Reforming federal flood insurance in wake of hurricanes

The federal government’s flood insurance program is facing billions of dollars in claims following the recent monster hurricanes, with those who live in flood-prone homes applying for government buyouts through the Federal Emergency Management Agency. Why not? American taxpayers have already bailed out the banks and automobile companies, among others.

There was a time when people who assumed increased risks as a result of where they chose to live would pay for those risks themselves. But in 1968 Congress enacted the National Flood Insurance Program, another product of the Great Society, to provide affordable insurance after private insurers stopped selling flood policies or began charging very high premiums for them because the business had become too risky. The program is administered by FEMA and covers about five million properties worth more than $1.25 trillion.

The flood insurance program borrows from the U.S. treasury because paying out more in damages than it collects in policyholder premiums has it drowning in $24.6 billion of debt. Congress must decide whether to reauthorize the program by the end of the year.

Since the value of the insurance exceeds the premiums being charged, taxpayers who reside inland foot the bill for the high-risk lifestyles of those who plant themselves in the path of hurricanes. The problem is only growing as sea levels rise and intense weather events become more frequent.

While originally designed to be self-funded from policyholder premiums, about 20 percent of flood insurance program policyholders pay insurance premiums that are about 60 percent lower than they would be if they reflected the true likelihood of flooding, according to government estimates.

The program places no restrictions on the number of times a property can be rebuilt and repetitive loss properties have accounted for 30 percent of flood claims paid since the flood insurance program began. As the Wall Street Journal recently reported, one Texas house has flooded 22 times. The homeowner made claims each time, and the resulting payments exceed the value of the house.

Why fret about rebuilding when the American taxpayer is there to foot the bill? It would be impossible for even the Angel Gabriel to make a program work when it encourages people to build in harm’s way.

A flood insurance program should discourage development in flood-prone areas by using risk-based premium pricing rather than encouraging people to use taxpayer money to build in flood zones. Those who face little risk of flooding should pay less for flood insurance; people at great risk should pay much more. The government may provide subsidies for the poor, but the flood coverage program should otherwise operate like other types of property and casualty insurance.

Encouraging development in vulnerable low-lying areas also increases the damage caused by these storms, which further increases taxpayer costs. It’s cheap for U.S. homeowners to build in harm’s way, but not for American taxpayers.

Despite the program’s rising costs, reforming the national flood insurance program will not be easy. It will require swimming upstream against the real estate lobby, homebuilders, and other development interests. The value of these littoral properties would decline if people were made to bear the true cost of their lifestyle choices, and that means a lot of coastal development would come to an end.

It is ironic that the one percenters who are affluent coastal dwellers and don’t like government programs enjoy the subsidized flood insurance premiums. Depending on others to bail them out is an addiction that knows no economic class.

Back in the day the American way was that you could live where you want, but you must assume the risks of your choice. The philosopher Joseph de Maistre wrote that people get the government they deserve. When it comes to federal flood insurance, ours is comprised of politicians mainly interested in staying in office and using taxpayer dollars to do so.

Originally Published: September 30, 2017


Hold Wall Street managers to account

At 1:45 a.m. on Monday, Sept. 15, 2008, Lehman Brothers Holdings Inc., the fourth largest investment bank, sought Chapter 11 protection in the biggest bankruptcy proceeding ever filed. There are many reasons why Lehman failed and responsibility is shared by auditors, government officials, regulators, and credit rating agencies.

Looking back, much of the blame for Lehman’s failure and the ensuing financial meltdown that led to the Great Recession resided with senior executives, aka professional managers, in the financial markets who did a poor job of allocating capital and managing risk. They acted less like stewards of their firms and more like the keepers of a guild, accountable only to themselves and focused on short-term results at the expense of long-term performance.

The failure to understand that there are huge risks associated with the pursuit of high returns was a major contributor to the financial meltdown. One way to avoid repeating this disaster would be to require top managers in industries that are important to the public welfare to earn government licenses that testify to their qualifications, just like physicians and lawyers, who must pass tough state exams, and accountants, who must also demonstrate a certain number of years of successful professional work in their field to gain a certified public accountant license.

Why not have the same rigorous licensing requirements for professional managers before they are permitted to hold top management jobs in critical industries and public-sector positions? It has become clear that the challenges of managing large organizations have grown to such a level of complexity that only individuals with the right mix of skills can effectively meet them.

One way to begin professionalizing management is to require anyone graduating with a management degree to pass a comprehensive federal or state exam that tests their mastery of the fundamental body of knowledge they allegedly learned, including accounting, finance, statistics, data analysis and organizational behavior.

