Archive for the ‘Causes of Poverty’ Category

I recently did a quick consultation with a friend of a friend who is an independent personal service provider. She has a reasonable hourly rate, though it’s not clear every client pays that. She’s independent because she likes the schedule flexibility, but it does mean her schedule is often not full. Looking at past taxes, her annual gross income has been 50-55K annually. It’s below the the median wage of 64K, but well above the living wage of $26,600. Or is it?

The two common challenges for small providers are 1) bookkeeping and 2) marketing. She knew her business worked on a cashflow basis but was talking to me because some months cash was feeling a little tight. After pulling some numbers together, it became apparent that her monthly expenses are almost $2000/month with rent, internet, phone, website, licensing, continuing ed, insurance, credit card processing and taxes. Lots of those are expenses that don’t come out every month, but add up. They’re also largely fixed expenses. So really, that gets her down to just above living wage as a take home.

We talked about a few marketing strategies – how she might get more referrals or remind existing customers about her service and maybe sprucing up her waiting lobby (though that’s a capital investment). It turns out it’s tricky to relocate or sublet her specific space so it’s difficult to chip away at those fixed costs. One solution she employs is some of her clients pay in cash. That contributes to difficulty in understanding her real profitability. I notice in my own efforts to hire a housekeeper that the first two have asked that I pay them in cash. Is this one of the signs the economy is not working for everyone? That those who can, go informal? Looking at risks – did I mention health insurance? She has to pay her own health insurance and that is a big chunk of those monthly expenses. It’s a significant risk to a small payer and there’s little help for her at a living wage.

Thinking about the risks of healthcare got me thinking about the risk of a major health disruption. Medical issues are the number one cause of bankruptcy in the US. It’s also another way the relatively rich stay richer – property protections in bankruptcy. If you are a property owner, you can protect some of your property in bankruptcy, and thus some of your assets. If you are a renter, and you don’t own tangible property, you’ve got nothing that you can protect, so it strikes me it’s much more likely you’ll be forced into homelessness. In fact, when I google for data to support this, what I learn is that a bankruptcy on your record is one of the things that can come up in a tenant screening and affect your ability to get a lease!

Net – there is no net, not of the safety kind. My provider just has to have faith in the continuity of her business (her track record to date is reassuring). A little effort in presentation or marketing might literally pay off. We also need to hope Obamacare and eventually medicare stay there for her, and that she doesn’t have a major health crisis that impacts her ability to work.

My takeaway for individual service providers is that it’s important to break the habit of letting personal & business expenses blur together – a habit that the tax reporting on Sole Proprietorships supports. You need to separate your business from your personal expenses, and track true monthly costs. You need to add up all those periodic one-time costs and figure out a monthly amount so you know your bottom line and not get lulled into complacency by your top line.

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I’m blogging about listening to Piketty’s Capital on audiobook, page numbers refer to the hardcopy.

This week I listened to chapter 14 on the Progressive income tax – how it came about, what role it plays in preserving equality.

The progressive income tax is an important part of supporting the Social State – we need that much tax and if it’s regressive then Piketty contends that people will find the system unjust and be unwilling to participate. The Social State does require substantial funding, it got close to 50% of total national income at its peak. Folks were willing to move up to that point in the 50s & 60s because everyone was doing well. Further, it was implemented very progressively. “All told, over the period 1932-1980, nearly half a century, the top federal income tax rate in the United States averaged 81 percent.” (p 507) It actually peaked at 88% in 1942, with surtaxes that created a high of 94% in 1944, before falling to the 70% some of us remember. Piketty calls that kind of rate “confiscatory”, and suggests it’s motivated to address “incomes deemed to be indecent (and economically useless)”. (p 473)

Progressive income taxes were introduced right around World War I, and took hold in part because of the huge debts governments ran up in the war and had no other way to pay off. The Bolshevik Revolution of 1917 and worker strikes are also suggested as a factor.   The United States actually introduced higher tax rates than in Europe, and Piketty attributes that to a reaction against “the hyperinegalitarian societies of Europe” as well as a response to the Great Depression. (p 506)

In the 1980s the US and Great Britain with Thatcher and Regan began to significantly cut top tax rates. My sense from this chapter is that part of the argument was that Germany and Japan were catching up to us technologically and we needed to get more competitive. That strikes me as a misguided argument now after earlier chapters talked about economic growth as being towards the current “technological frontier”. Rapid growth in the last near-century has been more about recovery from the two world wars than from technological advance and the catch-up of Germany and Japan was inevitable. The fear that they might slingshot past was misguided. Anyhoo, we did cut tax rates.

