Fixing CalPERS

Although it rarely comes up in mainstream financial media there is an enormous problem in the US with underfunded public pension funds. Unless this problem is addressed, it will have a serious impact on millions of pensioners and on the overall economy. Politicians will inevitably cut benefits which they will perceive is the only avenue open to them.

The California Public Employees Retirement System (CalPERS) is by far the largest pension fund at $326 billion. CalPERS provides pension and medical benefits for approximately 1.9 million state and municipal employees and retired employees in California.

CalPERS’ investment record can be described as lousy. By January 2009 before the financial markets had even bottomed out, its assets had declined in value by almost 30% from the preceding year and a half.  A lot of people saw the bubble rising before 2008. What was CalPERS thinking?

At that time the fund had about 65% of the dollars needed to pay the benefits it was obligated to pay. By June 2016 it was funded at almost 77%.  The fund posted an 11.2% return for 2016-2017 and is projecting an 8.7% return for its fiscal year 2017-2018.  Still, today it estimates that it is back to having $70 for every $100 it will eventually pay out. This is in the midst of a raging bull market when the DJIA more than doubled.

The fund needs to do a lot better if it is going to keep up with the pension demands of an increasing number of retirees who are living longer and increased medical and pharmaceutical costs for its aging population. Understanding why this happened is the first step to fixing it.

I do not want to mince words. The problem is that CalPERS is managed by a bloated bureaucracy of state employees and overseen by a board made up of largely incompetent political hacks.  In many ways just hiring professional managers would go a long way to solving the problems.  (No I do not expect this article will lead to a lucrative consulting contract. Telling the truth rarely does.)

Part of the problem can be attributed to the diversification policy being used. You cannot invest over $300 billion in just a handful of stocks but diversification for the sake of diversification is not the answer either.

In its last annual report, the fund reported that it held more than 1 million shares each of Chevron and Disney. Both are solid, blue chip, dividend paying California based companies.  No one would suggest either is a bad long term investment.

At the same time the fund owns hundreds of other equities, some well know and many not so well known.  Most pay no dividends. In more than a few cases the fund held only a few thousand shares of some of these companies. For a fund this size to own 5000 shares of small companies hoping that their price will increase $5 or $10 it is not worth the cost of a cadre of analysts to follow them.

CalPERS employs about 400 analysts all of whom are state employees and most will get a pension when they retire.  While they are not the most expensive analysts in the world (and they do not have to be) neither are they Wall Street’s best and brightest.

The portfolio also contains bonds issued by foreign companies and foreign governments.  There is nothing wrong with that, per se, but do we really need CalPERS to employ analysts to follow the economies of Chile, Germany and France?

Suggestion No. 1:  CalPERS could consolidate its portfolio a little, do away with smaller positions and foreign offerings and lay off a few analysts. There are individuals teaching economics and finance on the faculties of UCLA, Berkley and other state schools who are already employed by the state and who already get a state pension.  A blue ribbon panel composed of some of these individuals to help CalPERS see where the economy and the markets are going might help CalPERS avoid a substantial loss when the markets get ready to correct again (like now).

But that is just a start.

CalPERS seems to have a love /hate relationship with hedge funds and private equity managers.  In 2014 it announced that was going to begin severing relationships with its private equity and hedge funds, citing the high cost associated with these private managers. At the time these funds represented about 10% of its total portfolio — including $4 billion of hedge funds and $31 billion of private equity.

A year later, CalPERS disclosed that it still paid $700 million in performance fees to private equity firms and that it had paid a whopping $3.4 billion in fees since 1990. CalPERS justified the fees by pointing to the $34 billion in profits it made from these funds in the same period. Despite its promise to cut down on private equity funds, the fund was still invested in more than 280 funds at the end June 2015. In its most recent annual report, CalPERS cites the private equity funds as the most profitable segment of its portfolio.

Suggestion No.2 If CalPERS is considering investing a few hundred million dollars in a private equity fund, shouldn’t the fees be negotiable? Perhaps the legislature should step in and cap the fees that can be paid to a hedge fund or private equity manager.  No one can suggest that any private equity firm is going to say no to an investment of that size and the savings would go right to CalPERS’ bottom line.

Perhaps nothing points to the foolish way in which CalPERS invests its money than its history of real estate blunders. CalPERS invested almost $1 billion with home developer Lennar and lost most of it when Lennar went bankrupt. It invested and lost $500 million in Stuyvesant Town, a complex of 56 buildings with 11,000 rental units near the East River in Manhattan.  CalPERS response to this loss was to get back into the NYC real estate market and invest more than $300 million in 787 Fifth Avenue, reported to be the most expensive office building in Manhattan at the time.  Does CalPERS really need to invest in NYC real estate?

Suggestion No, 3.  There is a significant shortage of affordable housing in California. In Silicon Valley there are stories of police and firefighters living in RVs and trailers and school teachers living in their cars. Many of those people pay into CalPERS. CalPERS should consider funding at least 100,000 units (and perhaps a lot more) of affordable housing around the state. That will not really put a dent in the problem but it would be an excellent start.

In addition to the benefit from the construction jobs and the housing for people who need it, it should be obvious that people without a permanent place to live do not buy furniture and appliances.  Creating these permanent communities would certainly boost the sales tax revenue that the counties and municipalities are collecting. A population boost of 5-10,000 people in some smaller counties might create the need to hire more teachers and police who would pay into the CalPERS fund for decades.

More importantly, CalPERS could hold the mortgages on these properties and collect 5% and possibly more on its investment for 25-30 years.  I would think this is a more attractive investment than a bond issued by a foreign corporation even if the bond is rated triple AAA.  It certainly makes more sense than investing in high end office buildings whose tenants will move out when the market tanks.  Low end affordable housing is not sexy but the tenants tend to pay the rent in good markets and bad.

CalPERS also provides medical benefits for about 1.6 million current and retired state and municipal employees.  CalPERS does not break out the costs but it is obvious the skyrocketing costs for prescription drugs must be substantial and probably growing faster than the any other outlay.

Suggestion No.4. Instead of buying generic drugs for plan members, buy a generic drug manufacturer. CalPERS certainly has the money to own or joint venture with an FDA approved manufacturer to produce a lot of the pills it doles out every month.  One or two manufacturing facilities could make 10 or more of the top 20 generic prescriptions and mail them directly to plan beneficiaries who need them. This cuts out the manufacturer’s profit and the profit of at least one middleman. If one half of its plan participants get one prescription per month at a savings of $10 it could bring close to $100 million per year to CalPERS’ bottom line and that is probably conservative. I suspect that Kaiser or one of the other healthcare plans might be willing to take excess production or jump on the chance to invest as well.

People are always telling me that my blog articles expose problems and scams but that I rarely offer solutions or suggestions. At least when I expose a scam some people might not invest and thus not get hurt. The odds of anyone at CalPERS actually reading this are very slim, but who knows, it might actually resonate with someone who matters.


Why the Panic of 1893 is Relevant Today

The difference between studying economics and economic history is simple. In the former you learn how markets work and how to work within markets. In economic history you study all the times that the markets failed to work, including the market crashes, depressions and panics. The latter are far more interesting.

