Four Ways To View A Dollar

I’m glad I know sign language, it’s pretty handy. I used to have a fear of hurdles, but I got over it. Have you noticed that writing with a broken pencil is pointless?

I love puns. Words have so many meanings. Sometimes the multifaceted perspective about a single word causes confusion, but other times it’s the basis for humor. In financial planning, we often allocate money among different asset classes, security types, tax types, and buckets with each bucket having a different purpose and time horizon. We view each dollar from about four different angles – so many different perspectives that sometimes it no longer makes cents (get it?). Your financial advisor may take it for granted that you understand which point of view is being discussed at any point in time, but in reality the four-faceted view of each dollar is as often as not a source of confusion.

A dollar might be invested in a certain asset class. It could be invested in “stocks,” for example. And that same exact dollar might be invested in a mutual fund, as opposed to an individual security. The same dollar. It’s just a different way to slice up the portfolio pie. The dollar could be invested in an Individual Retirement Account (an IRA). This is just a type of tax deferred investing account. The IRA could be in a portfolio “bucket” designed to grow and protect the investor against the ravages of price inflation. Other “buckets” might be designed to provide income, or college money, or “fun money” or “pin money” for next Christmas.

We are constantly sorting money among different buckets. Sometimes, however, these different ways of viewing a single dollar can cause confusion.

For example, sometimes we ask clients how money is invested, wanting to know if it’s allocated to stocks or bonds, and they tell us that it is in an IRA, or a mutual fund. And no doubt the language of money is an equal opportunity obfuscator, perplexing and bewildering clients at least as often as it happens to us.

While each client situation is different, our solution is often to begin with a financial planning exercise to determine what overall asset allocation mix – which combination of equities, fixed income securities, real estate and other asset classes – helps clients meet their long term spending goals.

Next, we look at the taxable nature and investment purpose for each of the different portfolio “buckets” available for investment. For some people the Individual Retirement Account may be the perfect place to have tax deferred higher risk investments, like equities. Moreover, we may try to postpone taking distributions for as long as possible and take as little out as we can, to pass the assets on to heirs. For others, the IRA may already be so big and the deferred tax liability is already so great that we may want to slow down the growth by investing in fixed income securities, and tap the account hard for income during the income distribution years of retirement. Only by looking at both the goal of each account, and the tax status of each bucket, can we determine where we should allocate our growth dollars (what we call “red money”) and where we should place the less risky fixed income (“green money”) types of investments.

At this point, we still haven’t recommended whether to buy a stock, invest in a mutual fund or exchange traded fund, or buy an annuity or bank certificate of deposit. Each individual bucket has its own unique purpose, asset class, tax status and then, finally, type of security recommendation would be appropriate. Recommending securities, first, without taking the requisite planning steps, is all too often the industry norm. When a broker looks at a bucket of money and sees only the potential for a product sale, the joke is on the investor – and it isn’t funny.

This planning process can be short-circuited by investing each bucket in the same allocation, or always using the same type of securities in every bucket. Financial planning software rarely differentiates which bucket will be tapped first for distributions, and which will be last in line. In a good financial plan, however, your advisor has helped you know the order of distribution, the funding plan and distribution schedule for each bucket, and each portfolio strategy is tailored to each individual bucket while still working together at an aggregate level to present clients with an appropriate asset allocation well suited to each client’s personal risk profile and unique investment goals.

With a unique but cohesive planning strategy, it is easier to evaluate whether each portfolio bucket is meeting its goals and objectives. It is also easier to see that clients remain on track to reach their retirement long-term spending goals. Finally, clients are less likely to drastically change asset allocation, say cutting back on stocks at the worst possible time, because the overall strategy makes sense to them and makes them less likely to change horses mid-stream. The last thing we want for investors is that they “kick the bucket” and “upset the apple cart” at the wrong time, which could threaten the viability of their long-term plan and ultimately result in far too much spilt milk.

Okay. Now I’m just mixing metaphors and abusing altogether far too many puns. You can bet your bottom dollar that it’s time for this treatise on buckets to end. I really need to get a handle on this article if readers are going to grasp what I’m trying to say. Oh, editor. Please just make it stop.

Douglas B. May is President of May-Investments, LLC and author of Investment Heresies.

July 2013 Portfolio Summary

As the summer rolls on and the market continues up, the May-Investments portfolios sit pretty fully invested and well positioned, we believe, for the current market environment.

