When I read all of the complaints by people and organizations that have lost everything investing in Bernard Madoff’s Hedge Fund, I think about a recent Country song titled “…What Was I Thinking…” People who invest should know four basic principles:
1. Never place all of you investment in something where you have no idea how it will be used. Madoff never described how his Hedge Fund worked. This should have been a clue that something was fishy in on Wall Street.
2. Never put more than you can afford to lose in any one investment. Usually this means no more that 5% of you total investment. Endowment Funds, Pension Funds, and Financial Institutions should know this. In addition, individuals who are investing their pensions should follow the same philosophy.
3. If something is too good to be true it probably is. Madoff was consistently paying steady returns no matter what happened to the market. Markets are volatile by their nature. As a result, it is almost impossible to have steady returns over time.
4. Higher returns are the result of higher risk. 25 Years ago the President of my firm asked me to invest with a firm that was offering 75 to 125 basis points above market for Repurchase Agreements. I refused, saying that there must be a risk that hadn’t been identified. I only kept my job as Treasurer because the CFO backed me. Several months later local school districts and municipalities lost millions when the seller went under.
These four items may not make you rich however; they can help you from ending up poor. Individuals have to be especially careful in regard to these principles because people have a harder time recovering than organizations.
I firmly believe that the Trustees of the Charities that lost all of their endowments were lax in following their fiduciary responsibilities. While I feel for the beneficiaries of the charities; I don’t have sympathy with the managements or trustees. What were they thinking?
Tuesday, December 16, 2008
Sunday, December 14, 2008
IS DON QUIXOTE BERNANKE FIGHTING WINDMILLS WITH HIS LOYAL SANCHO PAULSON BY HIS SIDE
Once Again I read the newspaper and I am astounded by the cluelessness of our economic leadership. Today there is talk that the Fed will again lower the interest rate at which banks lend to each other (The Federal Funds Rate). You would think that by now Mr. Bernanke would realize that the country is in a liquidity trap where the traditional tools of Monetary Policy are ineffective. This is evidenced by the fact that both Mr. Bernanke and Mr. Paulson have been pouring liquidity intro the systems and the banks have responded by buying other banks, paying dividends, and funding bonus pools instead of making loans with the new found liquidity. Attacking an economic crisis with monetary tools when the country is in a liquidity trap is akin to tilting at windmills in the hope of killing a dragon.
The time has come to start using Keynesian aggregate demand based economics instead of the pump priming of liquidity enhancement. The pump is primed; the liquidity is there. What we need now is someone to start demanding the water. This can only be accomplished by a government spending stimulus package that is large enough to turn the economy around. This means that we need to spend as if we were fighting a war. All of the criticisms of the New Deal boil down to the fact that even FDR was too timid in his spending proposals. Alan Greenspan set the precedent of a Fed chief commenting on Fiscal Policy. It is now Mr. Bernanke’s turn to push Paulson toward a fiscal stimulus. At a minimum this should be a set of loans to GM and Chrysler that would stave off a shrinkage in demand. These two firms will eventually have to file for bankruptcy, but the inevitable can be delayed until the economy is better able to manage it and congress has time to arrange a post filing financing package which will mitigate the worst effects of a filing.
The time has come to start using Keynesian aggregate demand based economics instead of the pump priming of liquidity enhancement. The pump is primed; the liquidity is there. What we need now is someone to start demanding the water. This can only be accomplished by a government spending stimulus package that is large enough to turn the economy around. This means that we need to spend as if we were fighting a war. All of the criticisms of the New Deal boil down to the fact that even FDR was too timid in his spending proposals. Alan Greenspan set the precedent of a Fed chief commenting on Fiscal Policy. It is now Mr. Bernanke’s turn to push Paulson toward a fiscal stimulus. At a minimum this should be a set of loans to GM and Chrysler that would stave off a shrinkage in demand. These two firms will eventually have to file for bankruptcy, but the inevitable can be delayed until the economy is better able to manage it and congress has time to arrange a post filing financing package which will mitigate the worst effects of a filing.
Wednesday, December 10, 2008
What Fools the Conservatives Be
The title of this piece is very misleading because, for one of the rare instances in my life, I find that I am actually in agreement with the conservatives regarding the Detroit Bailout. The conservatives are calling for a “Structured Bankruptcy” in- stead of the bailout that is being proposed by democrats. In a November 26 letter to the editor of the “Allentown Morning Call” I outlined the advantages of a structured bankruptcy without using the term.
So, why am I calling the congressional conservatives fools? The problem lies in the fact that politics was once called the art of the possible. (I wish I could remember where the quote came from) The Republican leadership seems to have forgotten this. They are so intent on getting their own way that they appear to be willing to let the country slide further into the abyss of depression rather than agree to a program, which although flawed, has a possibility of passing. Eventually, GM and Chrysler will have to go for a structured bankruptcy. However, just letting them go into Chapter 11 now, without a government financed structure, would throw innumerable Americans out of work and exacerbate the economic downturn. Getting a bankruptcy plan passed under current conditions is impossible.
There is a time for principle and a time for action. Sometimes they do not coincide. This is one of those times. Conservative obstructionism may insure that Republican congressional representation remains out of power for another 40 years as happened in the mid 20th century.
