He’s not overpaid. You probably aren’t either

August 2, 2010

The labor market's biggest bargain

 

This post is written in response to a fellow financial blogger who argues that

“(Pro athletes) are all overpaid in my view… they should be paid for performance… $100K base salary… if you play well, you make more. Play bad, and we take money from you.”

She (I’m assuming it’s a lady. I hope it’s a lady) isn’t the first person to take this position, nor the first to put standard English usage through a cheese grater, just the most recent.

Jim Irsay, who owns the Indianapolis Colts, pays Peyton Manning $14 million annually. For that, Irsay gets about as indestructible a force as there is in pro football, the linchpin of an offense that’s a threat to go to the Super Bowl every year. Before Manning got to town, the Colts were the laughingstock of the league and the franchise value nowhere near what it is now.

Irsay didn’t remain rich enough to own a football team by overpaying people. If having Manning around is worth $14 million to Manning, you can be sure it’s worth more than that to Irsay.

Here at Control Your Cash, we neither idolize Manning nor disdain him (same goes for any pro athlete.)  But what good would result from paying him a base salary of <1% of what he commands on the market? Would the author have the remaining 31 NFL owners collude and refuse to pay any more than that to an athlete who could enrich their teams by tens of millions of dollars?

Begrudging athletes their salaries is nothing more than jealousy – the same activities we grew up doing for fun, these people worked so hard to get proficient at that they can command lots of money. Meanwhile, I’m punching a clock, getting yelled at by the boss and trying to figure out how to pay the mortgage. It’s so unfair.

Even years after high school is over, the star quarterback still receives a mixture of adulation and envy. Besides, how do you “pay for performance”, anyway? Say you tie LeBron James’ salary to his scoring and rebounding averages. In other words, you’d encourage him to shoot every time he touches the ball, even when the game situation calls for him to pass: or you’re giving him incentive to always play close to the basket, rather than ever defend someone on the perimeter. And yes, let’s put a coach in a position where he can draw up plays that have a direct negative financial impact on certain players. That won’t cause any resentment.

So, you argue, pay athletes for winning. Then how do you determine how much of each victory each player is responsible for? Should a player who works so hard in a game that he injures himself risk further injury by coming back earlier than he should, just so he can get paid more? Maybe you could just trust that the majority of pro sports owners know what they’re doing. And the few stupid ones (like the guy in Minnesota who just signed Darko Milicic for $20 million) are engaging in an exchange that doesn’t affect you or me in any direct way.

Instead, take this as a lesson: for the most part, how much an employee gets paid correlates to how much he’s helping his boss get paid. The salesman is the standard example, because sales is so easily quantified: bring $x to the company, keep $yx for yourself where y is a number between 0 and 1 (a lot closer to 0.)

Do you want more money? Let’s do a flowchart:

If you’re salaried, it’s a little more convoluted. Sometimes it’s a case of determining how much it would cost the company to not have you around. Even a receptionist or a custodian provides some value, in that respect. (If either of those happen to be what you do for a living, don’t let anyone tell you that it’s a “non-revenue” position. Ask how much revenue your company would be amassing if the grounds were filthy and the phones unanswered.)

If you’re a cubicle toad, it can be harder still. Your humble blogger used to work as a $45,000/year advertising copywriter. For this, the ad agency got:

-550 collateral pieces (or as normal people call them, “junk mail and flyers”)
-887 headlines
-223 radio commercials
-34 television commercials
-11 long-form presentation pieces

In other words, the agency was getting the biggest deal since the guy who bought Manhattan from Peter Minuit*. That work output was what about 2.2 ordinary writers could have done in the same period. An ordinary writer got paid around $40,000 (if you want to find out these things, it helps to make friends with the girls in the accounting department.) So in return for the $5,000 “surplus”, said writer was leaving an additional $43,000 on the table.

The agency billed its clients over $25 million that year. $45,000 was hardly a fair representation of a prodigious writer’s value. It was more fair than paying Peyton Manning “$100,000 base salary” would be, but not by much.

The point of all this? Know your worth. 99.something% of salaried employees don’t. Your employer knows exactly how expendable (or valuable) you are. If it’s the former, you’re about to get fired. If it’s the latter, he’s in no rush to share the details of that information with you.

And if you’re in business for yourself, you get to transcend this entire stupid charade.

*Minuit got the island for $24, we all know that. But his heirs don’t own it today, right? He must have unloaded it at some point.

Filed Under: Capitalism, Economics Tagged With: , , , , , ,

If a Containment Dome Doesn’t Work, Try Screaming

June 22, 2010

Pun level: 0.0 Rhyme level: 0.0 Scapegoating George W. Bush level: 0.0 All in all, a disappointing protest sign.

