For Your Consideration

Some time back, I was hopeful  that we could see an inadvertent renaissance in self-employment, as firms were reluctant to bring on full-time employees in the the current business environment we now call the “new normal“. Well, as hopeful as that post was, it may not come to pass if certain members of Congress have their way.

In January, Financial Advisor Magazine warned that “Rep. Jim McDermott (D-Wash) introduced legislation that would eliminate Section 530 of the Revenue Act of 1978, the so-called safe harbor provision that lets employers classify workers as independent contractors rather than employees as long as they meet specific criteria” and that Sen. John Kerry (D-Mass) introduced his version that “aims to kill Section 530, or at least make it more difficult and costly for businesses to incorrectly classify employees as independent contractors.”

More recently, Daniel J. Aguilar of Morrison & Foerster commented that the President’s proposed 2011 fiscal year federal budget includes a $25 million “Misclassification Initiative” for the U.S. Department of Labor, intended to target employers who (intentionally or unintentionally) misclassify workers. To accomplish this, the DOL plans to hire more than 350 new employees, including 177 investigators and other enforcement staff.

Mr. Aguilar also advises that the IRS is launching its National Research Project (“NRP”), which requires the audit of approximately 6,000 employers over the next three years. It’s goal is to “examine and compile trending information” in five categories (worker classification, fringe benefits, payroll taxes, expense reimbursements, and other related payroll issues) and “will require comprehensive audits” in an effort to close an estimated $15 billion employment tax gap.

Folks, this issue is a prime example of where regulatory, employment and legal risks intersect and one that is of prime importance to small business.

Due to the uncertainty this new proposal (amongst many other new government proposals) adds to the equation, businesses will continue to “hunker down“, depressing employment and economic activity in the process, as they attempt to ride out the storm. And while there will always be pockets of the economy where the sky is clear, structural debt stresses in the U.S. and global economies not only remain, but intensify.

—

In the end, however, I don’t think the heavy-handed approach will ultimately prevail, despite the best effort.

For every law that is created or “reform” enacted, there are hundreds of millions of people (some with very smart and talented attorneys) that will utilize their God-given talents to “game” the new system. And the more bone-headed and misguided the law, the more genius the response tends to be.

And it’s only a matter of time before we witness the miracle that is American ingenuity again.

 
For those that have been following the Rod Blagojevich trial (or not), U.S. District Judge James B. Zagel recently denied a defense request from Team Blago to order President Obama to give testimony in the case. Normally this is a good ruling for a sitting president, but Blago is, by all press accounts, a loose cannon and this decision will not likely be the last word on the matter.

Essentially, Team Blago argued that the President had direct conversations with Blago and that these conversations are directly relevant and pertinent to the Blago defense. The Court wasn’t buying it and ruled in favor of the government, which as these things go, is not inconsistent with past efforts to compel testimony of a sitting president.

But this leaves the President in a curious position. If only Blago testifies as to these alleged conversations, they go unchallenged into the record. And I’m not sure that that’s necessarily a “good thing” for either the President or for the concept of Justice.

So a chess piece is moved. While the Court’s most recent ruling that the President is not ordered to testify at this time (which is by all accounts a loss for Team Blago), there may come a time when it becomes virtually necessary to do so, so that Blago’s version of events may be refuted. Hence, in the end a seemingly Big Win for Team Blago, as the President gets to be examined under oath. But I would maintain that getting the President to testify is not likely to be Team Blago’s ultimate aim, it is merely a means to an end. Team Blago is likely betting that the President might prefer that the Justice Department drop the case rather than to subject himself to what would very likely be a grueling deposition.

This is all part of the normal course of high-stakes litigation, folks, whether the warring parties are corporate or government. Litigation is a thinking-man’s game. Chess pieces are placed on the board, moved as needed and sacrificed at the appropriate time. But there are many ways to get to the “desired result” in litigation and the best strategists see the game on multiple levels, plan for almost every contingency, and have a process to move forward despite any preliminary legal ruling.

So, with that said, don’t be surprised to hear that the President has agreed to testify via video deposition to refute Blago’s one-sided (and potentially damaging to the President) version of events. Of course, the President’s answers cannot be perceived as evasive or unsubstantial, otherwise Team Blago will press any weakness in the President’s recollection and Blago’s “very clear” recollection of events will still prevail, potentially damaging the prosecution’s case.

I cannot conceive any other outcome, unless of course the matter is dropped by the government prior to this eventuality, which is of course, Team Blago’s ultimate aim and would provide the Biggest Win Possible for Blago.

…to the show that never ends. As many of you have noted, I took a serious hiatus from posting. During my time away, I did a lot of writing, but was thoroughly unhappy with the results.  I’ve missed you, though and so, I am compelled to return to share a few more nuggets of joy while I still can.

