Wednesday, April 29, 2009

Dogwood Blossoms

Dogwood blossoms are fading now, but just three days ago they were glorious.

The Dogwoods cultivated in the lawns of southwest Virginia seem to glow white or pink. They generate a multitude of flowers - some of the trees appear as bright white or pink balls. I especially enjoy the lawns with white and pink Dogwoods mixed together and the occasional grafted tree with both colors springing from alternating branches.

Though domesticated trees are beautiful, wild Dogwoods draw my eyes as if by magic. Wild ones hide year around in the Virginia forests 30 to 50 feet below the towering canopy of Hickories, Oaks, and Locus. In the springtime, before the forest fills with leaves, the brilliant white blossoming wild Dogwoods shout from the midst of the forest, “Here I am! Look at me!” And I do.

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Monday, April 27, 2009

Liberty is Radical – Part 3 - Slavery

Two meta-decisions concerning liberty were at issue in the Civil War. One was slavery. That’s the issue everyone knows about.

The slavery meta-decision pitted the property rights of the slave owners against the human rights of the slaves. At bottom, it was about the definition of humanity. The literature of the day described African-Americans as somewhat less than fully human. Defining them thusly was the only way fair-minded people could justify slavery to themselves and others.

If Africans were fully human then slavery was an obvious abomination but if they were less than fully human then slavery was sensible and even humane. Since the argument that Africans were less than fully human was built on sand, its foundation crumbled. Institutionalized slavery in the United States was doomed and good riddance.

As an aside, informal sexual slavery seems to be a growth industry world-wide, including in the United States where local governments are reluctant to interfere with the literal slavery imposed on Muslim women by some Muslim men.

Links to Other Posts in the Special Report: Liberty is Radical

Wednesday, April 22, 2009

Liberty is Radical – Part 2 - The Declaration of Independence

The above link will connect you with a copy of the Declaration of Independence that announced the intention of 13 North American colonies to be permanently free from the tyranny of the British Crown on July 4th 1776 – to end their status as subjects in favor of becoming free citizens.

“We hold these truths to be self-evident, that all men are created equal, that they are endowed by their Creator with certain unalienable Rights, that among these are Life, Liberty and the pursuit of Happiness.”

“We hold these truths to be self-evident…” This phrase contradicted the established orthodoxy of the rest of the world. Everywhere outside of North America it was understood that men were created decidedly unequal and their inequality was assumed to be divinely ordained. Only the monarch had rights endowed by their creator. The rest had privileges granted by the monarchs and withdrawn at the monarch’s whim.

The Declaration contains some wonderful insights into the psychology of government too.

“…all experience hath shewn that mankind are more disposed to suffer, while evils are sufferable than to right themselves by abolishing the forms to which they are accustomed.”

We are disposed to suffer, while evils are sufferable. Isn’t that the truth? I have a life. To set my life aside to deal with an evil that is “sufferable” is difficult. There is a cost/benefit equation in play. For an evil to be “sufferable” means that the personal costs of correcting the evil outweigh the benefits.

For the signers of the Declaration the list of abuses at the hands of the British Crown had become insufferable and so they placed at risk their Lives, their Fortunes, and their sacred Honor to defy the superpower of their day.

How radical is that?

Links to Other Posts in the Special Report: Liberty is Radical

Liberty is Radical – Part 1 – Subjects or Citizens

Subjects of the United Kingdom took ship to North America in the 17th and 18th centuries for many different reasons. Many hoped for a new life beyond the reach of the British Crown.

Over time the Crown asserted increasing control over the North American colonies encroaching on liberties the colonists had enjoyed for generations. Individual liberty was a radical concept in 1776. The world was governed by kings, queens, emperors, and empresses with absolute power.
They taxed their subjects at their pleasure. They required work or military service from their subjects when and where they willed. They made law and changed it when they wished. Louis the 14th of France famously said, “I am the State.” – And he was.

People were known as subjects because they were subject to the whim of monarchy. Calling the citizenry subjects implies ownership of them by the State. When the government can subject people to taxes, property confiscation, required labor, imprisonment, and execution they are for all practical purposes owned by the State.

