Two-Headed Quarters

Eric Cantor’s Misunderstanding of Compromise

2012-01-31T06:45:00.000-08:00

The 60 Minutes interview with House majority leader Eric Cantor broadcast on January 1, 2012 had a number of moments that revealed the causes of the current dysfunction in Congress. One particularly revealing response occurred when Leslie Stahl asked him about compromise. He said:

"Comprising principles, you don't want to ask anybody to do that. That's who they are as their core being."

Stirring, noble words, but deeply misguided when the issues that Cantor is being asked to compromise on are considered. Somehow, Cantor has pulled off the ultimate misdirection when it comes to governing. Instead of debating the morality of what the government does, he has re-framed the debate to be on the morality of having a government.

Cantor is part of a loud contingent in Congress who refuse to compromise on budget and tax policies because according to their narrative, government itself is the problem. The constant refrain from Republicans, like Eric Cantor, that the normal activities of government are immoral, leads me to question why they even want to be a part of an institution that they abhor. If their idea of a utopia is a place without a government, maybe they should consider moving to Somalia, a country where a functioning central government ceased to exist many years ago. Of course the results have been far from utopian. With no government, Somalia has been racked by widespread famine and constant civil war, and its chief industry is international piracy.

The preamble of the U. S. Constitution sums up the reasons for the existence of the federal government: "to form a more perfect Union, establish Justice, insure domestic Tranquility, provide for the common defence, promote the general Welfare, and secure the Blessings of Liberty to ourselves and our Posterity,.." Obviously for the government to exist and carry out its mission, Congress must appropriate money through taxation, enact laws and regulations, and appoint judges and executive officials. There is nothing inherently immoral about any of these activities.

However, by framing the normal activities of government as immoral, Cantor gets to have it both ways. He can avoid the tough moral choices that actual governing involves. He can say that his failure to effectively govern is the better outcome. In short, he can avoid responsibility for doing his job. But, this approach is dangerous and destructive because it paralyzes government, poisons relationships, and worst of all cheapens morality.

When even the most basic functions of government are subject to debate, it becomes impossible for the government to operate at all. When Congressmen and staffers are denounced for doing their jobs, it becomes impossible to foster productive, cooperative relationships between people who need to work together. When all disagreements are framed as battles between good and evil, it becomes impossible to recognize real moral issues.

In fact, the vast majority of disagreements people have with their co-workers, business associates, friends, and family members do not have a moral component to them. Most disagreements are about the best choice of action from a menu of equally moral choices. Since none of us are omniscient, disagreements with the people around us are a normal part of life, which is why at a young age (kindergarten) most of us learn how to compromise.

The government is a necessary institution; it must be funded through taxes, and in the interest of the common good, it must to some extent curb individual freedoms. Reasonable people will of course disagree on the best courses of action to accomplish the goals of government, and that means compromise is necessary.

Framing normal disagreements in terms of moral absolutes, clashes between good and evil, heroes struggling to prevail against villains, makes for compelling narratives. But, the stories told are fraudulent. The only morality tale I see in the 60 Minutes interview with Cantor is the one of his hubris, self-aggrandizement, and intellectual dishonesty.

The Law of Unintended Consequences: BG&E Tree Trimming Policies

2011-08-31T18:55:00.000-07:00

Today marks day four and counting without power in my house. Hurricane Irene passed through early Sunday morning and tore up the area’s electrical grid. Initial reports were that over 850,000 customers were without power in the immediate aftermath of the storm. I’m not sure how customers are counted. Is a customer just the account holder, or the actual number of people using that account? In our household we have one account holder, but a total of five persons living in the house. If on average each account holder represents about three electricity users than 3 x 850,000 or 2.55 million people are without electricity. That is almost half of Maryland’s 5.5 million people, and there is no firm timetable for complete restoration of services.

The primary causes of the power outages are fallen trees and tree limbs. For the most part the electric poles and wires withstood the winds. But the wires cannot withstand trees being dropped on them. Maryland, including Baltimore County and City (where I live and work) is heavily forested, so almost all power lines have nearby trees. Several years ago Baltimore Gas & Electric (BG&E) decided to be “proactive” about the hazards that trees pose and sent crews out to trim back tree branches along their right-of-ways. However, as is often the case, the corporate policy makers don’t think through the real-world consequences of their policies. On my property, BG&E’s policies have increased, rather than reduced, the hazards to their power lines. I’m certain that my property is not unique.

The back edge of my property is along a BG&E right-of-way for power lines that feed many of the houses in my neighborhood. Several years ago, I returned home to find BG&E workers high up in the large mature oak trees at the end of my yard, cutting off the branches jutting out in the direction of the power lines. I asked them immediately to leave which they did, but it was too late. The damage had been done.

The tree trimmers insisted that lopping off branches would not harm the trees. That might be true if the trimmers took proper precautions, but it was clear to me that was not the case. The workers simply moved along the right-of-way, from one tree to the next, and did not stop and clean their cutting tools after each tree. There is a fungus in the area that attacks oak trees, and I had already lost several large oak trees in my yard to the fungus. I had to have the remnants of these trees cut down and removed, which is very expensive. A sure way to spread the fungus would be to do exactly what these tree trimmers were doing.

I’m sure that when trimming thousands of trees it would be tedious and time consuming to thoroughly clean cutting tools after every tree. I’m sure that my dentist finds it tedious and time consuming to clean dental instruments after every patient. However, not doing so is guaranteed to spread disease. The large oak trees, clearly many decades old, that BG&E trimmed, caught the fungus and died within a couple of years.

The trees are far from my house and no threat to anything but BG&E’s power lines. I have left them up because it would very expensive for me to have them removed (thousands of dollars), and they were perfectly healthy trees before BG&E mangled them. Through the years the wind and rain have stripped off most of the branches and bark.

Early this summer I called BG&E to explain that the trees are likely to fall on their power lines and recommended that a crew be sent out to remove them. The person answering the phone asked if the trees were touching the power lines. I said no, but I explained that when the trees do fall the power lines would be brought down. The BG&E employee told me that the trees have to be touching and putting tension on the wires before action would be taken. That is BG&E’s policy for dead trees that pose a serious threat to power lines. In contrast, when these same trees were alive and healthy and little threat to the power lines, BG&E had work crews out hacking away at them.

The morning after the storm the first thing I looked at outside were the dead trees. They withstood Irene’s onslaught and are still standing. It will not be Irene, but some other storm in the future that will eventually take them and BG&E’s power lines down. However, thousands of trees throughout the area did fall. I can’t help but wonder how many of those fallen trees were victims not of the storm, but of BG&E’s inane tree trimming program. I also wonder if the tree trimming actually prevented any power outages. With so many people without power due to fallen trees, it is hard for me to imagine that BG&E’s tree trimming programing accomplished much of anything.

Trees are an important part of the environment in Maryland. Even if it were not prohibitively expensive, it would still be undesirable to remove every tree that threatens a power line. However, healthy trees are far less of a threat than dead trees. If BG&E wants to be better prepared for the next storm, they should focus removing the dead trees along their right-of-ways instead of creating more dead trees through careless tree trimming practices.

My Suzuki Verona: Bait and Switch Warranty Repairs

2011-07-17T07:21:00.000-07:00

One year ago I purchased a used 2005 Suzuki Verona with about 40,000 miles on the odometer. Because of the low mileage and less than seven-year age of the car, many of its parts remained under the power train warranty. However, I have discovered that getting Suzuki to perform a needed warranty repair is extremely difficult, very expensive, and has left me wondering if Suzuki is manipulating their customers in order to cover up serious safety issues arising from design flaws.

A risk in buying any used car is being saddled with someone else's lemon. My Verona is certainly a lemon. I understand now why Suzuki stopped making Veronas. The car has been nothing but trouble since I bought it. Over the past year, there has not been a period of longer than two weeks without the check engine light coming on and staying on for several days at a time. During those intermittent periods of engine trouble, the car hesitated when I stepped on the gas and then either suddenly accelerated or stalled. Needless to say it was challenging and dangerous to drive.

However, diagnosing and fixing the problem proved difficult. My mechanic did the obvious-replaced the spark plugs, located and replaced a defective ignition coil, changed an O2 sensor-but nothing solved the underlying problem of hesitation followed by either a sudden acceleration or a stall. My mechanic eventually realized that the problem was with the on board computer that controlled the operation of the engine. Every time the check engine light came on the diagnostic codes from the computer were different and contradictory.

His recommendation to replace the computer was both good news and bad news. The bad news: it is a $1000 part. The good news: it is still under warranty. However, my mechanic cannot perform warranty repairs, those can only be done by Suzuki dealers. My trip to a Suzuki dealer turned into an expensive and time-consuming odyssey that raised troubling questions about the company and its products.

The closest Suzuki dealer to my house in Reisterstown, Maryland, is Adams Suzuki, located in Fallston, Maryland, about 40 miles away. After a hair-raising drive-the car stalled at most of the red lights along the way-I arrived and explained that my mechanic had recommended a new computer installation to solve the engine problems. The service manager received the car and told me that I would be called after they did their own diagnostics.

The next day I was told that the wiring harness needed to be replaced. This is an expensive part ($597.15) and labor-intensive repair ($227.50), for a total of $876.38 after taxes and waste disposal fees were included, and the warranty does not cover the parts and labor. The engine and computer are warranted, but conveniently for Suzuki, not the wires connecting them. The dealer said the computer worked properly. I asked the service manager how she knew that the computer worked. She said that the computer would not generate diagnostic codes at all if it didn't work, an assertion my mechanic says is false. However, the dealership provided me with no other option but to replace the wiring harness. I reluctantly agreed, although I said that if a wiring harness replacement did not fix the car's problem I would expect my money back.

In the mean time I rented a car so that I could commute to work. Two days later on a Thursday, the dealer called me back to say that Suzuki had sent them the wrong wiring harness and that the repair would be delayed another two days. I said that I would be out of town for the next week, and I would pick up the car on the next Thursday morning (one week later).

The following Thursday morning I called, only to find out the repaired had just been started. The car would be ready Thursday afternoon, which forced me to spend more money on a rental car so that I could get to work. I asked for a 10% discount on the repair to offset the added expense. The service manager's reply was no. She said that it was not her fault that Suzuki shipped the wrong part the week before.

I picked up my car that Thursday evening and paid the $876.38. The car continued to hesitate and then lurch forward, although no stalls occurred. The check engine light came back on before I arrived home. I returned to complain. This time the computer diagnostic codes indicated a vacuum leak that the dealership claimed to have repaired about 30 minutes later. I again asked about the reliability of the computer, and I was assured that it worked. I was not charged for the repair because the manager said moving parts around during the wiring harness repair could have caused the leak.

I drove away and traveled about 3 miles before the check engine light came on again. I returned and this time the computer diagnostic codes indicated a problem with an O2 sensor, a part that I knew had been recently replaced. This time I spoke directly to the service technician who told me that O2 sensors fail frequently on Veronas, even relatively new ones. But, when I asked what was wrong with the O2 sensor, he discovered that the computer codes kept changing. First the O2 sensor was completely dead, then it was good, then it was sensing a "lean" mixture, then a "rich" mixture. I argued that a computer spitting out bad codes was a more likely explanation for the problem than an O2 sensor cycling between all four possible states.

But, the service technician told me that Suzuki's instructions were not to replace computers, even when that appeared to be problem, but instead to replace wiring harnesses. I asked why Suzuki was so convinced that the wiring harness was bad. He explained that the original wiring harness had design flaws that caused the wires to corrode and form intermittent connections that could cause the same kind of problems as a malfunctioning computer.

The technician said that the service department would provide an estimate for a new O2 sensor. But, I said I wanted the computer replaced before I agreed to spend any more money. If the computer spits out bad codes, I could replace parts one at a time forever. After all, there are hundreds of possible diagnostic codes the computer can generate. Reluctantly, the dealership agreed to order a new computer and replace it under the warranty agreement.

I returned a fourth time when the new computer arrived to have it installed. I have not had any problems with the car since the computer was replaced. The O2 sensor appears to work fine. Needless to say the $876.38 I spent on the wiring harness repair has not been refunded. The dealership argues that it was still necessary, and since the car did not stall afterward, the new wiring harness resulted in some improvement.

However, the experience raises some deeply troubling questions about Suzuki. If the original wiring harness design is indeed defective, it should be recalled. There is no question my car was dangerous to drive given its propensity to either lurch forward or stall when pressing the gas pedal. It appears that rather than issue a recall, Suzuki is instructing its dealers to replace the wiring harness and bill the customer for the expense, before doing needed warranty repairs.

I would not have traveled to a dealer 40 miles away for a non-warranty repair. My mechanic could have replaced the wiring harness cheaper, faster, and closer to my house. I would not have had to make four round trips (320 miles total) to the dealer and spend a total of $235.55 on rental cars to get to work. But my mechanic correctly diagnosed the problem as a bad computer and recommended that I have it fixed under the warranty. Between the repairs, rental cars, and travel expenses, I spent over $1100 on what should have been a no-cost warranty repair.

The car definitely needed a new computer. I still don't know if the car needed a new wiring harness, but if Suzuki is correct that it did, that raises deeply troubling questions about the safety of Suzuki products and integrity of its management. If it did not need a new wiring harness I should get my money back.

The sequence of events leads me to believe that I was a victim of a bait and switch. I brought the car to a Suzuki dealer for a needed warranty repair. But, before Suzuki would honor the warranty, the company insisted on selling me an expensive non-warranty repair. If the wiring harness repair was necessary because of possible design flaws, the part should be recalled. Suzuki should not be insisting that customers pay for its replacement before agreeing to do necessary warranty repairs.

The Republican Party: In The Twilight Zone

2011-04-30T19:55:00.000-07:00

The ability to assert two mutually exclusive statements, as both being true, has been a requirement in politics for some time. But the cognitive dissonance within the Republican Party has gone off into the twilight zone.

The Republicans have threatened to not raise the federal debt limit unless the Democrats agree to substantial cuts in spending. This is equivalent to threatening to end a hostage standoff with a nuclear weapon. Obviously the United States government cannot default on its debt obligations because the worldwide economic catastrophe that would result would make the 2007-08 financial crisis look insignificant in comparison. A threat that can never be executed isn’t much of a threat at all.

Actually, it’s interesting to track where the federal largess that the Republicans so bitterly complain about goes. A USA Today article on April 25 ranks states in order of government benefits received. Heavily Republican states that voted for McCain in the 2008 presidential election tend to rank high on this list, meaning that they receive more government benefits than most states. For example, West Virginia ranks number 2. Some followers that voted Republican, with their rankings in parenthesis, are Kentucky (8), Mississippi (11), Arkansas (12), Alabama (14), and Louisiana (17). Why are the Republicans in those states so opposed to the benefits that they receive? Maybe they should be careful what they wish for.

On that note, I wish Ayn Rand were alive and giving interviews on her economic and philosophical theories. She is a cult figure in the Republican Party, especially among the Tea Party wing, for her advocacy of unfettered capitalism and ethic of rational self-interest. A new movie has just been released based on her novel Atlas Shrugged in which the capitalists are the heroes.

Actually, Ayn Rand, a Russian Jew who emigrated to the United States at the age of 21, was a committed atheist who opposed all forms of religion. To her, valid knowledge arose only from sense perceptions and human reason. She rejected all claims of knowledge obtained outside of the senses, such as divine revelation. It’s hard to imagine her going very far in today’s political climate as a Republican or a Democrat.

Although, some Republicans simply ignore inconvenient historical facts about their heroes. Maybe Republican Congresswoman and Tea Party favorite Michele Bachmann could re-write Rand’s biography in the same way that she re-wrote American history in a recent speech. She stated in regards to the U. S. Constitution that: “the very founders that wrote those documents worked tirelessly until slavery was no more in the United States.” Actually, many of the founders, such as George Washington and Thomas Jefferson, owned slaves. Not until after the Civil War, nearly 100 years later and long after the founders were dead, was slavery abolished.

On the other hand, if Ayn Rand did endorse Republicans her religious views might not matter. The Reverend Franklin Graham in an interview with Christine Amanpour says that Donald Trump could become his “candidate of choice” for president because “the more you listen to him, the more you say to yourself, you know, may be the guy’s right.” This was said in the same interview that Graham questioned Obama’s Christian faith. There was no discussion of Trump’s faith. Franklin Graham has since been clarifying his comments. I would advise him not seek help from John Kyle’s press agent for issuing clarifications.

John Kyle stated on the Senate floor that “well over 90% of what Planned Parenthood does” relates to abortion. When called out on that obvious falsehood, his office released a statement that “his remark was not meant to be a factual statement.” I checked the definition of the noun “lie” at dictionary.com and found this definition: “a false statement made with deliberate intent to deceive; an intentional untruth; a falsehood.” In other words, according to John Kyle’s office his statement on the Senate floor was a lie. Evidently John Kyle must have realized this too because he clarified his clarification by stating that he “misspoke.” As to the earlier statement released by his office, he said: “"That was not me - that was my press person.”

The upcoming presidential contest should be a great event for comedy writers. Unfortunately it’s going to be a very bad contest for the electorate who will have to listen to all this nonsense.

Closing My Bank of America Account: The Parable of the Ungrateful Servant

2011-03-10T17:38:00.000-08:00

"Therefore the Kingdom of Heaven is like a certain king, who wanted to reconcile accounts with his servants. When he had begun to reconcile, one was brought to him who owed him ten thousand talents. But because he couldn't pay, his lord commanded him to be sold, with his wife, his children, and all that he had, and payment to be made. The servant therefore fell down and kneeled before him, saying, 'Lord, have patience with me, and I will repay you all!' The lord of that servant, being moved with compassion, released him, and forgave him the debt.

But that servant went out, and found one of his fellow servants, who owed him one hundred denarii, and he grabbed him, and took him by the throat, saying, 'Pay me what you owe!' "So his fellow servant fell down at his feet and begged him, saying, 'Have patience with me, and I will repay you!' He would not, but went and cast him into prison, until he should pay back that which was due. So when his fellow servants saw what was done, they were exceedingly sorry, and came and told to their lord all that was done. Then his lord called him in, and said to him, 'You wicked servant! I forgave you all that debt, because you begged me. Shouldn't you also have had mercy on your fellow servant, even as I had mercy on you?' His lord was angry, and delivered him to the tormentors, until he should pay all that was due to him." Matthew 18:23-35

I thought about this parable from the Gospel of Matthew as I closed my Bank of America account at the start of the New Year. I had a long-time checking account (for more than a decade) in which I had dutifully kept the $750 minimum balance to avoid a monthly maintenance fee. In December I received a statement that showed $14 missing. At that point I read more carefully the letter I had received from Bank of America on new fee structures. It explained that to avoid a $14 monthly fee I now needed a $1500 minimum balance. I did not like either choice-paying the $14 per month or adding another $750 to the minimum balance.

It is bad enough that the interest banks pay on deposited money is negligibly small. Now you must provide the bank with large amounts of free capital or your deposited money will be appropriated. Prior to the 2008 financial crisis, institutions such as Bank of America generated large amounts of revenue from usurious interest rates on credit cards and hefty fees for overdrafts and late payments. However, new laws forbidding some of the more egregious practices have sharply curtailed that revenue stream, so banks are instituting new fees to make up the difference.

I decided to shop for a new bank and I was struck by some advice given while conversing with a local businesswoman. "Never do business with a bank that has more than three branches. Banks with three or less branches are too small to be of much value to bigger banks, so there is little risk of a buyout." On hearing this advice, I remembered that I had never opened an account at Bank of America. I opened an account at a large regional bank that was bought by Bank of America. The same is true of another bank I do business with-M & T. I originally opened an account with First Maryland Bank, which was bought by All First, which then disintegrated in a currency trading scandal and was acquired by M & T.

I went to Farmers and Merchants, a small community bank with only three branches, all in northwest Baltimore County. They offered me totally free checking with no minimum balance. I opened a new account and the next day went to Bank of America and closed my account before any additional fees could be assessed.

There are, of course, some tradeoffs with switching to a small local bank. I can only visit the bank when I'm near my house, not anywhere in the country, which was the case with Bank of America. I can only have free use of an ATM machine at one of those three branches, anywhere else I have to pay a transaction fee. But, with proper planning and use of the Internet-even small banks offer online banking-these inconveniences should not be much of an issue. I have to ask myself, is $14 x 12 months, or $168 per year worth it for the additional accessibility Bank of America offers. I would never have the need to use ATMs far away from my house often enough to justify paying $168 per year to access Bank of America's nationwide ATM network. If I have to do that occasionally, I'll pay the $2 transaction fee.

When I closed my account at Bank of America, the manager noted that I had been a long-time customer and asked my reason. I told her that I was unhappy with the new fees being imposed. I said that it reminded me of the parable of the ungrateful servant. She didn't seem to understand the biblical reference. She handed me the cash for the remaining funds in my account and had me sign for it. No counter offer or apology for the new fee structure was made.

Bank of America and the other large banks created an unsustainable business model that generated revenue from high fees and usurious interest rates on high-risk loans. When the model failed they were shielded from the market consequences with billions of dollars in taxpayer bailouts on the condition that they end many of the practices that caused the failures. But it appears that rather than comply with the intentions of the new law, Bank of America is looking for loopholes in order to revive their old business model.

Of course, the large banks insist that even though they are exempt, all their customers should abide by the rules of the market place. That being the case, I think we the customers need to shop more for banking and ignore much of the slick marketing. We also need to overcome our inertia and be willing to change banks when market conditions change. It is easy to close an account and open a new one at another institution.

Ask yourself, if I were shopping for a bank today and considering all the available options, would I choose the bank that I currently have? If the answer to that question is no, then it is time to change banks. Look around and you will find many community banks and credit unions that offer excellent services at fair prices.

When I think about it, there is really no reason for Bank of America and its ilk to even be in business. In fact, if not for the billions of dollars in bad debt forgiven by the taxpayers, they would not be in business. But, Bank of America was not about to forgive the new fees they were imposing on me. It is time for customers to stop paying for all the lunacy and take their business elsewhere.

Political Posturing: Misdirection with Numbers

2011-01-30T10:11:00.000-08:00

I've written a lot about misdirection with numbers in consumer advertising. But, the political posturing seen in Congress over the past two months takes misdirection with irrelevant numbers to a whole other level.

Consider all the indignation mustered on the Senate floor last month over the $8 billion in earmarks in a proposed bill. Let's put that number into perspective. The federal budget deficit hit a record $1.4 trillion last year. Eliminating the $8 billion in earmarks trims the deficit by 0.6%. While earmarks might be an unseemly practice, the dollar amounts are insignificant.

President Obama's federal pay freeze will save $60 billion. It's great political theater to require federal workers to tighten their belts along with the rest of the citizenry. But, that number is only 4.3% of the deficit.

In the mean time, Congress reached a painful "compromise" with a bill in which each side got what they wanted and no one had to pay. Republicans got their tax cuts while Democrats got their spending programs. In other words, voters have a choice between tax-and-spend Democrats or borrow-and-spend Republicans. It is no wonder that voters are angry. Most of us think that the word "compromise" means that each side has to give up something. This isn't a compromise at all.

To solve the government's fiscal problems will require looking at the numbers that matter, in particular the large numbers. As large it might sound, $10 billion is no longer a large amount of money in Washington. In fact $100 billion is no longer that large an amount. The significant amounts are measured in trillions of dollars and saving that kind of money requires overhauling programs that no one wants to touch.

The Bowles-Simpson commission made a sincere effort to propose significant deficit reduction, and few politicians of either party have embraced their proposals. Notice that their proposal will not eliminate deficits, just stabilize the problem. Their recommendations include:

* Reducing the yearly increases in Social Security
* Increase the retirement age
* Raise the Social Security contribution ceiling
* Eliminate the home mortgage interest deduction
* Raise the federal gas tax
* Increase Medicaid co-pays

These are just a few examples from a long list of recommendations, but what they all have in common is that no politician would ever dare support any of these actions. Unfortunately, these are the programs that soak up most of federal expenditures. I think Peter R. Fisher said it best in a 2002 speech when he was Under Secretary of the Treasury.

"Think of the federal government as a gigantic insurance company (with a side line business in national defense and homeland security) which only does its accounting on a cash basis - only counting premiums and payouts as they go in and out the door. An insurance company with cash accounting is not really an insurance company at all. It is an accident waiting to happen."

-Peter R. Fisher
Under Secretary of the Treasury
Remarks to the Columbus Council on World Affairs
Columbus, Ohio
November 14, 2002

Meaningful deficit reduction can only occur if we make an honest appraisal of where the bulk of the money actually goes. It isn't spent on the programs that Congressmen complain loudest about. In Peter Peterson's book Running on Empty: How the Democratic and Republican Parties Are Bankrupting Our Future and What Americans Can Do About It, he wrote: that the parties have mortgaged our future "with reckless tax cuts, out-of-control spending, and Enron-style accounting." He wrote that warning in 2004- six years ago-and the problem has only gotten worse.

In Peterson's moral structure, it is unconscionable to leave this enormous debt to our children. Each generation should pay for its own expenses and excesses. Actually, I find it the height of hypocrisy that the attitude of our political leaders towards money goes against everything financial principle we seek to instill in our children. Lessons on delaying gratification in order to save and invest, so that resources will be available for unforeseen problems, are apparently lost on politicians.

The real problem is the constant framing of political debate in terms of absolutes. In today's hyper-partisan climate you are either for or against Social Security, for or against Medicaid, for or against taxes. Actually you can be for and against all of these things. There is no reason that we can't have Social Security, Medicaid, and taxation, as long as all the costs are within reason. In other words, we need to make real compromises, not fake compromises for the sole purpose of political theater.

Joseph Ganem is a physicist and author of the award-winning The Two Headed Quarter: How to See Through Deceptive Numbers and Save Money on Everything You Buy

Save Big by Saving Small

2010-12-31T14:15:00.000-08:00

With the New Year upon us, the number of media stories on financial planning is exceeded only by the number on weight-loss. Most of us don't need sweeping changes to our finances. However, identifying and avoiding small-dollar losses can add up over the course of a year. Here are some small ways to save big.

Compare weight not size. For food items, large containers often cost more than small ones. But, frequently the actual amount of food in the big container is the same or only slightly more than the smaller one-usually not enough more to justify the higher price. Compare the price per pound-in small print-when you shop, not the large-print price per container.

