Unlike the private sector, government accounting is unaccountable. Governments are free to toss out ridiculous figures without an audit or criticism – Pres. Obama’s stimuli have saved 3 million jobs, please. One way governments claim to save money is through creative financing that would be illegal in the private sector. One recent example is the Denver bus system’s claim that it has saved $1.9 bln on a future train to the local airport. This savings is huge, considering the project’s budget is $2.3 bln. Nobody in the press questioned the improbability of such amazing savings or how the simple math could add up so favorably. In reality, RTD, Denver’s transit system, pulled a fast one by effectively taking out an illegal loan and raising taxes to pay for its airport train.
A little background on RTD’s train lust: RTD has always wanted to build a local train system for metro Denver, and voters rejected a series of tax measures to do so. In 2004, RTD finally succeeded in doubling the transit sales tax to fund an ambitious train system, including a link to the airport. Considering the fact that RTD had tried this several times in the past, one might assume that the budget was in place and that the tax increase would be sufficient. Oh naive ones, no. There was no budget or schedule, only empty promises. RTD eventually disclosed that they needed about twice as much money as they had initially told the voters. RTD wrestled with asking for a further 50% tax increase, but due to the recession and voter sentiment, they backed down. The solution, it turned out is a popular financing trick called the Public Private Partnership, or P3, which allows for off balance sheet financing of large construction projects.
While financiers like to parse deals to attract investors and sometimes hide risk, there is always a simple underlying truth. The reality of the airport train is that it will cost billions of dollars up front and passenger revenues cannot be collected until the work is done. Voters authorized a sales tax increase, along with eventual ticket sales, to pay for this project. No financial engineering can change the fact that this project needs about twice as much money as it has. The only solutions are to either delay construction or issue debt.
Enter the P3 concept. RTD partnered with a team of private contractors and train operators to reduce its upfront costs. This partnership will get the operating and tax revenues for most of the life of the train in exchange for building and operating it. Since the train is a money loser, RTD will pay the partnership $2.3 bln for taking on the liability. RTD will also allow the partnership to issue tax advantaged bonds to pay for the construction of the train. So, everyone is happy?
Everyone shouldn’t be happy because there are unanswered questions. Why didn’t RTD just issue its own bonds and save the middle man cost of a P3? Such muni bonds require the vote of the people, and public sentiment is generally against more government debt, so RTD went around the law and likely will of the people with the P3 concept. RTD has effectively entered into off balance sheet financing that, due to its lengthy term, violates the accounting rules a private company would have to follow. While the debt goes on the balance sheet of the private partners, the ultimate risk is still carried by the taxpayers, a financial sleight of hand that is often illegal under the Sarbanes Oxley law. Further, tax advantaged bonds like the one for the airport train siphon capital from the private sector because only the government can give investors a pass on income taxes. Further still, RTD has not stated who will set the train fares to and from the airport. Currently the bus to the airport is five times more expensive than a regular bus ride, and the P3′s train certainly won’t lower the fare.
Because RTD is the government, it makes its own rules. RTD engages in lease financing that would be illegal in the private sector. RTD skirts the law by issuing bonds without a vote of the people. RTD uses the power of the government to pay a lower coupon on its debt at the expense of regular bond issuers. Many of these sleights of hand that the Denver press lauded were tried ten years ago, by Enron. Former Enron CEO Jeff Skilling must be frustrated that had he done such things for the government, he would be a hero today instead of a federal prisoner.
In what is little surprise to anyone who is not a tort lawyer or megalomaniac Senator, government researchers determined that runaway Toyotas were caused by driver errors. While Toyota was quick to say that the matter is not yet settled, Shout Bits is now prepared to state that when an accelerator is pushed to the floor and the brakes are not applied at all, an accident may ensue. That’s right, when the US Government did an independent study of crashed Toyotas, they found that in every instance the gas pedal was to the floor and brake was unapplied. Naturally, all the Senators and trial lawyers who lined up to bash Toyota have apologized and admitted that Toyota actually sells high quality US made cars. Not yet, anyway.
From hearings on satanic rock music to steroids in baseball, Senators have never shied away from sensationalizing irrelevancies to distract from their many failings. The Senate does not have hearings on their own graft, pork, or special interest handouts. No, the Senate has hearings on whether teenagers should attempt to break aviation records, or whether cigarettes are unhealthy, or why Toyota is to blame for auto accidents.
