Relevant and even prescient commentary on news, politics and the economy.


By Spencer

The March employment report continued the trend of the last few months with payroll employment down 694,000, about the same as the last few months. This brought the unemployment rae to 8.5% and job loses of some 5.3 million over the past year.
The one encouraging item was a repeat of last month where the household survey is now showing weaker employment losses than the payroll survey. This is a leading indicator for the economy that I have watched for years. Interestingly, a couple of academics just published an NBER working paper where they discovered the cyclical pattern of the household survey leading the payroll survey at economic bottoms.

First quarter hours worked fell at an 8.7% annual rate versus a 7.4% annual rate in the fourth quarter. This data implies that the first quarter real GDP plunge could be worse than the fourth quarter despite the point that real PCE will probably grow at a 1% or higher rate. But this difference in real PCE growth should be offset by a massive inventory liquidation.

The economic cycle shifting from involuntary inventory accumulation to inventory liquidation is a positive economic development that signals we are closer to the end of the recession. Some people are actually starting to think the second quarter real GDP could show positive growth.
But that is a minority view. Inventory liquidation means firms are going from spending money to acquire goods they do not sell to selling goods they have already paid for. This shift does wonders for corporate cash flow and profits and sharply reduces the need to shed employees.

The index of hours worked is now at 93.6 — versus 100.0 at the peak. This is a more severe drop than the 94.2 in the 1981-82 recession and almost as bad as the 92.5 bottom in the 1974 recession.With the weakness in employment we are finally starting to see the expected cyclical moderation in wage gains. Over the last three months average hourly earnings rose at a 2.2% rate and average weekly earnings only grew at a 1.0% annual rate. This implies that it will be very hard to sustain the first quarter growth in real PCE if oil prices continue to rise and/or significant tax cuts for consumers are not enacted.

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CDS This Way CDS That Way

Robert Waldmann

is still trying to think of creative was to use CDS to commit fraud. One key use of CDS was to relax capital controls. A debt instrument plus a CDS from AAA rated AIG counted as AAA debt, thus banks could gamble more if they bought a CDS from AIG. Would this still work if the bank sold an identical CDS to AIG ? How about a very similar CDS ?

Hmmmm. Contingent liabilities appear on published balance sheets (I mean Q-10s) at market value and without details. So on the assets side, a CDS has an effect which depends on its notional value and on the liabilities side at it’s market value.

Now I’d guess that regulators can detect and disallow regulatory benefits from positoins which exactly cancel by definition. However, different CDSs can be very close substitutes without being identical. If I buy and write CDS on similar tranches of similar pools, I am not running (or insuring) much risk. If one counts at nominal value and one at market value, can I claim that I am insuring a lot of risk ?

How about “finite reinsurance.” I’m not sure I understand everything which that phrase can indicate, but it makes me think of reinsuring risk up to a limit, so that the risk is in some sense insured, but the original risk bearer still bears the lower tail. How about I buy a CDS on a tranche of a pool and sell a CDS on an overlapping tranche of the same pool. So I am owed money if 12 to 13 % of the underlying assets default, but have bought insurance on defaults of 12 to 100% (and sold on defaults of 13 to 100%).

Goldman Sachs assures everyone that they were not vulnerable to AIG counterparty risk, because they had hedged. They have also gotten a lot of money from the US Treasury via AIG. How exactly did they hedge ? Do I need to put on my tinfoil hat to stop the Martians from beaming the idea into my brain that they might have hedged by writing CDSs for AIG that were very similar to the CDS that AIG wrote *and* which had the clause that if AIG owes Goldman Sachs then Goldman Sachs doesn’t have to pay AIG.

In cleaning up AIG liabilities were AIG assets cleaned up too ? It seems to me that there are huge opportunities for AIG-FP employees who would like to work for AIG-FP counterparties.

Do click the link. It is fascinating no matter how confused my ignorance has made me.