Instead of taking this opportunity to discuss the ever-apparent “employer’s revolt” where “less bad” is not better or that cheap money is sowing the seeds of the next economic crisis or discussing the increasing (yes, increasing) global meltdown risk (irrespective of the results of the upcoming so-called “Wall Street reform” vote),

or even the new health care responsibilities “entrusted” to the I.R.S.,I really just wanted to share with you a quote from Abraham Lincoln from his address at Sanitary Fair, Baltimore, Maryland on April 18, 1864:

“We can not fail to note that the world moves… We all declare for liberty; but in using the same word we do not all mean the same thing. With some the word liberty may mean for each man to do as he pleases with himself, and the product of his labor; while with others, the same word may mean for some men to do as they please with other men, and the product of other men’s labor. Here are two, not only different, but incompatible things, called by the same name - liberty. And it follows that each of the things is, by the respective parties, called by two different and incompatible names - liberty and tyranny.”

It is sad state of affairs that many feel the only winning move is not to play and that “going Galt” (where one refuses to lend one’s genius to the world) is logically perceived as the most rational course of action. And while Publilius Syrus’ (a first century B.C. Syrian slave) maxim “Bonis nocet quisquis malis pepercit- Whoever spares the bad, injures the good” is currently out of vogue, its return will very likely be at once stunning, vicious and unexpected.

We can only be kept in cages we cannot see.

Once the bad are no longer spared, and a rational risk/reward equilibrium restored, Publilius Syrus will smile and we will all come to know (or remember) who John Galt really is.

Late September UPDATE: Apparently quite a few Americans believe as I do. According to a recent Rasmussen poll, 78% support the idea of allowing all Americans the option of purchasing the same health plan that Congress enjoys. So with support for the current incarnation of the health care “reform” at 41% approval, the question you must ask yourself is why Congress keeps pushing a plan on a populace that clearly doesn’t support the effort. I maintain that the answer lies in the concept of a “scheme of control” and fundamental loss of individual liberty. 

——

Few days go by that I’m not drawn into a conversation relating to the health care debate. And today, I got an email from a friend and attorney asking my thoughts on the subject. Politically, he and I are generally diametrically opposed, but he is a great guy with a sharp and inquisitive mind. We laugh a lot when we’re together. I consider it my honor to spar with him.

His position: [It] “seems to me the big issue that has been alluded to but not really spoken expressly is shifting the health economy from a finance and profit based model to a care based model.  The reliance on insurance companies and their place in the financial sector is what has to be addressed, as well as the fact that the consumer is not choosing the provider.”

I share with you now, my complete response:

For the sake of brevity, I think the President could go a long way to “ensure choice and competition”, by the adoption of a one-page bill: one that would give the general public access to the 300 or so insurance options that the federal government employees currently enjoy. The positives should be immediately recognizable: complete portability, affordability, lack of a employer-mandated solution, no waiting period for pre-existing conditions, etc. Some great progressive ends, wouldn’t you agree?

If paying for the insurance is still an issue for some, a solution like the Earned Income Tax Credit might be appropriate- in which the federal government, either by direct payment to the provider or via the 1040 form, can help subsidize the expense. Don’t misunderstand me, I am concerned about the constitutionality of these programs, but I’m also a realist.

I am also aware of the “creeping incrementalism” social programs generally exhibit, and think there are reasonable concerns over the increasing cost of the social compact of 3 generations ago, one which has not kept up with medical advancements. In short, my opinion rests on the following posit: there can be no social programs if we’re bankrupt.

Further, I have grave issues with what amounts to “generational theft”, as I see it as immoral and unethical. It does not matter how much our government requires, it is never enough. I agree with the progressives in one specific way: a revolution is occurring and cultural battle-lines drawn. I’m not suggesting that the revolution will be one of violence, but it certainly is being televised!

Hope I haven’t offended, I’m merely relaying the truth as I see it. You deserve nothing less. I would appreciate your candid thoughts. It’s only through rigorous examination of our positions can we be certain of their value.

There are mornings I wake in a “Groundhog Day” grip. The clock blithely reads 4:45am, the parking lot spot: 2278; familiar faces greet me as I pass them on the side streets of the city. I count how many times I’ve seen each and marvel as the numbers reach 5, 10… 15.

I wonder if they find my regular presence in their world at all unusual. In a place of over 8 million souls, it’s remarkable to view the same ones so consistently. It draws me to a question: are these moments a lucid dream of my sole creation or do I reprise a recurring role in theirs? Is the notion of free choice a sadistic joke or something real? With each morning eerily similar to its predecessor, I do not pose these questions lightly. I fear the answer.

As acts of defiance, I walk different paths to change the view. I steal moments to read new periodicals, smell new smells: Halal mixed with urine and steamed subway ventings. To break monotony’s hold, I change travel timings: an earlier train in and a later train out. I am iced coolly and a kid for today.

.

We choose the cage of our own desires and perhaps I am opening my eyes. Perhaps others are doing this in their own way as well. Perhaps I stand changed. Perhaps an end is in sight and the latest challenge will present. Perhaps everything will work out in the richness of time. And perhaps, just perhaps, as I breathe deep, slow my pulse to mentally mark the moment, this late evening in the city is warm and calm just for me.

Since “in the long run we’re all dead”, I’ve been wondering lately if I’ve been letting my “bad-attitude” get the best of me. You see, it’s getting increasingly difficult to see the proverbial light at the end of the tunnel. Forget the economic stats, there is a sense of unease and general “un-wellness” in people that’s positively unsettling.