Nobody can blame Congress for wanting to deflect attention from its massive, nation destroying failures, and its red herrings are usually harmless. After all, harping on lead paint on toys only ruined a handful of small business owners’ lives. In the case of Toyota, however, tens of thousands of jobs are at stake. Toyota has invested billions of dollars in US manufacturing along with decades of innovation that have driven up the quality of all cars worldwide. Congress’s whipping boy was a model of capitalism, prosperity, and the power of a free market to make everyone’s life better. Better still, Toyota never took bailouts from Washington (only union shops qualified for such aid).
Toyota played the game well, unlike BP, by prostrating itself before the uninformed bombastic jackasses who have never done anything to make cars safer. Mr. Inaba, Toyota CEO, nearly wept tears of blood as he admitted failings that his engineers most certainly told him were false. Inaba surely recalled the bogus acceleration charges levied against Audi ten years ago. Rather than defend his product, Inaba knew he had to submit to Orwellian prosecution in order to put the sensation behind him. Never mind that sudden acceleration complaints are only filed when the news is hyping them, not regularly as a real problem would suggest. Never mind that a cash strapped California driver clearly faked his high speed Toyota incident a few months earlier. Never mind that the accelerator systems allegedly at fault were used by many auto manufacturers. Never mind that Congress runs GM, Toyota’s main competitor. In fact Inaba deserves a prize for his containment and focus on preserving Toyota, rather than the objective truth that nearly all accidents are caused by driver error.
Now that the government study has fully exonerated Toyota, where are the apologies? Perhaps Rep. Barton can give it another go. Toyota has wisely remained cautious, likely fearful that claiming victory would incite a backlash. Of course it is no surprise that the old time media’s interest in restoring Toyota’s reputation is tepid. Car crashes caused by driver error are dog-bites-man boredom right down the middle. Likewise for the Senators that preened as Inaba kowtowed. Building up industry, supporting capitalism, or acknowledging that most companies want to do right by their customers is not the Washington way. So, as usual, the prattling classes take more interest in salacious falsehoods than they do in humdrum truth. Toyota: there is nowhere to go to get your reputation back, but thanks for playing the Washington game so well.
While hardly a household name, Dr. Harry Markowitz developed a new way of looking at savings and investment that has fundamentally changed the financial world. In the 1950′s, Markowitz quantified the benefits of diversification in one’s savings. Prior to his work, most investors thought in terms of individual good and bad investments, but Markowitz proved that the best approach is to consider how an overall portfolio performs. Among the many assumptions in the application of Markowitz’s Modern Portfolio Theory is the notion that US Treasury Bills are risk free. With the US assuming far more liabilities than it can likely service, this assumption is becoming more dubious by the day. The implications for savers and investors tell a story of how government benefits debtors at the expense of savers.
Modern Portfolio Theory’s penultimate conclusion is that the best portfolio is a mix between a risk free asset and a portfolio of all risky assets together. By altering the mix of these two assets, an investor can build the best portfolio for his or her risk tolerance.
The chart shows Return On Investment going up as risk (Standard Deviation) moves to the right. The line marked ‘CAL’ for Capital Allocation Line shows how an investor can choose a mix of a risk free asset and a portfolio of risky assets (the Tangency Portfolio) to get the best return for any given level of risk. If an investor wants a return higher than the Tangency Portfolio, he would borrow money to move along the CAL ever higher. Investors who operate to the left of the Tangency Portfolio are savers, while those to the right are in part borrowers.
Again, the slope of the CAL is dependent on the risk free rate of return. If US T-Bills are the basis for the risk free rate assumption, the current debt crisis affects the risk assumptions of investors. While ratings agencies still grant US debt a ‘AAA’ rating, global trust in the US’s ability to service its obligations is slipping. As the US’s default risk increases the yield on its T-Bills will also increase. So long as investors continue to wrongly assume that US T-Bills are risk free, the slope of the CAL will be too shallow. Savers will be taking more risk than they think they are and borrowers will be taking less.
The end result is that otherwise rational savers will be inclined to lend more to the US Treasury because they can achieve their return goals with a higher mix of Treasuries. However, their true risk will be higher than their tolerance for such risk. Savers will underwrite the risk of US default. Conversely, borrowers will be incented to take more risk to achieve their return goals, but will be taking less real risk because of the risk underwriting savers will be donating to the treasury.
The wrong assumption of US T-Bills as being risk free causes savers to assume the default risk of borrowers without compensation. Of course the obvious solution is to stop assuming US T-Bills as being risk free, but remember that a wide variety of Mortgage Backed Securities were rated ‘AAA’ right up to the point they collapsed. The Markowitz Modern Portfolio Theory is another example of how excessive government debt transfers wealth and security from those who save to those who borrow.
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