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World Economic Meltdown: Crisis for Social Insurance Solvency? Or opportunity to Kill It?

by Bruce Webb

Well the Republican Party and economic conservatives generally have made their position clear, they are openly using the current meltdown as an opportunity to kill Medicare and Social Security as they exist today. We saw this at the Stimulus Summit where the very first question by the Republicans, coming from Senate Minority Leader McConnell, was to ask Obama if he would commit to supporting the Conrad-Gregg plan for Social Security, a plan that starts from the position of crisis and only asks what kind of reform it needs (and if you guessed a combination of benefit cuts and a transition to PRAs you probably hit the mark). And in releasing the Republican counter-budget Ranking Member Ryan made eliminating Medicare for workers currently under the age of 55 in favor of an array of private insurance options a central part of the plan. I’ll leave the Medicare issue for Ezra and the people at TPM Republicans: Let’s Privatize Medicare! and focus on Social Security

It is no secret that Republican’s opposed the creation of Social Security in 1935 and the array of social programs established by the Great Society in 1964-65. Not only do many of them believe that Social Insurance is not a proper function of government, many believe it is unconstitutional, and some agree with Milton Friedman that such programs are immoral and a danger to freedom itself. But they also recognize that these programs are widely popular, attacking them directly having traditionally been seen as certain political death, Social Security and Medicare being seen as the Third Rail of American Politics.

The funding crisis that faced Social Security in the late seventies was seen by these people as their great opportunity. But they recognized that they couldn’t just shut down Social Security overnight they needed to supply a replacement mechanism and a transition plan. And so was born the IRA, the Individual Retirement Account and the Ferrara Plan. (This version is from 1997 but the plan itself dates back to before 1983.) They missed their chance in 1983, and the bitterness is palpable, for example Butler and Germanis called it a ‘fiasco’. So they retooled and moved on adding other plans to the Ferrara Plan, all however having as a central element the ultimate elimination of Social Security in favor of Personal Retirement Accounts. The problem is that all plans share the same three challenges: first how do you finance the transition for older workers who do not have time to build a private retirement plan, second how do you provide an equivalent return for workers making under the median, and three how do you do all that at a cheaper cost than just fixing Social Security via a payroll tax increase of less than 2%?

Answer is below the fold.

Umm, well it turns out that you can’t meet all three challenges at the same time. The various plans tackle this problem in different ways but even after their changes in benefits by changing the indexing they end up with results as seen here.
This table is from the LMS Plan. In each case you end up with substantial transfers from the General Fund, in some cases exceeding those needed to finance scheduled benefits in the system as designed. And remember this is after changing the benefit formula. That is if we examine LMS we see that while it proposes the least amount of transfer it also produces poorer results for lower income workers. When LMS was scored the payroll gap under traditional Social Security was 1.92%, in other words an immediate increase in FICA would have been projected to deliver 100% of the scheduled benefits over the 75 year window. Whereas LMS proposed a package of tax increases and benefit cuts for workers under the cap of 4.2% with the following projected result.

The authors of LMS recognized the problem of selling a 4.2% solution to a problem scored at 1.92% that produced worse results for many lower earners and tried to mitigate the problem some.

However, all three of us support the use of progressive matches to augment the personal accounts of low-income workers as long as a funding mechanism for the matches is identified. Thus, we would support, for example, integrating a paid-for Saver’s Credit with Social Security PRAs so that low-earners would have their PRA contributions matched by the government. We did not incorporate such a provision in our plan because changes to tax policy outside of Social Security are beyond the scope of our proposal.

. Which translates to even higher transfers from the General Fund. And while it may not be charitable my suspicion is that they didn’t include such a proposal because they didn’t like how it scored.

So how do you sell a crappier result at a higher price? Particularly when your Party is out of power? You seize on every opportunity to claim that the current system is ultimately unsustainable and will have to be replaced by something, anything. Moreover since that will require sacrifices by everyone it is important that the plan be bi-partisan, which in practice is meant a compromise on ground pre-established by the Blue Dogs and the Republicans. Hence the demand by McConnell (with implicit threat of withholding support for Obama’s stimulus and budget plans, which of course they did anyway) that Obama embrace Conrad-Gregg. Which in practice means embracing some combination of benefit cuts and PRAs.

What is fatal to such a sales campaign is the prospect that people will listen to Coberly who will helpfully point out you can get a 100% result with less than 2% of payroll (or 1.06% per CBO’s August estimate) or that they will listen to Rosser/Webb who point out that economic growth needed to fully fund Social Security as is is not that high by historical standards and moreover would need to be at those levels to fund PRAs anyway. That is you need to keep people from looking at the numbers or at least undermine people’s faith in them.

