Shrinking General Motors

“General Motors” just sounds big. It sounds like a company that is trying to make and sell something for everyone. When I ask my marketing class about their perceptual associations of General Motors, something I do when I teach the case “General Motors: OnStar,” invariably words like “big,” “old,” “outdated,” and “low-tech.” come first to my students minds.  This may or may not be a fair set of thoughts, but in many respects that is quite irrelevant. These first thoughts govern a whole lot of buying behavior.

But at some point in the conversation, after all of these negative comments have worked their way out of their heads and onto the blackboard, I ask if this is their perception of GM trucks. The psychology takes a sharp turn at that point. Many of the students have a completely different view of their trucks, believing them to be rugged and reliable.

GM is spending a great deal of money trying to recreate themselves as the kind of car company that could successfully make and market the “Volt,” a new type of electric vehicle. It won’t work. Once people have made up their minds what a company and brand is about it is exceedingly hard to change their view.  As GM looks to shrink itself, and most certainly that is what is going to occur, it should take a hard and realistic look not just at its union contracts but also what people will actually consider buying from them.

General Motors could become a profitable truck company. It will never be a profitable small car company. The cognitive stretch between what people think GM is and what they would need people to believe is simply too large.

The truck market is not going away anytime soon.  The Spanish-speaking market, a group that represents the next generation of American craftsman and contractors, will buy trucks from GM if GM focuses more than a token amount of their marketing efforts towards them.  That market would represent a regrowth opportunity for a smaller more-focused company. Those who work in the construction trades want big, tough and, yes, fuel efficient trucks.  They typcially put a lot of miles on their vehicles and fuel costs are very real to them. The “Volt” won’t sell, but GM can build these kinds of trucks — and perhaps more importantly, most people will believe they can.

So here’s to the General Truck Company. It at least has half a chance of survival. General Motors does not.

The Thrifty Gene

This is an edited version of a post I put up a couple of weeks ago. It talks about how evolutionary psychology affects our decision to save during difficult times. It is published in Forbes.

Reforming the Mutual Fund Tax Loophole

Important changes to our income tax structure are right around the corner. Increased government borrowing will exert pressure to find additional sources of revenue, and most of this additional revenue will be generated by increasing taxes on individuals. For those of you who have read my previous blog posts or publications, you know that I favor consumption taxes relative to income taxes, but let’s set this aside for the moment and examine one not-so-small, but highly under-publicized, loophole in our current tax system.  That is, the implicit ability to deduct the management fees that mutual funds charge their investors.

By deducting fees from fund assets mutual funds essentially disguise the fees that individual investors pay.  If you hire a money manager, or a financial planner, you cannot deduct the fees that this professional charges you from your investment returns. If you get a 10% return on your money and the money manager charges you a 1% annual management fee you pay taxes on the entire 10%. Because mutual funds deduct fees from assets before calculating return the tax situation is different. If your gross return from a mutual fund is 10% and the mutual fund charges you 1%  annual management fee you pay taxes on the net return — that is 9%.

This is a bigger money issue than it may first appear.  The aggregate net asset value of mutual funds shares held in the U.S. is about $10 trillion.  About half of this amount is held in non-tax-deferred accounts. So, the returns on about $5 trillion is exposed to taxes. The average mutual fund, considering both stock and bond mutual funds, charges about a .90% annual management fee.  That suggests that investors are paying about $45B a year in tax-exempted mutual fund management fees. If the average taxpayer pays a marginal tax rate of 25%, a simplifying but effective assumption given my purpose here, what you have is a little over $11 B that is not flowing into the government coffers that by all rights should be.

Why is this tax break particularly troubling to me?

1. A tax deduction for money management is massively regressive.  The more money you have, the bigger the tax break you are getting.
2. It is a loophole that is easily exploited. Wealthy individuals can, and do, pool their money with a reasonably small group of other individuals and legally start “mutual funds.” These funds are not marketed to the general public. They are constructed as legal tax shelters generated in order to allow their limited membership to deduct the cost of money management.
3. Because no taxes are paid on the fees, many mutual fund shareholders will pay less attention to the fees that they are charged. If fees were made explicit, and taxes paid on the gross rather than the net returns, individuals would undoubtedly pay more attention to the fees charged and many people would be made better off for it.