Piketty describes it thus: “After experiencing a great passion for equality from the 1930s through the 1970s, the United States and Britain veered off with equal enthusiasm in the opposite direction.” (p 508) One consequence? The explosion of CEO salaries. “If we look at all the developed countries, we find that the size of the decrease in the top marginal income tax rate between 1980 and the present is closely related to the size of the increase in the top centile’s share of national income over the same period…. Conversely, the countries that did not reduce their top tax rates very much saw much more moderate increases in the top earners’ share of national income.”

Why? “In the 1950s and 1960s, executives in British and US firms had little reason to fight for such raises, and other interested parties were less inclined to accept them, because 80-90 percent of the increase would in any case go directly to the government. After 1980, the game was utterly transformed…” (p 510)

Piketty continues “there is no statistically significant relationship between the decrease in top marginal tax rates and the rate of productivity growth…” so there’s no evidence that the rise of top salaries is justified.   In an earlier chapter he goes into greater depth about the difficulty of rationalizing high CEO salaries, or correlating them in any way with performance when compared with similar companies and similar demonstrable economic performance. It’s all about negotiation. After comparing CEO salary variations across countries he concludes “only dissuasive taxation of the sort applied in the United States and Britain before 1980 can do the job” of reigning in high salaries, not corporate governance reform. (p512).

This section particularly catches my attention because in my own experience as an investor reward is the intersection between luck and motivation to negotiate, more than skill or merit. I have long believed that the only way to keep people from gaming the system is to reduce their incentives to do so.  Sounds like Piketty concludes the same thing based on data.

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There’s a gag t-shirt that reads “There are 10 kinds of people in this world: those who understand binary, and those who don’t.” The gag being that if you understand binary numbering you immediately realize that “10” is written in binary numbering and therefore reads as “two” not “ten”. I feel a little that way talking about Piketty’s Capital. Since I work in finance, it sometimes seems like “everybody” will immediately recognize it as the most influential book on economics since Smith or Marx. But I’ve been spending time with folks outside of that community lately and running into more people who say “Eh?” Which stops me a little short.

SO, Le Capital au XXIe siècle, by French economist Thomas Piketty was published in August 2013 in France. The English translation by Arthur Goldhammer, Capital in the Twenty-First Century, came out in April of 2014. According to Wikipedia it’s the best selling book ever from Harvard University Press. It’s been #1 on both the New York Times nonfiction best seller list and the Wall Street Journal best seller list. I was gifted with my copy last year by Matt Talbot of Bristlecone Advisors. Seattle University just started a 6 week (spread out over 12) special seminar with talks from 6-9 on weekdays and it sold out, I couldn’t get in.
It’s a tome for sure – 577 pages, footnotes round it up to 655. In July of 2013 a math professor from the University of Wisconsin did an amusing analysis (published as a WSJ essay) of the distribution of reader highlights in Kindle editions of best-selling books. He used it as a metric for guesstimating whether or not people are finishing the books. If everyone is finishing the books, presumably there will be popular highlights throughout the book. At the time, all top 5 “popular highlights” of Kindle readers were in the first 26 pages of Piketty, earning it the label of the least-read best selling book. But hey, it had only been out 3 months and it’s over 600 pages! I don’t have it on Kindle so I can’t check but I bet it’s better now. There are also no end of derivative analytical summaries out there.
I’ve been listening to the audiobook, actually, and it’s great! Piketty refers to lots of charts and graphs so one might think I’d miss a lot, but actually I think I’m getting a much better “read” this way. For starters, I’m a fast reader so audiobooks really make me slow down and get everything. Piketty is also a good writer – he’s really good about telling you what he’s going to tell you, telling you, and then summarizing in conclusion. He explains all the charts and graphs so while I’m missing some, it’s not much. And this really is pretty interesting stuff to me so I’m good about skipping back and re-listening. The first couple chapters laying groundwork were a little dull but it’s been fascinating stuff since! The narration is excellent, L. J. Ganser- I’m your fan! The audiobook is 24 hours long and I’ve been getting in in 1 hour doses on a commute, so I end up really thinking about small sections at a time.
I want to blog about it, I’ve been daunted. But it’s time and it’s what will really help me process what I’ve been hearing. This book blows my mind – it really seems to me that the Occupy movement is based on it. Then the push to blow up individual political contribution limits in the US from like 30K to 300K is a countermove that Piketty practically suggests! As someone who has been a philanthropist working on issues of social and economic inequality for the last decade, Piketty is revolutionizing my thinking about how to measure it and how to address it.  I need to process and I need to write. You can help by bugging me to do it!

