Could Merrill Be Takeover Bait?

A picture is worth a thousand words. And the picture above shows billions of dollars in lost equity for owners of Merrill Lynch stock. The graph traces the price of a share of Merrill's common stock over the past year. If you are a shareholder, you like to see that line move higher from left to right. Merrill's chart is doing just the opposite and is good only for short-sellers, who have sold borrowed shares at a higher price with the intention of buying them back lower.

Regular visitors to this page know that I like to beat up on Merrill. After all, they are the company that sold Maine $20 million worth of toxic commercial paper last summer. Treasurer David Lemoine has since had to write off that entire amount, hoping with fingers crossed that some of that investment is eventually recovered. Meanwhile Merrill, unable to sell more than a fraction of all that risky merchandise that it helped create, has plenty on its own books.

Another investment bank, Bear Stearns, is right now biting the dust. The last remaining order of business is to figure out what the outstanding shares are worth. JPMorgan Chase tried to pull a fast one earlier this month by offering just $2 a share. When angry shareholders speed-dialed their congressmen, the offer was upped on Monday to $10. The very next day Papa Bear Jimmy Cayne, Chairman of the Board, figured that was all the honey he was likely to get, so he dumped all of his 5.6 million shares at a price of $10.84. The proceeds of over $60 million may sound like a lot, but those shares were worth almost $1 billion before credit markets started collapsing in August. Before you start feeling sorry for ol' Jimmy, understand that he was off playing bridge when the run on his bank began. That got him fired as CEO.

The day after Jimmy cashed his chips, rumors were swirling on Wall Street that Lehman Brothers would be the next investment bank to fall. I have a passing interest in Lehman because the CEO, Richard Fuld, was three years ahead of me at Wilbraham Academy. Hopefully Dick has his golden parachute already fabricated and fitted. He has just enough time left to strap it on.

So what about Mother Merrill? This morning Massachusetts Secretary of State William Galvin announced yet another investigation of the firm, this time for the sale of auction-rate securities. "My office has received calls from people who thought they were investing in safe, liquid investments," Galvin said in a statement, "only to find that they had, in fact, purchased auction-market securities that are now frozen, and they cannot get their money out"--exactly what happened with the MaineFail, um, MainSail investment. Meanwhile, back at corporate HQ, the writedowns that began in the third and fourth quarters of 2007 will probably continue for another quarter or two. A falling stock price might entice a foreign buyer, who could touch up those old TV ads proclaiming that Merrill Lynch is bullish on... Brazil?

How Many Legislators Do We Need?

Consolidation is supposed to save Maine money. So, says Governor John Baldacci, let's reduce the number of school districts, the number of administrative agencies, and the number of jails. But why stop there? The case can be made that there is one other public entity with too many people: the legislature.

The Maine statehouse currently has 35 senators and 151 representatives. The total of 186 legislators ranks Maine 10th among the 50 states, even though Maine is 40th in population. The nationwide average is over 40,000 citizens for each state legislator; in Maine the number is 7,081. Only five states have fewer citizens per legislator, and four of those have populations of less than a million (Vermont, North Dakota, Wyoming, and Montana). New Hampshire has about the same population as Maine, but a huge legislature of 424 members, further proof that Granite Staters are way different.

One last tidbit. Maine has five more legislators than Texas with only 5.5% of the population. I ask again: how many do we need?

The number of legislators is set by the Maine Constitution. An amendment would require a two-thirds vote in both the House and the Senate as well as a majority vote in a statewide election. A year ago Representative Edward Finch (D-Fairfield) submitted a bill, LD 1552, to reduce the the number of representatives to 105. On May 22, however, the House voted 79-60 not to advance the bill, and Senate concurrence killed it. The House vote broke along party lines. Democrats, eager to preserve their majority, lined up 73-11 against the bill under the presumption that what is best for the party is best for Maine.

How much would LD 1552 have saved Maine? Reducing the headcount by 46 in the House, by my reckoning, would save around $900,000 annually in salaries and per diems and another $900,000 every two years in public campaign financing.

[update, March 27:]
The calculation above was based on annual salaries of $12,000 and per diem allowances for food/lodging/travel of $70/day x 100 days. But there must be other perks (e.g. health insurance?) that I am omitting. Ed Finch indicates in an e-mail that his bill would save between $1.9 and 2 million each year, not counting the Clean Election money. Golly, I'll just have to get myself elected to find out what all those perks are! They raise the cost of a representative in the Maine Statehouse to over $40,000 a year. Rep. Finch, incidentally, intends to re-introduce his bill in 2009 if re-elected.

