This is riveting

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I got one of those emails I love getting from my Father, today. He'd read an article, and wanted my opinion. For those who don't know, I work as a Private Equity accountant. I spend hours every week working with this type of thing.

Sorry, Mr. President, Raising Taxes on Carried Interest Won't Work

The Obama administration is once again proposing to raise the tax on the carried interest managers of hedge funds, private equity fund, and venture capital funds receive. Even if it were to pass Congress, however, the tax would likely raise far less than the Obama administration expects.

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Byron - Thought you might find this interesting reading. Let me know your take on this. Would be curious to hear your thoughts! Saw this on the CNBC site & made me think of you!

To which I replied:

Carney, the author, gets the overall idea of Carry correct, but he doesn't delve into the mechanics of how carry is paid out, and he uses an absurd example (100% rate of return) under the guise of simplicity to gloss over the differences in the two structures.

Carry income is incentive income. It is structured in such a way as to align the interests of the GP (Private Equity Managers) and LPs (Investors).

He throws the slightly-critical reader a bone with his caveat about interest rates at the end, but as in all things finance, the incentives are in the details and in the range of likely outcomes.

The most important detail that isn't covered by his loan structure is that GPs get 20% of the entire gain after they surpass the hurdle rate. So on a $100 mm fund with an 8% hurdle rate, the first $8 mm of gain is split pro-rata, but then the next $2 mm goes entirely to the GP. This is called GP carry catchup, and so at $110 mm the GP has 20% of the entire gain. Under a loan structure, and with current tax rates and assuming carry is taxed at ordinary rates, the GP needs to earn about 39% annual return before they are worse off on an after-tax basis using carry rather than a loan. Nobody earns 39%. (See attached spreadsheet.)

Finally, his column fails the logic test: If it's so simple and everyone would agree to it, why aren't funds structured his way now? Well, the easy answer is the GP under almost any reasonable scenario would still prefer the carry model as they are better off under virtually every realistic return scenario using carry, plus the LPs (investors) would perceive the loan situation as riskier than the current model. Some other considerations that would be big issues in a real market:
- LPs would also have to carry part of these equity investments as debt, and this would throw off their portfolio allocation calculations.
- GPs would have massive tax liability issues if the Funds were to lose money. When non-recourse debt is not repaid, it all flows through as ordinary income to the defaulter. GP's don't want to take the risk of paying approximately 8% (40% ordinary rates on 20% of the fund as a "loan") of their invested capital to the IRS should their fund fail.
And here's the spreadsheet I attached. Carry Model vs Loan Model.xlsx

28 Great Times at Twenty Eight

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1. Singing HMS Pinafore with Brian Baum on the way to Detroit and winning a $10 bet
2. Saying goodbye to Nate and Kelley Taube before Ecuador
3. Hallelujah! with Emma Vis and the Apollo Choir
4. Line dancing with Mandy Kistler and Liza Alvarez at DC's Country Junction
5. Genesis & Exodus Bible studies with Mary Rodriguez, Stephan, and Jessica Gombis
6. Andrew Peterson concert in Elmhurst with Kathy Bernahl
7. Watching the river turn green on St. Patrick's Day with Andy Foreman
8. Dancing the tango at Enye for Mari Bolyanatz' bday
9. Watching the Cubs from the rooftop with Jill Hornok & Mel Vanden Berg
10. Fire game in Toronto with Kelsey Mays and then hanging out for four hours at a Burger King in Woodstock, Ontario on the way home.
11. Finding out that Laura Wolff is crazy good at drinking games while celebrating Jake Hogan's birthday at Tedd Hawks' place.
12. Beach volleyball with Mehran
13. Grilling at Keystone with Bill and Katie Smiljanich
14. 90s Party for Lindsay and Tyson Capel at Brian & Maria Hodapp's
15. Desperately trying to buy Yuengling in Pittsburgh before all the Alcohol stores close with Dave VanderZee
16. Breaking into abandoned blast furnaces with Charlie Galik and Brady Martinson
17. Breaking into Gretchen Schmidt's apartment with John Park after a weekend at the lake.
18. Climbing the Himalayas in India with Wyatt Clarke & Adam Baldocci
19. Riding bicycles across Wisconsin with Alicia & Brian Stien
20. Beignets at Grand Lux Cafe with Eric & Emily & Kelley
21. Laura Nelson's pool party in Glenview with Lex Bolyanatz & Jon Foiles
22. Tailgating at the Fire game with Joe & Leslie Wright
23. Hanging onto an inner tube for dear life with Ryan Hansen as Katie Rabe tried to kill us.
24. Sleeping on the shore of Lake Superior under the stars with Arash Rah
25. Conspiring to inebriate Adam Claus at Uptown Lounge
26. Slow dancing with Mandy Zachmeier at her going away party
27. Apple picking with Kristin Bush
28. Visiting Kyliah & John in Minneapolis and getting to hold Silas, Samantha, and Andreu.

