Subscriptions

I've always thought this blog would work better as a newsletter. I'm working on pieces all the time but unfortunately, the publishing is sporadic. For those of you that know me well, you are aware of pieces that were interesting, but never quite made the cut.

So I urge all of you to look to the right of the screen and type your emails in the subscription box, where it says, "subscribe via email." Some of you already have sophisticated technologies to inform you when I update this blog, which is excellent, but personally I find nothing easier than for readings to come directly into my mailbox. This is a much better alternative to checking up on the site and being disappointed, which is probably what's been happening for about a month now (sorry).

Just to be clear, I don't get anything if you subscribe. I don't make ad money from this, I don't sell the lists, and nobody other than my newsletter will email you. You can unsubscribe at will. This was just a note, from me to you, to open your in-boxes to my bear hugs.

Chow Time

I got this pamphlet in the mail. I live in the Trinity-Spadina riding, which is currently run by Olivia Chow. Normally, I just toss pamphlets like this away, but there was something compelling about the woman on the pamphlet. You see the way she has taken off her glasses and is pinching the top of her nose? As an accountant, I know exactly what that is about. That's what you do when the numbers don't make sense (or sometimes, you do that when you're adding a really long list of numbers, and then you type something in wrong and have to start over).

Let me walk you through the document. According to the NDP literature, the first important thing you need to know is that there is a "tax grab" going on and everyone is in on it (except for Olivia Chow and Jack Layton) . Harper, McGuinty, Ignatieff - all of them grabbing tax like a bunch of tax grabbers.

Then she walks us through some of the items that will be subject to the HST, and therefore have additional sales tax next year. Coffee. Donuts. Newspapers.

What kind of red-blooded Canadian wouldn't buy those things? It's clear she's aiming for a nerve.

Then she drops the bomb. She explains how "they" are getting away with it.

"Stephen Harper's conservatives are bankrolling them with $4 Billion of your own tax dollars." Our worst fears confirmed. They are exchanging our money for more of our money.

Of course, there are some details left out of the pamphlet. For one, she is missing a portrait of her and Jack Layton together. I can provide that:


The other thing missing is that Chow never does explain why "they" are taking our money (and exchanging it for more money). I will do that too.

Ontario is in more trouble as compared with the rest of Canada. Look at this graphic, courtesy of the globe (no seriously, look at it, it's cool). You will see the national unemployment average of 8.7%. You might also notice that most of the Ontario cities have a higher unemployment rate than the National average. As a nation, we are lucky to be so resource rich (I'm looking at you Western Provinces), and to get through this recession, we need to share that wealth across the board. That means Ontario gets more federal transfer payments to support our unemployed. The deal, as I understand it, is that in exchange for continued federal transfer payments to cover what will be whopping deficits in the years to come, we give the feds our PST.

It's a cheap trick to blame McGuinty for participating in the HST. I can't imagine that he really had a choice in the matter. To function properly as a country, it only makes sense that if you are completely dependent on the federal government transfer payments to make provincial ends meet, then the federal government should have control over your sources of income (such as taking over the sales tax).

However, from what I see, Ontario is actually in much more trouble than people think. We can use these transfer payments over the next few years to create jobs, extend employment insurance, subsidize adults to get retrained in school, but these are just temporary solutions. The elephant in the room is how we plan to replace the old manufacturing jobs that we have lost?

Getting through the next few years is a no-brainer. Redefining the Ontario economy for years to come is actually the exercise that requires thought, and I don't see anyone thinking about it.

Harmony

[This is a piece I wrote in the Spring when all this Harmonized Sales Tax stuff came up. I never ended up posting it because it really wasn't as a big deal at that time (massive job losses and slumping economy were dominating the headlines). But the decision to harmonize our sales taxes with the Federal authorities will continue to pop up, most likely as a political issue. This should provide a good background on why we did it and what it means, and it's a nice preface to my next article. The real reason I'm doing this is because I want you to be able to spot political misinformation as soon as you see it. When I hear the way politicians speak about tax issues, it's obvious they're counting on us to have no understanding of what is actually happening.]

Ontario recently passed the adoption of a single, unified, Harmonized Sales Tax which will now be referred to as the HST. It won't fully affect Ontarians until 2010, but I figured it can't hurt to know a little bit more about this change. This graphic from the Toronto Star provides a great summary of what goods will be affected by this tax change. You might want to take note of the “No longer PST Exempt” section of this graphic – this means all of these goods will be taxed at the new HST of 13%, rather than just GST at 5%.

There are some other important differences moving to a single harmonized sales tax. We’re moving entirely to a Value-Added Tax, whereas before only the GST portion was structured as a value-added tax. I'll illustrate what that means with an example, but let's cover some of the big stuff before we get into the detail.

Harmonizing the sales tax in Ontario (PST) with the federal tax (GST) to make one unified tax does several things:

1. Businesses no longer have to file two separate sales tax returns. They still have to pay the same amount (8% PST +5% GST = 13% HST). According to several sources, including the graphic above, the government estimates that harmonizing will save Ontario businesses $500 million in costs associated with filing two separate retail tax returns (one to the Province, and one to the Feds). In other words, at $50,000/year, per person, harmonizing sales tax will put 10,000 people out of employment.
2. Something Ontarians might find annoying in the future is that by harmonizing the sales tax with the federal government, Ontario has lost its ability to govern 8% of the total sales tax. They have given up their power to encourage or deter goods or services by using the sales tax. The feds decide that now.
3. The truly interesting part of harmonizing sales tax is that we now have a single Value Added Tax. The GST was already a value added tax, while the PST was not.

So, what is a value added tax?

A traditional sales tax system simply slapped a tax on the end user of a product or service. The various businesses involved in producing the good or service did not have to deal with the tax – only the retailer would collect it on the government’s behalf, and submit it to the government periodically.