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Traditionally lenders and insurers mitigate risk by screening borrowers and charging higher-risk borrowers higher rates.  This is done across all types of borrowing and insuring – home, auto, life, business, personal credit. This has always bothered me because it strikes me as self-fulfilling prophecy. Charging higher rates can only increase the risk of default. It’s also penalizing the people who need help the most. This is the opposite of the kind of system Americans like to see; we prefer one that reinforces opportunity for those who work hard, rather than just raising the bar for those who start closer to the bottom.

Recently a friend sent me an NYT article about Bruce Marks and the Neighborhood Assistance Program of America.  NACA focuses on the subprime market and has found a new way to mitigate risk. They mitigate the risk for the borrower rather than mitigating the risk purely for the lender. They do this by working with borrowers to create financial plans as part of the lending process. Instead of making borrowers with low down payments buy mortgage insurance, those borrowers pay into a neighborhood Membership Assistance Program.  Membership in the MAP gives them access to free financial and credit counseling. Further, the MAP can provide up to three months of mortgage payment assistance.  All assistance that protects the mortgage – by protecting the borrower.  Further, they engage the homeowners by creating Peer Lending Committees to review requests for assistance.

This is the kind of risk mitigation thinking we can use more of – ways of working together instead of against each other.  Reading the articles below it seems this hasn’t spread further because the founder is still very much in the culture of working against, he’s just redefined who he works against as other lenders.  Still, the ideas are good ones and remind me very much of grameen bank and their lending circles.

A Nonprofit Lender Revives the Hopes of Subprime Borrowers – NYTimes.com.


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A nonprofit I’ve supported for many years has been working on payday lending.  It has become a big issue nationwide – the Bush administration capped payday loans to military families at 36% APR and many states have followed.  An obvious thought is, if it’s such a lucrative business then why can’t a more socially motivated but still financially successful business undercut existing players?  One investor suggested to me that as a lending business you either have to be really good at screening (not the payday convenience model) or really good at collections (not the socially motivated model!)  The basic model seems to be that you do some screening and you charge huge APRs so the fund can withstand big losses.  What’s a big loss?   A bank loan fund might normally be designed with a 2% loss reserve. Nowadays banks are probably reserving 3-5%.  A Community Development Loan Fund might design for a 7-10% loan loss reserve.  A payday loan fund might be designed for losses up to 40%.  That means many good citizens paying high fees to cover their bretheren (as well as the costs & profits of the middleman).

Credit is more than just getting loans.  Folks of all income levels use credit for “consumption smoothing” – basically helping match lumpy inflow (bi-weekly paycheck or irregular investment income/liquidity) to lumpy outgo (monthly bills, unplanned expenses, opportunities).    Credit is usually provided by a bank, but a significant portion of the US population is not getting their needs served. Access to credit and financial services is a concern to the FDIC, in a 2009 survey they concluded that 7.7% of all households are unbanked and 17.9% of all households are underbanked. A 2005 paper for the FDIC describes Alternative Financial Services (AFS) as including check-cashing, pawn shops and rent-to-own along with payday lending.  This is in contrast to the Financial Services sector of banks, thrifts (Savings & Loan), brokerages and mutual funds.

The FDIC defines “unbanked” as no one in the household has a checking or savings account.  “Underbanked” means someone has a checking account, but has used alternative financial services at least once or twice per year.  To the above list they also include money orders, and FDIC also considers someone underbanked if they’ve used a refund anticipation loan at least once in the last five years.  Other reading I’ve done notes that overdraft protection can be regarded as a kind of payday loan in that it is a short term loan with very high fees.  The challenge with overdraft protection is that its not always consciously chosen but accidentally done! This is enough of a problem that in November of 2009 the Federal Reserve issued new rules for banks to require customers to opt-in for overdraft on debit and ATM cards.

It’s the fees when annualized that make short-term loans so expensive.  Part of the bad reputation comes from the assertion that customers end up being repeat borrowers and rolling their loans over repeatedly and so paying those high rates for long loans. Do they?  A Washington State Department of Financial Institutions study from 2008 shows that just under 20% of borrowers are one-time borrowers. However that’s for a total of 2% of all the loans, because from there there’s a very long tail of repeat borrowers that get up to borrowing 19 times in a year before any group accounts for less than 1% of the total.  Add them up and 60% of borrowers have borrowed 4 or more times in a year.

