Philippine Politics: Barangay Elections and the Pork Barrel System

The recently concluded Barangay elections reported accounts of massive and widespread vote buying (as much as 1,000 pesos per head) and a surge in the death toll from election violence (higher than national elections in 2010).

The 64 billion peso question: why all these?  What drives candidates to desperately seek political office at the cost of their lives and huge amounts of expenses?

The answer of course is no stranger to most: it has been both about perks and power.

Let us examine the perks or benefits from the officials of Barangay level.

The basic perquisites are as follows: 

Graph from the Rappler.

Aside from these, other benefits include Christmas bonus and cash gift, insurance coverage, as well as, benefits for accident, total or permanent incapacity, disability, death and burial.

There’s more. Barangay officials also get many subsidies in the form of “free hospitalization in government facilities, and free tuition in state schools for themselves and two of their legitimate dependent children (“legitimate” is specified in the law) during their incumbency. Based on their number of years in the service, barangay officials can get civil service eligibility”.

What are they not entitled to (for now)? 13th month pay, hazard pay, representation and transportation allowances, productivity incentive bonus, clothing and personnel and economic relief allowances.

[As a side note, the above also introduces the power aspect

National level officials have been pushing for more Barangay benefits from more funding to fare discounts. Why? 

It’s all about political power

This noteworthy excerpt captures its essence

“In theory, the law says [barangay elections] should be nonpartisan,” Casiple said, referring to a provision in the Omnibus Election Code barring candidates to represent or receive aid from any political party.

“But in reality, they’re important to mayors. That’s where the fight is. If you hold the barangay, it’s a ready-made machinery for ward leadership. It has become a fight by ordinary politicos,” Casiple said.

Casiple said this partisanship has translated the “perks” otherwise not stated by law, granted by higher government units. Off the top of his head, Casiple cited, as example: “Here in Quezon City, all barangay captains are given a car. “

Ergo, controlling the Barangay means ensuring votes from the grassroots level. So leaders from the local to the national level compete to gain their favor. This leads us to the key of Philippine patronage politics: whoever controls the local governments, controls the machinery for the national level]

Now even if we total cash and non-cash benefits these would amount to about at best Php 500k per year. For a three year term that would accrue to P 1.5 million. At P 1.5 million, 1K peso per vote expenditures, whether direct (vote buying) or indirect costs (ads or marketing campaign, organization, network and etc..), would translate to only 1,500 voters. There are about 3,518 voters per Barangay in the National Capital Region (registered voters: 6m, no. of Barangays 1,705 NSCB)

How will candidates recoup their election expenditures “investments”?

We can only make a guess. 

One, from their 20% share of the national internal revenue allotment (IRA). In 2013, the IRA budget for the 42,026 Barangays nationwide has been at P59,165,520,37.This will jump by 15% to 68.3 billion pesos in 2014.

Two, from their share of the other revenues from the allocations for local government units (ALGU) as part of the national government’s budget law, the General Appropriations Act. 

In 2014, the AGLU budget has been set  at 360.5 billion pesos.

Notes the Philippine Senate:

Other items in the ALGU are the shares of local governments from tobacco excise tax collections and taxes from mining and other extractive industries, and the budget of the Metropolitan Manila Development Authority, among others.

Third there are other sources of funding from the Barangay level, include (as per the Department of Budget and Management

-Service fees or charges for the use of barangay property or facilities;
-Barangay clearance fees; 
- Fees or charges for the commercial breeding of fighting cocks and on cockpits and cockfights;
- Fees or charges on places of recreation with admission fees;
- Fees or charges for billboards, sign boards, neon signs and other outdoor advertisements; 
- Toll fees or charges for the use of any public road, pier or wharf, waterway, bridge, ferry, or telecommunications system funded and constructed by the barangay; 
- Revenues from the operation of public utilities and barangay enterprises (markets, slaughterhouses, etc.); 
- Fines (not exceeding P1,000) for the violation of barangay ordinances; and, 
- Proceeds from the sale or lease of barangay property or from loans and grants secured by the barangay government

In short, fees and taxes from the Barangay level

The above is the flow chart of how the Barangay establishes and supervises its budget via the DBM

So there you have it. Pork in its varied forms applied to the Barangay: from the national level: AGLU via IRA and AGLU via other shares of taxes, and from the Barangay level fees and taxes.

