Guideposts Towards Economic Recovery

Originally publised in the CA and NV Examiner for the 11/26/2010 issue    

     I have written several articles in this column in the past, “ Obamanomics vs. Reaganomics,” “ Stimulus and Tax Cuts: Who Are We Kidding,” wherein I shared the views of the critics of this Administration regarding the failure of several Administration’s programs, such as the Cash for Clunkers, First Time Homebuyer’s Credit, Massive Stimulus Spending and Monetary Easing. (You may want to check out my Blog, http:artjaviertax.blogspot.com, if you missed these articles or if you want to check them out and read them again the second time).

      What seems to be perplexing is that in spite of these failures, the present Administration still holds on to the book of Keynes. Recently, the Fed announced to pump $600 billion of money supply to stimulate the economy- again embracing the Keynesian demand side economics. The Administration officials should probably take a  hard look to determine if their line of approach has not been effective to bring this country towards growth and economic recovery.

     A noted economist, Arthur Laffer, is saying that, "the solution to our economic problem can be found in the Price Theory which can be found in the most basic Economics textbook." It’s basic supply and demand, which we have learned in Economics 101. Let’s take the issue of Unemployment. Laffer argues that employment is low because the incentives for workers to work are too small and the incentives not to work are too high. Workers compare the wages or benefits they will get if they work vis-a-vis the unemployment benefits if they don't (they add the leisure value of not working). They conclude that they are better off not working and would rather enjoy the 99 weeks of unemployment benefits.

     With the workers’ wages really down, the supply of labor is therefore limited. Meanwhile the demand for labor is also down since when employers consider the costs of employing new workers-wages, health care, and more-they are greater today than the benefits.

     The Agenda.  But we need more specifics here, as in, "what agenda can we propose to the present Administration to bring us and propel us towards achieving economic recovery?" I share the views of Laffer and this is the agenda he proposes:

(1)   The full extension of the Bush tax cuts. The Republican controlled House of Congress will push this and the Senate may block it or President Obama can veto the House bill. Our unemployment problem can be worsened if we let the Bush tax cuts expire. Personal income tax rate should stay at the top rate of 35%, capital gains tax rate at 15%, dividend tax rate at 15% and pursue the permanent elimination of the estate tax.

(2)   The full repeal of the ObamaCare, which allows the individual to pay only five cents for each dollar of health care. Who do you think pays the other 95 cents? The former Senator Phil Gramm notes, if he had to pay only 5 cents for each dollar of groceries he buys, then he would really eat very well-and so would his dog. Many critics note that no single bill is more antithetical or an antithesis to growth and economic recovery than the ObamaCare.

(3)    The cancellation of all spending that punishes those who produce and rewards those who do not. Laffer argues that “this is really the distinction between the demand side economics and the supply side economics.”  Stimulus spending and quantitative easing don’t make it more rewarding to work an extra hour. If the government pays people not to work and taxes people who do work, is it really so difficult to understand why employment is too low? Talk about the Las Vegas or Nevada unemployment rate of 15%!

 

Hot Tax Issues of the Day

Originally published in the CA and NV Examiner 11/19/2010 issue     

     Now that the midterm election is over we now know that we have a divided government. The House of Congress is now controlled by the Republicans and we know that their top priority is to repeal the Obama Health Care. But equally important to the Republicans is the issue on taxes. From my readings I came across the still uncertain and unresolved burning tax issues. But what is certain is that Congress will reconvene on Nov 15 and leaders from both houses will meet with the White House on Nov 18. Both Chambers are still under control by the Democrats until power passes in January. The IRS urgently needs to know the right computations on next year’s withholding taxes as well as payroll executives who require at least three weeks to install a new system.

     While there’s a laundry list of tax issues that Congress needs to resolve, the following  seem to be the most outstanding:

     INCOME TAX. As we all know the Bush tax rates will expire by the end of the year. The top rate will go back to almost 40%. We have been told by the Obama Administration that the cuts will only be extended for those making less than $250,000.00 ($200,000 for singles). The Republicans disagree. They want the extensions be given to everyone and these cuts be made permanent.

      Are there other alternatives being considered by the Administration? Yes. A possibility will be a one to two year extension for everyone. This still is not acceptable to the Republicans. A possible compromise would be to extend permanently the tax cuts for those making less than a $1million.  As of press time, I have learned that the White House is amenable to extend the Bush tax cuts. But the details have not been given yet to the media as everyone await President Obama back from his meeting at the G20. 

     For those who are doing tax planning it might be good to accelerate income and take deductions at a later time. Even if the tax cuts shall be extended taxes are likely to be up sometime in 2012 or 2013.  We need to prepare for this likely event.

     CAPITAL GAINS AND DIVIDENDS. If the Bush tax cuts are not extended capital gains will go up to 20% and dividends will revert to being taxed as ordinary income with 39.6% as top rate. The fate of these rates will likely be parallel to the decision on the Income Tax rates.

