And I owe it all to my Alma Mater

Financial Review

 PUBLISHED: 28 Apr 2012 

Anna Bernasek

It’s graduation time in the United States. On college campuses across the country, students and parents are celebrating the end of four years of university, and the beginning of adulthood.

So after 22 years I’m visiting Ann Arbor, Michigan, this weekend to give a commencement speech at my Alma Mater, the University of Michigan.

Ann Arbor is one of America’s great college towns. The university was founded in 1817 in Detroit and moved to Ann Arbor 20 years later. The central campus grew around a vast lawn known as the “Diag” and the town and campus developed together so that there’s not much distinction between the two.

The university enrolls about 40,000 students and at this time of year Ann Arbor’s restaurants, bars and cafes are happily bursting at the seams.

Not too much has changed on campus over the years. At least, that’s how it appears. Yet for students today there’s an important difference you can’t see. Graduates are leaving Michigan with far more debt than at any other time in history. In the US, student debt isn’t like most consumer debt. Even in bankruptcy it stays with you. There’s no way to get out of it.

When I graduated in 1990, the average debt for graduating college seniors nationwide was about $US10,000 in today’s dollars. By 2010 it hit $US25,250, according to the Project on Student Debt. That means in a little over two decades average debt for college students more than doubled in real terms.

The aggregate figures are alarming. At the end of last month, officials at the Consumer Financial Protection Bureau released a new study that found outstanding student debt surpassed $US1 trillion last year.

The latest student debt figure is much higher than previous estimates. Earlier this year the Federal Reserve Bank of New York estimated outstanding student debt at $US870 billion. The NY Fed also estimated that 15 per cent of Americans, or 37 million people, have outstanding student loans.

Not long ago that included President Barack Obama and his wife, Michelle. This week, turning student debt into a campaign issue, Obama told a crowd of students at the University of North Carolina, Chapel Hill, that he and his wife only paid off their student loans eight years ago. They both completed graduate degrees in law at Harvard University.

Obama has urged Congress to extend legislation on federal student loans that is due to expire in July, affecting more than 7 million students. In 2007, president George W. Bush signed a bill that cut interest rates on federal student loans in half from 6.8 per cent to 3.4 per cent until 2012. Unless Congress extends the law, those rates will revert back to 6.8 per cent.

The $US1 trillion estimate for outstanding student loans raises the prospect of a bubble in student debt. But that misses the mark. At the same time that debt rose, the cost of going to college soared and the benefits from a college degree shrunk. With high youth unemployment for college students and stagnant wages it may be more appropriate to talk about the bubble in higher education costs.

In 1990-91, the annual cost of going to a public university was $US8403 in today’s dollars, according to the National Centre for Education Statistics. That included tuition, room and board. By 2009-10, the yearly cost had risen to $US14, 870.

The cost increase is even worse for private institutions. In 1990-91 a private college cost, on average, $US21,218 a year. By 2009-10 it had risen to $US32,475. Of course, that’s just an average. Tuition, room and board at some private colleges and universities reaches $US60,000.

The most disturbing part of ballooning student loans, though, is that the pay-off isn’t as obvious. It used to be that a college degree pretty much guaranteed a good job. That isn’t the case any more.
Inflation-adjusted hourly wages of college-educated men in their 20s fell 5.2 per cent from 2007 to 2011 and had been falling even before the recession hit, according to the Economic Policy Institute.

College-educated women have experienced a similar decline in earnings, about 4.4 per cent during the recession and 1.6 per cent between 2000 and 2007.

Then there’s the increasing likelihood of no job at all. The unemployment rate for young college graduates is 9.1 per cent, the highest rate in recent history.

For now, there’s no sign that college fees will stop rising. At this rate, I’m guessing that by the time my daughters (ages nine and five) go to college, the cost at top private universities will hit $US100,000 a year.

Many ageing baby boomers can recall a time when college education was free. Before 1970, tuition at the University of California cost exactly zero. Perhaps it’s just a coincidence, but that generation built a cultural and economic dynamo in California that’s the envy of the world.
I wonder what they would have produced with a trillion dollars of student debt hanging over their heads.