In essence, from top to bottom, Philippine politics operates under the Pork Barrel system

Every election, said the great libertarian H. L. Mencken, is a sort of advanced auction on stolen goods. The Barangay elections seem to validate this.

As I wrote in 2010

So essentially, the Pork Barrel culture reinforces the patron-client relations from which the Patron (politicos) delivers doleouts and subsidies, which is squeezed from the Pork Barrel projects, to the clients who deliver the votes and keeps the former in power. Hence, the Pork Barrel system is essentially a legitimized source of corruption and abuse of power seen from almost every level of the nation’s political structure, an oxymoron from its original “moralistic” intent (unintended consequences). As the saying goes “the road to hell is paved with good intentions”.

As we previously noted, ``Plainly said, when we demand for more social spending or welfare based programs to resolve our problems then we increase the funds allocated to politicians for their dispensation. Essentially, Pork Barrels signify our excessive dependence on government where the correlation of government spending and the price of getting elected are direct.”

Politicization of every aspect of social life from top to bottom leads to corruption, political and wealth inequalities and economic-financial repression which means a lower standard of living. The worst effect is the violence which politics incites, and of the degradation of society’s moral fiber

While the call for the abolition of the Pork Barrel is ideal and necessary it is not sufficient. 

For as long as the public thinks the Pork is a problem of personal virtuosity or what I call as personality based politics (and not of systemic defect), politicians will be able to camouflage pork into many different masks as shown by latest the speech by the Philippine president. 

In other words, to abolish the Pork requires a radical change of opinion by the public. As Scottish philosopher historian and economist David Hume wrote in Part I, Essay IV OF THE FIRST PRINCIPLES OF GOVERNMENT in Essays, Moral, Political, and Literary (bold mine)

NOTHING appears more surprizing to those, who consider human affairs with a philosophical eye, than the easiness with which the many are governed by the few; and the implicit submission, with which men resign their own sentiments and passions to those of their rulers. When we enquire by what means this wonder is effected, we shall find, that, as FORCE is always on the side of the governed, the governors have nothing to support them but opinion. It is therefore, on opinion only that government is founded; and this maxim extends to the most despotic and most military governments, as well as to the most free and most popular.

And the best way to attain such change is for the public to demand a third party audit of all forms of Pork from the top to the local level (past and current), with emphasis on the top. 

Only by opening the Pork's Pandora's Box will there be a bigger chance for an epiphany by the public that Pork is inherent in the nature or structure of the Philippine patronage based political system. Such that dismantling of the Pork Barrel has to occur from top to bottom. 

Yes this also means demolishing Pork at the Barangay levels.

Video: Halloween Humor Treat: How to Survive the Zombie Apocalypse with Economics

Professor Anthony Davies at the Learn Liberty explains (hat tip Zero Hedge)

Video: The Conversation

From the Foundation for Harmony and Prosperity (hat tip EPJ)

More Signs of China’s Hissing Bubble: Four Biggest Banks Post Biggest Surge in Bad Loans

China’s central bank the People’s Bank of China (PBoC) reportedly suspended reverse repo operations which allegedly led to a spike in China’s interest rate markets as previously discussed here and here.

The other day, the PBoC reportedly re-entered the market but appear to have failed to bring down high rates in the Shibor which has spilled over to the yields of China’s 10 year bonds. 

Only stocks (as shown by the Shanghai Index above) responded positively to the PBoC’s intervention with the Shanghai index jumping by 1.48% yesterday.

Today fresh reports indicate why yields have remained high, and why the continued stress in the Chinese interest rate markets despite the PBoC’s interventions: Increasing incidences of souring loans from China’s biggest banks.

From Bloomberg:

China’s top four banks posted their biggest increase in soured loans since at least 2010 as a five-year credit spree left companies with excess manufacturing capacity and slower profit growth amid an economic slowdown.

Nonperforming loans at Industrial & Commercial Bank of China Ltd. (601398), China Construction Bank Corp. (939), Agricultural Bank (1288) of China Ltd. and Bank of China Ltd. (3988) rose 3.5 percent in the three months to Sept. 30 from June to a combined 329.4 billion yuan ($54 billion), according to data compiled by Bloomberg News based on third-quarter results. Profit rose to 209 billion yuan.