Which explains the assault launched last week by Biggs, and this week by his colleague Hassett with an assist from the WaPo. What do you do when people are hearing rumors that Social Security is fully funded until 2041 or 2049? Well you simply change the definition of what ‘funded’ and ‘surplus’ mean, and point out that using a particular version of a data set that February one-month numbers failed to meet your new test, imply that that will continue to be true forever and suggest that the only solution is to sign on in advance to a plan prepared by a bi-partisan group. Hence Hassett this week Recession Bites Into Social Security’s Surplus

We have all been so busy whining about bonuses at American International Group Inc. and arguing about the so-called card- check legislation that we forgot to watch the Social Security surplus. While we were looking away, that surplus disappeared, eight years ahead of schedule.

And what is to be done about this new, recession caused crisis?

That means benefits payments will be under more stress than they have been in modern times. To the extent that the federal government continues to pump money into assorted bailouts and rescues, it will undermine its ability to support a retirement program that is now a drag on the overall picture.

The only responsible course is to do what reformers have been advocating for at least a decade, a step that worked in 1983: Establish a bipartisan commission to recommend fixes to Social Security, and implement them now. The myth that we can postpone reform because everything is just fine has been exposed as such. The time to act is now.

If this sounds familiar to the language deployed in creating the President’s Commission in 2001 or Bush launching his actual assault on Social Security in November 2004 it is not an accident. Because Cato and people and organizations aligned with it have always had the same goal in good times and bad, in 1983, in 2001, in 2004 and now in 2009 they insist that the only answer is to transition Social Security to a system based on Private Retirement Accounts. In fact the original title of Cato’s program makes that abundantly clear, it was called the PROJECT ON SOCIAL SECURITY PRIVATIZATION. That was a little too open so they changed it to Project on Social Security Choice but don’t be fooled, they are working backwards from their preferred solution.

These people wished that Social Security and Medicare had been strangled in their respective cradles, now that they are mature they want to weaken them progressively until they can be drowned in Grover Norquist’s bathtub. None of this is about improving retirement security, all of their plans start with guaranteed benefit cuts that in some cases exceed those of allowing Social Security to go to depletion, and many of them come at a higher cost to workers than just fixing the current system via payroll tax. No it is all about pissing on FDR’s grave and preventing Social Security from becoming the template for achieving universal health coverage. The people at Cato are committed to blocking any expansion of government that might increase transfers from the wealthy down the income scale, regardless of the overall social utility. Arguments that most European health care systems deliver better outcomes to more people at a lower cost leaves them cold, if it means higher taxes on the real upper income folk then no deal. On the other hand they have no objections to an LMS plan that increases taxes on people making up to the 90% income level (but no higher) while delivering crappier benefits to current and future generations of workers. So it really isn’t about overall tax levels or intergenerational equity, like everything else on the agenda of the economic right it all ultimately boils down to taxes on the wealthy and/or reversing the legacy of ‘class traitor’ FDR.

Everytime you see someone from Cato or AEI argue that ‘The time to act is now’ (as Hassett does) understand that the unstated sub-text is ‘before we lose this opportunity to set Social Security on a path to privatization’. The goal never changes, only the circumstances in which they have to operate.

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"Battles" Does Not Mean What You Think It Does

Headline from the Christian Science Monitor: “As G-20 battles protectionism, a cautionary tale in Ecuador” [emphasis mine]

Subhead for that same article: “The country has put steep tariffs on an array of goods. Seventeen of the world’s 20 largest economies have broken recent promises not to take protectionist measures.” [emphasis mine]

Presumably, the other three were smart enough not to make such a stupid promise in the first place.

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I Was Wondering When This Would Come Down

Tom Bozzo

A fund of fund(s) that funneled money into the Madoff scam is in Big Trouble:

Massachusetts regulators have sued the Fairfield Greenwich Group, one of the earliest of these so-called feeder fund managers, for fraud, saying it had repeatedly misled investors about how diligently it checked out Mr. Madoff’s operations over the years.