Infrastructure on road to nowhere

Financial Review

PUBLISHED: 21 Apr 2012

Anna Bernasek

Manhattan is connected to New Jersey by the slenderest of links.

There is only one bridge, George Washington Bridge, built in 1931 – the world’s busiest, with 14 predictably jammed lanes of traffic. Then there are two road tunnels: narrow, four-lane Holland Tunnel, built in 1927, and the six-lane Lincoln Tunnel, finished in 1937. That makes 24 lanes of traffic in all, operating at 100 per cent capacity every day, causing delays amounting to millions of hours in lost productivity.

Trains cross the river too. Tunnels dating from 1909 carry subway traffic from just across the river. The lone remaining train tunnel opened in 1910 and is known as North River Tunnel.

Every morning and evening, trains wait their turn to dash through the North River Tunnel; 60 trains can pass in an hour, one each minute. The situation hasn’t changed for 100 years and is only expected to get worse. Demand for mass transit between New Jersey and Manhattan is expected to grow 38 per cent by 2030.

So when construction began in mid-2009 on a new rail tunnel between Manhattan and New Jersey, it seemed like an idea whose time had come.

The new project, funded by the federal government, the state of New Jersey and the regional bridge and tunnel authority, was expected to double the number of main-line trains running between New Jersey and midtown Manhattan in peak times. The cost was put at a bit more than $US10 billion ($9.65 billion).

Just over a year later, newly elected New Jersey governor Chris Christie cancelled the project. Why? Because it was “too expensive”.

Christie promptly transferred $4 billion set aside for the tunnel into the state’s ailing highway fund. The highway fund is usually supported by petrol taxes.

The governor’s decision was pure politics. By shifting money to the near bankrupt fund, Christie avoided breaking one of his key campaign promises: not to increase the tax on petrol.

Austerity-minded conservatives applauded. Christie vaulted to national attention. Some even mentioned him as a future presidential candidate.

Now it’s come out that Christie’s figures showing the project was too expensive were unfounded.
The Government Accountability Office just released a detailed report revealing that Christie’s claims were flawed.

Cost estimates of the project in the two years before the cancellation hadn’t been rising and most of the funding was coming from the federal government and the local bridge and tunnel authority, not the state of New Jersey as the governor claimed.

But that’s only half the story. Like the man who knew the cost of everything and the value of nothing, “too expensive” can only be evaluated in relation to the tunnel’s expected payoff. That’s not something Christie wants to talk about.

The largest city in America, New York, sits hard by the most densely populated state in the country, New Jersey. A mile-wide river separates the two. Millions of people cross between them. Hudson River bottlenecks and traffic jams are the stuff of legend. Yet there’s been no expansion of bridges or tunnels since the 1930s.

You can run the numbers. Even on the back of an envelope, I quickly add up half a billion dollars in annual benefit. As a floor, that’s a return of around 5 per cent.

But numbers are hardly even necessary. The new tunnel is practically a textbook case for infrastructure spending. Just imagine what North Sydney would be like today without the harbour tunnel. Yet this kind of small-mindedness over infrastructure spending is characteristic of regions all over the US.

And it may be coming to other parts of the world. With austerity in vogue, the next few years don’t look promising for infrastructure spending in Europe either.

What’s more, cancellation of the New Jersey/Manhattan rail project couldn’t have come at a worse time. Heralded in 2009 as the biggest infrastructure project in the US, the rail link was widely considered as a sign that the nation was investing in its future. It would have doubly paid off as a much-needed, timely economic stimulus. And to top it off financing costs remain at historic lows.

Overall, the US record on infrastructure spending is abysmal. It spends about 2 per cent of GDP on the construction of infrastructure compared with 5 per cent in Europe and 9 per cent in China, government data says.

And it’s beginning to show. In 2010 the US ranked 23rd for overall infrastructure quality, behind Spain and Chile, according to a World Economic Forum report.

Meanwhile, the American Society of Civil Engineers consistently rates the nation’s infrastructure well below average. It’s most recent study assigned an overall D grade to US infrastructure and estimated it would take $US2.2 trillion over five years to bring it into a state of good repair.