This was the norm in 1776.

Links to Other Posts in the Special Report: Liberty is Radical

Wednesday, April 15, 2009

Tea Parties

I protested today. I participated in the Lynchburg, Virginia Tea Party. I’ve never publically demonstrated against anything before today and I think most of the estimated 1,800 people in the crowd were also first-time protesters.

Some local Republican politicians spoke and a couple of citizens. Most of the hand held signs were homemade with anti-big government, anti-tax increase, anti-big spending, and anti-Obama themes.

Although the dissatisfaction with government was palpable the crowd was polite and completely in control with nary a policeman in sight

I’m concerned that the spontaneous Tea Party movement will fissile out because political leaders are rushing to get in front of it. If they succeed people may turn it over to these “leaders” who are at least partially responsible for getting us in this Obama mess.

If it were not for Bush’s “compassionate conservatism” and the grotesque spending by the Republican Congress from 1995 thru 2006 Obama and the left wing statists would not be in charge of the Presidency, the Senate, and the House of Representatives.

If it were not for then majority Republicans backing down in the face of Barney Frank and company, Fanny Mae and Freddy Mac might have been prevented from buying up securitized bundles of sub-prime mortgages.

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Tuesday, April 14, 2009

Chaos by Incentives – Part 3

Thesis: Corporations would be better managed, have higher and more stable growth, the jobs of employees would be more secure, and overall shareholder returns would be higher if corporate dividends were tax-free and capital gains were taxed at a flat rate of 20% regardless of income.

Dividend paying companies are more stable. They have less volatile share prices and less fickle shareholders. Research has shown that on average they also deliver higher overall returns than non-dividend paying companies. What’s not to like?

Well, for one thing, fast growing companies need all the cash they can get to finance organic growth. That’s fine as long as they recognize the approaching end of their fast growth phase and begin the transition to paying dividends.

For another thing, the tax code favors capital gains over dividends even now that both dividends and capital gains are taxed at 15%. Dividends are paid from after tax net income and are immediately received by the shareholder as taxable income. Whereas when the company reinvests its net income the investment becomes either a deductible expense or a depreciable capital investment.

Despite the continuing double taxation of dividends when the 2003 tax cuts reduced the dividend tax rate to 15% many companies started paying dividends for the first time.

Tax policy should favor dividends over capital gains in order to encourage corporate stability, prudent management, organic growth, and productive investment. Dividends should be tax free to shareholders without punishing capital gains.

A 0% tax rate on dividends and a 20% rate on capital gains would set off a wave shareholder demands for more companies to pay dividends and the naturally accompanying corporate stability.

Links to Other Posts in the Special Report: "Chaos By Incentives"

Thursday, April 9, 2009

Chaos by Incentives – Part 2

Thesis: Corporations would be better managed, have higher and more stable growth, the jobs of employees would be more secure, and overall shareholder returns would be higher if corporate dividends were tax-free and capital gains were taxed at a flat rate of 20% regardless of income.

Organic growth of a company’s base business is clearly a good thing. Modest acquisitions that build on existing strengths or improve a company’s ability to serve its customers can be good things. But the “Peter Principle” is clearly at work when, through acquisition, companies outgrow their management competency; because of the shear size of the merged company or because the acquired companies are so different that management was never competent to manage the acquired companies regardless of size.

Shareholders in search of capital appreciation are of necessity a fickle bunch. They cannot get cash out of their investment unless they sell. So, in the long run, they must sell. Plus, when the earnings per share growth of a company slows or stagnates the capital appreciation shareholder sells and moves on to the “next big thing”. In a desperate and futile effort to forestall the inevitable, management invokes the “Peter Principle” and takes down many unwary shareholders along with the company.

Companies that focus on organic growth with modest acquisitions recognize the inevitability of slower growth and lower P/E multiples and generally start paying or start increasing dividends. MacDonald’s, Intel, and Microsoft are examples.

Dividends provide a second source of value to shareholders that can make up for the reduced share price appreciation. Dividend shareholders are also less fickle than capital appreciation shareholders. Because they don’t need the higher growth rates and because they get dividend checks every quarter just from owning the company’s shares – they are not forced to sell in order to get cash. As long as the company continues to pay ever increasing dividends these shareholders can hold their shares forever.