My work has had me in Manhattan daily for months and the arduous commute is a ritual that almost must be shared to be endured. To that end, I’ve made some “single-serving” friends, nice people that I talk to regularly during the commute to help pass the time, but whose relationships are limited in time and space. A woman I’ll call “Aural” is worried about President Obama’s seeming naivety and the possibility of what she calls, “another 9/11″. We swap stories on where we were and how we felt on that fateful day. It’s hard to tell her not to worry.

“Mike” sees the twisted humor of it all but worries about what kind of future awaits his kids. I can relate. It is hard to have confidence in our leaders when the person third in line to the presidency alleges that the CIA (and impugns the entire intelligence community in the process) has misled her and Congress about “enhanced interrogation techniques”.

and

I see this as a binary expression: either the Speaker has made a false accusation and should be removed from office or it’s the truth and we should bring those responsible to justice. I can’t get anyone to take odds on either one happening. As of yesterday, Madam Speaker stands by her accusation.

“Earl the Hip” is trying to make it to the end of his middle management career working for a large quasi-public entity. His tired and vacuous eyes are periodically punctuated by staccato rumblings about ineptitude people at work and the relentless uselessness of time spent there. He figures if he can eak out a few more years without getting “right-sized”, he’ll bail with his pension. I see in him the present and future of many. He counsels me on “being in cash” but I counter that I’ll “see his cash and raise him” via inflation. I explain that he may feel safe being in cash, but he’s likely to lose on a real, (post-inflation) basis.

I find it palpably ironic that the person to whom the “long-run” quote is attributed, British economist John Maynard Keynes, is most well-known for his work on the theories of interventionist government policies. The central theme of his work is that “modern capitalist economy does not automatically work at top efficiency, but can be raised to that level by the intervention and influence of the government.” (From Wikipedia). So essentially, anything a free-market economy can do can be outdone by government. Certainly from a spending point of view that is true.

I find it both humorous and sad that it’s the foreign press that’s beginning to see through the “news-speak” passed as journalism which we are spoon-fed from an adoring media. The main idea in this article from the U.K.’s Guardian, is that political risks usually relegated to third-world countries, are now present in the United States. This was once unthinkable as the most stable nation of laws, but the capricious and arbitrary nature of the intervention of the federal government in private enterprise cannot help but be a chilling pall over the stimulation of investment in America. Who wants to play a game when the rules not only can, but are now expected to, change as the political winds blow?

There will come a day when the interventionist party will be over, the guests will be left to recover from the proceedings and the property owners will be left to salvage what remains. The landscape will have been irreparably changed.

For many years, I have wrestled with the idea of working for a Masters degree. Many things kept me from this pursuit: work needs, lack of time, family needs, you name it. There also was that nagging “value-proposition” problem…. I couldn’t find a Master’s program that qualified me for more than a $75,000/year middle management position. As an owner of my own business, the idea of spending the time, energy and money to obtain a Masters for a position I was over-qualified for seemed rather silly. 

Fast forward a quarter of a century….

In my risk management studies, I met an individual (hat-tip to George) who turned me on to the possibility of using the graduate credits earned from my ARM and ARM-P coursework towards a Masters degree. I began investigating this possibility and found the Salve Regina University willing to accept at least 12 graduate credits towards the 36 needed for the conferment of a Master of Science in Management with a Risk Management concentration. I will be petitioning the Dean of Graduate Studies to accept 6 additional graduate credits once I complete my Associate in Commercial Underwriting (”AU”) designation, scheduled (if all goes well) for June 1.

Almost all of the work is online and much of it self-study: right up my alley! To that end, I decided to apply. My first assignment: “Provide a detailed statement which describes academic and professional experiences which will make a contribution to your pursuit of a graduate education at Salve Regina University. Include in this statement any unique aspects of your experience relevant to your intended course of study.”

My graduate admissions statement follows:

I find it humorous that as I sit here wrestling with an appropriate application statement, I am transported back 25 years or so wrestling with my USC and NYU application statements as if it were yesterday. In that sense, my experience is circular, with everything old being new again! I am smiling because it’s “interesting” to try to sift through a quarter century of life trying to figure out what experience should be highlighted in such a statement. And by “interesting”, I mean “pointless”!

Every thing I’ve done and every person I’ve met and every experience experienced has led me to this point in time, the “here and now”. Every person helped, every person counseled, every life touched is a part of what constitutes me as me. For me to attempt to judge which experience was more important than another strikes me as folly. So let’s recap…!

NYU days were hectic. I worked full time in the family’s trucking business my junior and senior years and took night courses and summer sessions to keep up. I did not do this by choice but the family business was struggling and I needed to pull my weight. I paid for my own education and therefore understand its value. Soon after my Bachelor’s conferment, the family business failed. Shortly after that, I was married to my bride, moved and started a new job all in the span of 30 days. It was during this time that I consciously learned and accepted that the only constant in this world is change.

