MOORLACH UPDATE — The FLaw of Averages — April 8, 2011

This Christmas, I received a couple of books that I’m mentioned in.  Sam L. Savage’s book is “The FLaw of Averages – Why We Underestimate Risk in the Face of Uncertainty.”  It’s published by John Wiley & Sons, Inc. (Copyright 2009, 47 chapters, 392 pages).

Sam L. Savage is a Consulting Professor of Management Science and Engineering at Stanford University and a Fellow of the Judge Business School at the University of Cambridge.  His book explains why plans based on average assumptions are wrong, on average, in areas as diverse as finance, healthcare, accounting, the war on terror, and climate change.  For more, check out http://www.flawofaverages.com/.

I’m mentioned in the opening chapter, which shares the title of the book.  The subtitle is “Red Ink in Orange County.”  It’s short and sweet, so I’m providing it in full.  Unfortunately, it is also full of errors.  Citron’s portfolio, known as the Orange County Investment Pool (OCIP), is the cash account (money market fund) for the County; it is not a pension fund.  Many county employees used the OCIP for their I.R.C. Sec. 457 supplemental retirement plan contributions, but these were a de minimis portion of the pool.  Futhermore, I have no recollection of potential investors being turned away from the OCIP.  Citron’s Assistant Treasurer, Matt Raabe, was very active in soliciting new depositors and spent a considerable amount of time during the 1994 Treasurer-Tax Collector campaign attempting to prevent current depositors from withdrawing from the pool.

Summer 1994:  Interest rates are low and are expected to remain so or fall even farther.  Orange County, California, has created a financial portfolio to fund the pensions of its teachers and firefighters, based on the expected future behavior of interest rates.  For several years, this fund, run by County Treasurer Robert Citron, has yielded much higher returns than comparable funds in similar municipalities.  For the sophisticated investor, this is actually a red flag; there is no free lunch, as they say.  John Moorlach, who unsuccessfully runs against Citron in 1994, argues in his campaign that “Mr. Citron believes he can accurately anticipate the market all the time, and also outperform everyone.  That’s impossible.”  Nonetheless, so many people line up with their money that the county has to turn investors away.  In fact, the fund has naively leveraged itself into a very risky position and goes bankrupt in December of 1994.

In 1995, Professor Philippe Jorion of the University of California in Irvine showed that if the county officials had explicitly considered the well documented range of interest rate uncertainties instead of a single average interest rate scenario, they would easily have detected the likelihood of the looming train wreck.

There was absolutely no need for such a pension fund to shoot for the moon.  Moreover, had the county’s government members understood the increased risk they faced as a result, they would no doubt have adopted a more conservative investment strategy in time to prevent the debacle.

BONUS:  Property tax payments are due on Monday.  (See LOOK BACK below.)

FIVE-YEAR LOOK BACKS

April 9

2006

If you are a real property owner, the second installment of your property tax is due on Monday.  The due date is normally April 10, but this year the 10th falls on a Sunday.  Jonathan Lansner of the OC Register covered the topic in “Tardiness on taxes remains troubling.”  This year, 2011, we’re ahead of schedule, according to Treasurer-Tax Collector Shari Freidenrich.  Here was the perspective from five years ago, which looks prophetic in retrospect.

                It was the most worrisome number I’ve recently seen about Orange County’s housing market.

In January, I told you that a decade has passed since this many of us missed paying a December installment of property taxes.

So with tax installment No. 2 due Monday — have you paid yet? — I checked with the county’s tax collector, John Moorlach, to see if we’ve made progress.

I’ve long wondered when the Fed’s two-year campaign to cool the economy would click. Raising short-term interest rates was going to eventually smack homebuyers with adjustable-rate mortgages in the wallet. That’s a large group in this town.

The county tax collector’s data from January boosted my hunch. Last week, Moorlach‘s staff was kind enough to whip up an interim report for me.

The fresh data show that the early trend wasn’t any statistical fluke, as we continue to be annoyingly late on our property taxes:

Through the start of April, 24,701 first-installment bills were still late — 16 percent more than the same time a year ago. The tax collector only sent out 2 percent more bills this year.

Those late bills were for $38 million in total taxes, up 37 percent from a year ago. That handily exceeds the 11 percent expansion in overall property taxes due to soaring home prices.

Since the last tally in January, Orange Countians managed to pay $50 million worth of their tardy first-installment bills. (That doesn’t include the 10 percent late fee — or the 18 percent annual interest penalties that start accruing July 1!)

Still, the county’s short 2 percent of the $1.9 billion due — from 3 percent of all taxpayers. The typical tardy payer owes a decidedly below-average bill of $1,560.

"I wasn’t surprised. So many people are stretching (to buy a home). It seems intuitive that some people are having a tougher time," Moorlach says. He calls payment results for this upcoming bill "the real test."

Other markers of homeowner financial woes are creeping up, too.

In the first two months of the year, mortgage makers served 700 Orange County borrowers with formal default notices — the first step toward foreclosure. That’s up 31 per cent vs. 2005.

In the same period, 39 county homeowners lost their homes to the lender through foreclosure. That’s more than double 2005.

Panic isn’t necessary. Yet.

The current levels of late tax payments, defaults and foreclosures are nowhere near the depressing heights hit during the 1990s great housing debacle. Moorlach suggests that bill-paying habits in recent years were so solid that one could argue such high performance was simply unsustainable.

Additionally, plenty of people in this town aren’t strapped by house costs. The tax collector’s tally shows that as of the start of April, 62.5 percent of taxpayers had already coughed up the second installment money due Monday — did I mention that deadline?

At the same moment in 2005, early payers had paid 61 percent of the total second bill due.

The tax collector’s data reaffirmed the notion that this is a tale of two cities.

Housing costs are no headache to a healthy chunk of The O.C. But a growing slice of the population may be feeling triple pain — pricey homes, rising mortgage payments and, perhaps, a slightly sluggish economy.

So far, the financially challenged group is a manageable lot. If this crowd expands dramatically, their tight wallets will hurt more than the tax collector and lenders.

If these folks decide to sell their homes to avert financial disaster, that added supply will challenge the housing market. And if homeowners who are late on tax and mortgage payments prune back shopping or entertaining, that could chill the retailing business.

Late tax payments are more than a bureaucratic woe. They add up to a real economic trend with big-picture consequences.

(714) 796-7966 or jlansner@ocregister.com

In a separate graphic:

Deadline coming

Monday is the due date for the second installment of 2005-2006 property taxes. Here’s how you can pay:

BY MAIL: Must be postmarked by Monday. Send to O.C. Tax Collector, P.O. Box 1980, Santa Ana, CA 92702-1980

BY PHONE: (714) 834-3411. Until midnight Monday, credit card* only.

IN PERSON: At Hall of Administration, 10 Civic Center Plaza in Santa Ana. Office open until 6 p.m. Monday. Drop box available afterwards.

ONLINE: Check or credit card*. Go to tax.ocgov.com/treas.    * Service fee applies on card payment.

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