A value added sales tax, on the other hand, taxes a business each time it adds value to a product or service. If we were selling paper airplanes for a living, this is how it would work:

• I would go to Grand & Toy and purchase paper, on which I pay 13% HST (the new value added tax) on $10 worth of paper. So I’ve paid $1.30 in tax;
• I sit at home that night, adding value to the product by making sheets of paper into airplanes;
• I sell my planes the next day, for $100, plus HST of $13, for a total of $113.

Total Taxes I collected on behalf of the government: $13

Total Taxes I paid in the process, that I should be reimbursed for is $1.30

I give the government the net of those two when I file my HST return: $11.70

Grand & Toy owes the government $1.30, because to them, I’m the end user of their product (paper).

In total the government receives the same amount as it would if only the final end user of the product (the consumer) paid the $13 tax. So why do it this way?

There are several advantages with a value added tax system, but two are relevant here. First, VATs require that businesses have to track the sales tax collected and sales tax paid, every step of the way. This means companies lose the ability to tax on top of tax, which is called "cascading," and is something that unnecessarily contributes to higher prices.

The other benefit is that the government does not have to wait for the end user to pay the tax, it will receive money throughout the process, which helps facilitate tax collection for the government.

Ontario should be able to leverage more transfer payments from the Federal government in exchange for giving up its right to control sales tax. The Ontario government itself has projected provincial deficits until the year 2015. It's not fair to analyze the economic affairs of a single province alone, because all provinces are heavily dependent on transfer payments from the Federal government to pay their bills. But if you are curious about what the projected Ontario 2009/2010 income statement looks like, this picture sums up the best guess.

Recession and Hip Hop

Here's a story that's not getting much coverage. You will be shocked.

Death Bonds Continued...

I wrote about Death Bonds back in May of this year. No, I didn't break the story or anything like that. However, I did perform the analysis ahead of everyone else. The New York Times recently did the analysis too, and came up with the same conclusions as me, which is reassuring and disturbing at the same time.

These are direct quotes from the Times article:

"And investors are not interested in healthy people’s policies because they would have to pay those premiums for too long, reducing profits on the investment."

"In addition to fraud, there is another potential risk for investors: that some people could live far longer than expected."

This is gonna be dirty. Wall Street is primed to make large bets on our elderly dying. They would prefer to cherry-pick policies from cash-starved unhealthy seniors, because that's where the money's at.

That doesn't worry me.

The article also mentions the practice of rigging bids for these policies. Imagine a recently laid-off father trying to make mortgage payments by selling of his insurance policy to bridge the uncertainty between jobs. With the life settlement market being so new, it's actually quite easy for colluding brokers to deceive him about the true market value of his policy. It's already happening.

But I'm still not bothered.

What about "stranger-owned life insurance," the practice where Wall Street firms wine-and-dine people to take out life insurance and then promptly transfer the policy over to these firms?

That's blatant manipulation, but whatever.

What kills me is that securitizing life settlements into death bonds is remarkably similar to what Wall Street was doing with mortgages, and we all know how that went. It's obviously a lucrative business to sell industrial sized securities, but there hasn't been any regulatory change to protect investors from poorly composed assets, nor have they modified the incentive schemes, which means much like mortgage backed securities, it's more important to make the sale even when you're selling shit.

The big underlying assumption this time is that people will die. Last time around it was about how housing prices will continue to rise in the long run. Make no mistake - both are true. It's just when we collectively get so involved in one particular market, not only does the assumption have to hold true, but it has to unravel in exactly the way we all expect it to.

I was arguing this point with my father and he told me to relax. He said insurance companies were in the business of making these calculations. You can rest assured that every single day they calculate how much they will have to pay out in future claims. It's their job to be prepared for these payouts.

But whether the insurance companies like it or not, they are slowly being pushed out of insurance and into betting against Wall Street. They don't have a choice in making these bets, which is what I find so strange. What initially starts out as an honest insurance arrangement with a family man, transforms into an investment for a Wall Street bank, but insurance was never meant to be an investment. Instead of people canceling policies when they no longer need to be insured (eliminating the claim altogether), they now have the option to cash them in for a higher value to a third party who is willing to wait for death to collect that ultimate payout.

As the death bond market emerges, it will test the resolve of American insurance companies unnecessarily for the sake of Wall Street profiteering. If you think it's really no big concern to the reserves and liquidity of insurance companies, that's fine. Only time will tell. As far as I'm concerned, the larger the death bond market becomes, the greater chance there is that insurance companies will face detrimental cash flow issues once people start dying.

But if we dig deeper, the real problem doesn't have to do with death bonds, or insurance, or any specific financial instrument. What is troubling is how much wealth is being transferred from the average American to the banks. In America, it's far too easy to take one person's financial problem and shove it into another person's pension plan. Clearly, lines need to be drawn.

Take pride in being a Canadian. Our nation has always been very strict with money managers. For our retirement plans, pensions and other savings, the banks can't just do whatever they want with it. They are permitted only a limited amount of risk, and many of the exotic financial products that have become so popular over the last ten years are completely out of the question. This is a good example (search "Canada's Foreign Property Rule" if you are interested).

This weekend, we should be thankful that our financial forefathers were ultra-conservative prudes. We should honour them because they were absolutely right to be so tight-assed with financial regulations. Their lameness is why Canadians have been able to preserve their wealth, relative to Americans. This fact, along with all the turkey you will eat this weekend, should secure you a good night's rest.

Epic Walk

[This is a piece from another blog and it has nothing to do with finance. I wrote it a year ago, and it's still one of my favourites. Enjoy the final weekend of the summer.]

My sister and I are bad Muslims. It's the month of Ramadan and we haven't fasted once. Don't get me wrong, we're not bad people, just bad Muslims. Our parents, however, have taught us what Ramadan is all about - sacrifice. And so, on the last day of summer my sister and I set out to walk from downtown Toronto (queen and john) all the way to our parent's place in Mississauga (like 401 and Mavis). That's over 30km and it took us 7 hours. I'd like to share the highlights with you.

The moon plays a great significance in Ramadan, and I thought it was nice that when we woke up early on a Saturday morning I could still see the moon. While I was waiting in front of my building, snapping photos of the moon and excited about our trek, I realized that I was waiting for my sister at the wrong place.