     Tax planners suggest that we consider taking dividends from C-Corps before the end of the year if the extension on tax cuts will not materialize. Again for high earners expect tax increases in the future even if there is an extension.

     ESTATE TAX. The status of the estate tax is chaotic at this point as described by Laura Sanders in her article in the Wall Street Journal. She stated that the estate tax lapsed last Jan.1 and will return on Jan 1, 2011, with an exemption of only $1million per individual and a 55% top rate. The House bill which was passed last year would have extended 2009’s exemption of $3.5 million and top rate of 45%. The Senate’s inaction, due to their internal contradictions, was unable to deliver any finality on the issue all year long. Some Senators want to keep the 2009 rates, while some want to raise the exemption to $5 million and still others just want to repeal the whole thing altogether.

      At this point, it is still unclear if a fix would be coming. There are strong sentiments to allow estates of people who died this year a choice of which rules to use. We don’t know yet if this would be allowed.

     So what would you do if you are an heir or an executor of someone who passed away in 2010? Well, determine if the 2010 rules would be the best. If not, use the 2009 rate if it would be allowed. But in all likelihood, it may not be good for those with assets of $1.3 million to $4 million.

The American Dream..That Was....

                  Originally published in the CA and NV Examiner on 11/12/2010 issue

     It used to be that owning your home was a hallmark for one to be identified as belonging to the middle class American family life. The fulfillment of home ownership is in fact the fulfillment of the “American Dream.” With the rest of the US citizenry, we too, the immigrants who came to this country shared the thought of home ownership as a symbol of the American Dream. Being able to provide a decent house gave our families not only a secured shelter but also for our young to have access to a good public education.  The financial aspects of a home are equally important since it became a strong speculative store of value to protect us- whether we originally intended it to be our long-term abode or as an investment or retirement asset in our sunset years.

     Today, millions of us whether U.S. citizens or immigrants, just shake and scratch our heads that the above so called “American Dream” is now a distant memory as we confront the realities of the times. Millions and millions of Americans have to face the fact that their homes declined in devastating figures-big time. What seems perplexing to the average Joe, is that, not only must he tackle the pressure of making his mortgage payment on a house that has lost its value- but he also lost his job and is now unemployed because of the debilitating and malignant recession that engulfed the entire economy. To add insult to injury, Joe cannot find a new job - not only because the job market is likewise depressed- but he is now faced with a very low credit score spawned mainly by his inability to make timely payments on his mortgage. Joe cannot recoup what he has put in his house and he cannot get out of his obligation since he cannot re-sell in this very miserable market.

     As reported by Mr. Zuckerman of US News and World Report, “new home sales, pending home sales and mortgage applications are down to a 13 year low despite the fact that long term mortgage rates have plummeted to an average of 4%. New home prices have fallen to about 30% to 40%.”

     It is a “given” that the fall in house prices will eat up the equity that we have in our homes. I have read reports that 11 million residential properties have mortgage balances that exceed the homes’ values. “And given the total inventory of homes and the shadow inventory of an additional 3.7 million empty (foreclosed) homes,” David Rosenberg, Chief Economist of Gluskin Sheff, notes that “home prices will still fall by another 5% to 10%. This would now leave an estimated 40% of all American homeowners with mortgages in excess of the value of their homes.”

     There is no denying the fact that the disappearing equity is an invite for strategic defaults. A lot of homeowners will take the “Cash for Keys” deal, that is, mail or personally surrender the keys to their “friendly” lenders and just walk away even if they can afford to make the payments. But some will just refuse to make any more payment and hang in there. The banks won’t take these deflated properties onto their books because they will then have to declare a financial loss- over and above the fact that they still have to worry about maintaining these properties. So, my dear readers, do you know now why a quarter of the people who have not made a single mortgage payment are still able to live in their houses for more than 2 years?  In fact, there are some unscrupulous people in Las Vegas and maybe in some areas, who have the audacity to rent out their houses which are already in a state of foreclosure. The naïve and poor renters are just caught in the middle and are forced to vacate the properties in a very untimely manner when the letters to foreclose from the lender start to come in.  So where did this ex-homeowner turned Landlord go after all these happened?  “Man, he’s gone…he’s nowhere to find.” He’s probably in Timbuktu, having a good time and spending your hard-earned money.  

     There is a report that states “a staggering 8 million homes are currently in some state of delinquency, default or foreclosure.” Alan Abelson of Baron’s reports, “ that an additional 8 million more homeowners are estimated to have mortgages representing 95% or more of the value of their homes leaving them with 5% or less equity in their homes, and thus vulnerable to further price declines.”