The rise in defaults adds to concerns bank profitability may decline as policy makers seek to trim production at cement makers to paper manufacturers that have gorged on credit since 2008, while urging lenders to build buffers to cover loan losses. China’s biggest state-run banks are trading near record-low valuations as investors brace for a surge in bad debts and slower credit growth.

Interest rate payments soar…

Interest owed by borrowers has risen to 12.5 percent of Chinese gross domestic product in 2013 from 7 percent in 2008, Fitch Ratings estimated in a report last month. The figure may rise to as high as 22 percent by the end of 2017, which could “ultimately overwhelm borrowers,” the agency said.

When the markets begin to question the ability of firms or nations to service their debt/s, where the cost of servicing debt (interest and principal) overcome the profit centers, then confidence to refinance existing bad loans will grind to a screeching halt. This leads to more accounts of bad loans and more bankruptcies.

So the bad loans from the periphery has now reached and exacerbated conditions at the core. As I earlier noted:

Fourth some major Chinese banks have been bruised from the recent losses in the bond markets. With $175 billion of maturing debt in 2014 amidst rising interest rates the S&P warns of an escalation of bad loans. So rising rates have begun to bite on China’s real economy. As to how credit will continue to expand in a system inundated with debt as rates continue climb is like water flowing uphill.

The question now is how policymakers will address this.

So far as of this writing Shibor rates have been mixed, with some maturities going up and while others marginally down. Overall, they have been trading at proximately  at recent highs.

Yields of Chinese 10 year bonds at new highs (since 2007), again as of this writing.

If Chinese financial markets unglues or crumbles, will there not be a contagion?

Japanese Government Bonds: The Bank of Japan is swallowing everything

One of today’s peculiar dynamics has been the fantastic rally (falling yields) of Japanese Government Bonds (JGBS). Yields of JGBs, despite the target doubling of BoJ’s balance sheet in 2 years (2013-2015), have almost returned to pre-Abenomics levels.

Ironically, the private sector led by the banks has pared down substantially their JGB holdings. Between March and August the Bank of Japan (BoJ) reports that the major domestic banks, once aggressive buyers, considerably reduced their JGBs holdings by 24% to ¥ 96 trillion, according to a report from Reuters.

JGBs held by non-residents likewise fell in June to Y81 trillion  from Y82 trillion. Overseas investor holdings of JGBs likewise fell .4% year on year in June, according to the Mni Market news of the Deutsche Borse.

So with the private sector selling, this leaves the Bank of Japan as the major buyer.

JGB holdings by the BoJ has skyrocketed from pre-Abenomics levels at about ¥ 98+ trillion yen to ¥ 126+ trillion yen or a growth of 25.5%. over the past 6 months. Chart from Japan Macro Advisors.

The Zero Hedge points to the ballooning JGB bubble (bold original)

The Bank of Japan's governor Kuroda proudly told the world "long-term yields are bound to rise at some point, but we can curb it when it happens," and on a grand scale - that is what they have done (for now). But market participants are growing increasingly concerned. As we have warned numerous times, the suppression of 'normal' volatility in teh short-term can only lead to larger uncontrollable moves in the future. As The FT reports, some worry, too, that the BoJ has pushed up JGB prices to the point where interest rates no longer bear any relation to the government’s creditworthiness - "effectively we have removed the light from the lighthouse." Some say the transition has been unsettling as many analysts talk more openly of the risks inherent in what the BoJ is trying to pull off. For one thing, liquidity has evaporated... "volatility looks low now, but if some investors start selling, the impact on the market could be much bigger than expected. That is a big risk."

As if to support this view that the Japanese are hiding reality, the US Treasury had some thoughts:

• *U.S. SAYS IT WILL CLOSELY MONITOR JAPAN FOR DOMESTIC DEMAND

Realized vol has collapsed in JGB rates (but forward implied volas for Japan swaptions is surging again)...

The following are noteworthy quotes from the Financial Times article as cited by the Zero Hedge (bold, italics and underline original)

But some say the transition has been unsettling. Analysts are beginning to talk more openly of the risks inherent in what Mr Kuroda is trying to pull off.

For one thing, liquidity has evaporated. Banks that used to be busy making markets for private-sector institutions say they have been marginalised...

“If a client asks us to bid it’s easy, as the market is very, very stable,” says one dealer who asked not to be named. “But if a client comes with an offer, it is a problem, as the duration to cover a short position is much longer and no one is offering. The BoJ is swallowing everything.”

