JustinIdea - Justin Ricaurte's Personal Blog

The Real United States Federal Deficit

During the Bush administration's reign, we've constantly heard the drumbeat about the ballooning federal budget deficit.  While deficits of $400+ billion dollars may sound like a lot, do they tell the entire story?  They don't.  The Federal Government has been manipulating the deficit numbers for the past 40 years in order to make itself appear healthier than it really is.  Is a Federal default likely?  It's a strong possibility with the impending retirement of the baby boomers.  While I hate to be pessimistic, realism is necessary and the stars are not aligned well for the Federal Government, and governments are not immune to default - remember Russia in 1998?

The Federal Government's deficit calculations are based-on the cash method of accounting, in conjunction with the unified method.  In the cash method, revenue is only recognized when cash is received and expenses recognized when cash is paid.  While it is very important to understand the cash flow of any entity, the cash method represents a dramatically distorted picture when it comes to the Federal Government's finances.

In 1968, Democratic President Lyndon B. Johnson had the Federal Government adopt a method of accounting known as "unified" budget accounting in order to allow his administration to use the Social Security surplus revenues to go against the then ballooning budget deficit caused by the Vietnam War.  Would a for-profit company be able to use surplus gains from its pension system and other obligations in order to show excess profits but not take a hit when those liabilities ballooned?  No, they wouldn't be able to.  These gimmicks would bring about an accounting scandal reminiscent of what happened with accounting manipulation at Enron and Worldcom.  So why does the government get to get away with it?  Good question.  Are the politicians in DC afraid the truth would be too great for the public to bear?

So what do the numbers really look like?  If you think a $400 billion deficit is big, you'll pass out from these.  

Note - 2004's huge increase is mostly due to the creation of the Medicare part D (Prescription Drug Benefit) plan

As you can see the Federal Government has been running an actual budget deficit of approximately $3 trillion a year for the last 10 years, with only one year of an actual surplus, which is about 20-30% of US GDP.  Sustainable? No, it's not.  Runaway spending has completely destroyed the Federal Government's financial position.  Currently the Federal Government is carrying $51 trillion in debt - $41 trillion from entitlements and $10 trillion in other liabilities.  If the Federal Government were a public corporation it would have a negative net worth and would be deemed insolvent.

So how can we make the Federal Government more accountable with this knowledge?

1. Replace use of the Unified Method with GAAP-based accrual accounting for Federal Government reporting (including taking into account the entitlement programs).
2. Modify the annual financial statements to show a Consolidated Income Statement, Balance Sheet, and Statement of Cash Flows, and put them at the beginning of the report to make them easily accessible.
3. Distribute financial statements to all registered voters in the country.  If shareholders of corporations are required to be sent this information, then the voters should receive it every year in the mail as well.
4. Require a balanced budget using GAAP-based accrual accounting. 
5. Reform the Entitlement System. 

Other Resources:

Defined Benefits, Loose Accounting - From CFO.com

What's the real federal deficit? - From USAToday.com

Financial Reports of the U.S. Government - From GAO.gov

Accounting Insolvency - From Bloomberg

Fudging the Budget - From the NY Times

Federal Deficit Reality - From Shadow Stats

Investment Bubbles Build America

In case you missed it, CNN Money had a great article on how investment bubbles have built America by Daniel Gross, the author of Pop! Why bubbles are great for the economy.  His arguments make a great deal of sense when you analyze American history.  From the telegraph in the 1840s-50s to stocks and credit in the 1920s to internet and telecom in the 1990s, where would America be without a bunch of evangelists at each turn of the way promoting the next big investment craze?

Applying this, what new bubbles could help build the infrastructure America needs to promote its further economic growth?  A few cool ones would be quantum computing, nanotech, sustainability, and space.  With massive investment bubbles in any of these, America could reap huge rewards and benefits after the smoke cleared.  A quantum computing rush could yield us computers the size of cell phone with the computing power of the Googleplex.  A nanotech rush could give us a fabulous array of new materials from which we could build more environmentally friendly products that are more efficient, less material intensive. and recyclable.  A bubble in sustainability could give us an infrastructure for distribution of clean fuels and excess capacity of clean energy creation and energy-efficient buildings.  A space bubble would give us the infrastructure to travel beyond Earth for cheap.  Excited yet?! :-)

Won't a lot of people in the mean time lose a lot of money?  Sure!  And that's the beauty of it.  With the risks American investors are willing to take, America booms and busts and booms all over again.  People strike it big and others lose out, but in the end our country grows by leaps and bounds and the rising tide lifts all boats.

SEC Rules on "Accredited Investors"

While doing some research on angel investors, I came across an SEC rule that made me wonder how useful it actually was.  Rule 501 of Regulation D regulates who is able to be labeled an "accredited investor" so that a company raising private capital does not need to register with the SEC.  When looking through the requirements, I was surprised to find the income and asset limits the SEC places on companies that take capital on the private market.  Using these requirements, neither of my parents would be able to invest in a company I create without being first affiliated with the company as a director or employee.

Considering one of the best sources of capital can sometimes be friends and family initially, if you want to give equity to them instead of taking out a personal loan, I wonder how many people run into the problem of not knowing anyone rich enough to invest in them.  For example, if someone were to try to raise the money from a group of friends and family without naming all of them directors, they would have to register with the SEC.  With small investments such as this, the majority of the population is kept out of private equity investments in firms started by friends and family.

