Bonus Outrage Resolved

If you read my post two days ago on the Wall Street Bonus Outrage you can imagine my relief at the President’s press conference yesterday.

You see, from all this hysteria about excessive Wall Street compensation, partially whipped up by Mr. Obama himself, I was really worried that the President might do something rash, such as, for example, restrict Wall Street compensation.

The new rules will not apply to firms that already have received government aid, will only apply in the future to the recipients of some kinds of help, will only restrict the compensation of a very small number of top executives (who collectively didn’t make much of a dent in the $18.4B that got everybody bent out of shape) and only requires that these few be paid in stock instead of cash, which is fairly typical anyway.

Whew. That was close. Turns out the President isn’t ignorant of how Wall Street works and isn’t a closet bomb-throwing socialist. He’s just a cynical politician willing to kick people when they are down to score political points. Thank god for that.

Wall Street Bonus Outrage!

There’s been rather a lot of self-righteous indignation lately about the bonuses paid out for 2008 by Wall Street. The hullabaloo started off with the New York State Comptroller announcing that bonuses were down 44% year-on-year. This was meant as a dire warning that the economy of New York City was going to hell in a hand basket. Somehow, what got picked up was that bonuses still weighed in at $18.4 billion, which some people still consider to be a lot of money.

Very surprisingly to me, some of those people turn out to be the folks in Washington who are planning to spend $887 Billion with a straight face. (How much money is that? See this brilliant post.) Last Thursday our President called the bonuses “shameful” and that unleashed an avalanche of outrage. The ever-level-headed Maureen Dowd called for a “a special prosecutor or three” in her New York Times column. Even personal finance blog The Digerati Life joined in on the fun.

If you have no idea how Wall Street works, don’t understand how many people work there, and are just generally the jealous type, it is easy to be sucked into this. Heck, it’s kinda fun. But the mundane truth is that the term “bonus” is confusing you. Wall Street bonuses are not extra money passed out at year end on top of regular compensation. They are the primary way people get paid for their labor.

Wall Street firms are very decentralized affairs, really more like vast collections of tiny independent operations that share office space and brand names. Strange as it may seem, the great majority of Wall Street workers made money for their firms last year and rightfully expect something like their usual cut. True, a very small number of employees managed to lose spectacularly large sums of money, enough to outweigh all that the profitable ones brought in. And it is also true that in most cases the firms were not contractually obligated to pay all that they did.

But you can only stiff your employees once, and only then in the process of bankruptcy. Nobody would ever work for you again. Vaporizing the big Wall Street firms is certainly a conceivable option, but I think there is general consensus that we should keep them alive.

And then there is the fact that bonuses are down 44% from 2007, which was down some from 2006. Are the car makers cutting pay 44%? Is anybody ready to suggest that to the UAW and then hint that even at that level it is “shameful”? (I know I’m not. Seriously, fellas, it’s just a blog.)

The financial crisis seems to be clouding all thinking as regards money and Wall Street. For example, my hero John Thain has been getting a lot of grief lately. David Brooks’ column in the Times today jokes that Thain got in trouble because “it is no longer acceptable to spend $35,000 on a commode for a Merrill Lynch washroom.” Which is really funny as long as you think that “commode” means a toilet and not the antique sideboard that he actually bought. (Geez, David, don’t you watch The Daily Show? Jon Stewart showed a picture of the thing last week.)

John Thain took over a brain-dead company in 2007 that, we know now, was circling the drain. He kept a good poker face, even spending lavishly to outfit his new office. He then hoodwinked one of the largest banks in the world into paying $50 billion for the company, which was at least $50 billion more than it was worth. That has got to be one of the greatest feats of salesmanship of all time. I’m not sure I would want to work for Thain, but he can work for me anytime.

A lot of the anger and frustration about Wall Street bonuses and office furnishings stems from the fact that these Wall Street types, who are at least partially responsible for getting us into this mess, are now the beneficiaries of government largess. That’s understandable. Why should these irresponsible pinheads get any of our money? It would be like enacting a subsidy for low-end home buyers or creating another wave of cheap mortgages or even passing a law to stop all foreclosures. All of those things would be just a transfer of wealth from the taxpayers to reward the fools that started this fiasco. Can you imagine the outrage something like that would cause?

I know I can’t.

How Much is $887 Billion, Really?

Several blogs (Such as this one, this one, and this one) have attempted recently to put the orgy of pork-barrel spending known as the stimulus package into perspective by explaining just how much $887,000,000,000 is in practical terms. The consensus winner seems to be that it’s about $3000 per American. That’s not bad as illustrations go, and does have some practical merit, as each American will owe that much more as their personal share of the national debt, but I think that as bloggers we need to do better.

How much is $887 Billion? It’s $12,770 per Obama voter. It’s every American’s mobile phone bill for the next five years. It’s 4.2 million new houses at last month’s average selling price. (That’s enough to give one to every family in Arizona, which, come to think of it, is awfully similar to how we got into this mess to begin with.) It’s more than the total value of all US currency in circulation.

Those things are all true, but they lack a certain visual element. Try this one. If it were printed in one dollar bills, $887 Billion would be enough to cover the total land area of Rhode Island, Delaware, and New York City combined. Or, if you prefer, it could cover New York in tens. Or Manhattan in hundreds.