So, why am I calling the congressional conservatives fools? The problem lies in the fact that politics was once called the art of the possible. (I wish I could remember where the quote came from) The Republican leadership seems to have forgotten this. They are so intent on getting their own way that they appear to be willing to let the country slide further into the abyss of depression rather than agree to a program, which although flawed, has a possibility of passing. Eventually, GM and Chrysler will have to go for a structured bankruptcy. However, just letting them go into Chapter 11 now, without a government financed structure, would throw innumerable Americans out of work and exacerbate the economic downturn. Getting a bankruptcy plan passed under current conditions is impossible.
There is a time for principle and a time for action. Sometimes they do not coincide. This is one of those times. Conservative obstructionism may insure that Republican congressional representation remains out of power for another 40 years as happened in the mid 20th century.
Monday, December 01, 2008
LIVING IN LA-LA LAND
This afternoon I listened to Paulson and Bernanke answer questions regarding the bailout and alternative solutions to our financial problems. Paulson was asked why he is not giving greater support to Sheila Bair’s proposals from the FDIC. Mr. Paulson’s response boiled down to the fact that he was more interested in saving Capital Markets.
What he forgets is that the failure of the Capital Markets comes from the inability to price Securitized Debt Derivatives because of the failure of the underlying debt which was securitized. This inability to price the derivatives means that their book-value is limited. (Simply, you can’t sell the derivatives because nobody knows if the original debt is good.) Limited book-value means that some of the financial institutions’ capital has vanished.
However, if the underlying debt is somehow guaranteed then the securities would become marketable. If the securities are marketable the markets will establish a price and capital would be restored. This is the approach that Ms. Blair has proposed and Mr. Paulson has pooh-poohed because he believes that it might apply to mortgages but, according to him, it doesn’t apply to what we are facing in the near future.
The future problems facing us have to do with more securitized debt. This time it is in car loans and credit card debt that has been bundled and sold as derivatives. Again, if we find a way to insure the debt, we can stabilize the price of the derivatives and avert a meltdown.
This is where Mr. Paulson is living in La-La Land. He is so close to the capital markets community that he forgets that the USA is a consumer driven economy. He wants to insure the capital markets without addressing the needs of the consumer. However, the capital markets don’t trust the consumer and are raising interest rates and reducing credit limits on credit cards in spite of the capital infusions Mr. Paulson has provided them. Convincing the consumers that they will not face foreclosure and that their debt will be put on a feasible workout schedule is the only way to restore consumer confidence and hopefully increase spending by those with the capacity to do so. Ms Blair’s approach seems to accomplish this goal as well as the goal of stabilizing the prices of the derivatives and should be expanded to other types of underlying debt.
What he forgets is that the failure of the Capital Markets comes from the inability to price Securitized Debt Derivatives because of the failure of the underlying debt which was securitized. This inability to price the derivatives means that their book-value is limited. (Simply, you can’t sell the derivatives because nobody knows if the original debt is good.) Limited book-value means that some of the financial institutions’ capital has vanished.
However, if the underlying debt is somehow guaranteed then the securities would become marketable. If the securities are marketable the markets will establish a price and capital would be restored. This is the approach that Ms. Blair has proposed and Mr. Paulson has pooh-poohed because he believes that it might apply to mortgages but, according to him, it doesn’t apply to what we are facing in the near future.
The future problems facing us have to do with more securitized debt. This time it is in car loans and credit card debt that has been bundled and sold as derivatives. Again, if we find a way to insure the debt, we can stabilize the price of the derivatives and avert a meltdown.
This is where Mr. Paulson is living in La-La Land. He is so close to the capital markets community that he forgets that the USA is a consumer driven economy. He wants to insure the capital markets without addressing the needs of the consumer. However, the capital markets don’t trust the consumer and are raising interest rates and reducing credit limits on credit cards in spite of the capital infusions Mr. Paulson has provided them. Convincing the consumers that they will not face foreclosure and that their debt will be put on a feasible workout schedule is the only way to restore consumer confidence and hopefully increase spending by those with the capacity to do so. Ms Blair’s approach seems to accomplish this goal as well as the goal of stabilizing the prices of the derivatives and should be expanded to other types of underlying debt.
Saturday, November 15, 2008
THE CASE AGAINST AN AUTO INDUSTRY BAILOUT
Today (14 Nov 08) President Bush called for $25 Billion in loans to the automobile industry. If Mr. Bush really believed in his “market work best” philosophy he would not be asking for these loans. Instead, he would say that the companies should file for bankruptcy under chapter 11. Chapter 11 allows companies to continue in existence while they reorganize. However, the current leadership of the companies, the basic constituency of Mr. Bush, would not be protected. In addition, the golden parachutes of the corporate elite could be nullified by the bankruptcy courts. The President who personifies the politics of greed could never allow this to happen.
On top of the protection of the current management, we are faced with continuing the support of the very people who made the errors which drove the companies to the brink. For the most part, these are the people who decided that they should rely on vehicles that can only be sold when energy is cheap. They gave up on basic transportation and pushed brobdignagian vehicles where it was possible to joke that the best measure of efficiency was gallons per mile rather than miles per gallon. They took the attitude that they were too big to fail. This may have some truth in the financial sector. However, reorganization is often the best solution in the manufacturing sector. If we want to bail them out and minimize the consequences the government should say that they will supply the financing only after GM files for Chapter 11. This will allow for reorganization without the burden of the current incompetent management and will allow the firm to renegotiate some of its most onerous obligations.