While there has been a massively inflating bond bubble orchestrated by BoJ’s Kuroda which has temporarily succeeded to bring down yields, reducing ‘risk free’ collateral from the banking system has its consequence. When markets encounter turbulence or when banks are required by regulators to meet specified capital ratios, the growing lack of supply of JGBs will eventually incite volatility.

So far, the Japanese yen appears to be holding ground, despite the goal of Abenomics to hit 2% inflation target. Yet if the yen fails to break from the current consolidation phase, this likely means that the BoJ’s objectives will founder. 

Said differently, whatever short term gains acquired from the recent spike in money supply over the past 6 months, may not be enough, such that this will instead result to a reversal of those gains. Boom will turn into a bust.

So I expect the BoJ to ante up on their means to attain their inflation targets in order to kick the proverbial can further down the road or to avoid an interim bust.

Curiously the chart of the Nikkei and the yen appears to reflect on each other, albeit there has been little signs of symmetry in their (yen-nikkei) flows. 

The conditions of the yen and the Nikkei, along with the JGBs will highlight on the whereabouts of the stages of Japan’s inflationism.

Quote of the Day: The Difference between a Politican and a Private sector CEO

Some of the president’s most central and important claims about Obamacare are revealed now – and widely admitted – to be wrong.  If he were the CEO of a private company he would be sued, publicly lambasted by all the major media, perhaps hauled before an admittedly grandstanding Congressional committee, and possibly prosecuted, convicted, fined, or even imprisoned for fraudulent misrepresentation.  But because Obama is a politician, his misrepresentations are excused as simplifying descriptions aimed at persuading the doofus public to fall for legislation that they would not have fallen for had the president described that legislation honestly and accurately.

This is from Café Hayek Blogger and Professor Don Boudreaux on the unraveling Obamacare. 

Politicians typically use noble sounding rhetoric (e.g. "change", "equality") to push for political agendas that serves their interests. Yet they rarely have been accountable for their actions, even in the face of flagrant failures. This gambling away of society's civil liberties, financial and economic resources and social order has largely been a product of the lack of skin in the game. 

And in the face of failures, politicians would usually resort to propaganda blitz by shifting the blame elsewhere, hoping that fickle voters will forget. And for as long as politicians can get away with this, they will keep on gambling away society's treasures.

Philippine Economy: The Unseen Factors behind the “Doing Business” improvements

Domestic media and the mainstream cheers on reports of the vast improvements by the Philippines in the Doing Business rankings by the IFC-World Bank. 

The Philippines joins other outperformers led by Ukraine, Rwanda, the Russian Federation, Kosovo, Djibouti, Côte d’Ivoire, Burundi, the former Yugoslav Republic of Macedonia, and Guatemala 

This article from Rappler gives a good account where the gist of the so-called positive developments has been allegedly made.

Regulatory reforms that helped improve the Philippines' ranking were evident in the following 3 criteria:

One, the introduction of a fully operational online filing and payment system that made tax compliance easier for companies.

The government has aimed to reduce the number of steps to pay taxes to 14 from the previous 47. The survey showed it still takes 36 steps.

Two, the simplified occupancy clearances that eased construction permitting:

The government wanted to cut the steps to obtaining construction permits to just 12 from 29. The survey results showed it currently takes 25.

Three, the new regulations guaranteeing borrowers’ right to access their data in the country’s largest credit bureau.

These were some of the areas the government has created specialized teams for to address each of the 10 indicators on the difficulty or ease of doing business in the country that IFC is tracking.

The teams' priorities were on indicators that have to do with starting a business, getting credit, protecting investors and resolving insolvency.

Here I will offer a contrarian analysis (using the great Bastiat's Seen and Unseen analytical framework) of the so-called outperformance in Doing Business rankings based on the areas which posted the biggest advancement.

1. Paying Taxes. 

It is natural for the Philippine government to prioritize in the enhancements of tax collections.

That’s because the government has been spending far more than the revenues the government has generated. Data from NSCB and Bureau of Treasury

Yet the increase in the growth rate of government spending has been accelerating to the upside. On the other hand, revenues while also increasing has failed to keep up with the pace of spending growth. 