Generally speaking, the mutual fund portfolio has nine fully invested positions and a tenth position in gold, which is only a partial position but the remaining cash in the portfolio is tentatively scheduled to increase our investment in the precious metals asset class.  We’re just waiting for it to stop falling before we double up.  It has been a long wait.

Eight out of ten positions are in U.S. stocks.  The U.S. market is much stronger than most international markets and alternative investments, so we are less diversified than we would be were that not the case.  We are over-weighted in financials (banks and brokerages), healthcare (biotech as well as a more broadly diversified fund), and consumer cyclicals (automotive and a more diversified consumer discretionary fund).  We are under-weight technology (but do have a position in software).  Our position in Japan is back up to a full weighting.

In the Custom Wealth Management portfolios, the core equity portfolio is fully invested again after a management buyout at Zhongpin, a Chinese pork producer, forced the sale of one stock and opened up room for a couple new positions.  The “flexible middle” part of the portfolio is fully invested, home to exchange traded funds in the financials, healthcare, and consumer cyclicals sectors, as well as an automotive industry sector mutual fund.  In the diversification part of the portfolio, we have Japan and a partial position in gold.  We also own the S&P MidCap 400 Value Index position, which isn’t much of a diversifier, but reflects the fact that few markets are keeping up with the U.S. market.  Why diversify when the best performing market seems to be our own?  Generally speaking, the remaining cash is set aside for us to allocate back into precious metals at some point in the future.

It looks like the economy may continue with its slow growth on into the latter part of 2013.  For the past three months, the May-Investments Leading Economic Indicators have posted modest increases, reversing a three-month decline during the first quarter of the year.  The fear of sequestration during the first quarter turned out to be worse than the reality of sequestration thereafter.

There is modest strength in retail sales, global shipping, corporate profits and manufacturing new orders.  Weakness is apparent in the outlook by small business owners, drilling activity, and capacity utilization, and the rate of growth in commercial & industrial loans and the money supply (M2) is declining. 

Overall, the LEI isn’t projecting robust growth, but at least there is a slight upward trend. The indicators are supposed to help us look forward about six months, so hopefully our January forecast for continued economic growth throughout the year will remain on target through the rest of 2013.

If so, I would expect markets to cooperate as well.  As money begins to dribble in off of the sidelines, valuations (Price/Earnings ratios) are adjusting up.  Corporate profits have increased slightly, but as P/E ratios increase the value of stocks goes higher and the strong performance of stocks is attracting the attention of investors who are getting paid almost zero, nada, zilch to have their life savings invested in banks.  Today’s low interest rates continue to enable huge deficits by the government at the expense of consumer spending, particularly by seniors.  It probably isn’t a good thing that “savings” are being moved into “investment” accounts, but it’s happening every day and it’s one reason why the market keeps rising even as the pace of economic growth simmers down.

The biggest market risk remains…the political mess in Washington D.C.  While we got past the debt cliff and have even moved past the onset of sequestration with minimal fanfare, the budget wars are far from over and it’s never too late for the folks in Washington to step in and make matters worse.  It seems to be what they do best. 

Douglas B. May is President of May-Investments, LLC and author of Investment Heresies.

Throwing Her Hat In The Ring

Throwing your “hat in the ring” is an early 19^th century boxing term. An 1810 article reported that “a young fellow threw his hat into the ring and followed, when the lame umpire called out ‘a challenge.’ …He then walked round the ring till a second hat was thrown in, and the umpire called out, “the challenge is answered.”

Given the rough and tumble world of political service, it may be appropriate to use a boxing term to describe Barbara Traylor Smith’s July 19th announcement that today she filed papers noting her interest in serving out the distinguished Harry Butler’s remaining term on the Grand Junction City Council.

Having served the community through the Grand Junction Rotary club, and more recently as Chairman of the Strive Foundation board, Barbara’s commitment to the local community is already well established. This latest challenge allows her to focus more time studying the issues confronting Grand Junction and learning more about how the community wants the City to serve its citizens in the future.

Here at May-Investments, we understand that it is a big commitment and we are enthusiastic in our encouragement about her decision. At work, as in retirement, “it’s not about the money. It’s about your life!” We want Barbara to feel free to contribute what she can to the city where we all live. Although it would be nice to coast and let others do all the work, that’s not the way it works in real life. After considering her family, faith, and business commitments, Barbara believes that she can make a positive contribution while still meeting her primary responsibilities. At May-Investments, we want everyone to reach their God given potential and are excited for Barbara as she steps up to this challenge.