We were late.

We scurried towards Bloor street and started walking West.

Some people feel sad when they see a dying tree. I always feel sad when I see a closed down coffee time.

I didn't ask.

Right around Dundas West we encountered a series of polish bakeries. We stopped at this one and ate some of that. We are both deeply in love with bakeries and butchers.

There's so much to see on Bloor street that the Humber river snuck up on us. We were already approaching Old Mill and it felt like we had only just started walking.

Things are getting uglier. Concrete apartment buildings from the 70's. Power lines galore. Racing traffic. Highway signs. We have to yell to talk to each other. We're in Etobicoke now. It's the end of the line - Kipling station. We decide to walk north and take Burnhamthorpe all the way to the heart of Mississauga - Square one.

All the signs that we were entering Mississauga were there. We had crossed highway 427. There was four-lane traffic zipping by us, long stretches between lights that allow the cars to go quite fast. We had passed a sign that welcomed us to Mississauga. We started to see trees that were held up with crutches. But we didn't know any of it. This was a stretch of Burnhamthorpe that we'd never seen before, and it wouldn't stop! To be honest, the walk up until Kipling was a joke. The stretch between Kipling and Square One was mentally draining.

When I saw a sign for Rockwood Mall, I was jumping for joy, because I had worked at the Royal Bank in that particular mall for about a week when I was in high school. When we passed Cawthra my sister's exact words were, "Hey, it's Cawthra! Remember Cawthra!?" I responded with an equally jubulated "Yeah, of course I remember Cawthra!"

Let me tell you something about Cawthra. Neither of us ever had any business on Cawthra. It was just one of those streets that you knew because you passed by it so often. But at that moment, we were so freaking happy to see Cawthra. We knew we were close.

We had finally reached Square One. We were slowing down, both physically and mentally. We had to stop for a Julius in the food court. On our way out my sister was telling me that a long time ago she had actually walked from Square One to home, and she remembered that it took over an hour. I didn't need to hear that.

But it was okay once we stepped outside to start walking again. We were basically home. Empty buses. Traffic lines on the streets seemed fresh. Blindingly bright sidewalks. Some brown girls honked at me to say "nice shirt," complementing my 100% Halal. Deafening traffic noise (because walking on major streets feels like you're walking on a highway). A general feeling of being unsafe as a pedestrian. My sister was getting angry at all the drivers.

The home stretch was all about pushing it. We had no idea how tired we'd gotten, but our arms had started to flail quite wildly, and there was a moment when we hit each other's hands, mid-stride, and both said, "oww!" simultaneously and then started to giggle. We finally got home and spent the next 1/2 hour convincing our parents that we had indeed walked all the way home. We spent the rest of the weekend trying to explain why.

Investment Advice

I just found THE best investment advice article. It's not written in a prophetic way, it's just stating some observations, but personally I find facts more useful than predictions when it comes to investments. The author, Jason Zweig, touches broadly on the economy as a whole, market history, and for me, no investment advice column would be complete without some psychological bias that investors commonly fall victim to.

He mentions the rapid recovery in global markets. The biggest reason for recovery in stock market value might just be the result of that gigantic global stimulus we deployed earlier this year. We've injected our economic system with a ton of money; despite the fact we just established there are a lot of holes in our financial systems. Under the guidance of a widely accepted mantra of "more money be good," we've been able to get people spending and keep companies producing, which is making all the numbers read like a recovery is looming.

When he talks about a V-shaped recession versus a W-shaped, it's simply economists trying to picture what the GDP production graph will look like years from now, when we're out of this mess and we can analyze what happened more accurately. The GDP graph of a nation should reflect the same ups and downs as a market graph, except the stock markets anticipate information whereas GDP is based on past data.

A V-shape would imply that we have already hit bottom, and we'll soon get into higher production levels globally and be back to normal in about a year's time. Although any proponent of the V will quickly point out that "normal" won't be what we're used to, we're still looking at positive economic growth in some sustainable fashion. If you believe in that, you are probably buying stocks now. The worst his behind us, and regardless of what the line will look like, it's going to go up.

Most economists who believe in the W are basically saying we're going to go through the same thing twice. They, like me, believe that stimulus packages are currently propping up global demand. When those effects disappear from our economic system, we will experience another dip.

Now, no proponent of the W believes that the second dip will be as severe as the first, but take a look at what happened after Black Monday in 1987. Recovery appeared to be on its way after the crash, but behind the scenes the economy was falling apart. It took over two years for the recession to actually hit us. It hasn't even been a year since the most recent crash.

Here's what we did this time around: Once we realized we had an enormous problem, we threw a lot of money at it. Then someone said, "wait." That's where we are at. We're waiting for the results. I'm not saying money can't be made in this market; I'm saying it's impossible to know the long term worth of stocks.

So what does it really mean when the stock market recovers the way it just did? One would think that the markets have reached a consensus that we are going to go through a V-shaped recession/recovery process. If the market was full of long term investors, I would agree that there is a general market sentiment that recovery is on the rise. This would still only be a market sentiment; a collective projection based on number crunching, best estimates and gut feel.

But the market isn't made up of investors. It's mostly speculators (individual day traders and their much more powerful institutional counterparts). So what is the general consensus of speculators worth to you? Do current market prices reflect anything other than the whimsical trading strategies of Wall Street banks and Hedge Funds trying to turn a profit?

The market recovery is being mistaken for an economic recovery, and that's where I start to worry. Sure, some of the market appreciation we experienced was due; so many strong and stable companies had their stock price plummet because of the widespread panic during the crash. Rightfully so, those stocks went up. But what Zweig’s findings point out is nobody really knows at what point these stocks should stop rising, and there’s a chance we’ve gone too high.

"What stocks do you like?" I've been asked this question a lot lately, and I'm currently invested 100% in cash. I'll be honest with you. Mostly, this reflects my aversion to risk. I also want to avoid situations where I have to constantly consult with the business ticker to determine my mood.