On top of the protection of the current management, we are faced with continuing the support of the very people who made the errors which drove the companies to the brink. For the most part, these are the people who decided that they should rely on vehicles that can only be sold when energy is cheap. They gave up on basic transportation and pushed brobdignagian vehicles where it was possible to joke that the best measure of efficiency was gallons per mile rather than miles per gallon. They took the attitude that they were too big to fail. This may have some truth in the financial sector. However, reorganization is often the best solution in the manufacturing sector. If we want to bail them out and minimize the consequences the government should say that they will supply the financing only after GM files for Chapter 11. This will allow for reorganization without the burden of the current incompetent management and will allow the firm to renegotiate some of its most onerous obligations.
Monday, November 03, 2008
Why Government Spending Over Tax Cuts?
In my last blog I indicated that increasing government spending has a larger impact on the economy that tax cuts. A reader has asked me to explain this as a Part 2 to that blog and I will take this opportunity to do so.
The problem arises from something called the multiplier. Whenever income is spent it becomes income to someone else. People do not spend all of their income. Some is saved, some is used to pay down debt, and some is spent overseas (imports). The multiplier is 1 divided by the proportion of new income not going to spending. To get the total re-spending effect we multiply the initial spending by the multiplier. If on average people do not spend 10% of their new income then the multiplier would be 1/.10 = 10. Therefore, a tax refund of $100 million would result in initial new spending of $90 million and a total re-spending effect of $90 x 10 = $900 million.
On the other hand, if the government builds new roads equal to $100 million the initial new spending is the $100 million. The total re-pending effect would then be $100 million x 10 = $1 trillion. A little algebra indicates that getting a $1 trillion increase in economic activity would require $111 million in tax cuts. In this simple example tax cuts would cost the treasury 11% more than increases in public spending. Lets face it, this means 11% higher cost to us. Either way the government would be required to borrow. The issue is which leads to a lower debt?
The right wing says so what if tax cuts cost more; we know how to spend our money better than the government does. The question is: do we? Will we spend our tax cuts rebuilding our infrastructure? Will we install sewage treatment plants? Will we invest in clean coal research? All of these things need doing but the private sector returns for doing them are limited.
The problem arises from something called the multiplier. Whenever income is spent it becomes income to someone else. People do not spend all of their income. Some is saved, some is used to pay down debt, and some is spent overseas (imports). The multiplier is 1 divided by the proportion of new income not going to spending. To get the total re-spending effect we multiply the initial spending by the multiplier. If on average people do not spend 10% of their new income then the multiplier would be 1/.10 = 10. Therefore, a tax refund of $100 million would result in initial new spending of $90 million and a total re-spending effect of $90 x 10 = $900 million.
On the other hand, if the government builds new roads equal to $100 million the initial new spending is the $100 million. The total re-pending effect would then be $100 million x 10 = $1 trillion. A little algebra indicates that getting a $1 trillion increase in economic activity would require $111 million in tax cuts. In this simple example tax cuts would cost the treasury 11% more than increases in public spending. Lets face it, this means 11% higher cost to us. Either way the government would be required to borrow. The issue is which leads to a lower debt?
The right wing says so what if tax cuts cost more; we know how to spend our money better than the government does. The question is: do we? Will we spend our tax cuts rebuilding our infrastructure? Will we install sewage treatment plants? Will we invest in clean coal research? All of these things need doing but the private sector returns for doing them are limited.
Sunday, November 02, 2008
THE POTENTIAL FAILURE OF MONETARY POLICY
Writing in today’s (10/31/08) New York Times Paul Krugman labeled our current financial crisis a “Liquidity Trap.” This is a situation where attempts to lower the interest rate have no effect on investment spending by businesses. The USA hasn’t seen a Liquidity Trap since the great depression. Now, analysts are predicting that the Fed might lower the Fed Funds Rate, the rate at which banks lend to each other, to zero. The Japanese tried this during their economic malaise of the 90’s and it had almost no impact.
Although the current condition of the US economy is unlike that of the 90’s economy of Japan, we are faced with a similar question. That is: are banks willing to lend? The current answer in the US economy is NO! Banks are in panic mode. As the Fed pumps money into the system, the money supply will continue to shrink because the banks are unwilling to lend. On the other hand, businesses are only willing to borrow to meet working capital (short-term) needs rather than capital expansion. With consumers worried about their futures, they have reduced their discretionary spending. An absence of demand will lead to a reduction of businesses' plans for capital expansion even if they can borrow at minimal cost. This situation points up a flaw in Supply Side Economics. The Supply Side assumes that falling costs of capital will induce investment. It ignores the behavioral element which indicates that executives would be hard pressed to recommend expansion when they have excess capacity. In addition, market analyst would pillory executives trying to expand capacity during an economic down turn.