We wish her the best. And, by all means, feel free to give her a call about potholes needing attention in the event that she is selected by the City Council to step into the ring.

Douglas B. May is President of May-Investments, LLC and author of Investment Heresies.

The Style Box Paradox

Zeno’s dichotomy paradox refers to a philosophical conundrum where someone wishing to get from point A to point B must first move halfway before completing the journey. However, since they always have to complete half the journey first, and the half-journeys can go on ad infinitum, the Greek philosopher was forced to conclude that they would never arrive at the destination but would forever be stuck at various halfway points. It’s a great theory, but it just doesn’t make sense in the real world. People get to their intended destination all the time.

In investing, the theoreticians often study portfolios in the context of investment style boxes. Some portfolios are characterized as small cap value while others are classified as large cap growth. Classifying portfolios in this way is helpful in understanding fund performance looking backward over a discreet time period. However, classifying portfolios by style box classification is not particularly helpful while building portfolios. In the real world, bottom up investors shouldn’t care that much what style box the stock falls in. A more helpful way to classify stocks when constructing the portfolio is by industry and sector. At May-Investments, our portfolio building process has always emphasized sector rather than style box classification. We might look for a consumer stock with good earnings growth prospects that sells for a reasonable valuation, but we really don’t care how the stock is classified by the style box methodology.

A recent Fidelity Investments study explains that, “beyond company-specific factors, sector exposure has been the most influential driver of equity market returns.” While passive indexers mimic their marketing masters who repeat ad nauseam the myth that stock selection doesn’t matter and that a static asset allocation makes up 85% of investor return, in reality the studies showed that asset allocation is so important that it shouldn’t be held static, and that stock picking and sector selection actually matter a lot. While these facts inconvenience the passive indexing crowd, that doesn’t change them.

Style box investing, while great for performance attribution, helps little during the portfolio construction process. It’s a great theory, but it just doesn’t make sense in the real world. The Fidelity study notes that managing sector exposure is key because, “of the distinct risk and performance characteristics of the 10 major sectors.” While a specific stock’s style box attributes fluctuate constantly as ever-changing financial characteristics evolve, companies’ sector and industry attributes remain fairly constant. Moreover, these consistent performance drivers have a wider dispersion between the best and worst performing categories. “Equity sectors tend to have significant performance dispersion relative to each other, which is a key attribute for any alpha-seeking equity allocation strategy,” Fidelity observes. In other words, for investors trying to focus their portfolio on the best performing investments, more can be gained by focusing on sectors where the difference between the best and the worst is significantly wider than is the case with styles.

Another key difference is that different sectors have lower correlations to one another. This makes it easier to diversify risk than can be done using a style box orientation. “During the 2000s, the average correlation of sectors versus one another was 0.52, while the same average correlation among style box benchmarks over the same period was 0.76.” The higher the correlation, the higher the risk that all types of styles will rise and (more importantly) fall at the same time. Fidelity goes on to note that portfolios created with equity sectors “are more efficient – providing higher return and lower risk – than those created using style box components.”

Vanguard Fund founder, John Bogle, has made quite a stir lately criticizing the exchange traded fund industry for creating industry specific ETFs and branding the investors who use them as some form of wild speculator. Bogle, of course, made his fame and living off of passive investing. To his credit, he developed a firm based on low-cost investing strategies. To maintain that his approach is the only legitimate strategy is a bit arrogant, however. The lowest price car in the U.S. is the Nissan Versa S Sedan, priced at $12,780. The car comes with a manual transmission, a less fuel efficient engine, 2 wheel drive, bad ground clearance, a hardtop and very few bells and whistles. Are we all fools for not buying the lowest priced car, as Bogleheads suggest? Or are there other reasons to prefer a different way of viewing the world?

Anyone interested in getting a copy of the Fidelity Investment Insights white paper (Equity Sectors: Essential Building Blocks for Portfolio Construction) can e-mail us and we will be glad to forward a copy of the study.

Douglas B. May is President of May-Investments, LLC and author of Investment Heresies.