Constitutional Abuses

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Either we have Constitutionally protected rights, or we don't... this week's news looks like we don't.

Police assaulting citizens exercising their First Amendment rights of Assembly and Speech.

The due-process-free assassination of U.S. citizens is now reality -

And the American Government putting to death one of it's own citizens without due process.

I personally was quite upset at the Bush administration for the warrant-less wire-tapping of American citizens - now, President Obama has his opportunity to trample the Constitution and does so.

Yes, I know, particularly the Anwar Al-Awlaki situation, are complex matters that involve balancing public security vs. individual rights, but there has to be a better way. As Americans we often talk about the "cost" of our Freedoms in referencing military service, but if we truly want to have some of those freedoms, one of the costs that we may have to bear is increased risk at home due to less "effective" methods of defending our country.

To illustrate this, Iran released some American hikers it had imprisoned for crossing into Iranian territory. Here's a paragraph from the article describing their release:

When they complained about conditions in Tehran's Evin Prison, Bauer said, their jailers would "immediately remind us of comparable conditions at Guantanamo Bay. They would remind us of CIA prisons in other parts of the world."

When we fail to interact with the rest of the world in a way that is consistent with our values, we lose the expectation of receiving those values in return. Chicken or egg, this is one of the outgrowths of the war on terror.

President Obama introduced a Jobs bill last night before a joint session of congress. There were some solid proposals included, but I want to extend an analysis from last year's decision to cut payroll taxes for workers. (President Obama's secret plan to Privatize Social Security - Extra credit points available for the first reader to identify the reference.)

In December, I pointed out that workers would need to save their 2% tax cuts under the principle that you don't get something for nothing. In many ways, economics can be a zero sum game, and if the government gives you a 2% tax cut, that will reduce their ability to provide you with benefits by at least 2%... so no matter which pocket the government says is absorbing the 2% tax cut, all the pockets are connected and the tax revenue is simply not going into the government, making it much more difficult for it to come out.

Recall, prior to these proposed changes, workers paid 6.2% of their income into Social Security, and employers matched that with another 6.2%. Now, the President would like to give workers another 1.1% off their Social Security contributions (down to 3.1%) - but he also wants to cut employers' contribution to 3.1%. As I pointed out last year, the cuts took the already underfunded Social Security contributions down from 100% to 84%, this latest "stimulus" will take contributions down to 50%.

What does this mean for the responsible wage earner? Well, it's a challenge. You see, the first 2% cut was simply a matter of the responsible wage earner deciding to save the 2% - it was essentially a privatization opportunity for workers. Take 2% of your pay, save it on your own, and hope that your savings out-earn the Social Security trust fund. But this year's cut poses a bigger problem for workers:

If this provision passes, your retirement contributions are being cut 4.2%, but you'll only be getting 1.1% of that in your pocket. Your employer will be allowed to pocket the other 3.1%! The responsible wage earner, who wants to continue saving toward their retirement target will now have to find another 3.1% of their income to stay the course - It's as if the President just decided he would like to hand out a 3.1% pay cut to all wage earners, and instead give that money to employers.

As a responsible wage earner - and someone who knows a bit more about personal finance than the average bear - I'm fine receiving up to my entire 6.2% personal contribution in a payroll tax cut. I'll save the money, but I protest allowing my employers to shortchange my Social Security contributions while allowing them to pocket the money. This is a step backwards in the current effort to close the income distribution gap, and workers across the country should insist that employers continue to fully fund their share of Social Security contributions.

Housing woes

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Housing continues to fall. Here's the latest property transaction in my building. BlockShopper

Running the numbers, this unit traded at 39 cents on the dollar from the peak transaction. My condo is, unfortunately, a very close analogy to this unit.