And many things did indeed change: I “fell into” the insurance sales business by accident and with my first home and daughter on the way, I had to figure things out very quickly. One thing I figured out quickly is that insurance sales producers could be broken down into two groups, one being so-called “social” producers, relying upon who they knew and not what they knew to make a living, or “technical” producers, those relying upon what they knew rather than who they knew. Since I didn’t have an effete, “social” background, you can pretty much guess which group I was relegated to!

I have yet to meet the person that grew up wanting to be in the insurance industry. A policeman, a fireman, an astronaut, yes, but not one insurance actuary, underwriter or risk manager. I think that this is the reason why there is such a lack of empathy, compassion and passion associated with the insurance industry. Its members think in terms of insurable risk,insurance contracts and how much the commission is going to be on the policy they just sold. After 20 years of practicing, I can tell you that the best insurance practitioners listen to people and find creative solutions to the problems faced.

At his trial for heresy, Socrates is acknowledged to have spoken “The unexamined life is not worth living”. In times of quiet, I close my eyes and allow myself to relax. In these moments of introspection, I listen and allow myself to hear what my heart is telling me. And what I’ve heard are the most important things, things that have shaped the tapestry of my life.  Among these “important things” is that I need to be a life-long learner not just to expand knowledge for its own sake or for personal hubris, but to deploy this knowledge to better the lives of others. Willingness to assist others is not enough, as it must be matched with commensurate ability.

Which is why, after 17 years from the conferment of my first professional insurance designation, I decided to listen to what
my heart was telling me and have dedicated two or so years to a remake, a refresh, a re-do. I chose the study of risk management in all its forms because it was the most natural progression from insurance. With it, I took my first steps into a much larger world. What I soon learned is that for all these years I had been applying risk management techniques and risk control mitigation in solving problems, I just never knew the language and could not articulate the ideas and solutions as well as I can now. I became aware, that despite its vast nature, just how small the world of insurance was.

Since January 2008, I have formally studied risk management at the AICPCU/IIA and National Alliance for Insurance Education and Research and have attained many acknowledged advanced technical designations. Conferment of a Masters degree in Risk Management will break down many walls to understanding, and give those whom I meet and help added comfort in my ability to adequately address the pressing problems they face.

I do not know what the future holds, but when the time comes to stand before my Maker, I do not want Him to think I’ve wasted my life, after all He’s given me.

This is a massive post for which I apologize in advance. Hope you have some time.

To my eyes it seems that society’s perception of risk is getting closer and closer to the actual risks we face. I have been a staunch proponent of markets ’self-correcting” and I have not minimized or sugar-coated the “pain” likely to be felt during this process. But my cautious optimism has in large part been based upon the political and regulatory processes of our country not radically changing.

But it’s right that we should expect change. The political wonks will tell you that it’s what the majority of voters “voted for” in November. While many can lament that more people didn’t ask for details of the proposed change, the reality of the situation is palpable.

Today, U.S. citizenry is faced with a dizzying array of emerging, high severity risks:

•     Surveillance Risks
•     Access to Information
•     Taxation Risks
•     Inflation Risks
•     Social Engineering Risks
•     Financial Risks
•     Regulatory/Political Risks
•     Class-Warfare Risks
•     Job and Home-Loss Risks
•     Loss of Liberty Risks

Probably not since our country’s founding have such a confluence of ideas and issues been thrust to the forefront for society to work out. Some thoughts on each risk follows:

• Privacy and Surveillance: Advances in technology has made it possible for government to surveil hundreds of thousands, even millions of people at relatively low cost. Whether the surveillance takes the form of monitoring computer searches or through security cameras the result is the same. I am appalled by the disingenuous nature of “marketing” these programs, using the guise of “protecting the public” by “helping fight crime” or “making the streets safer”. Privacy is a linchpin of liberty and the more we relent to intrusive surveillance, the more liberty is lost.

• Access to Information: In 1989, the modern internet was born when “Tim Berners-Lee invented a network-based implementation of the hypertext concept” (which we now call the world wide web). It is hard to imagine modern life without the internet. But our growing dependence upon “easy” access to information is a risk in and of itself as information may be withheld or corrupted to serve the needs of those who control not only the information itself but its flow and availability. The growing rate of loss of print media is also an alarming trend as we can envision a time when information is only disseminated through the internet.

• Taxation: The recently passed “Stimulus Package” at its heart is morally corrupt, as it makes future generations financially responsible for our folly today. Higher rates of taxation and new taxes not yet devised are a virtual certainty. Monies surrendered to a government means that it cannot spent in the “regular” economy. Taxation however, has a potentially dark underbelly as well. It can be used as a tool in social engineering, where taxed activities can be monitored. A recent idea of taxing people on the basis of the number of miles they drive rather than on how much gasoline they burn is only one step away from monitoring the who, what, where and when of such usage. See Privacy Risks.

• Inflation: A cousin to Taxation Risks. A natural consequence of “inflating” money supply in an economy is inflation, which is the loss of purchasing power over time. We intuitively understand this concept as the cost of goods and services tend to increase over time. However. as a result of current monetary policies, we can expect much higher rates of inflation in the near term future. The good news is that a little inflation is better than deflation, which is commonly defined as a “persistent” decline in the costs of goods and services.