Convenience & less hassle seem to be the big market drivers for payday loans.  According to Moneytree, all you need is proof of employment via paystub, though in California and Colorado they must also require an active checking account.   I’ve heard that payday lenders don’t report on your loan so if it goes bad it doesn’t impact your credit score.  The application process is minimal and the turnaround can be less than an hour.  I suppose the mainstream financial system equivalent is a credit card. A quick browse of Moneytree’s website shows a company that offers a huge menu of financial services: check cashing, payday loans, prepaid cards, coin counting, bill pay and more!  It seems to be the interface to the mainstream financial system for people who need it, and that’s what the industry argues: they provide a valuable service to customers who need it and shame on us for turning up our noses and trying to regulate them out of business.

I recently re-connected with a high-school friend whose life has taken a very different direction.  She has much more experience than I with living on the financial edge.  She was really frustrated by the automatic overdraft protection and is the one who told me her bank switched to opt-in recently.  She married a guy who has bad credit and collection issues. They’ve solved that by putting everything in her name but I get glimpses of what life must be like if you have bad credit. She told me that most of the “free credit report” websites are basically honeypots to collect personal data and pass it on to collection agencies.  She made some other comment about things they can’t do, I think one related to travel, because it might get the hubby identified by collections.  They’re both gainfully employed and decent citizens, but I have this image of a twighlight financial/legal status that, while probably not that melodramatic, definitely sucks.

Yesterday I stopped into my local Wells Fargo where I got my 2nd pitch to change my current account setup and this time I decided to bite out of curiosity.  I sat at the desk with the banker and heard about how I could set up a different checking account that would give me some number of free cashier’s checks and money orders, and if I set up an automatic sweep into savings and kept the money there it could earn 3% interest! Kudos to Wells Fargo for creating a savings incentive and at this miserable time 3% is quite impressive. (Did I ever tell you about the 8% CD I had at Navy Federal back in the 80s? Those were the days….)  I was curious about the heavy pitching of money orders and cashier’s checks,  I can’t remember the last time I got one personally, so I asked.  He said that more and more folks are using money orders and cashier’s checks instead of regular checks because the money comes out of your account at the time the check is issued. Apparently that’s easier for people to manage though he added that it’s much easier to cancel a regular check if it gets lost (so I gather that’s an issue).  He also said that 150 checks is a lot to have lying around if you’re not able to be responsible with them ( I guess from a security standpoint – roommates, family members?  Possibly a self-control standpoint?)   As I walked in the door at home 15-minutes later and fished out a still-undeposited 7-week-old check from a relative (d’oh! I was just AT the bank)  I found myself thinking that yeah, if you’re managing very close to the line the uncertainty of personal check cashing and clearing could be a pain.

Based on the above, my thinking:  if you have bad or no credit score (I’ll lump “in active collection” under this), if you live in physically insecure circumstances where you want to have your finances with your person at all times (so no checks or cards you leave at home), if you are not comfortable with accrual accounting or managing your check register and so live on a cash basis (which I think LOTS of people do: that crazy bestseller Rich Dad Poor Dad is basically about getting off of a cash basis for looking at personal wealth)  or frankly, if you’re just tired of putting your paycheck in a bank where they find a dozen reasons to ding you for small fees because as a small customer they don’t make enough money off you – minimum balance fees, overdraft fees, holding deposits for days, clearing things in the order that maximizes bounce fees and then charging them repeatedly while being slow to notify you – then you are trapped living on a cash basis – little access to credit for the float we all use, little access to automatic bill paying or online purchasing.  No wonder the FDIC is concerned –  is it healthy for our economy to say 25.6% (the Unbanked + the Underbanked) don’t get to be full players?

Hmm, maybe that IS the problem, that in a for-profit banking system, some people are just not profitable enough.  I know a credit union working to serve folks better, but interestingly it’s not tax-deductible (and might even be taxable!) to donate money to them.  Much material for future thinking and blogging!

Mark Flannery & Kathryn Samolyk, 2005, Payday Lending: Do the Costs Justify the Price
FDIC studies on the underbanked
Federal Reserve announcement on overdraft protection
Wa State DFI 2008 Payday Lending Report
FDIC small dollar loan studies
A feast of services from our local Moneytree. Regarding Payday Loans: “As an analogy, while you would not choose to take a taxi from Seattle to San Diego or Denver to Las Vegas, it is common to take a taxi for a short distance, such as from your hotel to a nearby restaurant.”