I'm assuming the transaction was a cash transaction as banks have been reticent to underwrite new loans in our building due to the Fannie Mae/Freddie Mac 80% Owner Occupancy rule. I happen to know that rent on that unit is probably $900/mo, and the assessment for the unit comes in around $350/mo. Taxes are probably $900/year but should be lower given the recent sales price.

So, if you assumed that you could rent the unit 75% of the time, you'd be looking at $8,100 of rental income, offset by $5,100 of ongoing expenses - or a $3,000 pre-tax profit on a $65,000 investment (4.6%). Continuous rental (12 months instead of 9 months/year) would increase your pre-tax profit to $5,700/year or 8.77%. This is in the first year, before the effect of principal appreciation or rent increases is taken into account. Wow!

This month at the Court

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I like law. I don't know why. I don't think I'd ever want to put in the time to study the law, practice it, and climb the ladder necessary to be a judge... and I started too late to be on the Supreme Court, but I do like reading about the cases that the Supreme Court rules on, and then sounding off.

As we approach the end of another term, I wanted to comment on two cases, and I suppose my evolving understanding of the law, and the courts' role in it.

Up first, we have an 8-0 finding in Ashcroft v. Al-Kidd where the Court held that former Attorney General John Ashcroft's actions in arresting a "material witness" and holding him for 16 days while never calling him to trial were not clearly illegal at the time. I suppose the Court correctly interpreted the law as I'm not going to pit my Law & Order J.D. (A J.D. awarded to oneself after watching greater than 90% of the Law & Order episodes and being well versed in "television law.") against the Supremes... but four of the justices wrote, what I suppose are concurring opinions, differing in points from the Majority opinion.

The question being settled wasn't whether Ashcroft's actions were unconstitutional, but whether they were clearly so at the time, to the point that Ashcroft should be liable. (There is generally some immunity from these types of suits granted to government employees.)

Regardless, I identify with Justices Kennedy, Ginsburg, Sotomayor, and Breyer when they express a little discomfort at the way a US Citizen was treated. Imagine for a moment, some DA decides that you're a "material witness" in a case, throws together some affidavit and gets a judge to sign a material witness warrant. Suddenly, you're thrown in the slammer without the normal legal checks (like needing to be charged with a crime)... and you're being held at the mercy of some DA... who doesn't ever need you for a material witness. How long have we held Sheik Mohammed since we captured him? Imagine if you were a material witness in that case. You could be looking at eight plus years of lockup waiting for the government to get around to "needing" your witness - and then when the government doesn't call you, you have no legal recourse against the government.

Scary! I like the limits that make the government charge you with a crime before/within 24 hours of detaining you... and then giving you the right to a speedy trial.

In a similar vein, we also saw the Court rule that California's overcrowded prison system constituted cruel and unusual punishment. A lower court had ruled on the case and determined that 137.5% of capacity was the upper limit for overcrowding in California's prisons, and the Supreme Court upheld the ruling.

This case is an example of both the best things about our judicial system and the worst. 137.5%? How does a court come up with that number. My guess is that the lower court has some great reasons why 137.5% is the right number and not 110% or 140%, or even 200%, but is that really the role of the judiciary to determine this? (No.)

That said, the role of the legislature isn't to make more actions illegal than funding for the prison space needed to enforce those laws. The legislature was derelict in their duty in how they formed the laws and funded the penal system. This is exactly the type of check and balance that the court should be providing... and although almost all the newspaper articles were headlined like this WSJ article ("Top Court Sets Stage for Felons to go Free"), the headlines should have read: "Courts impose balance on legislators, tell them to do their jobs and spend the money to properly imprison felons." After all, the new law for California isn't that the state needs to release 33,630 inmates, it's that California needs to build prison space suitable to hold 73% of the inmates it plans to incarcerate. (73% is the inverse of 137.5%).

OK, enough about the court. I should also note some exciting things from this month:


Congratulations to Wyatt and Ngoshali! They got engaged this month. Wedding date TBD.

Preach it Sister!

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Here's some wisdom.

LaSalle Street Church - Sermon from March 6, 2011
Not Your Last Chance to Tell the Truth - Senior Pastor Laura Truax

Would telling the truth force you to face your doubts about God? Would telling the truth force you to examine closely the fears that you really have about God? Does somehow - do you think that if you opened up the deep freeze and you took those questions and those doubts that were frozen way in the back, now crusted with ice, do you think that if you opened the freezer and took those out and let them defrost that it would be be too much? That this little teeny shred of faith that you're holding on to would just crumble and evaporate in your hands and then what would you do? Where would you go?