All of this indicates that McCain’s economic plan that is based upon increased saving leading to reduced costs of capital and Bernanke’s monetary expansion will have little or no effect upon an economic recovery. The great depression, and Keynes, has taught us that demand is still the primary determinant of economic activity. The Supply Side mantra of Say’s Law: “…supply creates its own demand…”works only in an economy that is already recovering. What the economy needs is a stimulus to demand. Given the deteriorating condition of our national infrastructure this would be best accomplished through an increase in government spending rather than tax cuts. In addition, it is well known that accomplishing a given increase in economic activity costs more with tax cuts than it does with an increase in government spending. Explaining the reasons for this would take too much space for a blog. However, Mr. Obama should take note of this problem if should he be elected.
Although the current condition of the US economy is unlike that of the 90’s economy of Japan, we are faced with a similar question. That is: are banks willing to lend? The current answer in the US economy is NO! Banks are in panic mode. As the Fed pumps money into the system, the money supply will continue to shrink because the banks are unwilling to lend. On the other hand, businesses are only willing to borrow to meet working capital (short-term) needs rather than capital expansion. With consumers worried about their futures, they have reduced their discretionary spending. An absence of demand will lead to a reduction of businesses' plans for capital expansion even if they can borrow at minimal cost. This situation points up a flaw in Supply Side Economics. The Supply Side assumes that falling costs of capital will induce investment. It ignores the behavioral element which indicates that executives would be hard pressed to recommend expansion when they have excess capacity. In addition, market analyst would pillory executives trying to expand capacity during an economic down turn.
All of this indicates that McCain’s economic plan that is based upon increased saving leading to reduced costs of capital and Bernanke’s monetary expansion will have little or no effect upon an economic recovery. The great depression, and Keynes, has taught us that demand is still the primary determinant of economic activity. The Supply Side mantra of Say’s Law: “…supply creates its own demand…”works only in an economy that is already recovering. What the economy needs is a stimulus to demand. Given the deteriorating condition of our national infrastructure this would be best accomplished through an increase in government spending rather than tax cuts. In addition, it is well known that accomplishing a given increase in economic activity costs more with tax cuts than it does with an increase in government spending. Explaining the reasons for this would take too much space for a blog. However, Mr. Obama should take note of this problem if should he be elected.
Wednesday, October 29, 2008
Mc Cain Clings to the Solutions That Even Greenspan Says were Wrong
Today, in Florida, John McCain once again proved that he has no understanding of economics. He stated that the nation’s economic problems would pass. This is the same argument that classical economists made back during the depression. They said that markets are self correcting and that unemployment and recession are self correcting. This is the same as the specious argument that market discipline would prevent economic excesses. Keynes, much maligned by the Greenspan school of economists, proved that recession was not self correcting.
McCain has also hung his economic hat on the argument that giving businesses breaks to reduce the cost of investing will stimulate the economy. This is saying that supply creates its own demand. This was known, by economists, as “Say’s Law.” The problem is that the biggest boost to investment is demand for the product. If there is no demand, and/or there is excess capacity businesses are not going to invest in equipment, buildings, or inventory.
Another element of McCain’s economic program calls for the reduction of taxes at upper income levels. This will supposedly accomplish two things. Firstly, the rich will save thereby increasing funds available for investment lending. Secondly, these funds will thereby reduce interest rates. For this to work, there have to be banks that are willing to lend and businesses willing to borrow for investment purposes. In the absence of demand, we have already established that businesses are not willing to borrow for investment. In addition, this approach will work only if banks are willing to lend. Observation of current banking behavior indicates that they are not willing to lend. Even with bailout money from the government banks are too risk averse to lend.
Recently, Alan Greenspan has stated that he was mistaken in the belief that actors on the financial stage would act appropriately. What makes McCain thing that this will change?
McCain has also hung his economic hat on the argument that giving businesses breaks to reduce the cost of investing will stimulate the economy. This is saying that supply creates its own demand. This was known, by economists, as “Say’s Law.” The problem is that the biggest boost to investment is demand for the product. If there is no demand, and/or there is excess capacity businesses are not going to invest in equipment, buildings, or inventory.
Another element of McCain’s economic program calls for the reduction of taxes at upper income levels. This will supposedly accomplish two things. Firstly, the rich will save thereby increasing funds available for investment lending. Secondly, these funds will thereby reduce interest rates. For this to work, there have to be banks that are willing to lend and businesses willing to borrow for investment purposes. In the absence of demand, we have already established that businesses are not willing to borrow for investment. In addition, this approach will work only if banks are willing to lend. Observation of current banking behavior indicates that they are not willing to lend. Even with bailout money from the government banks are too risk averse to lend.
Recently, Alan Greenspan has stated that he was mistaken in the belief that actors on the financial stage would act appropriately. What makes McCain thing that this will change?
Saturday, October 11, 2008
The Crisis in Non-Financial Companies
As we look about the business landscape we find that many older, former blue-chip, firms are on the brink of financial collapse. Given the shrinkage of credit, many are asking if these firms have enough cash to survive a major recession. GM is looking to the possibility of using the Fed’s discount window and GE has already started marketing commercial paper to the Fed. Why are these firms so cash poor that they have to go to extremes to survive?