Economic Indicators Up For Second Month In A Row

The economy has been sending mixed signals for most of 2013. May-Investments developed its own Leading Economic Indicator to help our firm understand the current economic environment. Today’s LEI readings are again forecasting continued economic growth during the months ahead. After weakening earlier in the year, the month of May proved to be the second straight up month.

May-Investments developed its in-house indicator rather than rely on the Conference Board’s traditional LEI. With the Federal Reserve adopting Enron-style off balance sheet financing vehicles in order to move the government’s new bond issuance out the doors into buyers’ hands, the old economic indicators became obsolete and the Conference Board’s new indicator is untested. In the meantime, investors are having difficulty understanding whether today’s economic growth is a mirage, an encouragement, or a house of cards about ready to fall and take investors down with it.

Our economic indicator peaked a year ago when activity in the drilling patch declined, small business owners retrenched, and purchasing manager new orders dropped off. Whereas eight of ten component indicators were rising in March of 2012, by the end of May only half of the indicators were on the rise. In October, 2012, only three were moving higher. As 2013 began, in spite of our positive economic forecast for the year, the May-Investments Leading Economic Indicator began trending down again.

In April, however, small business optimism improved slightly and the decline in drilling activity was less significant than it had been a few months back. Overall, the upturn represents less of an “improvement” than it does a less forceful downtrend than at the beginning of the year.

Retail sales are still an area of strength, but they are not as strong as they were a year ago, or in January, and are what we are watching mostly closely for signs that the recovery will continue. Global shipping rates remain weak and bank lending is not growing as fast as it did in 2012. A slowdown in the growth rate of the money supply is also surprising, and worrisome, given the moves that the Federal Reserve continues to make to try to flood the economy with money. We are thrilled that the LEI moved up, but it is too early to conclude that there is much strength there.

As things are now, we stand by our forecast for continued economic growth during 2013. We had projected Gross Domestic Product (GDP) growth of +2.5% this year. We projected an economy that would be making progress in its move back toward normal. As of the most recent GDP report at the end of May, the U.S. economy is growing at a +2.4% rate, pretty much as we expected. Hopefully this recent upturn in our Leading Economic Indicator suggests that slow steady growth rate can continue throughout the rest of this year.

Douglas B. May is President of May-Investments, LLC and author of Investment Heresies.

Japan ETF Trade

The Japanese stock market has been on a tear since Prime Minister Shinzo Abe initiated his own version of Quantitative Easing (printing money) which appears to be QE100X (quantitative easing “on steroids”).  Money has to flow somewhere, it seems, and these days the money seems to flow directly into the stock market.  In response to the rapid printing press strategy, the value of the yen promptly and materially declined in value.  Japan’s twenty-year bear market seemed finally to come to an end, and it did (for a few months).

As we mentioned in our Tuesday Noon Classes in April, our strategy calls for moving money toward asset classes that are working.  The strong and seemingly sustained strength in the Japanese market led to our initiating positions at the beginning of May.

The Japanese market kept rallying into mid-May, and then the short-lived rally came to an end.  The Nikkei 225 turned down and never really looked back, entering bear market territory this week.  At the moment, to generalize, we have small losses in our positions and are frankly not in the mood to take a big loss. 

The Japanese market ran up fast in furious in 2013.  The iShares Japanese Index ETF (ticker symbol EWJ) is still up about 11% year-to-date, in spite of the market currently being in “bear” territory.  The Japanese market is another QE-driven asset class with an ETF that is quickly attracting widespread hedge fund interest, somewhat reminiscent of gold in 2011.  The main difference is that gold wasn’t just coming out of a 20-year doldrum when it ramped up.

For the most part, I have viewed the recent sell-off as somewhat appropriate given how fast the Japanese stocks moved up earlier in the year.  Some “consolidation” would actually be a good thing.  Stocks don’t go “straight up,” typically.  Those that do go parabolic usually do so just before crashing back down again.  A little correction would have been welcomed.  At the beginning of the week, it seemed more like a time to add to positions, rather than a time to bail out.

Then came Wednesday night.

On Wednesday night, the Japanese market fell about -6.5%, overnight.  As you can imagine, this created a bit of consternation as I watched the sell-off unfold that night.  Moreover, the yen (currency) was also moving a lot.