The forthcoming overhaul of financial regulations should not focus exclusively on institutional transactions, but should grapple with needed changes in the retail market for financial services as well. Informed regulation of the financial markets and revisions in the tax code are inextrcibly intertwined. One focus of good regulation should be to close obvious tax loopholes. What I have written above is one example of a change long overdue.

You May Be Richer Than You Think

The Wall Street Journal today posted a blog entry that referenced and quoted a conversation with me about how perceptions of wealth can be biased and how relative wealth is often more important than absolute wealth for personal happiness. Here is the link.  I thank The Wall Street Journal for their interest in my research.

The Irrelevancy of the Paradox of Thrift

USThrift Blog is back from a long winter’s nap and the birth a new little Wilcox.

This post has been published by Forbes. It argues that American households are not stifling economic recovery by saving too much and that public policies designed to increase consumer spending are misguided.

Blagojeviched

Today’s blog entry was published by Forbes. It argues for increasing the salaries of senior-level government officials as a way to reduce the public’s exposure to the Rod Blagojevich’s of the world.

Enlisting Credit Unions

Credit unions have been a success story in the Unites States. Begun 100 years ago as a movement to provide for the credit needs of individuals of modest means and to promote thrift, they have grown to become a large-scale member of the financial services market.  Owned by their members, they hold a privileged position in the world of financial services. Unlike their banking counterparts, credit unions do not pay corporate income tax. They operate as not-for-profits solely for the benefit of their owner-members. In this time of economic uncertainty, credit unions need to do more to help their most vulnerable members.

Credit unions are in a natural position to combat some of the most pressing long-term financial problems facing the people who are standing on the lower rungs of America’s economic ladder.  Properly constructed regulatory incentives could spur credit unions to use their privileged position to be more proactive in their efforts to ameliorate those problems, which  include:

1.       Endemic financial illiteracy. Everyone needs a basic level of financial knowledge to successfully navigate today’s complicated marketplace. Far too few people have such knowledge, and those who seek it typically do so quite late in life.  Efforts to increase financial literacy must move beyond sponsoring adult-oriented financial planning seminars (which are attended largely by retirees) and out into America’s high schools. It is there that learning of real consequence and broad social impact can take place.  Some proactive credit unions have set up branches inside high schools, using students as employees and accepting limited deposits and withdrawals for the purpose of introducing young people to the basic concepts of compound interest and the time value of money.  More credit unions should be engaged in this valuable public service.

 

2.       Payday loans. A culture of dependency on payday loans is a scourge on lower- and lower-middle- class households. This cycle of debt is enabled by commercial payday loan establishments that appear to be a model of cheerful customer service yet charge mind-bending rates of interest.  Many of the same people who walk in the door of a payday loan establishment are either credit union members or are eligible to be. Credit unions should aggressively market products that compete directly with those offered by commercial payday lenders.  The difference between the fees charged by the credit union and the commercial vendor should comprise part of a small required deposit into a savings account at the credit union. Over time, as an individual repeatedly accesses the payday loan product, he or she builds assets that can ultimately break the short-term debt habit.  Some credit unions already offer such products and vigorously communicate their availability. Others have the products, but have not marketed them effectively. Many have no product that offers a viable alternative commercial payday lending.

 

3.       The unbanked.  Ten million U.S. households do not have any type of bank or credit union account. Short of stuffing dollars underneath their mattresses, these individuals quite literally cannot save money.  Banks are, understandably, not attracted to segments of the market with limited profit potential and set their account minimums and fees accordingly. Credit unions should allow access to a no-fee checking account for anyone in their membership field that is willing to deposit five dollars. It’s true that these individuals will not help the credit union generate the monies needed to cover their operating expenses; in fact, they can be a drain on resources. But this is exactly the kind of member service that justifies credit unions’ continued tax-exempt status.