• Social Engineering: For those unfamiliar with the term, social engineering can be thought of as those “efforts to influence popular attitudes and social behavior on a large scale”. Social Engineering is glaringly apparent in a bill currently circulating in the Illinois General Assembly, (HB0687). The bill, if passed, would amend the current Illinois Firearm Owners Identification Card Act to require firearm owners to provide proof of liability insurance in the amount of at least $1,000,000 specifically covering any damages resulting from negligent or willful acts involving the use of such firearm while it is owned by such person. As of today, lawmakers sense that they will not be able to suspend the Second Amendment to our Bill of Rights, so we can look at this proposed litigation as an attempt to circumvent it. Issue #1: the proposed law will require an insurance policy that covers “negligent and willful acts” of firearm usage. Good luck finding that today. Issue #2: if such a policy is not obtained, the owner’s firearms are subject to seizure. If something cannot be banned, there are those that seek to control it.

• Financial: A picture is worth a thousand words. As of this writing, the Dow Jones Industrial Average is shown directly above, which as of this writing is down more than 16% YTD. The basic problems? Lack of trust, lack of transparency, and lack of ethics. Increasingly, we do not trust our elected officials to get it right. Changing rules of the game “while the ball is in play” is particularly troublesome and does not assuage the people that make up the markets.  The Fed’s refusal to disclose the recipients of over $2 TRILLION dollars that not one American citizen or his designated representative voted on is completely unacceptable. In an information vacuum, trust suffers. In the “lack of ethics” department, think Madoff, Tom Daschle, Tim Geithner or Rod Blagojevic, all involved in some violation of trust. Simply speaking, without trust (which flows naturally from open and ethical frameworks), financial markets will continue to exhibit weakness and society will bear the brunt of its full force.

• Regulatory/Political: More and more, this is aligned to Financial Risks as New York and London cede financial power to Washington DC. So long as we delude ourselves into thinking that Washington has the answers to all our problems, the higher the frequency and severity of risks CAUSED by the political process. I promised a friend I would not mention that the “cult of personality” of some of our leaders today poses its own set of risks.

• Class-Warfare: a cousin to Taxation risks and an increasingly closer cousin to Political Risks. Societal unrest is an increasing possibility as battle lines of class-warfare are being drawn. There does seem to a bubbling sense of unease between recipients of governmental programs and those tasked with “paying the freight”. I sincerely hope this doesn’t rip us apart.

• Job and Home Loss: Simply speaking, the rock upon which our modern society stands (or falls). Job losses can cause an “infinite vicious regress” of home losses, which results in tax-base erosion, which results in lower tax amounts to government, which further strains government resources, which has to increase tax rates, which may result in further home losses and so on. (I’ve always wanted to use the term “infinite vicious regress” and now I have!)

• Loss of Liberty: By far, the risk that concerns me the most. Without blatant political commentary, I ask that you remember and consider this one risk as time goes by and events unfold. It is likely that this will take the continued form of “incrementalism“, where small liberties are asked (or demanded) as a “reasonable” trade-off for perceived safety. This is a close cousin to Privacy/Surveillance Risks, but be aware that the more power we relinquish to our government, a commensurate loss of liberty results.

.

While our future is uncertain, being aware and thinking carefully of the emerging risks we face will put you ahead of the curve. As always, I look forward to your comments!

Given our recent proclivity to nationalize financial “pain”, it seems that it’s only a matter of time before those very well-heeled hedge funds (and their very well-heeled investors) taken in the $50B Bernard Madoff ponzi scheme will formally request a bailout of their own. I suspect it will happen very shortly after January 20, 2009 and just might be one of the first national policy “tests” of our new President, Treasury Secretary and SEC Chairperson.

From this recent Newsday article, “There’s no doubt that hearings will be held on this, and some government aid is a very logical request,” said Robert Schachter, an attorney with New York-based Zwerling, Schachter & Zwerling, which is representing several Madoff victims. “If we’re bailing out Wall Street and the auto industry, maybe these individuals should be bailed out too.”

When the time comes, will you blame them for making this, using Mr. Schacter’s own words, “very logical request”? Especially in light of the SEC’s own press release on the issue which reads in part…

“The Commission has learned that credible and specific allegations regarding Mr. Madoff’s financial wrongdoing, going back to at least 1999, were repeatedly brought to the attention of SEC staff, but were never recommended to the Commission for action. I am gravely concerned by the apparent multiple failures over at least a decade to thoroughly investigate these allegations or at any point to seek formal authority to pursue them.”

Well if that isn’t a prima facie admission of negligence, I don’t know what would qualify….

In fact, read for yourself the SEC “Case Closing Recommendation” which plainly states that the SEC staff “found no evidence of fraud” as of November 21, 2007.

….This has not gone unnoticed by the legal community as Phyllis Molchatsky has filed an “administrative claim” against the SEC for damages due to its alleged failure to protect investors.

Luckily for the SEC, like most government agencies, it operates under the doctrine of sovereign immunity, which means that for all intents and purposes, “the king and queen can do no wrong” and cannot be sued under most circumstances.