They say a house is the biggest purchase the average person makes in his or her life. I want to be one of those people. And if there's money leftover, I'm letting it ride on the Toronto Raptors taking it all this year. I mean, at least they'll let me cheer and scream from the sidelines.

You should really know who you are before investing in this market.

Sick of Garbage?

After repeatedly trying to piece together some semblance of an article, I decided to go the old-fashioned route and write several blog entries.

Some Nasal Observations:

I've been through two garbage strikes and I must admit this one smelt way better. During the last one it was actually so hot that you could smell the piled up garbage for miles. A stench-filled breeze drifted around the city and hit me each on my walk home from work, reminding me that this city's got issues.

It was more contained this time around, despite the fact that the strike lasted longer. The city was prepared for it. I'm personally proud of Toronto business owners who took ownership of their streets, and violated the law, by collecting garbage they aren't technically allowed to. Some found a way to get into the city receptacles and change the bags each day. Some strategically taped empty garbage bags so street litter would have a home. Thanks to them, my friends and I were still able to meander through the excruciatingly complicated process of picking a restaurant, the way we always did.

Sick Day History and Customs:

The issue that held up negotiations (as everyone probably knows by now) is the ability for city workers to aggregate sick days, and either receive a cash payout for them in the near term, or roll them forward in order to bank them for retirement, at which point a payment would be received.

This Toronto Star article provides us some history on the situation. Basically, imagine a time where the City of Toronto (and much of Ontario) was growing so fast that it was a problem retaining city employees. Any compensation policy that gears its rewards toward retirement is an attempt at keeping employees here for the long run. It was an indirect form of compensation, a perk, if you will. Traditionally, government worker salaries can't compete with private salaries, so they offered indirect forms of compensation, and banking sick days is just a way to defer cash payments for the employer, but still provide a benefit for the employees.

It's silly to debate whether or not someone should be able to bank a sick day and cash it in later. The answer is no. A sick day is an entitlement to an employee so that they don't get a dock in pay should they miss work once in a while. Most of the people striking are garbage workers, and I fully understand the need for them to have more sick days than say, an office worker like me, because they are much more likely to get sick in that line of business. So it's not about how many days they get, it's the premise that they can translate unused sick days into cash.

But what annoyed me during all of this was people couldn't get past that ability for them to bank sick days. It was unheard of. But I would just like to point out one thing: we all do this.

Everyone is guilty of is using up sick days before they expire. For most of us, we are entitled to a certain number of sick days, and we all find ourselves planning to be sick on Fridays and we get away with it because at the end of the day, it's really no big deal, and after all, you are entitled to those sick days and you wouldn't want them to expire. In effect, each sick day you use is deferring the use of a vacation day, and you are entitled by law to either receive vacation as time off, or in cash. This garbage situation is not so different fundamentally than some of the ordinary nickel-and-dime tactics we use to milk our respective employers. The major difference is that they talk about it openly and it is formalized in their contracts, whereas we bank our sick days in a more cloak and dagger fashion. Of course, that's nickels and dimes, and this is millions of dollars - but I'm just saying.

Discrimination?

A friend of mine was speaking with a lawyer who had a very interesting take on the entire matter. The argument was that the sick-day bank benefit was discriminating against sick people. While the relatively healthy could defer and bank their sick days, slowly padding their retirement plans, the people who were actually sick would have to forfeit this cash benefit.

Sick Day Psychology

I happen to work for a company that does not define how many sick days we are entitled to. The policy is simply to take a sick day when you need a sick day, and if you are sick for several days in a row, the short-term disability stuff will kick in. So in effect, it's unlimited sick days. Contrast that with companies where they give you 5 or 10 days total. When you know you have 5 days, it's much easier to figure out a way to "use them up," by the end of the year, because they would all wash away and a new set of 5 would be awarded. But when there's no number, there's no unwritten rule that the employees have at our company with sick days, so we end up using them when we're sick, and we look to each other to see what is normal. I just find it interesting that without a benchmark, people just end up being more honest with their sick days. At least that's what I'm seeing.

Hurricane Hazel

Something I discovered recently was how the City of Mississauga, and its mayor Hazel McCallion had influenced this negotiation. I have always had a soft spot for the Hurricane. She started her political career in Streetsville, where I grew up. The ageless wonder has won the hearts of many Canadians for her political savvy, love of Hockey, and the fact that she still gets trashed at cocktail parties, like to the point where they have to carry her to the limo and send her home (granted, it's usually around 9pm she is getting sent home, but let's see how you do when you're 88 years old).

It was in 1982 that Hazel took a hard stance against sick days and their bankability, at least for all new employees, and 27 years later the old-timers have dwindled down from 150 to less than 10.

Toronto has chosen the route to phase these liabilities out over time, so the old people that were banking these days can continue to do so, while the new people have new rules.

But I do want to warn our David Miller that taking the same line as Hazel did 27 years ago might not translate into the same results. Mississauga's problem was relatively small compared to Toronto's current situation where they have millions of dollars in sick pay to distribute. I ran some quick numbers to try and determine the relative wealth of the two municipalities:

Toronto: $901 tax revenue/person
Mississauga: $1,792 tax revenue/person

[If you care: I used property tax figures because that's really the key funding tool any mayor has at his/her disposal. But since Toronto is much larger than Mississauga, I used per capita numbers for comparison.]

This simple math is the major reason why Hazel was adamant Mississauga wasn't going to be a part of the GTA amalgamation. She knew a long time ago that they would end up bailing Toronto out of all financial jams because the tax revenue would be pooled.

A Brief History of Goldman Sachs

Thanks to Andy for sending me this Rolling Stone link. It's a great summary of how Goldman has accumulated wealth over the years, but in particular it focuses on the way each time a gigantic wealth bubble bursts, everyone loses money except for Goldman Sachs.

What I find startling is how speculation completely supplants investment in all the bubbles. When you make any specific market into a shiny casino, where people in suits are walking out with money stuck to their feet like toilette paper, some blame has to be attributed to the suckers that see this and walk right into the Casino. At some point you have to count on money managers and investors to know whether they are signing papers to an investment, or whether they've just let everything ride on a spin of the roulette wheel.

