Author: Megan McArdle

Mike Konczal, bank-blogger extraordinaire, has a piece titled “What Are You Worth to Your Bank?” that I find sort of puzzling.

Here’s the answer that Konczal comes up with, after some head scratching:

But anyway, we went out for drinks and it quickly got crazy and financial equations were being written down on napkins. The question at hand was, “How much is a customer worth to a commercial bank?” This is what we came up with:

There’s whatever you pay in fees. Whatever you having in your checking and savings account is lent out, and the spread is going to be at least 2.5 percent, so they make a ballpark 2.5 percent off whatever you keep in your accounts. And whenever you pay with a credit card or a debit card, your bank is making at least 1.7 percent of the transaction, paid for by the merchant.

So let’s assume there’s this family. Let’s say they make $60,000/year, so they take home about $3,500 a month after taxes. They don’t live month to month, but they certainly live quarter-to-quarter, and they keep three months worth of money in their checking and savings account, so about $10,500 through the year. Let’s also say that they spend half their money on essentials. Two-thirds of the remaining budget, goes through a credit card or a debit card when it is spent, so they put $1,155 through a card in a month. They are very clever and somehow manage to dodge all fees.

How much are they worth as a customer? A quick check tells us: $498.12.

Maybe you can relate to this budget. So here’s a good question: Do you feel you get half a grand worth of service from your bank?

This doesn’t make much sense to me.  For starters, it assumes that you do not cost your bank anything, which is not likely to be true.  They have to spend money clearing your checks.  They need a customer service agent to deal with you.  Probably you enjoy having branches and ATMs available.  You use computer time and bandwith for your online banking.  Your withdrawals and deposits must be recorded and audited.  Insurance must be paid to the FDIC, and regulators complied with. And so forth.

Now, obviously, many of these things have threshhold effects–you can add one additional customer without adding branches or customer service agent.  But there is a marginal cost to providing services to you, which means that $498.12 is not what you are “worth” to your bank; it is, in theory, the revenue you provide them.  But when I look at bank income statements, it seems like the top line differs rather dramatically from the bottom line.  And my understanding is that customers with moderate balances aren’t all that lucrative for banks–which is why they don’t particularly encourage low-income customers to sign up for their services.

Conversely, Konczal implies that leaving your money with your bank is somehow costing you almost $500 a year.  But that would only be true if you, yourself, could go out and get a better riskless return on your money, which you can’t.  Especially not if you want the right to pull all your money out at a moment’s notice.  Your alternative to the bank, if you want guaranteed principal return and perfect liquidity, is sticking the stuff under your mattress.  And while it may be gratifying to know that the mattress doesn’t really get much out of the transaction, it also won’t pay you any interest at all–not even the pitiful percentage I get from Citibank.

Konczal has done a lot of good work on the scuzzy ways that banks maximize things like overdraft fees.  But I don’t think that this is the right way to look at checking account pricing.

I do our taxes using TurboTax’s pricey business edition, since we have a ton of freelance income, but it’s worth noting for those who may not be aware that the IRS has a Free File program which allows people making less than $57,000 to use any of a dozen different services to file their taxes for free.  If you’re under the income cap, and you don’t have anything more complicated than a mortgage and a couple of dependents, you should definitely check it out.

Tim Carney has a terrific column on the legislative history that led up to the prescription drug kerfuffle I read about last week.  It makes something clear that I found hard to explain during the back and forth with commenters (as I said to Tim last week, this is the most semantically complicated, and yet least actually complicated, issue I’ve tried to explain in a long while). 

Say you have a company that in 2002 was providing drug benefits to its retirees at a hypothetical cost of $2500* per retiree.  Each $2500 you pay reduces the taxes you owe by about a third of that amount, so the actual cost of the subsidy to the corporation is about $1700.

In 2003, the Congress passes a Medicare prescription drug benefit.  Worried that corporations would drop their benefits and stick the government with the tab, they offer a subsidy for firms that continue their retiree drug benefits.  That subsidy, 28% of the total benefit cost (up to a cap), costs the taxpayer on average much less than providing the drug benefits, so it’s a good deal for the taxpayer.