Links to Other Posts in the Special Report: "Chaos By Incentives"

Monday, April 6, 2009

Chaos by Incentives – Part 1

Thesis: Corporations would be better managed, have higher and more stable growth, the jobs of employees would be more secure, and overall shareholder returns would be higher if corporate dividends were tax-free and capital gains were taxed at a flat rate of 20% regardless of income.

Double taxation of dividends encourages companies and shareholders to favor capital gains in the form of ever increasing share prices over dividend payments. As a result companies are under pressure to increase their earnings per share every quarter.

Companies that meet or exceed expectations are rewarded with rising share prices and high price/earnings (P/E) multiples. Those who fail to grow their earnings fast enough languish at low P/E’s and become takeover targets. Those that grow earnings quickly for a time and then slow down are punished with precipitous drops in their P/E and hence in their share price.

Consequently, management seeks to constantly increase their earnings per share. Conceptually this is a good thing. But the extreme is normal.

Many, if not most, mid-to-large size companies maintain “mergers & acquisitions” departments and have for decades. Every Spring business schools graduate thousands of aspiring “M&A” specialists. Supporting and financing corporate acquisitions is a huge part of the investment banking business.

Institutional and sophisticated individual investors believe that it is a productive use of a company’s resources to buy its own shares on the open market. They believe this because when a company buys its own shares the number of shares outstanding declines. This increases earnings per share even if the company’s overall earnings are flat.

The pressure for short term earnings per share growth drives boards of directors to create management incentives in alignment with this overarching objective. In turn, management is driven to outsource, acquire other companies, leverage earnings by taking on debt, creating unfathomable securities like credit default swaps, securitized bundled mortgages, and other “weapons of financial mass destruction” (quote from Warren Buffet).

The result is chaos. Well run stable companies are bought by unstable weak managements at companies whose share prices are inflated. The purchases are usually exchanges of stock or at best some combination of stock and cash. The acquiring companies frequently are not up to the task of running the acquired companies but they are quite capable of running them into the ground. Look at the history of Sanmina-SCI (SAMN) for one example amid hundreds.

Jobs are lost. Profitable businesses are bought and sold four or five times in a single decade; and each time resources are wasted realigning business systems and reorganizing departments.

Links to Other Posts in the Special Report: "Chaos By Incentives"

Wednesday, April 1, 2009

A “Borrow and Spend” Binge

Our current financial system woes have been blamed on greed and lack of regulation. We heard about “predatory lenders” who took advantage of unsuspecting borrowers by giving them mortgages they could not afford with future rate changes they did not understand.

We also heard about lying borrowers who took advantage of gullible lenders by misrepresenting their income and assets in “no doc” application packages wherein the gullible lenders accepted the borrower’s word on their income and assets in exchange for a slightly higher mortgage interest rate.

We heard about “derivative” securities based on complicated formulae developed by brainiac academics that were calculated to transform risk into safety – QED. I can’t help but quote Warren Buffet here – several years ago he called these securities “weapons of financial mass destruction” and more recently he warned “beware of geeks bearing formulas”. I love that.

We heard that “mark-to-market” accounting requirements caused banks to write down their derivative security assets when no one would buy them anymore.

And we heard about the housing bubble and people in some regions paying millions for modest homes; other people “flipping” houses to catch the capital gain accrued in a few short months and still others refinancing their mortgages to withdraw equity to fund consumer purchases.

This is all crazy stuff. The bottom line is that that whole country was on a “borrow and spend” binge. Individuals borrowed to buy things. Companies borrowed to “leverage” their earnings. The Congress (Republican controlled before 2006 and Democrat controlled post-2006) borrowed to fund pet projects to ensure their reelection.

Since the we borrowed too much at all levels – it seems unlikely that the problem will be solved through the dramatically increased government borrowing we have seen in recent months.

Individuals and companies have started saving and paying down their debts. The government hasn’t figured it out yet.

Links to Other Topics in the Special Report: Economic Stimulus