But such claims against the SEC will provide “cover” for the politicos who’ll support the notion of a Madoff claimant bailout. And thankfully for them, they don’t have to look very far for the potential sponsor of such a bill: Senator Frank Lautenberg of New Jersey, who entrusted his family’s charitable foundation to Madoff. According to the Senator’s attorney, Michael Griffinger, the extent of the foundation’s losses is not known as yet, but “that the bulk of its investments had been handled by Madoff.”

………

Still, I am struck by some of the most basic and glaring risk management deficiencies as the facts of this matter emerge…

In the risk analysis phase of the risk management process (once risks have been identified), assessments of potential impact on the firm are reviewed. If done comprehensively, both quantitative AND qualitative analyses are performed. Quantitative analysis deals with so-called “hard numbers” and includes a review of things like projections of loss, cost/benefit analyses and net present value calculations.

Well-trained financial “quants” on Wall Street get paid “the big bucks” to do these type of analyses, and their reports are usually quite impressive on paper.  The problem is that too many financial and business decisions are made on the basis of these “impressive” reports/projections alone.

Without a concurrent review of the qualitative risks undertaken, the risk analysis is INCOMPLETE and can lead to unforeseen and financially disastrous results as evidenced by the recent collapse of so many financial services firms.

Qualitative risks are by definition, difficult to define as they are not “hard number-oriented” and rely to a great extent on the experience, judgment and intuition of the members of the risk management team.

I think the primary reason I see almost no discussion of qualitative risk analysis undertaken is because IT IS HARD TO DO. It is also time-consuming. It requires a thorough understanding of the business, its processes, and its place in the physical, organizational and socioeconomic environments the business operates in. It requires people who are TRAINED IN RISK MANAGEMENT TECHNIQUES, not just financial wizards who can make a report read however management wants it to read. Finally, it requires corporate management support, which is notoriously difficult to get (and keep).

………

Despite the political grandstanding that is likely to happen when this matter is undertaken by Congress, we cannot legislate greed out of existence and scams like this will come to light in the future.

In Errol F. Moody Jr.’s discussion of “Investment Malfeasance and Breach of Fiduciary Duty” (which is an excellent read and is VERY highly recommended reading), he makes the case that for all intents and purposes, matters such as Madoff all come down to the same issue: “a failure to gauge risk”.

Clearly, the risks posed by Madoff were either not identified or analyzed properly by investors and a price for failing to properly manage risk shall be exacted.

The stack of stuff I want to share seems to be growing by the day… too much stuff and not enough time! So instead of writing fewer/longer pieces, here are a few succinct words of advice/counsel on each subject in one “omnibus” post. Hopefully, you’ll find a “nugget of joy” that’s of use to you and I can start to cut through my growing stack of stuff. So, let’s get to it…

1. Putting money in bank CD’s may seem like the safest choice today, but it might not be. You’ll be told that these things are “riskless”. They’re not. The one primary risk they don’t tell you about and that you retain (and it’s a biggie!) is inflation risk. Very simply. when the inflation rate is higher than the CD’s APR, you’re losing money. Historically, the one asset class which has a real return ABOVE inflation is equities. With stocks “on sale” at about 40% off, you might consider “buying low” today if you have the time to wait until the market recovers. I suspect that 10 years from now, you’ll wish you put every dollar you had in now.

2. Every personal insurance policy should be reviewed annually to make sure it still meets your needs. Take some time to do it. You might find that coverages can be eliminated, deductibles can be increased, insurers can be changed, etc. to reduce your insurance cost.

3. Every small-business owner should review their insurance program annually as well. If your business operates on a 10% operating margin and you save $10,000 in premium, the savings was not just $10,000- The real savings is $100,000 in gross sales you didn’t have to make just to pay the insurance premium.

4. The “annuity vultures” are out in full force. They usually take the form of “investment advisors” working for insurance agencies and especially prevalent in poor economic times, such as today. They prey on your fears that you’ll run out of money before you die which they cryptically call “longevity risk”. There’s 3 main reasons you should shun: 1. These are extremely complex insurance contracts. Most come with a 200-300 page prospectus. Unless you read and understand all those terms and conditions, be ready to get hurt. 2. Annuities are guaranteed by the issuing insurer- want to make any bets on which insurer(s) are going to survive? 3. COSTS. Depending on the insurer and the particular product being promoted du jour, the underlying costs of the annuity are outrageously high. Remember, the agent needs to be compensated for selling you this complex contract. You’re the one paying the freight.

5. If you have a private disability (DI) policy, look to increase your “elimination period” (which is a essentially a deductible measured in time, not dollars) to decrease your cost. I recently changed the elimination period on one of my DI policies from 30 days to 90 days. When the policy was originally written, I could barely afford to be without an income for 30 days. Blessedly today things are a little bit different. I saved over 25% in making this one change.

6. Our preconcieved notions and the media shape perceptions of risk. Do you really think that Congress knows how to “fix” the economy? Do you really have faith in their stewardship? Should we allow government to grow or would you prefer that industrious, entreprenurial Americans be tasked with our economic recovery?

7. Turn off CNBC. Stock market-timers have to be right not only once, but twice. Even Warren Buffett can’t do it. The stock market-timers “Hall of Fame” is an empty room.