So now the cost to the company for these benefits is $1700-700 or about $1000.  The cost to the taxpayer is $2500-1000, or about $1500–still slightly less than Medicare pays for the average Part D beneficiary, but for much more generous benefits.  One can argue about the economic distortion, but it’s not your traditional “corporate giveaway”.  If it’s a giveaway to anyone, it’s to corporate retirees.

However, had the Congress structured it the way that is now mandated by the new reform, the company would minimize its tax bill by about $600 instead of $800.  The cost of the drug benefits to the company would be $1200; the cost to the taxpayer, about $1300.

So this really is an instance of giving the subsidy, and taxing part of it back, because the company was already getting the standard tax subsidy for its retirement benefit.  On the one hand, you’re giving them a new subsidy; on the other hand, you’re taking away part of the old subsidy.

Now, that doesn’t tell you whether this was the right thing to do; I don’t know how many companies will drop their now-more-expensive retiree benefits as a result, which is the relevant question.  But I feel like a lot of people were struggling with the notion that this was the equivalent of taxing the subsidy, so I thought it worth highlighting.

*This is an arbitrary number mostly chosen because the math is easy.  Please do not attempt to engage me in a discussion of whether or not this corresponds with real-world averages.

In the new issue of the New Yorker, James Surowiecki has an article comparing the debt problems of our states to the member states of the EU.  Surowiecki points out that unlike European states, our states get “automatic fiscal stabilizers” from the federal government, which eases the problems.

But for all that, I think he’s rather too sanguine about the fortunes of American states.  For one thing, while it’s true that the US government has greater institutional capacity to transfer money from feds to states, Europe may have a larger incentive.  If a member state defaults, the euro may well go under, causing havoc across the eurozone as their currency falls apart, and lenders start demanding currency risk premia.  If California defaults . . . well, a bunch of other states will get the fish eye from the financial market, but this probably won’t translate up to the national level.

Perhaps more importantly, I think he dramatically underweights the risk of moral hazard:

All this aid comes at a price, of course: it increases moral hazard, and it increases the national deficit. But the federal government is able to borrow money at exceptionally cheap rates, and, at a time like this, when the economy is still trying to find its feet, forcing states to cancel building projects and furlough teachers and policemen makes little economic sense. (Indeed, there’s a strong case to be made that more of the original stimulus package should have gone to state aid.) The European model would do more harm than good, as American history shows: in the early eighteen-forties, after the bursting of a credit bubble, many states found themselves in a debt crisis. The federal government refused to bail them out, and eight states defaulted–a move that cut off their access to credit and helped sink the economy deeper into depression. The U.S. did then what Europe is doing now, putting the interests of fiscally stronger states above the interests of the community as a whole. We seem to have learned our lesson. If Europe wants to be more than just Germany and a bunch of other countries, it should do the same.

The moral hazard involved is no small thing.  We’ve already introduced quite a lot of it into the banking system, but at least the CEOs of those banks got the sack, and the rest have some genuine fear that regulators will get more involved in their business.  The Federal government is constitutionally prohibited from the kind of prudential regulation that would be necessary in the wake of bailouts.

This is particularly worrisome because of the nature of the state problems.  This is not a classic sovereign debt issue, where there’s a giant overhang of high-interest bonds that can be renegotiated at a haircut, or bought down by money from outsized sources.  What the states have is a bunch of other obligations, especially to current and past employees.  I don’t see how these can be bought down, and there are substantial legal and political (not to say moral) issues with asking, say, current pensioners to “take a haircut”.

If the feds bail out these states, they’re assuming an ongoing obligation–and encouraging other states to let their fiscal problems get as big as possible, so Uncle Sugar will have to pay off.  Leaving aside any ideological questions about robbing Peter to pay Paul, and the proper size of government,  the federal government simply cannot afford to take on all these new obligations–and if it did, its ability to borrow money would rapidly becaome unsustainable.