When I was teaching economics I would throw in a discussion of a panic or depression just to keep the students awake.  A good financial panic can get and keep your attention in the same way that motorists will never fail to look at two cars parked along the side of the highway that have been involved in an accident.  The more damage to the cars, the more people just cannot look away.

I frequently discussed the Panic of 1893 because it was at the same time a relatively simple and complex affair.  It was the worst economic disaster in the US up to that time and it came at the end of a period of prosperity and expansion the likes of which the US had not previously seen.

The events that led up to the Panic of 1893 and the measures taken by the government to deal with it are all relevant today.  There was a lot being discussed back then that is still being discussed today.

A lot of people who favor crypto-currencies frequently tell me that our current financial system is flawed and doomed because of the crash in 2008. That our economy survived 1893 and was still around to crash in 2008 is an indication of the market’s resiliency.  The reforms that took  place in the century after 1893 only made the US financial system stronger.

During the period 1870-1890 the railroads opened the west and people moved onto the Great Plains.  Farmers, not the industrialists, were the foundation of the US economy and were apparently too busy farming to have children because the food supply actually grew faster than the population.  Wheat was the primary commodity and whether the farmers understood it or not, the price of wheat was very much determined by a global economy.

US farmers borrowed heavily to finance their own farming operations. As production went up, prices came down and the depressed prices made it difficult for them to pay back the banks that had lent them money.  The same was true of cotton farmers in the South. Cotton was a major cash crop both before and after the Civil War. By 1890 the price became depressed as growers in Egypt and India added more and more tonnage to the world markets.

Since the farmers could not sell their wheat or cotton, there was no need to ship it anywhere and railroad revenues also dried up. The Philadelphia and Reading Railroad went bankrupt as did the several other large railroads. All were big employers and unemployment started to climb.  Part of this was due to the fact that as the railroads had been building more and more track and added to capacity that outgrew their market.

A company called National United Cordage which made rope out of hemp also went bankrupt.  The company had sold bonds to finance its operation and used the money to try to corner the market on hemp.  National Cordage was the most actively traded stock on the New York Stock Exchange at the time until rumors that the company had over extended itself caused the lenders to call the bonds and the company collapsed.

As National Cordage and the railroads went under, the stock market became uneasy and crashed.  Somewhere in the neighborhood of 500 banks closed as did thousands of businesses and farms. Unemployment shot up.  By some counts as many as 50% of the able bodied men who had been working in factories in Ohio were out of work.

In 1890 there was a drought in Argentina which killed off the wheat crop. This should have been good for American farmers but was not, for reasons that few people saw coming.  Years later when there was a similar drought and famine in the Ukraine, Herbert Hoover engineered the purchase of wheat from US farmers and shipped it to Russia. That would have helped the farmers in 1893, but no one apparently had the foresight to come up with this solution until 30 years later.

The Argentinean farmers were largely financed by British and European banks. In order to obtain the investment, the banks in Argentina originally hired Baring Brothers, one of the oldest English merchant banks, to assist them.  When I was giving this lecture to my economics students in 1995-1996, Barings had just been put out of business by a single young trader on its derivatives desk in Singapore who had made huge bets with Baring’s money and lost.

Barings was a little smarter in the 1890s because at the same time it was steering its clients into Argentine bonds, it was also buying US treasury bonds which were backed by gold.  European investors, panicked by the losses in South America, began to cash in the US bonds and demand gold as repayment. Almost immediately the US gold reserves fell to 100 million ounces which, by law, they were not supposed to fall below. The government actually borrowed gold from JP Morgan to make up its deficit.

The US was in the midst of a decade long debate about fiat currency.  At the time, fiat meant anything that was not gold or convertible into gold. The primary alternative was silver and many economists disregarded it out of hand simply because it was not gold.  You can only imagine how an economist from in the 1890s would feel about Bitcoins as an alternative currency today.

In 1890 the Congress had passed the Sherman Silver Purchase Act which required the US to purchase silver from mines in Western states. The idea was to deflate that value of US currency so that farmers could re-pay banks with currency that was worth less than it was when they borrowed it.

This encouraged silver mining and an over-supply of silver which helped to reduce the price of silver in the marketplace. It actually got to the point where a $1 Morgan silver coin had only about $.60 worth of silver in it.

The Silver Purchase Act was passed in conjunction with the McKinley Tariff, a very protectionist law that caused taxes on imports to rise dramatically and prices on many common goods to increase.  Certain protected industries such as wool and tin plates did well but overall prices went up for ordinary consumers.

At the time tariffs were the primary source of tax revenue for the US Government because the income tax had not yet been enacted. Tariffs were taxes that impacted small people buying common goods and aided the rich industrialists whose businesses were protected.

One of the interesting things about the Panic of 1893 is that it happened very quickly.  The railroads filed for bankruptcy, the banks closed and the stock market crashed all in a period of about 10 weeks. It led to several years of a deep depression.

Just prior to the 1893 collapse there had been a growing Populist movement that supported an agrarian economy and chastised Eastern elites, banks, railroad interests and gold. The Panic should have helped their cause, but did not. The Populists won 5 states in the Presidential election of 1892 and 9 seats in the House of Representatives in 1894 but had largely faded away by the end of the decade.

Not much in the way of reforms came out of this Panic but it was not the last. The Federal Reserve Act followed the Panic of 1907 when a few hundred more banks failed and securities market regulation and the FDIC originated after the stock market crash in 1929.

What I personally find interesting is that the issues present in 1893, globalization of finance and trade, the over-extension of credit, over supply of commodities and services, droughts, tariffs and protectionism, fiat currency, railroads and transportation, Populism and regional politics and even hemp are still in the headlines and issues surrounding them still on the table.

The overriding lesson is that finance is about trust and value.  It took 100 years after this Panic and several subsequent panics until the phrase “irrational exuberance” entered the economic lexicon but that phrase only explained what we should already have known.  The best lesson of 1893: “Do not build what you cannot use. Do not borrow what you cannot re-pay”.


Is Technology Changing Finance?

A lot of people seem to believe that technology will fundamentally change or disrupt finance and the financial markets.  Many, if not most, of those people seem to be developing technology, selling it or using it to sell products to investors and financial consumers.  Most of these people seem to have degrees or backgrounds in technology not finance.

Having a background in technology does not give you an understanding of finance or the financial markets.  You cannot fix or disrupt what you do not understand and the lack of understanding behind many of these products is simply ridiculous.

I only write about the law and the financial markets. I spent my career as an attorney working in and around the financial markets. I also taught Economics and Finance so I have a pretty well rounded idea about how the capital markets work and how they are evolving.

So I feel perfectly justified to call out the many techies who think they understand the financial markets even though they have never worked in the markets or studied finance. Nonetheless many seem hell-bent to create products that they think are making these markets better and are quick to label the products that they sell as “disruptive”.

I call these people the “algorithms fix everything” crowd.  It is an interesting thought, except that these mathematicians have no math to back up much of what they say about finance.

At the same time, there is an ongoing narrative that suggests that everyone who works in the financial markets is evil. I find it amazing how many people actually think that all bankers and stock brokers get up in the morning thinking “who can I screw today?”  I have personally brought more than 1000 claims on behalf of aggrieved investors against Wall Street firms and written a book about some of the really bad things that Wall Street firms can do, but even I know that Wall Street firms are not evil.