Buy only the amount of food that you need. Bulk purchases to "save money" can actually cost more when items are thrown out after spoiling. When you shop, ignore the suggested number of items to purchase. Signs created by retailers, such as "2 for $5," or "4 for $10," are for their convenience, not yours. In most instances a purchase of a lesser number of items will be automatically pro-rated at the register. If that doesn't happen, buy from a different store.

Consider the total cost of a purchase rather than just the price. Long distance drives to chase sale prices can cost more for gas than you save on the purchase. Visit ComputeGasSavings to determine how far you should drive for a lower price. Even chasing down low-price gas can get expensive. At $3 per gallon and climbing, driving long distances, or idling your car in long lines to save a few cents per gallon on gas, can cost more than the savings.

Start a savings fund for home and vehicle repairs. Because few people budget for these recurring expenses, most are forced to pay with credit. Paying cash for needed repairs is much cheaper than accumulating credit card interest. Look over your repair receipts for the past couple of years to get a feel for how much you spend. It could easily be $1200 to $1800, over the course of year. That averages to $100 to $150 per month. Start setting aside $100 per month now for repairs so that you are financially prepared for these "emergencies."

Ask your insurance agent how much you would save by increasing your deductibles. Over the long run it might be cheaper to pay out-of-pocket for life's little mishaps than to pay extra year-after-year for a low deductible. Would you pay for a small repair (less than $500) on your own rather than report it to your insurance company and risk a rate increase? If the answer to that question is yes, your deductible should be $500, not the standard $250 that comes with most policies.

Avoid Extended Warranties. Almost all electronic devices and appliances become obsolete before they break down. Lots of people have stories to tell about an extended warranty on a new purchase that proved valuable. But, these same people forget about the dozens of problem-free devices that they have bought through the years. A 10 to 20% extra surcharge on each item for an extended warranty added up to far more than the cost of that one repair. If you make it a rule to always decline extended warranties, you will save more than enough money in the long run to pay for the few repairs that you actually need.

Increase your retirement contribution the next time you receive a raise. Put half of the additional income into your retirement account. You will save on taxes, increase your future retirement income, and still see more money in your paycheck.

In fact, if you examine some of the small ways to save money that I've mentioned, it's possible that you could find $100 per month of unnecessary expenses. That is the equivalent of a raise that could be set aside and invested for the future.

Joseph Ganem is a physicist and author of the award-winning The Two Headed Quarter: How to See Through Deceptive Numbers and Save Money on Everything You Buy

Distorting Science: BP's Buy Out

2010-11-19T05:25:00.000-08:00

An investigation by the Mobile Press-Register revealed that BP has offered lucrative contracts to scientists engaged in research on the Gulf of Mexico oil spill. According to one source, BP attempted to hire the entire marine sciences department at an Alabama university. The Press-Register reported that the contract "prohibits the scientists from publishing their research, sharing it with other scientists or speaking about the data that they collect for at least the next three years."

I find this a disturbing development in the ongoing oil spill catastrophe because it will allow BP to pretend that it is doing science, when it is not. Employing scientists for private purposes is not a new practice. Nor is the act of keeping data and results proprietary. Many scientists work for private companies and must uphold the terms of the contract agreed to by both parties. Open sharing of information is often not desirable because companies that invest in research should be the first to benefit from the results.

However, conclusions drawn from proprietary data are not necessarily scientifically valid. BP's contract is a deliberate attempt to control the publication of data on the effects of the Gulf oil spill, while at the same time invoking scientific authority for the conclusions obtained from the research. This is not how the scientific method works, and to pretend otherwise is dangerous.

The act of employing scientists to take data, publish results, and interpret findings, does not necessarily mean that valid scientific conclusions will result. Scientists are fallible human beings, prone to error and motivated, in part, by their own beliefs, prejudices, self-interests, and parochialisms. In other words, the work of science is hampered by the same human foibles that plague all human endeavors.

But in the past few centuries science has advanced at a remarkable rate because its method has a self-correcting mechanism built in. Scientists throughout the world usually work independently and openly share ideas and results. Independence and openness are two features of the scientific method that are little appreciated, but essential to scientific advancement. By reviewing and checking each other's work, scientists uncover errors and biases. Over time evidence accumulates to support valid results and interpretations. Ideas that are wrong get culled and eventually become relegated to the history books.

Independence and openness are qualities not typically valued by businesses, or for that matter governments and churches. In fact, these institutions tend to regard open sharing of information and independent questioning of established precepts as existential threats. But, these institutions often invoke scientific authority to buttress their own self-serving claims.

But, you cannot have it both ways. Scientific "authority" derives from a method that self-corrects because of a tradition of independent researchers openly sharing information. You cannot take away this part of the method and still claim that you are doing science.

Science is a method for interrogating nature. While people might answer questions incorrectly, nature never does. In fact nature never makes mistakes in the human sense of that word. Natural laws are obeyed at all times, and the natural laws are blind to human concerns.

To date, science has been a remarkably successful human endeavor, but we should not take for granted the continued advancement of science. Especially while the benefactors of science attack it. The recent phenomenon of people choosing scientific beliefs that are consistent with their choice of church, or career, or political party is deeply troubling. Obviously nature has no affiliation with any churches, corporations, or governments.

But, more and more, we see organizations of various types cherry-picking data to advance their own agendas. BP will be very careful in regards to the proprietary data it releases, in the same way that pharmaceutical companies are very careful about the results of drug studies that they release. Creationist/intelligent design advocates are quick to point out any problems with evolution theory, while ignoring reams of supporting evidence. In the United States, belief in global warming now falls along party lines, a situation that could not possibly occur if people were independently evaluating the evidence.

In fact, it would be remarkably coincidental if natural phenomena just happened to perfectly align with the economic self-interests of a particular group. Such a coincidence is highly unlikely. In the aftermath of the space shuttle Challenger disaster, the physicist Richard Feynman noted that political pressures contributed to the disastrous decision to launch that day. He warned: "Reality must take precedence over public relations because nature cannot be fooled." It is a warning we should all keep in mind.

Joseph Ganem is a physicist and author of the award-winning The Two Headed Quarter: How to See Through Deceptive Numbers and Save Money on Everything You Buy

Atheism, Creationism, and Tautologies

2010-10-01T05:16:00.000-07:00

Renowned physicist Stephen Hawking was back in the news this month as co-author of a new book titled: The Grand Design. He and collaborator Leonard Mlodinow set out to answer three central questions in science: Why is there something rather than nothing? Why do we exist? Why this particular set of laws and not some other? That's an ambitious agenda for a single volume, but the newsworthiness of the book was its assertion that no creator was necessary for the universe. Hawking writes that "the universe can and will create itself from nothing."

The publicity surrounding that assertion reminded me of a famous quote from the nineteenth century French mathematician Pierre-Simon Laplace who also wrote a book on the laws of the universe. He presented the book to the emperor Napoleon who said to him: "M. Laplace, they tell me you have written this large book on the system of the universe, and have never even mentioned its Creator."

Laplace answered: "I had no need of that hypothesis."

When Napoleon told Joseph-Louis Lagrange, another renowned mathematician of the time, what Laplace said, Lagrange replied: "Ah, it is a fine hypothesis; it explains many things."

After reading The Grand Design, I can't help but think that nothing has changed in the two centuries since this back-and-forth between Napoleon and the mathematicians. Explaining the universe without God is about as futile as explaining the universe with God. To assert that the universe creates itself from nothing, Hawking and Mlodinow appear to lapse into the same kind of tautology that creationists use to defend their beliefs.

A tautology is a statement that is true by definition and therefore provides no real explanation or insight. The Christian understanding of God, in the words of the Nicene Creed, is that God is the "creator of all that there is." This statement alone provides no insight on the mechanisms or motivations for creation.

Scientists have sought to understand the mechanisms for creation, and in doing so have amassed enormous amounts of evidence that the Earth and its inhabitants did not simply come into being over a one-week time span 6000 years ago as creationists believe based on their literal interpretation of the book of Genesis. But, a creationist will argue that none of this evidence matters because God, as the omnipotent creator of all that there is, could just as well have created the "appearance" of an older Earth and evolutionary processes. This is a tautology because the creationist position is unassailable. All evidence that does not support the creationist's views can be dismissed as part of God's creation.

In Ken Miller's book, Finding Darwin's God: A Scientist's Search for Common Ground Between God and Evolution, he likens the belief that the universe was created with "the appearance of age," to a belief in God as a charlatan. Miller is a committed Christian who believes in God, not in spite of evolution, but because of evolution. In Miller's view, the process of evolution is awe-inspiring. In response to creationists, Miller writes that a God that has negated science by "rigging the universe with fiction and deception" is not a plausible divine being. To Miller, embracing the God of creationists is to "reject science and worship deception itself."

But, the model of a universe devoid of God presented in The Grand Design falls into a tautological trap akin to creationism. The "M-theory" Hawking and Mlodinow advocate allows for the existence of innumerable universes each with different laws of physics. To explain why our universe is so remarkable, they resort to a decades-old idea known as the "anthropic principle." The essential idea is that of the multitude of universes that can exist, only a tiny fraction of them have physical laws that allow us to evolve. Therefore our existence as observers means that our particular universe must appear to us as special in extraordinary ways.

Whether the alternative universes exist in parallel or sequentially is not important because other universes are inaccessible. The universe is by definition "all that there is." And this is the tautology that Hawking and Mlodinow fall into: To say that anything that could possibly happen actually does happen in alternative universes, is an unassailable position. For example, it is a tautology to say that I write this blog entry or I do not write this blog entry. To say that I write this blog entry in one universe and do not write this blog entry in another universe, explains nothing. Saying that both events happen but in different universes is wordplay, not physics.

Hawking and Mlodinow cite the implausible values for the fundamental constants in physics as evidence for their anthropic argument. It is a great mystery in physics as to what determines the values for the fundamental constants. The basic forces in nature and the elementary particles that form all matter, possess intrinsic properties that to date have no theoretical explanation. The electron, which is a fundamental particle that determines how atoms interact chemically, has an intrinsic mass, electric charge, magnetic moment, and angular momentum. These values are measurable, and essentially define the particle because electrons have no discernable size or internal structure.

What is especially striking is that all electrons are identical. Nature does not make defective electrons. Apparently every electron that there ever was, or ever will be, has the exact same physical properties. Electrons are identical to the point of being indistinguishable from each other. It is impossible to ever label or tag an electron, and the fact that no single electron can ever be distinguished from all the others in the universe, has profound consequences when formulating the physical laws that govern electrons.

The precise values for the physical attributes of an electron are among the fundamental constants in nature that can only be measured. No theory accounts for their values, but it appears that these values must be set very close to what they actually are in order for our species to have evolved. Because the "M-theory" that Hawking and Mlodinow advocate allows for many possible universes, each with different fundamental constants, they contend that all these universes exist and we just happen to be the observers in a universe with fundamental constants that allow us to observe.

In other words, M-theory doesn't explain the values of the fundamental constants. It just says that if you roll the die an infinite number of times, a universe with our fundamental constants will eventually appear. That is not a theory in the scientific sense of the word because it doesn't predict anything about the actual universe we observe.

Physicists have long hoped that a unified theory of all the forces in nature (Theory of Everything) will predict the values for the fundamental constants. In other words, the mathematics would predict the existence of particles, such as electrons, and the mathematical solutions would provide numerical results for the electron's physical attributes that would agree with what we know about electrons.

Such a theory remains elusive so let me make my own tautological statement. A future Theory of Everything will either predict the values for the fundamental constants or it will not. If it does, physicists will find the theory extraordinarily elegant, and theologians will say that God intended our existence by establishing physical laws at the moment of creation that allowed us to evolve. If the theory does not predict the values for the fundamental constants, physicists will keep puzzling on the issue and theologians will say that God intended our existence by choosing values for the fundamental constants that allowed us to evolve.

Either way scientists and theologians will agree that God is a hypothesis that cannot be tested. There comes a point in theology where you just have to believe that the universe has a higher purpose and meaning, even if that meaning is not readily discernable. There comes a point in physics where you have to say: "that is just the way things are" because explanations through causation have to stop at some point.

My own view is that humans might not be evolved enough to comprehend a Theory of Everything. There is no reason to believe that the human brain is the pinnacle of evolution because there is no reason to believe that the evolution of intelligence will not continue long into the future. On an evolutionary time scale the human species, Homo sapiens, has not been around all that long. Modern humans have only existed about 100,000 years, which is an insignificant amount time compared to the hundreds of millions of years that evolutionary processes have shaped species on the planet. What might brain structures and intelligence look like 100 million years from now?

As I write this paragraph my dog lies patiently at my feet waiting for me to get up and do something of interest to her, such as work in the garden where she can enthusiastically contribute by chasing the various critters that inhabit our yard. My endless fascination with pixilated patterns of light on a computer screen has no meaning to her. I sometimes say to her that if she could do calculus, or edit and proof my writing, she could do work that would be of real use to me. She listens to me attentively, as she does everything I say, wags her tail, and maintains her vigil.

Of course, I could talk to my dog all day about advanced calculus, unified theories of physics and their theological implications, and she would listen attentively and understand nothing. We know that this is not the fault of the dog. A dog does not possess the brain structures to process the concepts needed for language, mathematics, or theology. Nor does a dog have the life span humans require to learn advanced concepts in all these subjects.

But those facts about dogs leave open the possibility that far into the future, another species, with a more advanced brain structure, might have similar things to say about humans. Will they say that the species, Homo sapiens of the Holocene epoch, figured out many important concepts in physics, but lacked the brain structure needed to understand the math required for the Theory of Everything?

A central tenet of Christianity is that God created humans in God's image. As a result the human striving to understand the natural world (God's creation) is a quest to know God. It also follows that how humans treat other humans is a reflection of our relationship with God.

But, all around I see humans creating God in the image of humans. Much of the evil done in the name of God, that atheists cite to disparage theists, arises not from believing in God, but from anthropomorphizing God. Humans have created innumerable images of God that for most part depict God as acting and thinking like humans. But, the sheer scale and grandeur of the universe is evidence that a creator God is unimaginably extravagant and inventive. I would be careful about concluding that humans are the endpoint in the creative process.

Joseph Ganem is a physicist and author of the award-winning The Two Headed Quarter: How to See Through Deceptive Numbers and Save Money on Everything You Buy

When Markets Fail

2010-09-01T19:05:00.000-07:00

I just finished reading Broke, USA: From Pawnshops to Poverty, Inc. How the Working Poor Became Big Business by Gary Rivlin. It is a disturbing read about what Rivlin calls the "poverty industry" in the United States. Poverty is in fact a lucrative business opportunity for the many entrepreneurs that Rivlin profiles. This is a discovery not lost on major banks that now have large investments in companies that provide sub-prime loans of all types. I knew from doing research on my own book--The Two Headed Quarter: How to See Through Deceptive Numbers and Save Money on Everything You Buy--the counterintuitive result that collectively the working poor represent an enormous source of wealth for those who know how to tap into it. Rivlin's reporting explains how the systematic stripping of resources from communities on the financial edge is accomplished.

In my book, I liken some of these payday loans, sub-prime mortgages and credit card products to old-fashioned "company stores." But, as I read Broke, USA, I was reminded of another analogy raised in the book by Stacy Mitchell-- Big-Box Swindle: The True Cost of Mega-Retailers and the Fight for America's Independent Businesses--colonialism. Mitchell reports on the systematic destruction of local economies and businesses by mega-retailers such as Wal-Mart, Home Depot, and Target. The rationale for allowing mega-retailers entrance into a community is the market demand for their products. But, often after the destruction of local businesses and jobs, there is no longer enough wealth left in the community to support these large retailers. The corporations move on, abandon their stores, and leave a shuttered main street as well. To Mitchell, this is not the free market at work. Rather, it is exploitation akin to colonialism, in which a large power imbalance allows a distant corporation to appropriate wealth for its own enrichment at the expense of a local community.

But, the question I kept wondering about was: Why doesn't the market for loans work for poor people? Much of Rivlin's reporting was about political battles fought in state legislatures, not about businesses trying to out-compete other businesses with a better product. One of Rivlin's protagonists, Martin Eakes is founder of the Center for Responsible Lending (CRL), a company that specializes in providing reasonably priced mortgages to high-risk, low-income homebuyers. Eakes argues that CRL shows that it is possible to lend at reasonable rates to "sub-prime" borrowers and make money. He contends that the usurious, triple-digit annual interest rates, routinely charged by sub-prime lenders are not necessary, and should be banned.

However, in Rivlin's narrative, Eakes spends more time joined with community activists lobbying for bills to protect consumers against predatory lending, than expanding the CRL business model to compete nationwide against the sub-prime lenders by offering a lower-priced product. It is this paradox that gnawed at me while I read the book. It was only by the end that I realized the reason the market fails for sub-prime borrowers, and why government intervention is necessary.

The argument from the sub-prime lending industry is that interest rate caps take away consumer choice. No one forces people to take-out payday loans, pawn possessions, or sign documents for sub-prime home equity loans. Because these choices are freely made, the borrowers must see some value in the loan product. If the demand for sub-prime loans didn't exist, neither would the sub-prime lenders.

I tend to have a bias in favor of these kinds of arguments. I believe that consenting adults should be free to make decisions with their money for or against products. I have also observed that in any event, markets are extremely resilient and difficult to stamp out. One only needs to look at the markets for vices--such as drugs, gambling, and prostitution--to see the futility of trying to eliminate the supply of a product or service when there clearly exists a demand.

As a result, I tend to believe that the best way to effect change is through the market. Educating consumers on how to act in their best interests is my preferred approach. My writing, in books like the Two Headed Quarter, is intended to teach consumers how to make the best choices, not to proscribe choices. Admittedly, my bias is influenced by my own societal role as an educator.

However, I also know that markets cannot solve all problems. We would not have roads, airports, the Internet, universal phone and electrical service, without the intervention of the government acting for the common good. I also know that markets can and do fail. I was never naive like Alan Greenspan, who seems to have believed that the self-correcting tendencies of markets would eventually right all wrongs. (This belief came from a man whose job was to artificially manipulate the mortgage market by raising and lowering interest rates.) As we have recently seen, market failures can be spectacular and so threatening to the financial order, that the most committed "free market" advocates will abandon their principles and grovel before Congress when their luxury lifestyles are at stake.

But, I realized by the end of the book that the problem is deeper than lack of education. For a market to work the participants must trust each other. They must act in good faith. It would be impossible to conduct business of any kind if no trust existed between the buyers and sellers. The simplest economic interactions-grocery shopping, car repair, hair styling, eating in a restaurant-could not happen. Think about the implied contract when you order food off a menu, drop your car off for an oil change, or get your hair cut. You trust in an honest delivery of the service, and the provider trusts that you will pay.

During the financial crisis of 2008, banks could not trust other banks to repay loans, and the entire system for extending credit on a daily basis to cover short-term obligations froze. Without government assurances the banking system might have collapsed, not because of a shortage of money, but because of a shortage of trust.

Many of the lending practices profiled in Broke, USA violate trust. The lenders are not acting in good faith when they sell loans to people who cannot possibly repay the money, sell unnecessary and overpriced mortgage insurance, provide less favorable loan terms when the borrower qualifies for better terms, and then sell the toxic products to investors representing them as a safe securities. It is disingenuous for the lenders to rationalize these actions by saying that they were only acting in their best financial interests, and that the borrowers and investors should have taken more care to act in their best interests because that is how free markets work.

No, free markets will not work if greed is the only motive driving them. There is a famous quote from Adam Smith that is frequently invoked to justify greed. He wrote:

"It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest."

--Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations

But, self-interest in the community setting that Smith describes is more than just maximizing income. It's also about sustaining the relationships necessary for a community to exist in the first place. The butcher, the brewer, and the baker, will not be in business for very long if greed is their only motive. They must trust in and look out for each other, or else none of them will have their needs met. Their self-interest is not just money; it includes a need for each other.

Joseph Ganem is a physicist and author of the award-winning The Two Headed Quarter: How to See Through Deceptive Numbers and Save Money on Everything You Buy

Avoiding the Expectations Trap: A Tribute to Dick Norberg

2010-08-01T11:34:00.000-07:00

My scientific mentor, Richard (Dick) Norberg, died this spring. He provided my training as a scientist and supervised my doctoral thesis. Dick was a professor of physics at Washington University in Saint Louis for more than 50 years, and a pioneer in the field of magnetic resonance. Long before magnetic resonance (MR) became part of the medical imaging technique known as MRI, he made key discoveries and obtained insights that led to our modern understanding of the phenomena.

I worked with Dick for three years in his laboratory at Washington University. Learning to become a scientist is nothing like school would lead you to believe. Science, as it is practiced by scientists, is more of a craft than a method. Graduate training in science is akin to an apprenticeship in which an aspiring scientist learns the trade from a master craftsman. Each master has his or her own style and approach. I am often confused when my children ask me for help with their science homework because I am unfamiliar with the "scientific method" their classes teach. For an excellent article on how actual scientists conduct science see: "How Science Works." It is on a Website http://www.UnderstandingScience.org that provides resources for K-12 teachers to correct many misconceptions about the process of doing science.

Dick loved doing physics and remained enthusiastic and engaged until the very end of his life. I loved having him as a teacher. He expressed his usually strong opinions in ways that stayed with you forever. I can still hear his voice when I recall the many words of wisdom he imparted. Some examples of his observations and advice:

"Any academic department with the word 'science' in its name is not."

I recalled that statement with a chuckle the year after I left Washington University to do postdoctoral research at the University of Georgia. On one of my daily walks from the bus stop past the school of home economics I noticed that a new sign had gone up in front of the building that said: "School of Consumer Sciences."

"When you write a paper, always separate the data and put it first. What you say about the data might turn out to be wrong later on. But, if you did the experiment correctly the data will be true forever."

This is actually a profound insight on the nature of scientific progress that many people fail to understand, and high school science classes fail to teach. People are always quick to point out that scientific theories change and that many ideas scientists of the past believed turned out to be wrong. The implication is that nothing about science is permanent. But, nature does not change. An experiment poses a question directly to nature and the answer that comes back will always be true. All future scientific theories will still have to explain today's scientific facts.

But, the most important advice I received from Dick Norberg was on the day I left. I had completed and defended my doctoral thesis, finished up with the movers, and packed my car for the drive to my new city and job. I stopped at his office to thank him and say goodbye. His parting words were:

"Whatever you do in life, do what you enjoy. Don't do what others expect. Your wife, your parents, your children, your friends, will all have expectations. Don't give into them. Do what you most enjoy."

As time has gone on, my appreciation of this advice has grown. As a teacher for the past 16 years, I've seen many students sabotaged by expectations.

I've seen students in majors for which they have no real interest or aptitude, but their parents refuse to fund their college education unless they study something "practical." The result is students in engineering programs even though they cannot do the math and have no interest in building anything. There are also students muddling through business degrees who would be much better served in the long run with a liberal arts degree. It is actually more practical to have good grades in history major than bad grades in a business major.

I've seen students who are not mature enough to be in college but go because it is the expected next step after high school. The result is that they are wasting their time and their parent's money. Partying all night and sleeping all day can be done at a much lower cost at home than in college, and the results achieved will be the same.

I've seen exceptionally smart students who should become scientists, but their parents expect them to become medical doctors because of the prestige it will bring to the family. The result is if you ask these students why they are so passionate about medicine that they intend to devote their life to its practice, they can only express a nebulous desire to "help people." Of course, I can think of many professions that "help people" and are unrelated to medicine. If you intend to become a medical doctor you should have a real interest in medicine.

I've seen students juggle the demands of double and even triple majors so that they can pursue their interests and satisfy family expectations. The result is a great deal of stress from pursuing credentials that have little meaning in the long run. Employers care more that you have a degree with decent grades than all the majors and minors that you acquired along the way.

My own three children are all artists. I have two in college and one in high school. They are now aware enough to observe friends doing what's expected. My daughter said to me one day: "I'm so happy that you and mom support me. You don't discourage my interest in theater and force me do something else. Many of my friend's parents aren't like that."

I said: "You have to do what you enjoy the most and see where your interests and talents take you. You'll figure out how to earn a living. You can't spend your life doing what others expect."

I thought about Dick Norberg when I said that. Dick loved to teach and loved doing physics. I was one of 47 doctoral students he taught in his more than half-century as a physics professor. Had he wanted, he could have held more prestigious administrative positions at the university. But those kinds of positions would have kept him away from research and teaching.

I now realize that as a teacher he wasn't just speaking to me that day. He was speaking to my children and my students, and in the future their children and students. Teachers have the ability to speak to the future. That is what he enjoyed.

Joseph Ganem is a physicist and author of the award-winning The Two Headed Quarter: How to See Through Deceptive Numbers and Save Money on Everything You Buy

The BP Oil Spill: Why Slow Is Much Faster

2010-07-04T07:34:00.000-07:00

As I read an article in the online Wall Street Journal about the equipment failures leading to the disastrous oil spill in the Gulf of Mexico, I am reminded of a lesson that I teach my laboratory students. It is this: The fastest, cheapest way to get something done is to proceed slowly. Check and recheck each step before proceeding to the next. Don't rush and don't make assumptions. It is counterintuitive advice to give students, who like everyone else, are in a hurry. But, as BP is finding out, assumptions can be costly, time consuming, and deadly.

The Wall Street Journal investigation is the most complete account to date in the media of what went wrong on the Deepwater Horizon. It is a story of rushed procedures and faulty assumptions that appear motivated by schedule and budget considerations. For example:

BP cut short a procedure designed to detect gas in the well and remove it before it becomes a problem.
BP skipped a quality test of the cement around the pipe (despite a warning from the cement contractor).
BP installed fewer centering devices than recommended (6 instead of 21).

The article also reported that on the day (April 20) the Deepwater Horizon exploded and sank, a disagreement broke on the rig over the procedures to be followed. A BP official had a "skirmish" with Transocean officials over how to remove drilling mud. BP prevailed and several hours later 11 people were dead and oil was spewing into the Gulf.

It appears that all involved knew corners were being cut, but a consensus emerged that the process would "most likely work." The cementing contractor Halliburton said that it followed BP's instructions, and that while some "were not consistent with industry best practices," they were "within acceptable industry standards."

But, the problem with complex equipment and procedures is that "most likely" can easily become "very unlikely" when everything has to function. Simply adhering to "acceptable standards" is no guarantee that everything will work.

