Posts tagged ‘Cyprus’

I Have Been Wondering This Same Thing

In an article on an incipient bank run in Greece, Zero Hedge wonders, "What is perhaps more shocking is that anyone still had money in Greek banks at all..."  I agree.  With talk for weeks of capital controls and the example of raids on depositor funds (even supposedly insured deposits) in Cyprus, my money would have been long gone.  Even in the US in 2008-2010, I took our corporate funds out of the main Bank of America account and spread them all over.  It was a pain in the butt to manage but even facing much smaller risks than in Greece, I thought it was worth it.

Let's Make Employment of Low-Skill Labor Profitable Again

Brink Lindsey of Cato is on the topic "If you could wave a magic wand and make one or two policy or institutional changes to brighten the U.S. economy’s long-term growth prospects, what would you change and why?"  I am by no means in the distinguished academic company that were invited to contribute, but I thought it was an interesting topic.  Here is my (uninvited) contribution.

The question of skills and the American workforce is typically tackled in only one direction:  that we need more high-skilled workers to meet the challenge of emerging industries and business models that are increasingly driven by technology.  A recent report by the OECD, and as summarized in the New York Times, is a typical example of this concern.  As Eduardo Porter writes in the Times:

To believe an exhaustive new report by the Organization for Economic Cooperation and Development, the skill level of the American labor force is not merely slipping in comparison to that of its peers around the world, it has fallen dangerously behind.

The report is based on assessments of literacy, math skills and problem-solving using information technology that were performed on about 160,000 people age 16 to 65 in 22 advanced nations of the O.E.C.D., plus Russia and Cyprus. Five thousand Americans were assessed. The results are disheartening....

“Unless there is a significant change of direction,” the report notes, “the work force skills of other O.E.C.D. countries will overtake those of the U.S. just at the moment when all O.E.C.D. countries will be facing (and indeed are already facing) major and fast-increasing competitive challenges from emerging economies.”

A lot of head scratching goes on as to why, when the income premium is so high for gaining skills, there are not more people seeking to gain them.  School systems are often blamed, which is fair in part (if I were to be given a second magic wand to wave, it would be to break up the senescent government school monopoly with some kind of school choice system).   But a large portion of the population apparently does not take advantage of the educational opportunities that do exist.  Why is that?

When one says "job skills," people often think of things like programming machine tools or writing Java code.  But for new or unskilled workers -- the very workers we worry are trapped in poverty in our cities -- even basic things we take for granted like showing up on-time reliably and working as a team with others represent skills that have to be learned.  Amazon.com CEO Jeff Bezos, despite his Princeton education, still learned many of his first real-world job skills working at McDonald's.  In fact, back in the 1970's, a survey found that 10% of Fortune 500 CEO's had their first work experience at McDonald's.

Part of what we call "the cycle of poverty" is due not just to a lack of skills, but to a lack of understanding of or appreciation for such skills that can cross generations.   Children of parents with few skills or little education can go on to achieve great things -- that is the American dream after all.  But in most of these cases, kids who are successful have parents who were, if not educated, at least knowledgeable about the importance of education, reliability, and teamwork -- understanding they often gained via what we call unskilled work.   The experience gained from unskilled work is a bridge to future success, both in this generation and the next.

But this road to success breaks down without that initial unskilled job.   Without a first, relatively simple job it is almost impossible to gain more sophisticated and lucrative work.  And kids with parents who have little or no experience working are more likely to inherit their parent's cynicism about the lack of opportunity than they are to get any push to do well in school, to work hard, or to learn to cooperate with others.

Unfortunately, there seem to be fewer and fewer opportunities for unskilled workers to find a job.  As I mentioned earlier, economists scratch their heads and wonder why there are not more skilled workers despite high rewards for gaining such skills.  I am not an economist, I am a business school grad.   We don't worry about explaining structural imbalances so much as look for the profitable opportunities they might present.  So a question we business folks might ask instead is:  If there are so many under-employed unskilled workers rattling around in the economy, why aren't entrepreneurs crafting business models to exploit this fact?

A few months back, I was at my Harvard Business School 25th reunion.  Over the weekend, they had dozens of lectures and programs on what is being researched and taught nowadays at the school.  I can't remember a single new business model discussed that relied on unskilled workers.