Moreover, while the rate of government spending appears “linear”, revenues has been subject to fluctuations in the economy

The current “boom” has hardly cut back on the budget deficits that had been accrued during the global 2008 crisis.

In 2010, deficits swelled in the aftermath of a sharp decline in tax revenue collections relative to what seems as steady or constant increase in the trend of government spending. The current deterioration of deficits erased the earlier efforts by the past administration to balance the budget.

In addition, according to the Department of Finance, through July year on year growth of revenues was at 17.3% relative to spending at 21.7%. So nominal deficits (-4.4%) at the current rate will likely even deteriorate more if such a trend persists.

Of course deficit spending unfilled by taxes has been and will be covered by debts. So underneath the surface of a supposed boom has been the swelling of the debt levels. 

The government has already been spending a lot more than they can earn, even at pre-Doing Business improvement levels. This means that in contrast to the optimistic perspective, more efficient tax collection will motivate politicians to spend even more.  And with bigger government spending, efficient tax collections will extrapolate to higher taxes. 

Moreover, money spent for public consumption will mean less money spent for productive activities. Government spending will only add temporarily to statistical growth. In reality, via crowding out of the private sector, government spending diminishes real economic growth. That's because government has no resources to fund any of their spending programs such that the government principally relies on the forcible extraction of savings, output or wealth from the productive agents by taxation. And because government spending cannot be measured by market metrics as they are a monopoly, such spending represent consumption.

So this hardly signifies a positive news over the long term.

2. Construction Permits

In the consensus perspective, ballooning budget deficit and public debt figures when compared to the statistical growth (debt/gdp, deficit/gdp) has been seen as 'stable' or barely viewed as a source of concern.

This is largely because the 'strong' denominator or statistical growth figure (gdp) have “muted” the numerators (debt and deficit).

Such underappreciation of risks has been due to the skewed computation of statistical growth. Yet debts and deficits has largely been driven by the very factors (government spending), aside from the bubbles in the formal economy (nominal private sector debt), constituting statistical growth.

This leads us to the next "big" advance in Doing Business.

The 2nd quarter 2013 Philippine statistical growth clock came at 7.8%. But when one scrutinizes on the National Statistical Coordination Board data, economic growth emanated from mostly construction and government spending (based on expenditures).

And the construction share of growth includes government spending, where the share of public construction has increasingly added to statistical growth data based on World Bank data

In short, measures to improve regulations in the construction and real estate industry seem as deliberately designed to accommodate a real estate-construction boom in order to boost the statistical economy.

Yet how has the boom in these sectors been funded? Well by credit expansion.

BSP data shows how bank lending to the real estate has exploded since 2010 until 2012

Despite some moderation in the current pace of bank lending, construction and real estate loans remains vastly above “statistical growth”. Of course there has also been the Philippine version of the shadow banking industry.

3. Getting Credit.

The third room for the Doing Business upgrade has been in the partial easing of credit regulations, particularly “guaranteeing borrowers’ right to access their data” 

As noted above, the booming areas, specifically real estate and construction and allied industries have mainly been funded by a credit boom

On the consumer side, given that 8 in every 10 households are estimated as unbanked according to the BSP’s annual report…

…and that only 4% of the households have credit cards…

…and where 6.8% of households borrowed money for housing

The above data suggests that “Guaranteeing borrowers’ right to access their data” will hardly be a factor in enticing the informal economy to access the formal banking sector. The average borrower will hardly be concerned about right to access data but rather over access to funds.

True, consumer credit has grown in 2010-2012

…and also through 2013, but they have largely remained below the pace of the supply side growth rate.

Again the so-called “guaranteeing borrowers’ right to access their data” will unlikely boost the overall credit market for the simple reason it does not address the disease: rigid regulations (e.g. AMLA) and taxes that inhibit access to the formal banking system.

Instead “getting credit” will likely buttress the asset speculators, whom have been driving an asset mania, the same entities who have access to the formal banking sector and to the capital markets, as well as, the financiers of these speculative boom.

In short, the credit financed boom has been concentrated to a small sector of the Philippine economy who will benefit from "doing business" upgrade. 

Yet in order to maintain current statistical growth levels largely dependent on debt, this means inflating bigger asset bubbles financed by even more ballooning of debt levels. The so-called Doing Business reforms has just facilitated this.