The capital markets handle millions of transactions every day involving trillions of dollars and the almost all of those transactions settle with both the buyer and seller happy. Banks and stockbrokers fund schools, universities, roads and hospitals and virtually every company since WWII, again without serious problems or complaints from anyone. Banks aggregate and intermediate capital and over all they do it quite well.  So what, exactly, needs disrupting?

Still there is a never ending stream of new products and services which claim to be revolutionary and which promise to disrupt the capital markets. On closer examination many of these innovations are more hype than substance. Say what you will, there is nothing disruptive here.  A few examples for your consideration:

1) Algorithmic stock trading – This is a good place to start because it is pure technology applied to the existing markets. “Quant” traders use computers to evaluate trends and trading patterns in the market of various securities. They attempt to anticipate the price at which the next trade or subsequent trades will occur.  Logic says that computers should be able to take in more information that is pertinent to stock trading, analyze it almost instantaneously and execute transactions in micro seconds.

It sounds right, but the reality is that all stock trading is binary; every buyer requires a seller. No one buys a stock unless they believe that the price will appreciate; sellers generally will only sell shares when they think the price will appreciate no further. Both sides to any trade cannot be correct.

Analyzing the information or executing faster is of no use unless each trade you make is profitable.  No one has yet figured out how to accomplish that, nor are they likely to do so.  What we are talking about is predicting the future which is difficult to do even if only a micro-second or two ahead.   And please do not suggest that artificial intelligence will change this.  If there is one right answer based on the current information, e.g. buy APPL, then who is going to sell it?

2) Robo investment advisors- These are similar but much less sophisticated. Robo-advisors do not actually attempt to anticipate future market performance. They make investment recommendations based solely on the past performance of the markets. Anyone who has ever bought a mutual fund is required by law to be told that past performance is not a basis for future results. But that is all you get with a robo-advisor.

FINRA did a study of a half dozen robo investment platforms and found that they provided widely divergent portfolios for the same types of investors. No robo is any better than any other and none is really worth anything.

3) Crypto currency- It was a discussion about Bitcoins that was the initial impetus for this article. Aficionados of crypto currency actually think that they are developing an alternative currency for an alternative financial system. People seem to want to just print their own money and on one level I can understand that.  But that level is more of a fantasy than reality.

The reality is that I can buy food or virtually anything else in most places in the world with US currency. Why do we need Bitcoins? What exactly, is their utility?   When I ask that question I get any number of weak responses. More often than not, I get a tirade about banks and/or governments being evil.

What proponents of crypto currencies never want to face is the fact that the crypto currency market has been full of people laundering money from illegal activities.  The banks that crypto currency fans love to hate are required by law to know their customers and have systems in place to prevent money laundering.  It costs money to follow the law and have those systems. It is money that the crypto currency platforms do not want to spend. If there is a common thread in the crypto currency world, it is that people want to skirt or simply ignore the regulations that keep the markets safe and functioning.

4)  Crowdfunding Platforms- Crowdfunding clearly works and works well as evidenced by the significant amount of money that it has raised for real estate and real estate development projects.  At the same time the crowdfunding industry is populated by a great many people who fall into the “I do not care what the rules say, I am in this to make a buck” crowd.  I have written several articles about how some of the crowdfunding platforms do not take the time to properly verify the facts that they give to potential investors.  Due diligence can be expensive and some of the platforms just refuse to spend what it takes to do it correctly.

Crowdfunding replaces the role that stockbrokers typically fulfill in the process of raising capital with a website and do it yourself approach.  With a stockbroker, the company that was seeking capital got that money the vast majority of the time because the brokers were incentivized to sell the shares. With crowdfunding it is very much hit or miss whether the company will get funded. Many of the better crowdfunding platforms charge close to what a brokerage firm would charge and the investors get none of the protections or insurance that they would get with a stockbroker.

5) FinTech and FinApps – I can go to my bank’s website and send a payment to my electric utility company. I can do the same at the utility company’s website. I admit that it is convenient, but it is hardly disruptive.   Remittance companies like PayPal merely move money from my bank to a vendor’s bank.  And PayPal posted a $3 billion profit in the last fiscal quarter.  So they may charge less of a fee per transaction than a bank, but is not essentially different, and again while PayPal holds my money, I get no insurance against hacking or theft.

Apps that allow me to apply for a mortgage on my phone are really doing no more than eliminating a bank employee who would enter the same information from a written application into the bank’s computer. Again, it is convenient but not necessary.  And the money for the mortgage comes from either a bank or stock brokerage firm so there is nothing disruptive here, either.

Is there nothing truly new and disruptive in finance? Of course there is. They deservedly gave the 2006 Nobel Prize in Economics to Muhammad Yunus for developing a system of micro-finance that continues to create millions of entrepreneurs and lift millions more out of poverty. I doubt that one line of computer code was needed.

Micro-finance has the ability to put globalization on steroids.  Who will be disrupted?  Quite of few people with big school pedigrees and enormous student debt who write code to disrupt finance but who never understood finance in the first

The Economics of Healthcare

I suspect that I am like a lot of people who have boxes of old documents in storage. I recently began cleaning mine out and I came across some of the lecture notes that I used when I was teaching Economics back in the 1990s.

One particular set of notes originated from a panel discussion I was asked to join about healthcare reform in 1993 or 1994.  Not unlike today, there was a substantial and partisan discussion about healthcare reform in the early years of the Clinton Administration.

There were two main topics covered by the panel. The first was should the government follow the British model and simply provide healthcare to all citizens. The second was a general discussion on what could be done to reduce the cost of healthcare for everyone.

As to the first, I was and continue to be an advocate of free markets.  I thought that if government provided healthcare and paid the providers it would necessarily do so at the lowest common denominator of care.  I have to admit that I was wrong on this point.

In the interim years, I became a large consumer of healthcare. In 2011 I was diagnosed with a very deadly type of leukemia. I had 5 rounds of nasty chemotherapy, two stem cell transplants and spent a total of 148 nights in the hospital. I beat the cancer only because I got world class treatment at the University of California San Francisco Medical Center (UCSF).

Every one of the doctors, nurses, technicians, kitchen staff and parking attendants at UCSF is an employee of the State of California. This is government provided healthcare at its best and I am certain that it is the same at UCLA or UC Davis. I will not dwell on whether or not the government can provide high quality healthcare because I witnessed it firsthand.

A lot of the real problem with healthcare costs in the US can be laid at the feet of the insurance companies. Insurance companies are entitled to make a profit meaning that they will charge consumers as much for coverage as they can while at the same time negotiating the lowest price from the service provider.

During the course of my treatment, when I was not in the hospital I got my blood drawn and tested often.  If I did not want to drive to San Francisco, I could have my blood drawn at the county hospital nearer to my home.  The bill for the same blood test was several hundred dollars more at UC than at the county hospital. How much the insurance company paid either provider for the same test is a different matter. Still, a blood test is a blood test and the cost of one should not vary from location to location as much as it does.

The real focus should be on reducing the cost of providing medical care and services. Economics teaches that basic price theory applies. The cost of healthcare is largely determined by supply and demand, just like the price of anything else.