     Foreclosures may have slowed down a bit with the Home Affordable Modification Programs and other government efforts. But as I have already stated in a previous article of this column that these programs have not worked as hoped since more than 50% re-defaulted within 6 to 12 months, after modification, even after their monthly payments were cut by as much as 50%.

     Mr. Zuckerman writes, “While the foreclosure pipeline remains clogged, as it unclogs, a new wave of homes will wash into the market and precipitate additional downward pressure on prices. The number of foreclosed homes put on the market by banks will be a more powerful influence on the further decline of home prices than either consumer demand or interest rates.”  

     As I have also written in my past article, the mortgage finance was a sick market and today is still deeply troubled. Conventional lenders are now asking for substantial down payments and are imposing very stringent financial requirements. More and more home sales are now being conducted on cash basis transactions.

     At the end of the day, what is the most critical factor that is subduing the demand for housing? Well, home ownership, which was once referred to as the great American Dream, is now the great American nightmare. Mr. Zuckerman writes that, “It is no longer seen as a great, long term buildup in equity value. It will not be difficult for one to understand why the demand for housing has declined and will not revive anytime soon.”

     In conclusion, I would say that there is no immediate panacea that will solve this catastrophe. The more the government tries to interfere with the housing crisis the longer it will take time for the market to correct itself and the longer it will take for the realistic price to find the equilibrium between supply and demand.

Recession: The Second Coming

     Originally published in the CA and NV Examiner on 11/05/2010 issue

     The American public is indignant on the way the present Administration is handling current government affairs. The most recent survey showed a low 36% approval rate on the President. Two years had passed and the “Obama Change” we were promised if it did materialize, probably needs to be changed-again.

      But brace yourselves. What is more lamentable to note, more than survey results, is that some observers are in fact saying that we will all be witnesses, a polite word for “victims,” again to the second wave of recession. Sounds scary. Haven’t we had enough?

     On the contrary, according to the Obama allies, “Assuming all variables remain constant, the U.S. economy will slowly gain momentum starting next year and should start to be normal again sometime in 2012 or 2013. At that time, unemployment will improve and the housing market will be revived and this should finally boost consumer spending.” Are you saying then, that we should be out of recession?

     The truth is, in the real world, the variables do not remain constant. Variables are dynamic and ever-changing. In my opinion, we may still be stuck in our situation right now and we should be cognizant of the events that could trigger another bout of recession. The possible re-emergence of recession should be understood within the context of national and international scenarios.

     The National Scenario. First let’s look at the national level. The U.S. economy is like a turtle growing at a very insignificant rate of about 2 per cent. It is now election year and the Democrats with supporting actor, former Pres. Bill Clinton on the forefront of the campaign trail, are saying that we are on the road to economic recovery and recession should be over. Sorry, Mr. President, I cannot agree with that. With such an anemic growth rate of 2% and the absence of a healthy demand in the housing market and no sign of increases in consumer spending economic recovery cannot possibly be achievable. The fact is, we are more akin to experiencing a “double dip” recession in light of current situations. When everything else is said and done, do you know, my dear readers of this column, why we will still be overwhelmed and fall victims to another round of recession? Read my lips –“unemployment.”

     Monetary Policy. So what national monetary policies may likely be implemented to get us out of this mess? According to Rick Newmann of U.S. News, “most likely the Federal Reserve Bank will inject more money supply in the economy by buying pools of Treasury securities and this move will drive interest rates even lower. The stock and bond market can rally; our balance of payments will improve, since a devalued dollar could mean cheaper prices of our exports. Businesses can be persuaded to spend that $2 trillion they are hoarding.” We’re all gonna be back on track! Sounds simple. Not really because there are a host of factors that can stop this from happening.

     The International Scene. Let’s look at the international arena. It is a known fact that China is the biggest foreign holder of debt issued by the US government. Rick Newmann writes, “the mutual interests of both countries are served. China gets to keep its currency low, which makes its exports cheap, while the U.S. government is able to run a deficit and keep interest rates low here. But if China were to abruptly dump significant amounts of treasuries, interest rates would spike and the U.S. government would have to pay more to borrow. This alone would probably trigger a recession.”

     Over the past year, China had been gradually reducing its holdings of U.S. treasuries. This had triggered tensions over interest rates and trade policy. Some members of the U.S. Congress are advocating for imposition of tariffs on Chinese goods while the opposite camp are criticizing U.S. borrowings and hinting that China should permanently divest its U.S. holdings. This action could easily destabilize the markets and possibly be the origin of another bout of recession in the U.S. economy.

     Conclusion. My position to this issue is as follows: There are no crystal clear economic indicators to assert that the U.S. economy is on its way to recovery. Let’s not kid ourselves. On the contrary, against the backdrop of local and international scenarios that we have shortly discussed here, the U.S. government should in fact be wary and implement policies and procedures that should counteract the possible second coming of recession. Probably then, the survey rating of President Obama should be up again.