During the financial meltdown, Lehman’s top executives could have by no means been described as competent. Ditto for Merrill Lynch, AIG, and so many other firms. Finding incompetent executives among this crowd was like finding sand on the beach; they were clueless to the real dangers of excessive risk taking in the form of the lack of protective equity capital and massive use of leverage built around short-term borrowings.

Despite earning more than managers in any of the world’s other major industries, they were like irresponsible children who had somehow gained access to Cold War missile control rooms, playing with the shiny buttons that could launch nuclear warheads against an unsuspecting world.

Which they ultimately did, wiping out more than $11 trillion of wealth in the process and leaving the American taxpayer to clean up the mess.

In addition to core technical skills, a management licensure test should measure the ability to think critically and consider the moral consequences of decisions. Is it too much to expect a management graduate to be educated about how to leverage the power of markets to create a better world rather than serving only their own selfish interests? Or to possess the ability to think critically, which allows them to solve problems beyond those addressed by their functional training?

For sure, such an examination would increase employers’ faith in a graduates’ competence. It might be wise to make passing the test a periodic requirement to ensure that managers stay current in their knowledge and the ethical challenges posed by an ever-changing business world.

To paraphrase the philosopher George Santayana: those who fail to learn from history are destined to repeat it. The incompetence of senior managers was a driving force behind the 2008 financial meltdown from which many Americans still have not recovered nearly a decade later. The time has come to hold managers to the same standards as other professionals whose competence impacts the well-being of society.

Originally published: September 16, 2017

Hero CEOs need to look in the mirror about economic inequality

In a strong rebuke to President Trump’s response to the recent violence in Charlottesville, Virginia, a chorus of masters of the universe, titans of industry, and corporate rock stars lined up like soldiers to take head shots at the president, criticizing him by name for his handling of the violence.

Many were so appalled by what the president did and did not say that they resigned from his business advisory councils. The media certainly milked it for all it was worth, some characterizing senior executives as heroes for speaking truth to power.

Nothing stokes cable ratings like a sustained campaign of outrage that feeds into the attention deficit disorder of the American news cycle. But perhaps some of that outrage should be directed at the crusading corporate giants themselves.

Perhaps it is only a matter of time before chief executive officers show the same passion and anger when it comes to speaking out against the economic inequality that has risen so sharply since the mid-1970s. For example, CEOs could voluntarily take less compensation and use their concentrated political and economic power to support a national living wage.

After all, the Gods of Fortune have continued to smile down upon corporate executives with outsized payoffs. The average CEO earns something close to 300 times the pay of the median American worker, whose real wages have been stagnant for decades. This ratio is up from roughly 40 to 1 in 1980. In contrast to this growing gulf between the haves and the have-nots, the ratio of CEO to average worker pay in Japan is 16 to 1. In Denmark, it is 48 to 1 and in the United Kingdom 84 to 1.

CEOs do not have to worry about saving for retirement or their children’s college education as they enjoy expensive perquisites from country club membership to second homes a little smaller than Rhode Island, to the personal use of corporate jets.

Is it any wonder that the public is mad as hell? They make the connection between business executive pay and growing economic inequality.

A few decades ago, executives were paid mostly in cash. Much of the story of executive compensation in recent decades comes down to two words: stock options.

To align incentives between shareholders and management, boards of directors use equity compensation by granting stock options. Today, they comprise two thirds of the typical executive’s pay.

Stock options give the executive the right to buy a company’s stock at a predetermined price sometime in the future. If share prices rise above the negotiated strike price, the executive stands to reap significant gains. If the options become worthless, the CEO breaks even, having paid nothing for them.

The result is a win-win for executives, especially when supplemented through the use of stock buy backs and the labyrinthine of accounting shenanigans such as excluding depreciation and amortization in calculating earnings for performance based compensation.

The stock buyback binge of $4 trillion since 2008, much of it with borrowed money thanks to low interest rates since the Great Recession, has resulted in firms reducing the number of outstanding shares by which profits have to be divided. So the share repurchases lift per-share earnings, improving a key metric for determining CEO compensation.

Solutions to the CEO compensation issue include tightening the cap on tax deductibility of CEO pay and disallowing deductions for excess salary, stock options, and perks. Fat chance, these reforms will happen when the positions of too many politicians closely reflect those of their big money donors.

Cynicism about those in positions of power seems to be confirmed afresh each day by the latest tweets, pandering, and headlines. As a general rule, assume the worst about elected officials and the thinly veiled plutocracy. That way you will not be disappointed.

Originally published: September 12, 2017