I blame the Wall Street analysts and the MBA programs of America. In the last 40 years there has been a growing emphasis on distributing cash to share-holders at the expense of a company’s future financial health. About eight years ago I spoke with the management of a firm which had recently moved from listing on the American Stock Exchange to listing on the New York Stock Exchange. Management was flabbergasted when the stock analysts assigned to their firm said that they could not recommend buying the company’s stock because they didn’t owe enough money. The company’s management had always pursued a program of internal financing. They believed that low leverage (borrowing) ratios meant lower costs to share holders and safety in the event of an economic turn-down. The analysts insisted that the company should do more borrowing and hand the excess cash over to the shareholders.
UPDATE 9/27/2011: THE FIRM IS NOW PRIVATELY HELD
Almost all publicly traded companies are faced with this dilemma: Do they look to the long term financial health of the company or do we put emphasis on maximizing short-term shareholder value? The fact is that that the two may be mutually exclusive. High cash distributions may enhance short-term shareholder value while undermining long term financial heath. It is similar to the kick an addict gets from cocaine. It feels good every time the addict gets a hit. However, the addict’s long-term physical health is at risk.
As a product of several of America’s business schools I am well aware of the financial analyses that are being taught. I also understand the economic theory underlying the analytic thought processes. The problem lies in the fact that most of the analysts are working from a strictly academic angle. Most have never worked outside of the financial sector and have no notion of how a firm producing real as opposed to financial worth operates. The crux of the problem is that they treat all wealth creation as if it were financial wealth. This leads to a casino mentality where the emphasis is on short-term results. We end up in a world where there are no investors. All we end up with is traders. If you don’t believe this, just look at the turn-over ratios of some of our largest pension plans. The ratios often indicate that the portfolios are being completely liquidated and repurchased more than once every year. This is not investing. It is gambling masquerading as an investment strategy.
If we want America’s firms to survive, we need to break this gambling mentality. We need to restructure the nature of business education. We need to realize that risk is more than the financial analysts’ notion of price variability. They believe that diversification will get rid of the specific risk of bankruptcy. What they fail to recognize is that the emphasis on leverage increases the bankruptcy risk of all firms. If all firms are under increased bankruptcy risk then specific risk becomes market risk and it is impossible to diversify it away.
I blame the Wall Street analysts and the MBA programs of America. In the last 40 years there has been a growing emphasis on distributing cash to share-holders at the expense of a company’s future financial health. About eight years ago I spoke with the management of a firm which had recently moved from listing on the American Stock Exchange to listing on the New York Stock Exchange. Management was flabbergasted when the stock analysts assigned to their firm said that they could not recommend buying the company’s stock because they didn’t owe enough money. The company’s management had always pursued a program of internal financing. They believed that low leverage (borrowing) ratios meant lower costs to share holders and safety in the event of an economic turn-down. The analysts insisted that the company should do more borrowing and hand the excess cash over to the shareholders.
UPDATE 9/27/2011: THE FIRM IS NOW PRIVATELY HELD
Almost all publicly traded companies are faced with this dilemma: Do they look to the long term financial health of the company or do we put emphasis on maximizing short-term shareholder value? The fact is that that the two may be mutually exclusive. High cash distributions may enhance short-term shareholder value while undermining long term financial heath. It is similar to the kick an addict gets from cocaine. It feels good every time the addict gets a hit. However, the addict’s long-term physical health is at risk.
As a product of several of America’s business schools I am well aware of the financial analyses that are being taught. I also understand the economic theory underlying the analytic thought processes. The problem lies in the fact that most of the analysts are working from a strictly academic angle. Most have never worked outside of the financial sector and have no notion of how a firm producing real as opposed to financial worth operates. The crux of the problem is that they treat all wealth creation as if it were financial wealth. This leads to a casino mentality where the emphasis is on short-term results. We end up in a world where there are no investors. All we end up with is traders. If you don’t believe this, just look at the turn-over ratios of some of our largest pension plans. The ratios often indicate that the portfolios are being completely liquidated and repurchased more than once every year. This is not investing. It is gambling masquerading as an investment strategy.
If we want America’s firms to survive, we need to break this gambling mentality. We need to restructure the nature of business education. We need to realize that risk is more than the financial analysts’ notion of price variability. They believe that diversification will get rid of the specific risk of bankruptcy. What they fail to recognize is that the emphasis on leverage increases the bankruptcy risk of all firms. If all firms are under increased bankruptcy risk then specific risk becomes market risk and it is impossible to diversify it away.
Friday, October 10, 2008
Will Our Own Expectations Kill Us?
I just finished taking a CNN on line survey. Once I entered my response the results to date were listed. The outcome scared the hell out of me. The question was: “Are you confident world leaders can solve the financial crisis?” The result was that 70% of the respondents said no.
Normally, survey results do not have any effect upon me, especially ones that merely ask for opinions. Then why does this particular result scare me? The reason has to do with the effect people’s expectations have upon their economic behavior. Generally, people will either buy or save depending upon their expectations of their future economic health. If they believe the economy is slowing, they will cut their spending. If they believe the economy is healthy, they will continue to spend or even increase their spending. The current financial crisis has led to decreased expectations for the economy. This has led to a concurrent decrease in consumers’ economic activity. Consumers are the engine that drives the American, and subsequently the world, economy. This is where the survey result comes in.