Bottom line: The biggest improvements in the Philippine IFC’s "Doing Business" has hardly been about promoting small and medium scale businesses and or the informal economy

Induced by zero bound rates, the selective easing of regulations essentially compounds on the accommodation by the government of the debt financed speculative binge on asset markets, as well as, debt financed government consumption. 

Instead, ease of paying taxes, construction permits and getting credit only reinforces the transfer of resources (via inflationism, deficit spending and asset inflation) from society to the political class and their favored allies and constituents

This has been hailed by the short term looking consensus as an ideal growth paradigm. 

But as the great Austrian economist Ludwig von Mises warned,

The popularity of inflation and credit expansion, the ultimate source of the repeated attempts to render people prosperous by credit expansion, and thus the cause of the cyclical fluctuations of business, manifests itself clearly in the customary terminology. The boom is called good business, prosperity, and upswing. Its unavoidable aftermath, the readjustment of conditions to the real data of the market, is called crisis, slump, bad business, depression. People rebel against the insight that the disturbing element is to be seen in the malinvestment and the overconsumption of the boom period and that such an artificially induced boom is doomed. They are looking for the philosophers' stone to make it last.

Yet the soundness of such paradigm may soon be tested by the global bond vigilantes

How Wall Street Gamed the TARP

Through a report from a special investigative body appointed by the US Congress, Sovereign Man’s Simon Black explains how Wall Street cronies in cahoots with the US Treasury gamed the $700 billion bailout Troubled Asset Relief Program (TARP)

In the wake of the bailout, Congress created a special position to oversee how the funds were spent. Like anything else in government, they used an unnecessarily long name followed by a catchy acronym–

Special Inspector General for the Troubled Asset Relief Program, or SIGTARP.

(The first SIGTARP was a former federal prosecutor who had previously indicted 50 leaders of the Revolutionary Armed Forces of Colombia… just the right man to keep a watchful eye on bankers.)

SIGTARP just released its quarterly report to Congress… and it’s scatching, suggesting that “the toxic corporate culture that led up to the crisis and TARP has not sufficiently changed.”

There are some real zingers in the 518 page report, including:

• “[F]raudulent bankers. . . sought TARP bailout dollars to have taxpayers fill in the holes on their fraud-riddled books.”

• “Some bankers cultivated a culture of self dealing, criminally concealing that the bank was funding their luxury lifestyles, believing they were entitled to the finest money could buy. . .”

• “They were trusted to exercise good judgment and make sound decisions. However, they abused that trust. Many times they abused that trust for their own personal benefit.”

Moreover, the report calls into question the Treasury Department’s administration of the bailout.

For example, many banks have been delinquent in making TARP payments, or payments to one of TARP’s sub-programs.

Yet while many banks are delinquent by 1-2 quarters, according to the report, roughly 3% of the banks who received funds under the Community Development Capital Initiative are more than –two years– behind in their payments.

Yet the Treasury Department has done nothing to enforce terms on behalf of taxpayers.

Most alarmingly, though, the report throws a giant red flag on the Treasury Department’s deceit.

In 2011, the report states, 137 banks took in billions of dollars of funding from the Treasury under the Small Business Lending Fund (SBLF). They then used those funds to repay their TARP loans.

In other words, they repaid taxpayer money with more taxpayer money.

But the Treasury Department still reported that TARP was being repaid, suggesting in a May 2013 press release: “Taxpayers have already earned a significant profit from TARP’s bank programs.”

Total BS, says the report.

SIGTARP writes that “Treasury should not. . . call these funds “repayments” or “recoveries”. Treasury owes taxpayers fundamental, clear, and accurate transparency and reporting on monies actually repaid.”

Something tells me this woman isn’t going to have a particularly long career in government.

And given the Obama’s administration’s track record against whistleblowers, SIGTARP had better start booking her flight to Moscow. Or better yet, marry a Brazilian.

Soaring stock markets, induced by the Fed's easy money policies, has been part of such implicit bailout-transfers in favor of Wall Street and other cronies

Peter Schiff: The Website is Fixable, Obamacare Isn’t

Peter Schiff explains on why Obamacare virtually digs itself into an abyss.