The supply of doctors and nurses has not kept pace with population growth. Just about everyone agrees that there is a significant shortage of both doctors and nurses.

There are roughly 1,250,000 licensed physicians in the US. Some do not practice or practice part time. Many specialize; some do research.  Overall it works out to about 400 licensed physicians per 100,000 people.  We add about 12,000 net new physicians every year (new graduates minus retirees).

We could add an additional 5000 new doctors per year if we wanted to do so. That comes out to an average of 100 more per state with perhaps 150 from New York and California and fewer from Montana and Alaska.

Medical school is very expensive but does not need to be as expensive as it is. Much of the first year curriculum (anatomy, immunology, genetics) are lecture courses that can be given on-line freeing up classroom space and faculty salaries.  Not that much more laboratory space is needed to accommodate an additional 100 students, especially if there was more than one medical school in the state. Clinical courses and research require patients and supervision and there are enough of both to go around.

Most medical students graduate with piles of debt. We could arrange to let them work that debt off after they become doctors by working part-time over a period of years at free or low cost clinics in rural or inner city areas where they are needed.  That way people without insurance could still get care and a lot of doctors would not have to be concerned about having to charge as much as they can to pay off their debt.

There has also been a shortage of nurses in the US since I first looked in the early 1990s. Current estimates seem to be between 250,000-500,000 unfilled nursing jobs by 2025.  These are good paying, middle class jobs in a rewarding albeit challenging profession. A shortage of this magnitude necessarily increases what nurses earn. If we want the cost of care to decrease, we need to train a lot more nurses.

The demand for healthcare is rising at the same time. More people are becoming insured with the Affordable Care Act and the population of baby-boomers is getting older. The best way to reduce the cost of healthcare might be to reduce the demand.

If we wanted the population to be healthier over all we could, for example, outlaw smoking and tobacco products altogether. We could make a first offense for drunk driving punishable by a permanent loss of driving privileges. Drunk drivers add significantly to healthcare costs every year.

We could reduce diabetes and obesity by imposing a hefty surtax on fried foods or sugared beverages. We could outlaw vending machines that sold potato chips and require that they sell fruit instead.  We could also require school children to spend part of their lunch hour walking around the block a few times. Healthcare costs will not come down in the long term if 30% of school age children are already obese.

I am not suggesting that any of this will happen. We did, however, get rid of asbestos, lead paint and DDT for health reasons and we require seat belts for the same reason. Each action reduced healthcare costs. Somehow sugary drinks and fried food seem a lot harder to regulate.

Perhaps health insurance companies could take a page from auto insurers who offer discounts for good drivers.  If you get a physical every year (which itself leads to early detection of many diseases and reduces the costs of treatment) and are not significantly over weight, you get a discount on your premium.  Economics teaches that incentives usually work better than penalties.

The one place you will never find a solution to the costs of healthcare is the US Congress.  The lobbyists who represent the industries that receive our healthcare dollars will see to that. As I said, Congress has been “fixing” healthcare since at least the early 1990s.  A market driven solution may be our best bet.


Understanding Globalization

When I was teaching economics back in the mid-1990s globalization had not yet made its way into the textbooks in any significant way.  Golden Gate University had a very international student body. Some of the students, who had come from other countries, intended to graduate and stay in the US; some intended to return to their home country.

The basics of economics can be applied to any marketplace, but I often found myself making references to specific American companies or advertising campaigns that were not recognized by everyone. Rather than approach the topic from a US perspective, I tried to find more universal examples in order to explain to the students how the competitive business world was likely to be trending during the first 20 years of their working lives.

The one business model, with which every student was familiar, regardless of their country of origin, was a sweatshop. The image of a group of people huddled over sewing machines in less than ideal working conditions is a universal experience.

Sweat shops are in almost every country. When I gave this lecture in the mid-1990s there were sweat shops within walking distance of the San Francisco financial district where the GGU campus was located.

Sweat shop workers typically get paid by the piece, as opposed to an hourly wage. They get no benefits and if they get ill or injured or fail to produce a sufficient amount of goods, they have no job security whatsoever.  In many countries they are willing to work for a ridiculously small amount because the job is the only thing keeping their families from hunger.

The very first requirement for teaching economics is finding a way to keep the students awake.   I focused the lecture on a fictional pair of entrepreneurs. I told the class that these characters had formally been GGU students that had made a lot of money based upon what they had learned in class. That got the students attention.

The two fictional protagonists were Jane who had studied marketing and was working as a buyer for a small chain of stores selling casual wear in Seattle and Eduardo who had grown up in Manila, studied management and returned home after graduation. Eduardo worked in a factory that made shirts and slacks. The business that they founded together I called JESSE, Inc. (Jane and Eduardo’s Sweat Shop Emporium).

The product that brought them together was unremarkable, except for its price. It was a short- sleeved men’s pull over sport shirt made of woven cotton. Generically they were called “tennis” shirts.  At the time they were very popular with two brands in particular dominating the market.

One of the dominant brands was European; the other American. Neither shirt had a breast pocket; each had their firm’s distinctive logo embroidered on the left side. The European firm had an alligator; the American firm had a polo pony.

Both firms had been around for a while and the shirts were somewhat of a staple among those who played tennis or polo which traditionally had been wealthier people.  Wearing one of these shirts conveyed a certain wealth or status.  They were sold only in upscale retail stores and the retail price at the time was around $60 per shirt. To be fair, the shirts were made from high quality, thick woven cotton.  They were well made and lasted for a very long time.

There were a lot of cheaper shirts on the market that were similar but they were made of thinner cotton or a cheaper cotton/polyester blend. Those shirts were available in less than high-end stores and had an average retail price of $20.

Eduardo worked as a manager in the factory outside of Manila where one of the better shirts was made.  The factory was not a sweat shop. It was clean and well lit. The workers were paid an hourly wage and worked an 8 hour day. The factory was able to deliver a shipping container full of shirts to the company’s distributor in Los Angeles for about $12 per shirt.

The US based distributor paid for an expensive advertising campaign and paid sales people to reach out to buyers representing high-end chain stores and shops. The wholesale price to the retail stores was about $30 per shirt which permitted the stores a 100% mark-up from their cost.  The US distributor was able to derive a nice profit after its costs and paid US taxes on those profits.

Jane approached Eduardo with the idea of producing a similar shirt, different from the cheap knock-offs because it would use the more expensive high quality woven cotton. Except for the distinctive logos the shirt would have the same look and feel of the higher priced shirts because the cloth was the same.

Eduardo initially arranged to buy a single bolt of the material from his boss. He took it to a local sweatshop, along with finished shirts in 4 sizes which were used for patterns. Jane designed her own logo, a palm tree, and created a story about Jesse, a beachcomber who didn’t wear shoes but still wanted to look good. The story would be printed on the outside of the plastic bags that each shirt came in.

Using the sweatshop labor, Eduardo was able to deliver shirts to Jane in Seattle for $8 apiece and still retain a handsome profit.  Jane took a suitcase full of the shirts to a buyers’ convention where she gave them away to other buyers in attendance and began writing orders.

Because she was running a lean operation without a national advertising program, she was able to sell the shirts at a wholesale price of $15. The retail stores could offer them to customers at $30.   Consumers got a product that looked a lot like the shirts that cost twice as much and significantly better than the $20 knock-offs that these same stores had been offering.