8. Remember, it’s all relative. All assets are being repriced. Globally. There’s no place to hide. Forget U.S. Treasuries with their 0.01% interest rate. Invest in your own education. You want security? Look in the mirror. It’s the only place in this world that you’ll find it.

9. Worry only about the things you can DIRECTLY control. Everything else will take care of itself and you’ll save yourself a lot of heartache.

10. Continue to fund your 401k. If enough people opt-out, these tax deferred programs will go away and that’s not a good thing.

11. If you’re in business (or work for one), don’t forget to advertise and market the goods and services you provide. Your competitors aren’t and it’s a great time to steal market-share from them.

12. You may have noticed the increase in advertising by gold sellers, I know I have. Before buying, understand that gold has a ZERO expected rate of return, as it produces NOTHING. Gold has no intrinsic value, only the value we ascribe to it. You’re also going to need to buy A LOT of it to make it “worthwhile”. Where you gonna put it all?

13. Taking medications (legal ones, that is)? Want to try to save some dough? Live in NJ? Try www.njdrugprices.nj.gov for an online prescription drug registry. Prices for a one month supply can vary widely, even within the same zip code. It works surprisingly well.

14. According to John Montgomery, Founder and Portfolio Manager of Bridgeway Funds, there have been nine bear markets since 1940. The average time for the stock market to “recover” to its previous high is 13 months (excluding this current bear market). 13 Months- a little over 1 year. Of course, this time may be different but know that historically speaking, if you can keep your head when everyone has lost their’s, you’ll be well-rewarded.

15. THIS IS NOT THE GREAT DEPRESSION, PART TWO. We do not have 25% unemployment and the only thing we stand on lines for are HDTVs, not bread! Don’t “buy” the doom and gloom the media is “selling”. It’s all meant to manipulate.

Go live your life. Smile and be grateful.

“What we anticipate seldom occurs; what we least expect generally happens.”- British prime minister and novelist Benjamin Disraeli.

Risk managers understand that there is a price (or cost) to uncertainty. For example: money spent on a loss which did not occur was still spent. But you don’t have to be a “risk manager” to understand this, we know this from our own daily experience. Almost any variety of insurance expense incurred that went “unused” such as life insurance (because you didn’t die yet) or auto insurance (for a loss which did not occur during the policy period) was still spent. It is gone, ostensibly to pay for someone else’s loss (plus a portion for the insurer’s operating profit). This doesn’t nullify the need for the coverage, it just means it wasn’t “your turn” at the insurer’s trough.

Similarly, anticipated (projected) future losses may be worse than projected. They can be better (meaning “lower”) than expected but this seldom occurs in the wild. This usually occurs when a loss that happens today is not paid out by an insurer for years, which usually occurs with liability exposures. For example, take a situation where someone is injured severely in a car accident you caused and litigation ensues. The litigation process alone can take years to resolve. In the meantime, the prudent insurer has to put aside the money that it expects to pay for the loss, or hold it “in reserve” until the claim is resolved and the loss is ultimately paid.

As you can imagine, the process of reserving losses is just as much art as science. Most of my actuary friends (very, very smart numbers people) agree as these are the folks who are brought in to review these future losses regularly and to make sure the entity has the money to pay for the loss at that future date.

One of the factors used in their quantitative loss analyses is called an “uncertainty factor“. Think of it as (to paragraphrase ex-Defense Secretary Donald Rumsfeld), the “unknown unknown“. Most people know this term from their daily lives as the “fudge factor”, used when a variety of outcomes could ensue from a single event. Because all types of activity entails a certain level of risk, (including getting out of bed this morning to go to work), we can deduce that all activity contains an element of uncertainty.

I strive to keep political discourse here to a dull roar, except where it directly intersects the discussion and application of risk management techniques. For the past two days, the pundits are wondering why our financial markets have dropped about 10% since the results of the election. It’s uncertainty in action, folks. No one knows how President-Elect Obama will govern and perhaps a sense of buyer’s remorse is in play.

Added to this, is the stark realization that the $850B bailout isn’t necessarily going to help in the near term and that the federal government (that’s us guys!) may soon be in the business of bailing out individual state governments, instead of forcing them to live within their means. Of course, these events will only continue to destabilize and debase our currency because all we have left to do is print more money to “pay” for these bailouts, since no foreign government seems to be interested in buying our debt today.

We also don’t know the rules of the bailout lottery, as in why do some companies get bailed out (AIG, Bear Stearns) and some don’t (Lehmann Brothers)?  We had a perfectly good remedy for companies that could no longer operate, it was called bankruptcy. It was messy, it took time, but it worked and we as a society understood it. Now we’re in unknown waters as no one can explain to us how the rules of the bailout lottery work. This apprehension breeds more uncertainty.

And as uncertainty grows, our economy, financial markets and society weaken.

Back in 2002, I was spending my time full-time educating myself as to the academic underpinnings of markets. I was uncomfortable investing with alleged financial experts without having a basic understanding of the language of and the basis for their investment ideas and techniques.

One of the very first things I learned was that according to academic research, over 95% of all investment returns was determined by your asset allocation. It should not surprise that a portfolio of 80% stocks and 20% bonds has a greater *EXPECTED* return over time than a portfolio constructed of 60% stocks and 40% bonds, yet this simple illustration eludes many.