When we bought the iShare (EWJ), we chose the exchange traded fund security that demonstrated the best liquidity characteristics.  There are other ETFs available that try to eliminate the impact of currency adjustments by hedging away currency moves.  We weren’t buying EWJ in order to speculate on the yen, one way or the other.  We have, however, seen futures-based ETFs disappoint investors as the constant and costly futures trading result in those securities underperforming our expectations.  We chose EWJ in order to avoid the currency issue, prioritizing liquidity and low expense ratios over currency strategies.

Instead, this week it became clear that one way or another, currency is going to be part of the equation.  To be honest, not understanding the currency impact as well as I should have, when I saw the dollar/yen relationship moving –1.5% on Wednesday night, the pessimist in me pretty much assumed that the currency was moving against us as well.  On Thursday morning, I came in to the office expecting to see EWJ moving down –8% (just days after doubling up on some of those holdings).

So, imagine my surprise when EWJ closed UP over 2% that day.

This caused me to do a couple of things.  First, I jumped for joy.  The security we owned performed 10% better (in a day) than I had expected.  Luck was on my side.

However, it also meant that I really didn’t understand how this ETF was working, not nearly as well as I needed to.  If it meant that I could be 10% lucky on one day, I could just as easily get a 10% disappointment on (literally) the next day.  That was unacceptable.  So the first thing I did was cut our position in half until I could get a better understanding of what was driving the performance of this security.  In theory, it’s really not that tough.  ETFs are usually pretty straightforward instruments.  The Nikkei 225 Index goes up or down, and this ETF should follow.  But at the end of Thursday, I had all sorts of questions.

Why is the Nikkei suddenly so volatile?  Moving –6.5% in a day is not the norm for a healthy market.  How could the U.S. market response to the previous night’s plunge be so different?  EWJ opened up, and just kept getting stronger.  It never reflected the sell-off at all.

There are four fundamental factors that I needed to monitor in order to come up with the answer.  First, the action on the Nikkei stock exchange is the primary influence on returns.  Second, the movement of the currency is significant – more significant than I had originally wanted to believe.  Moreover, in my shock at the –6.5% decline in the market, I had assumed that the currency was also moving against me.  In fact, the yen was increasing in value on Wednesday night, which reduced the dollar-denominated loss to a –5% market move.

Third, ETFs trade at a premium or discount to their net asset value and this, too, was having a bigger impact than I had expected.  ETFs normally trade pretty close to net asset value, by design.  If the computer-generated valuation of the stocks in the index is $10, then the ETF might trade at a discount of $9.98 or a premium of $10.02, but in general discounts and premiums aren’t material.  One of the reasons that we prefer exchange traded funds (ETFs) to closed-end funds, which also trade at discounts and premiums to net asset value, is that market makers can generally keep the gap to a minimum.

On Wednesday night, before the Japanese market opened, EWJ was trading at a pretty hefty 2.5% discount to net asset value.  As a result, the first –2.5% decline in the value of the Nikkei 225 was already “baked in” to the price of EWJ.  Now, instead of having to explain a 5% variance, I’m down to only a 2.5% variance in what happened to EWJ as compared to my expectations.

Finally, at the end of the day on Thursday, EWJ was trading at a 4% PREMIUM to the Nikkei 225.  As the trading day continued, it is quite possible that money was flowing INTO the EWJ exchange traded fund.  As buyers came in to “buy the dip” in the Japanese market, the demand for EWJ shares was so strong that they actually began to trade up versus the security’s intrinsic value (the “net asset value”).  Also, the U.S. market was trading up during Thursday, and certain large Japanese stocks like Honda and Toyota trade on the American exchanges, so the intrinsic value of the Japanese market was moving up even though the Japanese market wasn’t open at the time.

The bottom line is that our positions in EWJ are still slightly below cost.  If EWJ goes down much more, we will cut our losses and sell out.

Second, the volatility the yen is having an enormous impact on the valuation of our EWJ investment.  We really wanted to ignore the currency impact on this investment.  That was naïve.  Just because we don’t want to be currency speculators, and use a security that doesn’t focus on currency hedging, doesn’t mean that we will be able to.  Once again, the political ramifications of easy money policies are creating enormous uncertainty in the markets.  There’s just no way around it, these days.