Here is slice from LewRockwell.com

Since Obamacare made its debut, discussions have focused on Ted Cruz’ efforts to defund the law and the shockingly bad functionality of the Website itself. Fortunately for Obama, polling indicates that Senator Cruz has lost, at least for now, the battle for hearts and minds. The President has not been nearly so lucky on the technological front. If current trends continue, the rollout may go down as the worst major product launch in history. But given the government’s enormous resources, it’s safe to say that the site itself will ultimately be fixed. But when it is finally up and running, the plan’s many deeper, and more intractable, flaws will come into focus. That’s when the fun will really begin.

Put simply the program is built on a mountain of false assumptions and is covered by a terrain of unanticipated incentives. Any cleared-eyed observer should conclude that it is perfectly designed to raise the costs of care and wreck the federal budget. However, like just about every other complicated problem that bedevils the nation, the public has become far too caught up in the politics and has ignored the horrific details.

Most people agree that the plan can only remain solvent if enough young and healthy people (“the invincibles”) agree to sign up. They are the ones who are likely to pay more into the system than they take out. But now that insurance coverage is guaranteed to anyone at any time (at the same price — even after they have gotten sick or injured), the only incentive for the invincibles to sign up will be to avoid the penalty (I think we can dismiss “civic duty” as an effective motivator). But as I detailed in a column last year, Justice John Roberts declared the law to be constitutional only because the penalties are far too low to actually compel behavior. Once young healthy people understand that they can save money by dropping insurance, they will. No amount of slick, cheerful TV ads will change that.

The good news for Obama is that the plan will get a large percentage of young people covered. The bad news is that many of those that do sign up will not help the bottom line. The youngest and healthiest of the group are under 26 and will now be able to stay on their parents’ plans. This group will add nothing to the pool of premiums (but will use services). Among those older than 26, the ones who qualify for the largest subsidies will be more inclined to sign up. The way the plan is structured, individuals and families earning between 1.38 and 4 times the Federal poverty level will qualify for a subsidy. The government subsidy covers almost the entire premium for those near the bottom of that spectrum. These individuals will definitely sign up. But just like those under 26, they will be a net drain on the system.

From my estimations, private premium contributions don’t surpass the government contributions until an individual or a family makes about 2.5 times the poverty level (which equates to about $28,000 for an individual and $55,000 for a family of 4). Since a very large percentage of young people earn less than that, many will sign up to get the benefit. But these people will likely be net drains to the system as well. Their total premiums paid may be more than the services they receive, but that may not be true when you look only at what they actually pay in.

Read the rest here

More on Russell 2000s Outrageous Valuations

The usual or conventional way to spin or rationalize a bubble is to embellish or sell them as “growth”.

And that’s the way media treats the outrageous valuations of the small cap Russell 2000 which I earlier discussed

Media says that since robust revenues from Russell 2000 companies depend on domestic demand, then the booming Russell 2000 heralds a strong economic recovery.

From Bloomberg:

Gains in smaller companies that are more dependent on U.S. growth show investors are betting the world’s largest economy will pick up even after jobs growth slowed and the government shutdown weighed on gross domestic product. Smaller firms are surpassing analyst earnings estimates by more than Dow (INDU) companies and are forecast to grow faster next year….

The average company in the Russell 2000 gets 84 percent of its sales from the U.S. and is valued at $972 million, compared with 55 percent and $152 billion for the Dow, data compiled by Bloomberg show.

And this trend supposedly should support the current bull market.

Smaller companies usually climb faster at the start of a bull market, making them a proxy for future economic activity. The Russell 2000 was up 71 percent in the first six months of the 2009 rally, compared with a 46 percent advance in the Dow. This year’s outperformance is occurring almost five years after stocks started rallying, signaling the economic recovery will accelerate from what has been the slowest rate since World War II….

Small-cap gains of this size have proven prescient in the past. They preceded faster economic growth and a broader stock market advance in 2003 and 1991, and coincided with them in 1979. The Russell 2000’s outperformance in 2003 was at the start of the last equity bull market, when the S&P 500 more than doubled from October 2002 through October 2007. GDP expanded at the fastest rate in four years in 2004.

To be balanced, the article did allot 3 short paragraphs to some critics, but almost the entire article has been framed to convey "bullishness".  

For instance, they presented the National Federation of Independent Business’s optimism index which I used last Sunday on the side of the bulls. But if one would note of the actual quote by the NFIB, bullishness has hardly been the message. 