Dig Now, Vote Later

Ambulance service in the River Valley is about to get a lot more expensive. The Northern Oxford Regional Ambulance Service (better known as Med-Care) wants a new building in Mexico to house its fleet--and wants it now. It is so eager to get going that it wants member towns to accelerate voter ratification of a new ten-year extension to the inter-local agreement that first went into effect in 1988. The current renewal is set to expire on June 7.

"It is certainly not our intention of trying to underhandedly break ground prior to all eleven towns affirming their desire to continue to have their emergency medical services needs delivered through NORAS," states Board President Stephen Brown in a December letter to the Peru Selectmen, before adding the caveat "however." Brown goes on to explain that any delay would add to the cost of the project and that, in any case, all eleven towns "will most likely be instructed by their voters to renew."

That perception of voter unanimity was shattered last Saturday when the Town of Andover voted not to renew at its annual town meeting. Undoubtedly the $2 million price tag for the new building loomed large in voters' minds, along with the 30 years of debt service to pay for it. But at a follow-up hearing three days later, Med-Care Director Dean Milligan reminded Andover residents that they are still on the hook for their share of the capital project anyway. The vote to renew the agreement is not the same as a vote to proceed with the project.

The NORAS Board, it turns out, does not need voter approval to borrow for a capital project. According to the inter-local agreement, "the Board shall have all necessary and incidental powers granted to directors of non-capital stock corporations under Title 13-B" of the Maine Statutes. And right there in Title 13-B, Chapter 2, Section 202 it says such a corporation has the power "to make contracts and incur liabilities, borrow money on such terms and conditions as it may determine, issue its notes and bonds and other obligations and secure any of its obligations by mortgage, pledge or other encumbrance of all or any part of its property, franchises and income." The inter-local agreement does stipulate that a debt obligation requires a two-thirds vote of the Board.

Despite the Board President's protestation, this seems to be a gun-to-head proposition for voters. The debt obligation practically forces the towns to renew. Peru residents may be reminded of the infamous inter-local agreement with Mexico and Dixfield 30 years ago for the construction of the wastewater treatment plant in Mexico that was to service all three towns. When grant money for the project dried up, Peru pulled out, but still got billed for many years for its share of the plant construction. In the bargain, Peru got to keep its effluent.

Perhaps Peruvians were hoping to avoid a repeat of that fiasco by voting affirmatively for renewal of the ambulance agreement in a December 10 referendum. Missing from the warrant article was any financial disclosure that Peru's monthly assessment for Med-Care service is due to jump by nearly 27% when the new fiscal year begins July 1. Nor was there any disclosure as to what kind of interest rate NORAS is likely to get. The municipal bond market is a tough place to shop merchandise these days.

Maine Goes to Market

Was this free money, or what? Maine voters seemed to think so, last year authorizing the State Treasurer to borrow up to a quarter of a billion dollars for all sorts of good things--road improvements, economic development, land acquisition, water protection, building renovations on college campuses, etc. The list was split between two ballots five months apart, perhaps under the hopeful notion that two smaller lists might somehow cost less than one big one. And we bought it! Channeling old Alka-Seltzer commercials, I can't believe we ate the whole thing.

Fortunately, the Baldacci Administration is not spending the whole thing right off. Treasurer David Lemoine explains in an e-mail that Maine seeks to reduce borrowing costs by "borrowing no more than is needed, no sooner than we need it." Allocations are made on a quarterly basis through Bond Anticipation Notes (BANs). The notes mature at the end of each fiscal year, at which time "we go to the markets for long term (up to 10-year) bonds and use the proceeds to pay off the BAN debt. We work throughout the year with the agencies, legislature, Governor and underwriter to match debt service with budget."

As of Monday Maine had rung up BAN debt of $88,820,000--roughly one-third of the total amount authorized by voters in 2007. So in June we will have to issue general obligation (GO) bonds totaling at least that much, or one-fifth of the total GO debt already outstanding as of December 31. This will reverse a three-year trend of declining GO debt. Maine's annual debt service comes to over $100 million, and that figure is rising.

Maine tries to time its borrowing to actual need, but not to interest rates. In Lemoine's words, a relatively steady capital improvement plan allows for costs to "even out over time. This approach also provides for a more level budgeting approach from year to year." So even with impaired credit markets in 2008 and increased volatility in long-term rates, Maine will conduct business as usual.