Third, the market makers aren’t doing a particularly good job of closing the gap between the price of EWJ and its net asset value.  This is a pretty new problem.  Normally, gap issues only impact investors during times of crisis.  In normal trading times, the gap is relatively immaterial.  Right now, that’s not the case.  Hopefully it’s just an unusual time for this particular ETF, rather than a sign of big underlying liquidity issues across all of the international markets.  Still, we’re going to have to treat EWJ almost like a closed-end fund, limiting buying opportunities to times when there is a significant discount, and taking advantage by selling into premiums, as we did on Thursday.

Lastly, I have a sense that the underlying fundamentals in Japan are not what’s driving the market.  The Nikkei was said to dive because U.S. quantitative easing policies are about to “taper” off.  Why would U.S. monetary policy cause a –6.5% mini-crash in Japan?  That doesn’t make much sense.  Unless, of course, what’s driving the Japanese markets higher are U.S.-based investors, using EWJ as the preferred speculative tool.

In watching markets, this week, it did not appear that EWJ (the U.S. trading tool) was following the Japanese market.  It appeared the EWJ was LEADING the Japanese markets.  It seemed, at times, like the entire Japanese market was responding to what EWJ was doing over here.  The tail seemed to be wagging the dog.

If that’s true (and I’m not at all sure that it is), then it would appear to be somewhat like when all of those U.S. investors bought gold ETFs in 2011, which drove the real markets higher as the financial demand for gold overwhelmed the actual supply in the physical markets.  Could it be that financial demand for the Japanese market, through hedge funds buying ETFs, is the source of Japan’s rally?  If the fundamentals in Japan aren’t improving, and the source of the Nikkei rally, then that’s a big deal and makes me much less willing to own shares of EWJ in the portfolio.

In any case, this week’s buy-then-subsequent-sale of EWJ shares is not something that I ever want to do again.  Because the Japanese market mini-crash wasn’t being reflected in the U.S. traded shares of EWJ, mostly because the ETF swung overnight from a 2.5% discount to a 4% premium, we took advantage of the gift and reduced the size of our exposure.

Soon we’ll have to decide if we’re going to completely eliminate it, or not.  If Abenomics works and this finally helps Japan begin to climb out of its twenty year recession, then we’ll get back in and just pay more attention to the yen and the gap between the ETF and its net asset value.

On the other hand, if we decide that the fundamentals in Japan aren’t driving the Japanese market, but rather it’s just U.S. speculators pushing that market around, then I’m not as inclined to stick around.  If trading in U.S. markets determines what the Japanese market does the next day, then something’s wrong.  If Japanese news causes its market to rise and fall, on its own, and then the U.S. ETF simply reflects these changes, then that’s an asset class in which I will consider investing.

Right now, it’s not clear what’s the driving force with this investment.  If trading activity doesn’t start making sense, and I mean soon, then we’ll just exit the rest of our position.

You know what they say about markets and poker.  If you don’t know who the patsy sitting at the table is, then it’s time to fold your cards and go home.

Douglas B. May is President of May-Investments, LLC and author of Investment Heresies.

A Question For Secretary Lew

I’ve met two U.S. Treasury Secretaries in my lifetime.  Technically, when the Stanford Committee On Political Education dined with G. William Miller, he was a former Secretary.  He was relatively disgraced at the time, so the campus speaker bureau paid a lower fee than we would have paid for Paul Volcker, his successor.  Volcker later became a national hero for having the courage to raise interest rates until the inflation beast was tamed.  Often times, doing the right thing requires a thorough understanding of what ails us, in order to do the unpopular, but ultimately necessary, thing.

Last week, I had my 45 seconds of fame with Jack Lew, the current Secretary of the Treasury Department during the Colorado Capital Conference. 

I would have enjoyed having more time - enough time to have an extended discussion, but that wasn’t in the cards.  I decided, instead, to ask a question that sends a message, just in case the administration official with the most direct influence on my financial well being was in a mood to listen.

After noting that in 2009, bank examiners came into our neck of the woods and forced local banks to cut back their real estate loan books, forcing them to call in loans (even ones that were current) at the worst possible time – and making things worse than they needed to be – and then after noting that even now the mortgage markets remain much tighter than necessary, with even millionaire clients having difficulty getting loans that ought to be a lay-up, I told Secretary Lew that I did not blame him.  After all, he was just newly appointed to the position.

Prior to that, he’d been doing a bang-up job for the administration on debt reduction, as he is the author of sequestration.  Before that, he was a Chief Financial Officer at Citigroup, joining the firm just as the real estate bubble was getting going, shepherding that failed organization into the financial crisis and collecting multiple million-dollar bonuses funded by taxpayers as it unfolded, before finally jumping back to the mother ship to re-join the newly elected Democratic administration. 