This is lesson my students usually have to learn the hard way, even though it can be proved mathematically. Suppose you have a 90% confidence in your ability to make electrical connections. You think that if you wire your project without conducting tests, it will have a 90% chance of working. But, if you have 10 connections and each one must work, it is unlikely your project will succeed. The reason is that probabilities for simultaneous events multiply. If two events with a 90% chance of success must occur together, the likelihood of the combined events happening is (0.9) x (0.9), or 0.81, which is 81%. If 10 simultaneous events must occur, the chance becomes (0.9) multiplied by itself 10 times (0.9)¹⁰, or 0.35, which is a 35% chance of success.

A relative high confidence of 90% for a single can connection can be a deceiving number if all of them have to work. Worse still, when it doesn't work, you won't know why. It is difficult and time consuming to track down errors. The only solution is to spend extra time during assembly to test each connection when you make it, before proceeding to the next one.

I see this problem all the time when I teach. Students will follow the assembly instructions but do not perform the tests as they go along. They assume everything is correctly assembled. At the end they will have a beautiful piece of equipment that doesn't work. It is brought to me to figure out why and the students watch in dismay as I dismantle it piece by piece to search for the problem. Sometimes it is a mistake or misunderstanding on the first step, and that forces the students to begin all over again. They learn that time-consuming testing actually saves time.

It's not only students that struggle with this lesson. A friend once asked me for help wiring an external keyboard he purchased for a handheld device. He had followed the instructions, but after making all the connections it didn't work. Frustrated and confused he didn't know what to do next. He took it apart, put it back in the box, and called me.

He came to my office where I spread the parts out on my desk and followed the enclosed wiring instructions. But, after making each connection, I tested it with an electrical meter while twisting and pulling to make sure it was secure. I did this for every connection, because I made no assumptions about reliability based on how it looked or the high probability that almost all the connections I make are secure. When I finished, I turned the device on and it worked.

My friend said: "But, I wired it the same way you did. Why didn't it work?"

"You didn't do the same thing I did. You didn't test each connection when you made it. When it didn't work, you had no good way of finding a single bad connection, which is all that is needed for it to fail. I made sure each connection worked before I continued to the next one."

For highly complex equipment, such as on oil drilling platform, a 99.9% success rate for each step might not be acceptable. Consider a procedure that involves 10 steps with a 99.9 % chance of succeeding. The number 0.99910 is equal to .99, or 99%. A 1% chance of failure sounds safe, but the fact is 1% events happen frequently, about 1% of the time to be exact. If an event with a 1% frequency results in deaths, injuries, environmental and economic devastation, and possible bankrupting of the company, the risk is unacceptably large.

But, what is most disturbing is that even if the executives at BP making decisions understood the mathematics of risk it might not have made any difference. The root of cause the Gulf oil spill is the same as the root cause of the financial meltdown two years earlier. The executives take dangerous risks because they realize enormous personal gain when they succeed, while others will pay for the losses when they fail.

Imagine if Tony Hayward, BP's CEO, faced personal financial ruin from an oil spill. What if he had to contemplate having no yacht, no house, no assets, no job, and complete loss of livelihood? After all, those are the circumstances facing thousands of people on the Gulf coast as a result of the oil spill. What if Tony Hayward had to personally operate the equipment on the Deepwater Horizon so that its failure would end his life as it did eleven others? Do you think he would run his company differently? I bet if his life and livelihood were on the line he would make sure careful testing is done to insure safety for all concerned.

Unfortunately, the most likely outcome of this disaster is that nothing will change. There will be calls for tougher regulation, but, just like the financial overhaul working its way through Congress, change will be cosmetic. Opponents of more financial regulation use the same rhetoric as opponents of more oil industry regulation. They denounce increased regulation as an attack on "free markets."

But for "free markets" to work the agents must have a personal stake in the outcomes. Real free markets are composed of the thousand of small business owners and their workers who have a personal financial stake in their successes and failures. It's a sham to say that the executives of banks and oil companies are agents in a free market when they can only reap profits, while everyone else pays for their losses.

Joseph Ganem is a physicist and author of the award-winning The Two Headed Quarter: How to See Through Deceptive Numbers and Save Money on Everything You Buy

Financial Literacy: Maryland's Education Proposal

2010-02-27T10:23:00.000-08:00

The Baltimore Sun recently published an op-ed piece by Maryland Comptroller Peter Franchot, supporting proposed legislation in the Maryland General Assembly to require all high school students to complete a stand-alone course on financial literacy before graduation. Franchot argues that educating our children in the basics of financial literacy will help avert future economic downturns. As is typical of many people in the government, he blames the recent economic crisis on bad choices made by consumers. Mr. Franchot writes:

"Thus, in far too many instances, we entered into financial commitments that we couldn't afford, with terms and conditions that we didn't truly understand, in order to buy things that we really didn't need. If more Marylanders had the benefit of sound financial literacy education, fewer of our friends and family members would be facing the loss of homes and life savings today."

I think teaching financial literacy to high school students is a good idea. But, the problems with the financial system go far deeper than a new high school course will fix.

First there is the problem with "stand alone" courses. To understand personal finance, students need to understand more about math, especially arithmetic, than they currently do. Many consumers made bad decisions on loans because they did not understand the basic math behind interest and payment calculations. My own belief is that personal finance education should be woven into current math courses. It would make math more interesting, and therefore relevant. Too many students, and adults view math as a "stand-alone" subject with no connection to their daily lives. If consumers learned just how many dollars their lack of mathematical knowledge costs them in the marketplace, they would see that math is an important subject.

Second there is widespread corporate-government collusion to deceive consumers and then blame them for falling victim to the deception.

I gave a talk on the U. S. mortgage crisis at an international conference on science in society at Cambridge University in the United Kingdom this past summer. In academic jargon the paper I presented was titled: "Quantitative Reasoning Applied to Modern Advertising." The term "quantitative reasoning" just means applying arithmetic to real-world problems. It is a way of thinking that is second nature to scientists, but unknown to most people outside of science.

I argued that if consumers learned some of these quantitative reasoning methods, they could greatly improve their day-to-day financial decision-making. I concluded that the best way to effect economic change is through the market. I said that people selling mortgages act according to their financial interests. In response, consumers need to educate themselves to make choices that are in their best financial interests.

After my presentation, an Australian economist, in a private conversation, disagreed with my conclusion. He said that home pricing, and mortgages are too complex for the average person to understand. It is incumbent on the government to regulate the market. He said that Australian government did not allow the kind of toxic mortgage products that brought down financial institutions in the US and UK, and wiped out millions of homebuyers. As a result, Australia did not have a mortgage crisis.

I admitted that my American bias influenced my conclusion. I told him that in the United States, government and corporate corruption is so institutionalized, that meaningful regulations to safeguard the financial well being of average Americans would never be implemented. From my viewpoint, education is the only realistic way American consumers have to protect themselves.

But, my viewpoint is not meant to excuse corrupt behavior. If you leave your house unlocked and are robbed, you made a bad choice. But, a crime was still committed. If you agreed to a mortgage that you didn't understand, you made a bad choice. But, the lender should have made sure that you understood the mortgage. Instead, lenders created mortgages designed not to be understood.

That is why I get so angry when I see government officials like Mr. Franchot blaming uneducated consumers for the financial crisis. Education is needed, but it will only go so far in fixing our financial problems. It will not replace trust. All parties to a contract must act in good faith for our financial system to work.

Joseph Ganem is a physicist and author of the award-winning The Two Headed Quarter: How to See Through Deceptive Numbers and Save Money on Everything You Buy

The Big Snow: Fooled by Variance

2010-02-11T18:22:00.000-08:00

No need to visit the gym this week, even if it were possible. I've had plenty of exercise shoveling more snow than I have ever seen at one time in my entire life. More than 4 feet of snow fell in the Baltimore region in just 5 days. As someone who grew up in Albany, New York, and attended schools in Rochester, New York and Madison, Wisconsin, a heavy snowstorm is not a novel event for me. I do not panic the moment flakes start swirling in the air, as many Baltimore-area drivers do. I often question the judgment of school officials, who close the entire system down when an inch or two of the white powder appears. But, 4 feet is an impressive amount of snow by almost any standard. I would not be able to drive anywhere even if I wanted to. Forward motion of my automobile is not physically possible under these conditions.

As snowfall totals go, this event has shattered records. That has kept the media and government people busy tabulating and interpreting numbers. The tabulations are of interest, but the interpretations are mostly silly. Nassim Taleb's wrote a brilliant book on investing titled Fooled by Randomness
. With apologies to Taleb, I've titled this post "Fooled by Variance," which is a condition afflicting a great many of the public statements about the storm.

Variance is a measure of the typical deviation of a measurement from its average value. The usual definition is that it is the range encompassing 95% of the measured values. For example, if we use our rulers to measure human stature instead of snow depth, we would find that the average height of an adult male in the United States is 69 inches. Of course, finding males taller or shorter than 69 inches is common. However, 95% of adult males have a height within 6 inches of the average-between 63 and 75 inches. That range is the variance. However, extreme cases outside of the variance still occur-male heights as short as 30 inches, and as tall as 100 inches have been measured.

In the past week media reports about the storm have referred to it as "a once in a lifetime event," "unprecedented," and "a hundred-year storm." In other words, the storm intensity was far outside the expected variance. But is that claim true? In the 16 years that I've lived in the Baltimore area, this is the third time that I've been snowed-in for an entire week. The week of January 7, 1996 delivered a similar one-two punch with 22.5 inches falling on January 7 and 8, followed by another storm a few days later with more than an additional foot. The blizzard of February 15-18, 2003, with 28.2 inches, remains the record holder for a single storm event. We will never know if the February 5-6, 2010 storm would have topped that number, because the observer, at the official airport weather station, did not follow the proper procedure in recording snowfall measurements.

The established procedure, for determining snow accumulation, is to wipe the snowboard clean every six hours, and then total all of the six-hour measurements. If you wait until the storm ends to measure snow depth, the number will be smaller because the snow will compact under its own weight. If you total more frequent measurements-say every hour-the number will be higher because of reduced compacting. Of course, there is nothing magical about totaling six-hour measurements. It is just an agreed upon protocol to insure that the snowfall amounts were measured under the same conditions, so that a comparison makes sense. But, it also shows that these numbers, and the "records" based on them, are to a certain degree arbitrary.

The 1996, 2003, and 2010 events were all massive paralyzing storms that in each case shut down the city for an entire week. There is not much difference between these three events, which would suggest that the natural occurrence of these kinds of storms is more frequent than "once in a hundred years" or even "once in a lifetime." Not that we would have anyway of knowing the actual intensity of a "hundred-year storm." Snowfall record keeping in Baltimore began in 1883-127 years ago-so we are many centuries away from having enough data to analyze for "hundred-year" or even "once-in-a-lifetime" events.

So should Baltimore be more prepared for large snow events? An article in the Baltimore Sun reports on the amusement of the northern cities. They brag that their streets are clear and their businesses and schools open. But, I lived for five years in one of the snowiest cities in the United States-Rochester, New York-with an average annual snowfall of 92 inches-about 7.5 feet. Actually, 4 feet of snow in 5 days would shutdown Rochester too. The high annual snowfall in Rochester results from lake effect flurries that blanket the city with light snow almost everyday during the winter. My freshman year at the University of Rochester it snowed for 60 consecutive days. It never snowed enough at one time to close the school, but over the course of the entire winter it resulted in an impressive snowfall total. Lake effect flurries mean that snow removal is an ongoing activity during the winter in Rochester. It is not an "event" like it is in Baltimore.

Apparently Rochester has a high average annual snowfall but not much variance. In contrast, Baltimore has a much smaller average annual snowfall-only 18 inches-but a large variance. It is rare, but it does happen that in Baltimore a single storm will dump more than an average annual snowfall. In Rochester it is nearly impossible for a single storm to deliver more than the average annual snowfall. Which means that it makes no sense to have the snow removal capability of Rochester. It would be an under utilized resource, and still not save us in extreme weather events, when the real problem is where to put all the snow that is plowed.

Although, if the climate changes, and monster snowstorms become frequent, then investing in more snow removal equipment would make sense. But a single storm event does not define a climate-a fact that commentators at Fox News are oblivious to. These global warming deniers were quick to claim that the storm "proved" that climate change theories are wrong. It is scary enough when science is politicized. After all, the laws of nature are oblivious to party affiliations. But the inane reasoning of Fox News is laugh out loud funny, a point made in a hilarious spoof on the Daily Show on how to misinterpret data. What is not funny is that Fox News commentators have such a high-profile platform to promote ignorance.

So what can we conclude about this event? The scientific answer is not much. Annual snowfall totals have a great deal of variance, especially in cities such as Baltimore where the annual average is a small number. In those cases, annual snowfall totals will not even form a normal distribution about a mean, because snow accumulations have no upper limit, but a lower limit of zero that cannot be breached. That means that the "average" annual snowfall isn't all that meaningful a number. It is the variance that we should be concerned about.

Cash for Gold Scams: Exploiting Desperation and Ignorance

2010-01-26T19:19:00.000-08:00

With the price of gold soaring, while the economy falters, selling little-used gold jewelry has become an attractive means for raising extra cash. In early December of 2009, gold hit a peak of over $1200 per troy ounce, about 3 times the just over $400 per troy ounce it sold for 5 years earlier. As a result the melt value of gold necklaces, rings, and bracelets, has become a valuable asset for many jewelry owners.

That fact has also been noticed by gold dealers, who do a brisk business these days buying up unwanted jewelry in order to extract, and resell the gold content. Commercial TV, and the Internet are awash with ads offering cash for gold. Unfortunately, many of these "cash for gold" operations are scamming their customers. It is easy to fool people, because many jewelry owners have no idea how to estimate the worth of what they own.

The Today Show on Friday January 22, reported that heavily advertised online sites, such as Cash4Gold.com, only pay between 11% to 29% of the value of the gold. The reporter interviewed Ben Popken from the consumer watchdog site consumerist.com that did a study on Internet cash-for-gold offers. According to Popken a pawnshop would pay far more for your gold jewelry than many of these Internet sites. You can see a video of the Today Show report and interview with Ben.

The advice is to always get more than one offer for any gold jewelry that you sell. But, it is actually not that hard to appraise your own gold, and determine if an offer is reasonable or not. I've even created a Web calculator to assist in doing your own appraisal. All you need is a kitchen or postal scale that determines weights in ounces (oz). Place your gold chain on the scale to determine the weight.

Next you need to know the purity, which is expressed in carats. If you have the original packaging, the purity is usually on the label. The most common gold alloy used in jewelry is 14 carat (although 10 carat and 18 carat are also widely used). Pure gold is 24 carat, which means that a 14-carat chain has (14/24) or 0.58333 gold content.

The spot price of gold varies by the day. Updates can be found at many financial and precious metal Websites, such as goldline.com. Today the price is about $1100 per troy ounce. A troy ounce is slightly more than a postal, or food ounce, it is 1.09714 ounce to be exact. That means an ounce measured on a postal scale is (1/1.09714) or 0.91146071 troy ounce.

Those are all the numbers you need to appraise the gold content of your jewelry. Suppose your 14-carat gold chain tips your food scale at 1.5 ounce. You own (14/24) x 1.5, or 0.875 ounce of gold. That is 0.875 x 0.91146071, or 0.7975 troy ounce. The dollar value today would be $1100 x 0.7975, or $877.

Obviously no dealer will offer you that much for your gold chain. The dealer needs to cover costs of overhead, purifying the gold, and reselling it. The dealer will not be in business without a markup. But, if you are offered $250 for the chain, an amount that might seem like a lot, you are getting ripped off. The dealer's services are not worth that much of a difference between the spot price and the offer. A local pawnshop might offer 75% of the value, or $658.

If you want to estimate the value of your gold, get out your food scale and use this calculator.

Debit Card Deceits: When Zero Isn't The Floor

2009-09-27T18:11:00.000-07:00

Debit cards have become a popular alternative to credit cards because they have many of the conveniences of credit cards without actual debt. I have come to rely more and more on my debit card because I don't have to carry a checkbook and hold up checkout lines with identification hassles every time I write a check. I simply swipe the card and go on my way. Money is deducted directly from my checking account, just as if I wrote a check. Once I deplete my checking account balance, the card stays in my wallet until the next payday. It appears to be a full proof system for staying out of debt.

However, appearances can be deceiving because the belief that you can't get into debt using a debit card is based on a false assumption. Account holders naturally assume that once the balance is zero, transactions will be declined. The reality is banks will process the transaction even if the money is not in the account and then assess hefty overdraft fees. The account holder becomes liable for the purchase, the overdraft fee, and any additional fees that the bank dreams up.

My teenage daughter had a recent run-in with debit card fees. She does not have a credit card, but she has a checking account at M &T Bank with a debit/ATM card, and a job with direct deposit for her paychecks. Like many consumers, she believed that a debit card protected her from ever spending more than the balance in her account. However, a couple of small purchases during a night out with friends unleashed a cascading series of bank charges put the balance on her account hopelessly below zero.

At a local eatery she bought a sandwich for $8 and then moved across the street to the local coffee shop where she made a $4 purchase. She thought her checking account balance was low, but each transaction on her debit card was approved. What she didn't realize is that because she did not have the money to cover either purchase, each transaction triggered a $35 overdraft fee. Checking her account online the next day, revealed that she was now more than $70 below zero. She thought the problem would be solved in a few days when her paycheck for $90 would be posted.

However, that was another false assumption. M&T's fee structure imposed a $10 charge everyday that the account remained below zero. By the time the $90 arrived she was more than $100 in the red and counting. Her paycheck vanished and the $10 daily charges continued. The next $90 paycheck would be in two weeks. It had become mathematically impossible for her get out of debt.

After learning all this, I understand why payday loan operations continue to thrive despite their exorbitant fees. In some circumstances, a payday loan is a much better deal compared to a bank. For low-income people with small balances, a simple math error made while shopping can cause unrecoverable financial harm if a bank is involved.

Because my daughter wanted to be responsible for her own finances, she avoided telling me what was happening. I found out by accident, when coincidentally, another problem occurred with her account that prompted the bank to call, and I answered the phone. Someone had obtained access to her debit card number and was making fraudulent purchases. These transactions, totaling hundreds of dollars for purchases in places outside the United States, had not been declined either. But the bank's monitoring systems had flagged them as suspicious and called to verify their authenticity.

We had to visit the bank and fill out paperwork certifying that the transactions were indeed fraudulent so that the charges could be reversed. By the time we arrived, the fraudulent purchases, multiple overdraft fees, and daily charges had resulted in a checking account balance that was close to $1500 below zero.

I asked the M&T bank manager: "At what point does the balance get so far below zero that transactions are declined?" Interestingly, he did not have an exact answer to that question. He indicated that there are limits, but that the limits are not hard and fast. From his point-of-view, the bank was doing a favor by allowing purchases to go through even if no money was in the account to cover them. Of course, it is an unasked favor, for which the bank is charging fees that are often far greater than the purchase amounts in question.

On reflection, I found the bank's priorities deeply unsettling. After all, M&T had asked us to come in, but it was the suspicious pattern of activity that triggered the phone call, not the negative balance. A $4 purchase at a local coffee shop that resulted in hundreds of dollars in fees is part of the bank's business model. A $300 purchase for tickets to a Canadian amusement park that my daughter couldn't possibly have made, is a threat to the bank's business model. The latter event triggered a phone call from the bank; the former event did not concern them. The bank had no moral qualms about appropriating my daughter's entire paycheck for a $4 coffee purchase, but acted outraged by someone taking money from the bank.

After reversing all the fraud, we still had the negative balanced caused by the fees associated with the legitimate purchases. I managed to negotiate reversals for all but the first overdraft fee. That restored her account balance to a positive number and eliminated the daily $10 charges.

However, I found agreeing to even one overdraft fee a distasteful compromise given that my daughter never agreed to overdraft protection in the first place. In fact, not only do banks provide an expensive service that is not always wanted, but they also deceive customers further by re-ordering transactions to maximize fees. Suppose you went shopping with $100 in your account and made purchases of $4, $6, $8, and $102 in that order. You might think that the $102 purchase at the end would trigger a $35 overdraft fee because you had a large enough balance to cover the first three purchases. But, at the end of the day the bank would assess $140 in fees by re-ordering the purchases. It would process the largest purchase first as an overdraft, followed by the other three small purchases all as overdrafts.

These practices might be changing because Congress is debating new legislation that would require banks to get your permission before setting up your account with expensive overdraft protection. Consumers are also fighting back. Eileen Ambrose reported in The Baltimore Sun that Maxine Given of Baltimore County, sued M&T Bank, claiming the bank's overdraft program violates Maryland's consumer protection laws. And, as Bob Sullivan reported in his Red Tape Chronicles, consumers are leveraging the power of social media online to publicly embarrass and shame the shady practices of many banks. Let's hope Congress gets the message and enacts meaningful consumer protections.

Joseph Ganem is a physicist and author of the award-winning The Two Headed Quarter: How to See Through Deceptive Numbers and Save Money on Everything You Buy

The Public Option for Healthcare: Logical Flaws in the Argument Against

2009-09-10T12:01:00.001-07:00

I am mystified by the arguments presented by opponents of the “public option” for health insurance. Their line of reasoning has a rather obvious logical flaw. The gist of the argument against the public option is that it would lead to a government take over of the entire health care system because private insurers couldn’t compete with the government. Opponents of the public option say that would be a bad outcome because government-run-health care would not be able to provide the kind of health care services people want and need. Their underlying assumption is that any health care plan run by the government would be an inferior product compared to private health insurance.

But, that assumption is the source of the logical flaw. Since when is it a competitive advantage to offer an inferior undesirable product? If public health care were really as bad as opponents claim, why would anyone choose it? It seems that the real fear opponents of the public option have is that many people might find it an attractive choice. But, if it’s an attractive choice, why is that a problem?

Actually the market place is full of examples where private, for-profit companies compete successfully against government-run or non-profit entities.

My job at a private college is not threatened by the existence of cheaper public schools.

Rural electric cooperatives are not a threat to for-profit electric companies because those companies do not find it profitable to serve the rural market.

Package delivery services provided by private companies such as UPS and FedEx compete successfully against the “public option” of the U. S. Postal Service.

The existence of member-run credit unions did not put private banks out of business.

In fact the banks managed to fail by themselves; no outside competition was needed. That fact calls into question the entire assumption that privately-owned equals competent and efficient while government-run equals inept and wasteful. To borrow the title of a recent book on the collapse of Lehman Brothers, “a colossal failure of common sense ” permeates the management of many privately run companies.

No organization, public or private, is immune from ineptness and mismanagement. But, if I worked for an organization that I perceived as incompetent, I would work to fix the problems or find another job. I would not contribute to the problems just to prove my point that the organization is dysfunctional. Unfortunately, many members of Congress work for the government solely to prove that government doesn't work.

Actually, private and non-profit health insurers already compete head-to-head in the marketplace. My health plan through my employer is with a non-profit company. Its existence hasn’t put the private for-profit health insurers in my state out of business. I fail to see how public health insurance for people not currently served can be a threat to the existing private insurance system.

No one has suggested that private insurance and private health care be outlawed. This being America, I have no doubt that those who have the jobs and income that provide adequate health care will continue to receive the kind of care to which they are accustomed. The issue is how do we as a nation provide care for the tens of millions of fellow citizens who are not served by the current system. Many of the uninsured have zero options available. Every other developed nation in the Western world takes care of its citizens. How can the richest nation of them all, claim it cannot afford to?

Joseph Ganem is a physicist and author of the award-winning The Two Headed Quarter: How to See Through Deceptive Numbers and Save Money on Everything You Buy

UK Trip Part I: Executive Compensation

2009-08-14T11:30:00.000-07:00

I just returned from a trip to the UK where I spent four days touring London and then four days at Cambridge University where I gave a talk about the mortgage crisis in the United States. It struck me perusing the London media just how many of the banking problems in the UK mirror those in the US and even more striking, how the rhetoric matches word-for-word.

A British tabloid-style newspaper—The Independent—ran a headline on August 4: ‘Big bonuses? It would be wrong to stop paying them.’ Beneath it ran the subheading: "Barclays’ £50m-a-year boss delivers a defiant rebuff to critics who say bankers are overpaid." Quotes in the article could have been lifted from the financial section of any newspaper in the US. Here is a sampling:

“performance-related bonus payments were vital given the bank's "obligation to run a client-first business”

“It is pay for performance and it is based on principles we have followed for a while now.”

“It would be wrong for the bank not to pay out ‘if we had really good performance.’”

And my favorite quote described seven-figure bonuses as:

“essential if we want people to work in our industry”

When I returned home, the first headline I saw in my local paper, the Baltimore Sun read: “CEOs paid more even as profits fall” followed by the subheading: “Debate swirls as most of the area's 10 top-earning CEOs receive higher compensation during a recession that has dragged down many companies' stock prices and profits.”

The reporters analyzed the compensation for 20 Baltimore-area companies that paid their CEO at least $1 million and found that 17 received compensation increases even though in most cases company profits fell. The reporters obtain their compensation figures from documents filed with the SEC. The company spokepersons who responded to questions couldn’t give the usual “pay for performance” justification without sounding completely out of touch with reality. Instead elaborate mathematical manipulations were offered to convince everyone that the figures for executive pay on SEC-required filings were misleading because of SEC-enforced rules. The spokespersons insisted that the pay the CEOs actually received was much lower. I don’t know if I should take comfort in the argument that federal law requires that SEC documents misrepresent actual pay.

It occurred to me as I read the articles in Baltimore and London that no matter what order of magnitude is attached to compensation figures, spokespersons for the industry will argue that it must be at that level. As the recession squeezes budgets, teachers with 5-figure incomes warn public education will suffer if salaries are cut, medical doctors making 6-figure incomes warn that public health will suffer if government-run healthcare puts limits on their income, and here we have bankers with 7-figure incomes arguing that banks will fail to function if CEO compensation is limited. It appears that compensation is like closet space, no matter how much you have, expenses will expand to require all of it. Any reduction in income then becomes unimaginable.

However, I find the logic for executive compensation interesting on many different levels. First it would be interesting to know if independent studies have found cause and effect relationships between executive pay and company performance. Recently I came across a study on the relationship between the cost of executive homes and company performance.

Two business professors, Crocker H. Liu and David Yermack, conducted a study reported in a paper titled: "Where are the Shareholders Mansions? CEOs Home Purchases, Stock Sales, and Subsequent Company Performance." The study found an inverse relationship between company performance and CEO stock sales to finance large real estate purchases. In other words the bigger the CEO’s home the worse the company performs. The authors concluded that, “regardless of the source of finance, future company performance deteriorates when CEOs acquire extremely large or costly mansions and estates.” It is wrong to generalize from a single study but it does suggest that the justifications for high executive compensation might not hold up when the facts are examined.

