Constitution and “Bill of Rights”. It is really good stuff! One key provision is that, “all rights not granted to the government are to be retained by the people”. Political leaders seem to have forgotten the limited powers granted to them by the people.<br /><br />Recently we have seen the American auto industry turned into a public works project, to be owned and operated by the government and unions. Certainly, Chrysler and GM have been badly managed for decades but, do we really believe that the government has any skill to run a business?<br /><br />For sure, the banking system needed resuscitation, but government activism was extreme. Last year we saw the public officials force “shot gun weddings” between unwilling financial services firms (e.g. Bank of America’s acquisition of troubled Merrill Lynch and others). Major banks are being nationalized, driving talent out of those enterprises. Public servants are setting executive salaries and eliminating any pay-for-performance incentive. Through government ownership, political pressure is also being applied for banks to lend aggressively to borrowers with marginal credit worthiness …when their own balance sheets are already over-leveraged and feeble.<br /><br />It is almost unbelievable that we have seen Congress propose the insidiously titled “Employee Free Choice Act” which would eliminate the secret ballot in forming union shops. This would allow old style coercion, deception and harassment by union organizers. Is this America in the 21st century? Under this proposed legislation, if 50% signed union “cards”, all employees would be swept into the union and the government (not the employer) would have the power to set wages and benefits. Why isn’t the public outraged about such legislation?<br /><br />It is troubling to see the loss of a balance-of-power in Washington which has led to free wheel spending that will mortgage the future of generations to come. While the promise is stated, “no new taxes on 95% of Americans,” the message is silent about the tax burden to be borne in years ahead. With the current year deficit set to exceed the combined deficit for all Presidents in US history (200 years), there will be a price to pay for this lack of fiscal discipline.<br /><br />Clearly the plan is to tax “producers” at a higher rate, but when that source is exhausted, which will be soon, government will have to apply the burden to Main Street America. There is simply no way to avoid it. This will be exacerbated as the increasing tax burden on the “producers” results in the diminishment of individual initiative, investment and innovation. Discouraging incentive will lead to lower growth in the economy and lower tax revenues. It is a vicious cycle that is certain to adversely affect our nation’s prosperity and the American way of life.<br />So, is there hope for the future? It is in our hands. We must renew our appreciation for the basic values that have led to our nation’s prosperity. We must relearn to celebrate an individual’s success and recognize that the success of one adds to the quality of life for all. It is not a “zero sum game.” We live in a world where the innovation, leadership, willingness to take risk and personal initiative of any individual can raise the quality of life for many.<br /><br /> A glimmer of hope occurred in the recent (May ’09) election in California, when voters soundly turned down the five propositions placed on the ballot by its legislature. These propositions were designed to let the state’s elected officials “off the hook” from dealing with the self-inflicted budget deficit. Had the propositions passed, Sacramento would have been able to push off the hard work of “living within its means” to a future year.<br /><br />It would be wonderful if the cycle in society was beginning to turn back towards our basic American values. The California referendum on fiscal responsibility may be just a tax payer revolt and not reflective of a broader shift in social values. But, as California has led the way in so many aspects of this nation’s life, perhaps it may too lead the way back to the renewal of the “American Dream.”</div>Chuck Martinhttp://www.blogger.com/profile/01165029253566700876noreply@blogger.com0tag:blogger.com,1999:blog-6692844783818951328.post-24501612224442252072009-03-02T16:39:00.000-08:002010-05-22T16:42:10.424-07:00Short Story: The Economy<div align="justify">About two decades ago the expansion of credit in America began to accelerate. In the mid ‘90s consumers commenced what was to become a credit “binge” that would last 15 years. During this period consumer debt grew much faster than incomes. From 2003 to 2008 consumer credit tripled while the economy did not grow sufficiently to support that debt load. The consumer was not the only party that was binging on credit. The US Federal Government dramatically increased its borrowings during this period. In addition the government took on huge amounts of liabilities in the form of a growing Social Security and Medicare burden, neither of which shows up on its balance sheet.<br /><br />The US society, during this period, embarked on a “borrow from tomorrow and spend today” way of conducting business. This caused the American economy to grow faster than the fundamental drivers (productivity and wage expansion) would justify. The result was that we leveraged up our economy.