Sure, there’s nothing wrong with giving states temporary assistance to keep the recession from hitting too hard–but we’re approaching the point where that’s not really what we’re talking about.  We’re talking about letting states make big promises without bothering to find sustainable sources of revenue with which to pay for them.  That’s not something the federal government can afford to encourage.

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In the new issue of the New Yorker, James Surowiecki has an article
comparing the debt problems of our states to the member states of
the EU. Surowiecki points out that unlike European states, our states
get “automatic fiscal stabilizers” from the federal government, which
eases the problems.

But for all that, I think he’s rather too
sanguine about the fortunes of American states. For one thing, while
it’s true that the US government has greater institutional capacity to
transfer money from feds to states, Europe may have a larger incentive.
If a member state defaults, the euro may well go under, causing havoc
across the eurozone as their currency falls apart, and lenders start
demanding currency risk premia. If California defaults . . . well, a
bunch of other states will get the fish eye from the financial market,
but this probably won’t translate up to the national level.

Perhaps
more importantly, I think he dramatically underweights the risk of
moral hazard:

All this aid comes at a price, of course: it
increases moral hazard, and it increases the national deficit. But the
federal government is able to borrow money at exceptionally cheap rates,
and, at a time like this, when the economy is still trying to find its
feet, forcing states to cancel building projects and furlough teachers
and policemen makes little economic sense. (Indeed, there’s a strong
case to be made that more of the original stimulus package should have
gone to state aid.) The European model would do more harm than good, as
American history shows: in the early eighteen-forties, after the
bursting of a credit bubble, many states found themselves in a debt
crisis. The federal government refused to bail them out, and eight
states defaulted–a move that cut off their access to credit and helped
sink the economy deeper into depression. The U.S. did then what Europe
is doing now, putting the interests of fiscally stronger states above
the interests of the community as a whole. We seem to have learned our
lesson. If Europe wants to be more than just Germany and a bunch of
other countries, it should do the same.

The moral hazard involved
is no small thing. We’ve already introduced quite a lot of it into the
banking system, but at least the CEOs of those banks got the sack, and
the rest have some genuine fear that regulators will get more involved
in their business. The Federal government is constitutionally
prohibited from the kind of prudential regulation that would be
necessary in the wake of bailouts.

This is particularly worrisome
because of the nature of the state problems. This is not a classic
sovereign debt issue, where there’s a giant overhang of high-interest
bonds that can be renegotiated at a haircut, or bought down by money
from outsized sources. What the states have is a bunch of other
obligations, especially to current and past employees. I don’t see how
these can be bought down, and there are substantial legal and political
(not to say moral) issues with asking, say, current pensioners to “take a
haircut.”

If the feds bail out these states, they’re assuming
an ongoing obligation–and encouraging other states to let their fiscal
problems get as big as possible, so Uncle Sugar will have to pay off.
Leaving aside any ideological questions about robbing Peter to pay Paul,
and the proper size of government, the federal government simply
cannot afford to take on all these new obligations–and if it did, its
ability to borrow money would rapidly become unsustainable.

Sure,
there’s nothing wrong with giving states temporary assistance to keep
the recession from hitting too hard–but we’re approaching the point
where that’s not really what we’re talking about. We’re talking about
letting states make big promises without bothering to find sustainable
sources of revenue with which to pay for them. That’s not something the
federal government can afford to encourage.

The post office and the DMV are always the butt of conservative jokes about the malfunction of government, to which liberals protest, with some justification, that they’ve reformed.  

Felix Salmon has a post on insider trading in credit default swaps that prompts Kevin Drum to say 

I think a lot of the outrage over the retiree benefit “loophole” stems from a moral intuition that I just don’t share.  I don’t think the tax code has moral content.  I don’t think tax subsidies are somehow different from, or worse than, other kinds of subsidies–and nay, conservatives, no matter how long you try to persuade me, I will remain indifferent to the distinction between “letting people keep more of their own money” and, um, giving them money from the tax coffers.  As long as “letting people keep more of their own money” means raising money from someone else to make up for the lost tax revenue, they are functionally–and to me, morally–equivalent.