A large part of the problem as Jay Hancock pointed out in a recent column is that CEO pay is not negotiated with the company owners. Boards of directors determine CEO pay, not the shareholders who actually own the company. As a result market forces don’t work, an observation made by the father of free-market capitalist principles Adam Smith more than two centuries ago. It is worth reading the entire section below from Smith’s treatise The Wealth of Nations because it describes exactly the problems with executive pay today.

“The trade of a joint stock company is always managed by a court of directors. This court, indeed, is frequently subject, in many respects, to the control of a general court of proprietors. But the greater part of those proprietors seldom pretend to understand anything of the business of the company, and when the spirit of faction happens not to prevail among them, give themselves no trouble about it, but receive contentedly such half-yearly or yearly dividend as the directors think proper to make to them. This total exemption from trouble and from risk, beyond a limited sum, encourages many people to become adventurers in joint stock companies, who would, upon no account, hazard their fortunes in any private copartnery. Such companies, therefore, commonly draw to themselves much greater stocks than any private copartnery can boast of. The trading stock of the South Sea Company, at one time, amounted to upwards of thirty-three millions eight hundred thousand pounds. The divided capital of the Bank of England amounts, at present, to ten millions seven hundred and eighty thousand pounds. The directors of such companies, however, being the managers rather of other people's money than of their own, it cannot well be expected that they should watch over it with the same anxious vigilance with which the partners in a private copartnery frequently watch over their own. Like the stewards of a rich man, they are apt to consider attention to small matters as not for their master's honour, and very easily give themselves a dispensation from having it. Negligence and profusion, therefore, must always prevail, more or less, in the management of the affairs of such a company. It is upon this account that joint stock companies for foreign trade have seldom been able to maintain the competition against private adventurers. They have, accordingly, very seldom succeeded without an exclusive privilege, and frequently have not succeeded with one. Without an exclusive privilege they have commonly mismanaged the trade. With an exclusive privilege they have both mismanaged and confined it.”

Adam Smith understood that “negligence and profusion” would always prevail in the management of publicly traded companies because the directors are not the owners. Of course newspapers like to report on the excesses of high-living executives and print their self-serving explanations because of the public outrage stirred. There is an obvious “two-headed quarter” in play that angers people. Executives profit handsomely when performance is good and profit handsomely when performance is bad.

However, I see an attitude that is even more deeply troubling. Beyond the conflicts of interest Adam Smith described, the idea that seven-figure salaries are essential or there would be no executives might be a more revealing testament to the cause of dysfunction in corporate America.

For most people pay is a necessary condition to work but not sufficient. Motivating people to do a job well usually requires more than money. For many people work is an opportunity to perform a social good and contribute to a cause larger than oneself. Teachers teach and doctors practice for reasons beyond money.

But, the apologists for high executive pay, talk about compensation and performance only in monetary terms. This is an attitude that does a disservice to the majority of their own employees. When I go into my bank the people who work there seem genuine in wanting to help me. It is a social transaction, not just financial.

I am well aware that in any industry, compensation is determined by market forces that have more to do with scarcity than the value of the work to society. It is for those reasons major league baseball players will always make orders of magnitude more than teachers. But success in teaching and sports is usually defined in non-financial terms. To do the work requires a desire for more than just money.

The evaluation of executives needs to include more than just financial measures. There needs to be ethical and societal dimensions when evaluating the performance of executives because the decisions they make have impacts far beyond the company stock price. The underlying assumption behind performance evaluation—rising stock price equals good; falling stock price equals bad—is overly simplistic. When large companies fail many more people than the shareholders lose.

Joseph Ganem is a physicist and author of the award-winning The Two Headed Quarter: How to See Through Deceptive Numbers and Save Money on Everything You Buy

The Widening Gap Between High School and College Math

2009-07-16T14:18:00.000-07:00

An article in the Baltimore Sun this past week: “A Failing Grade for Maryland Math,” highlighted a problem that I believe is not unique to Maryland. The author, Liz Bowie, explained that the math taught in Maryland high schools is deemed insufficient by many colleges. More and more entering college students are required to take remedial math. In many cases incoming college students cannot do basic arithmetic even after passing all the high school math tests.

The article resonated with me because in recent years I’ve witnessed first hand the disconnect between high school and college math curricula. As a parent of three children with current ages 14, 17, and 20, I’ve done my share of tutoring of middle school and high school math. The problems assigned to my children have become progressively more difficult through the years to the point of being bizarre. My wife keeps shaking her head at how parents without my level of math expertise assist their children.

For example, my eighth-grade daughter asked me one evening how to perform “matrix inversions.” This is a technique I teach in a college sophomore-level mathematical methods course for physics majors. Matrix inversion is difficult for me to do off the top of my head. I needed to refresh my memory by referring to a highly advanced math book. Another night my daughter brought home a word problem that was easy for me to do with my advanced knowledge of differential equations but it took me a lot of thought to arrive at an explanation comprehensible to an eighth-grader.

My other daughter struggled through a high-school trigonometry course filled with problems that I might assign to my upper-class physics majors. I certainly wouldn’t assign problems at such a high level to college freshmen. I kept asking her how she was taught to do the problems. I wondered if the teacher knew special techniques unknown to me that made solving them much easier. Alas no such techniques ever materialized. The problems were as difficult as I judged. At least I could solve the problems, a feat the teacher couldn’t manage in a number of cases.

At the same time I work the summer orientation sessions at Loyola College registering incoming freshmen for classes. Time and again students cannot pass the placement exam for college calculus. Many students cannot pass the exam for pre-calculus and that saddles them with a non-credit remedial math course. Without the ability to take college-level math the choices students have for majors are severely limited. No college-level math course means not majoring in any of the sciences, engineering, computer, business, or social science programs.

A colleague in the engineering department complained to me that many students who wanted to major in engineering could not place into calculus. The engineering program is structured so that no calculus means no physics freshmen year and no physics means no engineering courses until it’s too late to complete the program in four years. For all practical purposes readiness for calculus as an entering freshmen determines choice of major and career. The math placement test given to incoming freshmen at orientation has much higher stakes than any test given in high school. But, the placement test has no course grade or teacher evaluation associated with it. No one but the student has any responsibility for its outcome.

So if eighth graders are taught math at the level of a college sophomore why are graduating seniors struggling? From my knowledge of both curricula I see three problems.

1. Confusing difficulty with rigor. It appears to me that the creators of the grade school math curricula believe that “rigor” means pushing students to do ever more difficult problems at a younger age. It’s like teaching difficult concerti to novice musicians before they master the basics of their instruments. Rigor—defined by the dictionary in the context of mathematics as a “scrupulous or inflexible accuracy”—is best obtained by learning age-appropriate concepts and techniques. Attempting difficult problems without the proper foundation is actually an impediment to developing rigor.

2. Mistaking process for understanding. Just because a student can perform a technique that solves a difficult problem doesn’t mean that he or she understands the problem. There is a delightful story recounted by Nobel-prize winning physicist Richard Feynman in his book Surely You're Joking, Mr.Feynman!: Adventures of a Curious Character
about an arithmetic competition between him and an abacus salesman. (The incident happened in the 1950’s before the invention of calculators.) Here is the link to the full text of the story.

Feynman and the abacus salesman competed on who could do arithmetic faster. Feynman lost when the problems were simple addition. But he was very competitive at multiplication and won easily at the apparently impossible task of finding a cubed root. The salesman was totally bewildered by the outcome. How can Feynman have a comparative advantage at hard problems when he lags far behind at the easy ones? But when Feynman tried to explain his techniques he discovered the salesman had no understanding of arithmetic. All he does is move beads on an abacus. It was not possible for Feynman to teach the salesman additional mathematics because despite appearances he understood absolutely nothing.

This is the problem with teaching eight-graders techniques such as matrix inversion. The arithmetic steps can be memorized but it will be a long time, if ever, before the concept and motivation for the process is understood. That raises the question of what exactly is being accomplished with such a curricula? Learning techniques without understanding them does no good in preparing students for college. At the college level emphasis is on understanding, not memorization and computation prowess.

3. Teaching concepts that are developmentally inappropriate. Teaching advanced algebra in middle school pushes concepts on students that are beyond normal development at that age. Walking is not taught to six-month olds and reading is not taught to two-year olds because children are not developmentally ready at those ages for those skills. It is very difficult to short-cut development. All teachers dream of arriving at a crystal clear explanation of a concept that will cause an immediate “aha” moment for the student. But those flashes of insight cannot happen until the student is developmentally ready. Because math involves knowledge, skill and understanding of symbolic representations for abstract concepts it is extremely difficult to short cut development.

When I tutored my other daughter in seventh grade algebra, in her words she “found it creepy” that I knew how to do every single problem in her rather large textbook. When I related the remark to a fellow physicist he said: “But its algebra. There are only three or four things you have to know.” Yes, but it took me years of development before I understood there were only a few things you had to know to do algebra. I can’t tell my seventh grader or anyone else without the proper developmental background the few things you have to know for algebra and send them off to do every problem in the book.

All three of these problems are the result of the adult obsession with testing and the need to show year-to-year improvement in test scores. Age-appropriate development and understanding of mathematical concepts does not advance at a rate fast enough to please test-obsessed lawmakers. But adults using test scores to reward or punish other adults are doing a disservice to the children they claim to be helping.

It does not matter the exact age that you learned to walk. What matters is that you learned to walk at a developmentally appropriate time. To do my job as a physicist I need to know matrix inversion. It didn’t hurt my career that I learned that technique in college rather than in eighth grade. What mattered was that I understood enough about math when I got to college that I could take calculus. Memorizing a long list of advanced techniques to appease test scorers does not constitute an understanding.

Joseph Ganem is a physicist and author of the award-winning The Two Headed Quarter: How to See Through Deceptive Numbers and Save Money on Everything You Buy

Overdue Warnings on Acetaminophen

2009-07-02T12:01:00.000-07:00

The news that the government is issuing stronger warnings about acetaminophen and possibly banning its use in some products is long overdue. Because of my own experiences, I have been mystified by perceptions of the safety of this drug for years. To me the medical community appeared as oblivious as the public.

Like most people, I believed acetaminophen to be very safe drug. In 2003 I had an illness with a high fever that continued for more than a week. I had never in my life, before or since, been so sick. The fever was so debilitating that to stay lucid I found myself taking the maximum recommended dose of acetaminophen each day. The chills and sweats came back as soon as each dose wore off and every six hours I popped more pills.

After a week elapsed with no improvement I went to see a doctor. He examined me and said that I appeared to have hepatitis. Blood work would be necessary to confirm the diagnosis. He drew the blood and sent me home.

How could I have hepatitis? I immediately started to read about the disease to learn more about the different types and causes. Hepatitis is a general term that refers to an inflammation of the liver. It is not a single disease because there are a number of causes of liver inflammation. If the condition continues untreated it can lead to liver failure.

After learning about the different viral causes of hepatitis I started reading about chemical causes. A number of drugs can inflame the liver but the most common drug-induced hepatitis is caused by acetaminophen.

Learning that fact caused the science part of my brain took over. What hypotheses can I form given the data and how can each be tested. I could construct two cause and effects narratives to fit the data.

1. I have hepatitis that caused a fever and in response I took acetaminophen.
2. I have a fever that caused me to take acetaminophen and in response I developed hepatitis.

The doctor had jumped quickly to testing the first hypothesis. But, given my unlikely exposure to any viral form of the disease, it occurred to me that the second hypothesis was the most plausible. I stopped taking acetaminophen and in a few days the hepatitis symptoms went away. The doctor called back to say that I tested negative for all the viral forms of the disease. He never asked about acetaminophen or mentioned its use as a potential problem.

I eventually recovered from the illness. It took almost a month before I felt completely well. To this day I don’t know what I had. Most likely it was some random viral infection that it took my immune system a long time to eliminate.

A few months later I crossed paths with a colleague who I had not talked to in a while. We inquired about each other’s families and he told me about a health crisis with his adult son. He began a story with remarkable parallels to my own. His son had an unexplained fever that went on for more than a week. The doctors did not know the cause and advised him to take acetaminophen to control the fever. But then his son’s experience took a harrowing divergence from my own. Following the doctor’s advice he continued to take acetaminophen for the fever and found himself hospitalized with liver failure.

My colleague said to me: “We had no idea acetaminophen could cause liver failure. We thought it was safe drug because the doctors kept telling him to take it.”

The makers of acetaminophen products—Tylenol, Nyquil, etc.—insist the drugs are safe when used as directed. But, I am skeptical about directions that include just two dosage variations—adult and child. There must be more variation in acetaminophen tolerance within the adult population. A one size fits all number for the recommended dosage for adults does not make sense.

For example, I am an almost exactly average adult male—5-feet 10-inches, 185 pounds, right-handed. That means almost all personal products—furniture, cars, homes, etc. and yes, drug dosages—are designed for me. All other people have to make adjustments when they use these products because I’m the person everything is designed for.

But, the dosing instructions for acetaminophen are too much for me to metabolize. Does that mean I have a less than average tolerance for the drug? How many other people are like me? What about the female half of the population? The current dosage instructions address none of these questions. Given the dangers of acetaminophen those questions should be addressed and the government is right to require warnings.

The most important lesson I learned from my experience is to ask these questions early and do independent research. Do not blindly follow dosing instructions on a package or follow “expert” advice from doctors who cannot think through all the possibilities in the short 10-minutes they allot for an exam. It took me some time and effort to figure out what was happening but the insights saved me from potentially dangerous complications.

Joseph Ganem is a physicist and author of the award-winning The Two Headed Quarter: How to See Through Deceptive Numbers and Save Money on Everything You Buy

Dropping the SAT Requirement at Loyola College

2009-06-13T19:44:00.000-07:00

The announcement by the school where I teach, Loyola College, that it would no longer require SAT scores for applicants brought a vitriolic response from recent alumni that the Baltimore Sun published. That opinion piece generated a heated discussion on blogs that the Baltimore Sun published two days later.

I found deeply troubling the arguments made by the alumni for keeping the SAT requirement at Loyola and the tone of their reaction to the news disturbing. The assertion made in the opinion piece that making SAT’s optional for admission will “financially depreciate” the bachelor's degrees granted by Loyola is based on two underlying assumptions that are false.

First, admission to Loyola is not a guarantee of a degree from Loyola. Students have to do the work required to earn the degree. Admission standards should not be confused with academic standards. I am never told the SAT scores, high school grades, or any of the reasons the Loyola admitted the students in my classes. Honestly, I am not interested in any of that information.

I teach my subject to the students enrolled in the class and assigned grades based on performance expectations that have not changed throughout my career. SAT scores have no bearing on the criteria I have established for passing my courses.

I also serve on Loyola’s academic standards committee. At the end of each semester that committee is charged with reviewing student grades and dismissing any students who are not making satisfactory progress towards a degree. Again it is grades earned at Loyola that are reviewed, not the reasons the students were admitted. SAT scores have never entered into these discussions.

Second, college degrees have no “financial value” so it is not possible for them to “depreciate.” A degree is a non-transferable status that cannot be bought or sold. I know this seems like a strange assertion given the wide disparity between the average lifetime earnings of college graduates compared to those without college degrees. But students are mistaken if they believe that degrees are the cause of the higher income typically earned by college graduates.

No employer pays a person because he or she has a college degree. Employees are paid for the performance of work if it has sufficient value that it becomes in the financial best interest of the employer to pay. It happens that the knowledge, skills, and insights that are acquired through the process of obtaining a college degree often results in the ability to perform work that is of greater value to employers. But there are people without degrees who are highly paid because they perform valuable work. It is work that causes payment, not the abilities associated with the degree. Graduates who cannot establish themselves as productive workers will find that their degrees mean very little financially.

So do I think Loyola should become an SAT-optional school? I am in agreement with the new policy. I find the entire concept of “scholastic aptitude” that the SAT purports to measure suspect. Readiness for college depends on acquiring the necessary language, writing, and math skills necessary for college-level work. These are not “aptitudes” that a single test can measure, rather, these are skills acquired through study and practice.

Once in college success is more dependent on attitude than aptitude. Students will do well if they attend class, do the assigned work, and major in a subject that interests them. That sounds simple and trite, but my experience on the Academic Standards Committee has revealed that students who fail in college haven’t mastered those basic practices.

SAT scores were meant to provide a level playing field for college admission by putting students from all backgrounds on equal footing. But, as it usually happens when a number is substituted for judgment, inordinate amounts of time, effort, and expense are allocated toward manipulating the number. Witness the entire test preparation industry that has grown up because of the SAT. Spending thousands of dollars on SAT prep classes defeats the original purpose of a level playing field. It’s time to retire the number.

For recent graduates entering the workforce, college reputation and courses of study are important because it is all employers have as a basis for judging competence and abilities. But within four to five years of graduation it will be performance on the job that counts. For me it has now been 32 years since I entered college and 28 since I graduated. I no longer remember my SAT scores and if my alma mater, the University of Rochester, changes its SAT policy there would be no impact on my life—financial or otherwise.

Joseph Ganem is a physicist and author of the award-winning The Two Headed Quarter: How to See Through Deceptive Numbers and Save Money on Everything You Buy

The Neglect of Probability Bias: What is normal for the market?

2009-04-10T07:51:00.000-07:00

The failures of large investment and insurance houses—Bear Sterns, Lehman Brothers, AIG, Freddie Mac, Fannie Mae—demonstrate that the models these companies used to manage risk were deeply flawed. The defense offered by many on Wall Street is that market events of the past year have been so extreme, so far from the norm, no one could have predicted or planned for such as financial catastrophe. Repeatedly financial and political leaders have compared the past year to events of the Great Depression. It appears that the risk models failed because market contractions of the current magnitude were not considered a possibility.

Extreme events by definition have low probabilities of occurrence. But low probability does not equal zero probability. Was it reasonable for the financial analysts to consider current events in the markets so far outside the norm that they would not occur? I keep hearing that current market conditions are not normal. But, in reflecting back over the past few decades I’m hard-pressed to think of any time that was “normal.”

During the mid-1990s stocks increased so fast that investors not making 20% per year felt left out of the boom. At the beginning the bull market in 1995 the Standard and Poors 500 index increased 34% in that year alone. From 1995 to 1999 it had returns in excess of 19% for each of those 5 years, more than doubling its overall value. Plenty of warnings were sounded that those market conditions were not normal and would not last. The crash at the end of the decade revealed that many companies simply made up numbers on earnings reports to drive the increase in stock prices. High-flying companies of the 1990s such as Enron, Global Crossing, Worldcom became synonyms for fraud and a number of their top executives are still in prison.

The recession of 1991-92 was so deep it cost President George H. W. Bush his job. Despite winning a popular war, he was unseated by Bill Clinton’s laser-like focus on economic problems. Everyone remembers “The economy, stupid” sign hung at his campaign headquarters.

In 1987 the stock market lost 25% of its value on a single trading day. At today’s valuation levels that would be the equivalent of a one-day drop of 2000-points.

During the mid-1980s certificate of deposits paid double-digit interest rates. I remember owning a one-year certificate of deposit that paid 10% annual interest. I also remember a life insurance salesman running a projection on the future value of a whole life policy that he was trying to sell me. Based on just small premiums (about $100 per month) he calculated an impressive future value of over a million dollars by the time I would retire in 40 years. Of course his calculation assumed an annual interest rate of 12% in perpetuity—a laughable projection given that annual rates on money market balances today are less than 1%.

The recession of 1981-82 resulted in unemployment greater than 10%, a rate we have yet to reach in the current recession.

I could extend this list of extreme economic events and conditions indefinitely back in time. But, the above reflection on events over the past 30 years shows that it is a fallacy to believe extreme events are outside of the “norm” and unlikely to happen. Instead it is apparent that extreme events are the norm. History is not going to stop and economic conditions, whether part of a boom or bust, never continue indefinitely.

But, I have noticed a tendency for financial planners and prognosticators to assume that economic conditions of the moment—whatever conditions are at that moment—will continue indefinitely. Much of the financial advice on buying, financing, and investing in homes over the past decade was all based on the assumption that prices in the housing market would only go up. This belief mirrors beliefs in the mid-1990s that stocks could only go up. The same thinking led my life insurance salesman in the mid-1980s to argue that interest rates on savings would be in the double digits forever.

The future is always uncertain and psychologists who study how people make decisions under uncertainty have identified a long list of “cognitive biases.” A bias refers to a repeated and predictable flaw in judgment that results in making less than optimal choices. For example, if you don’t know the future, optimal choice requires acting on the basis of the most probable outcomes. But the “neglect of probability bias" results in instances where people disregard probabilities when considering future outcomes.

Failure to use seat belts is an example of the neglect of probability bias. Car crashes are low probability events. You can drive for years, even decades and never be in a car crash. But, because the probability of crashing a car is not zero and consequence of even one crash potentially catastrophic, seat belts should be worn. The fact is car cashes occur with a rate predictable enough that auto insurance companies remain financially solvent. Evidently it is not that difficult to correctly price auto insurance.

Executives in banking and investing should consider devising something akin to a “financial seatbelt.” Rather than assume market crashes are too far outside the norm to worry about, they should accept the fact that market crashes have happened in the past and will happen in the future. They should have restraints in place ahead of time to limit the damage.

Joseph Ganem is a physicist and author of the award-winning The Two Headed Quarter: How to See Through Deceptive Numbers and Save Money on Everything You Buy

Stewart versus Cramer: Is the world completely upside down?

2009-03-17T18:08:00.000-07:00

The confrontation between John Stewart and Jim Cramer last week illustrated just how upside down and surreal the U. S. media has become. The Stewart versus Cramer dust-up actually started when Rick Santelli of CNBC made an on the air rant blasting the Obama administration’s proposal to help homeowners facing foreclosure. Santelli said in his tirade “the government is promoting bad behavior,” and referred to homeowners facing foreclosure as “losers.”

In response Stewart ran a montage of clips showcasing consistently wrong CNBC financial predictions over the past year. The “experts” at CNBC urged viewers to buy the stocks of Bear Sterns, Lehman Brothers, Merrill Lynch, and AIG, in the months before these companies imploded. A particularly embarrassing clip showed Jim Cramer on CNBC recommending Bear Stearns as a buy just weeks before the company went under.

The Daily Show With Jon StewartM - Th 11p / 10c

CNBC Gives Financial Advice

Daily Show Full Episodes
Important Things w/ Demetri Martin

Political Humor
Jim Cramer

Stewart’s point is that if the “experts” dispensing advice are so completely wrong about the future, how are average homebuyers suppose to know the future? After all, many of the “loser” homeowners went broke taking advice from “experts” like Santelli and his ilk in the financial services industry.

The feud reached a climax last Thursday night when Cramer appeared as a guest on Stewart’s show. Stewart conducted a pointed interrogation interspersed with previously unaired video clips from December 2006 of Cramer explaining to someone how to make money from short positions by spreading rumors about companies. Referring to the video, Stewart said: “I want the Jim Cramer on CNBC to protect me from that Jim Cramer.”

The Daily Show With Jon StewartM - Th 11p / 10c

Jim Cramer Unedited Interview Pt. 1

Daily Show Full Episodes
Important Things w/ Demetri Martin

Political Humor
Jim Cramer

Cramer defended himself by claiming that the CEOs of the companies he recommended lied to him. When Stewart suggested that he not take at face value what CEOs say Cramer responded with a bizarre defense. He said: “I’m not Eric Sevareid. I’m not Edward R. Morrow. I’m a guy trying to do an entertainment show about business for people to watch.”

At this point in the interview I realized what has gone so wrong in the media. The irony of this exchange is breath taking.

John Stewart bills himself as a comedian and works for a network called Comedy Central. His show—The Daily Show—is presented as a spoof of network news broadcast. Jim Cramer bills himself as a financial news reporter and works for a news network CNBC. His show—Mad Money—is promoted as serious financial analysis and investment advice.

But, when Cramer shows up as guest on Stewart’s comedy show, he is bombarded with tough, pointed, serious, questions about the soundness and ethics of the advice he dispenses. Cramer defends himself by asserting that he needs to entertain an audience that would tune out if his talk became too technical.

So a comedian is asking relevant questions while a news reporter pleads that he doesn’t ask questions because he needs to entertain. Has the world gone completely upside down? If I want real news reporting I need to watch “fake” news on the comedy channel. The “real” news people are too busy entertaining to do actual investigative reporting.

The over arching point that Stewart stressed throughout the 15-minute interview with Cramer, is that the financial reporters at CNBC are not fulfilling their responsibilities as journalists. The role of a free press is to investigate and question those in authority, not simply serve as a mouthpiece.

Much has been made of the failure of the regulatory agencies such as the SEC in the current financial meltdown. But where was the press while all of this was happening? Bernie Madoff ran a $50 billion Ponzi scheme for more than a decade while a financial analyst sent warning letters to the SEC that were ignored. No one at CNBC bothered to investigate and ask questions.

No reporter investigated or questioned AIG issuing more credit default swaps than it could ever possibly payout on. Bear Sterns, Lehman Brothers, and Merrill Lynch all used massive amounts of leverage, in some cases more than 30 to 1, to artificially inflate their investment returns—a reckless strategy that again no reporter questioned. Instead stocks in these investment firms were touted as good buys.

While all of this was happening the reporters at CNBC were concerned about “entertaining” their viewers. Stewart said: “I understand that you want to make finance entertaining, but it’s not a fucking game.”

No it’s not a game. Real money and real livelihoods are on the line. Real hard-earned wages went into now decimated 401k and pension plans. Real tax dollars are being spent to hold off collapse of the financial system.

I believe that if the financial reporters would do their jobs they would find criminal culpability on the part of many of the executives who ran these failed companies. I don’t believe that a blow up of the entire financial system to the tune of a trillion dollars happened without actual fraud taking place. With dollar amounts that large it should not have been that hard for the so-called “experts” to figure out what was going on.

Much has been made of the need for more oversight and regulation in the financial services sector. But, the government needs to take a hard look at possible criminal violation of regulations already in place. And the journalists need to get back to holding the government and CEOs accountable by investigating and asking questions. Leave the entertaining for the comedians.