I also found this lighter response to all the Goldman-haters out there by Michael Lewis. Enjoy your weekend reading.

Clear as Mud

In the Monday, July 13th edition of the Globe and Mail I came across this article about how the economic slump is all but over. Then I clicked around, and came across this article about how Ottawa's credit strategy (part of the overall stimulus package) isn't working. The hole in the stimulus plan is that it won't help small business, which is always a critical part of any nation's economic recovery.

Same paper. One page points to a sign that the recession is over. Flip the page and it says we're failing to get out of this mess.

So are we clear?

The experts have made it known that the recession will officially end this year. If not this year, then it will definitely end next year. But nobody made that prediction without qualifying our fate by saying it will be an excruciatingly slow recovery. The word stagnant has been thrown around. I've also seen "jobless recovery" several times. I urge you to read all about the "painful recovery."

Which begs the question, what the hell kind of recovery can you have if job creation and growth is not a part of it? To me, it sounds like we're making the GDP rise, even though the basic economic conditions have yet to improve. That's not a recovery, that's an accounting trick.

I know lots of accounting tricks. An oil spill, as tragic as the event can be, ultimately increases the GDP. If you want to decrease unemployment, subsidize going back to school since if you are in school you're no longer part of the statistic. Better yet, someone that works 12 hours a week at McDonald's isn't considered unemployed.

Here's a new one: Let's have all tour World leaders meet and decide to collectively spend billions upon billions of dollars worldwide to stimulate the economy! That money will take a few months to run through the system, but once it does, it will allow people and companies to spend on goods which will in turn increase the GDP! All we need is one quarter of GDP growth and we're out of the recession!

[Note: The technical definition of a recession is two or more consecutive quarters of negative economic growth]

Every recession is different. But in no way are we on our way to economic recovery unless there is sustainable job creation. Canada is in a good situation, relatively speaking, because we have stuff (oil) that other people need. That's safe. But we're certainly not out of the woods yet, and provinces like Ontario things will get worse before they get better. But overall we simply won't have much of a recovery until the US economy turns around, and from what I see they are a long ways away.

You're about to hear lots of reports about how the recession is nearing the end, But this is an accounting trick. It's just the bean counters number crunching and saying we're in the black.

I ask you, how can a recession be over if a recovery does not follow?

Twitter

There’s been a great deal of chatter in the business community about Twitter. To me, most of it appears to be excited businessmen smelling a hot commodity, but still struggling to understand what makes Twitter so popular. Here is an article where a businessman shares his insights by creating a parallel between Twitter/Facebook and the Id/Ego. Just the fact that he’s trying to force Twitter into an existing and familiar framework not only seems forced, but it’s a reflection of about 90% of the business thinking surrounding new ideas like Twitter. Too often there's a disconnect between a hot technology idea like Twitter, and the people with money to spend on these ideas. There is an inclination to squeeze these ideas into an old-fashioned business model, until profits oozes out.

This is a good summary article of how most business people view twitter. They outline 10 ways that Twitter will change business. I’m going to save you some time by telling you that there’s only about five unique ideas in this piece, the rest is just filler to make the list 10. The core of these ideas fall into one of two business advantages:

1. Corporations can gather personal data about people;
2. If people follow corporations, the companies have a direct channel to their consumer through tweets.
   

But when I read the article, I had an out-of-body experience that the year was 1993 and I was reading this exact same article, except it wasn't about Twitter, it was about a new thing called E-mail and the Internet:

1. “In utilizing the Internet, we are able to collect personal data from consumers about their preferences!”
2. “By collecting hotmail addresses we can use electronic mail to harass the customers about promotions and sales at pennies of the cost as regular mail!”
   

It’s really all the same stuff. There are definitely some good uses outlined in the article, but there’s no game-changer. Twitter, in-and-of-itself, is a minor connectivity improvement.

Then there’s Howard Lindzon, who has leveraged Twitter to create something called Stock Twits. Essentially, it’s designed to be twitter specifically for day-traders. Follow truth and rumours from the investor gurus in real time! I suppose this is an important step for day-traders, Twitter can help unify hundreds of different investment chat rooms into a single massive investment community. But I'm just not feelin' it.

But then I read this. It blew me away. The idea is that StreamBase Systems wants to collect and interpret tweets to determine if there is a particular sentiment towards a stock or the stock market in general. The challenge for them is to interpret all the tweets and organize that data into forming a collective sentiment.

The article goes as far as citing an old day-trading secret, which serves as a convenient example of how the power of this tool would manifest. Recall last week we discussed how markets are efficient, and that any news about a particular stock, or the general economy as a whole, is quickly incorporated into stock prices as soon as the news is made public. There is an old trick that day-traders use (which might have a slick short name that I am unaware of) called, “Buy on rumour, sell on news.”

For example, let's assume RIM is going to announce its 2nd quarter earnings on July 15th. Now, as day-traders we believe that RIM has a positive sentiment associated with it (by that I mean RIM is a good company, it gives investors a positive feeling because it often exceeds expectations). Because we believe this, we can potentially ride this sentiment to profitability. How? The way we can profit from this is to buy the stock early, and sell the stock right before the news about their earnings is made public, so in this case we would sell it July 14th. At the end of the day, we just have to guess which way the herd is leaning to make money. It doesn't actually matter if RIM has exceeds its estimated profits on July 15th - we're not actually betting on the stock; we're betting on the market's collective perception of the stock.

With StreamBase Systems data, we can potentially tap into a more accurate depiction of that sentiment. We can decide based on their data if the market is relatively positive on RIM, and make an educated guess about whether the price will creep up on anticipation of the Q2 earnings report. Investors will pay StreamBase for this privileged information, because in theory, it provides an information advantage on the market.