 

4.       Mortgages.  The mess in this market is self-evident. Credit unions can help by holding more of the mortgages they originate instead of selling them in secondary markets. When problems arise with individual mortgages, it is easier to rework terms when the buyer and seller of the mortgage are known to each other.  No one wins when a home is foreclosed upon—not the mortgage lender, not the community in which the house is located, and certainly not the person who loses his or her house.  Credit unions should construct portfolios that allow them to hold the majority of the mortgages they sell. This will result in greater financial stability within the communities they serve.

 

Federal and state regulators already have a powerful set of tools at their disposal to help create a marketplace in which credit unions have the incentive to engage in this socially beneficial behavior.  Most prominent among these tools is the ability to allow a credit union to expand its field of membership.  A successful expansion allows a credit union to benefit from the economies of scale and reduce costs associated with providing services to individual members. It can also help justify more generous compensation packages for senior executives who are now presiding over larger organizations. Many credit unions have sought or currently seek the expansion of their field of membership.

 It is entirely at the discretion of state and federal regulators to determine whether increasing the field of membership would be beneficial for a newly expanded credit union community.  To determine whether a community would benefit from expansion, benchmarks should be established against which to assess progress in the areas of increasing financial literacy, decreasing reliance on payday loans, reducing the ranks of the unbanked, and increasing credit unions’ holdings of mortgages.  We all benefit when credit unions that are vigilant in service to their communities expand.  Their creative energies are needed to help steady the perilous financial footing of far too many American families.

Reaction to Kiplinger’s Review

Kiplinger magazine reviewed my book, Whatever Happened to Thrift. They called it one of the “top money books of 2008.”

I thank the editors at Kiplinger for their kind words and attention to my book.

The Ghost of FDR

Few past presidents have been invoked as many times in the last month as Franklin Delano Roosevelt. His ghost hovers over every conversation about how to extract ourselves from the current economic abyss. While I did not experience the world of FDR, my mom did. She was very young at the time, but his legacy graces the edge of her memory. Her father, a Democratic organizer, smiles confidently at me from a sepia picture that hangs in my home; his over-sized FDR button worn like a badge. While my mom is conservative by both disposition and political leanings, that conservatism comes to an abrupt end when she tells me of FDR. For her, he was hope in a time of darkness, a fireside companion in a time of cold, and a champion of public policies that put the working man and woman back at the front of the line. He was, and will always remain, a hero.

And that hero enacted policies that are widely regarded as pulling us out of the Great Depression. Did they? Most economists believe that they did not.  World War II started the process of bringing us out of the Depression and the pent-up demand that was created from government-mandated rationing and what amounts to forced savings during the war pulled us the rest of the way through the end of the depression. FDR was, by almost any measure, a great president, but the size of his austerity program, though large by the historical standards of the time, was nowhere near potent enough to pull the country out of the Great Depression.

The Great Depression was the hangover from the Roaring 20’s. In order to bring the country back to economic stability households had to go through a period of rebalancing their financial lives, of reducing debts and building assets. Only when that occurred, largely by coercion because of the urgent need to provide funding and material to the armed forces, did consumers reemerge to take the economy onto their backs, to begin spending and to bring finality to more than a decade of material scarcity. 

Economic stimulus packages that speak of short-term fixes have little hope of success. American households are in a far more serious debt position than households of the 20’s. If you hand Americans money right now, they will save it. They will ignore politicians who exhort them to spend it. The American consumer cannot pull us out of this downturn, at least not yet. Over the next months or even years, we will experience a rapid decline in household debt and an increase in savings. It will take time, and savings, to resurrect the economy. If we do spend government money to help our economic prospects it should be focused on long-term programs that have the capacity to lift everyone’s quality of life in the years to come; energy, education, and our nation’s transportation infrastructure. It is a time for investment, not for handing out money.

American Optimists

My posting today is published by Forbes. Its title is “American Optimists” and it discusses why some of the successes our country has had in the past make it more difficult for us to save.

I thank Forbes for taking an interest in my writing.