Now this man who helped sink the ship at Citigroup is in charge of defending Americans against a Federal Reserve hell bent on impoverishing the elderly with 0 percent Certificate of Deposit rates in order to bail out a banking sector so flush with cash that it can’t think of anything to do with the money, other than return to the days of multi-million dollar bonuses for its hard working executive staff.  Is he up to the job?  Is he even trying to fix the problems in the banking sector?  Is he even vaguely aware that the problems exist?

Which is why I asked him if he was aware of the fact that the Treasury Department, itself, is part of the problem.  If he’s not aware of this, then he probably isn’t working too hard to find a solution, was my thinking.

Others heard his response, which was long-winded and in which he noted that we don’t want to return to the days of “no-income check and low-doc loans.”  I would agree with him on this point, which was (alas) irrelevant to the question that I asked.  He also pointed out that evidence of problems in 2009 is not important to today, however the mortgage loan example that I gave him happened only a month ago.

I didn’t want to be one of those people who demand 120 seconds of fame by asking a 3-minute question, so I left out a few other examples of why I believe that the Treasury Department, itself, is part of the problem.

For example, I’ve been told that banks which used to specialize in farm and ranch lending are now no longer allowed to have an above-average concentration in…farm and ranch loans.  Every institution must conform to the average, which is itself constantly declining because there is no longer any incentive to be particularly good at a certain type of lending.

These days, clerks at Fannie Mae and computers programmed to reflect the new bank Examiner requirements are making lending decisions, easily automating tough decisions that once required experienced credit analysts to decide.

Nor did I question the current regulatory imperative to consolidate the banking industry, forcing small community banks to merge into the fold of growing regional giants.  This, they think, will ease the burden on regulators.  However, it wasn’t the community banks that were the root cause of the sub-prime crisis.  Ground zero for those problems were the financial industry giants who packaged up toxic loans in order to sell them through their investment banking subsidiaries.  You know;  companies like, well, Citigroup.

The Treasury should be pushing back against the Federal Reserve.  The Fed’s charter is to protect the banking system.  The bankers in the system are doing quite well, frankly.  Wells Fargo’s CEO, on the backs of government subsidies and benefitting from Dodd-Frank regulations that have left it with nearly 100 percent market share of the local mortgage business, was paid $19.8 million in 2012.  Now, I happen to believe that Wells Fargo is one of the most profitable and rational of the big money center banks, but if they’re paying Stumpf $20 million bucks a year, I maintain that they are not in need of their free money subsidy.  Savers, most of whom are retirees and many of whom are low income elderly, are the folks in need of an advocate.

Logically, that advocate should be the Treasury Department, rather than the Fed.  The Treasury Secretary is the President’s key advisor on the people’s financial plight.  He’s supposed to be on our side, right?

But, to fix a problem requires a certain amount of insight.  Enough, for example, to realize that a problem exists.

I asked Lew a “yes” or “no” question.  Is there an awareness at Treasury that they are part of the problem?  The Treasury Secretary’s long-winded statement should probably be interpreted as a “no” answer.  I sure didn’t hear a “yes” hiding in there anywhere.  Really, is it that hard in Washington to admit that the government is not perfect?  In any case, I was discouraged by his response.  I see no signs that the leadership at Treasury is going to do anything to fix the problems that he refuses to acknowledge.

Volcker had the knowledge to understand what it would take to whip inflation, the courage to take unpopular measures in the interest of restoring long-term health, and the integrity to do what was best for the people of America, even when they didn’t like him (or the Administration) for doing it.  Jack Lew, I’m afraid, is a political hack who neither understands the problem nor has the integrity to acknowledge there even is a problem.  His crowning achievement up until now, sequestration, is both foolish and cowardly, and designed to fail by relying on formulas instead of accepting responsibility for making responsible budget cuts.

He is unlikely to understand what ails us or take the unpopular but necessary actions required to make things better. 

Fortunately, worldwide, the resilience of America’s economy is still the envy of the world.  But someone in Treasury needs to start working on these problems.  As someone once said, what good does it do if we’re still nothing more than the best looking horse in the glue factory?

Douglas B. May is President of May-Investments, LLC and author of Investment Heresies.