“Fairfield’s complete disregard of its fiduciary duties to its investors and its flagrant and recurring misrepresentations to its investors rises to the level of fraud,” [said the complaint].

Henry Blodget had nicely ripped Fairfield Greenwich’s marketing claims a while back (Fairfield Greenwich also apparently forgets that the Internets remember all). If the rap can be beaten with a claim that those were mere puffery rather than outright fraud, then the law surely is an ass: performing rigorous analysis of investment managers’ strategies is one of the (few) ways a fund-of-funds can justify its fees-on-fees [*]. An interesting question is why this is being handled as a state matter; maybe now that the Ted Stevens debacle is over, some Justice Department resources can be liberated.

One thing this points to is that the “accredited investor” concept — the “safe harbor” that allows hedge funds to escape much regulation by limiting their services to high-income, high-net-worth investors — deserves a place (however minor) on John Quiggin’s growing rubbish heap of refuted ideas. Merely being rich (or at least upper-middle class) didn’t make the Madoff suckers and suckers-of-suckers sophisticated (in U.S. securities regulation, sophisticated investors is a more restrictive category such that few funds apparently use it), and there’s really little more (if not much less) reason to think they can evaluate complicated investment strategies than that they can reliably complete their own taxes. Ultimately there’s a reliance, possibly at a couple degrees of separation (part of the fraud that I leave to the sociologists), on actual expertise.


[*] That is, substantively justify, as opposed to charging what convention and apparent market failure allows the market to bear.

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Another look at the budget deficits


Another look at the budget deficit:

Discussions of the budget outlook typically begin with the budget “baseline”… In building the baseline, CBO follows rules that … generally assume that current laws affecting taxes and mandatory spending will continue without change.

Sometimes, however, current law diverges from current budget policies. This year, the official budget baseline incorporates several especially unrealistic assumptions. In particular, the latest baseline assumes that Congress will allow the 2001 and 2003 tax cuts, relief from the Alternative Minimum Tax, and other temporary tax provisions all to expire. It also assumes that the reductions in physician fees called for under Medicare’s sustainable growth rate formula — including a 20 percent reduction in 2010 — will actually take effect, even though Congress has stepped in to prevent such reductions since 2003. Finally, the baseline extrapolates enacted defense appropriations for 2009, which represent only a portion of the amount needed for operations in Iraq and Afghanistan this year and in coming years. …

Budget experts have been saying for a number of years that the official baseline departs sharply from reality. … In February 2009, CBO issued alternative budget scenarios that offered a more accurate representation of current budgetary policy. [2] We rely here on elements of those alternative budget projections and have updated them to be consistent with CBO’s new March 2009 baseline…

In our projection of the deficit under current budget policies, we adjust the official CBO baseline… These adjustments are detailed in the appendix table. Cumulatively, they point to deficits of $10.2 trillion over the next 10 years… CBO estimates that the cumulative deficit from 2010 to 2019 under the President’s proposals would total $9.3 trillion. Compared to our realistic baseline, the President’s proposals would reduce projected deficits by about $900 billion over the 2010-2019 period. [4] The deficit would be higher in 2009 and 2010, however, because the budget sets aside an additional $250 billion for stabilization of financial markets. …

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Federal Register

By Spencer,

Just checked this years Federal Register. In Team Bush’s final year it was 80,700 pages long, the second highest on record.

But now that we have the complete Bush record we find that on average the Register was 75,894 pages over the eight years of his terms. This set a new record for any President surpassing the previous record held by Jimmy Carter.

So much for the anti-government, anti-regulation Republican administration.

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New Tactics in an Old War: Vanishing the Social Security Surplus

by Bruce Webb

A new front was opened Monday in the war on Social Security. The first shot came from Kevin Hassett of AEI who wrote a piece for Bloomberg Recession Bites Into Social Security’s Surplus

We have all been so busy whining about bonuses at American International Group Inc. and arguing about the so-called card- check legislation that we forgot to watch the Social Security surplus. While we were looking away, that surplus disappeared, eight years ahead of schedule.