As you might imagine, the business took off; new products were added and both partners made a lot of money.  Jane was paying more and more taxes on the profits that she was making.

After a while Eduardo wanted to expand and offered Jane a simple solution to both of their problems. Eduardo raised the price that he was charging Jane to $10 per shirt.  He used the extra $2 to allow Jane to buy into his manufacturing company to fund his expansion.  Jane made a smaller profit and paid less US taxes. She now owned a portion of a Philippine company that was taxed at a far lesser rate.

When I first gave this lecture the internet did not have the bandwidth for moving pictures. Jane was a necessary part of the story because someone had to be the conduit to the US retailers who interacted with the ultimate purchasers.  In the modern internet era, Jane and the retailers are no longer necessary.  Eduardo can have an entire catalog of products on his website. DHL or FedEx will deliver the product directly to the consumer’s door regardless of where in the world that consumer lives.

Eduardo was happy to sell his shirts wholesale for$8-$10 each. He can now sell the same shirts, factory direct to consumer for $25- $30.  Advertising costs using social media and targeted digital ads have never been lower.

When I was young, New York City had a thriving garment center. Much of the labor was unionized. Those jobs are gone because a union shop in the US can never compete with a sweatshop elsewhere. It is not even the cost of the labor that was the determining event in this transition. It was the overnight package delivery which did not become a part of the system until the mid-1970s.

What has happened in the 20 years since I gave that lecture? APPLE for one manufactures overseas using cheap labor and adjusts the price to leave much of the profit overseas exempt from US taxes. Remember that when you are tweeting about the loss of jobs in the US on your iPhone.




Tax Policy and Economics

When a politician tells you that they will bring good paying jobs back to their district you should know that they are lying.  And while it should surprise no one that politicians lie; this lie is particularly insidious because it is something that could easily be accomplished. Politicians lie about job creation because many have themselves swallowed a lie called “trickle down economics” hook, line and sinker.

The idea of paying taxes to fund government operations goes back to the early Chinese emperors. Taxes can be broad based, like the tax on tea that precipitated the American Revolution. Historically governments appreciated that if they wanted to raise a lot of money, they needed to impose taxes on the wealthier people in the system.

The US federal income tax, beginning in 1919, was always progressive. It taxed people who earned higher income at higher rates.  For most of the time between 1919 and 1970, the highest tax rate on people who earned the most was 70%.  That amount seems confiscatory and it was, but for most of that time it applied to a very small portion of the total population.

The highest period of job growth in the US was during the post-WWII era, roughly 1945-1975.  During that time, the US federal government paid for two wars, Korea and Vietnam (which was very expensive), the US interstate highway system, the cold war military buildup (intercontinental ballistic missiles, battleships and aircraft carriers) and the space program.

All of these were very expensive outlays of funds that originated with taxpayers. At the same time, virtually all of these funds were spent within the US, the great bulk of it on salaries of workers who were building the highways and the hardware that the government was purchasing.

In the mid-1970s the US economy was battered with high inflation caused in large part because oil production was taken over by a cartel (OPEC). That raised the cost of everything in the US that moved by truck which was just about everything.

The OPEC oil embargo caused shortages which resulted in people waiting in long lines to get gasoline.  It also caused home heating oil prices to soar causing difficulties and dissatisfaction during the winter months.  Those of you who remember President Gerald Ford on television with a WIN (whip inflation now) button can relate. That dissatisfaction led to the election of President Reagan in 1980.

It is actually a 1978 article that is credited with the birth of “trickle down” economics and the “Laffer curve”. The article related the events that had occurred at a dinner attended by Dick Cheney and Donald Rumsfeld, both of whom worked for Pres. Ford. At this working dinner Prof. Arthur Laffer, then at the University of Chicago, sketched a curve on a napkin as an illustration of the tradeoff between tax rates and tax revenues.

Laffer suggested that tax revenues would increase as rates decreased because the untaxed funds would be used efficiently to create businesses and jobs and hence additional revenue which could be taxed.

For his part, Laffer claims that the restaurant had cloth napkins and he would never have used one for the illustration.  He also is quick to point out that the idea that cutting tax rates increases tax revenues goes back to the 14th Century.

Economics is a science that is very much based in mathematics. At its core is the idea that people will spend money in ways that satisfy their own best interest. The primary interest is getting the same or similar goods or utility at the cheapest price, so that you can get more goods and services with the money that you have.

There are mega gigabytes of data covering income, spending, taxes and a great many formulas and equations to explain and extrapolate that data.  If you took algebra in high school you know that when you change the variables in an equation, you get different results which you can then plot on a graph.

The Laffer curve is a graph that has no equation or data supporting it.  Most economists never accepted the Laffer curve but “cutting tax rates will make the country better off, create more jobs and result in higher tax collections” is an argument that has needs little factual or statistical support. It is a bastardization of a slogan we used to have in the 1960s: “if it feels good, do it.”

The Laffer curve is the basis of the Reagan era tax cuts on the wealthiest Americans and subsequent tax cuts at the state levels that continue to this day. The sales presentation for these tax cuts was that these wealthy individuals would invest the money that they saved creating new businesses and new jobs as the money “trickled down” into the economy.

It never happened.  Several states, (Louisiana and Kansas) continue to cut state taxes and have increasing difficulty funding schools and essential services. But the slogan: “I’m going to cut your taxes so you will have more money in your pocket” wins elections.

There seems to be an abiding desire to return to the “good old days” when there were many good paying jobs in the US.  As we learned with the New Deal and in the post-war prosperity, government can create those jobs. But it also needs to pay for them.

In round numbers, if your adjusted gross income is more than $375,000 per year you are in the top 1% of US taxpayers. The average overall federal tax rate for this group is just about 25%.  This includes some business owners, some doctors, some lawyers, all NBA rookies, many entertainers and hedge fund managers. Not all create that many jobs for others.

If the tax rate for this group were raised by 5% there would be more than enough money to create 1 million good paying jobs in the US; fixing highways, highway bridges, airports, ports and other infrastructure projects that just about everyone agrees need to be fixed. Fixing the highways would also reduce commute times, gasoline consumption, air pollution and the cost of everything that moves by truck.

These workers would pay taxes on their earnings which would fund other government programs and expenditures. They would also buy homes, cars, hamburgers, movie tickets and just about everything else people buy. It is money that would truly trickle down to other businesses. These types of construction jobs usually come with medical benefits as well.

Understand that even these workers will buy products like clothing and iPhones that are manufactured overseas. Overseas workers charge substantially less per hour for their time and Apple does not repatriate the profits it earns overseas or pay US taxes on them.

That is part of the problem with the current tax system and with the current “trickle down” theory. Left to their own devices business owners will use the money that they save from tax cuts to create jobs overseas.

I appreciate that there is a certain amount of “down with the top 1%” in this but I am not advocating a mass redistribution of wealth.  If anything, it is the tax cuts in the last 30 years that have caused the current disparity between rich and poor. Swinging the pendulum back the other way for a decade or two would seem to be a good way to promote growth and overall economic stability.