Joseph Ganem is a physicist and author of the award-winning The Two Headed Quarter: How to See Through Deceptive Numbers and Save Money on Everything You Buy

Interest-only Mortgages by Another Name

2009-03-10T14:33:00.000-07:00

After all the carnage in the mortgage industry over the past few years, I am still amazed that many in the financial services industry still do not understand the number gimmicks that led to the mess. An op-ed piece published in the February 27, 2009 Baltimore Sun by Sim B. Sitkin a professor of management at Duke University, advocated extending mortgages to 50 or even 100 years as a way to make houses more “affordable.” That sounds like an impressive proposal for lowering monthly payments. However, whether the mortgage term is for 50, 100 or even 1000 years, monthly payments can never fall to an amount less than the interest due on the first month of the loan. In the limit of extremely long loan terms, the loan effectively becomes an interest-only agreement.

Of course Mr. Sitkin didn’t use "interest-only" as a descriptor. That label now has a negative connotation given the millions of homeowners with interest-only loans currently underwater because home prices went down while their debt did not. But lets look at how much 50 and 100-year loans differ from interest only loans. I’ve constructed tables below with some examples. Scroll down to view the tables.

30-Year $200,000 loan	5%	7%	9%
Monthly Payment	$1073	$1330	$1609
Interest paid in the first month	$833	$1166	$1500
Principal paid in the first month	$240	$164	$109
Time to pay 10% of loan (years)	6	7.7	9.6

50-Year $200,000 loan	5%	7%	9%
Monthly Payment	$908	$1203	$1517
Interest paid in the first month	$833	$1166	$1500
Principal paid in the first month	$75	$37	$17
Time to pay 10% of loan (years)	15	20.5	25.4

100-Year $200,000 loan	5%	7%	9%
Monthly Payment	$839.04	$1167.75	$1500.19
Interest paid in the first month	$833.33	$1166.66	$1500
Principal paid in the first month	$5.71	$1.09	$0.19
Time to pay 10% of loan (years)	55	67.2	74.4

Here are some numerical facts from these tables.

First note that a 100-year mortgage proposed by Mr. Sitkin is for all practical purposes an interest-only loan. No significant debt reduction will take place in the borrower’s lifetime.

Second any advantages that a 50-year loan would have over a 30-year loan in reducing monthly payments diminishes at higher interest rates. The difference in monthly payments been a 30-year and 50-year mortgage decreases as interest rates increase. Also the amount allocated towards principal in the early years of the mortgage becomes less for both 30 and 50-year loans at higher interest rates.

Mr. Sitkin used 5% as an example interest rate. However, I pointed out in a letter to the editor that the Baltimore Sun published that “to get a lender to commit to so long a loan would probably require paying a higher rate than the historically low 5 percent mortgage rate used in the example. In that case, the numbers get much worse for the borrower.”

My published letter provoked a response from Mr. Richard T. Webb, CEO of Atlantic Financial Federal Credit Union, that the Baltimore Sun published on March 8. In his letter he made two statements I find puzzling. In response to my assertion that interest rates would be higher for a 50-year loan compared to a 30-year loan he wrote:

“And from the point of view of the lending institution, I'd rather own a long-term 5 percent loan than have a bankruptcy judge cram down a mortgage payment.”

This prompted me to check the loan rate page on his credit union’s Website. I found the same pattern for interest rates on that page that I find at every other financial institution—the longer the loan’s term the high the interest rate. On the Baltimore Sun’s business page today, the average rate for 15-year mortgages rate is 4.76% and for 30-year mortgages 5.17%. Although those numbers fluctuate daily, every single day the 30-year rate is greater than the 15-year rate. I have no reason to believe that the pattern of higher rates for longer loans would not continue for loan terms beyond 30 years.

The other puzzling assertion he made is that I failed “to consider the length of time most homeowners keep a mortgage.” He wrote:

“It's highly unusual for a homeowner to keep a mortgage for 30 years. The average time a mortgage is held is around seven to nine years. Extending the repayment period would achieve the desired effect of reducing the monthly mortgage payment. Wouldn't it make sense to be making smaller payments on a longer-term loan when the chances of staying in a house for 30 years are small?”

But isn’t that the reason why a homebuyer should avoid a 50-year loan? Again look at the numbers in my table above. Homebuyers who don’t pay down debt are at the whim of the market when it comes to refinancing or selling. If home prices rise they can sell or refinance. But, if prices fall homeowners have negative equity. No bank or lending institution will finance a home with negative equity. If rates fall, homeowners cannot refinance to take advantage of the lower rate for homes with negative equity.

Events of the past few years have shown that the assumption that home prices can only rise over time is false. But financial institutions are still dispensing advice based on that underlying assumption.

I still stand by my concluding paragraph in my letter to the Sun. Focusing only on monthly payments with no long-term plan for paying down the debt is one of the root causes of the housing crisis. Homebuyers would be better served with monthly payments that allow them to build equity, even if it means scaling down or deferring their homebuying choices.

Joseph Ganem is a physicist and author of the award-winning The Two Headed Quarter: How to See Through Deceptive Numbers and Save Money on Everything You Buy

Lifetime Promotional Credit Card Rates from Chase: Responses

2009-02-28T18:53:00.000-08:00

My previous post on Chase Credit Card Services reneging on agreements for low promotional rates prompted several comments, including one from a Chase employee. The comment from the Chase employee is very telling about the mindset of the credit card industry both for what it says and what it doesn’t say. That person wrote:

“I work for Chase Credit Card Services and thought I should inform you that we didn't just announce these Changes in Terms last week. We actually sent notifications to effected card members back in November, so they were informed 45-60 days in advance. If you are going to writing an article from a negative standpoint and try to preach to other people, at least make sure you have your facts straight.”

The commenter is correcting my use of the phrase “last week” twice in my February 16, 2009 post to set the timeline of events. I meant “last week” to refer to the publication of the newspaper articles I cited about Chase’s change to its credit card terms. Instead I made it sound that Chase changed its terms the week prior. Had I published the post in November it would have been correct. I should have used the ambiguous word “recently” which would have left wiggle room in setting the timeline.

This comment is telling in that it doesn’t address the question posed in my post: Whose lifetime was referenced when Chase offered a “lifetime” rate on a balance? As another commenter pointed out:

“If they gave 45 days notice, or just two, it's still false advertising, and a violation of the Truth In Lending Act: the terms of the loan were ‘fixed for the life of the loan.’ ”

But the mindset of the Chase employee is that the credit card agreement allows Chase to change the loan terms at any time, for any reason, as long as a minimum of 30 days notice is given. I believe that is why my use of the phrase “last week” stirred outrage. My usage implied more than 30 days noticed had not been given—a time period I regard as immaterial but to Chase is the only obligation they have under the terms of the agreement.

Like a magician—and many political and corporate leaders—the comment from the Chase employee uses misdirection. Their actions are to holler loud and long about minutiae and hope nobody notices what is actually happening.

As Dr. Robert Lahm commented:

“Imagine that, a company that has previously testified before Congress about playing fair and providing "opt outs" (none exists in this instance) correcting you in getting ‘facts straight.’ ”

Dr. Lahm has set up a protest/advocacy Website http://www.changeinterms.com to organize consumers to fight against abusive credit card practices. I applaud his efforts to call on Congress to force some semblance of fairness in credit card agreements.

Financial services companies are on the brink of collapse and many blame their failures on consumers. From the point-of-view of financial service providers, consumers spent too much, took out loans they could not afford, and were irresponsible in their use of credit. But, now Chase is disclosing that hundreds of thousands of its customers made rational decisions about credit and honored the terms of the agreement. These customers astutely saw that Chase offered them a loan with a favorable interest rate, borrowed the money and kept up payments under the terms of the loan agreement. Aren’t those the kind of informed, rational, financially responsible customers a credit card company desires? Apparently not.

I have a suggestion for Chase and all the other credit providers. Cut the enticements, the teaser rates, the cash back, the bonus points, the coupons, the gift cards, the air miles, the gasoline credits, the weekly bulk mailings, and all the other gimmicks. Offer consumers a credit card with a reasonable rate interest rate (less than 10%), a credit limit commensurate with income and credit history, and terms of use of that are fair to both parties. Events of the past year have demonstrated that the current business model for credit cards benefits no one.

Joseph Ganem is a physicist and author of the award-winning The Two Headed Quarter: How to See Through Deceptive Numbers and Save Money on Everything You Buy

Lifetime Promotional Credit Card Rates: Whose lifetime?

2009-02-16T18:28:00.000-08:00

The announcement last week from JP Morgan-Chase that some customers would be assessed fees on promotional credit card rates reminded me of a line from former St. Louis Cardinals baseball manager Whitey Herzog. It was back in the mid-1980s when the Cardinals were one of the top teams in baseball and Herzog widely lauded for his managerial skills. Gussie Busch, principal owner of the Cardinals and the Anheuser-Busch brewery offered Herzog a “lifetime appointment” as manager. Herzog’s response to the frail man well into his 80s: “Whose lifetime are we talking about?”

A valid question that looking back over the intervening 25 years was prescient. Gussie Busch died in 1989, Herzog is still alive today but quit managing the Cardinals in 1990, Anheuser-Busch sold the Cardinals in 1996, and in 2008 Anheuser-Busch itself was sold to the European conglomerate InBev.

What does this have to do with credit card fees? In recent years Chase credit card services has offered cash advances at low promotional rates under 5% to its credit card customers that promised the low rate for the “lifetime” of the balance. But, it happens that a “lifetime” for a typical customer is a long time on Wall Street where executives have trouble thinking beyond the end of the current quarter.

Chase now regards as problem customers those who took the bait but not the hook. Hundreds of thousands of customers thought “lifetime” referred to their longevity and have been in no hurry to pay back borrowed funds that accrue low finance charges. Chase never specified what it meant by “lifetime” in its promotional brochure and is now in the process of defining that time period as something considerable less than the numbers found in the actuarial tables for life expectancy.

Last week Chase announced that it would begin charging monthly “fees” to customers carrying balances with low promotional rates. Just how a “fee” differs from a “finance charge” has always been a mystery to me. To me money is money, but for Chase its new flat $10 per month fee is not a finance charge because it doesn’t use the same mathematical formula that it uses to compute finance charges. However, customers who called to complain about the monthly fee were told they could opt out of paying it if they would agree to pay a higher interest rate on the promotional balance.

Chase also changed the minimum monthly payment for these same customers from 2% of the balance to 5% of the balance. That means someone with a $10,000 balance will now need $500 to make the monthly payment instead of $200. Of course failure to make the minimum monthly payment on time results in forfeiture of the promotional rate and a default rate in excess of 25% immediately kicks in.

A spokeswoman for Chase, Stephanie Johnson, explained that the change only affects consumers with low promotional rates who have carried a large balance for more than two years and made little progress paying it off. So Chase’s answer to Whitey Herzog’s question is that “lifetime” means two years. Maybe Chase should only market promotional rates to customers in their late 90s.

A New York-base law firm, Giskan Solotaroff Anderson & Stewart, has brought a class-action lawsuit against Chase for changing the terms of the agreement. The terms of the promotional rate never disclosed that a $10 service fee would be applied after two years. It will be interesting to see how the lawsuit plays out. Most credit card agreements allow banks to unilaterally change the terms for any reason at any time. The agreements also require customers to waive their right to sue and must submit disputes to binding arbitration. I’ve always wondered if agreements with these kinds of provisions meet the legal definition of a contract. Hopefully this lawsuit will test the legality of bait and switch credit card agreements in a court of law.

By the way, JP Morgan Chase received over $25 billion in bailout money from taxpayers last year.

Joseph Ganem is a physicist and author of the award-winning The Two Headed Quarter: How to See Through Deceptive Numbers and Save Money on Everything You Buy

Peanut Contamination: How Not to Interpret Test Results

2009-02-10T19:25:00.000-08:00

The scrutiny of Peanut Corporation of America’s food safety practices is uncovering more problems and forcing closures of more plants. This week a second plant in Texas was forced to shut down.

An infuriating revelation from this fiasco is that Peanut Corporation failed to tell inspectors that samples from its Georgia plant had tested positive for salmonella in 2007 and 2008. The company continued to sell products after having a second set of tests performed by another lab that came back negative.

It makes sense to repeat tests that reveal potentially expensive problems. For example, patients are counseled to seek second opinions before agreeing to expensive and invasive medical procedures. But interpreting secondary tests, particularly ones that conflict with earlier tests, requires care.

Managers of the peanut processing plant are right to conclude that a single positive test doesn’t provide conclusive proof that salmonella is a problem. But, that same reasoning also means that a single negative test doesn’t provide conclusive proof that the product is safe. Tests need to be repeated and more importantly, conflicting results need to be understood. Choosing to believe the test that provides the most convenient result is a recipe for disaster.

Test shopping has led to other expensive high-profile disasters. When the main mirror for the Hubble telescope was manufactured, preliminary tests showed that the mirror did not meet specifications and suffered from an optical flaw known as “spherical aberration.” But much more elaborate and much more expensive tests showed that the mirror had no abnormalities. Managers of the project reasoned that precision and expense must mean results that are more accurate and reliable. Unfortunately this is faulty reasoning. When tests give conflicting results there must be underlying reasons. A test that is designed to be more precise can still be performed improperly.

Rather than seek to understand why the test results conflicted, the mirror was approved for launch. When the first images came back so blurred as to be unusable, astronomers immediately knew the problem—spherical aberration. An expensive optical corrective system had to be designed and a space shuttle launched to install it, before the Hubble could provide usable images.

The lesson is that test results do not make something true. If peanut plant conditions are conducive to the growth of salmonella, the microbes are probably present whether the tests come back positive or negative. Testing cannot be a substitute for actual sanitation.

It’s of course easy for managers to fool themselves with wishful thinking. It’s easy to fool health inspectors and the public with “certified” test results conducted according to “standard” procedures that meet all the legal requirements. But the corporations, government officials, and public, should all be mindful of Richard Feynman’s famous last sentence in a report on an earlier deadly debacle—the space shuttle Challenger disaster. That failure stemmed from the same underlying cause—managers choosing what to believe rather than understand the reasons for the conflicts.

Feynman wrote: “For a successful technology, reality must take precedence over public relations, for nature cannot be fooled.”

Joseph Ganem is a physicist and author of the award-winning The Two Headed Quarter: How to See Through Deceptive Numbers and Save Money on Everything You Buy

Wall Steet Compensation: Gaming the System

2009-01-31T10:44:00.000-08:00

I have written about the practice of re-labeling expenditures with a different, nicer sounding name. Financial service companies are masters at this practice. Want to advertise an eye-catching low interest rate. Use a different word for the finance charges. Labels such as: transaction fee, points, rebate, origination fee, can all be used as reasons take money from consumers without using the emotionally charged label “interest.”

Given that financial institutions are masters at re-labeling, I am completely mystified by their use of the word “bonus” in labeling parts of employee compensation. This past week John Thain was fired when it became public that the day before his failed company, Merrill Lynch, was taken over by Bank of America he dispensed over $4 billion in bonuses. At the same time, the full extent of liabilities Bank of America had assumed was not fully disclosed. Probably because no one really knows just how much bad debt Merrill Lynch owned. Bank of America, after discovering that it had acquired a deeper and possibly bottomless money pit than it previously thought, was forced to go back to the government and plead for more bailout money.

Meanwhile a report that total year-end bonuses on Wall Street exceeded $18 billion brought a rare public display of anger from President Obama and promises to rein in Wall Street compensation packages. The practice of executives rewarding themselves while their companies and clients are ruined is described succinctly in a Forbes Magazine piece titled “Five Legal Scams” by William Baldwin. One scam labeled “Heads I win” is this: “Be a hedge fund manager. Pocket 20% of the gains if you are lucky, but chip in for none of the losses if you aren't.”

Executives on Wall Street defend bonuses as being performance-based and necessary to attract top financial talent. Which makes me wonder why they haven’t re-labeled “bonuses” with the word “commission.” From their defense of the practice its sounds to me that the kind of compensation they are describing is known as a “commission” in most other industries. The public might wonder why anyone would pay for the kind of “performance” and “talent” that created the mess on Wall Street. But, if a car dealership went belly-up no one would dispute that the salespeople should still receive their commissions.

However, the fact that it has never occurred to these executives to use the word “commission” is a telling statement about the kinds of products they sell. Auto salespeople are paid commissions for selling a tangible product. Each car manufactured has a vehicle identification number that is recorded and tracked by the manufacturer, dealership, state government, insurance company, lien holder and owner. As cars arrive and leave the lot it is nearly impossible to fake selling them. It is difficult for dealers to simply make up sales figures.

For financial services firms, making up numbers to describe profits and losses is easily doable. As the financial system unravels it is apparent that many firms did make up numbers. The fact that someone like Bernie Madoff could get away with a $50 billion Ponzi scheme for more than a decade is telling about the lack of real accountability in the financial services sector.

Perhaps instead of a different label executives should rethink their compensation packages and incentives. As it stands now, workers and managers have an incentive to “game” the system. I have written in my book, The Two Headed Quarter, about what I call “The Numerical Outcome Principle.” Once a number is used to judge outcomes, people will adjust their behavior to maximize that particular number. The actual outcome no longer matters. Because numbers are so fluid on Wall Street that is exactly what happened.

Joseph Ganem is a physicist and author of the award-winning The Two Headed Quarter: How to See Through Deceptive Numbers and Save Money on Everything You Buy

Bailout Money: The Problem with Null Experiments

2009-01-20T19:35:00.000-08:00

One of the difficult problems in experimental science is drawing conclusions from a null experiment. Suppose a theory forbids an event to happen—faster than light travel for example is forbidden by the theory of relativity. Looking for faster than light travel and not succeeding is a result consistent with the theory. But, the result doesn’t “prove” the theory. Your experiment might not have looked for faster than light travel in the right way, in the right place, or at the right time. You could spend a lifetime looking for an event that shouldn’t happen, not see any examples, and still not know for sure if the event could never happen.

Contrast that situation with an affirmative experiment. For example relativity predicts the bending of light by gravity. Einstein became famous after astronomer observed the bending of starlight as it passed by the sun. That affirmative result doesn’t “prove” the theory either, but at least you know light bending by gravity is a real effect. You don’t have to keep looking.

I was thinking about the problem with the null experiment this week because it arises in the current debate about the effectiveness of the government bailout of the financial industry. This past September congressional leaders and President Bush predicted imminent collapse of the United States’ financial system unless a $700 billion bailout plan passed. On September 29, 2008 the House of Representative rejected the proposal and the markets responded with a 777-point loss in the Dow. It closed at the end of that day at 10365.

The economic catastrophe theory appeared to be confirmed. House members quickly saw the error of their ways and within days a new version—containing additional pork to assuage some hurt feelings—passed into law. So did the bailout work? Was financial disaster averted?

In the three and half months since its passage the Dow has fallen another 2000 points and is now near 8000. The unemployment rate rose from 6.2% in September to 7.2% at the end of December. Major banks such as Citigroup are still teetering on edge of collapse and asking for more government money. Had the federal government not passed a bailout bill in October these events would be cited as the predicted catastrophe. But, because the government did pass the bailout bill a different interpretation is needed. Advocates, including Henry Paulson, have argued that without the bailout the economy could be much worse.

Which brings us back to the problem of the null experiment. Would it ever be possible to conclude that the bailout hasn’t worked? As long as the Dow remains above zero and the unemployment rate less than 100% it will always be possible to say the economy could be worse. But just because a total economic collapse has not happened doesn’t mean the theory that the bailout worked has been proved. Saying that the bailout prevented a total economic collapse because a total collapse was not observed is faulty logic. Taxpayers could feed money to banks forever on the basis of that reasoning.

It’s time for treasury officials to devise some affirmative experiments. The needs are for actions designed to produce positive economic effects that can be observed and measured. Only then will we know if the money has been productively spent.

Bernie Madoff and The Mediocrity Assumption

2009-01-13T08:28:00.000-08:00

The question asked repeatedly since the exposure of the Bernie Madoff fraud: How could so many smart money-savvy people be fooled for so long? What I find especially troubling is that the answer to that question is mundane. The techniques for enticing investors into a Ponzi scheme are timeless and trite.

Early in my adult life, a "buyer's club" enticed my wife and I to visit. A salesman subjected us to a high-pressure pitch to join. The proposition was that for a $1000 one-time membership fee, a lifetime of “savings” totaling hundreds of thousands of dollars would be ours. Everything we would ever need—appliances, furniture, electronics, even cars—would be available to us at greatly reduced prices.

Of course the offer came with conditions. The invitation to join the club was exclusive and would not be repeated. Although, the price would be reduced if we “nominated” friends and family for membership. All merchandise ordered had to be prepaid and members were responsible for the shipping costs. The catalogs detailing the merchandise and actual prices were kept secret and would not be revealed until we joined. The salesman explained that if it became widely known just how low club prices were no one would shop in a retail store again. The local economy would collapse. The reason that these fantastic discounts were available is that the club profited only from membership fees, not from merchandise sales.

The last statement tipped me that this was a Ponzi scheme and I walked out. If the club profited only from membership sales that would mean that as soon as the club sold all the memberships possible it would fold. The “lifetime” membership referred to the club’s lifetime, not mine. Besides there is no reason to believe that I am special, that my money is special, or that my friends and family should be granted special buying rights denied to others. In my book The Two Headed Quarter I call this line of reasoning the “mediocrity assumption.” As much as I would like to believe that my circumstances and opportunities are special and unique, they are not. Any salesperson trying to convince me otherwise is lying.

In reading about Madoff, I am struck by all the parallels to my buyer’s club experience. The aura of exclusiveness he created, the network of friends and families, the secrecy about what he did, and most striking—that he did not charge for his services—all telltale signs of a Ponzi scheme. But, he preyed on the wealthy and famous so that it was much easier to convince his marks that they were special. I think the scam would have failed with ordinary investors who know that they are not special. Madoff knew, that ironically, those most likely to fall for his scheme would be the kind of people thought least likely to be taken in by a such a scam.

Of course in the end Ponzi schemes fail because of the math. Security analyst and graduate of my institution—Loyola College—Harry Markopolos alerted the SEC in 1999 that Madoff’s investment success made no mathematical sense. In 2005 he sent a 19-page paper to the SEC titled: “The World's Largest Hedge Fund is a Fraud.” While the document is technical, the fundamental numbers on which it is based are telling. You don’t need a background in forensic accounting to realize what is going on. All you need to do is apply the mediocrity assumption. His reasoning is a classic use of that assumption. Markopolos is quoted as saying:

"No Major League Baseball hitter bats .960, no NFL team has ever gone 96 wins and only 4 losses over a 100-game span, and you can bet everything you own that no money manager is up 96 percent of the months either."

Unfortunately many people bet everything they owned that Madoff could be up 96% of the time.

A few months after I said no to the offer from the “buyer’s club” it closed its doors and its managers disappeared. The local news reported that the State Attorney General was investigating. Many people with “lifetime” memberships prepaid for merchandise they never received. That was 24 years ago. I am still alive. The same techniques for deceiving people are still in use and continue to be effective.

Joseph Ganem is a physicist and author of the award-winning The Two Headed Quarter: How to See Through Deceptive Numbers and Save Money on Everything You Buy

History on Fast-Forward

2009-01-05T17:31:00.001-08:00

George Santayana’s observation that “Those who cannot remember the past are condemned to repeat it” remains true, but the repeats have been put on fast-forward. For the past year the economy has given me a sense of déjà vu, as if I’ve lived through the past year in another time. In fact, in my early adult life I did live through the events of the past year. It is just that back then—the 1970’s—economic trends took a little longer to play out.

Consider the spectacular rise and subsequent collapse of gasoline prices over the past year. After hitting a high in July 2008 of just over $4 per gallon of regular in the United States, gas prices have fallen to an average near $1.60 as of last week. Similar price action took place before when, in terms of inflation-adjusted 2007 dollars, gas prices went from nearly $2 per gallon in 1978 to over $3 per gallon by 1980. A fall to $1.50 per gallon followed, but it took nearly 5 years. It was not until 1985 that inflation-adjusted gas prices undercut the prices in the late 1970s.

Nominal price and real price in 2007 dollars of a gallon of gas

The causes of the 1970s oil bubble were much the same as ones that caused the 2008 bubble—wars and instability in the mid-east, massive federal deficits that weakened the dollar, trade deficits with other nations.

Then, as now, the economic and political effects of price movements of this magnitude were profound. The price run-up resulted in a severe recession, steep rise in unemployment, depressed stock market, and nationwide disenchantment with its political leadership.

U. S. auto companies had built their business model on selling large gas-guzzlers that suddenly no one wanted. Plummeting auto sales threatened the financial stability of the big three automakers. By 1979, Chrysler Corporation appeared on the verge of bankruptcy. Its chief executive arrived in Washington begging Congress for a bailout in order to save American jobs.

The ruling party in the Whitehouse was decisively voted out of office and a charismatic new president took over, brimming with confidence and optimism and promising change. On February 19, 1981, shortly after taking office, the new president had a question-and-answer session with news editors about his program for economic recovery. He stated in regards to the energy crisis: “The best answer, while conservation is worthy in itself, is to try to make us independent of outside sources to the greatest extent possible for our energy.”

But, when gas prices fell and stock prices rose, the events of the 1970s were quickly forgotten. Everyone resumed their old habits and considered the decade an aberration. Even though no one did anything to solve the underlying problems, no one planned for a repeat of the events of that decade.

It will be interesting to see what happens in the coming year, but I would not become complacent about low gas prices remaining. Oil prices started to rise this week as mid-east fight flared. It is the same war that was fought in the 1940s, and the 1970s being fought today. The same political rhetoric about energy self-sufficiency is coming from the mouths of a new generation of politicians. A new line up of auto company executives beg Congress for bailout money and promise that they have finally learned the lessons of a generation ago.

None of the problems in the 1970s were actually solved or are they being solved now. History repeats itself but this time on fast-forward.

Joseph Ganem is a physicist and author of the award-winning The Two Headed Quarter: How to See Through Deceptive Numbers and Save Money on Everything You Buy

Debit or Credit?

2008-12-29T18:27:00.000-08:00

As I finished my Christmas shopping this past week, the “debit or credit” question at checkout is annoying me more than the longer-running “paper or plastic” inquiry. While I miss paper bags when it comes to carrying goods, I do not miss writing checks for payment at the cash register. Swiping my plastic check card is quicker and easier. But for some bizarre reason two alternative methods for processing the same transaction have evolved. In each case money is deducted from my checking account to pay the merchant. However, whether I say credit or debit, or more precisely whether I choose to identify myself with my signature or my PIN number makes a big difference on who pays the cost of the transaction and the risks I take as a consumer.