Let us put into perspective the article’s allegation that outperforming stocks of smaller companies serves as harbinger to “the start of the bull market”

The above represents the 3 year trend of the S&P 500

Based on the chart from bigcharts.com which compares the S&P 500 relative to the Russell 2000 over a ten year period, the Russell 2000’s shocking vertical climb, which has severely outclassed the S&P, seems like a manic episode.

And instead of a “start of the bull market”, the consequence based on past behavior of the RUT-SPX has been the opposite: 

Each time the RUT pulls away from the S&P as in the case of 2007 and 2011 (green ellipses), what followed has been significant retracements (2011), if not a bear market (2007).

The same dynamic can be seen in the RUT-Dow Jones Industrials chart.

But there is more…

Notice that the spread—between RUT on the one side relative to the S&P and Dow Industrials—have not only been in an unprecedented widening, but the intensifying variance has also signified unparalleled duration.

In other words, at NO time in the last 10 years have we seen such a massive departure by the RUT vis-à-vis the SPX and the Dow in terms of relative variance of stock price performance for an extended period of time!

So while for the bulls, the above represents "this time is different!", but if past were to rhyme, today’s manic phase suggests of a coming major retrenchment. It's now a question of until when FED policies will be able to extend maintaining such massive imbalances.

Let’s go back to fundamentals…

Again recent surveys has not supported such incredibly wild optimism.

The July survey by Wells Fargo optimism improved (highest since Great Recession) but “recovery has been slow”

However according to an October survey by the Wall Street Journal, small business sentiment has materially deteriorated!

From the Wall Street Journal (bold mine) 

Of 692 business owners surveyed online between Oct. 7 and Oct. 16, 36% said they felt the economy was improving, down from 47% in September. Just 21% said they expect conditions to pick up in the year ahead, down from 30%, according to the survey, which was conducted before Congress reached an agreement on Oct. 17 to reopen federal offices. The survey was limited to firms with less than $20 million in annual revenue.

Overall, the WSJ-Vistage Small Business Confidence Index dropped to 97 from a record-high 105.3 in September, though it is up from 95.3 a year ago. The monthly index is based on survey responses to issues ranging from economic conditions to hiring and spending plans. The index had remained above 100, its baseline score, since February….

A separate survey of more than 600 small and midsize businesses, released Wednesday by the Principal Financial Group, also found that small-business owners are keeping spending tight. While two-thirds of owners said they had surplus capital, 75% said they aren't spending it, the survey found. Most owners blamed the spending slump on health-care costs and the unsteady economy.

So we have a parallel universe, soaring RUT while real business sentiment and activities reflect on apprehensions over the future.

Recent economic data supports these anxieties. Factory output in the US in September reportedly rose less than expected along with a slump in the pending sales of US housing 

From another Bloomberg article:

Factory output rose less than forecast in September and contract signings for U.S. home purchases fell the most in three years, showing the economy was having trouble gaining traction before the government shutdown.

The 0.1 percent advance in manufacturing followed a revised 0.5 percent gain in August that was smaller than initially estimated, figures from the Federal Reserve showed today in Washington. Pending sales of previously owned homes slumped 5.6 percent in September, the fourth straight month of declines, the National Association of Realtors reported.

So how will unimpressive factory output translate to explosive earnings growth for SMEs? 

Also non-financial companies hold record cash even as they pile up on debt.

From the Wall Street Journal (September):

Nonfinancial companies held more than $2 trillion in cash and other liquid assets at the end of June, the Federal Reserve reported Friday, up more than $88 billion from the end of March. Cash accounted for 7.1% of all company assets, everything from buildings to bonds, the highest level since 1963.

So this squares with the October small business survey where “small-business owners are keeping spending tight”.

If small and medium firms have been dithering on capital spending, which should translate to future revenues, I wonder where will small businesses of the Russell 2000 get their profits to justify such stupefying valuations?

As English writer Aldous Huxley once wrote

The trouble with fiction... is that it makes too much sense. Reality never makes sense.

Quote of the Day: In democracies the main alternative to majority rule is the markets

In the minds of many, one of Winston Churchill’s most famous aphorisms cuts the conversation short: “Democracy is the worst form of government, except all those other forms that have been tried from time to time.” But this saying overlooks the fact that governments vary in scope as well as form. In democracies the main alternative to majority rule is not dictatorship, but markets

This is from prolific blogger, author and professor Bryan Caplan’s must read The Myth of the Rational Voter