Not only is the average person barred from investing in their friends' business without a directorship or employment, but they are barred out of the another high-return asset class, hedge funds.  I agree with the comments in the article that just because you aren't a millionaire doesn't mean you should be disqualified from investing.  Having an asset threshold seems a bit arbitrary, more arbitrary than say one based-on IQ or education-level would be (not that I would advocate for one). 

Even with its intentions of protecting the average investor, the government isn't protecting the rest of the investing public though by having "accredited investor" rules.  It's merely ensuring that the average person will not have access to the asset creation vehicles that the rich have access to.  With so much debate over the rich-poor income/asset divide, you would think politicians would want equal access to investment products for every American.  If every American has access to all wealth generation products, then they should achieve the same returns on average, allowing the average person who is financially responsible to keep pace with their wealthier counterparts.

MyMint.com - Simple Personal Finance

I discovered this company through an email sent by my friend Shaun at Stanford (if you're interested, they're having their Rainmakers Conference on April 12th!).  This is something I have playing with in my head and on paper for the last half-year, and it looks like the people at mymint.com beat me to it.  From reading the little bit they have on their blog, I have high hopes for this company (*note* the site is not open to the public yet).

MyMint.com is working on creating a free, simple personal finance web service to help people better manage their finances.  The market need they are filling is very real and might be crucial to helping some people get out of debt.  Instead of trying to figure out what you've spent your money on through statements and receipts, their service will pull all of the data from your various accounts and put it in a more digestable format, such as graphs and charts (and no, I have not seen it yet, just something I read on the blog).  Wouldn't it be more fun to readily see what your money was going to?

The company not only is working with a great concept, but their founder also created a convenient algorithm that will "categorize financial transactions with amazing precision (often 95%+ accuracy), just given a text description."  Talk about making our lives a lot easier. :-)

As a last little bit, I would highly suggest everyone check out this blog entry at their site.  If you know very little or nothing about credit reports, it explains why they matter so much and how they work.  This is something that we cover in the financial literacy program at HBSA, because people need to understand how their financial decisions affect their credit.

Real Estate 2.0 (and beyond?)

Last week while pondering about my finance class, this article on Zillow came to mind.  It brought up a lot of great points about how Zillow is and could dramatically change the way we think of real estate transactions. 

If Zillow were to completely revolutionize the real estate market by making realtors unnecessary, would the lower cost of real estate transaction decrease the time the average person lived in a residence?  Would the amount of time a home is on the market decrease as well?  Especially with the "Make Me Move" feature where you can list what price you are willing to sell for.

Would this introduce more investors into the real estate market regardless of boom or bust?  We might see investors pop-up with sophisticated algorithms and day trade real estate to take advantage of small swings in the market. Albeit moving would still be a pain (for those who wished to live in the home) and knowing about the kinks in a house would take a lot of analysis (and honesty), but anything is possible when you don’t need a property to appreciate by more than 6% to break even.

If Zillow could completely automate real estate transactions and investors controlled the majority of housing, real estate might look a lot more like stocks do. Real estate exchanges and everything. How long for this scenario?  Optimistically probably 20-200 years. :-)

Financial Literacy Seminars

Today I finished my final of three seminars on financial literacy at Ingraham High School.  During the last three Fridays, I covered banking services, loans, checking, budgetting, and saving and investing. I touched a little on consumer protection for the first class. 

The students stayed very engaged (and yes, there were a couple of drifters) during the seminars, and through the evaluations they gave back to me, they seemed to appreciate the fact I was teaching something that was directly relevant to themselves now and in the future.  Its a great feeling to know you have done something that has improved others lives and to receive thank you's in return. 

Most of the students had never thought about some of the topics I covered, especially budgetting, saving and investing, and consumer protection.  Considering how much information I was still waiting to give, I felt bad I wasn't able to cover it all, but the amount of questions students would ask more than made up for it.   I think next time I am going to focus on some of the larger topics, maybe the first class do a little on banking with a focus on loans, and then dedicate a day to budgeting/saving/investing and then another to consumer protection and credit reports.

Out of all of the courses they make you take in school, you would think they would teach you how to manage your money, haha.  And that's why our club is working on partially filling that void. 

Brokerage v. Marketocracy.com

I know Marketocracy.com doesn't allow you to trade stock with real money, but the tools that they let you use make investing on their site very exciting.  The tools allow you to see how well you are doing at timing the market, how your portfolio is weighted, see comments people make about the stocks you invest in, and their portfolios also.  You can even make groups and see how all of the members rank.

So my questions is...why don't brokerages offer some cool features like these?  When I do my trading, my brokerage firm doesn't show me what my portfolio looks like compared to the major indices since its inception.  It doesn't give me any of cool analytical tools that marketocracy provides (for free!).  By making investing more exciting for the average investor, a brokerage company could potentially shield itself from market downturns.  Why stop investing when you get to see how well you are doing compared to the market and others?  Your competitive advantage would not be "low-priced trades" or "fast execution", but to help people improve their stock performance.

If marketocracy.com offered low-price trades, I'd definetly switch to doing trades with them.