The Icahn Speaks

Billionaire investor Carl Icahn released a new video.  If you don’t understand much about the financial system, I’d be interested in hearing what you had to say after you watched it.  I am really curious what points stood out for you and what points didn’t.  In the video, Icahn talks about a lot of the things that I have been seeing for years too.  He explains why Donald Trump has caught on as a Presidential candidate.  I don’t agree with everything he says.  For example, instead of changing the way we tax carried interest, I’d change the entire tax code.

Because of what I do and my background, I see a lot of intersecting things that lead me to conclusions.  Right now, I have a gut feel about certain things-but I really am trying to combat my confirmation bias to see things in a clearer manner so I can make the right decisions.  I am trying to understand why I am feeling fearful and vulnerable, and turn it into a strength I can use.

There are all kinds of undercurrents in our economy that have the potential to create massive problems.  Some are tax policy, which our politicians control.  Some are regulatory, which are politicians have little control over, but the President does.  Some are at the Federal Reserve, which no one has control over.  Some are in Europe, which we have a say, but no control over.

Years ago, when the Federal Reserve started down the QE forever road, my friend Yra Harris and I agreed on the outcome.  No wealth is being created.  Everyone just feels wealthier because the cost of money changed the risk/reward ratio.  Instead of the safety of high grade corporate bonds and US treasuries, the Fed created incentives to invest in stocks and risky junk bonds.  The price of all assets inflated.  Check out what all commodity prices did in 2009.  It was financial suicide to short it.

I have seen spillover effects in real estate.  It depends on where you invest in startups as to whether there is a bubble or not.  Startup valuation is pushing to higher highs at all levels of the funding cycle.  Seed stage companies I have seen that normally would raise capital at $2M-$3M are raising at $6M-$10M.  Later stage companies, and even some middle stage companies are raising capital from places that probably shouldn’t be putting money to work in the startup market.  At least this time, startups aren’t in the public markets.

The core thing to remember is when a tax is proposed or repealed, when a subsidy or price floor is established, or when a regulation is written, there is a direct economic response to it.  People are indeed rational and they try to do what is best for themselves.  It’s not that their response is “good” or “bad”.  The policy affects all people, but not equally.  The wealthy have the ability to deal with and rise above many of the proposals.  The upper middle class and middle class cannot.  For example, the US insistence on taxing foreign profits 35% stops job creation in America.  Professor John Cochrane correctly pointed out that all this government action has adversely affected America.

Professor Craig Pirrong blogs at Streetwise Professor.  He is an expert in commodities, and the clearing of those commodities.  This is one of the clearest pieces I have read that incorporates basic microeconomic theory into how regulatory policy affects actions.  There is a lot of regulatory effort in the commodity industry worldwide today.  It seems the more the regulators regulate, the more screwed up the industry becomes.  Coase Theorem works, most people just don’t understand and have faith in it.  Craig writes,

One can make the case for banks and some other financial intermediaries. Banks have fragile capital structures because they engage in liquidity and maturity transformations that make them vulnerable to runs. Runs on a particular institution can impose costs on other institutions, and the resulting financial crises can have devastating effects on the broader economy. The effects on the broader economy occur because financially impaired banks cannot produce their most valuable output, credit, and contractions of credit can cause a broad downturn. Banks don’t internalize these effects, and thus may choose capital structures that are too fragile. Capital requirements can ameliorate this externality.

How do these sorts of regulations affect the middle class?  Because futures are primarily a place where producers and suppliers can hedge. The increased costs of hedging will increase the prices everyone pays for things like gasoline, bread, clothing, and other staples of life.

If you think a politician can save you, you are probably wrong.  As Icahn also points out, many of them are not acting in your best interest but in the best interest of themselves.  Pirrong also notes this,

In 1993, I wrote a study, titled “Political Rhetoric and Stock Price Volatility,” that contributed to one of the early Clinton scandals. For you see, while blasting pharma companies, Hillary was also invested in a hedge fund that shorted health care stocks, and I documented using standard event study methodology that her speeches led to economically and statistically significant declines in pharmaceutical company stock prices.

All politicians aren’t on the take, but the ones that are really screw it up for the rest of them.  Electorate anger has manifested itself in the polls that the political establishment is finding hard to process.  Trump, Carson and Fiorina lead the Republican side.  Businessperson Carly Fiorina beats crony capitalist Hillary Clinton head to head in some latest polls.  Socialist Bernie Sanders is the one with momentum and emotion on the Democratic side. There is a huge fight inside the Republican Party right now between establishment Republicans and Milton Friedman Republicans.  Speaker Boehner’s resignation is evidence of that. I think this anger has been around for awhile.  The 2006 Democratic win was based a large part in that anger.  Obama’s Presidential victory in 2008 was about “hope and change” and how we were going to cut the deficit and make things right for the middle class.  The Republicans captured that anger in 2010,12, 14.  But, they have done little with it.  True outside candidates are now capturing that anger.

Right now, I have a pretty healthy fear that the stock market will fall out of bed sometime soon.  I have been saying this for the past few years.  If the Federal Reserve can’t raise interest rates a quarter point without the market tanking, then we don’t have a real bull market.  As Tim Knight at The Slope of Hope has written, shorting the market has been extremely painful.

Another real healthy fear I have is that somehow, the socialists of the Democratic Party (and they are the majority when you count union members) and the corporate crony capitalists of the Republican Party will somehow come together in a coalition and really screw things up.  If you want to see how it looks, check out the state of Illinois balance sheet, and the city of Chicago balance sheet after Governor’s George Ryan, Rod Blagojevich and Pat Quinn.