Is this just the way it is now?  Have the Internet and computers and robotics and complex genomics made unskilled work obsolete?  I don't think so.  I have been running a business for over a decade that employs more than 300 people in unskilled positions.  I will confess that the other day I came home tired from work and told my wife, "Honey, in my next company, I have to find a business that doesn't require employees."  But that despair doesn't come from a lack of opportunities to deliver value to customers with relatively unskilled labor.  And it doesn't come from any inherent issues I might have running a large people-driven service company -- in fact, I will say there has been absolutely nothing in my business life that has been more rewarding than seeing a person who has never had anything but unskilled jobs discover that they can become managers and learn more complex tasks.

The reason for my despair comes from a single source:  the government is making it increasingly difficult and costly to hire unskilled workers, while simultaneously creating a culture among new workers that short-circuits their ability to make progress.

The costs that government taxes and rules add to labor have been discussed many times, but usually individually.  Their impact is clearer when we discuss them as a whole.  Let's take California, because that state is one I know well.  To begin, the minimum wage is $9 (going to $10 an hour in 2016).  To that we have to add taxes and workers compensation premiums, both of which are high because because California does little to police fraud in unemployment and injury claims.  For us, these add another $3.15 an hour.  We also now have to add in the Obamacare employer mandate, which at a minimum of $3000 per full-time employee (accepting the penalty is cheaper than paying for health care) adds another $1.50 an hour.  And the new California paid sick leave mandate adds another 45 cents an hour.  So, looking just at core requirements, we are already up to a minimum of $14.10 an hour, less than 2/3 of which actually shows up in the employee's paycheck.

But these direct costs don't even begin cover the additional fixed costs of hiring employees.  We pay a payroll company thousands of dollars a year to make sure that regulations on taxes and paychecks are followed.  We spend so much time making sure our written plans and documentation on safety meet the requirements of OSHA and its California state equivalent that we barely have the capacity to actually focus on safety.  In California we have to have complex systems in place to make sure our employees don't work through their lunch break, that they have the right sort of chair and that they sit in them frequently enough, that they follow all the right procedures when the temperature outside goes over 85 degrees, that they get paid for sick leave and get their job back after extended medical leave.... the list goes on and on.

In a smaller company, we don't have lawyers and a large human resource staff.  In fact, we tend to have little staff at all.  If some new compliance issue arises -- which happens about every day the California legislature is in session -- the owner (me) has to figure out a solution.  In one year I literally spent more personal time on compliance with a single regulatory issue -- implementing increasingly detailed and draconian procedures so I could prove to the State of California that my employees were not working over their 30 minute lunch breaks -- than I did thinking about expanding the business or getting new contracts.

Towards the end of last year I was making a speech to a group of business school students, and someone asked me what my biggest accomplishment had been over the prior year.  I told them it was probably getting the company down from hundreds of full-time workers to less than 50, converting everyone to part-time.  And it was a huge effort, involving new systems and a number of capital investments to accommodate more staff working fewer hours.  And it had a huge payout, saving us hundreds of thousands of dollars a year in Obamacare penalties and compliance costs.  But come on!  How depressing is it that my biggest business accomplishment was not growing the business or coming up with a new customer service but in cutting the working hours for good employees?  But that is the reality of trying to run a service business today.  The business couldn't be profitable until we'd adjusted our practices to these new regulations, so there was no point in even thinking about growth until we had done so.

Labor-based business models that work at a $7 or $8 total labor cost may well not work at $15, and they certainly are not going to grow very fast if the people responsible for seeking out growth opportunities are instead consumed in a morass of legal compliance issues.  But there is perhaps an even more damaging impact of government interventions, and that is to the culture of work.  I will confess in advance I don't have comprehensive data to prove my hypothesis, but let me tell a couple of stories.