Unfortunately, dollar bills don’t make a very practical floor/land covering, and at $9.60 a square foot for the ones, it’s kinda steep. Lowe’s has some decent looking vinyl tile at $1.08 each. It’s much more durable, and at that price for $887 Billion we can cover South Carolina.

If covering up states doesn’t help you feel how much money we are talking about, let me try and put it in terms of something you might buy. 8GB iPod Nanos go for $134 at Amazon. So the stimulus package is equivalent to ordering 6,619,402,985 of them. (Don’t forget to click on free super-saver shipping.) At a shipping weight of 1 lb. each, and assuming an average weight of 177 lbs per person, that’s more than enough to give every resident of California their weight in iPods.

Of course, iPods are relatively durable items. What about in terms of something that gets consumed by you, the average American? My local on-line grocery delivery service will sell me a 24 oz. jar of Chi-Chi’s Fiesta Salsa Thick and Chunky Medium for $4.19. So the stimulus package is equivalent to 39.7 billion gallons of the stuff. And what could we do with it? Well, this is only a suggestion, but to stem the tide of illegal immigration from Mexico, we could dig a trench 4 meters deep and 10 meters wide along the entire 1,969 mile US-Mexico border and fill it with salsa. Because there is nothing that would repel an actual Mexican more than Chi-Chi’s Fiesta Thick and Chunky Medium salsa.

But maybe this is all too impractical for you. How about something useful? For example, a 2009 Mercedes SLK55 AMG convertible? It’s got a 355hp V-8 that will take it 0-60 in 4.9 seconds. We could buy one for every one of the 14.3 million college and grad students in the US. Or all the men divorced in the last ten years.

So now you know.

Inflation, Deflation, and You

Every day, people come up to me and say things like:

Frank, what are these inflation and deflation things that I keep hearing about? Are they something I will enjoy? Do I need any special skills to participate?

Inflation is when the prices of everything go up. Put another way, it is when the value of money, US dollars for example, goes down, so it takes more of it to buy the same old stuff. Deflation is the opposite, when prices go down and the value of money goes up.

That sounds like fun for the whole family! What causes inflation and deflation? Are they something I can make at home?

Folks (by which I mean economics professors) used to think that inflation/deflation was caused by changes in things like the level of production and unemployment. Currently, the consensus is that it is a “monetary phenomenon” which means that it is really all about money itself. Inflation is caused by one of two things: an increase in the supply of money in the economy or an increase in the “velocity” of money, how fast it is changing hands in the economy. Deflation is the opposite, caused by a drop in the money supply and/or a fall in the velocity.

The money supply is what people usually watch to predict inflation/deflation because velocity is pretty constant over time. It really only drops in very extreme circumstances, such as the early 1930s and right now.

That sounds awesome. How can I spot inflation or deflation myself? What are some of the exciting things that will happen to me because of it?

Spotting inflation/deflation is easy. Look for prices of the things you buy to go up/down.

Under inflation, what will probably most concern you is that although the prices you pay have gone up, what you get paid may not go up as quickly.

In the long-run, the more significant effect is on the value of dollar-denominated assets you own and debts you owe. Since the value of dollars is decreasing, the value of bank deposits you have and bonds you own will decrease, possibly faster than the interest paid is growing them. On the other hand, the value of your debt also goes down in the same way. In principle, the value of “real” assets, such as your house and shares of stock in companies, do not decline under inflation. In practice, this is not so easy to see because periods of inflation are also often bad times for the economy so the value of assets tends to go down.

Deflation is similar but worse. You will notice things getting cheaper and the amount you get paid may not immediately go down, which will be fun while it lasts. But it is hard for companies to cut salaries. The last time we had meaningful deflation, at the start of the Great Depression, instead of cutting everybody’s salary companies laid off some people and stopped hiring. If you were one of the lucky who still had a job, then things were fairly good since you could buy more with your salary. If you were one of the one third of Americans out of work, things were not good.

The same effect on dollar denominated assets happens under deflation as inflation, but backwards. The value of your bank deposits and bonds increases, but so does the value of your debts. If you have money in the bank you should be rooting for deflation, if you owe money you should be rooting for inflation.

They both sound like a blast. Is there a reason to pick one over the other?

Go with inflation. Deflation has really nasty effects on the economy. If the value of your dollars is increasing every day, you have less incentive to spend or invest them. And if today’s dollars are worth a lot less than the dollars of a few years from now, borrowing money becomes expensive, even at zero percent interest. This can lead to a vicious spiral, with people hoarding money because of deflation, which causes a drop in velocity, which causes more deflation.

Okay, I’m ready to play. What should I expect first, inflation or deflation?

For the moment, we appear to be in a period of deflation. The fiasco in the financial system has caused a lot of people and companies in the economy to hold on to their cash, which has greatly reduced the velocity of money. But the Fed and the government have made it clear that they will go to whatever extremes necessary to keep deflation from setting in for long. Fed Chairman Bernanke has hinted that if he has to he will fly over cities in helicopters dropping cash. Bernanke believes that the Fed caused the Great Depression by not increasing the money supply when it should have (in fact it decreased it) and he has made it his life’s mission that that particular debacle not be repeated.

The medium- and long-term effect of the massive increase in the money supply now under way should be obvious. Velocity will stabilize and/or rise and we will get inflation. Lots of it. Inflation is good news for debtors, those that owe dollar-denominated debts. And who is the largest dollar-denominated debtor in the world? Not at all coincidentally, the US Federal Government. Runner up are American homeowners, who could use a break.