This was immediately picked up by the Washington Post stenographers in a piece from Lori Montgomery on Tuesday Recession Puts a Major Strain On Social Security Trust Fund: As Payroll Tax Revenue Falls, So Does Surplus

With unemployment rising, the payroll tax revenue that finances Social Security benefits for nearly 51 million retirees and other recipients is falling, according to a report from the Congressional Budget Office. As a result, the trust fund’s annual surplus is forecast to all but vanish next year — nearly a decade ahead of schedule — and deprive the government of billions of dollars it had been counting on to help balance the nation’s books.

If true this would be a totally ‘Holy Crap Batman!’ moment, because per the 2008 Report Social Security ran a positive balance of $190 billion in 2007, was projected to run a $196 billion positive balance in 2008 and $212 billion in 2009 Table IV.A3.—Operations of the Combined OASI and DI Trust Funds, Calendar Years 2003-17. In fact it was still projected to be adding assets to the tune of $213 billion in 2017. How could all of that just vanish without anyone noticing?

Answer? It didn’t. Hassett is mostly just playing word games. If we back up and examine the Historical Operations of the Combined OASI and DI Trust Funds, Calendar Years 1957-2007 we can see combined balances in the Trust Funds at the end of 1993 of $378 billion dollars with a Trust Fund ratio of 107, which is to say just over one year of reserves. In the years since that balance has grown to $2.4 trillion and a TF ratio above 350. The increase in the fund balance is normally called the ‘Social Security surplus’ and is scored as such when calculating the Unified Budget deficit or surplus. But in point of fact Social Security does not extract the full amount of the fund increase from the current year economy, a big part of the annual surplus is from accrued interest on the Trust Fund which in 2003 accounted for more than half of that surplus and the percentage is increasing all the time. So if we examine Table IV.B3 and look at the projections for 2017 we can see that of a total fund increase of $213 billion that $238 billion is the result of interest. Or in other words the amount of dollars extracted from the economy via FICA payroll tax and tax on benefits will be $25 billion less than is needed to pay then current benefits, an amount that will have to be made up by a PARTIAL payment of interest due on the Trust Fund.

Hassett has simply redefined this long known crossover point (known as Shortfall) as the time that ‘surpluses’ vanish. And then piles on by claiming that February numbers show that it had actually moved right up to today. This is totally misleading and verging on outright lying. To see why follow me below the fold.

While commenters and the Trustees alike for most purposes treat the Trust Funds as a combined whole there are legally two different funds, OASI (Old Age/Survivors Insurance) and DI (Disability Insurance). DI is approximately 10% of the size of OAS and has in recent years been much the weaker of the two. While the combined funds are projected to reach Shortfall in 2017 when DI is examined in isolation we can see that it actually hit Shortfall in 2005. From that point on the difference between cost and income excluding interest has been made up by tapping the interest on the DI Trust Fund. Even before the current downturn DI cost was projected to run ahead of total income including interest in 2012. As it turns out that event happened sometime between June and August of 2008. In June the DI Trust Fund was sitting at $220 billion which was actually ahead of Intermediate Cost’s year end projection and close to that of Low Cost’s year-end of $221 billion. By August it had actually dropped to $219 billion and has continued to sink from there until in February it had fallen to $214 billion down a pretty shocking $1.8 billion for the month. Which led Andrew Biggs to post the numbers under the title Slowdown Slashes Social Security Surplus. In fact the DI deficit overwhelmed the $525 million OAS surplus for the month to create a combined OASDI deficit of $1.25 billion and so leading Hassett and his faithful stenographer Montgomery to claim the sky was falling.

This is nonsense, they are simply counting on readers to not know these numbers or the breakdown of them between OAS and DI or how DI actually interacts with OAS. Certainly neither makes any effort to actually supply the numbers or the context, in fact Hassett who links to just about everything he references somehow manages to not link the the CBO and Social Security documents he is drawing from. So I guess it is up to me to supply that context.