Until 2010, we never had an employee sue us.  We had over 8 years hiring 350 seasonal workers a year, mostly older retired folks, without any sort of legal issues.  Since 2010, we have had eight employee suits threatened or filed, all of which we have won but at a legal cost of $20-$25 thousand each (truly Pyrrhic victories).  So what changed around 2010?  Well, our work force composition changed a lot.  Before that time, we typically hired older retired folks, because the seasonal nature of the job is simply not very appropriate for a younger person trying to support themselves without other means (like retirement or Social Security).   However, after 2009 when a lot of younger folks were losing their traditional jobs, they began applying to our company.  Our work force shifted younger, which actually excited me because I felt it would help us in attracting a younger demographic to the campgrounds we operate.    But all eight of these legal actions were by these new, younger employees.  I asked one person who was suing us over what was a trivial slight, really a misunderstanding, why they did not just call me (my personal number is in their employee handbook) to fix it.  They said that if I had fixed it, they would have lost the opportunity to sue.

I mentioned earlier that we had struggled to comply with California meal break law.   The problem was that my workers needed extra money, and so begged me to be able to work through lunch so they could earn a half-hour more pay each day.  They said they would sign a paper saying they had agreed to this.  Little did I know that this was a strategy devised by a local attorney who understood meal break litigation better than I.  What he knew, but I didn't, was that based on new case law, a company had to get the employee's signature every day, not just once, to avoid the meal break penalties.  The attorney advised them they could get the money for working lunch AND they could sue later for more money (which he would get a cut of).  Which is exactly what they did, waiting until November to sue so they could get some extra money to pay for Christmas bills.  This is why -- believe it or not -- it is now a firing offense at our company to work through lunch in California.

Hopefully you see my concern.   I fear that we have trained a whole generation that the way one gets ahead is not to work hard and gain new skills but to seek out and exploit opportunities to file lawsuits.  That the way to work in an organization is not to learn to manage the inevitable frictions that result from different sorts of people working together but to sue at the first hint that you have been dissed.  As an aside, I think this sort of litigiousness, both of employees and customers, is yet another reason employers are reluctant to hire low-skilled employees.  If as a business owner one is absolutely liable for any knuckle-headed thing your most junior employee might utter, no matter how clear you are in your policies and actions that such behavior is not tolerated, then how likely are you to hire a high-school dropout with no work experience?

Is it any surprise that most entrepreneurs are pursuing business models where they leverage revenues via technology and a relatively small, high-skill workforce?  Uber and Lyft at first seem to buck this trend, with their thousands of drivers.  But in fact they prove the rule.  Uber and Lyft are very very careful to define themselves and their service in a way that all those drivers don't work for them.  I would go so far to say that if Uber were forced to actually put all of those drivers on their payroll, and deal with they myriad of labor compliance issues, their model would fall apart

We cannot address the skill gap unless people have entry level, low-skill-tolerant jobs to take the first steps up the ladder of success.  If the government continues on its current course, it will become impossible to run a business that employs unskilled workers.  The value of the work performed will simply not justify the cost.  We may be concerned about income inequality today, but if we kill off the profitability of employing unskilled workers, then we are going to be left with a true two-class society -- those with high-skill jobs and those on government assistance --and few options for moving from one to the other.

Cyprus and the Rule of Law

There was no particularly good way to resolve the banking mess in Cyprus.  But what worries me about how things played out is that there appears to be no rule of law that applies to bank failure in Europe.  There should be some clear principle that guides a bank resolution - e.g. equity holders and bondholders get wiped out first, then uninsured depositors, then insured depositors.  Or perhaps there is some ratio of pain between insured and uninsured depositors.

It is clear that no such rule exists across Europe (or if it does, it does not enjoy any particular force such that folks feel free to ignore it in real time).  That is the real danger here.  Results, however bad, should be transparent and predictable in advance, which is far from what happened in Cyprus.  Without a rule of law, one gets a rule of men -- in other words, rules are set by individual whim, often based on which government or corporate interests wield the most influence.

Think I am being too cynical?  Here is a detail that was new to me about the depositor haircuts in Cyprus:

A few weeks ago, the Central Bank of Cyprus published a curious set of "clarifications for the better understanding of the resolution measures." The principle of a bail-in—that uninsured creditors should suffer losses before taxpayers are on the hook—turns out to contain a few lacunae. "Financial institutions, the government, municipalities, municipal councils and other public entities, insurance companies, charities, schools, and educational institutions" will be excused from contributing to the depositor haircuts, though insurers later were removed from the exempt list.

