Perfect Pain: Inflation & Deflation
7:08 am October 24, 2008 by Brian J. Ritchey · Leave a Comment
I have spent considerable time discussing the increasing inflationary threat to the economy over the past year. The rapid popping of the asset bubble, however, has worked its way into the rest of the economy and has had an deflationary effect that is beginning to show in core prices. The most recent Consumer Price Index (for September) has inflation falling under 5% (4.94%) after skyrocketing to 5.6% in in July and 5.37% in August. The inflation rate for 2008 is still 4.5% - over 1.5% increase over the average rate (3%) since 1992.
The recent “bailout” of $800b of new freshly printed money should serve to increase inflation. However, according to Tim McMahon on his site Inflationdata.com, the loss of over $7 trillion in value from the NYSE and NASDAQ creates a “net deflationary effect” on the economy:
And that is not counting the value lost in housing prices. And to make matters worse the mortgage industry took those initial mortgages and leveraged them using “derivatives” to compound the gains on the upside. This leverage was by a factor of hundreds of times. Actually no one even knows the full magnitude of how much compounding went on. So there could easily be Trillions more of liquidity that evaporated when housing prices stopped going up and began their downward descent.
So how do you reconcile a high inflation rate and net deflation on the economy at the same time? McMahon explains that the consumer price index considers over 10,000 items that “take into consideration all aspects of the economy.” What is happening in the stock market is based, at least initially, on housing prices. So, in effect, we get bad news on both fronts: Our house values are deflating and our cost of living is inflating.
Need it be reiterated the importance of measuring performance? The boom economy of the past two decades is unfortunately giving way to an as-yet unknown period of economic decline. We have suffered through two minor recessions during this period, but the extent of this downturn is certain to be more protracted and deeper. The recession in 1990 was practically non-existent and short and was arguably preventable without the massive tax increases placed on the economy. The recession in 2001 was again short and based primarily on the bust of the tech sector - with not nearly the impact on the majority of Americans as a drop in home values.
The good news for law firms is that regardless of who wins the Presidential election, there will be a rush to enact new reactionary laws to protect consumers that will invariably lead to an increase in lawsuits. The bad news is that your personal income will be devalued based on the realities of the economy. Also, those in transactional practices will not be as fortunate, as transactional business typically suffers during recessions.
Next week the government will release 3rd quarter GDP results. Most expect us to report the first negative growth in seven years. The time to plan for the economic downturn was several months ago - but it is never too late.
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The Role Of “Effective Rate” To Law Firm Profitability
2:00 pm October 21, 2008 by Brian J. Ritchey · Leave a Comment
There are 6 main profit drivers for all law firms: Rate, realization, leverage, margin, operating expenses and cash flow. Rate can be tracked in several ways.
- Standard rates are rates you would charge a client, all things being equal. These are typically your highest rates.
- Worked rates are your actual rates you charge a client. Worked rates are affected by client negotiation or perceived need to reduce rates to stay competitive.
- Billed rates are rates after you invoice a client. Billed rates take into consideration both mark-downs and discounts.
- Collected rates are the final hourly fee after the invoice has been reduced to a zero balance. Collected rates take into consideration write offs and other post-bill adjustments.
Rate can be measured from standard to billed or worked to billed to judge how well you are converting your work to invoiced fees. These rates are measured on an accrual-basis.
Rates can also be measured from billed to collected. These rates are measured on a cash-basis.
However, to get a full view of what happens to your standard rate as work moves through the billing cycle, firms need to measure the effective rate. The effective rate can be measured either from standard to collected or worked to collected.
Measuring effective rate means creating targets, forecasting results, and holding your fee earners accountable for results.
The below chart shows how you can measure effective rate. Click on the graph to download.
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Europe Follows US Lead: Eases Mark To Market Accounting Rule
10:45 pm October 20, 2008 by Brian J. Ritchey · Leave a Comment
Weeks after the US drops the mark to market accounting rule requirement (and not so coincidentally bank failures ceased), the EU has fallen in line and has backed proposals to ease the rule.
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Quote Of The Day
7:42 pm October 5, 2008 by Brian J. Ritchey · Leave a Comment
From Democrat strategist Jenny Backus, when discussing Governor Sarah Palin:
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Panacea Bill Passes; Bush Cautions “It’s No Panacea”
10:59 pm October 3, 2008 by Brian J. Ritchey · Leave a Comment
The Emergency Economic Stabilization Act of 2008 is now law. The markets responded by losing over 350 points (taking into consideration where the DOW was at the time of the vote).
President Bush with Treasury Secretary Henry Paulson.
President Bush, after signing the bill, cautioned that it will “‘take some time’ for the measure to have its ‘full impact’ on the economy, and that the task of buying up troubled financial assets in the wake of the mortgage meltdown ‘cannot be accomplished overnight.’”.
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Is Suspension Of Mark-To-Market Rule Irrelevant?
2:37 am October 3, 2008 by Brian J. Ritchey · Leave a Comment
Good counter-argument to what former FDIC chairman Isaac and Newt Gingrich have said regarding the role of mark-to-market accounting rule:
Even if mark-to-market rules are suspended immediately, it won’t change the makeup of a company’s balance sheet. Investors have decided that these assets are toxic and no matter how a bank accounts for them in its books, that sentiment isn’t likely to change unless investors see some proof that the instruments are actually undervalued.
On the other hand, there is the other argument:
“For almost every bank, especially the regionals, what they’ve taken the biggest hit on is mark-to-market securities,” said (Joshua Siegel, managing principal of Stone Castle Partners, a private equity group). “This is what they needed to do first - not cut a $700bn check. They first need to take the pressure off earnings.”
For now, it appears the SEC is moving towards suspending the rule. In the meantime, it was announced Tuesday that “managers could use their own judgment when valuing securities in illiquid markets, which means they can use measurements other than actual market prices.” The revised rule can be read by clicking here.
I am not sure that sort of ambiguity is what is needed to help this crisis. Perhaps a sane rule that doesn’t devalue assets based on immediate marketability would help investors better than leaving the valuation to the whim of the managers. Further, taking the point of Phil Izzo from the Wall Street Journal’s “Real Time Economics” Blog, is it too late for the change to make a difference in the current crisis? Can you really go back and increase the value of assets that you have already deemed toxic and worthless and expect anyone in the market to trust it?
Opinions on mark to market are strong and more and more people are speaking out on it:
- Jeff White, Financial Post; “Mark To Market Madness”
- The Motley Fool, “Mark-to-Market Accounting Basics”
- Andrew Willis, Globe And Mail, “Making the case for mark-to-market Rules”
- Joshua Boak, Chicago Tribune, “Critics Say Accounting Rule Off Mark”
- Floyd Norris, New York Times, “Mistakes Of Past Live Again”
- The Economist, “Fair Cop: Fair Value Accounting Becomes A Political Issue”