Earlier this month Lemoine joined the treasurers of ten other states in a petition to the three largest ratings agencies--Moody's, Fitch, and Standard & Poor's--to have the same rating scale applied to municipal markets that is used for corporate markets. State issuers are currently held to a higher standard than corporate borrowers even though their default rates are historically lower. As a result, states such as Maine (rated only AA by Fitch and S&P) have incurred higher borrowing costs by having either to buy bond insurance or to swallow higher interest rates. Lemoine figures the penalty came to $78,000 for the 2007 bond sale.

In a hearing last week in Washington, Massachusetts Congressman Barney Frank, chair of the House Financial Services Committee, gave the ratings agencies one month to unify their credit standards, or else. Moody's promptly offered to comply, but Maine needs the other two to do the same.

The Smell of Panic in the Morning

Robert Duvall in Apocalypse Now? Oh, right, that was napalm. But the financial equivalent is hitting Wall Street this morning with the news that JPMorgan Chase & Co. is taking under Bear Stearns for a measly two bucks a share. Bear Stearns was trading just below 60 at Thursday's close, but the stock price was cut nearly in half Friday when the investment bank announced that its short-term creditors were fleeing en masse. Shareholders are now looking for the nearest window from which to jump. It's a good thing Maine keeps windows close to the ground.

My concern has been that Maine will be going to market in June with general obligation bonds. Don't forget, we voters approved $265 million in new borrowing in 2007, half in June and half in November. Legislators had cleverly spread the package over two ballots so that we would perhaps not notice how big this number really is. Another $30 million on the June 2008 ballot will be the icing on the cake.

The bonding authority granted by the voters has triggered the issuance of Bond Anticipation Notes (BAN) to begin funding the projects sold on the ballots. The BANs will then be redeemed with the proceeds from the annual GO bond auction. With interest rates for municipal bonds going through the roof, my personal opinion is that we should be putting our capital projects on hold until the credit markets settle down. I have e-mails in to the State Treasurer and the Chair of the Legislature's Appropriations & Financial Affairs Committee requesting information about the upcoming June issuance. As they reply, I shall keep you posted.

The War That Will Keep on Taking

U.S. Senator John McCain, the presumptive Republican nominee for President, points to the rather depressing prospect that American soldiers will be deployed in Iraq not just for months or years longer, but for generations. That will cost money. With federal budget deficits continuing for the foreseeable future, it is money that we do not have. But even if we deploy out of Iraq tomorrow, the meter will still be running. How long will we be paying for the war's collateral damage? For generations.
Another year, another $300 billion - The Boston Globe

A reader of this morning's Maine Sunday Telegram suggests that this protracted conflict is by design. How does he know? Mainah47 of Lewiston, ME, reasons that Osama Bin Laden is still at large because we allow him to be. "We found Saddam in a hole in the ground. We can't find a very tall Arab-looking man, that needs dialysis?" Bin Laden's capture would be Mission Accomplished in the minds of many people, who would then call for an end to the American occupation. But private contractors are not done extracting profits yet. Mission Extended.

Forget the "R" Word, How About the "D" Word?

Please take a break from your regularly scheduled programming and check out what the Federal Reserve is up to. Although prohibited from buying mortgage-backed securities (the low-grade stuff that nobody else wants right now), the Fed proposes to do the next best thing. It will accept these securities as collateral for loans to banks stuck with them. Tricky, but will it work? Yesterday the stock market thought so; the Dow soared over 400 points.

Let us not, however, confuse a bear-market rally--typically violent but brief--with meaningful intervention. The Fed is offering up to $200 billion in this latest injection of liquidity, but that's like pissing in the ocean. The MBS market adds up to $6 trillion. Moreover, the Fed's new deal is a short-term lending facility that will need to roll over in 28 days. Wonder what the collateral will be worth by then.

These events in the credit markets are unprecedented in my lifetime and are beginning to draw comparisons to the 1930s. In the words of MSN's Jon Markman, "true panic has been kept at bay because the size of the potential losses has been underestimated at the same time that the redemptive power of government entities like the Federal Reserve has been overestimated."
Fed takes boldest action since the Depression to rescue US mortgage industry - Telegraph

Expanding Health Coverage: Step Two

Medicare may not be perfect, but it is the best we have. Big Government, often derided as being inefficient, often is. But when it comes to processing medical claims for Americans over 65, it outperforms the private sector. Just take a look at what the industry calls the "medical care ratio." To compute that ratio for any insurer, divide the total benefits paid for medical services by the total premiums collected during a given time period (MCR= benefits/premiums).

A private insurer will go bankrupt if its MCR exceeds or even approaches one. Insurance executives like to see their MCR down around 0.80, and they swap high-fives if the MCR decreases quarter-over-quarter or year-over-year. For them, lower is better. The difference between the MCR and 1.0 goes toward overhead and profits. Operating costs typically range between 10 and 15%.