Apparently, individual parties are lining up for special exemptions as well (much like connected corporations did with the Obama Administration to get exemptions from early provisions of the PPACA).  Essentially, all bank losses will be assigned to depositors who don't have access to powerful friends in the government.

Bitcoin, Short Sales, and Volatility

I am fascinated by Bitcoin and would love to see it be a success.  But Tyler Cowen has a quote that reflects some of my concerns about it:

…bitcoins are an uncomfortable combination of commodity and currency. The commodity value of bitcoins is rooted in their currency value, but the more of a commodity they become, the less useful they are as a currency.

Bitcoin is in the midst of an enormous price bubble, with increases in value of as much as 50% over just a few days.  This is astounding volatility for even a commodity, much less a currency.

Cowen said something at the end of the post, almost as a throw-away, that got my attention:  "There is, by the way, no current way to short Bitcoin."  The reason this caught my eye is that I have argued a long time that short selling is an important mechanism to reduce market volatility.

Every time we get to a market bubble or problem, insiders always start arguing against short selling saying it makes volatility worse and undermines markets.  But what they are really saying is that they like volatility so long as it is up. They had no problem with the bubble that propelled their securities up, they just don't want them to come back down to Earth.

In certain bubbles, when interest in a certain asset class gets really frothy, anyone who is skeptical of the asset and its new high values will sell and get out.  This means that as the bubble grows, all the skeptics are long gone from the market.  No longer owning the asset, these skeptics have no further "vote" or influence on the price.  Short selling is a way for skeptics to continue to influence the price and asset values.  To this extent, I think it tends to limit the peak of bubbles, just as bottom-fishers limit the debt of troughs.

Bitcoin would likely benefit from skeptics having some sort of influence on bitcoin values.  But without a way to short, Bitcoin values are driven solely by wacky anarcho-capitalists (e.g. people like me) and people fearful of Cyprus style depositor losses.  Essentially all the true believers are bidding against themselves.

Re-Inflating the Bubble

We all know from progressive and Democratic writers the the Community Reinvestment Act and other efforts to offer cheap home loans to people without good credit had nothing to do with the mortgage industry offering too many loans to people without good credit.

So we should not be in the least bit worried that the Obama Administration is calling for more mortgages to be given to people with weaker credit, while sub-prime auto loans are simply booming.  Because we have learned from Iceland and Greece and Cyprus that the best way to deal with a debt crisis is by encouraging consumers to take on more debt, and the best way to respond to an asset bubble is to try to re inflate the bubble.

All of this, of course, is simply crazy talk.  The people who are involved HAVE to know this won't end well, because the most recent example of this leading to disaster is only 4 years old.  Hell, the people doing this were in office when this same approach fell apart last time.  But politicians refuse to face some pain now to avoid huge pain in the future - for politicians, the discount rate on pain is infinite.

Krugman Dead Wrong on Capital Controls

I am a bit late to the game in addressing Krugman's comments several days ago when he said:

But the truth, hard as it may be for ideologues to accept, is that unrestricted movement of capital is looking more and more like a failed experiment.

This was in response to the implosion of Cyprus banks, which was exacerbated (but not necessarily caused) by the banks being a home for a lot of international hot money - deposits so large they actually dwarfed the country's GDP.

I generally rely on Bastiat's definition of the role of the economist, which I will quote from Wikipedia (being too lazy on this Friday morning to find a better source):

One of Bastiat's most important contributions to the field of economics was his admonition to the effect that good economic decisions can be made only by taking into account the "full picture." That is, economic truths should be arrived at by observing not only the immediate consequences – that is, benefits or liabilities – of an economic decision, but also by examining the long-term second and third consequences. Additionally, one must examine the decision's effect not only on a single group of people (say candlemakers) or a single industry (say candlemaking), but on all people and all industries in the society as a whole. As Bastiat famously put it, an economist must take into account both "What is Seen and What is Not Seen."

By this definition, Krugman has become the world's leading anti-economist.  Rather than reject the immediate and obvious (in favor of the larger picture and the unseen), he panders to it.  He increasingly spends his time giving intellectual justification to the political predilection for addressing symptoms rather than root causes.  He has become the patron saint of the candle-makers petition.