The survey indicates that American consumers believe that world leaders will not be able to solve the financial crisis. Therefore, they believe that the economy will continue to decline. As a result, consumer spending will either stay low or decline. Either way this spells trouble for the economic future. A continued shrinkage in consumer confidence can turn what already looks like a severe recession into another great depression.
This weekend’s G-7 meeting must come out with solid plans that people believe will stop the financial decline. If this happens we can expect that people will begin to change their behavior. However, if the plans are tentative indecisive political obfuscations we can expect to see an economic disaster in our future. The Hoovervilles of our parents and grand-parents will become the Bushbergs of the 21st century.
Normally, survey results do not have any effect upon me, especially ones that merely ask for opinions. Then why does this particular result scare me? The reason has to do with the effect people’s expectations have upon their economic behavior. Generally, people will either buy or save depending upon their expectations of their future economic health. If they believe the economy is slowing, they will cut their spending. If they believe the economy is healthy, they will continue to spend or even increase their spending. The current financial crisis has led to decreased expectations for the economy. This has led to a concurrent decrease in consumers’ economic activity. Consumers are the engine that drives the American, and subsequently the world, economy. This is where the survey result comes in.
The survey indicates that American consumers believe that world leaders will not be able to solve the financial crisis. Therefore, they believe that the economy will continue to decline. As a result, consumer spending will either stay low or decline. Either way this spells trouble for the economic future. A continued shrinkage in consumer confidence can turn what already looks like a severe recession into another great depression.
This weekend’s G-7 meeting must come out with solid plans that people believe will stop the financial decline. If this happens we can expect that people will begin to change their behavior. However, if the plans are tentative indecisive political obfuscations we can expect to see an economic disaster in our future. The Hoovervilles of our parents and grand-parents will become the Bushbergs of the 21st century.
Wednesday, October 01, 2008
THE COMING DEPRESSION
Now that congressional Republicans have decided that they want narrow political expediency to defeat the bailout package I am fearful for the future of our nation and the rest of the world, Although I did not believe that the proposed compromise was the best way of handling the problem I felt that an expedited poor plan was better than no plan at all.
People and markets are driven by expectations. If they believe that something will be done to alleviate a problem they will act as if the problem has been solved. On the other hand, if they see political divisiveness, they will act as if the problem will never be solved. This means that the financial markets will see a flight to quality. A flight to quality means dumping stocks and buying US Government Securities. The goods and services market will experience falling sales because people see their jobs as being in jeopardy, their 401k investments and savings shrinking while the value of their homes is falling. All of this will bring about further layoffs and a downward spiral in both consumer confidence and sales. I really don’t know a better description of the factors leading to a depression.
I know that many commentators believe that we now have the opportunity to do the job right. I do not believe that we will. The republicans believe that a total reliance on a market solution will solve the problem. In fact they are calling for market solutions devoid of regulation. This is what got us into the problem in the first place and the democrats would be dumb to go along with it.
On the other hand the democrats are calling for a “New Deal” type solution which might actually work. The problem here is that the republicans are so opposed to anything that smacks of the “New Deal” they’d rather sink the country than let it pass. They will throw procedural road blocks to the system that would prevent any solution that didn’t give the market reign.
We are still a month away from the election and three months from a new congress and president. In that amount of time we can face a complete economic, as well as financial, collapse. If our congressional leaders cannot create a new solution before the end of the week it will be too late. I am afraid we are destined to relive the great depression. Hello 1932. Hoovervilles will be Bush Bergs, Buddy can you spare a dime will become fella can you spare a 5, and 25+% unemployment will rein.
People and markets are driven by expectations. If they believe that something will be done to alleviate a problem they will act as if the problem has been solved. On the other hand, if they see political divisiveness, they will act as if the problem will never be solved. This means that the financial markets will see a flight to quality. A flight to quality means dumping stocks and buying US Government Securities. The goods and services market will experience falling sales because people see their jobs as being in jeopardy, their 401k investments and savings shrinking while the value of their homes is falling. All of this will bring about further layoffs and a downward spiral in both consumer confidence and sales. I really don’t know a better description of the factors leading to a depression.
I know that many commentators believe that we now have the opportunity to do the job right. I do not believe that we will. The republicans believe that a total reliance on a market solution will solve the problem. In fact they are calling for market solutions devoid of regulation. This is what got us into the problem in the first place and the democrats would be dumb to go along with it.
On the other hand the democrats are calling for a “New Deal” type solution which might actually work. The problem here is that the republicans are so opposed to anything that smacks of the “New Deal” they’d rather sink the country than let it pass. They will throw procedural road blocks to the system that would prevent any solution that didn’t give the market reign.
We are still a month away from the election and three months from a new congress and president. In that amount of time we can face a complete economic, as well as financial, collapse. If our congressional leaders cannot create a new solution before the end of the week it will be too late. I am afraid we are destined to relive the great depression. Hello 1932. Hoovervilles will be Bush Bergs, Buddy can you spare a dime will become fella can you spare a 5, and 25+% unemployment will rein.