For Medicare, operating costs are down around 1%, and there is no profit. So when a guy like Ohio Congressman Dennis Kucinich talks about single-payer government-sponsored health insurance, he is talking about recovering the nearly 20% of non-medical costs that support a private industry. He also tacks on another 10% to account for unnecessary paperwork in the billing offices of medical providers chasing after the private insurers, who make their money by not paying. I can tell you from firsthand experience (I am married to a self-employed speech pathologist and have done her billing for twenty years) that insurers can be quite creative and persistent in finding ways not to pay.

There are many reasons why Americans, who pay twice as much per capita for health care than any other industrialized nation, get less in return--lower life expectancies, lower rates of childhood immunization, higher rates of infant mortality. One reason is the skimming by private insurers. During their presidential campaigns, Republican candidates have offered tax credits to help offset the payment of insurance premiums. Cost-benefit analysis indicates that those credits would be better applied toward direct payments to providers.

Ultimately, as suggested by Marcia Angell, M.D. and Editor-in-Chief of the New England Journal of Medicine, we may want to extend Medicare coverage, dropping the upper-age limit to 55, say, and including all children five and under. Over time we could gradually shrink the uninsured middle, implementing cost-control measures as we go to make sure that we can afford the extension of coverage. The migration would be cost-neutral if any increase in taxes does not exceed the insurance industry's current 20% take.

Expanding Health Coverage in Increments: Step One

Fixing health care in the U.S. will take time. The hybrid system that we have now, part government-sponsored and part market- based, has too many moving parts to be easily repaired. A Big Fix, furthermore, is probably beyond the fiscal capacity of this, the world's largest debtor nation. We are going to have to do this in pieces.

One place to start is to expand eligibility for Health Savings Accounts (HSA). This will not matter to workers whose employers offer Flexible Spendings Accounts (FSA), allowing employees to bank pre-tax earnings to save up for future medical expenses. Individuals without such a benefit can set up Health Savings Accounts on their own, but there is one major hitch: they must first buy coverage under a qualifying High Deductible Health Plan (HDHP). In other words, you cannot self-insure with pre-tax dollars until you buy insurance first. Who but a lobbyist could have come up with that one?

Now, the reason that nearly 50 million Americans lack insurance is because they cannot afford to pay both the premiums for a high-deductible policy and the out-of-pocket costs required to spend down the deductible. When you think of it, high-deductible insurance is a mirage. By the time you accumulate medical expenses to offset the deductible, you have nothing left to pay the next premium. Your coverage will lapse before you ever access the promised benefits. That is why they call it "coverage without care."

Out of simple fairness, the prior-coverage requirement for HSAs should be eliminated so that people who do not have "cafeteria" benefits can enjoy the same tax advantages as people who do. Alone among the 2008 presidential candidates, Ron Paul proposes exactly that. A truly level playing field would also call for a rebate of any payroll withholdings on earnings directed into HSAs. John McCain would level the field the other way, by taxing cafeteria plans out of existence and instead offering personal tax credits to help cover medical expenses.

Lacking an HSA, the best a tax filer can do to recover a portion of out-of-pocket medical expenses is to claim a Schedule A deduction. But that deduction only kicks in after you have already spent 7.5% of your Adjusted Gross Income (AGI) on health care in any one year, which makes the deduction pretty useless for most people (Paul would grant deductibility to the first 7.5% as well). Let's face it, the tax code really wants you to buy insurance from the industry that helped write the code in the first place.

River Valley Youth Tighten Their Belts

As I post this, local teens are 19 hours into their fast, with eleven more to go. The 30 Hour Famine has become an annual ritual for Friends on a Mission, a youth group based out of the United Baptist Church in West Peru. They typically go from lunchtime on a Friday to suppertime on Saturday with nothing to eat and only water and clear juices to drink. They fill the hours with community service, camaraderie, and quiet reflection.

The event is meant to sharpen awareness of world hunger, and nothing does that better than a gnawing emptiness in one's own belly. While empathy is a good first step, the Famine also includes a call to action. Again this year, FOAM is raising hundreds of dollars for a donation to World Vision, a faith-based organization addressing issues of hunger and poverty worldwide.