There are some potential loopholes here. If the service is truly good at depicting market sentiment about a stock, most or all day-traders will rely on it (heck - institutional investors will be all over this too). If most day-traders rely on the same source, it means they'll receive the same data at the same time, and will transact as a herd which eliminates their profit margin on the buys and sells. The other problem is information being leaked. Currently, I don’t have to read the Wall Street Journal to know what WSJ is writing about because bloggers and tweeters are writing about it for free – I just have to follow the right people and I can get my information for free.

But whether or not one can profit from this service is not why I found the article powerful in the first place. What fascinates me is the potential to interpret tweets and form a general sentiment. The idea of a collective consciousness was always said to be possible with the internet, but will Twitter be the application to make it a reality?

Back to School

Efficient Market Hypothesis (EMH). When our professors first introduced the concept to us in finance class, we were all blown away. Everything we knew about the stock market had been crumpled up and thrown into a waste basket in the span of an hour’s lecture. Although the idea lives primarily in classrooms, there’s no denying its power.

I noticed that instantly my classmates had either rejected the theory because it went against everything they knew and practiced, or they wholly embraced the idea like a new found religion. Nobody sat on the fence.

Wiki says: In finance, the efficient-market hypothesis (EMH) asserts that financial markets are "informationally efficient", or that prices on traded assets (stocks, bonds, or property) already reflect all known information, and rapidly change to reflect new information. Therefore it is impossible to consistently outperform the market by using any information that the market already knows, except through luck.

For example, as soon as RIM announces bad news, something like a product defect, the stock price drops before you can click on “sell” on your computer. By the time your order is processed you will have sold at a lower price, one that reflects the loss incurred by RIM. There are so many investors trading this stock around the world that that its price is perfectly efficient, given the information available at any point in time.

It doesn’t have to be company specific-information; it can be general economic news. For example, the stock price of a clothing store like the GAP can suffer from economic reports that state consumer spending is down and consumer confidence is low. It’s worked into the price by the time you hear the news. Retail stocks depend on consumer demand, the connection is real and the reaction is instant.

An extension of this theory is something called the Random Walk.

Wiki says: The random walk hypothesis is a financial theory stating that stock market prices evolve according to a random walk and thus the prices of the stock market cannot be predicted. It has been described as 'jibing' with the efficient market hypothesis. Economists have historically accepted the random walk hypothesis. They have run several tests and continue to believe that stock prices are completely random because of the efficiency of the market.

There is a myth that lives in finance textbooks about the Random Walk. We were told that in order to prove the theory, a scientist scattered some bird feed on the stock listings of the Wall Street Journal and allowed a pigeon to peck at the various stocks on the paper. Wouldn't you know it? The pigeon's portfolio provided a return equivalent to the overall market's performance! The idea is that fund managers don’t have any distinct advantage over me, you, or the bird. In the long run, the fund managers that invest in equities simply earn the same overall rate of return that the market earns.

It was easy for me to embrace this theory. Entering the technology stock boom, at least a third of the people in my program were playing the market. These kids could not stop talking about their stock picks. They were buying low and selling high, or sometimes buying high and selling higher. They couldn’t lose. I didn’t understand how a bunch of bright-eyed pimple-ridden adults were beating the market. But once I learned about the EMH, things clicked. Anyone trading stocks during that time was profiting from a very positive market sentiment.

[An aside: One reason students could get in on the action was electronic trading and online brokerage services had become mainstream. Before online brokerages, you had to hire a broker and the commission costs were much larger, which was a barrier to younger inexperienced investors.

Another important note about that time was not only how misunderstood tech-stock valuations were, but there were some aggressive accounting policies that made many technology stocks look much more attractive. So you had good ideas being sold as profitable ideas, which wasn’t always the case, and on top of that you had company management aggressively recognizing revenues, both of which made several companies appear more profitable than they really were.]

What EMH and Random Walk are saying is that during a boom like that, everyone wins. And when the bubble bursts, everyone loses (including the pigeon). Of course that doesn’t change the money that was made and lost. It just illustrates that there is a general wave the stock market roller coaster rides, and whether you get stock advice from a pigeon, whether you read about the market and do your own analysis, or whether you invest in a mutual fund where a professional picks the stocks for you, ultimately, we’re all riding the same wave, and our returns will average out to be the same in the long run.

But you see, the real benefit of knowing these theories has nothing to do with making money. It has everything to do with how you look when you make money. It’s like when you fill out an NCAA bracket and you end up winning the office pool and then you tell everyone that your girlfriend made all the picks for you.

Of course, investing gets more complicated than that, especially when we start to look at what hedge funds can do. But for people like you and me, and the pensions and mutual funds that invest on our behalf, the EMH simply serves as a reminder that you win some and you lose some. But most importantly, it assures us that there is no secret way to beat a pigeon at investing.

J.D. Salinger

I had completely forgotten why I’ve always wanted to be a writer. Over the years, I've just assumed that I always had an interest in reading and writing. Then I came across this. I remembered that it was actually one particular book that inspired it all.

Before I read Catcher in the Rye, my reading experiences went like this:

• The Hardy Boys (and other similar fiction series) were good stories but nothing about those books were special;
• I read Sweet Valley High in 6th grade simply because I knew it would bother my teacher who didn’t think I should be reading books like that because I was a boy;
• I read Lord of the Rings but it didn’t feel right because I skipped so many boring pages, and felt like I was just pretending to like it because everyone else liked it;
• In 7th grade I read Farewell to Arms by Hemingway and didn’t get it.
  

I had no idea what I was looking for until I read Catcher the summer before I went to high school. I quickly accumulated everything I could find written by J.D Salinger (the entire family: Franny and Zoey, Carpenters, the banana fish, etc.) I found several different occasions to re-read Catcher (normally squeezing some credit out of my English teachers for doing so). It was the only book I knew that got better each time I read it.

But it wasn’t until an English presentation in 12th grade where I decided to enter the classroom in character, as J.D. Salinger, and present his works to the class for my independent studies project, when I realized how obsessed I actually was with J.D.

Lucky for me, the internet had emerged by that time, and I quickly discovered I wasn’t alone. The question that haunted all of us was always the same: Why?