I am not naive to the fact that there are pools of international hot money that seem to be some of the dumbest money out there.  Over the last few years it has piled into one market or another, creating local asset bubbles as it goes.

But to suggest that international capital flows need to be greatly curtailed merely to slow down this dumb money, without even considering the costs, is tantamount to economic malpractice.

You want to know what much of the world outside of Western Europe and the US would look like without free capital flows?  It would look like Africa.  In fact, for the younger folks out there, when I grew up, countries like China and India and Taiwan and Vietnam and Thailand looked just like Africa.  They were poor and economically backwards.  Capital flows from developed nations seeking new markets and lower cost labor has changed all of that.  Over the last decade, more people have escaped grinding subsistence poverty in these nations than at any other time in history.

So we have the seen:  A million people in Cyprus face years of economic turmoil

And the unseen:  A billion people exiting poverty

By pandering to those who want to expand politicians' power based on a trivial understanding of the seen and a blindness to the unseen, Krugman has failed the most important role of an economist.

Other thoughts:  I would offer a few other random, related thoughts on Cyprus

  • Capital controls are like gun and narcotics controls:  They stop honest people and do little to deter the dishonest.  In the case of Cyprus, Krugman obviously would have wanted capital controls to avoid the enormous influx of Russian money the overwhelmed the government's effort to stabilize the banks.  But over the last several weeks, the Cyprus banks have had absolute capital controls in place - supposedly no withdrawals were allowed.  And yet when the banks reopened, it become increasingly clear that many of the Russians had gotten their money out.  Capital controls don't work as a deterrence to money that is already corrupt and being hidden.
  • No matter what anyone says, the huge capital inflows into Cyprus had nothing to do with the banking collapse.  The banks had the ability to invest the money in a range of international securities, and the money was tiny compared to the size of those security pools.  So this is not like, say, a housing market where in influx of money might cause a bubble.   The only harm caused by the size of the Russian investments is that once the bank went bad, the huge size of the problem meant that the Cyprus government did not have the resources to bail out the bank and protect depositors from losses.
  • Capital controls are as likely to make bubbles worse as they are to make them better.  Certainly a lot of international money piling into a small market can cause a bubble.  But do capital controls really create fewer bubbles?  One could easily argue that the Japanese asset bubble of the late 80's would have been worse if all the money were bottled up in the country. When the Japanese went around the world buying up American movie studios and landmark real estate, that was in some sense a safety valve reducing the inflationary pressure in Japan.
  • Capital controls are the worst sort of government expropriation.  You hear on the news that the "haircut" taken by depositors in Cyprus might be 20% or 80% or whatever.  But in my mind it does not matter.   Because once the government put strict capital controls in place, the haircut effectively became 100%, at least for honest people that don't have the criminal ability or crony connections to beat the system.  Cyprus basically produces nothing.  Since money is only useful to the extent that it can buy or invest in something, then bottling up one's money in Cyprus basically makes it worthless.
  • Capital controls are a prelude to protectionism.   First, international trade is impossible without free flow of capital.   No way Apple is going to sell ipods in Cyprus if they cannot at some point repatriate their profits.  Capital controls can also lead to export controls.  If I can't export money, I might instead buy jets, fly them out of the country, and then sell the jets.
  • Let's not forget that the core of this entire problem is a government, not a private, failure.  Banks and investors treated sovereign euro-denominated debt as a risk-free investment, and banking law (e.g. Basil II) and pension law in most countries built this assumption into law.  Cyprus banks went belly-up because the Greeks, in whom they had (unwisely) invested most of their funds, can't exercise any fiscal responsibility in their government.  If European countries could exercise fiscal responsibility in their government borrowing, 80% of the banking crisis would not exist (housing bubbles and bad mortgage securities have contributed in some countries like Spain).  There is a circle here:  Politicians like to deficit spend.  They write regulations to encourage banks to preferentially invest in this government paper.  When the government debt gets iffy, and the banks face collapse, the governments have to bail them out because otherwise there is no home for their future debt.  The bailouts get paid for with more debt, which gets crammed back into increasingly over-leveraged banks.    What a mess.
  • All of this creates an interesting business school problem for the future:  What happens when there are no longer risk-free investments?  Throughout finance one talks about risk free rates and all other risks and risk premiums and discussed in reference to this risk-free benchmark.  In regulation, much of banking capital regulation and pension regulation is based on there being a core of risk free, liquid investments.  But what if these do not exist any more?
  • I have thought a lot about a banking model where the bank accepts deposits and provides basic services but does no lending - a pure deposit bank with absolute transparency on its balance sheet and investments.  I think about a web site depositors can check every day to see exactly where depositors money is invested and its real time values.  Only listed, liquid securities with daily mark to market.   Open source investing, as it were.  In the past, deposit insurance has basically killed this business model, but I think public confidence in deposit insurance just took a big-ass hit this week.