There are plenty of people who would qualify for DI who remain in the workforce. Some just like their jobs, others make more income than their DI check would yield, and most of them are interested in boosting their ultimate OAS check. Because DI is not permanent, at full retirement age recipients are shifted over to OAS. This gives people who would qualify for DI an incentive to continuing working and making contributions to OAS. Until of course they lose their job and are faced with the choice of say trying to find new work as a wheelchair bound person over the age of 55 or taking DI as a form of early-early retirement. Well it looks like a large number of workers are letting their feet or perhaps their wheels do the talking. The result is a big yet temporary hit on the DI Trust Fund (temporary because I think we can readily assume that most of these people are approaching retirement years and will soon transition out of DI anyway). Moreover this hit on DI is offset somewhat by them probably getting a reduced check under OAS than if they had managed to stay in the work force. (And BTW that is also true for that group of workers who are old enough for early retirement, certainly if I were unemployed and 62 I would be filing (because you can always go back in the workforce and qualify for higher permanent benefits by paying back early retirement ones-and IIRC interest free)). Making the following statement from Hassett simply wrong.

Permanent Changes

Second, many individuals who retire early or go on disability in this crisis may not return to the workforce once the recession ends, so the higher payments are probably with us forever.

Hmm no, the hit to DI is temporary while the hit from increased levels of early retirement is offset actuarially by a lower permanent retirement check. Plus the followup is wrong as well.

Finally, Social Security just increased everyone’s benefits by 5.8 percent to cover the increase in the cost of living last year, the biggest increase since 1982. That adjustment jacks up benefits payments permanently.

Uh Kevin, a prolonged period of low inflation or deflation lowers benefits permanently compared the the baseline projection, that knife cuts both ways.

DI has long been in actuarial trouble per Intermediate Cost projections. As it turns out it was actually outperforming those projections by running bigger surpluses than anticipated in 2006, 2007 and the first half of 2008. But even with that it was pretty clear that something would need to be done for DI in the relative short run, the 2008 Report projected DI Trust Fund depletion for 2025 or sixteen years ahead of the combined depletion date of 2041. DI TF depletion may well move up some as a result of this downturn, and the longer and more severe the recession gets the more effect we can expect to see. But a potential crisis in DI is still not a reason to tamper with OAS. What we have here is just another use of crisis conflation, just as a real challenge to Medicare and Medicaid is used to sell ‘Entitlements Crisis’ so is a problem with DI turned into a crisis for Social Security as a whole. These guys want to kill traditional Social Security and always have.

OASDI cash surpluses were already dropping but the overall surplus is continuing to rise and in fact will continue to do so even after cash transfers from the General Fund start redeeming part of the interest. Only when those transfers exceed the total amount of interest owed and principal starts being paid down can Social Security even plausibly be said to be in deficit. And even that is a little odd considering at that point the Trust Funds are projected to have a combined $5.7 trillion in assets. Though he won’t come out and say it Hassett’s argument implicitly denies that workers have a valid claim on the interest and principal in the Trust Funds, his talk of ‘vanishing surpluses’ is just a gambit in an effort to abrogate the trillions of dollars in excess contributions plus legally accrued interest that is still adding to the balances in the combined Trust Funds.

Don’t fall for this bait and switch attempt to steal our money. Social Security will still run a surplus in 2009 from the $110 billion in interest owed on the current balance plus the probably small OAS surplus. Fixing DI is something we could do but even if it runs deficits at February’s level it still has about ten years of available balances, there really is now rush. If we did decide to fix it we are faced with an long term actuarial gap projected at 0.24% of payroll in the 2008 Report, which translates to $120/year for a median household earning $50,000. Hassett is just trying to make a mountain out of a mole hill.

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Another kind of recovery


Zero Hedge notes the beginnings of another kind of recovery by the big guys. This paragraph caught my eye.

While on one hand it is surprising that NTRS could generate losses on lender arrangements, which traditionally have a 0 lower return bound, what is much more shocking, is that such a large company as Exxon is taking legal action to recover pension losses. This will likely soon become the modus operandi for all major corporate pension schemes that have experienced losses, who piggy back on this example as a means of recouping at least a portion of losses. And taking from Newton’s 3rd law, the defendants will likely end up having to pony up billions of new dollars.


“Lastly, as Northern Trust (at least for now), and many of the other collateral custodians, are TARP recipients, this will present a brand new and unanticipated cog in the taxpayer-bank relationship, as banks will end up having to potentially pay out taxpayer money to pension funds, which invest the capital of these very same taxpayers. The circularity is enough to make one’s head spin.”

I have never had to play musical chairs for a haircut, but the circling is widening.

Update: H/t reader SBayer for summary of plaintiffs case.

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