If I choose debit, the transaction proceeds much like taking cash from an ATM machine. A PIN number is required and after entry funds for the purchase are debited from my checking account along with an additional fee to pay for the transaction. It is not as costly as using a remote ATM, but it is not free. My bank charges me $0.50 for each transaction and that adds up quickly. If I make purchases at three or four different stores it would be cheaper for me to just go to the ATM and get the cash. It would all come out of the same checking account. After all, I’m not using actual credit.

If I choose “credit” the money also comes out of the same checking account, but a different set of rules apply. This is what I find so weird. I no longer pay the transaction fee because no electronic funds transfer takes place. Instead the Visa credit card network takes over and the merchant is hit up for the usual 2% to 3% of the purchase price even though no credit is extended. However, I have the protection of using a credit card meaning I can dispute charges and there are limits on my liability for fraud. In contrast, I have no protection for unauthorized PIN transactions. If someone obtains my PIN and check card numbers that person could drain my entire checking account and I would have little leverage for recovering the loss.

There is little reason for me to ever make a debit transaction at checkout. It is costly and risky to use my card in that mode. Naturally the store wants me to use debit because it is cheaper and safer for them. As a result all the machines are set up to prompt for a PIN number. To use credit I need to hit the nonsensical “cancel” button to move on to the credit option. No matter how many times I do this I still get confused by this step. The concept of “canceling” my purchase so that I can complete it just doesn’t sink in.

So are there ever any reasons to choose debit? Actually consumers who choose credit for gas, hotel, or rental car purchases could be in for a nasty surprise if their checking account balance is too low. The reason is that merchants selling open-ended purchases such as these typically place “holds” on the account for much more than the purchase price and these holds can last for days.

For example, suppose you intend to buy $25 of gas and swipe your visa check card. The computer doesn’t know your intention so it might automatically request an authorization for $50 to make sure you have the funds to fill up a large tank. In your checking account $50 is immediately set aside. You drive away with your $25 purchase, but the $50 set aside stays for several days. Over that time you could easily be writing bad checks because you keep account of your actual balance. Your bank has a different number—the “available balance”—that is less because of the funds set aside for the credit authorization.

You the consumer have no idea what number represents the “available balance” but you will be paying hefty bounced check fees if you overdraw on it. It’s all perfectly legal and just another excuse banks have for soaking consumers.

Joseph Ganem is a physicist and author of the award-winning The Two Headed Quarter: How to See Through Deceptive Numbers and Save Money on Everything You Buy

Good News/Bad News for Credit Card Holders

2008-12-22T18:52:00.000-08:00

It has been a good news/bad news week for consumers who use credit cards. Labeling current credit card practices “deceptive” and “unfair,” the Federal Reserve proposed new rules for credit card issuers. What is most striking about reading the list of practices the Fed now intends to abolish is that these tactics were ever legal in the first place.

First the good news–if adopted the new rules will prohibit such practices as:

• Assessing hefty late fees if a payment arrives one or two days late. Borrowers will have a reasonable grace period of 21 days before a payment is deemed “late.”

• An interest computing practice known as “double-cycle billing.” As it stands now, a balance that is not paid in full is assessed interest beginning from the date of purchase rather than from the end of the grace period.

• Charging high fees for exceeding the credit limit solely because of a hold placed on the account. Consumers often don’t know the amount of holds when they check into hotel rooms or rent cars. I’ve had $1000 holds placed on my account just for checking into a $200 hotel room.

• Applying payments to the part of the balance with the lowest interest rate. Under the new rules, any payment above the minimum will have to be applied to the balance with the highest interest rate. It is not uncommon for consumers to have balances with multiple interest rates because cash advances and balances transfers often have different interest rates than purchases. Currently banks apply payments to balances in ways that maximize finances charges by applying all money paid to the part of the balance with the lowest interest rate.

Now the bad news: These are “proposed” regulations, not laws and they will not take effect until July 2010. As Bob Sullivan noted in his blog: “A 300-page report by the Office of Thrift Supervision described bank misbehavior in great detail, at times using stinging language.” Federal regulators “then invited card issuers to continue those unfair tactics for the next 18 months.”

A December 18 report on the NBC Nightly News stated that the rationale for allowing these practices to continue was to give banks time to adjust. A spokesperson for the American Bankers Association, Nessa Feddis, stated on camera: “The regulations, in effect, require the credit card industry in effect to completely dismantle and rebuild their credit card business model.”

This is a bizarre defense of an indefensible delay. Maybe in the future the Feds should give organized crime syndicates time to dismantle and rebuild their “business model” instead of busting them.

In the mean time, while the banks retool, all of the practices listed above are still in use. I’m not optimistic that a “rebuilt” credit card business model is going to be any better for consumers. The Federal Reserve is taking steps that should have been taken many years ago in response to the current economic crisis. I think the banks are creative enough to put together a different set of deceptive practices that will still gouge consumers. And, once the crisis is past, federal regulators and Congress will go back to looking the other way.

Joseph Ganem is a physicist and author of the award-winning The Two Headed Quarter: How to See Through Deceptive Numbers and Save Money on Everything You Buy

Gaming the Inflation Numbers

2008-12-16T09:41:00.000-08:00

Is inflation good or bad? Most consumers and businesses would say inflation is bad. By distorting prices, inflation makes financial planning for the future difficult, it squeezes family budgets, wrecks business plans, and destroys savings. The government, at least in principle, agrees that inflation is bad and one of the duties of the Federal Reserve is to “fight inflation” by tinkering with interest rates.

But there’s a problem with this good versus evil story line. Inflation actually has beneficiaries with a vested financial stake in seeing it continue. For example, debtors benefit from inflation. People who borrow money during periods of inflation get to pay back cheaper dollars than the ones they spent. Homeowners benefit from inflation because no landlord raises the rent. That means as a homeowner’s income increases, the fraction of income needed for housing decreases. Most people who own homes are also in debt because of the home, so they get duals benefits from inflation.

But, the biggest beneficiary from inflation is the federal government itself. The same institution that controls the money supply and purports to fight inflation benefits from it. Actually, the government benefits most from stealth inflation. If the real rate of inflation can be hidden, the government realizes all the benefits from inflation without having to bear the same costs that everyone else does.

The federal government benefits from inflation because it is the largest debtor on the planet. No other institution measures its debt in trillions of dollars. Not only is the debt enormous, it is projected to go on forever. Vague proposals to balance the budget are lame attempts to end the growth of debt, not the debt itself. Inflation makes the national debt manageable. Without inflation it would be mathematically impossible for the federal government to meet its financial obligations.

In fact inflation is an ideal two-headed quarter for the government. Devaluing the currency is a means of taxation without the need to pass a law raising taxes. The government cheapens the dollars it owes and collects more money through the effect of tax bracket creep. At the same time, rising prices create an illusion of wealth while purchasing power falls. But much of the mathematical magic of inflation would go away if the government were honest about reporting inflation rates.

For example, the government issues inflation-indexed bonds that pay a variable interest tied to the inflation rate. Increases in entitlement spending on such a programs as Social Security are based on the inflation rate. The idea that the government can “stimulate” the economy by lowering interest rates only works if you can convince lenders that the inflation rate is low so they don’t need a high rate of return just to break even.

So how does the government pull off this deception? The problem is no one agrees upon a definition of inflation. CEOs of large corporations will say that their ever increasing, stratospheric compensation packages are necessary for a prosperous company. Of course these same executives will fight raising the minimum wage on the grounds that such an action is “inflationary.” It is rather convenient to label your rise in income as deserved and label someone else’s as delusory.

So it is with the federal government. It can tinker with economic data to underreport inflation so that it reaps the benefits but doesn’t have to pay the costs. In Jim Jubaks December 5, 2008 column: “Fake Inflation Numbers Mask Crisis” he explains some of the techniques the government has used in recent decades to disguise inflation.

For example the government started using “hedonics,” a technique that reported a $100 increase in the price of a car as $0 if in the judgment of the government the “usefulness” of the car increased by $100. An increase in the power, safety, or other features would qualify as increasing its “usefulness.” Never mind that the car does essentially the same thing—take its driver from point A to point B.

The government also started to make “substitution” adjustments to its inflation numbers. If the price of steak goes up, the government assumes consumers will substitute chicken and not pay more for food. Therefore food prices are not actually rising. Got the logic on that one? Of course some government official has to decide what substitutions consumers will make and those decisions are subject to a later change.

According to Jubak the result of fudging the inflation numbers is that the Fed should have been raising interest rates to fight inflation instead of lowering them and allowing the housing bubble to develop. Of course the Fed could accurately report the money supply figures that would give a much better insight into real inflation. While there are disagreements on what inflation is, there is common agreement that printing money to circulate without a corresponding increase in economic activity will cause inflation. But in 2006 the Fed stop publishing broad measures of the money supply focusing on more narrow measures instead.

According to the Fed, the cost of collecting the additional data outweighed the benefits the data provided–a rather convenient cost/benefit analysis to make.

Joseph Ganem is a physicist and author of the award-winning The Two Headed Quarter: How to See Through Deceptive Numbers and Save Money on Everything You Buy

Shopping our way to prosperity?

2008-12-08T18:20:00.000-08:00

Individuals who wish to accumulate wealth and become financially secure are told to work hard, be productive, save, and invest. The advice is old fashioned and trite. Recent events have shown it doesn’t always work, but, it’s difficult to suggest a better alternative. Work hard, don’t produce, spend every dollar you make and then some will certainly not lead to financial security.

However, as the holiday season approaches and with it the annual nationwide orgy of shopping, we are told that the way out of the economic crisis is to keep up the behavior that made the mess. Black Friday sales figures are headline news. The media, politicians, and corporate executives spread a gospel of salvation through consumption. Robust consumer spending will lead us out of the financial wilderness and avert a reenactment of the 1930s great depression.

On my local NBC affiliate in Baltimore— WBAL— the general manager broadcast an editorial Saturday night pleading with people to shop. While he urged responsible use of credit, he stated: “If you can shop you should. We must each do our part to get the economy jumpstarted. The message from Washington is clear—happy shopping.”

I’m sorry but if consumption without production is not a recipe for individual success, how can it lead to prosperity for all? If Americans saved, invested and then produced what they consume the argument might have some validity. But, as a nation Americans accomplish none of the above.

Americans buy lots of stuff that people in other countries make. For the first time since the great depression our national savings rate is quantified with negative numbers. And for all the trillions of dollars our federal government and large corporations have burned through recently, there appears to be nothing with future value to show for it. Our public infrastructure is crumbling along with our manufacturing base.

Consider Dan Rodricks' column Sunday where he observed: “Look at us: We've become a nation that thrives when people spend money they don't have. This is completely upside down from the society baby boomers recall, when the economy was robust, when people made a decent wage and benefits from manufacturing jobs, and the only things they had to finance were their homes and cars.”

The lesson from the economic crash of 2008 is that unchecked consumption and debt accumulation without production and investment in the future is unsustainable. All bills come due and all debt must be paid back. Shopping is not the magic elixir that will lead us to economic salvation; it’s an ingredient in the poisonous brew that’s killing our prosperity.

Joseph Ganem is a physicist and author of the award-winning The Two Headed Quarter: How to See Through Deceptive Numbers and Save Money on Everything You Buy

Credit Card Crisis Next?

2008-11-30T08:51:00.000-08:00

The marketing of credit cards by banks has mystified me for years. How can banks shower the public with credit cards offers like confetti, charge usurious interest rates, tack on exorbitant fees and still have customers who are able to keep up with payments? The answer might be coming soon and it appears the answer will be—not forever. Speculation in financial news reports is that the subprime mortgage crisis will be followed by a credit card crisis.

A Reuters news story: “Looming credit card debt may be the next crisis” quotes John Whitehead, former chairman of Goldman Sachs Group, as saying that a credit card crisis is “waiting in the wings.” And a USA Today story “Why banks are boosting credit card interest rates and fees," quotes Gregory Larkin, a senior analyst at Innovest, as saying "Mortgages were simply the first storm to make landfall. Credit cards are next." According to Innovest, a research firm, by the end of 2009 banks are likely to write off 10% of credit card debt—a staggering $96 billion.

The aggressive marketing of consumer debt appears counter to the careful conservative image we generally have of loan officers and underwriters. After all, most people who loan money to friends and family members expect to be paid back. Are not banks in business to be paid back? Yet even individuals who have rung up tens of thousands of dollars in consumer debt are still inundated with new credit card offers.

So why are banks so intent on lending money to people with questionable means to pay it back? The answer in a word is—securitization. Just as they did with mortgages, banks have packaged and sold credit card debt in the form of securities to unwitting investors. The risk associated with the debt becomes some else’s problem. In the mean time if customers stay in debt, the bank can profit from hefty fees associated with managing the account.

It is actually more profitable for the banks if it customers are overloaded with debt. If a customer has too much debt to pay back in a reasonable period of time, he or she has no choice but to accept whatever additional fees and interest rate hikes the bank decides to levy. A further irony is that the inability of a customer to easily pay off the debt can be used as justification for imposing the additional fees and rate hikes.

Banks looking to make up for losses during the current financial crisis are finding that customers with outstanding credit card debt are easy targets. The USA Today story reported on consumers like Tommy Newsom who never missed a payment but had his credit card interest rate doubled to 27% for no apparent reason other than the law allowed the increase.

Banks justify sudden interest rate increases by claiming that a customer’s risk category has changed. A spokeswoman for Bank of America was quoted in the USA Today story has saying that the bank "regularly assesses the risk profile of accounts. If the bank decides to raise a customer's rate, it will notify the customer first and give him or her the chance to "opt out" and pay off the card balance at the existing rate.”

But notice the two-headed quarter in use in this statement. Customers whose “risk profile” have changed are most likely the ones identified as being unable to “opt out.” Without the means to pay off the balance the customer’s only option is to “accept” the new rate.

Banks can get away with this behavior because of loan agreements that are not agreements in the ordinary sense of the word. Credit card agreements contain language that allows the terms of the agreement to be changed by one party (the bank) at any time for any reason. The legality of such an agreement will never be tested in a court of law because consumers also sign away the right to sue. Only binding arbitration is permitted as means of resolving disputes in credit card agreements.

Of course the bank’s response to rising levels of credit card debt will accelerate the impending crisis rather than avert it. No need to worry though. More than likely customer paid tax-dollars will be sent to bailout the banks.

The “Housing Market” - The Greatest Fraud of All

2008-10-30T14:17:00.000-07:00

As the financial crisis has unfolded over the past few weeks, many high profile leaders have had their faith in a market driven economy shaken. Even Alan Greenspan had to admit in testimony before Congress that the assumptions behind his economic policies were wrong. He now says he made a mistake in believing that banks “operating in their own self-interest, would do what was necessary to protect their shareholders and institutions.”

Actually, I think markets work well when the conditions for them are allowed to exist. But we are seeing the unmasking of one of the greatest economic deceptions of all time—the claim that in the United States a market determined home prices. The “invisible hand” that Adam Smith envisioned setting prices in a marketplace is suppose to be just that—invisible. Smith’s economic model rested on the assumption that many buyers and sellers acting in their own self-interest and without government interference would negotiate fair prices for scare commodities.

But lets count the ways the so-called “housing market” has failed to meet these conditions.

Government subsidies for homeowners – For decades the federal government has taxed homeowners at a lower rate than renters. It accomplishes this by allowing payments for home mortgage interest to be deducted from income. Homeowners can borrow up to the entire equity in their house and spend the money on whatever they want—cars, vacations, college tuitions—and the interest paid on the loan is tax deductible. Renters are not allowed to deduct interest paid on loans. The effect of this policy is that homeowners are taxed less as long as they remain in debt. That makes owning a home intrinsically more valuable than just having a place to live.

Government-backed loans eliminate lenders’ risks-The point of Freddie Mac and Fannie Mae was to encourage banks to loan private money to purchase homes by promising public money if the loan went bad. This policy effectively privatized gains and socialized losses. The result is a moral hazard that subverts the functioning of the market. Banks can loan money under the most outlandish of circumstances because they have everything to gain and nothing to lose.

A single person sets interest rates – The Federal Reserve Chief dictates interest rates. It’s no accident that Alan Greenspan had the nickname “Maestro” when he ran the Federal Reserve. Rather than allow market processes to determine interest rates he orchestrated market movements by dictating the rates himself. Allowing the judgment of one person to determine something as fundamental as the cost of money on such a grand scale is the antithesis of a free market.

Of course the government had good reasons for these policies. Congress decided that communities benefited from widespread home ownership. In other words a social good resulted if more people owned homes rather than rented. But government manipulation of markets to achieve a social goal is the definition of socialism.

That is where the great fraud arises—the creation of a socialist system for home ownership but labeling it a “free market.” The claim that no regulation is needed for mortgages because the market will operate is absurd. Socialist systems need regulation; otherwise the moral hazards are too great. The government appears to have no plans for ending the mortgage interest deduction, ending bailouts of failed lenders, or ending Federal Reserve control of interest rates. If it continues to use these policies to manipulate home prices its needs to be intellectually honest. The government should admit that fact that the housing market has been socialist for decades and adopt appropriate regulations to protect the public.

Irony in the Financial Crisis

2008-10-24T07:43:00.000-07:00

How much should the government pay for the bad mortgage-backed securities that the banks no longer want? I find a profound irony in that question. A problem in the current financial crisis is that no one knows what many of these securities are worth. Settling on a price that will solve the problem is tricky. If the government pays too little the bailout could fail and the banks will go under anyway. If the government pays too much banks will reap enormous profits at the expense of taxpayers and have little incentive to change the lending practices that resulted in this mess.

The reason no one knows a fair price to pay is that the securities in question are too complicated for anyone to understand. The irony is that the complexity was intentional. The securities were designed to make it difficult if not impossible for anyone to know their underlying value.

Much as been written during this current financial crisis on the question of whether free market capitalism is dead. But the mortgage industry during the past few years was anything but a free market. The idea behind a market is that fair and accurate prices will result from negotiations between buyers and sellers acting in their own best interests. But, for consumers to act in their own best interest, they need to understand the agreements they enter.

Corporations have put enormous effort into making contracts so complex the normal rules of the market do not apply. The premise behind my book, The Two Headed Quarter, is that financial companies can mislead consumers without lying by presenting numbers in such complex ways that rational decision-making becomes impossible. Bob Sullivan’s book Gotcha Capitalism exposes how companies use complex contracts to cheat consumers out of money with hidden fees and surcharges. The idea throughout corporate America is to find deceptive yet still legal methods for taking as much money as possible from consumers without them noticing.

Now there is no money left in the consumer’s pocket for the corporations to take. But, it turns out that a constant flow of money from the consumers is needed or the system falls apart. This was never a “market” in the ordinary sense of the word; it was a Ponzi scheme.

In a healthy marketplace, buyers and sellers need each other. Sellers need satisfied customers willing to come back and give referrals. A small community-based business will not survive without repeat customers. Buyers need merchants that they can trust to provide reliable goods and contribute to quality of life in their communities. A business with contempt for its customers, that exists only to acquire as much money as possible, will eventually fail.

Failure is of course what has happened. But, what I find deeply ironic is that these corporations are now victims of their own deceptions. These corporations attribute their failures to customers who did not understand agreements designed not to be understood. Now these same corporations are shocked to discover that no one understands the agreements. The executives who created the complex securities don’t understand them, Treasury Secretary Paulson doesn’t understand them, Fed Chief Bernake doesn’t understand them, would be buyers don’t understand them. A security that cannot be understood cannot be fairly priced.

A mortgage is actually a simple idea. Over the long run it benefits no one to turn package mortgages into complex, incomprehensible, financial instruments. As the government moves forward to craft better regulations to prevent a future financial catastrophe’s it should consider going back to basics. A free market will work but only if the participants understand the agreements.

The Deceptive Math of Financial Leverage

2008-10-12T19:10:00.000-07:00

In physics a lever is a tool for obtaining a large torque (rotational motion) with a relatively small force. Anytime you use a screwdriver, a lug wrench, a jack, a crowbar, or a doorknob, you are using a lever. In each of these circumstances the rotations achieved would be nearly impossible without the lever.

By analogy, the leverage principle in finance is intended to magnify rates of return on invested money so that relatively small amounts of money can grow much faster than the actual rate of return on the investment. But in finance the tool used to obtain leverage is debt. Borrowing against an asset to fund an investment is financial leverage.

For example, a homebuyer who takes out a mortgage is leveraging the asset—the home—to increase the rate of return on the money used for the down payment. Suppose a buyer puts $10,000 down on a $100,000 house and finances the remaining $90,000 using the house as collateral. If the value of the house rises 50% to $150,000, the homebuyer now has $60,000 of equity in the house. The $10,000 investment has multiplied 6-fold even though the asset only increased 50% in value. Had the buyer paid $100,000 cash for the house a 50% return on investment is all that would have been achieved.

Investors in the stock market can also use leverage. An investor with a normal brokerage account is allowed to borrow up to 50% of the value of stocks owned to purchase more stocks. That means $10,000 can be used to purchase up to $20,000 worth of stocks. This is called buying on margin. If the stocks double in value to $40,000 the investor now has $30,000 in equity—a tripling of the initial $10,000 investment.

Leverage seems like a kind of financial magic. For many investment banks and hedge funds it was magic because these institutions were not bound by the normal rules that limit ordinary investors and homeowners. Stockowners cannot borrow more than 50% of the value of their stocks; homeowners cannot borrow more than the value of their homes. But, in the unregulated dream world of investment banking and hedge funds, there was no limit on the amount the managers could borrow against their assets. For example, by the time Lehman Brothers went bankrupt it was leveraged more than 30 to 1. It owed $30 for $1 in assets it held. Imagine a homeowner borrowing $3 million against a $100,000 home. That might sound crazy, but that’s effectively what Lehman Brothers did.

The motivation for investment banks and hedge funds to leverage their assets to such absurd levels is that it allows them to report fantastic rates of return for modest investment gains. Suppose a $3 million cash investment returns just 5% in a year so that the value is $3.15 million. That does not sound all that impressive. But, suppose the fund managers had only $100,000 in equity in that $3 million investment. The total equity after the 5% gain is now $250,000. The fund managers can now report a “return on equity” of 150%. That is an eye-catching number to report to investors, prospective customers and stockholders. The managers can reward themselves with bonuses for the their remarkable results. At the same time the appreciation of the actual investment was nothing out of the ordinary. It is a beautiful example of a two-headed quarter—using numbers to have it both ways.

But leverage has a dark side. Not only does it magnify gains it also magnifies losses. In the example above, if the $3 million investment loses just 3.3% of its value, the $100,000 of equity is completely wiped out. In markets with normal volatility, a 3.3% downward move is not unusual for a solid investment. The problem is that many of the investments were in mortgages, which are also a leveraged investment. Many of the subprime mortgages being called assets, were for homeowners who had no equity in their houses. Leverage was piled upon leverage. No wonder the banks have no idea what the mortgage securities they hold are worth. Homeowners with no equity have every incentive to walk away when prices fall. After all, when a homeowner invests nothing, there is nothing to lose.

In the same manner, the executives and fund managers had nothing to lose by taking on such absurd levels of debt. They pocketed huge salaries and bonuses for their financial “genius.” And it was an ingenious scheme—taking home the profits and billing the taxpayers and stockholders for the losses.

Joseph Ganem is a physicist and author of the award-winning The Two Headed Quarter: How to See Through Deceptive Numbers and Save Money on Everything You Buy

The Difference Between Gambling and Investing

2008-09-30T14:29:00.000-07:00

The crisis in the financial markets this month is a reminder of easy it is for people to convince themselves that they know far more than they actually do. The executives in charge of Lehman Brothers, Merrill Lynch and AIG were highly compensated for their years of experience in investing and finance. Their companies made billions when the investments they made appeared to be profitable.

But, the events of the past month show that the experts running these companies had no more insight into the future than anyone else. Probably even less knowledge of the future than many people because they apparently forgot all the known principles of sound investing. Instead these executives became seduced by the lure of making quick money by gambling with the enormous sums of money entrusted to them.

The problem with gambling is that winning streaks occur frequently. It is possible to place a series of bets and come out ahead. But, suppose I walk into a casino and win five hands of blackjack in row. Does that mean I know something that the other losing players do not? Should I increase my bets? Should I give up my job and become a professional gambler?

Winning five hands in row at blackjack means nothing more than that is how the cards fell for those five hands. It does not mean that I am smart or gifted or have any special insight into the future. I certainly should not be increasing my bets or plan a career change to full-time gambling.

But, the executives running these investment firms and insurance companies had a few profitable years placing high-risk bets on real estate and concluded that they knew something others did not. Instead of being thankful for coming out ahead on bets that should not have been placed, they kept increasing their exposure to risky loans.

In my book The Two Headed Quarter I draw a distinction between gambling and risk-taking. I write:

“Gambling involves betting money on a game or contest for the purpose of winning more money. Attractions of gambling include the thrill, the entertainment value, and the possibility of wealth without work. Risk-taking involves using money to achieve broader goals that have an uncertain outcome. Anyone who pays for an education, buys a house, relocates for a new job, or starts a business, is taking a risk.”

Investing should be a risk-taking activity. The basic idea is to pool and allocate capital to grow businesses and production capacity. The end result should be economic growth resulting in more jobs, more goods and services, and a higher stand of living for all. In contrast gambling simply transfers money from losers to winners. Nothing of value is created. Imagine an economy where everyone is a full-time gambler. It would be unsustainable because nothing would be created.

But somehow the executives running firms on Wall Street convinced themselves that moving money around using complicated impossible to understand formulas was creating wealth where none existed before. They rewarded themselves handsomely for creating what amounted to a shell game. Wealth creation by subtraction does not work. You cannot keep taking out money of the pot and claim that there is more in it. No matter how complicated you make the financial formulas you cannot work around the basic facts of addition and subtraction.

Joseph Ganem is a physicist and author of the award-winning The Two Headed Quarter: How to See Through Deceptive Numbers and Save Money on Everything You Buy

Tips on Mortgage Math

2008-08-30T19:00:00.000-07:00

I have been writing this month on what has gone wrong in the mortgage industry and mistakes lenders and homebuyers have made. Here are some tips about mortgage numbers that consumers should know to protect themselves.