Postscript:  I don't want to fall into a Godwin's law trap here, but I am currently reading Eichmann in Jerusalem and it is impossible for me to ignore the role strict capital controls played in Nazi Germany's trapping and liquidation of the Jews.

PS#2:  Oops,

The extent of the control over all life that economic control confers is nowhere better illustrated than in the field of foreign exchanges. Nothing would at first seem to affect private life less than a state control of the dealings in foreign exchange, and most people will regard its introduction with complete indifference. Yet the experience of most Continental countries has taught thoughtful people to regard this step as the decisive advance on the path to totalitarianism and the suppression of individual liberty. It is, in fact, the complete delivery of the individual to the tyranny of the state, the final suppression of all means of escape—not merely for the rich but for everybody.

Why Europe Won't Let Banks Fail

Dan Mitchell describes three possible government responses to an impending bank failure:

  1. In a free market, it’s easy to understand what happens when a financial institution becomes insolvent. It goes into bankruptcy, wiping out shareholders. The institution is then liquidated and the recovered money is used to partially pay of depositors, bondholders, and other creditors based on the underlying contracts and laws.
  2. In a system with government-imposed deposit insurance, taxpayers are on the hook to compensate depositors when the liquidation occurs. This is what is called the “FDIC resolution” approach in the United States.
  3. And in a system of cronyism, the government gives taxpayer money directly to the banks, which protects depositors but also bails out the shareholders and bondholders and allows the institutions to continue operating.

I would argue that in fact Cyprus has gone off the board and chosen a fourth option:  In addition to bailing out shareholder and bondholders with taxpayer money, it will protect them  by giving depositors a haircut as well.

The Cyprus solution is so disturbing because, hearkening back to Obama's auto bailout, it completely upends seniority and distribution of risk on a company balance sheet.  Whereas depositors should be the most senior creditors and equity holders the least (so that equity holders take the first loss and depositors take the last), Cyprus has completely reversed this.

One reason that should never be discounted for such behavior is cronyism.  In the US auto industry, for example, Steven Rattner and President Obama engineered a screwing of secured creditors in favor of the UAW, which directly supported Obama's election. In Cyprus, I have no doubt that the large banks have deep tendrils into the ruling government.

But it is doubtful that the Cyprus banks have strong influence over, say, Germany, and that is where the bailout and its terms originate.  So why is Germany bailing out Cyprus bank owners?  Well, there are two reasons, at least.

First, they are worried about a chain reaction that might hurt Germany's banks, which most definitely do have influence over German and EU policy.  There is cronyism here, but perhaps once removed.

But even if you were to entirely remove cronyism, Germany and the EU have a second problem:  They absolutely rely on the banks to consume their new government debt and continue to finance their deficit spending.  Far more than in the US, the EU countries rely on their major banks continuing to leverage up their balance sheets to buy more government debt.  The implicit deal here is:  You banks expand your balance sheets and buy our debt, and we will shelter you and prevent external shocks from toppling you in your increasingly precarious, over-leveraged position.

Update:  Apparently, there is very little equity and bondholder debt on the balance sheets -- its depositor money or nothing.  My thoughts:  First, the equity and bondholders better be wiped out.  If not, this is a travesty.  Two, the bank management should be gone -- it is as bad or worse to bail out to protect salaried manager jobs as to protect equity holders.  And three, if depositor losses have to be taken, its insane to take insured depositor money ahead of or even in parallel with uninsured deposits.