Altus Insight - July, 2013

The Altus Insight
Market news, commentary and relevant topics for today’s alternative asset investor

Date: July 31, 2013
FR: Forrest Jinks
RE: Affordable Healthcare and Unaffordable Pensions

July and August are generally slow months in the world of investing and economics, which is good, because all of us need a little time of reduced intensity to gather our thoughts, clear our heads and prepare ourselves for the activity of the fall. I myself enjoyed a week away from the office this month, no phones, no email, no news…equals great relaxation and rejuvenation. The slowness of the season provides only two major matters of discussion for this past month, which while the issues are important, result in a shorter article and will leave you, the reader, with more time to go out and enjoy the summer. As a quick reminder, Altus is now sending out a second email each month discussing its business and investing activities and opportunities to invest with or through Altus. This is an opt in distribution. If you haven’t yet been added to the distribution but would like too, please respond to this email so we can include you.

Patient Protection and Affordable Care Act (Obamacare): This past month the administration made something of an unprecedented move in choosing to delay implementation of a portion of the landmark legislation it helped push through in its first term (commonly called Obamacare). Part of the legislation is the employer mandate which requires employers with over 50 full time employees to provide health insurance for all their employees or face governmental penalties. With the promised health care exchanges not yet set up as a source for that required health insurance the administration pushed back the employer mandate by one year. While unquestionably a benefit to the employers who can now push off the expense for one year, this unilateral decision by the administration opens an important philosophical discussion that could have a large impact on investors. If this administration has the right/power to implement only a portion of passed legislation without approval from Congress and the Senate, won’t future administrations have the same right/power? Does that mean a future administration can choose not to enforce a portion of Obamacare (the coverage requirement or penalties for instance)? Does that mean a future administration can choose not to enforce several portions of a piece of legislation, in effect eliminating the legislation altogether? And if this is the case, of what purpose is Congress and the Senate? If a president can act without the collaboration of the Legislative Branch it will result in a decision being made much more quickly and likely without warning (did anyone know the administration was going to delay the employer mandate?). Legislation can have a huge impact on any particular investment or on an entire investment portfolio, and if the Administrative Branch can in effect create its own legislation then changes to “legislation” may happen too quickly for investors to adjust their investment positions.

There is an additional Affordable Health Care issue currently surfacing. As mentioned above, employers with over 50 full time employees will be required to provide health insurance. So what of full time employees (> 29 hours per week)? According to an article written by Mort Zuckerman in the July 15thedition of the Wall St. Journal, there has been a 753,000 net increase in US jobs since January 1st. Of those jobs, 557,000 (74%) are part time. As can be imagined, a good portion of the part time jobs are going to the younger generations (less educated/less experienced). Remember, this is the same portion of the population that was supposed to be the healthy persons added to the health care base, thus supplementing the cost of covering the older/less healthy citizens. Part time workers don’t end up with company health insurance and likely can’t afford to buy their own, which results in the government (i.e. taxpayers) paying for the health insurance for the very people that were supposed to be the cost backbone of the legislation as a whole. Companies can’t be blamed for taking the part time route. In a difficult business environment health care is a large expense to add to a company’s overhead. According to an article published in the Contra Costa times, even call centers set up by the government to spread information about the Patient Affordability Act are hiring mostly part time workers.

While this trend has certainly been exacerbated by The Patient Affordability Act (and the stats bear this out), the entire blame can’t be laid at the feet of Obamacare. Research done by GK Research shows that the current part time employment trend (as a percentage of total employment) started in 2002, which coincides with major Federal Reserve intervention into the economy. They went further to show quantitative easing has historically always been accompanied by a percentage increase in part time versus full time workers. This makes logical sense. Quantitative easing lowers borrowing costs below what they would be in a free market scenario. Lower cost of capital increases the likelihood of capital expenditure (fixed costs) which is often at the expense of labor (variable cost). Automation is the most obvious real world example of this. By lowering the cost of (financing) automation, the breakeven threshold for making the investment into equipment is lowered, making it easier for companies to use machines to replace workers. While not an appropriate topic for this article, GK Research goes on to show that quantitative easing, through a number of factors, increases the rich/poor gap and increases the difficulty to move up to higher socio-economic stratas, one of the base tenets of the American Dream.How all this adds up to affect investors I do not yet know.  I do know that it is material enough that I need to keep an eye on the proceedings and continue to try and position my investments in such a way as to maximize the gain and minimize the losses associated with the possible outcomes.  I do know that future tax increases are on the horizon in order to pay for the missing health care contributors.

Detroit Demise and Demographic Issue: When Stockton, California went into bankruptcy a couple of years ago it was a big deal for investors, especially municipal bond investors. However after a brief period of instability and the publishing of some doomsday reports from analysts, investors largely brushed off municipal insolvency and continued to invest on their merry way. While it remains to be seen how Detroit will affect the municipal bond market long term, there is no question that the Detroit issue dwarfs the issues of Stockton by many multiples. How bad is it? Detroit has been running a $100 million deficit per year since 2008. To put that in perspective, despite having only approximately 0.3% of the population of the US, the city alone rang up a deficit equal to roughly 1% of the average federal deficit over that same time period. The US federal deficit is shameful. Detroit’s, adjusted for the size of the population is 3 times as bad, as a CITY.  Additionally, as a percentage of the population, Detroit has a much lower base of tax payers than the US as a whole. We have documented previously in this newsletter how hard it will be for the US population to pay off the US debt. Detroit can’t, thus the bankruptcy. But it gets worse.

This past winter Michigan Governor Rick Snyder appointed Kevyn Orr as Emergency Financial Manager, in effect taking over the city government from the elected officials.  Mr. Orr spent the next several months going through the city’s finances (discovering many instances of accounting irregularities along the way) until going public with his bankruptcy plan for the city this past week. Mr. Orr reports that the city has $11 billion in unsecured debt and is proposing that these debt holders take a write down to 10 cents on each dollar of debt, a 90% write down on the face value of the debt. A cynic may ask, “Who cares? It’s just investors that will take the hit anyway.” In this case, the investors are mostly past employees of the Detroit government via their pensions or health plans. “Mostly” being defined as $6 billion of retiree health benefits and $3 billion for pensions, equating to 82% of the outstanding unsecured debt. This will never fly.

This leaves a situation where 1) The city can’t pay its obligations, 2) They can’t raise taxes because there is no one left to tax (the Detroit population has fallen by 25% in the past 13 years), 3) There is no chance the Federal Government is going to let the retirees take the hit (this isn’t to say the Federal Government is wrong or right in that decision), which results in 4) US taxpayers paying for Detroit’s years of mismanagement.

With several other large Michigan cities already in receivership and likely facing a similar fate, and several additional Detroit size cities across the US also in a precarious situations (according to the Wall St. Journal this includes Philadelphia, Oakland, and Chicago) it seems investors should be spooked, even if just a little. To the contrary, the stock market continued its seemingly baseless climb last week. This is a bizarre investing world we live in. The laws of economics and finance can be suspended for a while but never eliminated. There will be an adjustment; probably large in scope and immediate in speed. Are you structured for such an event? Or are you at least aware of its possibility/probability and willing to accept the risks associated with your investment position?

Until next month,