The money will go a long way. Malnutrition and dehydration, largely preventable, lead to much death and disease among infants and young children in developing countries: one in ten will die before age 5. A small fraction of what super-sized Americans now spend on their own health care (over $2 trillion annually) would do wonders overseas. Watch the video:
Welcome to 30 Hour Famine

Quick Shots: Rail Freight Slows, Merrill Shrinks

Maine legislators are serious about improving freight-rail service in the state. Today the Utilities and Energy Committee is expected to pass a formal resolution to seek the forced sale of the rail lines owned by Pan Am Railways, the state's largest railroad. Lawmakers have been jawboning the company for three years about inconsistent service to manufacturers statewide, but little progress has been made during that time. A move is now afoot to direct MDOT and Maine's Attorney General to petition the federal Surface Transportation Board to force a divestiture. If successful, the state could then choose another railroad company to operate trains on the lines.

A Pan Am line runs right up the River Valley as far as the NewPage mill in Rumford. The mill depends on incoming rail deliveries of coal, carbonate, chlorate, and clay. Finished product leaves by truck or in rail-borne containers. Mill officials have been particularly frustrated during the past month or two, as a build-up of ice on a few hundred yards of rail at Smith Crossing has blocked shipments. NewPage has had to scramble to add deliveries by truck and has paid for salt to be applied to tracks owned by Pan Am. The moves have cost the company hundreds of thousands of dollars.

Customers want their paper on time and just in time--no warehousing, no delays. The railroad represents the weakest link in the Rumford mill's transportation chain. While managers are loath to criticize Pan Am publicly, they privately suggest that Pan Am does not value its customers as highly as NewPage does their own.

The implosion at Merrill Lynch continues. The venerable financial-services firm has just announced job cuts and office closures related to its First Franklin Financial Corp subsidiary, which until now has been active in subprime mortgage lending. That part of the business is now history. Merrill expects to incur charges of $60 million over the next two quarters. Remember, Maine is standing in line hoping to recover the $20 million invested in MainSail II last summer, an investment touted by a Merrill broker. There may not be enough Merrill meat to go around.

Dominoes Doing What Dominoes Do

The Federal Deposit Insurance Corporation (FDIC), the government entity created by Congress during the Great Depression to insure bank deposits, expects a busy year in 2008. The FDIC keeps a list of banks at high risk of failure. If necessary, it will take a troubled bank into receivership to protect depositors.

The FDIC is looking for more staff, viz. no-nonsense individuals with, shall we say, a certain skill set. These are guys who arrive for work at a target location at closing time on a Friday afternoon, freeze a bank's assets, and re-open on Monday morning prepared to babysit nervous customers. If you have no more than $100,000 with an insured bank, you're fine. Otherwise, you need to be very careful about where you park all your hard-earned dough.

The FDIC's "help wanted" ads bode ill for the coming year. There were three bank failures in 2007, and before that none since 2004. Fed Chairman Ben Bernanke warned last week that 2008 will be different.
The ultimate sell signal: Part II - MarketWatch

An Idea So Crazy It Just Might Work

Mike Huckabee's candidacy may be about to expire, but it would be too bad if the talk about the so-called Fair Tax expired as well. Fair Taxers propose eliminating the federal income tax and replacing it with a national sales tax. Not only would the income tax go away (and the filing headaches that go with it), but so too would payroll taxes, estate taxes, and taxes on corporate profits. Instead, consumers would tack on 30% to everything they purchase.

Now 30% may sound hefty, but it would apply primarily to discretionary spending. Subsistence spending would be covered by a per-person "prebate" provided by the government. Besides, 30% is the minimum that a self-employed person is already paying in combined income (at least a 15% marginal rate) and Social Security and Medicare taxes (the latter adding to 15.3%). For people who do not borrow to spend, the tax swap is a wash. For those who save some of what they earn, the Fair Tax is better.

One of the problems with the income tax is that it does not get at all the income. Some income is received under the table (and not reported), some is generated by illicit activity (and certainly not reported), and some of it is sheltered by loopholes not available to peons like you and me. Consumption, on the other hand, is much harder to hide. When a drug-dealer surfaces to buy his fancy new car, that is when we extract his contribution to society. In such a case 30% does not seem like too much.

A consumption tax with prebate is more progressive than our current tax system, which wealthy folks have learned to game. Much of their income is reported as capital gains, which are taxed at 15% and are not subject to the same payroll taxes taken from wage-earners. But why even realize capital gains? The rich can borrow cash, using their assets as collateral, at a rate far lower than 15%. Nice work, if you can get it.

What economists have to say about government intervention can be summed up briefly. If you want less of something, tax it; if you want more of something, subsidize it. It would follow, then, that the Fair Tax would lead to more production and less consumption, an outcome that would begin to repair our personal and collective balance sheets. The State of Maine could do its part by adding a penny or two to the state sales tax and shrinking income-tax collections by an equivalent amount.