How many times could you fill the world’s largest supertanker with the oil that’s spilled since the Deepwater Horizon disaster began?

Come on, guess.

Okay, let’s make it multiple-choice. Is it:

  1. 20,000
  2. 100,000
  3. 600
  4. .2

The answer is 4), although that’s using the low estimate. At the absolute most, the oil that’s spilled so far would barely fill the TI Africa once.

Whoever says America’s education system is in shambles is wrong: in the last 7 weeks, we’ve become a nation of 300 million petroleum engineers. Still, that leaves the number of economists dangerously low.

British Petroleum is not evil. Joseph Stalin slaughtered people for the pleasure of it. O.J. Simpson too, on a smaller scale. The worst you can call BP is negligent, and even that implies that there’s no such thing as an unavoidable disaster.

11 BP employees died*, in case you forgot or never knew. Also, now is not a great time to be a shearwater. The human and animal costs notwithstanding, there remains an economic impact. If that sounds crass, denying the existence of said economic impact doesn’t make it any less real or eliminate the need to acknowledge and minimize it.

So let’s pretend that the people who are screaming that SOMETHING MUST BE DONE are willing to replace rhetoric with logic. Here are facts, not opinions:

  • It’s not the worst spill in Gulf of Mexico history. (That’d be the Ixtoc I spill of 1979, which lasted 9 months.)
  • It’s not the worst spill in American history. (Lakeview Gusher, California. 101 years ago. You’ve never heard of it, which should give you an idea of its lasting impact.)
  • It’s not even close to the worst oil spill in world history: we can still thank Saddam Hussein for that. At least Deepwater Horizon wasn’t deliberate.
  • Some people are convinced that there’s nothing the federal government can’t do.
  • Wishing, even demanding, is never enough to solve a problem.
  • BP stock has lost most of its value since the spill began, with a floor to be determined. (“Good! Teach those planet-rapers what’s what!”)

Voluntary exchanges of stock have already cost BP $97.9 billion, to say nothing of the costs involved in cleaning up the mess. If that’s not enough for you, what would be?

Seize their assets!

Their rapidly dwindling assets? To what end? So federal bureaucrats with zero accountability and zero experience can manage those assets? Never mind that BP, as its acronym would indicate, is headquartered in the United Kingdom and harder for the federal government to claim than, say, General Motors.

Wiping BP from the face of the earth would make a bad situation worse. BP has created 92,000 jobs around the world without requiring taxation or a confiscatory stimulus package to do so. Is employment important?

And if BP went broke, then what?

Bankruptcy court!

According to its 2008 balance sheet, BP has $228 billion in assets including $103 billion in “hard” assets – property, plant, equipment etc. Those would go to the highest bidder. Which would be a company that has not only a use for supertankers, rigs, and a distribution network, but the wherewithal to bid for them. Someone like, say, ExxonMobil. Yes, let’s increase the market share of the only company that environmentalists hate more than Amalgamated Lead Paint & Plastic Grocery Bags, Inc.

Solar and wind!

It’ll take more than a blog post to expose the holes in that argument, but for now, there’s no denser and more efficient way to transport potential energy than via petroleum and its derivatives. If there is, whoever discovered it is keeping awfully quiet and must hate money.

Perhaps it makes you feel good to join the “Boycott BP” Facebook group, even though all the BP stations in the United States are owned by franchisees. If you organize a protest, or pull an Ashton Kutcher and draw a connection between an oil spill and a political convention, think about what that does as far as solving the problem.

BP wants to stop and clean up the Deepwater Horizon spill a lot more than you do, so much so that they’re actually putting workers on the job. The next Code Pink volunteer who helps to float a containment boom up the Mississippi Delta will be the first.

Unless you’ve attempted to cap a drilling rig – one under a mile of water – you almost certainly don’t know if BP management is doing a good job or not.

They’re working on it. Sorry if that’s an unsatisfactory answer, but sometimes unfortunate events happen, and maybe laying blame is less important than solving the problem.

Any man-made disaster is like this. Exactly what are you supposed to do with the benefit of hindsight? If doctors didn’t prescribe thalidomide for pregnant women from 1957 through 1961, thousands of babies wouldn’t have been born with deformities. If a series of bureaucrats at the Federal Aviation Administration had refused to prohibit commercial pilots from carrying firearms, the World Trade Center would still be standing, 2743 civilians wouldn’t have been murdered, and there would have been less cause to invade Afghanistan and Iraq.

To write about Deepwater Horizon and say anything other than “hang BP’s CEO by his thumbs” might not be judicious, but there is a larger point. The stock is trading at a 13-year low. (Which might be a great buying opportunity. See here.) President Obama can show all the grave concern he wants. He can temporarily move the White House to Gulfport, Mississippi: it won’t stop the flow of oil. Nor will tarring and feathering BP chief Tony Hayward, to coin a phrase.