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Earlier this year I listened to a really interesting This American Life episode (from May 2008) on “the giant pool of money”. It seeks to understand the sources of the mortgage meltdown. My takeaway from that episode is: there was more money looking for secure income-generating investments than there were high-quality income-generating investments, of which mortgage-backed securities were the favorite. Market pressure caused standards to be lowered. That standards could be lowered in a way that was not entirely transparent to the end-purchaser, IE that people were still able to buy AAA rated crap, is clearly a system failure, but more interesting to me is the problem that there was too much money chasing too little return.

What I remember of Kantian ethics from college philosophy is essentially this: an act is immoral if it causes a system breakdown when everybody does it. As a computer scientist I automatically think of the tragedy of the commons – I can get away with grazing my goat in the commons, but if we all do it the commons is done for, ergo even though I can get away with it, it’s an immoral act even for just me to do it. If I acquire a fortune and live only off the generated income of my fortune I’m doing quite well by the moral standards of my time. But… what if we were all trying to live off fixed-income investments in other people’s work? Like the Giant Pool of Money… perhaps too many of us have made it good. Somebody has to be generating real value.

This was in the back of my mind when a friend forwarded me a look at Common Good Bank, an effort to start a bank that would not have equity owners but be owned by its depositors. In grad school we talked about other banks like that, most famous is JAK bank of Sweden. Browsing around to see who is behind this effort I found the blog of the founder and eventually figured out he is William Spademen. He wrote a post with the provocative title “Unearned Income is the Root Cause of Poverty”. I thought that was a bit of a broad statement, but given the context already simmering in my brain, it caught my attention. Unearned income… we can’t all live off it and if we’re all trying to, where does it come from? Out of the pockets of others? Making them poor?

On his blog someone commented and said “I rent out a house, is that unearned income?” Spademan replied and hedges a bit but does say “In general, owning land is not a productive activity”. This is very accepted in our society that giving others access to our capital IS providing a value, for which they justifiably pay us interest. Yet how is it that we have that capital in the first place and they don’t? Often it’s what resources or business infrastructure you were born to (Bill Gates, Sr likes to point this out), or what great opportunities you stumble in to so that your hard work actually does pay off as opposed to the hard work of many others which doesn’t. We tell ourselves people who are renting instead of owning are choosing a different risk/reward distribution. But is it really their choice, or their lack of choice?

On an email list I received a link to an animated video called “Money as Debt”. (Warning – this link plays music: http://www.moneyasdebt.net/ ) It’s 45 minutes long and talks about the fractional reserve banking system and how money is created in the system when banks are approved and allowed to write loans at a 9:1 ratio against their equity, and a 1:9 ratio against their deposits since those deposits are assumed to be originated somewhere upstream as debt. It keeps the system in balance, except for the problem of interest. If we’re all circulating capital out of the same pool, the pool needs to keep continually expanding to account for the interest we’re all charging each other. That made sense to me, and what really caught my attention starts at about minute 23, that we can’t simultaneously pay off all our debt because Money IS debt – otherwise we’re back to bartering and time banking. But more intriguing for me was the assertion that this kind of closed system of principal circulating to pay off principal + interest has an inevitable math: (Interest)/(principle + interest) = foreclosure rate. That’s a bit of an oversimplification of all debt to mortgages, but I did a little research and turned up that mortgage debt is about 78% of all debt and consumer debt is less than 10%. Constant economic expansion, and support of that expansion through the creation of new debt is what keeps us ahead of the curve – this year’s circulating principal is more than last year’s.

This has been very tricky for, interestingly, men I know to understand. Women don’t seem to have as much trouble. There’s a difference between creating new value (inventing something, discovering something) and creating additional money (by opening a new bank or changing reserves through open market operations). Perhaps substituting the word “currency” for the word “money” will help keep it straight. I find myself thinking that problems must come when the pace of those two creations gets out of wack: value is created faster than currency or currency is created faster than value. Aha, the Fed validates me: “Inflation is caused by excess growth of money and credit relative to the supply of goods and services in the economy” (via another noisy link!) No wonder monetary policy and managing inflation is so complex – how can we really tell how much value is being generated year to year? Also several papers have demonstrated that the velocity of money – how quickly it changes hands, has changed considerably over the last few decades and also impacts how much total money can be said to be in circulation. And finally, how much control does the Fed really have over the amount of money in circulation when investment banks can invent entire new private debt vehicles (CDOs) and loan back and forth to each other?

With this thread, I don’t have any answers yet, still trying to formulate clear questions. It does seem that built into our monetary system is a need to balance the accumulation of interest, through some combination of expansion or bankruptcy. If we’re unknowingly in a game of musical chairs to avoid the short straw, it seems likely the less educated and well connected will more often end up with the short straw, but I can’t show that connection yet.

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