Is that maybe one of the reasons you don't tell the truth? Because you can't bear to have your faith examined? Because you don't think God can handle it? Oh man. If you're thinking that, mark this day, because that God is not the God of Jacob. That God is not the God of David and Nathan. That is not the God that had Abraham go all the way across country on a promise. That is not the God that Jesus goes to the cross bearing the sins of the world for. That's not the same God!

If you really think all your intellectual rigor is going to be too much for that God? If you think you have too much going on in the inside, too much depression, too much failure, too many times where you're just sitting in the gutter? Too many of those moments, where you just kept saying, "I'm sorry, I'm sorry, I'm sorry?" You think God can't handle that? Then your God is too small. That's not the God. That's not the God of Jesus.

So count yourself lucky if you're willing to articulate your doubts and your questions and your fears and your insecurities and all those ways you think God is not enough for you, because that's the beginning of a whole different experience with the living God. You can tell the truth to this God, this God of David, father of Jesus. He can stand up to anything you can throw down.

Over lunch, my boss was telling me how her husband's brothers had once convinced him to call a teacher a scrotum, because that's how you tell a teacher you really like her. To which, I answered by telling the story of "tais toi."

Tais toi is french for shut up. Myles and I knew this, Wyatt did not. Wyatt was annoying. So, we got our revenge by telling him to shut up whenever we felt like it, and then told Wyatt we were simply calling him T-3, which was short for Theis #3.

It didn't make a lot of sense, but that's what we did, and Wyatt wasn't stupid, so he cottoned onto the fact that something was amiss... but he was short on resources to find out what we were actually saying. After some months of this, Wyatt decided to email Kyliah, who was in Spain at the time, and inquired as to the true meaning of tais toi.

Of course, Wyatt let us know his plan because we were sure going to be in trouble when Kyliah delivered him from our persecution... so Myles and I got into the email account when Kyliah responded and printed out a doctored copy of the email for Wyatt, which of course explained that tais toi simply meant T3, and his brothers must of been calling him that because he was Theis' third brother. We were geniuses!

Wyatt continued to be smart and checked the original email, thus exposing our game, and learning that we'd been telling him to shut up for the past three months. It was a terrible day for older brother oppression... but not quite as bad as the day that Myles and Wyatt both decided ranks in the ByronLand army were not as worthwhile as I had led them to believe... but I digress.

Anyhow, upon hearing my story, my boss chuckles and exclaims, "That's what's wrong with your family! Nate's brothers get him to call his teacher a scrotum, and your family hazing involves foreign languages and doctored emails!"

So there, I now know what's wrong with me.

The Charisma of Competence

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I'll preface this with a little about how I view government.

Good government, like good personal budgeting, is taxing $100 for every $100 you spend.

Politics is whether you should spend $100, $200, or somewhere in between.

As long as we agree to tax what we spend, the incentives are properly aligned to discuss spending levels. When we tax only $75 for $100 of spending, or $150 for every $200, incentives are skewed and the political discourse is necessarily dishonest.

I like Mitch Daniels because he and I share the same view of Good government. He wants to balance the two, and I get excited that someone out there wants to have an honest political discussion.

My concern about Governor Daniels is that he'd like to spend $50 where maybe I'd prefer to spend $200. In his time as Governor, he has cut Government services severely... and from some of the articles I've read, perhaps too much so, especially in the area of services for mentally ill Hoosiers. Regardless, Governor Daniels spoke at CPAC, to a conservative audience this weekend... and I would desperately like everyone to watch his speech. We may disagree on the size of government, but I think Good government is more important than politics. So, please watch: it's 40 minutes well spent.

Mitch Daniels CPAC Speech on CSPAN. Or, the full printed text.

A quick recap of the speech from WaPo.

If I speak in the tongues of men or of angels, but have not love, I am only a resounding gong or a clanging cymbal. If I have the gift of prophecy and can fathom all mysteries and all knowledge, and if I have a faith that can move mountains, but have not love, I am nothing. If I give all I possess to the poor and surrender my body to hardship, but have not love, I gain nothing.


#1: Congress shall make no law respecting an establishment of religion, or prohibiting the free exercise thereof; or abridging the freedom of speech, or of the press; or the right of the people peaceably to assemble, and to petition the Government for a redress of grievances.


The Gross National Debt