It tantalized me. How could someone that connected to so many people simply not care about his popularity? How could someone that wrote such a perfect book not want to write more?

The number of artists and writers influenced by him is astonishing. There are numerous attempts trying to extend his work somehow, trying to write the sequels, finish the Holden Caufield story, or tell Salinger’s story – for so many people J.D. Salinger is not a person, but an inspiration.

The only time you ever hear about J.D. in the news nowadays is when he is fighting to protect the unique existence of Holden Caulfield in the locket that is Catcher in the Rye. There is actually a "legal conflicts" section in his wikipedia page, if you're interested.

It’s my dream to create something, just one thing that people of my generation would hold dearly to their hearts. Now that I’m all grown up, I don’t really think about the “why” anymore. I understand it completely. Jean-Paul Sartre described this concept as the "ultimate goal,” a singular objective that an individual strives to achieve. It is the sole creation that justifies all the steps needed to create it. It is a lasting impression left on earth that justifies all the coffee, cigarettes, and sleepless nights.

The New Credit Card

Last week there was a great deal of buzz and coverage surrounding future regulations of the credit card industry. I’m surprised that everyone stopped talking about it so quickly. I believe these regulations will have a serious impact on the growth of both the US and Canadian economies. The credit card is the least discriminating form of credit widely available to humans. Regardless of how old you are, what you do for a living, what assets you own and what you want to do with the money - you can get a credit card.

Consumer spending represents over 70% of America’s GDP and personal credit cards facilitate a great deal of that spending. This entails that the US GDP growth is joined at the hip with individual consumer spending. Restrictions on credit cards will hinder consumer spending resulting in slower economic recovery. At the same time, the American consumer clearly needs to be protected from fast and easy credit given the ridiculously high levels of consumer debt they’ve accumulated.

So what exactly are the proposed changes? In the US, a bill was recently passed by the Senate making it harder for people under 21 to get a credit card. It also stops the banks from raising the interest rate on a consumer unless he or she is more than 60 days late on making minimum payments. Relatively minor changes thus far, but will there be more?

This New York Times article hints that card companies will employ a completely different scheme for credit cards in the future among this changing regulatory landscape. They say there will be more user fees and a reduced (or eliminated) grace period where no interest is charged. This would affect customers that pay on time every month the most, which is estimated to be 40% of credit card holders in the States.

I find this hard to believe because consumers that pay on time don’t actually need the credit, in most cases. Many people only get credit cards because of all the perks they can earn, not because they need the financing. If they had to pay ridiculous amounts of interest and high user fees, it would cease to be an attractive option.

In addition to this, the credit card companies make money from vendors. A standard charge that Visa or Mastercard might impose on a vendor is 3% of the purchase price on each transaction, which might be capped if the vendor reaches a certain volume level each month. The reason these vendors have these credit card machines is because customers like paying with credit cards, and accumulating points. If credit card companies make their "gold" cards unattractive to their prime customers, they will start to lose revenue at the stores as well.

Let’s change focus to the majority of American credit card holders (the 60% that carry a balance from month-to-month). What the banks are implying is that everyone will be treated the way these customers are treated, extremely high interest rates and very little perks. Eerily similar to the business model of subprime lending, the incredibly high and volatile interest rate schemes serve to protect the credit card companies from a naturally high rate of default. Remember, they are giving you a completely unsecured loan to purchase whatever you like. At least with a subprime mortgage there is a house that the bank can takeover should someone default. With credit cards, the rate of interest has to be high enough to compensate these companies for all the customers that never pay back the loan. There is nothing else to fall back on.

In Canada, everything works exactly the same, except 70% of Canadians pay their bills on time so they never pay interest. This CBC news brief notes that Canada is also working on regulating the industry. Because of the diligent client base, our regulatory changes are not likely to be as drastic as in the US.

I want to share a story with you about my father in 1989, right around the time that the recession was surfacing in Canada, and credit became tight. He had been using an electronic typewriter for all his business communications, but once he learned about the word processor, he realized that it would save him an incredible amount of time. He would be able to customize documents for each sales pitch faster, meaning he could fit more appointments in each day.

He purchased an 80-86 computer (if you recall the progression, it was the one before 286, 386, 486, Pentium, etc). It had a monochrome orange monitor that weighed as much as a big screen TV even though it was 15 inches in diameter. He paid $100 extra to install an 8 MB hard disk (it came with no disk space) which was barely enough space to load the start-up disks and a word processor called "8-in-1." Add another $100 for a dot-matrix printer to complete the set.

He didn’t actually have the money to purchase this computer. What he did was use his credit card to make the purchase, and then obtain more credit cards to make minimum payments each month in order to avoid default or harm to his credit rating. This was by far the most expensive way to purchase a computer (let’s not even mention the fact that it was going to be obsolete in two years). He was fully aware that time was against him, and that ultimately he would run out of room on those credit cards and would be unable to make minimum payments this way. But he got through it, and he had the credit card companies to thank for it. Sure, they charged him an incredibly high rate of interest, but without them his business would never had made the jump that all the other businesses were making with the word-processor.

It certainly helped that the banks didn’t ask about how he was borrowing money from friends to make mortgage payments. Nor did they ask about how regular his income was. That is the reason he was able to get through a very tough time. Ultimately, he was a positive contributing member in the Canadian economy for years to come. Regulations will make credit card companies think twice about extending more credit to people like my father this time around. For example, if regulation forces card companies to reduce rates, then they will only lend to customers worthy of the reduced rate. Each time a rule is created designed to protect the customer, the card companies must re-assess how to maximize profits.

Expect more severe regulations to reduce the amount of credit available in the future through these cards and curtail consumer spending altogether. Reduced American consumer spending will slow the recovery of both the US and Canadian economies. But more importantly, these subtle tweaks to the rules will change the way we take risks. The new credit card will change how we live our lives.

Death Bonds

One evening at the dinner table, my father told me that he would probably die before my mother. He was much older than her, and he explained how he no longer needed to pay premiums on his life insurance now that all of us kids had grown up and made lives of our own. He and my mother would be comfortable for the rest of their retirement without this policy. He said that the insurance companies would refund some of his money, but those bastards completely rip you off. If you’ve paid ten grand in premiums, they’ll give you back two.