The Purely Passive Permanent Portfolio

My nephew recently asked me to recommend a good book on investing for someone who was just starting to make contributions to his retirement plan.  Somewhat reflexively, I recommended Prof. Malkiel’s “A Random Walk Down Wall Street” as a good place to start.

I first read “Random Walk” in the 1980s and it was an eye-opener for me at the time. I was and continue to be a dyed in the wool Graham and Dodd fundamentalist. I had met and followed quite a few research analysts when I worked on Wall Street. Their opinions were coveted by institutional investors. The brokerage firms were justifiably proud if one of their analysts was named to the annual “All-American” institutional research team.

The random walk theory was not original to Prof. Malkiel. He popularized it in layman’s terms. He used a coin flip to create a trading pattern for a fictional stock and then attempted to have an analyst apply technical analysis to the resulting chart.  When the technician told him to buy the fictional stock he concluded that analysts could not accurately predict the future price of a stock, so why bother?

In Malkiel’s view, simple asset allocation with periodic rebalancing will outperform the overall stock market. The standard allocation, 60% stocks and 40% bonds will never increase as much in a bull market as stocks alone, but the bonds will buffer loses in a bad market.  Many people believe that this type of allocation is fine for investors over the long term.

Asset allocation requires the construction of a portfolio with non-correlated assets. The stock portion of the portfolio must be selected carefully or the entire purpose of the allocation will be defeated.  Prof. Malkiel currently shills for one of the large robo-advisors that does not perform asset allocation very well.

Correlation is a tricky concept. The idea is to purchase investments that are affected differently by shifts in macro-economic conditions.  A truly diverse stock portfolio should have stocks from at least 15 non-correlated sectors.  You cannot create a truly diverse portfolio by investing in large cap, small cap and emerging market funds or ETFs. The stocks in these funds are correlated to each other in too many ways.  Capitalization does not define a sector for allocation purposes.

If you buy an index fund or ETF such as the Standard and Poor’s 500 you get the average market return in good years and in bad years. If the market happens decline for the 3 years just before you need your money, such as the 3 years before you retire, your portfolio may be worth the same as it was worth ten years earlier. You may have earned nothing during the last 10 years that you were working.  That is ten years in which you could have easily doubled your portfolio’s value if you were 100% invested in income producing investments.

Many people want a portfolio that will give them “higher than average market returns with lower than average market risks.”  It clearly is something that can be accomplished but it takes work to get there.

You can beat any index or sector fund by identifying the “dogs” that are in it. Some of the stocks in an S&P 500 fund are not expected to do all that well in the next 12-24 months. Certainly if you constructed a portfolio of the 250 stocks most likely to do well and leave out the dogs, you should beat that index every year.

Eliminating the dogs requires analysis. Fundamental analysis works and is still the primary way in which most professional investors make their investment decisions.

The “problem” is that a lot of people do not think that anyone can actually analyze individual stocks and pick the winners over the losers. That, of course, is not true.

There are a great many securities analysts and portfolio managers out there who are more than competent. The problem is that the best investment advisors are mixed in with a lot of advisors who are more adept at sales than analysis.

Rather than take the time and put in the effort to understand investing well enough to choose a good advisor, people have fallen back on the idea that they can buy a few index ETFs, rebalance periodically and all will be well. That is the investment philosophy behind robo-advisors. It is an investment philosophy I call “cheap and stupid.”

This brings us to Harry Browne.  Browne developed what he called the “permanent portfolio” back in the early 1970s.  He introduced it to the world in a well received 1987 book called “Why the Best-Laid Investment Plans Usually Go Wrong”.

I came across this book when I started teaching Law and Economics in the early 1990s.  Much of the literature around Law and Economics at the time came out of the University of Chicago and had a very libertarian bias.  Browne was a Libertarian and later became the Libertarian Party candidate for President.

Browne’s book described the virtues of a diversified portfolio whose composition would stay constant year in and year out — permanent, in other words, except for annual rebalancing. Browne’s idea of diversification into non-correlated assets was different from what you might think and very different from the diversified portfolio that you will get with any robo-advisor.

Browne’s portfolio divided your funds into only four asset classes. The portfolio was equally divided between aggressive growth stocks, which do well in times of prosperity; gold which does well in times of inflation; long-term Treasury bonds which increase in price during times of deflation and Treasury bills which do well in times of tight money/recession.

Browne was a “gold bug”. He recommended that you hold the gold portion of the portfolio in bullion or gold coins. This was fairly common advice at the time.

At the time the book came out, Browne reported that the portfolio had produced an annual return equal to 12% over the preceding 17 years. Much of that return was due to the doubling and re-doubling of the price of gold. Gold was still pegged at $35 per ounce when the portfolio began.  The latter half of the 1970s was a period of high inflation which helped the price of gold to move up.

Browne’s permanent portfolio continued to do quite well in its original form until his death in 2006. A number of books and articles have been written about it and several people have modified it with funds and ETFs.

There is a mutual fund called the Permanent Portfolio fund (NYSE: PRPFX) which uses a modified permanent portfolio including real estate and Swiss Francs. The fund holds about $3 billion in assets. If you are really determined to be a passive investor and appreciate that those robo-advisors are a scam you might take a look at this fund.  You will discover that it has done quite well since 2006, when Browne died, until the present.

As always, I do not know anyone at this fund and no one has offered to compensate me in any way for recommending it.

Browne’s permanent portfolio has apparently produced positive results continually since 1970 through the present. It can do so because growth and recession, inflation and deflation are opposites and assets that perform well in each cycle are non-correlated by definition.

Will Browne’s permanent portfolio continue to do well, year in and year out?  It should. It represents asset allocation and diversification in its purest form.










How Much is One Hour of Your Time Worth?

More and more people in the service sector of the economy are independent contractors setting their own hourly rate. For many self-employed people, it is one for the most important business decisions that they make.  It is also often one of the most difficult.

I worked as a lawyer for many years and I would periodically adjust my hourly rate upward, usually on the first of the year, to reflect the added expertise I had acquired during the year. Being self-employed allowed me the luxury of setting my own rate.

My hourly rate took into consideration that I had office rent and employees to pay as well as all of the ancillary expenses that come with running a business. However, that does not mean that I reduced my rate when I moved out of a pricey financial district office tower and into a lower rent office in the suburbs.

I was recently contacted by a very large international consulting firm that wanted to add me to their stable of experts. They had a client in need of a consultation about a fairly new regulation that I had written about and they invited me to call in and sign up.

The person with whom I spoke had all of my information from Linked-in and was happy to sign me up and explain their procedures. The assignment was a one hour phone call with an executive at one of the large Wall Street investment banks.

The last question the interviewer wanted to know was the most important; she wanted to know my hourly billing rate. Now that I am semi retired, I have even lower overhead and fewer expenses. I intended to handle this consultation sitting in the shade on my deck.

I asked my interviewer what she thought the right hourly rate would be.  We settled on a rate that she felt was appropriate.  The rate was the same that other experienced lawyers who were still working and paying overhead expenses would charge. I could have charged less because I had no overhead. Because I had written about the regulation I had demonstrated expertise and did not need to charge less.

Three factors will always come into play when setting your hourly rate; how good you are at what you do, your overhead and expenses and what the market will bear. It sounds much easier than it is.

