Terror on Wall Street, a Financial Metafiction Novel (21 page)

APPENDIX NINE

NATIONAL DEBT

The long-term economic health of the United States is threatened by $58 trillion in government debts and liabilities that will start to come due in four years, when baby boomers begin to retire.

     The “Greatest Greatest Generation" and its baby-boom children have promised themselves benefits unprecedented in size and scope. Many leading economists say that even the world's most prosperous economy cannot fulfill these promises without a crushing increase in taxes — and perhaps not even then.

     This hidden debt equals $473,456 per household, dwarfing the $84,454 each household owes in personal debt. The $58 trillion is what federal, state and local governments need immediately — stashed away, earning interest beyond the $3 trillion in taxes collected last year — to repay debts and honor future benefits promised under Medicare, Social Security, and government pensions. And like an unpaid credit card balance accumulating interest, the problem grows by more than $1 trillion for every year that action to pay down the debt is delayed.

APPENDIX TEN

PUBLIC SECTOR PENSIONS

In California, the cost of employing a policeman or a fireman in Los Angeles is approximately $180,000 per year. That is for wages.  The big costs occur when they stop working and retire at the age of 50 combined with inflation, linking health benefits and lump sum payments for unused sick leave.

     But California is also shelling out fortunes to retired state and municipal managers – more than 9,000 have retirement incomes of more than $100,000 per year

     Unfunded pension liabilities are in the neighborhood of $574 billion.  At this rate, all pension assets will be exhausted within the next nine years. We see a conflict between public-sector employees and taxpayers, the majority of whom rely on social security and their personal savings, recently destroyed by the stock market crash. Social Security itself is in big trouble and so is the so-called “trust fund.” The employee and worker contributions for the last 50 years never did exist, because it has been spent on the current government’s costs. It is estimated that Congress has two choices: either increase the age at which the benefits are paid, or raise the contributions of the employer and workers to 30% of earned income, closing all of our military bases overseas, and  declaring that we have won the wars in the Middle East. 

     It will shortly become obvious to the man on the street that our Congress is irresponsible when it comes to managing our tax dollars and that we are at the point where there is no solution to our problems except to renege on the promises the government has made all these years. The cure will be to change the way our government operates by a Constitutional amendment mandating term limits and reorganizing the way the committee system in Congress works. The public should demand that politicos be tried and punished in the same way that private citizens are when they steal and commit crimes.

APPENDIX ELEVEN

THE BIGGEST LIES

1. The total amount of all debt outstanding in the United States has increased from $25 trillion to over $60 trillion in just the last ten years, and this does not include the unfunded liabilities in Social Security and Medicare obligations. Over the last forty years, Congress, finally stated that the money employees and their employers contributed to Social Security has been spent and that today all these funds, some 15% of earned wages, have disappeared. We know that our legislators are not only liars but a bunch of thieves who cannot be trusted. In every one of the last 40 years, Congress has been told of this problem and the only action it took was to increase the amount withheld by raising the earnings that would be taxed. Today, blue collar workers pay more in Social Security than they pay for income taxes. The money their employer pays is money that should have gone to the employees.
   
2. You will hear a lot of rhetoric to the effect that the employee will be receiving more money than he put into the plan, but if you count the interest that should have been earned over some 40 years, that is not a true statement. 
   
3. Just as the government has gone on a spending spree, so has the public followed, by increasing credit card debt and taking out equity loans on their housing. 
   

APPENDIX TWELVE

VALUE AVERAGING

     According to Bogleheads.org, an investor sets a predetermined worth of the portfolio in each future time period as a function of the size of the initial investment, the size of periodic investments, and the yield expected. The investor then buys or sells sufficient shares of the investment such that the predetermined portfolio worth is achieved at each revalue averaging point.

     Edleson simply defined the value averaging concept as follows: make the value averaging (not the market price) of your portfolio go up by a fixed amount each month. Considering movements in the investment’s market price and the size of periodic investments, the investor then either acquires or disposes of sufficient units of the investment such that the investment’s required value averaging is achieved at each subsequent revalue averaging point.

     During periods of market price decline, the investor is required to purchase a number of units to maintain portfolio value averaging.                   Conversely, during rising markets the technique requires the purchase of relatively few shares to achieve required value averaging. During these periods the extra money is put aside for those times that more shares are required to achieve the value-averaging target.

    During extended bull markets or during unusually large upward spikes in market price, the technique requires that units be sold to maintain portfolio value averaging at the desired level. This technique is even more intuitively appealing than dollar cost averaging. As with dollar cost averaging, more investment units are purchased when prices are low. However, value averaging requires that relatively more units be purchased as prices decline than does dollar cost averaging, since the unit price decline reduces the value averaging of the portfolio. Furthermore (and contrary to dollar cost averaging), value averaging gives a rule for selling. As the market price increases beyond what it was recently, value averaging may require unit sales, since the growing price rise increases the value averaging of the portfolio. And if the market price continues to increase dramatically, value averaging gives even more aggressive sell signals to control the value averaging of the portfolio to the level desired.  

     Intuitively, DOLLAR COST AVERAGING is contrary in the sense that fewer shares are purchased when price are ‘high’ and more shares are purchased when price are ‘low’, facilitating the ‘buy- low’ aspect of the ancient investment adage ‘buy low, sell high’. VALUE AVERAGING conceptually does an even better job. Even more units are purchased at “low” prices and probably some, at least, are sold at “high” prices. The American Association of Individual investors (AAII) follows VALUE AVERAGING  closely. Investors should consider joining the organization if they intend on following the method. AAII claims a historical increase of returns of 1 ½%.

