AskDong

For those who are interested in financial markets, the recent rally Volkswagen shares is a study of the sublime and absurd. Porsche has historically had a large minority stake in the company, totaling about 25%. In the last few months, Porsche via options has accumulated a nearly 76% stake in the company. Apparently all of this caught investors unaware, especially hedge fund short seller. Porsche’s desire to buy Volkswagon has been no secret, however. As a result the float (actual circulated shares) of the company dwindled to less than 5%.

Between October 25th and 29th, Volkswagon share rose nearly 600% in the span of days. At one point it’s market capitalization exceeded Exxon Mobile, making it the largest company in the world. That fact highlights how illusory market capitalization actually is. Share price times total outstanding shares is not a particularly good measure at times of what company is really worth. In the case of Volkswagen because Porsche was not selling, the price only reflected an artificial supply and demand imbalance. In actuality if all the shares could transact, they would not transact at the high of 968 Euros. The shares only traded at that level because people who were short were forced to buy. These people/hedge funds effectively had to buy at any cost, and the limited number of sellers knew this. Basically the small set of actual VW shareholders besides Porsche were able to place the hedge funds over a barrel.

Porsche recently let out some of the steam out and Volkswagen shares have tumbled 50% as a result. The irony of all this is Porsche is now able to fund it’s purchase of Volkswagen by the profits it’s earning by selling elevated shares of Volkswagen. It’s not often you get paid to buy a company…

A friend of asked me why I hadn’t tackled this topic as the elections loom in a few weeks.   I didn’t have a good answer.   Taxes are definitely up my alley, and I’m more than interested in the outcome of this election.

In the interest of full disclosure before I proceed, I want to state I’m voting for Obama.   I have a great deal of respect for McCain and many of the policies that he supports and has supported, but have been incredibly disappointed in the direction of the Republican party over the last 8 years.

Highlights of the Obama Plan

• Repeal Bush Tax Cuts on the top two tax brackets (Both Income and Capital Gains)
• Dividends will be taxed at 20% for those making over 250k
• Keep Estate Tax that is set to expire 2010, though with a higher exemption

Some Highlights of the McCain Tax Plan

• Keep and extend all the Bush Tax cuts
• Reduce Corporate Tax Rate to 35%
• Doubling Personal Exemption from $3500 to $7000

On of the better representations comparing the plans is on the Freaknomics blog.   McCain can say that his tax plan will lower taxes for the American taxpayer.  Obama can just as easily say that most Americans will pay lower taxes under his proposal.  Speaking points don’t tell much of a story, and nor do statistics if they’re not given a context.    Tax rates cannot be taken out of context income distribution, and more importantly changing income distributions.  Republicans are correct in pointing out the tax burden born by the rich has steadily increased, but that is more a reflection of the fact that money has accrued to top income earners.   The fact is that the “Rich” are paying more in taxes despite having their taxes lowered.  At the end of the day, it’s still better to make more and pay more taxes than it is to make less money and pay less in taxes.

Personally, I’m proponent of keeping taxes as low as possible as long as we get the services we need and don’t run a deficit.  It’s debatable if we’re doing too little or too much of the former, but there’s no question that we’ve failed on the second measure.   As much some people may want to believe that cutting taxes increases government revenue by increasing total GDP, this is not theoretically supported, and empirically ambiguous.

I do believe cutting too high a marginal tax rate can increase tax revenues by spurring economic growth to degree that overall tax revenues do increase, I do not believe that U.S. anywhere near these tax rates.   I have a hard time believing that increasing the marginal top tax bracket back to 39.6% (Pre-Bush) vs 35% (Post Bush) changes the behavior of tax payer so much that tax revenues actually decrease.   Let’s say for example I made $350k of which $200k would be taxed at the higher marginal rates.  I would have to choose make $363k to pay the same in taxes at the lower tax rate to make the tax cuts pay for themselves.

I imagine there is some income retardation for high income earners, but I certainly have never met a lawyer who makes $350k who seems to actually have choice to work less….

I hardly think Obama’s plan is perfect.  My biggest problem with it is does nothing to actually simplify the tax code.   On the surface tax code simplification might seem like a small issue, but in truth I think it’s the biggest issue.   A complicated tax code leads to more abuse.  Tax loopholes rewards those with good lawyers rather than the deserving.

Ultimately, I rather pay higher taxes now to get the country back on track.   Balancing the budget will require both spending cuts, and tax increases.   While political partisans on the left hate cuts in spending as much as the extreme right hate taxes, the pragmatic center (of whom I’d like to think I belong amongst) realizes that both are necessary.