So as blogged yesterday, the new health care plan changed the tax treatment of a subsidy for retiree prescription drug benefits, which caused those companies who had received the subsidy to announce a charge against their deferred tax assets.  Conservatives gleefully pointed out that this was probably going to change peoples’ drug benefits.  Liberals leaped into the fray, arguing that all the law had done was ‘closed a loophole”, and accusing the companies of “double dipping”.

Accounting basics:  when a company experiences what accountants call “a material adverse impact” on its expected future earnings, and those changes affect an item that is already on the balance sheet, the company is required to record the negative impact–“to take the charge against earnings”–as soon as it knows that the change is reasonably likely to occur.

This makes good accounting sense.  The asset on the balance sheet is now less valuable, so you should record a charge.  Otherwise, you’d be misleading investors.

The Democrats, however, seem to believe that Generally Accepted Accounting Principals are some sort of conspiracy against Obamacare, and all that is good and right in America.  

Here’s the story:  one of the provisions in the new health care law forces companies to treat the current subsidies for retiree health benefits as taxable income.  This strikes me as dumb policy; there’s not much point in giving someone a subsidy, and then taxing it back, unless you just like doing extra paperwork.  And since the total cost of the subsidy, and any implied tax subsidy, is still less than we pay for an average Medicare Part D beneficiary, we may simply be encouraging companies to dump their retiree benefits and put everyone into Part D, costing us taxpayers extra money.

But this is neither here nor there, because Congress already did it.  And now a bunch of companies with generous retiree drug benefits have announced that they are taking large charges to reflect the cost of the change in the tax law.

Henry Waxman thinks that’s mean, and he’s summoning the heads of those companies to Washington to explain themselves.  It’s not clear what they’re supposed to explain.  What they did is required by GAAP.  And I’ve watched congressional hearings.  There’s no chance that four CEO’s are going to explain the accounting code to the fine folks in Congress; explaining how to boil water would challenge the format.

Now, it’s entirely possible that these companies are taking as large a charge as possible, because that’s what companies like to do–if they have to recognize a negative event, they try to make it as big as possible.   Firms like to recognize as many upside surprises as possible, while minimizing the number of unexpected adverse charges.  It is better to take one “big bath” then dribble out seven “Oops, we underestimated the size of the problem” notices.  And, of course, companies have some discretion over when they “recognize” that the charge they took was too big, which allows them to use a “conservative” (very large) charge to smooth out future earnings somewhat.

But these charges aren’t going to have much impact on the stock price, or anything else; they’re non-cash charges, the costs will be spread over a number of years, and they’re not a huge surprise to investors.  I doubt it’s even going to have much impact on the popularity of the health care plan.

As accounting sins go, this is the corporate equivalent of moving your printer ink purchases up by two days in order to deduct them in the current tax year.  It certainly does not warrant congressional investigation.  What AT&T, Caterpillar, et al did was appropriate.  It’s earnings season, and they offered guidance about , um, their earnings.

Obviously, Waxman is incensed because this seems to put the lie to the promise that if you like your current plan, nothing will change.  But this was never true.  Medicare Advantage beneficiaries are basically going to see their generous benefits slashed, retiree drug benefits suddenly cost more and may now be discontinued, and ultimately, more than a few employers will almost certainly find it cheaper to shut down their plans.  If Congress didn’t want those things to happen, it should have passed a different law. 

If Congress thinks that it made the right tradeoffs–or at least, justifiable choices–then our Congressmen should step up and accept responsibility for what they’ve done.  At the very least, I think we can ask that they refrain from trying to force companies to join them in denying reality by threatening congressional investigation of any company who dares to notify investors that this thing is going to cost them money.

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Accounting basics:  when a company experiences what accountants call “a material adverse impact” on its expected future earnings, and those changes affect an item that is already on the balance sheet, the company is required to record the negative impact–“to take the charge against earnings”–as soon as it knows that the change is reasonably likely to occur.