Governor Christie’s decision to cancel the rail project may have been clever politics but it is dreadful policy. The Government Accountability Office report noted that the project would have generated economic activity in the region in the form of jobs and income, business activity, and increased home values. How expensive is that?

No Stomach for Stimulant Care

Financial Review

PUBLISHED: 14 Apr 2012

Anna Bernasek

A second marriage, in the immortal words of Samuel Johnson, represents the triumph of hope over experience. That’s a good assessment of US economic policy.

It’s been four years since the great recession came and the best to be said about the US economy is it may recover in a few more years. Last year real gross domestic product grew 1.7 per cent and most economists forecast growth of 2 to 2.5 per cent for 2012. No one expects much change in 2013 and 2014.

Unemployment is stuck above 8 per cent and recent signs of life in the labour market seem fading. The latest employment data show jobs growth stalled in March, barely keeping up with rising population.

Yet policymakers aren’t ready to act. They hope that somehow everything will turn out just fine.

At the Federal Reserve, the chairman and board have adopted a wait and see attitude. Recall the central bank’s dual mandate. Not only is the Fed charged with keeping prices stable, it also must promote full employment.

Inflation is in the comfort zone at about 2 per cent, but 8 per cent unemployment is perhaps double what it should be. Yet comments from Fed chairman Ben Bernanke and minutes from a recent board meeting suggest that the central bank has no intention of further monetary stimulus unless things go horribly wrong.

And that’s despite the central bank’s own forecast of persistently high unemployment and moderate growth until well into 2014. So you can forget about the dual mandate.

What about Congress? As usual, America’s legislators seem far more concerned with ideology than economics. Whenever economic policy comes up, so do cries for spending cuts. But fiscal tightening, at least right now, is exactly the opposite of what sound economics calls for. A move to cut government spending would only make matters worse. Even the Fed’s assumption of a slow recovery may have to be revised if Congress gets its way.

The quality of the political debate is even worse than you might think. Earlier this month, Republicans released their budget proposal, drafted by Representative Paul Ryan, a Wisconsin Republican who chairs the budget committee.

The main idea behind the Ryan budget is to shrink government in order to reduce the deficit. Laissez-faire groups such as the misleadingly named Club for Growth were quick to criticize Ryan’s plan for not cutting spending enough. Democrats made the rather obvious point that cutting benefits to the poor while giving the super-rich further tax cuts might prove unpopular.

Even some seemingly reasonable commentators have lost the plot, commenting favourably on the Ryan proposal. They’ve had trouble getting a simple idea: the economy, and in particular employment, could use a boost rather than a further handicap.

But suppose, for a moment, you are willing to forego helping the economy in the interest of deficit reduction. The deficit and US government debt, after all, are big long-term economic problems. Yet despite all the attention it has received, the Ryan budget is not credible on deficit reduction.

Together with spending cuts, it proposes $US4.6 trillion in tax cuts over the next 10 years. That amount is going to be made up, says Ryan, by closing unspecified “loopholes”.

There’s just one little problem, though. Americans only want to close loopholes they don’t personally use. So there is not much prospect of closing them across the board, thereby raising taxes on all of the beneficiaries.

Meanwhile, Ryan’s proposal details spending cuts with laser-like precision. He would remove about $US3.3 trillion from low -income programs over 10 years, according to the Centre on Budget and Policy Priorities. For those who believe in extreme self-reliance, that may be fine. But in an election year such austerity looks like a dead letter.

Then there’s Ryan’s take on military spending. His budget won’t cut anything. With two deeply unpopular wars begging to be downsized, propping up military spending seems a bit out of touch.

The trouble with taking Ryan’s plan seriously is that it’s merely an ideological place holder. Ryan shifted the policy debate away from jobs and onto the hoary old chestnut of smaller government, at a time when the economy can’t easily withstand a contraction in fiscal policy.

Stepping back for a moment, it seems that lots of people in Washington can live with 8 per cent unemployment.

After all, unemployment doesn’t seem to be harming everyone equally. The stockmarket has been fairly strong. Corporate profits look good. And a big pool of unemployed workers keeps wages down and inflation in check. There’s no social unrest to speak of and, admittedly, unemployment has come down from 10 per cent.