            
 
APPENDIX THIRTEEN

                 SORTINO RATIO

The Sortino ratio is computationally very similar to the Sharpe Ratio, but diverges from the excess return of the portfolio by the standard deviation of the negative returns. The ratio, therefore, uses downside standard deviation as the proxy for risk for investors instead of using standard deviation of all the fund's returns, as this number includes upside standard deviation. This, in effect, removes the negative penalty that the Sharpe Ratio imposes on positive returns.

     To help you use this ratio, imagine a hypothetical portfolio: Portfolio A, which never experiences negative returns. However, Portfolio A has an incredible standard deviation in its positive returns: one day it returns 0.1% and another day, 1,000%. The standard deviation of Portfolio A will therefore be very large. When measured by the Sharpe Ratio, Portfolio A will have a low ratio because it is symmetric in its treatment of upside and downside deviation. However, the Sortino Ratio of Portfolio A will be infinite! This is the case because there is zero standard deviation in negative returns. The Sortino Ratio only considers downside standard deviation as important.

      Similarly, imagine Portfolio B, where there are only negative returns. In this case, the Sharpe Ratio and the Sortino Ratio will be exactly the same. Therefore, the higher the Sortino Ratio, the better the risk adjusted (as measured by downside standard deviation) returns are for your portfolio.

APPENDIX FOURTEEN

FINANCIAL FACTS

Full service stockbrokers do not have a fiduciary duty to supply their customers with financial products that are suitable for them considering their age, net worth, and skill in using financial products. These brokers live and work in a culture where the client is a helpless sheep waiting patiently to be sheered. The broker is compensated and rewarded when he sells and promotes toxic financial products. These rewards include paid vacation trips, bonuses for selling certain products, and other perks.

     Insurance agents are permitted under law to promote and sell equity-indexed annuities. This toxic product is sold with a guarantee that the investor will receive an 8% return on his investment. This is an outright falsehood. Insurance companies currently have difficulty meeting their obligations on some insurance products that have a true 3% return.

     The indexed annuity is sold by applying math that uses an 8% multiplier but, in reality, the actual earnings rate of the deferred annuity is about .2% - that’s two tenths of one percent. The agent will not let you take the contract to study or show to a competent third party, but presses you for a signature immediately, and a time period to cancel the contract. The surrender fees are in the nature of 14%. This product carries the highest commission that an insurance agent can earn. That free lunch that you get for attending a sales meeting will be the most expensive meal you will ever eat.

     With respect to stocks and bonds, investors should be careful that that they are adequately compensated for the level of risk undertaken. That makes sense, doesn't it?  Uncompensated risk can be virtually eliminated with a portfolio containing a large number of stocks. To virtually eliminate uncompensated risk for domestic stocks, a portfolio of about 3,500 different securities is required.

      Other things to look for are: low expense ratios, low portfolio turnover, compound annual returns, below average annual return. Knowing the portfolio's standard deviation will enable you to compute the compound annual return, but the mutual fund salesman will not voluntary give you that number (if, indeed, he knows what the term means). 

      Be aware that a properly constructed portfolio of securities will produce a return significantly higher than the weighted average return of its individual components. If your broker doesn’t know what you are talking about, find another broker.

      Be aware that even highly talented and highly compensated professional portfolio managers have difficulty meeting the return of the total domestic stock market after the costs and fees they incur trying to beat the market. In fact, it is extremely difficult (if not impossible) to separate those managers that have skill from those who were just lucky.

     There are a number of data items that should be required so that investors can evaluate when purchasing securities (especially mutual funds).

   They are:

• Portfolio turnover for 3-, 5-, and 10-year periods
  
• Compound returns for 3-, 5-, and 10-year periods.
  
• Risk compared to the total stock market for the same periods.
  

     There are some long-term problems on the horizon that are caused by demographic trends, which need attention. The latest crisis originated from the baby boom from servicemen returning from the Second World War. When the baby boomers reached maturity, we had a housing boom which, together with the expansion of credit, caused a business boom that was based on housing financing and the availability of equity and credit card financing. This boom was financed by loans that were beyond the ability of the borrowers to repay.

       A recession caused by excessive credit card debt and loans on household equity loans is very difficult to manage because a financial stimulus is not effective.

     Now, currently the population is aging and the birthrate is simultaneously falling. This means relatively fewer workers and an expanding senior population. This also means inflation coupled with rising prices due to the shift between workers and retirees. Now add to this mix the problem of the defined benefit pensions of public service employees and the defined contribution pension plans of private industry.

       There is a world of difference between these two methods of income for retirees. The public service employees are recipients of guaranteed pensions (often containing inflation indexing for inflation and medical benefits and defined contribution plans) offered by private industry that shifts risk from the company to the employee who, by no stretch of the imagination, is capable of handling the risk factors.

       The typical worker is not capable of reading and understanding the factors required to manage a portfolio of securities, and the fees for professional portfolio managers are prohibitive.

      Now for the really bad and discouraging part.  Our political system is blatantly corrupt when it comes to regulating the financial system.  First, the employees of the government in our regulatory system are outmatched by the employees of the financial services industry.

       Lobbyists are able to grease the chairmen of the important committees to the extent that the funds available virtually guarantee their re-election. The financial services industry could dig up FDR and run him for reelection and win, for example, with their lobby funds.