I don’t know when they fixed it, but I can once again download all my Yodlee transactions in one fell swoop.  I had written a few months ago that Yodlee has ceased that functionality.  Of course what I found even more irking at the time was that they denied that there was any problem.

As a result over the last few months, I didn’t track my spending.   I didn’t know exactly how much I was spending on food.  I didn’t know how much gas I was using, or how much my rounds of golf were costing me.   I wasn’t in the dark, but I felt like I was in the shade.   Did I end up spending more?  Not at all.    Tracking my spending is useful, but ultimately I do it because for some warped reason I actually enjoy it.   At this point my budget is more unconscious habit than anything else.  I have a vague sense pretty much at all times about how much I should be spending.  You don’t need to breakdown every cent to do that properly.  Most of the time just knowing what your balances are is more than enough.

I still have one rather big gripe about Yodlee.   For whatever reason, I can’t seem to access Yodlee on my Mac these days.   Both FireFox and Safari on my mac endlessly try to reload the home page.   The page never gets loaded.  It’s very odd, but works fine on my PC at work and laptop.

The worst of the credit crisis is probably over.  Governments around of the world have taken dramatic action to avoid a Great Depression like outcome.  However, tough economic times are almost certainly ahead.  People have and will lose their jobs.  Small business will feel the pinch of slowing consumer spending.

In light of these tough economic times, my first tendency is cut my own spending and hunker down.  From the perspective of the economy this is absolutely the wrong attitude.   The largest part of the economy is consumer spending.  When I cut my spending I effectively contribute to the oncoming recession.   As a nation, we cannot avoid this recession by merely spending more.   The root problem is that we’ve already spent more than we have.  This includes both the Government and its citizens.   The bill needs to be paid now.

So while consumer spending in general cannot save us from recession, I probably should be doing my best to spend more.   I am gainfully employed, and actually have more than enough savings considering I have no depedents.  I’m exactly the type of person who can risk spending more.   A modest tick up in my own spending does not endanger my finances, and would probably do a great deal of good on per capita basis for the economy.  In the end, I cannot deny my own nature.  I’m not going to ratchet up my spending, but there is at least one place I can do a little more.

GDP = C + I + G + (X-M)

Above is the basic equation of the Economy.  Gross Domestic Product = Consumption + Investments + Government Spending + (Net Exports).   I’m not much into consumption, and as much as I know I should be spending more, I doubt I will.   I’m by no means a miser, but I just don’t really have much of desire to spend much more than I already do.   However, I can add to “I” side of the equation.   Investments as definied economically is not investing in stocks or bonds.  Investing is considered capital expenditures as building a factory.  I can’t build a factory, but I could remodel my home, or look at investing in new business opportunities.    Ultimately that’s the key to turning round this current economic malaise, is to spend money or rather invest with eye toward better times.

As we enter another week of the continuing credit crisis, I have begun too wonder if the critical mistake of the last few weeks was allowing Lehman to fail.   I do not envy the position that Federal Government is in.   On one hand they must let banks fail as it should not be the position of Government to backstop every failed business in America.  On the other hand, I do believe the Government has a role in ensuring the Economy operates smoothly.    When large banks fail, those failures run the risk of taking down the whole economy.  A single failure of a large enough bank has an ability to set off chain reaction that can cripple the whole banking system.    Was Lehman such a bank?  That I don’t know, but stock market certainly has not fared well since it’s demise.

Too Big To Fail?

Why are some banks too large to fail?  A bank has financial ties to not only other banks, but companies and individuals especially in today’s interconnected global markets.   Banks owe as money as they are owed, and in the case of failed bank they usually owe much more than than actually have.  As result when bank A fails it has the ability to take down Bank B and company C and start a chain reaction of failures in the economy.   A smaller bank can disappear without too much effect because its ties are limited.  The scope of larger Bank’s failure is often uncertain.  The network of ties are more numerous and interconnected.  The danger is not he first layer of credit obligations, but the nth connection and how those all tie back.   As a result Company C might be able to withstand Bank A’s failure, but not withstand Company Z’s failure which resulted from Bank X’s failure which resulted from Bank B’s demise.

Lehman

It’s strange that Government considered Bear Stears to big to fail, but not Lehman.  Lehman is arguably a much bigger bank with many more interconnections.  There’s no question that Lehman’s failure started a chain reaction.  Part of the reason that many Banks remain unwilling to lend is that they unsure of the risk their counterparties have with regards to Lehman assets.  Had the Government come to rescue, it would have faced credibility issues.  If the Government did not allow Lehman to fail, the question would have to be asked, “Is there any bank that’s too small to fail?”  The threat of failure needs to exist.