I chat with Diane Sawyer about recessions and morality.

Thank God we have government programs like EnergyStar to help us live a greener lifestyle:

Steven Waldman takes a look at the yield on long term US bonds and concludes that although it’s low, it’s not really that low when you consider short term rates:

Since the financial crisis began, the market determined part of the Treasury’s cost of borrowing has steadily risen, except for a brief, sharp flight to safety around the fall of 2008. Investors have been demanding greater compensation for bearing interest rate and inflation risk, but that has been masked by the monetary-policy induced drop in short-term rates.

Taking a longer view, we can see that the current term premium is at, but has not exceeded, a historical extreme

Stan Collender tut-tuts at me for saying that the CBO process can be gamed.  He seems to think that I am inplying some dark conspiracy between the folks at the CBO, and Democrats in Congress. I confess, I have no idea how he derived this from an offhand observation that the CBO process can be gamed, but not infinitely.  But had he read any of my other writings on the subject, he would know that I have the highest respect for the CBO.  It is how the CBO is being used in the political process that I object to.

Big Government has written a post suggesting that the individual health care mandate will not actually be enforced by the IRS.  It will be assessed, but if you refuse to pay it, the normal enforcement mechanisms under Subtitle F of the tax code–such as liens and garnishments–may not be employed.

The Obama administration has just released the details on yet another “major” push to help homeowners who are underwater on their mortgages–a number now estimated at something like 20% of all homeowners.

The last big pushes yielded little in the way of results.  The problem we thought we had a year ago–vulnerable homeowners being rocked by resetting “teaser rates” on their adjustable mortgages–turns out to be much less pressing than we thought.  Instead, we an income problem:  a lot of homeowners whose income has fallen too far to afford any reasonable payment on their homes. This is actually a particularly tragic subset of a larger problem, which is the market rigidities introduced by underwater mortgages.

Until around 2005 or 2006, home equity actually cushioned other income shocks.  If anything bad happened, you could always refinance, or in extremis, sell.  Now people who have had income shocks can do neither.  People who need to move for career or family reasons are also trapped.

That’s why many people have suggested principal writedowns.  But this has run into multiple problems.

1. The ownership structure of mortgage securities makes this very complicated
2. Banks reasonably fear that if you make it easy to demand a principal reduction, everyone will do it, causing them to lose money on loans that would otherwise have paid off
3. This moral hazard problem is particularly pressing for second lien holders.  Second mortgages became popular, either to tap home equity, or to avoid the need for mortgage insurance on low-downpayment loans.  To do principal reductions, second-lien holders usually have to sign off on taking a total loss on the loan–knowing that they are going to encourage more creditors to stiff them in a similar fashion.
4. In households that have suffered a job loss, there is often not enough money to pay the loan even with a sizeable principal reduction.
5. The above is also true of the worst mortgages, which were given to people who never had any reasonable hope of repaying even at a more realistic market price.
6. Servicers have little incentive to do principal writedowns, which are complicated and don’t help them.

The old plan to deal with the problem was to offer modest incentives for modifications, which barely dented most of these issues.  So now the administration is going to give lenders incentives to temporarily reduce payments for homeowners who are unemployed, and to do principal reductions large enough to let homeowners refinance into FHA loans.

This probably has more chance of working than earlier efforts–and by working, I mean reducing foreclosures.  But there are a few things to worry about:

• The temporary payment reductions only seem to last 3-6 months.  Given the long-term unemployment problems we’re now facing, I’m not sure how much this will help–and if it does help, it seems likely to assist only the least needy.  In fairness, however, it at least keeps people with a brief job loss from racking up arrearages that send them into an otherwise unnecessary foreclosure.
• The easier you make this, the more moral hazard there will be.  You may not care, thinking that this is just about transferring money from banks to needy people–but with the aggressive deployment of FHA loans, that ultimately means the taxpayers are going to be on the hook for a lot of marginal mortgages.  Given how badly the FHA has already been overstretched by the collapse of the private market, this is worrysome.
• The new plan, like the old plan, will probably provide minimal relief for borrowers in the worst-afflicted areas.  The FHA will not finance anything that results in more than 115% being owed on the home, while places like Las Vegas and parts of Florida have seen price decreases of 50%.