Friday, September 26, 2008
EXPLAINING THE MORTGAGE MELTDOWN
My oldest son recently asked me to explain the current mortgage mess in terms a non-economist could understand. My reply to him follows:
1. Several years ago the government, through Fannie Mae and Freddie Mac started to make mortgages easier to obtain. They did this by pooling already issued mortgages and selling Bonds backed by them. This provided more money to issue mortgage loans.
2. Eventually the private market began to engage in the same sort of pooling
3. At some point in time a smart MBA or engineer turned financial analyst realized that real estate prices seemed to be on a constant rise. If this was the case, you could lend money to people who had poor credit. If they didn’t pay their loans you would make money on the resale of the house. If they did pay, you’d make money because their fees and interest rates were higher.
4. When this happened, many investment banks, and even commercial banks, saw that they could borrow short term at lower interest rates than they would earn on the long term mortgages. So they bought the mortgage bonds and borrowed short term, making money on the differential in interest rates.
5. Now we come to the real problem:
a. People started to default on the loans
b. The extra houses on the market pushed real-estate prices down below value of the outstanding mortgages
c. The value of the securities backing the mortgages began to drop.
d. Then people found out that the system assigning specific mortgages to specific bonds was so convoluted that you couldn’t tell if the mortgages backing your bonds were good or bad.
e. This drove the prices of the bonds even lower.
f. The short term debt that the banks used to borrow funds became due.
g. The lenders however would not refinance all of the short term debt because the bonds pledged to cover the debt in case of default, had less value than the refinancing need.
h. If what you owe the (short term borrowing) is higher in value than what you own (the mortgage backed securities) then you are legally insolvent (bankrupt).
i. Nobody wants to lend money to someone who is bankrupt. In times of uncertainty, nobody wants to assume any risk by lending to anyone.
j. Without credit, business stops and we have a depression.
6. Now we have to ask why the republican Mantra of Market Discipline didn’t work. I addressed this in a Blog I wrote several days ago and have reproduced here so you don’t have to go looking it up:
For “Market Discipline” to work the participants and decision makers in the system have to be subject to both the rewards and the potential losses from assuming high risk. When the decision makers are subject to the potential losses they tend to act in a prudent manner. The problem lies in the fact that the remuneration systems in place in today’s markets provide very high rewards to executives who engage in successful risk taking. On the other hand, if the risks are unsuccessful, there is no penalty to the decision makers. They may lose their jobs, but their separation packages have such high payouts that the losses are limited. Just look at the Fannie Mae and Freddie Mac CEO’s. The payouts are in excess of $10 million each. Bears Stearns had similar arrangements and I’m sure that Lehman executives will also come out well off. The biggest losers are the shareholders and the public. The people making the decisions are not the risk takers and have no incentive to be prudent decision makers.
Lets face it, if you are allowed to gamble with someone else’s money and are allowed to keep a high percentage of the winnings while getting paid for doing the gambling if there are losses, why wouldn’t you make the riskiest bets. In fact, looking out for your own self interest, you’d be dumb not to take inordinate risks. For you it is a win-win situation.
This is the simplest I could make it. To be honest, one of the biggest reasons for the whole problem is that the people making the decisions didn’t have a clue as to what they were doing. Let’s face it, look at all the education I have and look at how hard it is for me to explain it to you.
Good luck absorbing all of this. Let me know if I’ve helped.
Dad
1. Several years ago the government, through Fannie Mae and Freddie Mac started to make mortgages easier to obtain. They did this by pooling already issued mortgages and selling Bonds backed by them. This provided more money to issue mortgage loans.
2. Eventually the private market began to engage in the same sort of pooling
3. At some point in time a smart MBA or engineer turned financial analyst realized that real estate prices seemed to be on a constant rise. If this was the case, you could lend money to people who had poor credit. If they didn’t pay their loans you would make money on the resale of the house. If they did pay, you’d make money because their fees and interest rates were higher.
4. When this happened, many investment banks, and even commercial banks, saw that they could borrow short term at lower interest rates than they would earn on the long term mortgages. So they bought the mortgage bonds and borrowed short term, making money on the differential in interest rates.
5. Now we come to the real problem:
a. People started to default on the loans
b. The extra houses on the market pushed real-estate prices down below value of the outstanding mortgages
c. The value of the securities backing the mortgages began to drop.
d. Then people found out that the system assigning specific mortgages to specific bonds was so convoluted that you couldn’t tell if the mortgages backing your bonds were good or bad.
e. This drove the prices of the bonds even lower.
f. The short term debt that the banks used to borrow funds became due.
g. The lenders however would not refinance all of the short term debt because the bonds pledged to cover the debt in case of default, had less value than the refinancing need.
h. If what you owe the (short term borrowing) is higher in value than what you own (the mortgage backed securities) then you are legally insolvent (bankrupt).
i. Nobody wants to lend money to someone who is bankrupt. In times of uncertainty, nobody wants to assume any risk by lending to anyone.
j. Without credit, business stops and we have a depression.