Home Prices: Speculation abounds in the media on when the mortgage market will bottom. My research suggests that the magic number for a fair sustainable housing market is 3. That number is the ratio of the median home price to the median household income in the United States. An examination of census data shows that from 1987 to 2002 that ratio remained unchanged at 3, even though home prices and income rose steadily during that time period. In 2002 home prices began increasing much faster than household income causing the ratio to shoot up to nearly 5 at the peak of the housing market in 2006.

The fact is home prices cannot rise substantially faster than household income or soon everyone will be priced out of the housing market and there will be no more buyers. At the beginning of 2008, the U. S. median home price—$195,900—divided by the median household income—$50,233—was equal to 3.9. That means more time is needed for income to rise and/or home prices to fall for that ratio to go back to its historical average of 3.

Monthly Payments: The number 3 is important in another way. Total monthly payments for principal and interest should not exceed 1/3 of after-tax household income. Many people think that at higher income levels a greater fraction of income can be allocated toward the mortgage. My last post profiled people who were willing to allocate more than half of their take-home pay to monthly mortgage payments. I imagine they thought that their income was so large that all additional living expenses could be funded with 30% - 40% of take-home pay.

But, ownership costs scale with the price of the home. The more square footage bought, the more it costs to heat, cool, maintain, insure, furnish and pay property taxes. All of those additional costs rise with inflation. If you take out a 30-year fixed-rate mortgage and live in the house a long time, there will come a day when the monthly cost of owning the home will exceed the monthly mortgage payment. That will be true for just about any size home.

Mortgage Options: Creative financing has risks. Recent years have seen an explosion of exotic mortgages. You can choose ARMs, interest-only mortgages, 40-year mortgages, mortgages with balloon payments and many other combinations and payment structures. But, the common element in all of these financing schemes is to make the initial monthly payments as small as possible by postponing actual debt reduction. That’s not a problem in a rising market, but it can be a disaster in a falling market. When prices fall it’s easy to find yourself “upside down” meaning that you owe more than the house is worth, while payments adjust upward to level that you can’t afford. If you are considering a mortgage without a fixed rate, figure out what the monthly payment will be in a few years after the interest rate adjusts. If you can’t afford to make that higher payment now, chances are you won’t be able to afford to make it in the future.

Plan for maintenance: Set aside money equal to about 1% – 1.5 % of the value of the home each year for maintenance, repairs and improvements. It’s easy to be optimistic, but the fact is things will break on a regular basis. When you think of all the things in a house with finite lifetimes that are essential—furnace, water heater, air conditioner, refrigerator, roof, plumbing—you realize that repair and replacement will be an on going expense. It is better to budget ahead of time those expenses with money set aside in a separate bank account. Repairs should not be a financial emergency requiring borrowed money every time they happen.

Joseph Ganem is a physicist and author of the award-winning The Two Headed Quarter: How to See Through Deceptive Numbers and Save Money on Everything You Buy

Motivations Behind Bad Loans

2008-08-19T06:55:00.000-07:00

I’ve written columns for the Baltimore Sun on the mortgage crisis and the emails I received from readers included these comments:

“It is hard to feel sorry for folks who got in over there heads, knew it and now what us to bail them out.”

“You are omitting the fact that the majority of subprime borrowers are in their current situation due to fiscal irresponsibility or carelessness.”

My response to these comments is that the goal of my writing is to educate consumers so that they are able to make better decisions. Markets do not work as intended if the consumers do not understand the contracts they sign.

But, for the people who write these comments, their underlying assumption is that homebuyers do know or at least should know what they are doing when they sign a loan agreement. The mortgage crisis is the result of character defects—greed, irresponsibility, over consumption, and so on. Pick one or several character flaws from a list and that explains the problem.

Of course, attributing misfortune and/or good fortune, on one’s character is as old as the Bible. Outcomes do depend on character, although not always. More personal failures and successes result from chance than most people would like to believe.

But the issue of character is an interesting one and I’ve been pondering it after recently reading two profiles of homebuyers facing foreclosure. In both cases the numbers involved in the loan agreements were so outrageous, it’s hard to believe any reasonable person would be party to such a contract.

A July 30, 2008 article in the Baltimore Sun profiled Veronica Peterson, a single mother of four who operates a home daycare in Columbia, Maryland. She is loosing her $545,000 home to foreclosure after the rate adjusted from 8.25% to 11.25%. The article provides few other details on her income and mortgage payments. However, if I work with the numbers provided and assume a 30-year loan, such an increase would mean monthly payments changing from $4094 to $5293 per month, an increase of $1199 per month. This does not include taxes and insurance that must add an additional $500 to each monthly payment.

I cannot image how a home daycare operator could generate the kind of income needed to support monthly payments that high; especially since the State of Maryland limits the number of children home daycare providers can care for to no more than eight. The average cost of daycare in Columbia, Maryland is about $1000 per month. That means by law she cannot gross more than $8000 per month and she must still pay income taxes. Living in a half-million dollar home while paying no taxes is sure to raise questions from the IRS. She said her mortgage broker inflated her income. I wonder what number was stated for her income on the loan application and how it compared to her tax return.

Another profile I read was in Jay Hancock’s August 8 column on Kimberly Thomas who showed up at a closing to find the interest rate on her mortgage from Wells Fargo Bank changed from 7.13% to 10.65%. The change resulted in the monthly payment going from $3000 to $4667. Her monthly take-home pay is $5000. The title company agent conducting the settlement told her to sign the documents anyway. It was 6 PM and no one else was present or available to contact. He assured her the bank would correct the “mistake” the next day.

But the next day Wells Fargo insisted that there was no mistake and that she was bound by the terms of the agreement. Because she couldn’t afford the terms, she ended up not taking possession of the house or making a single payment. The mortgage went into foreclosure immediately. She sold the house for which she paid $505,000 for a $95,000 loss and spent tens of thousands on legal fees. Eventually a jury agreed that Wells Fargo had acted fraudulently and awarded her $1.25 million in damages. Wells Fargo maintains they did nothing wrong and are appealing the verdict.

So what is it about the character of these people that results in situations where the numbers in the agreements are so ridiculous as to be unbelievable? My own take is that it is a combination of optimism bordering on wishful thinking, wanting to please others, and willingness to trust people presenting themselves as “professionals.” Homebuyers want to believe what the agents and brokers are telling them. And, the agents and brokers are very good at telling people what they want to believe. The fake friendships that develop allow the brokers and agents to take advantage of people who want to please others. Homebuyers do not want to anger people by scuttling deals at the last minute and willingly believe that everyone is acting their best interest.

Brian Paul, the lawyer for Kimberly Thomas, said: "She honestly believed there was a mistake in the terms that could be fixed after the fact."

I remember my own experiences with home buying. The real estate agent told me: “It’s impossible to overpay for a house because it has to be appraised. The bank will not allow you to pay more than the appraised price.” I’m sure all the homebuyers he works with get that same line and many believe it.

I remember a refinance of my house where the day of closing, a settlement sheet was faxed to me with a completely different set of numbers than previously agreed to. I took a hard line telling the broker the deal would not happen unless the numbers were changed back. Within an hour a new settlement sheet appeared with the original numbers. But many people are reluctant to “cause problems” at the last minute. It is also easier to walk away from a refinance than a home sale.

So, is believing the best about ourselves and others a character flaw? It can be when it allows us to be taken advantage of and enter into agreements not in our best interest. As I warn in my book The Two Headed Quarter, the lender and realtor profit from immediate sales, not the long-term financial health of the borrower. If the government, or some other investor backs the loan the lender is at no risk. That means homebuyers must look out for their own interests. Don’t believe the agent when he or she tells you that a bank would never loan you money if you couldn’t repay it.

In fact the real crux of the mortgage problem is the ability for agents, brokers, and executives to profit by gambling with money that is not their own. That is the point I made in my previous post. Wells Fargo and its agents don’t care if a loan is paid back because they will collect commissions and fees while selling the loan to other investors. The loan would become somebody else’s problem, not theirs. The homebuyers might have character flaws but the behavior of the lenders in these cases is criminal.

Joseph Ganem is a physicist and author of the award-winning The Two Headed Quarter: How to See Through Deceptive Numbers and Save Money on Everything You Buy

The Dream World of Mortgages

2008-08-12T10:56:00.000-07:00

I dreamt the other night of being at a casino. I sat at a $5 per hand blackjack table and began playing. As the dealer flipped the cards across the felt strange events started to happen. Each time I lost a hand the other casino patrons would take up a collection to cover my loss. Then someone would rush over to add more chips to my stack. But each time I won I got to keep the money. I simply put the chips I won in my pocket. Wow, I thought; I should try this at a more expensive table.

I moved to a $10 per hand table and the same thing happened. Next I tried $50 per hand and then $100. No matter how large a bet I placed or how long a particular losing streak lasted, the lost chips would magically reappear. But, any win was mine to keep and no one seemed to care. An attractive waitress came to offer a drink. I asked for some Grand Marnier and tipped her with a $100 chip. She rushed back with the drink, a seductive smile and a food menu. I kicked back and doubled-down on a hand blackjack players call a hard-16. (Yes, I know that is a stupid play, but I might win and it doesn’t cost me when I lose.) I think I’ll just stay here. No need to go back home and return to that activity called work.

Then I awoke and regained my senses. Real life isn’t like that; or so I thought. I made some coffee and as I sipped and savored the aroma my eyes focused on the morning newspaper. I read about the government bailing out near bankrupt companies with names ending in Mae and Mac. Wait, I must still be dreaming. Is the caffeine working this morning?

Indymac, Freddie Mac and Fannie Mae were run as private companies with stockholders and highly compensated executives. The executives made a series of large questionable bets on real estate that for several years paid off handsomely. But now fortunes have changed and the bets are losing big time. Like many problem gamblers, these executives did not know how to control risk, stay within a budget, or quit before going completely broke. But it didn’t matter to them because while they got to keep their winnings for the bets that paid off, ordinary citizens are being forced to take up a collection to cover the bets that lost.

Government talk and action on the financial crisis caused by bad loans is completely disingenuous. Political leaders extol the virtues of free, unregulated, private enterprise motivated by profit seeking executives and corporations. But when these private businesses fail, our leaders tell us that taxpayers must step in to prevent the entire financial system from collapse. It turns out that the Maes and Macs performed a necessary public service, much like a utility. But Marylanders already know what happens when utilities are deregulated and run for profit. We pay extra on our electric bills every month for that improvement.

IndyMac grew rapidly during the real estate boom by specializing in so-called “Alt-A” loans. These loans did not require homebuyers to actually document the income or assets they claimed. After its failure the FBI launched an investigation of the company for possible fraud. I’m just shocked, shocked to think that without documentation, bank officials might have just made up the numbers on loan documents.

Private enterprise works well with private money. But, in the mortgage business we have a system that allows private gain to accrue from risking unlimited amounts of taxpayer money. The result is that since March authorities have indicted more than 400 people who worked in the real estate industry. We the taxpayers are now footing the bill for massive amounts of collusion and outright fraud.

In Maryland, I know of no legal blackjack games. Neither the state nor federal governments trusts its citizens to play the game responsibly. But, while casino blackjack is stacked against the player, at least it’s regulated in states where it is allowed. Many tax-paying citizens were financially ruined in the poorly regulated real estate market. But, the government says that they should have made more responsible choices. Do they think this is a dream world?

Joseph Ganem is a physicist and author of the award-winning The Two Headed Quarter: How to See Through Deceptive Numbers and Save Money on Everything You Buy

Numbers Used to Quantify Writing Styles

2008-07-31T18:57:00.000-07:00

At the end of May, Microsoft gave up in the race with Google to digitize all the world’s printed books and magazines. The motivation for these ambitious projects is to allow search engine technology to reach inside the pages of every book in print. These corporations envision a future with no need to actually thumb through a book at a store or library in search of information. Search engines will perform the task much faster and return the exact location inside of any book for any text or keyword a user is seeking.

Whether such a future is a good or bad one for writer and publishers remains to be seen. Publishers have been less than enthusiastic about these digitization projects because of fears of copyright infringement and potential loss of sales. My own view as a writer is that exposure is a good thing. Obscurity is a greater threat to a writer’s livelihood than copyright infringement.

The Microsoft explanation provided for the decision to abandon the project came in classic corporate-speak. On a Microsoft blog, Satya Nadella, Senior vice president for search portal and advertising, wrote:

“Given the evolution of the Web and our strategy, we believe the next generation of search is about the development of an underlying, sustainable business model for the search engine, consumer, and content partner. For example, this past Wednesday we announced our strategy to focus on verticals with high commercial intent, such as travel, and offer users cash back on their purchases from our advertisers.”

If I ever need to write a parody of a corporate memo these sentences are a good starting point. Just how many buzzwords—evolution, development, strategy, sustainable, verticals, model, etc—are packed into just these two sentences with 65 words of prose? Actually with digitized books, questions such as that can be answered. In fact Google and Microsoft have been playing catch up with Amazon’s “Search Inside the Book” program launched in 2004. Publishers are now encouraged to submit electronic copies of printed books for Amazon to digitize and make searchable.

But, Amazon’s “Search Inside The Book” program allows for more than just keyword searches. You can now look at statistics about the writing style of a book before you purchase it. I checked Amazon’s listing for my book—The Two Headed Quarter—and discovered all sorts of numerical facts that I did not know. My book has 672, 289 characters arranged into 99,104 words. As expected in a book about deceptive numbers, the word “number” appears frequently—567 times, but it is the second most frequently occurring word. I had no idea that the most frequently used word in my book, appearing 709 times, is “years.”

But most fascinating is the statistical summary of my writing style that Amazon provides. Potential buyers can view the “readability” and “complexity” analysis of the text. My book rates as highly readable with a Flesch-Kincaid index of 7.2, meaning that you only need a 7th grade education to read it. According to Amazon 77% of all the other books are harder to read and in the category of personal finance books, 93% are more difficult to read. The easy reading arises in large part because the complexity analysis reveals that I have a simple writing style averaging only 8.6 words per sentence.

Now that last number threw me. I opened my book to some random pages and I found myself hard pressed to find sentences as short as 8 to 9 words, let alone enough sentences less than 8 words that would allow 8.6 to be the average. Amazon’s number for my average words per sentence just didn’t seem reasonable to me. I decided to run my own check using Microsoft Word’s analysis tools on some chapters from the original manuscript. I had never done that kind of analysis on my writing before, which shows you how much I think about readability statistics when I’m writing. The results:

For Chapter 1:18.0 words per sentence, Flesch-Kincaid index —10.1
For Chapter 2: 17.2 words per sentence, Flesch-Kincaid index —10.7
For Chapter 5: 18.9 words per sentence, Flesch-Kincaid index —11.4
For Chapter 8: 19.3 words per sentence, Flesch-Kincaid index —10.8

This means the readability of my writing is consistently at a 10th to 11th grade level (not 7th grade) and about average in complexity (according to Rudolf Flesch, co-inventor of the Flesch-Kincaid scale, the average words per sentence found in reading material is 17).

So how can Amazon’s statistics be so skewed? I don’t know but I have a good idea. Again, my book is about numbers and there are many numbers in the book. There are figures and tables with numbers along with worked examples containing numbers that allow readers to figure out numerical answers to many common financial questions. Many of the numbers in the book contain decimal points. My hypothesis is that the software Amazon uses to perform readability analysis cannot tell the difference between a period and a decimal point. After all, there is no difference between the two characters. Only an actual reader who can interpret the meaning of a sentence knows that a decimal point inside a number does not terminate a sentence.

I find it ironic that a book about deceptive numbers has an Amazon listing with a bunch of deceptive numbers to characterize its readability. Another example of companies spending time and resources to compile and publish useless numerical information. By the way, according to Amazon’s site my book has 3348 words per ounce and if you buy it you will receive 4715 words for each dollar you spend.

Joseph Ganem is a physicist and author of the award-winning The Two Headed Quarter: How to See Through Deceptive Numbers and Save Money on Everything You Buy

Does showing up for work cost more than you earn?

2008-07-15T07:16:00.000-07:00

The Sunday (July 13, 2008) Baltimore Sun this week had a front-page article about mothers: “Back to Work, Like it or Not” with the subtitle that “Women who left jobs for children find economy reverses the trade.” Reporter Jill Rosen writes “The soured economy—with its ever-increasing gas, food and utility prices, its sinking home values and its corporate downsizing—is forcing mothers who have traded careers for families to think about trading back.”

I can relate to the article because my wife will change from part-time to full-time work this fall. Energy and food prices have increased so much in the past year our budget no longer works as it once did. But our three children are teenagers and our current financial goal is getting them all through college. The Baltimore Sun article profiled women in much more difficult circumstances—mothers of toddlers and infants who planned on being stay-at-home moms. But, the article left me wondering if working for a paycheck outside the home is a financially viable option for many these women.

Women who can work professional salaried jobs will come out ahead financially by working outside the home. But women who work part-time or for lower wages might find that the same financial pressures forcing them outside the home might also make it impossible to realize any financial benefit.

How much money will these women have left after paying for commuting costs, daycare, work expenses, Social Security, and state and federal taxes? I’ve already seen television news reports about men with commutes so long it no longer pays to drive to work. I can imagine many common circumstances where stay-at-home moms would be hard pressed to increase the family income by working outside the home.

To assist families in figuring out how much additional income can be generated by working outside the home, I’ve teamed with my publisher to create a new calculator for the Compute Gas Savings Website. The calculator, at http://www.computegassavings.com/earningscalc.html, computes daily take home pay after subtracting all of the costs associated with showing up for work.

Consider a married mom in the suburbs with one child who finds a job in a city that pays $12 per hour. She must commute 25 miles each way in a family SUV that gets 20 miles per gallon. She manages to find daycare for $25 per day and finds herself spending an additional $5 per day on average for other work-related costs—coffee, snacks, clothes, car maintenance etc. Because she is married her additional income is not completely sheltered by deductions and exemptions. For this example we will assume a net federal tax rate of 10% and state tax rate of 3%. After entering all these numbers in the calculator it shows that she will take home just $36.17 per day out of her $96 per day net earnings or about $4.50 per hour.

Where did the money go? The combined cost of Social Security, federal, and state taxes takes one-quarter and the combined cost of daycare and gas takes one-third. That means it costs more than one half of her pay just to show up for work. This assumes she has only one child. Add the cost of daycare for a second child and daily earnings come to $11.17.

In fact it is easy to construct plausible scenarios where real earnings per day become negative. Keep the same tax rates, lower her hourly pay to $10, or $80 per day, give her two children so that daycare becomes $50 per day, make the distance to work 30 miles and the gas mileage 15 miles per gallon, and the real earnings per day becomes a negative $7.52. Going to work will cost her more than she makes.

I urge women looking to increase family income by working outside the home to test out different scenarios before deciding on a job. The hourly pay offered might not be the relevant number to compare when making a decision.

Joseph Ganem is a physicist and author of the award-winning The Two Headed Quarter: How to See Through Deceptive Numbers and Save Money on Everything You Buy

Oil Prices Are Not Dependent on Oil Sources

2008-07-03T09:02:00.000-07:00

A reader of my post “A Tax By Any Other Name” felt that I was naïve to suggest that supply and demand sets oil prices. The reader believes that oil pricing is driven more by speculation than anything else.

I agree with the reader that speculation is a large part of the reason we are paying $4 per gallon for gas at the moment. In my post I stated the supply and demand for oil is only a part of what sets the price for gas. I was mostly writing on how the increasing supply and decreasing demand for dollars is contributing to oil price increases. But in the last six months the falling dollar and increased oil consumption cannot account for the sudden 50% price rise for a barrel of oil. Speculation is clearly part of the problem.

It is no secret that the banks, investment houses, hedge funds, and oil companies now conduct most the trading in oil futures on all electronic foreign exchanges (such as the InterContinental Exchange or ICE) that are out of reach of U. S. regulators. A CBS news story quoted Michael Greenberger, a former top staffer at the Commodities Futures Trading Commission, as saying that 25% -50% of the price per barrel might be due to speculation. Greenberger believes that “If you can trade out of the sight of U.S. regulators, you can manipulate these markets."

What is especially disturbing about “foreign exchanges” like the ICE is that it is not actually foreign. Among its founding partners are Goldman Sachs and Morgan Stanley, its headquarters is in Atlanta, its primary data center is in Chicago, and it settles most trades in U. S. dollars. Despite all of its U. S. ties, the ICE claims that because its energy futures business is conducted in London—whatever that means—U. S. laws or regulations do not apply to it.

But all this supports the crux of my earlier argument that the energy independence that politicians speak of achieving is a myth because oil companies “will always sell their product to highest bidder, wherever the bidder resides.” The price of oil has no relationship to its origin.

In 2007 the U. S. imported about 10 million barrels of oil per day and produced about 5 million barrels per day. According to the Energy Information Administration, the top three countries of origin for imported oil in 2007 were Canada (1.85 million barrels per day), Mexico 1.47 million barrels per day) and Saudi Arabia (1.36 million barrels per day). Canada and Mexico actually supply more oil to the United States than Saudi Arabia.

If the U. S. decides to increase its domestic production of oil through offshore drilling or other means, it will contribute to the world supply of oil and that additional supply will be factored into the world price. Any politician who claims we can be more energy independent by drilling for more oil in the U. S. is being disingenuous. A far more relevant question to ask our political leadership is: Why are U. S. investment banks allowed to manipulate energy futures markets with no government oversight? I don’t think there is going to be a straight answer for that question.

Joseph Ganem is a physicist and author of the award-winning The Two Headed Quarter: How to See Through Deceptive Numbers and Save Money on Everything You Buy

Deceptive Numbers Used to Described Floods

2008-06-22T18:40:00.000-07:00

Of all the deceptive numbers in circulation, the most ridiculous, expensive, and tragic are the numbers the U. S. Army Corp of Engineers use to describe the levees that they build. I saw an interview with General Michael J. Walsh on the NBC news this past week. In it he referred to the rainfall flooding Cedar Rapids as a “500-year storm.” The levees were not designed for such a rare event. According to General Walsh: “A lot of levees have over topped. We don’t consider that a failure.”

He is consistent with other officials I’ve seen interviewed, who refer to levees as having “100-year” or “500-year” designs. The terminology means that according to the statistical models used to predict floods, water should top a 100-year levee about once every 100 years and top a 500-year levee once every 500 years.

You wonder how engineers and government officials can quote these numbers with a straight face. Does the U. S. Army Corp of engineers understand anything about what they are doing along the Mississippi. Clearly once levees are constructed along the river all the flood statistics become meaningless.

Timothy Kusky, director of the Center for Environmental Sciences at St. Louis University, described in an interview on NPR how before levees were built, the Mississippi River was 4000 ft wide at St. Louis. Today the river is 1500 ft wide. As Kusky stated: “It is a simple concept; confine the river to a narrower channel and there is nowhere for the water to go but up.” The result according to Kusky is that we’ve had 15 hundred-year floods in the past hundred years, and many more 500-year floods in the past 150 years. Building structures changes all the statistics.

The other problem is that the flooding statistics are based on past events. Climate change models predict a 20% increase in rainfall in the coming decades for the Midwest. With that rainfall will come a 50% rise in the height of the rivers.

But, communities, developers, and home owners continue to invest large sums of money on the basis of the bogus statistical claims made by the Army Corp of Engineers. Chesterfield, Missouri now has the largest strip mall in the United States—3 miles long. The mall, along with 30,000 new homes, is built on land that was completely under 10 ft of water during the 1993 flood. The developer erected a “500-year” levee for protection and declared the area safe.

Robert E. Criss, Ph.D., professor of earth and planetary sciences at Washington University in St. Louis has strongly criticized such development as “ignoring geological reality.” On a Washington University news website, Criss describes as an "absurd exaggeration” the claim that a levee will withstand floods for 500 years. “If some private company were making claims that they'll sell you a car that will run for 500 years, they'd be in jail. Somehow, the government feels justified making absurd claims that have no basis."

It appears that little of substance was learned from the 1993 floods. The conclusion that higher levees need to be built ignores the reality that all of the water must have some place to go. A higher levee in one location will force water over the top in another location. The statistics that are the basis for the levee building and development become meaningless. But government officials and developers still rely on these absurd numbers and the result is heartbreaking for the people affected.

Joseph Ganem is a physicist and author of The Two Headed Quarter: How to See Through Deceptive Numbers and Save Money on Everything You Buy

A Question About the Monty Hall Problem

2008-06-18T18:54:00.000-07:00

A reader forwarded me a link to an excerpt from a new book—The Drunkard’s Walk: How Randomness Rules Our Lives by Leonard Mlodinow. The excerpt discusses a widely misunderstood issue in probability theory that has become known as the “Monty Hall” problem. The reader asked me: “What is going on in this one? I looked through your book [The Two Headed Quarter] for a possible answer, but no luck.”

Coincidentally I just started reading Mlodinow’s book a few days ago and at least through the first two chapters I’m enjoying it. The book’s subject has always fascinated me and the author is a fellow physicist.

My book does not discuss the Monty Hall problem explicitly, but I do in the last chapter discuss how people become deceived by events that are conditionally probable. The Monty Hall problem is an extremely subtle example of how people are fooled by conditional probabilities. It is so subtle it has fooled professional mathematicians including Paul Erdos, one of the 20th century’s most prolific mathematicians.

Here is the problem. You are a contestant on the game show Let's Make a Deal. The host, Monty Hall, asks you to pick from one of three doors. Behind one is the grand prize and behind the other two are worthless consolation prizes. You choose door number one. Monty Hall, who knows what is behind all three doors and will not reveal the grand prize, opens door number two to reveal a consolation price and asks if you want to switch your choice to door number three. Should you switch or stay with door number one?

Many people argue that at this point your chances of winning are 50-50 and switching your choice to the other door will not improve your chances. But the reality is you should switch because you will win two-thirds of the time if you do. This fact is hard to believe. In his biography of Paul Erdos, The Man Who Loved Only Numbers, Paul Hoffman describes how Erdos, did not understand why switching improved the contestant’s chances. A friend wrote a computer program that simulated the Monty Hall problem and showed that switching does win two-thirds of the time, but Erdos still did not understand the reason why.

The reason you should switch is that once the all-knowing Monty Hall opened a door, he gave away information. His choice is not random; which means that your choice now has conditional probabilities associated with it. Had Hall acted first and then presented you with a choice of two doors, your chances would be 50-50. But he acted after you did and now you have a chance to respond. These are the three possible scenarios:

Prize behind door 1 – Hall opens either door 2 or 3, you switch to the one he doesn’t open and loose.
Prize behind door 2 – Hall must open door 3, you switch to door 2 and win.
Prize behind door 3 – Hall must open door 2, you switch to door 3 and win.