Of course, because the 80/20 portfolio has higher EXPECTED returns, (by most commonly used risk measures) it is also more “risky” than the 60/40 portfolio.  One can slice and dice these portfolios (US vs. International Stock, Large vs. Small Stock, Growth vs. Value Oriented), but that is not the subject for today.

What I wanted to share was some insight and assistance in choosing an equity percentage from some of the finest academic-oriented financial authors, both of which I have listed in the Reading Room.

Authors William Bernstein (WB) and Larry Swedroe (LS) have published some guidelines relating to this issue. Both agree on two major points:

1. Determine your maximum tolerable percentage loss from the following tables,
2. Use the LESSER of the amounts shown to determine your maximum equity exposure.

Maximum      Maximum
Tolerable      Equity
Loss             Exposure
———- ……  ———-
5% …………….. 20%
10% …………… 30%
15% …………… 40%
20% …………… 50%
25% …………… 60%
30% …………… 70%
35% …………… 80%

This first table deals with a “stomach acid test“. If your heart starts palpitating at a 10% stock market loss, according to the first table, your maximum equity exposure should be no more than 30%. However, the “stomach acid test” is only the first gauge- we need to think in terms of time.

Accordingly, a person needs to consider the time horizon as to when funds placed in the stock market need to be “repatriated back” for use as originally intended. Both authors have a slightly different take on this issue as shown in the following table:

.                     Max Equity
Investment     Allocation
Horizon           WB … LS
———- ………. —– … ——
1 year ………. 10% .. 0%
2 years ……… 20% .. 0%
3 years ……… 30% .. 0%
4 years ……… 40% . 10%
5 years ……… 50% . 20%
6 years ……… 60% . 30%
7 years ……… 70% . 40%

So, if you need the money that you’ve invested in the stock market in four years, William Bernstein recommends no more 40% allocated to the stock market. Larry Swedroe is much more conservative, advising no more than a 10% stock allocation.

My personal belief is that Swedroe is right, as four years is simply not enough time for the stock market to recover ground in the event of a severe downturn. You may need to sell at a most inopportune time (like today), negating the market’s historical long-term benefits. Of course, you would lose the opportunity for gain if the market trends higher over that hypothetical four year period.

So when you hear/read about those people “soon to retire” who now have to postpone retirement due to the state of the U.S. stock market today, ask yourself: Were these people getting the “right” advice on asset allocation?

It appears they were not.

Recalling a prior post (which recalled the “Death of Equities” from a prior era) is instructive if you can keep your wits about you. While pop psychologists and new agers repeat the oft seen “Danger + Opportunity = Crisis” it isn’t quite so. Risk is real. Market risk is real. And what we are seeing in the markets these last few days is the repricing of that risk.

“These are the times that try men’s souls” a phrase written over 200 years ago by a founding father, Thomas Paine, who knew a thing or two about risk. In his December 23, 1776 discussion of the our recent declaration of independence from Britain, he wrote about panics:

“Yet panics, in some cases, have their uses; they produce as much good as hurt. Their duration is always short; the mind soon grows through them, and acquires a firmer habit than before. But their peculiar advantage is, that they are the touchstones of sincerity and hypocrisy, and bring things and men to light, which might otherwise have lain forever undiscovered.”

Yes, our world is changing below our feet, but that doesn’t mean the end result is ruin. The market is gripped in panic, but it appears our final capitulation bewitching hour is nigh. I suspect this because the media has finally called the bottom with this gripping headline: ‘The World As We Know It Is Going Under‘.

Which to my eyes looks like this headline from AUGUST, 1979:

Now that the US taxpayer is now bailing out Fannie Mae, Freddie Mac and the home-debtor speculators (not to mention all the banks that are being liquidated by the FDIC) it might be a good time to ask this question: Who’s going to bail out the US taxpayer?

But wait, there’s more!  Why not bail out Lehman Brothers as well?

It just wouldn’t be “fair” if Lehman is denied the bailout status Bear Stearns, Fannie Mae, Freddie Mac, the banking industry and the home-debtor speculators have been afforded by our elected politicians from *BOTH* sides of the aisle.

It’s absolutely laughable that after 18 years at the Fed, ex-Chairman Alan Greenspan is warning not to use the Fed as a “magical piggy bank“. There apparently is no shame left in America.

In fact, why don’t we just nationalize the entire financial pornography services industry like our pols want to do with our health care industry? I’d wager there’s more fraud and wrong-doing in the financial services biz than in health care.

The US taxpayer might get a fairer shake then.

In a prior post, I mentioned that the US government debt is not $9 trillion as is most commonly reported by the main-stream press, but $53 trillion. Some of you asked for an outline of the difference:

It’s ugly. And it doesn’t include the most recent bailout numbers. Perhaps it would be better if Congress took off the next 4 years so we could catch up with the damage done.

Five short minutes containing audio of the late comedian Bill Hicks, video of Carl Sagan, and some Hendrix against a down-tempo, ambient dub music backdrop. Enjoy.

The game is to find out what you already are.