In a perfect world, if you are very good at what you do, you should be able to charge more. That is not always the case.

In a great many cases, the customer is not looking for the best of the best. The customer is looking for someone who is good enough to get the job done.  I call it the good enough economy and there is a lot of it going around.

Basic economics teaches that the one universal factor determining how much you can charge per hour is what your competition charges. Price matters and it is going to throw the old idea about hiring the best people who went to the best schools and then worked at the best companies out the window.

The easiest example of this is code writers. It is an industry full of freelancers and independent contractors.  I live near Silicon Valley where I have heard many people say that the best code writers congregate.  Except those code writers have priced themselves out of the market.

If you have a fair amount of student loan debt because you learned code writing at Stanford or MIT and you live in Silicon Valley where rents are higher than almost anywhere else outside of San Francisco or Manhattan the amount that you need to earn in order to cover your monthly overhead is substantial.

There are excellent code writers living near Seattle or Austin as well as London, Moscow and Mumbai who will get the job done and charge far less because they need a lot less to pay their bills. I appreciate that Silicon Valley is where the action is, but even the big Silicon Valley companies have been outsourcing overseas for years.

This is not limited to tech jobs.

There are radiologists in India and the Philippines who read x-rays for hospitals and insurance companies in the US and Europe. There are teams of lawyers and paralegals in other countries who handle the volume of documents produced in large cases litigated by large Wall Street law firms. These firms have lawyers and paralegals on staff and would be happy to bill them out to accomplish the same tasks. But the clients do not want to pay Wall Street rates for tasks that they can buy cheaper even if they hire the most expensive law firm to represent them.

The simple truth is that a significant amount of student debt may actually be an impediment to making a lot of money as an independent in your chosen field. It may require you to work at a big company for a big salary. It can restrict your ability to take chances, like working with a start-up that could have a big time pay-off.  It can even rob you of the kind of opportunities, like a business convention in Hong Kong, that could really open up doors for your career.

Self worth is an interesting concept. Many independent contractors have difficulty setting their hourly rate because they do not have a good feel for how they stack up against their competition.  If you post a higher hourly rate you are advertising that you are better than your competitors. Of course, you need to back that up by doing a better job if you are hired.

It seems that a better approach would be to charge a little less and deliver a little more.  I have certainly read articles by many experts who would claim that that is the best way for an independent contractor to build his/her reputation and gain valuable referrals.

Never confuse your hourly rate with your advertising budget.  How you present yourself to prospective clients is still essential. If you want to charge more than your competitors you need to convince potential clients that you are worth more. And you need to reach more potential customers through advertising.

I read business plans and pitch books for start-up companies for free.  I will get on the phone with a budding entrepreneur and spend an hour answering specific questions and offer some suggestions or perspective about their business without charge. I have the experience, a fair amount of free time and I enjoy speaking with people who are starting a business. I often learn a lot more from them about what is going on in the marketplace than I do from reading the business or financial press.

Occasionally, a company wants to hire me to do more.  If I want the assignment, then I often have to charge less than I am worth because the company rarely has the cash to pay me what the NY investment bank paid me.  In most cases the company wants my on-going business and legal advice. In those cases, I usually prefer a monthly retainer to hourly billing.  That way, neither the company nor I are watching the clock.

I was recently approached by a very successful businessman who had started and sold three start-ups.  He had a pretty good idea for start-up number four and offered to give me equity in exchange for my expertise and on-going advice.

He was surprised when I declined because he had spent ten minutes explaining how my small share would be worth millions.  I told him to sell the shares he was offering to me to someone else for a deep discount and use the proceeds to just pay me my hourly rate.

For those of you who think that I was foolish for passing up what may have been a great opportunity, I can only tell you that I have been there before.  If you pay for my advice and then don’t take the advice, well okay, every lawyer has clients like that.  If I have equity and you don’t take my advice then I should not have taken you on as a client in the first place.

Do I really think that my advice is that good?  Yes I do, but mostly I know that advice that is not paid for is often disregarded.

Being semi retired and overhead free, I can give or sell my time to whomever I wish at whatever rate I wish to charge. It is truly liberating.  I only take on clients I like and projects that interest me. I can apply myself to only those projects where my experience and skills will add value.

I am not going to be giving seminars on this but I invite any independent contractor to adopt the same mindset, at least as an exercise.  What would you charge a really nice person who really needs your help?  Someone with a project that you could really enjoy sinking your teeth into even though they cannot pay you what you would like to get paid.

I suggest that amount is your base hourly rate. Charge more for mundane projects or difficult clients. There is no Nobel Prize winning economics behind this but I suspect that you will be happier when you are compensated at above your base rate for work that you do not enjoy and clients that you do not like. I suspect that you will probably be more productive, as well.

Making the new capitalism efficient

Economic theory teaches us that capital in a perfect world would always be allocated to its best use. The best use is always viewed from the perspective of the person or entity that is deploying the capital. Consequently we normally calculate the best use as the highest rate of return that the capital can reasonably achieve. The object is always to use money to make money.

To further this goal, capital has always been deployed to companies that have had the best chance of success. A due diligence process is employed to separate the best companies from those that the market deems less worthy. While far from perfect, this system has historically worked well enough to create our modern society with few truly innovative ideas left by the wayside, meaning unfunded.

In the last 20 years, some people with capital have been content to deploy it for other, more altruistic reasons. Specifically, they want to make capital available to people who have no access to the mainstream capital markets and others who for a variety of reasons could not get funded.

This new capitalism has taken two innovative forms, micro-lending and crowdfunding. Each has the potential to put capital into the hands of people who otherwise would never have access to it. Both have the potential to be transformative at the lowest tier of the global economic system. Neither is focused on highest rate of return as its primary goal.

In its purest form a micro-loan is very small and will often help a subsistence level individual transform into a capitalist. Micro-loans are frequently used to purchase one sewing machine to create a manufacturer; one shipment of goods at wholesale to create a merchant. Some micro-loans are used by a rural community to purchase one used truck or tractor. The benefits of these loans are obvious.

As originally envisioned, micro-loans were often interest free or loaned at an interest rate low enough to cover only the lender’s overhead and the costs of defaults. Even though no one who gets a micro-loan has a FICO score, statistics show the rate of default worldwide to be very low. As much as 97% of the loans are repaid. As conceived, micro-lending is a model of market efficiency.

Unfortunately, as this industry has developed and matured, there are some places where micro-loan programs are managed by bloated bureaucracies. There are stories of interest rates that would make loan sharks blush, corruption and exploitation in the lending process and misappropriation of funds intended for borrowers.

Crowdfunding, which is still in its infancy, is still remarkably inefficient. Fraud is prevalent because no one really vets the companies that seek funding. Far too many companies sell products that they can never deliver. The process itself can be expensive and is often hit or miss. Only about 30% of the rewards based crowdfunding campaigns successfully raise the funds that they seek.

Investors who buy into the equity of a small company on a crowdfunding platform must understand they may take a total loss. Even if the company is initially successful, there is no liquidity for the equity that investors purchase. Despite all of the enthusiasm for crowdfunding, this much risk and inefficiency cannot be sustainable.