Unless something really bad happens, don’t expect any change on economic policy. It’s actually right where the 1 per cent wants it to be.

Red flag pay day for hedge funds

Financial Review

PUBLISHED: 05 Apr 2012

Anna Bernasek, New York

The sums are staggering. The highest-paid hedge fund manager in the United States hauled in $US3.9 billion in 2011. That’s right, billion. The runner-up made $2.5 billion and third place raked in a mere $2.1 billion. Those figures approach the kind of numbers major US corporations employing tens of thousands of people can earn in a good year.

Yet 2011 was a bad year for hedge funds. In fact, it was the worst year since 2008, when financial panic spread across global markets. Although the S&P market index rose 2 per cent in 2011, the average hedge fund lost about 5 per cent, according to Hedge Fund Research.

That’s not supposed to happen. In theory, at least, hedge fund managers are entitled to get paid eye-popping fees because they don’t just beat the market, they are expected to trounce it.

To be fair, as a group the highest-paid hedge fund managers’ earnings dropped by about 35 per cent last year, according to a survey by AR magazine. But that means the top 25 hedge fund managers still earned a collective $14.4 billion, averaging $576 million each.

Are they really worth all that?

Hedge fund pay seems strangely out of line with that of the rest of finance, and that’s saying something. Wall Street’s bankers are not typically shy about claiming big bonuses.

Jamie Dimon, chief executive of JPMorgan Chase, is among the most powerful and respected of America’s bankers. In 2010 his total compensation was $23 million and he’s expected to earn about the same for 2011.

Compare that with chief executive pay across all industries. The average CEO of a top-100 company in the US is worth about $12 million, according to pay consultants. That includes everything: salary, bonuses and the value of stock and stock option grants at the time of the grant.

Of course, corporate America can afford to pay its top performers a lot more than the average worker. But no mere chief executive gets anything near the pay hedge fund managers earn. Take Ford, which posted a $20.2 billion profit last year. It recently announced that its chief executive, Alan Mulally, earned $29.5 million in total compensation for the year.

However, it’s tricky to compare hedge fund pay with executive pay more broadly. For a start, hedge fund figures include not only the fees managers earn from running the fund but also gains from their own holdings in funds they manage. Since fees are not broken out separately from fund gains, it’s a matter of guesswork to figure out how much pay comes from outside investors. As well, the data on hedge fund pay is not consistently available. Hedge fund managers are not required to disclose pay details, so there is no industry-wide metric.

We are left to look at each hedge fund case by case. One might ask, how did the highest-paid hedge fund manager last year, Ray Dalio, earn $3.9 billion? With about $120 billion under management, the firm Dalio helped found and now runs achieved a 16 per cent gain in its main fund last year. Remember, the broader market returned only 2 per cent last year, so a 14 per cent outperformance is a very good result. The question is whether, adjusted for risk, that return deserves a payday measured in billions.

There are other managers who performed in line with the market. Take Paul Tudor Jones. While his main fund did no better than the S&P, he got $175 million.With that kind of performance, it doesn’t make sense to pay a premium fee.

None of that would matter if investors reaped rewards over the long haul. Yet the latest evidence suggests that might not be the case. A New York Times analysis of public pension fund investment in hedge funds shows that over a five-year period, hedge fund investors did not fare very well.

The study looked at the public pension funds with the largest proportion of their portfolios in alternative investments and compared the results with funds with the smallest stakes.

The 10 funds with the highest share of alternative investments returned 4.1 per cent on average over five years. That’s more than a full percentage point less than the 5.3 per cent average gain for the 10 with the lowest share of alternative investments. All their efforts to get into non-traditional pension investments didn’t pay off.

But just because it didn’t pay off doesn’t mean the funds didn’t pay for the “help”. Fees paid by the funds in the group that plunged into alternative investments were four times those paid by the funds that steered clear.

The New York Times analysis highlights that there’s a lot we don’t know about the details of hedge fund performance and pay. So long as funds are not required to report their details, the public, and perhaps even hedge fund investors, will be left to guess whether compensation is way out of line. But even without all the details, you can see red flags. In fact, you can see billions of them.