Righteous anger works fine when you punch out the guy who slapped your girlfriend. It works horribly with problems that are harder to fix. It takes composure, reason and hard science to make the Gulf of Mexico livable. If you can’t offer any of that, at least get out of the way.

——-

* Adam Weise, Dale Burkeen, Don Clark, Roy Kemp, Jason Anderson, Steve Curtis, Gordon Jones, Blair Manuel, Dewey Revette, Karl Kleppinger and Shane Roshto.

Filed Under: Economy Tagged With: , , ,

Ignorance is no excuse

March 14, 2010

This is strip, not prime, but close enough

What does prime rate mean?

In between poking fun at people, occasionally we deconstruct complexity and explain what’s what. Prime rate is a term you hear frequently but might not know the meaning of – like “Dow”, “consumer confidence”, and other commonplace but commonly misunderstood terms.

(If you can’t get enough of Control Your Cash, read our guest posts on LenPenzo.com. Len Penzo is an engineer based out of Los Angeles – a financial amateur. But his common-sense approach and avoidance of stupidity make his blog one of the most insightful you’ll find.)

Prime rate is the interest rate banks charge their most creditworthy customers. Last January the U.S. prime rate fell from 3.61% to a 55-year nadir of 3¼%, where it’s been ever since. In 2007 the rate was 8¼%, and it reached its all-time zenith of 20½% in 1981.

Does that mean that if you’ve always paid all your bills on time and in full, Chase will loan you money at 3¼% to buy a house? No. But if you were Costco (America’s 24th largest corporation), and wanted to build a new location at a cost of $4 million, you’d pay $130,000 in annual interest charges. For individual investors, who don’t have millions in cash on hand, your bank sets its rates higher. Which is why mortgage rates average 5.09%* today.

Prime rate generally derives from the federal funds rate, which banks lend to each other in the short-term (i.e. overnight) at and which we touched on here. Under normal circumstances – 1981 was about as abnormal as it got – add about 3 percentage points to the federal funds rate, and that’s your prime rate.

Where does our 3¼% rate stack up internationally? Here:

So, two questions:

a) Why is the prime rate so historically low right now?
b) (As always,) how can I use this to my advantage?

It’s low because the Federal Reserve, the quasi-governmental leviathan that has an unduly large hand in our economy and answers to no one, wants to make it as easy as possible for people to borrow money. The federal funds rate (which is really a range of rates, rather than one rate) sits at close to 0. Banks obviously have to make money on loans or they wouldn’t stay in business, which explains the spread of 3% – which has been fairly uniform throughout American history.

But wasn’t it those low rates that got us in trouble in the first place?

Yes. People bought houses larger than they needed, cars fancier than they could normally afford, ATVs they were going to ride maybe once a year. And financed them all. It seems almost too obvious to mention, but borrowing money makes sense if you can pay it back. More to the point, it makes sense if you can buy assets with it. A piece of vacant industrial land that appreciates by 2% annually, ceteris paribus, isn’t a worthwhile investment if you’re paying 5.09% for the privilege of borrowing the money to pay for it.

So why is the Fed encouraging people to engage in more of the same destructive behavior?

The Fed would argue that this is the least bad option. Getting money circulating in the economy means borrowers are hiring people to complete their projects, and those newly hired employees will spend money on goods and services. If the prime rate were at 1981 levels, or even at 2007 levels, people would be more cautious to invest. They’d sit on their money, and the economy would stagnate.

So how can I use this to my advantage?

Don’t defer for a tomorrow that might never come. Understand that no economy is an island, and that time is not static. Interest rates can’t get much lower than they are now. The federal funds rate isn’t going to go negative. Banks aren’t going to accept a spread much lower than 3%. The eventual pressure on interest rates should be to rise. It’s no guarantee, but 6 or 12 months from now it ought to cost more to borrow money to finance an investment than it does today.

So if you’re thinking of making your way into the investment class, and joining the ranks of people who derive their income through passive means rather than earning a salary, now would be as good a time as any to take the leap. Don’t wait for a perfect set of circumstances, because a) such a thing never arises and b) it’d be tough to identify if it did.

———————-

*There are several kinds of mortgage rates, the vast majority of which you don’t need to concern yourself with. If you see the unadorned phrase “mortgage rate”, whether at Control Your Cash or elsewhere, assume that it refers to the most generic mortgage of all – the 30-year, fixed-rate kind. And if you’re thinking of buying an adjustable-rate mortgage, think again. Or did you not hear about the foreclosure crisis?

Filed Under: Economy Tagged With: , , , , ,
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