There is, I would think, a way to combine the micro-loans with crowdfunding in a way that would remove much of the inefficiency, at least in the developing world.

In most developing countries there are universities whose students are  themselves often making the transition to the middle class. They should appreciate that strengthening the underclass will provide a greater market for the products and services that they themselves will eventually make and/or sell.

What I would propose is that each university creates a crowdfunding platform to enable students to fund micro-loan programs in their own communities.

Most peer-to peer lending platforms allow companies in need of loans to borrow from multiple individuals, essentially syndicating each loan. I envision the university students creating a single fund from which to make micro-loans to many borrowers.

I would ask the students to fund the program by purchasing shares in the fund with a small yearly tithe for the 4 years that they are students and for a few years after they graduate. Call it a 10 year voluntary commitment to purchase shares.

Additional funds would come from sale of shares to faculty, alumni, local banks, businesses and importantly, each country’s expatriate community. University students in western countries could partner with university students in developing countries. All anyone need do to participate is buy one share.

I have intentionally left out any local government involvement or participation. Direct government participation rarely adds efficiency to anything.

Business students and volunteer faculty at each university would administer the fund. This would remove much of the costs and corruption. It would give these students valuable experience evaluating business proposals and detailed knowledge about the local economy that will not be found in their textbooks.

Borrowers would pay a fixed interest rate. A rate of 6% might be sufficient to cover the risk of defaults and provide some amount of internal growth. Real growth will come from new students who will join the program each year as they enter college.

At some point each fund would reach a predetermined principal amount and be closed. In the US and elsewhere a closed-end mutual fund can become registered and be listed and traded in the regulated securities markets. This would provide liquidity to these crowdfunded investments where none exists.

Even after it is closed, a fund can continue to collect payments on existing loans and make new loans year after year. There would be no reason or requirement for it to liquidate. As the fund grows after it is closed the per-share value will continue to appreciate. Providing for growth and a liquid market would mean that shareholders could expect to make a profit from their investment.

The closing of one fund will be followed by the opening of a new fund to replicate the process. Over time, multiple funds will exist in every country that wants them, sponsored and funded by university students and others who will see both the benefits of the program and the potential for their own modest profit.

Replicated university to university and country to country a program like this would have a demonstrable effect within a decade. On a continuing basis it has the ability to transform communities and economies in the developing world from the bottom up.

It is an opportunity to demonstrate that altruism and capitalism are not mutually exclusive.

How I know that the stock market is coming down

Every investor would like to be able to predict the future. It is not always easy to do, but neither is it that difficult. It helps if you stick to the math.

Income investors aside, most people buy stocks that they believe will appreciate in value. If you own a stock and do not believe it will go up any higher then why wouldn’t you sell it?

The majority of shares in all financial markets trade between large banks and institutions. They have access to much more relevant information about the shares they trade, the world economy and the markets in general. Good research is the key to purchasing good investments.

For the average investor good research is a non-starter. Most people do not know how to do basic research on a company or where to obtain it. That has not deterred millions of people from investing trillions of dollars based upon bad information. Much of that bad information comes from the financial services industry itself.

Companies in the financial services industry need to grow and to be profitable. They grow by adding new customers and by encouraging existing customers to add more money into their accounts.

It should be obvious then that the one word that the industry is least likely to utter is: sell. If you sell, you might ask for a check and take your money elsewhere. That is something that the industry would like to avoid at all cost.

This is the reason that many financial professionals will tell you not to “panic” when markets start to go down. They will tell you to “stay the course” and that you should not worry because the market will “always come back”.

This is a sales pitch. It is not based upon facts or analysis. The charts that you will see accompanying this advice are bogus. The facts the charts assume are never about you and the facts they assume about the market are never real.

Consider that the market decline in the last month has been widely attributed to two factors, slower growth in China and a sharp decline in oil prices. Upon examination neither would seem to have a negative effect on the US economy.

The Chinese market for US goods is not growing as fast as it has in the recent past. China is not in recession. Certain industries and certain companies will surely be impacted. Overall, there is no indication that China will buy substantially fewer goods from US companies this year than it did last year.

Volatility in the Chinese stock markets is also cited as problematic for the US markets. In truth, very little US capital is at risk in the Chinese capital markets. Volatility and higher risks in the Chinese markets will usually cause capital to seek safer markets. That means more capital coming to the US. This is positive for the US economy.

Oil has been priced by a cartel since the 1970s. The current sharp decline in its price is being caused by a political decision to increase the international supply and to force US suppliers out of the market. Dramatically lower prices are not good for domestic oil companies and domestic oil workers.

Lower prices are also not good for the very largest oil producers whose margins and profits are likely to decrease. Shares of large oil companies are found in many portfolios and account for a significant amount of the weight in the Dow Jones Industrial Average and other indexes. So, yes, declining oil prices will bring averages down, but do not negatively impact many industries like pharmaceuticals or housing.

For the rest of us, dramatically cheaper gas prices increase our buying power for other goods and services. They should reduce the price of any goods that are shipped by truck which is almost everything.

Cheaper gas prices should not crash the market. Indeed low gas prices coupled with lower prices for other commodities and low borrowing costs should all continue to bode well for the US economy.

Why then do I believe that the market is coming down?

The upcoming market “correction” will be the 7th or 8th of my career going back 40 years. Throughout, the single factor about which most professional investors concern themselves is a stock’s price to earnings ratio.

Historically, across the market those ratios fluctuate between 10 to 1 and 20 to 1 with a mean in the middle at 15. It should cost $15 dollars to purchase one share of a stock in a company that is earning $1 per share.

So ingrained is the notion of price to earnings ratio as a market indicator that each of the corrections that I have witnessed over 40 years has been characterized as beginning from a point where P/E ratios where at the high end of the range. Markets usually fall from there to a point below the mean and then begin to level off.

That P/E ratios will always revert to the mean is a verifiable and well known fact.

At January 1, 2016 the average P/E ratio for the overall market was in the neighborhood of 20 to 1, which is at the higher end of the range. It might go up a little higher first, but history and mathematics would suggest that it is likely to drop to the 12 -13 to 1 range before it starts back up.

If you stay in the market, your portfolio will sustain that loss. It might take several years for the value of your portfolio to return to where it is today. If you “stay the course” you will have wasted the earning power of those years. You will have ridden the market down and back up and essentially be back to where you are today.

The better strategy would always be sit on the sideline while the market is going down and to invest in the companies that you like when they are cheaper. There has never been a better investment strategy than “buy low, sell high”.

If you do stay in the market then your portfolio should contain stocks that pay dividends. Dividend paying stocks generally decline less than stocks that do not pay a dividend. If you do sell now and accumulate some cash, you will be able to buy these stocks at lower prices and lock in a more attractive yield going forward.

I know for certain that all but a few market professionals will tell me that I am out of my mind. I submit that a great many of these professionals will have a personal stake in your decision to leave the market or stay the course. If every customer decides to sit on the sidelines these market professionals will be washing cars or waiting tables.

If you would like to “gut check” your broker, ask him/her what the average P/E of your portfolio is today and what your portfolio’s value would be if you do stay the course and your portfolio’s value does decline to a ratio of 15 to one or less. Like I said, do the math.

If you stay the course, you will be robbed of the profits that this bull market has given to you.