History behind Obamacare case

Financial Review

PUBLISHED: 31 Mar 2012

Anna Bernasek

All eyes turned to Washington this week as the Supreme Court examined President Barack Obama’s controversial health care law. After this week’s arguments, the Supreme Court will work quietly for about three months and then deliver what promises to be a momentous decision.

In the US, commentators offered predictions and guesses about which side would win. That’s understandable, since after all, Obama’s entire healthcare reform bill is at stake. Healthcare repeal would be a glittering trophy for Republicans in this highly charged election year.

Yet despite all the focus on health care, it seems there’s a much bigger game being played for a far more valuable prize.

To see what’s really at play, take a look at the case before the Supreme Court. In March 2010, a respectable majority of Congress approved President Obama’s healthcare legislation requiring health insurers to provide coverage not only to healthy Americans but sick Americans too.

Not wanting to drive up costs, the government added a law requiring every American to have health insurance or pay a penalty added to their income tax. Around 50 million Americans, about one in six, don’t have any health insurance. The idea was that making all those people pay premiums would offset the burden of covering those who are not covered due to a costly illness.

In order for Congress to pass any law it must rely on a specific authority granted under the US Constitution. If it’s not authorised in the Constitution, Congress simply can’t do it. So in this case, Congress relied on a provision called the “commerce” clause.

The commerce clause gives the US government the power to “regulate commerce … among the several states”. That authority is the foundation for a whole mountain of legislation, covering among other things labour and employment regulation, worker safety, financial regulation and environmental protections.

So the question before the Supreme Court is whether the health insurance reform falls into the category of regulating commerce or not.

Opponents of the law seized on the so-called “individual mandate” in the law that requires individuals to buy health insurance. They claim making people buy something is an unprecedented expansion of federal power.

And that would be interesting if it were true. But until the court agreed to hear the case there wasn’t much to dispute about the subject. The last time the Supreme Court decided a significant case on the commerce power was in 1942. Then conservatives were enraged by president Franklin Roosevelt’s energetic responses to the Great Depression. Progressive legislation in the 1930s brought federal government influence into areas it had formerly steered clear of. In response to FDR, a huge conservative backlash that continues today sought limits on government power.

Back in 1942 Roscoe Filburn, an Ohio farmer, raised wheat on his own land for consumption by his livestock. Filburn ignored federal regulations limiting the amount of acreage he could plant with wheat, growing more than his share. The limits were part of a nationwide scheme to support commodity prices in the face of the devastating deflation of the Great Depression. When Filburn refused to destroy the excess wheat, the government took him to court.

It was a striking case. Could the government, as part of its power to regulate commerce, tell a farmer not to grow a crop on his own land for his own animals? In a landmark decision, the Supreme Court found the government did indeed have that power.

Looking back, the implications of the Filburn case were profound. Since 1942, it has been settled law that Congress has the power to act in virtually any area so long as a decent argument can be made that it relates to commerce.

Up to now most constitutional lawyers considered the commerce power to have few if any practical limits. And over time law after law relied on the commerce power for its justification. So it’s interesting that the court is revisiting something that hasn’t been seriously questioned for 70 years.

The motivations, of course, go way beyond health care. After all, the basic scheme of Obama’s health insurance law was a Republican idea. In the early 1990s, conservative groups known as the Heritage Foundation and the American Enterprise Institute dreamt it up in response to Hillary Clinton’s healthcare plan.

Substantively, there’s a lot in the law for conservatives to like. Requiring the young and healthy to pay for insurance they don’t need shifts a financial burden from the public treasury to a broad swath of individuals, in effect operating as a regressive tax. That’s something Democrats usually detest, but in this case they held their noses and accepted it in order to get the rest of the health care bill through.

So it doesn’t make sense that conservatives are against the law itself. What they really object to is a broad reading of the commerce power. Virtually every progressive achievement of the 20th century – social security, medicare, environmental protection, financial regulation – depended on the commerce clause for its validity. For those who believe the government’s influence should be scaled back, the commerce clause is perhaps the ultimate prize.