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Maybe my standards for readers of the New York Times is too high, but this “financial tuneup” offered today seems awfully basic.  I mean, fine, save 1% more and rebalance your portfolio, but do you really need to be told to get renter’s insurance  and read your tax return?

If you do, dammit, get renter’s insurance and read your tax return.  Then look into having a financial guardian appointed for yourself, because you seem to have flunked Bourgeois Basics 101. 

Here’s what we’re doing this year:  filing our financial records properly, and making sure that every transaction is correctly identified and tagged in Mint, particularly the tax deductible ones.  Paying down debt as quickly as possible.  Mulling whether or not to buy a fixer-upper with a Section 203K loan.  Looking into exciting married-couple things like extra life insurance.

What are you doing to retune your financial future?

The Obama administration has just released the details on yet another “major” push to help homeowners who are underwater on their mortgages–a number now estimated at something like 20% of all homeowners.

The last big pushes yielded little in the way of results.  The problem we thought we had a year ago–vulnerable homeowners being rocked by resetting “teaser rates” on their adjustable mortgages–turns out to be much less pressing than we thought.  Instead, we an income problem:  a lot of homeowners whose income has fallen too far to afford any reasonable payment on their homes. This is actually a particularly tragic subset of a larger problem, which is the market rigidities introduced by underwater mortgages.

Until around 2005 or 2006, home equity actually cushioned other income shocks.  If anything bad happened, you could always refinance, or in extremis, sell.  Now people who have had income shocks can do neither.  People who need to move for career or family reasons are also trapped.

That’s why many people have suggested principal write-downs.  But this has run into multiple problems.

1.
The ownership structure of mortgage securities makes this very complicated.

2. Banks reasonably fear that if you make it easy to demand a principal reduction, everyone will do it, causing them to lose money on loans that would otherwise have paid off

3. This moral hazard problem is particularly pressing for second-lien holders.  Second mortgages became popular, either to tap home equity, or to avoid the need for mortgage insurance on low-downpayment loans.  To do principal reductions, second-lien holders usually have to sign off on taking a total loss on the loan–knowing that they are going to encourage more creditors to stiff them in a similar fashion.

4. In households that have suffered a job loss, there is often not enough money to pay the loan even with a sizeable principal reduction.

5. The above is also true of the worst mortgages, which were given to people who never had any reasonable hope of repaying even at a more realistic market price.

6. Servicers have little incentive to do principal write-downs, which are complicated and don’t help them.

The old plan to deal with the problem was to offer modest incentives for modifications, which barely dented most of these issues.  So now the administration is going to give lenders incentives to temporarily reduce payments for homeowners who are unemployed, and to do principal reductions large enough to let homeowners refinance into FHA loans.

This probably has more chance of working than earlier efforts–and by working, I mean reducing foreclosures.  But there are a few things to worry about:

• The temporary payment reductions only seem to last 3-6 months.  Given the long-term unemployment problems we’re now facing, I’m not sure how much this will help–and if it does help, it seems likely to assist only the least needy.  In fairness, however, it at least keeps people with a brief job loss from racking up arrearages that send them into an otherwise unnecessary foreclosure.
• The easier you make this, the more moral hazard there will be.  You may not care, thinking that this is just about transferring money from banks to needy people–but with the aggressive deployment of FHA loans, that ultimately means the taxpayers are going to be on the hook for a lot of marginal mortgages.  Given how badly the FHA has already been overstretched by the collapse of the private market, this is worrisome.
• The new plan, like the old plan, will probably provide minimal relief for borrowers in the worst-afflicted areas.  The FHA will not finance anything that results in more than 115% being owed on the home, while places like Las Vegas and parts of Florida have seen price decreases of 50%.