<br /><br />At the same time, the excessive demand that resulted from credit expansion (and the excessive spending that accompanied it) caused asset values to grow faster than the underlying economic expansion could support in the long run. No place was this more evident than in housing. <br /><br />Public policy was a major factor in the explosion of credit and unrealistic growth in housing prices. The US Congress and Presidential leaders promoted the concept of expansion of home ownership in America. They dramatically expanded the scope of mortgage financing in the nation. The extraordinary expansion of FreddieMac and FannieMae were central to this public policy adventure. Politicians believed that home ownership should be a right of all Americans, regardless of their economic status or creditworthiness. Consumers bought homes that they could not reasonably afford and refinanced them to higher levels, all of which fueled a spending boom. This metastasized through the economy as consumers spent at a high level on furniture, furnishings, house wares, boats, cars, recreational vehicles and much more.<br /><br />The private sector contributed to the credit binge also in a big way. The securitization of mortgages added fuel to the fire. This mechanism facilitated the flow of investor funds into the mortgage markets in huge amounts. The creation and proliferation of new instruments also contributed to the credit binge. Credit default swaps provided a form of insurance against borrower defaults that allowed low quality credit to be upgraded and sold to the market. Collateralized Debt Obligations (CDOs) were another “creation” that fueled the flow of funds to the credit markets. Through these instruments portfolios of loans (mortgages, autos loans, credit card loans, etc.) could be bundled and divided into tranches that could be sold to the market. The symbiotic relationship between credit rating agencies and mortgage financing firms was also an unsightly mechanism that contributed to the growth of these debt securities.<br /><br />For almost two decades this dramatic expansion of credit has fueled a growth in asset values, pumping money into the economy and creating a massive number of buyers (spenders). Home prices grew to levels that were well above the affordability level that could be supported by incomes. The low cost of mortgage debt mask the fact that homeowners simply could not afford the purchases that they made on a sustainable basis. Artificially low interest rates contributed to this problem.<br /><br />The artificial stimulation of demand lead to an expansion of capacity in the economy that was not sustainable; too many stores, too much auto manufacturing, too many homes built; just too much “stuff”. We now find our economy oversupplied. It must shrink to the level that is required to supply the real demand.<br /><br />So now comes 2008; the “day of reckoning”. The economy has begun to go through a deleveraging process. Unwinding leverage is a very painful process and can take time to reach a state of normalization. In this process asset values must fall. There are no buyers and all parties seek to sell at the same time. Banks, brokerage firms and consumers must follow this painful course. Fortunately most (non-financial) companies did not fall into this trap and have good balance sheets. Financial firms will make this journey fairly quickly, but it will take a long time for consumers to deleverage. This will curtail their spending and investing for a protracted period.<br /><br />The backbone of the growth of the American economy in recent years has been the consumer. The consumer has been spending beyond his means for a protracted period of time and has now crawled into a fox hole and will stay there. In a strange way this is intelligent behavior. After partying all night and waking up with a hang over, the consumer must dry out; must live more conservatively; must moderate their spending behavior. Consumers have seen their household wealth disappear. Home equity has vanished, retirement savings and savings for the college education of their children have dropped precipitously in value, unemployment is running at very high levels…and the consumer is afraid. It will be a long time before they feel confident again.<br /><br />So what about government intervention to “save the economy”? We have just witnessed the “loony tunes” in Washington pass a “stimulus” bill, the size of which is the largest in history. Presumably it will create millions of jobs. Politicians point to a large number of “shovel ready” projects that will be funded. This may help employment in the construction industry, but will not support employment in financial services, retail, manufacturing and virtually all other industries. Somehow I do not see a retail clerk, auto executive or bank executive getting a shovel and going to work.<br /><br />More importantly, it was a “borrow from tomorrow and spend today” scheme that got us into this mess….and Washington’s solution to get us out is…to borrow from the future and spend it today. This is pure folly. The government, through the Federal Reserve has also attempted to manage the economy through monetary policy. Interest rates were lowered to unreasonable rates in the 2001/2002/2003 time-frame and fueled excessive, unsustainable, economic growth in the years that followed. Now it is happening again. Why can’t these economically illiterate political leaders keep their hands off the “steering wheel” and let the market do its thing.<br /><br />This would mean that our economy would grow at a slower pace, but at a sustainable rate and perhaps might not go through the big cycles that are created by too much stimulus and too much government meddling in an effort to make things better today than the underlying economic drivers can support over the long haul.</div>Chuck Martinhttp://www.blogger.com/profile/01165029253566700876noreply@blogger.com0