He offered me a chance to purchase his life insurance. I would pay him a few thousand, the same as what the insurance companies were offering, and take over ownership of the policy although it was still tied to his death. I would continue to pay premiums, but I would be the one to receive the big payout in the end once he died. This way, all the money he poured in over the years would stay in the family.

I’m sure that analyzing the numbers would have made the decision much harder for me, but I have one important rule when it comes to investing or gambling: if everything inside you says it’s a bad idea, don’t do it. Besides, I don’t think there’s very much on this earth that can destroy him anyway. He’s filled himself with smoke since he was ten. Up until recently, fried chicken was a weekly tradition. His father and siblings abandoned him or stole from him. He's had over 20 different jobs, careers and business failures under his belt. And now, to top it all off, he’s embraced death. There’s no freaking way I would bet against him.

My father is an insurance broker. He had been introduced to this idea a few years back at an annual conference he reluctantly attends. What he discovered was that there are investors out there willing to accept the proposition that I couldn’t. They were buying insurance policies from people who no longer needed them. But why?

To fully understand, let’s go over some more details about life insurance. Most people are like my father. They take out life insurance so that while the kids are growing up, should anything happen, the family is taken care of. But once the kids grow up and move on, paying those premiums becomes harder to justify. There’s no need for the big payout anymore. In fact, insurance companies count on people to accept the “cash surrender value,” to end the contract. They refund you a fraction of what you’ve paid in premiums over the years – you surrender the rest. That’s your only option if you want to stop paying the monthly bill.

But a new option has emerged in the last few years. With outside investors willing to pay a premium to take control of these unwanted insurance policies, people like my father can get a lot more cash back than what the insurance companies traditionally offer in surrender values.

It’s a great investment for the outside investors too. Because cash surrender values are so absurdly low, the investors are still able to scoop up the policies at a discount. They focus on cherry picking policies from older, unhealthy people. Once the investor takes over, part of sustaining the investment is to continue paying the premiums, and waiting for the jackpot. The earlier people die, the greater the profit. The beauty of investing in insurance policies is it has nothing to do with the economy. Markets can go up or down, but you can always count on people dying.

So who’s buying all these policies? Enter: Death Bonds. Numerically sculpted like the Grim Reaper, this is a financial instrument composed of unwanted life insurance policies. Institutional money managers, like hedge funds, are letting insurance brokers everywhere know that they are interested in buying insurance policies from people who need the cash. As they aggregate these policies, they securitize them. Securitizing is just a fancy word for taking similar financial instruments (like several insurance policies), and lumping them together to make an industrial sized financial instrument (like a bond that is based on several individual insurance policies).

Now that we have all the pieces, here’s the recipe for a Death Bond:

• Picking the fruit is essential. Lucrative insurance policies tend to come from people who are older and have paid into these policies most of their lives. Their recent health history shows a lot of risk. Of course, the big payout at the end is crucial too. Buy as many of these policies as you can;
• Add up the total death benefits of all of these policies once everyone is ultimately dead (assume $1 Billion);
• Securitize these individual policies to make a much simpler, larger, and more attractive financial product for institutional investors: the Death Bond;
• Find investors that collectively will give you $1 Billion in exchange for your Death Bond;
• They effectively invest $1 Billion in your bond. The investment will pay them interest each year, and 15 years from now, the Bond will return their $1 Billion principal;
• The issuer of the Death Bonds receives $1 Billion in cash up front. They take this money and continue paying the premiums in order to keep the underlying insurance policies alive. They can invest the rest in low to moderate risk investments for the next 10-15 years. Part of this cash would be used to pay a coupon to investors each year, so they receive about 5% per annum on their $1 Billion dollar investment in the Death Bonds;
• By the time these bonds have matured, most of the underlying insurance policies should have paid the death benefit. There is plenty of cash available to pay the investors their principal back when the bond expires. Also, the Death Bond issuer has been investing the excess cash during this time which they can draw from as well, just in case people outlive their calculated life. Once they have paid back the investors in full, the remaining cash is gravy.
  

It sounds like a win-win situation, right? Individuals that need the money get more cash for their policies because of this emerging market. Creators and issuers of Death Bonds are able to make a profit on these policies by securitizing them, making them attractive to other institutional investors. Finally, those institutional investors make a moderate and safe return during a time of extreme volatility. But in finance, someone has to lose. In this case, that would be the insurance companies.

The Death Bond market is growing. They are especially attractive right now because they provide a decent rate of return that isn’t correlated with the markets. As the policies change hands, from individuals to institutions, more of the policies will be carried out until maturity (death). This means insurance companies will have to make additional lump sum payments that they may not have accounted for in their reserves.

Insurance companies calculate reserves based on the probability of death, but remember, historical data reflects that a great number of people traditionally accept the cash surrender value – there was no other alternative before. With the emergence of Death Bonds, these policies are kept alive until the death benefit is collected. Insurers must respond by facilitating this drastic change in their cash outflow. The faster the Death Bond market grows, the harder it will be for insurance companies to recalculate what a sufficient reserve is.

By forcing insurers to pay out these death benefits, rapid growth in the Death Bond market will pose liquidity problems to life insurance companies. This is primarily an American phenomenon, but we can already name life insurers (AIG) that are barely staying afloat, kept alive by periodic government cash injections. Should the Death Bond market explode, this could push struggling insurance companies to the brink of extinction.

But I don’t want to end this on such a pessimistic note. Let’s assume that everyone involved is doing their homework and only transacting on insurance policies that are backed by healthy insurance companies. Let’s pretend that Wall Street won’t try to lowball people like my father for their insurance policies to enhance their profits. Let’s even go as far as saying that all the issuers of Death Bonds, who by the way have no prior experience with predicting life expectancy, somehow grasp the actuarial task proficiently enough to structure the duration of Death Bonds correctly. This way, everyone involved lives happily ever after – until they die.