Switching wins two-thirds of the time and looses one-third of the time. But if you do not switch you have ignored the critical information that Hall provided. You win only the one-third of the time your original choice was correct.

That you do not even win half the time when you do not switch is another surprise. But if you ignore the information provided, the original odds cannot change. The mere act of opening another door has no effect on your original one out of three chance. You have to change your choice based on the new information. Notice the effect of the word “must” in the last two scenarios. Hall does not have a choice in these two scenarios but you do.

Note that you only lose by switching the one-third of the time your first choice was correct. The two-thirds of the time your first choice is wrong, switching guarantees a win. To understand this it helps to imagine an extreme example. Suppose there are 100 doors and you are asked to pick one. Your chances of being correct are 1%. Monty Hall then opens 98 doors revealing consolation prizes behind each. You are faced with a choice of two un-opened doors. I’d switch immediately to the one door he avoided opening. It will win 99% of the time. Only on the 1% chance that my first choice is correct will it be possible to lose.

The Monty Hall problem is subtle but people who play poker should recognize it as the entire premise of the game. In poker, players are dealt random cards, but they do not play random cards. Once the players act and additional cards are exposed it is not correct to say that someone vying for a pot could be holding any of the possible hands. In Texas Hold’em the odds against being dealt two pocket Aces are 220-1. But, if someone is betting and acting as if he or she has a great hand, the odds are much better than 220-1 that player has pocket Aces. The deal might be random but, like Monty Hall, a player’s actions are usually deliberate.

Joseph Ganem is a physicist and author of The Two Headed Quarter: How to See Through Deceptive Numbers and Save Money on Everything You Buy

A Tax by Any Other Name

2008-06-15T20:07:00.000-07:00

One of the most ludicrous debates of the never-ending election season is the one on tax policy. John McCain has changed his position on the Bush tax cuts and now says we should keep them. Congressional Democrats, who have argued for letting the tax cuts expire, quickly agreed to an economic stimulus package that includes mailing tax rebates to millions of American households. But it’s a sure bet that as November approaches, the “borrow and spend” Republicans will be saturating the airwaves with the “tax and spend” epithet hurled against the Democrats.

But what is lost in all in the election name-calling is that the government has two methods for taxing and it has been squeezing all of us financially while never using the word “tax.” The most familiar tax method is the one we all see with every paycheck; the method of subtraction. The government compels your employer to deduct money from your pay and send it to the U. S. Treasury. However, the government also controls the value of the currency you are paid in. Devaluing the currency is the second method of taxation.

As the U. S. government spends more and more dollars it doesn’t have, the world is being flooded with dollar-denominated IOU’s known as treasury bonds. These bonds are considered super-safe investments because the U. S. government has never defaulted on its debts. But why should it ever default? Unlike the rest of us, Uncle Sam has the power to print the dollars needed to pay its debts.

Federal debt is soaring into the trillions of dollars with no end in sight and no plan to pay it back. Foreign buyers of treasury bonds are losing confidence and the result is a steep slide in the value of the currency we are paid in. Eight years ago a Euro cost $0.82; today a Euro costs nearly twice that amount—over $1.50. The steep rise in the price of gas is only in part a change in the supply and demand equation for oil. The supply and demand equation for dollars is a significant part of the cost increase for gas, energy and food.

Politicians speak of their plans for “energy independence” or “food independence” as if the United States could wall itself off from the rest of the world and live only on its own resources. But independence is a myth. Oil is a global commodity and will always be sold on a worldwide market. Exxon-Mobil will always sell their product to highest bidder, wherever the bidder resides. The same is true for food companies.

If in the last election a politician had proposed a new substantial tax on gasoline to go towards federal debt he or she would have been voted out of office. But that has happened anyway without the word tax used as a label.

David T. King wrote in an op-ed article in the Wall Street Journal on May 23, 2008 that Oil is up because the dollar is down. A graphic that accompanied the article compared the price of oil in dollars with the price in Euros since 2002. In 2002 oil sold for $30 per barrel that at the time was equal to 30 Euros. Today oils sells for over $130 per barrel or just over 80 Euros. King concludes that we don’t need a gas tax holiday; we need an exchange rate policy.

In King's words: “Exchange rates can be managed.” But I don’t understand how exchange rates can be managed without the federal government first getting its own finances in order and wean itself away from reliance on debt.

Joseph Ganem is a physicist and author of The Two Headed Quarter: How to See Through Deceptive Numbers and Save Money on Everything You Buy

Who Will Bail Out The U. S. Government?

2008-05-19T20:05:00.000-07:00

My “stimulus” payment from the federal government arrived on the same day that a front-page article in USA Today reported that federal deficit is far greater than the government admits. While the politicians struggle to bailout the housing crisis and head off a recession, they are also rigging the budget numbers to hide the fact that there is no money to give away.

The reported deficits of hundreds of billions of dollars sound bad. But, USA Today found that federal deficits would be trillions of dollars if the government used the accounting rules that are required of corporations when issuing financial reports to shareholders. The reason for the discrepancy is that trillions of dollars in unfunded liabilities to Medicare and Social Security do not show up on the government’s balance sheet. A corporation would have to report future financial obligations as a liability unless it had the funds set aside to make the payments.

But the federal government avoids reporting unfunded liabilities. It collects Social Security and Medicare taxes to supposedly set aside in trust funds to pay for future financial obligations. That allows the government to claim its future obligations are funded. The ruse is that the money never remains in the trust funds. Instead money is “borrowed” from the trust funds to pay for present day obligations. Because the money is “borrowed” from funds the government controls, it never reports that obligation as part of the deficit.

What the practice means is that a mathematically equivalent expression for “borrowed from the trust fund” would be “spent the trust fund.” But the government never admits that it has spent the trust funds because that would undermine the entire rationale for collecting separate Social Security and Medicare taxes.

None of this is a secret. When I wrote The Two Headed Quarter I included a chart that showed that projected indebtedness to the Social Security trust fund was expected to increase from $1.5 trillion to $4.0 trillion between the years 2003 to 2014. The Congressional Budget Office (CBO) made the projection. I simply made a chart of data taken off the CBO Website. The chart makes clear that the government has no plans to every pay back the money it is “borrowing” from the trust fund.

Even though these trust funds exist on paper, the fact is money is not in them.

Joseph Ganem is a physicist and author of The Two Headed Quarter: How to See Through Deceptive Numbers and Save Money on Everything You Buy

Confusing Prices at the Grocery Store

2008-05-12T18:03:00.000-07:00

One of the frustrations with grocery shopping is the refusal by stores to post prices on many individual items. In fact, if the item costs less than a dollar the stores rarely post a single-item price. If you are not facile with division in your head or have a calculator, comparing prices is difficult and this is clearly the intention of the store. Yesterday, I was especially irritated because most of the items I bought had pricing designed to thwart rational price-comparisons.

At the produce area limes were priced 15 for $2. I’m sure the store would have liked for me to pick up 15 but I only needed 2. But, knowing the cost per lime requires dividing $2 by 15 to get 13.3 cents. That is not a simple mental division to arrive at the single item price.

With lemons the comparison problem was worse because bulk lemons were sold by weight while loose lemons were sold by quantity. The loose lemons were priced 2 for $1.38 while the same size lemons packaged in 2-pounds bags sold for $3.98. Both prices staggered me; were talking about lemons not apples or pears. It brought home how fast the prices on produce (and all other groceries) have risen in recent months.

I needed about 6 lemons; so how should I chose? I counted 7 lemons in the 2-pound bag so that is 57 cents per lemon compared to $1.38 divided by 2, or 69 cents per loose lemon. That means if I buy six lemons loose it will cost slightly more than the 7 in a bag so I bought a bag.

At the frozen meals section the quantity pricing was used to hide higher prices. In contrast to the lemons you could spend more per item buying in bulk. I reached for some meals on “special” that were priced at 2 for $6. Then I realized a competing product priced normally at $2.89 each is actually cheaper. I put the higher-priced meal back behind the large sign advertising the special price and replaced it with the less expensive product that lacked the flashy signage.

I felt like having a chocolate bar on the way out, but once again at the register I needed to perform division to know the price. My favorite Hershey chocolate with almonds bars were priced 3 for $2. I added one to my groceries because I only wanted to eat one and it rang up for 67 cents.

Of course stores intentionally post prices in this manner because it works in two ways in the store’s favor.

First, it suggests to customers that they buy quantities greater than actually needed. Most customers think they need to buy the quantity posted to get the advertised price. In fact most of the time the pro-rated price will ring up at the register, just as it did for my candy bar. But sometimes you do need the entire quantity to get the price and many customers don’t want the aggravation of finding out at the register that they needed one more of an item to get a price break.

But customers would be better off buying exactly what they need and fighting at the register when necessary if the store over charges. Why shop for special prices and clip coupons if you spend 50 cents extra on many purchases because of an artificial number the store selected for quantity? Consumers should control decisions on quantities to avoid wasting money and food.

Second, stores subvert market forces by making price comparisons difficult. The market cannot work properly if consumers cannot compare prices. It might be aggravating, but grocery shoppers should take small calculators along and do the division. Consumers should base buying decisions on single-item prices for the quantity they actually

Joseph Ganem is a physicist and author of The Two Headed Quarter: How to See Through Deceptive Numbers and Save Money on Everything You Buy

It’s The Consumer’s Fault

2008-04-30T12:31:00.000-07:00

Have you noticed that no matter what happens with the economy it is the consumers who are at fault? As the economy slides into recession, the reason given is that consumers are spending less. Consumer spending supposedly accounts for most of the economy and when consumers are not out buying the entire country suffers. When the media reports on the “stimulus” checks being sent out by the government this summer, the question is raised of whether consumers will actually spend the money. A repeated implication is that the “stimulus” plan will fail if people use the money to pay existing debt or worse save the money.

Of course the reason given for the recession is the subprime mortgage crisis. How did that economic disaster come about? Consumers were irresponsible. People bought houses they could not afford. Not enough money was saved for a down payment. People refinanced and took cash out of their homes to spend on frivolous consumer purchases. Banks tried to help people who were poor credit risks by extending credit anyway. Look at what happened. Those people took the money, spent it on consumer goods, and did not pay it back.

In fact consumer spending has been a problem for so long, the banks lobbied intensively for a new bankruptcy law that President Bush signed in 2005. The “Bankruptcy Abuse Prevention and Consumer Protection Act 0f 2005” made it more difficult for consumers to discharge debts through bankruptcy. The banking industry claimed that the law was needed to protect our financial system from irresponsible consumers.

So now in 2008, the health of our financial system depends on consumer spending. Actually people are spending more money than ever today. The problem is that the money is being spent on frivolities such as gasoline to commute to work, groceries to feed the family, healthcare and education for children. Those costs have risen so dramatically in the last year that most family budgets are overwhelmed. Few families ever expected that the gas to run the car would cost more per month than the payments to purchase the car.

Government leaders and the executives of financial services companies keep finding reasons to blame the consumer for any and all economic problems. Perhaps the leaders of these institutions should look more carefully at themselves. Unprecedented government debt totaling trillions of dollars is undermining the value of U. S. currency. The result is that food and energy costs more in dollars on the world markets. Lenders are quick to sell all sorts of exotic mortgages to people with questionable ability to repay. Then the lenders are just shocked to discover that people judged poor credit risks actually are.

Despite all the media hype about a recession resulting from consumers not spending, I don’t think that is the real source of our economic problems.

Joseph Ganem is a physicist and author of The Two Headed Quarter: How to See Through Deceptive Numbers and Save Money on Everything You Buy

How Retail Stores Thwart Price Comparisons

2008-04-22T19:18:00.001-07:00

It was a beautiful spring day in Baltimore Saturday. Time to begin the yard and porch cleanup. That required a trip to Home Depot for supplies. Having put all the local hardware stores out of business within a year after arriving, Home Depot is the only choice. The store offers what has become a typical retail shopping experience—disorder in every aisle that appears to intentionally thwart rational buying decisions.

I needed work gloves for outside and reasoned that the garden department would be the place to go. Sure enough there was an entire display rack of gloves. I selected a pair made of canvas with latex dots on the palms and fingers for a better grip. The price of $3.97 seemed substantially higher than I remembered last year. Then I saw I had picked a pair of women’s gloves. In fact the entire rack had nothing but women’s gloves. So gardening is a feminine activity? I never knew that. I must think of a masculine activity that needs gloves.

Off I trekked to the paint department in hopes of finding men’s gloves. Surely painting must be more masculine than gardening. Actually in my house, my wife does most of the painting and gardening. But, I’m trying to imagine how Home Deport marketers might stereotype men and women. Sure enough, the men’s gloves were all in painting. I found the same style and color—canvas with the black latex dots on the palms for the price I remembered—$1.94. In fact, except for the men’s gloves being larger, I could not find any difference in the make or quality compared to the women’s pair for $3.97 in the garden department.

So now I understand why men’s and women’s glove are not sold on the same rack. It would be hard to justify doubling the price for the women’s gloves in a side-by-side comparison. The sex stereotyping is just a clever ploy to avoid putting men’s and women’s gloves together.

Next I needed a new wheel for my wheelbarrow. I had two choices—an air-filled one for $14.99 and a solid never-goes-flat model with no price marked. Not needing air seemed like a good idea. How much more expensive can it be? At the self-serve register it rang up for $37.95. I could buy an entire wheelbarrow for that price. I had to disturb the attendant for the self-serve registers, who looked like he was falling asleep, to have the wheel taken off my total.

I put the items I did buy in my car, but then decided that $14.99 for an air-filled wheel seemed reasonable. I went back inside, found the wheels again in the back of the store, and waited in line at the register. The wheel rang up for $24.00.

“The price is $14.99,” I said.

“That’s not what the computer has.”

“Never mind, I’m not going to buy a wheel.”

Before leaving without a wheel, I went back to recheck the price. This time I read the fine print underneath the large $14.99 lettering. The price referred to some kind of “mat” that was nowhere to be seen. The wheels were on the shelf instead.

When I got home I showed my wife the gloves and asked her how much she usually paid for them.

“Those are about $4 to $5,” she said.

“The women’s gloves in the garden department are about $4. But men’s gloves in painting are only $2.”

“But, the men’s have more fabric.”

“It’s not about the cost of making the gloves; it’s about marketing. The stores know they can get away with charging women more for gloves, so they do.”

My wife rolled her eyes in disgust.

Joseph Ganem is a physicist and author of The Two Headed Quarter: How to See Through Deceptive Numbers and Save Money on Everything You Buy

T-Mobile Rebate Run-Around: Part II

2008-04-15T08:28:00.000-07:00

When I last wrote about my problem collecting promised rebates from T-Mobile, the company had assured me that the correct paperwork had been processed and checks would be in the mail. Despite my skepticism, the phone representative confidently stated that all was in order. But this week, a month after that conversation, I spent more time on the phone trying again to coax the promised rebates.

Progress has been made but not easily. To re-cap, on January 5, 2008 I purchased four new phones for $50 each when I upgraded my family cell phone plan. I had been promised a $50 rebate on each once I submitted the rebate form, receipt, and bar codes from the box. In February I received one $50 check and three rejection letters. When I called in February to question the rejection, they reprocessed the paperwork and said the checks would soon be sent. Three more rejection letters came instead. When I called again in March, they repeated the reprocessing of the paperwork. It was the March phone call I last wrote about.

The result was two more $50 checks and one rejection letter. I called this week to recover the remaining $50. But now the story from T-Mobile had completely changed. They refused to issue a rebate on the fourth phone. The reason given is that prior to upgrading my phone plan, I had three phone numbers. Part of my upgrade included adding a fourth phone number. Now T-Mobile claims that the additional phone needed for the new number was not part of the upgrade and not eligible for the rebate offer.

I asked to speak to a supervisor. He listened as I stated the following facts:

• I had been promised a rebate at the time of purchase and the store had issued a rebate claim form.

• I had been told when I called in February that a rebate would be sent.

• I had been assured again in March that all the paperwork had been finalized and a rebate would be sent.

• Only now in April, three months after purchase had I been told that no rebate was available for the phone.

He did not dispute those facts; he just reiterated that no rebate was available.

I asked if I could return the phone and get my money back. He said no.

I asked if I could discontinue the additional telephone line and not have to pay the $200 early termination penalty. He said no.

I said that their business practices were incredibly dishonest. He disagreed by reading to me the fine print on the rebate form I had submitted. It reads:

“No employee, dealer or agent is authorized to make, and no customer is entitled to rely upon, any representation (other than described in this rebate request form) about a rebate or change in any terms of a rebate.”

The call ended, this time, with an absolute no from the supervisor on ever receiving a rebate for the fourth phone.

I find the T-Mobile definition of honesty fascinating. The fine print on the rebate agreement absolves all of their employees and agents of legal responsibility for misrepresenting the rebate agreement. When I submit a rebate claim I agree that no promise made to me will ever be binding. Because I’ve agreed to that condition, no misrepresentation made by T-Mobile can ever violate the agreement. So it is a completely honest agreement.

Of course, this license to misrepresent is only granted to T-Mobile. I am still bound by the conditions I agreed to when I decided to purchase the phone and add the new line, even though their misrepresentation influenced my decision.

Joseph Ganem is a physicist and author of The Two Headed Quarter: How to See Through Deceptive Numbers and Save Money on Everything You Buy

Deciphering Auto Insurance Rates

2008-03-30T08:03:00.000-07:00

Of all the bills I receive, the biannual renewal of my auto insurance ranks as one of the most expensive and mystifying. It is usually worth my effort to call my insurance agent and review the numbers with her over the phone. I am usually several hundred dollars richer after the phone conversation for reasons that make no sense to me.

My auto insurance bill is made complex by the fact that we own two vehicles and have four drivers. Two of the drivers are teenagers with my son having a license and my daughter a learner’s permit. While these circumstances make for a complex bill with lots of additional charges and discounts going into the final computation, my situation is in no way unusual. I’m certain that I am one of millions of fathers with teenagers at home learning to drive. But the banality of my situation makes me wonder even more about the kind of logic insurance companies employ when setting rates.

For example, each of the four drivers in our household must be “rated” on one of our vehicles. We own two vehicles that are vastly different in value. Our “family” car, a 2005 Dodge Grand Caravan, has a book value of about $10,000; while the 1997 Geo Prizm with over 140,000 miles that I use to commute to work, is worth almost nothing. I am “rated” on the Prizm, but the rest of the family was “rated” on the Caravan.

“Can I drive a vehicle that I am not rated on?” I asked.

“Yes, you can drive either vehicle,” the agent replied.

“What about my kids? Can they drive the prism?”

“Yes they can drive either vehicle; they’ll be covered.”

“What does the rating mean then?”

“We need to rate each driver on one of the vehicles to determine the rate for insurance.”

Talk about a circular definition. I then asked what would happen if my teenage drivers were “rated” on the prism. After a silence while she entered the scenario into the fields on her computer screen, she came back with a figure that was about $500 less.

“Why the big difference?’

“Because you don’t have any collision coverage on the prism.”

“It has no book value so it wouldn’t be worth insuring for collision.”

She agreed and said that she would change the policy to rate my children on the prism. She assured me that each of us could drive either vehicle and we would be covered. There would be no practical consequences to the policy change; only the rate computation would differ. I hope she knows what she is doing. But, I imagine my policy would come with dire warnings if being rated on only one vehicle meant that you couldn’t drive the other.

I then asked why I didn’t see any mention of the “good student” discount on the policy even though I had faxed report cards several weeks earlier. She wasn’t sure what happened to the faxes and admitted that the discount had not been applied. She applied it and informed me of another $300 reduction.

By the time I was finished with the phone call about $800 had vanished from my six-month policy. Not a bad outcome for 20 minutes of my time. But it was a strange kind of price negotiation. The agent’s demeanor was that of a disinterested third party (which she essentially is) rather than an advocate for her company. The price for the product was determined by some arcane formula programmed into a remote computer. Manipulating the price while staying within the rules of the policy was easy if you took the time to ask the right questions. After all, the computer only responds to numerical inputs with numerical outputs; it doesn’t know what the numbers mean either.

You wonder if anyone at the insurance company knows what these numbers mean. But asking the right questions is saving me over $1600 this year.

Joseph Ganem is a physicist and author of The Two Headed Quarter: How to See Through Deceptive Numbers and Save Money on Everything You Buy

Fooling with Credit Scores

2008-03-20T12:09:00.000-07:00

Bob Sullivan of MSNBC.com has written an instructive series of articles on credit scores. He explains how credit scores determine the interest rates consumers are charged when borrowing money. Small changes in credit scoring can result in tens of thousands of additional dollars in finance charges a consumer could be required to pay on a mortgage.

What fascinates me is his explanation of how the reliance by the lenders on scoring invites people to “game the system.” Not only do the borrowers look for tricks to enhance their scores, but, the lenders use the scores to convince investors that the loans are not as risky as they actually are. It amazes me the great effort spent determining precise measures (FICO scores) of risk to lenders, while ignoring obvious problems with the bigger picture. It is a classic case of not being able to see the forest for the trees.

For example, while in the process of preparing a talk for a one-day university event this coming April, I made a simple plot using Census Bureau data of the ratio of the median home price to the median household income in the United States for the past 20 years (1987-2007). That ratio is flat at about 3 until the year 2001 when it suddenly takes off reaching nearly 5 by 2007.

Obviously the rise in home prices over the long run cannot outpace household income because a point in time will come when people no longer have the money to make the loan payments. I’m sure all those brokers at Bear Stearns invested a great deal of effort and expense modeling their risk with precise credit score data. But, a simple look at Census Bureau data would have shown them that their business model—betting that even in a foreclosure there would always be another buyer able to pay an even higher price—was doomed to failure.

Joseph Ganem is a physicist and author of The Two Headed Quarter: How to See Through Deceptive Numbers and Save Money on Everything You Buy

Refusing to Take No for an Answer

2008-03-17T18:07:00.000-07:00

The “Do Not Call” registry has been a wonderful advancement in phone etiquette. I remember signing up the first week it became available and it resulted in a noticeable reduction in annoying sales calls. However, the calls did not reduce to zero because of a loophole that allows companies to call existing customers. This seems like a reasonable exception. For example, my bank should be able to call me if there is a problem or reasonable question to ask about my account. But recently my bank has been calling me everyday, both at home and at work, to sell me insurance. It appears that as long as I don’t buy the insurance, my bank will call to keep asking. Saying no to the offer does not end the daily calls.

The calls are a minor nuisance at work because I have caller ID. I don’t answer the phone when the bank’s number appears and a voice mail is never left. At home I do not have caller ID and it’s more of a problem. I have found an effective response to quickly end the call. When I pick up the phone and hear the short pause followed by a hesitant mispronunciation of my name in the question: “Is Joseph Ganem there?” I reply: “May I take a message.” The result is a rushed: “No, this is just a courtesy call from his bank,” followed by a quick hang-up. My wife has followed me on this and asks to take a message for me first before calling me to the phone. I need to teach my children next to ask to take a message before admitting that I’m home and interrupting me to take the phone call.

Someday, when I have the time, I would like to engage the salesperson in a conversation about the answer “no.” Is it possible to say “no” and have that answer stop the calls for a period of time longer than 24 hours? Of course, I’m aware that the salesperson doesn’t know and doesn’t care about the answer to that question. But it could lead to some interesting musings about the meaning of the word no. Because “no” does not mean “never,” does that allow the solicitor to repeat the same question with a given frequency hoping for a different response? If that is case, what is a reasonable repetition frequency? Every hour? Every day? Every week? Every month? Every year? What if I did say never? Would that make a difference or are yes and no the only allowed responses?

Does the computer dialing the phone have a repetition frequency programmed, or does it just keep cycling through the same list of numbers over and over again? I would like to know if anyone at the bank has thought or not thought about these issues and what the rational is for annoying their customers.

Joseph Ganem is a physicist and author of The Two Headed Quarter: How to See Through Deceptive Numbers and Save Money on Everything You Buy

Rebate Run Around from T-Mobile

2008-03-06T13:44:00.000-08:00

I spent some more time on the phone with T-Mobile this week, trying to collect the rebate promised on a cell phone upgrade. The last time I upgraded the cell phones for my family, I was given the new phone in the store. This time I was told I had to purchase the phones for $50 each and then file a claim for a $50 rebate on each one. My first reaction was to wonder why the company would go through all the expense of processing rebate claims and mailing checks when the phone could just be handed out in the store? Two months later, I know the answer. If the rules of the rebate process are made difficult, time consuming, and onerous, T-Mobile can get away with not issuing a check and simply pocketing the money.

My problems began because I needed four phones for my family plan and had to file four separate rebate claims. I needed to fill out four rebate forms, make four copies of the receipt, and cut out four barcodes from four separate boxes. The rebate forms asked for the “customer’s phone number” and because I paid for the phones and the account was in my name, I thought I was the “customer.” So I put my phone number on each of the rebate forms.

Big mistake. It turned out that the “customer” according to T-Mobile is not the person paying for the phones. The “customer” is the phone. T-Mobile wanted the number for the phone associated with the rebate claim. I received one $50 check and three rejection letters for the other claims. The reason given is that my phone number could only be used once.

I called to complain about the rejections. After navigating the voice menu I reached a real person who said she could straighten everything out by manually entering in all the correct information. I gave her the 9-digit tracking numbers for each letter I received, the 15-digit serial numbers for each phone, and each 10-digit phone number. She read back to me the new 9-digit tracking numbers for each of my three new claims. After reading off all 129 digits [3 times (9 + 15 + 10 + 9)] she seemed rather confused and put me on hold. A while later she returned to tell me she had entered some information incorrectly, but not to worry, her supervisor would fix everything and my checks would be sent.

Two weeks later I received three new rejections letters with the three new tracking numbers. So this week I repeated the same phone conversation and with a reading of all 129 digits to a different operator at the rebate center. She assured me that my checks would be sent. When I asked what was different this time, she told me that, unlike the previous operator, she had entered all the information correctly this time. I like her confidence, but, that’s a lot of digits to get correct.

I’m still waiting for the checks. When I upgraded the phones, T-Mobile insisted I sign a contract promising to pay $800 ($200 per line) if I discontinued the service within the next two years. The contract has no contingency and no penalty for T-Mobile failing to honor their rebate promise.

Joseph Ganem is a physicist and author of The Two Headed Quarter: How to See Through Deceptive Numbers and Save Money on Everything You Buy