6. Now we have to ask why the republican Mantra of Market Discipline didn’t work. I addressed this in a Blog I wrote several days ago and have reproduced here so you don’t have to go looking it up:
For “Market Discipline” to work the participants and decision makers in the system have to be subject to both the rewards and the potential losses from assuming high risk. When the decision makers are subject to the potential losses they tend to act in a prudent manner. The problem lies in the fact that the remuneration systems in place in today’s markets provide very high rewards to executives who engage in successful risk taking. On the other hand, if the risks are unsuccessful, there is no penalty to the decision makers. They may lose their jobs, but their separation packages have such high payouts that the losses are limited. Just look at the Fannie Mae and Freddie Mac CEO’s. The payouts are in excess of $10 million each. Bears Stearns had similar arrangements and I’m sure that Lehman executives will also come out well off. The biggest losers are the shareholders and the public. The people making the decisions are not the risk takers and have no incentive to be prudent decision makers.
Lets face it, if you are allowed to gamble with someone else’s money and are allowed to keep a high percentage of the winnings while getting paid for doing the gambling if there are losses, why wouldn’t you make the riskiest bets. In fact, looking out for your own self interest, you’d be dumb not to take inordinate risks. For you it is a win-win situation.
This is the simplest I could make it. To be honest, one of the biggest reasons for the whole problem is that the people making the decisions didn’t have a clue as to what they were doing. Let’s face it, look at all the education I have and look at how hard it is for me to explain it to you.
Good luck absorbing all of this. Let me know if I’ve helped.
Dad
Wednesday, September 17, 2008
Whoops
If you've read my "Nightmare..." blog, please substitute Palin for Huckabee and everything else will stay the same.
Also, please note that many commentators are speculating as to why McCain is doing so well when his policies are so in line with Bush's. I believe that my "Nightmare..." Blog has the answer: Unfortunately many Americans are just not yet ready to vote for a minority group member. I believe Obama's candidacy is ten years early.
Also, please note that many commentators are speculating as to why McCain is doing so well when his policies are so in line with Bush's. I believe that my "Nightmare..." Blog has the answer: Unfortunately many Americans are just not yet ready to vote for a minority group member. I believe Obama's candidacy is ten years early.
Tuesday, September 09, 2008
There Is No Market Discipline!!
As an economist I have always believed that “Market Discipline” would provide the means of preventing excess risk and imprudent actions on the part of corporate executives. I believed that ENRON and World Com were aberrations. I did wonder, however, how these aberrations could occur.
The recent meltdown in the mortgage markets has convinced me that the excessive risk taking is not an aberration. Rather, it is built into the very fabric of the modern financial system. How this came about is very simple:
For “Market Discipline” to work the participants and decision makers in the system have to be subject to both the rewards and the potential losses from assuming high risk. When the decision makers are subject to the potential losses they tend to act in a prudent manner. The problem lies in the fact that the remuneration systems in place in today’s markets provide very high rewards to executives who engage in successful risk taking. On the other hand, if the risks are unsuccessful, there is no penalty to the decision makers. They may lose their jobs, but their separation packages have such high payouts that the losses are limited. Just look at the Fannie Mae and Freddie Mac CEO’s. The payouts are in excess of $10 million each. Bears Stearns had similar arrangements and I’m sure that Lehman executives will also come out well off. The biggest losers are the shareholders and the public. The people making the decisions are not the risk takers and have no incentive to be prudent decision makers.
Lets face it, if you are allowed to gamble with someone else’s money and are allowed to keep a high percentage of the winnings while getting paid for doing the gambling if there are losses, why wouldn’t you make the riskiest bets. In fact, looking out for your own self interest, you’d be dumb not to take inordinate risks. For you it is a win-win situation.
The recent meltdown in the mortgage markets has convinced me that the excessive risk taking is not an aberration. Rather, it is built into the very fabric of the modern financial system. How this came about is very simple:
For “Market Discipline” to work the participants and decision makers in the system have to be subject to both the rewards and the potential losses from assuming high risk. When the decision makers are subject to the potential losses they tend to act in a prudent manner. The problem lies in the fact that the remuneration systems in place in today’s markets provide very high rewards to executives who engage in successful risk taking. On the other hand, if the risks are unsuccessful, there is no penalty to the decision makers. They may lose their jobs, but their separation packages have such high payouts that the losses are limited. Just look at the Fannie Mae and Freddie Mac CEO’s. The payouts are in excess of $10 million each. Bears Stearns had similar arrangements and I’m sure that Lehman executives will also come out well off. The biggest losers are the shareholders and the public. The people making the decisions are not the risk takers and have no incentive to be prudent decision makers.
Lets face it, if you are allowed to gamble with someone else’s money and are allowed to keep a high percentage of the winnings while getting paid for doing the gambling if there are losses, why wouldn’t you make the riskiest bets. In fact, looking out for your own self interest, you’d be dumb not to take inordinate risks. For you it is a win-win situation.
Monday, August 18, 2008
LAWS NEED ACCEPTENCE TO WORK
I am often amazed by people who seem to believe that the mere passing of a law will cure the social ills of the world. The failure of prohibition has proven that this approach does not work. The real reason we gave up the 55 mile an hour speed limit was the police saying that there were so many violators that they could not enforce the laws. Yet MADD (Mothers Against Drunk Drivers) persists in insisting that a 21 year old drinking age will solve the problem of Binge Drinking. The fact that we have had a 21 year old drinking age for many years and Binge Drinking continues to be a problem has no effect on their belief that their approach works.
The problem is that there are too many people who operate on belief rather than evidence. They let their beliefs govern policy decisions and win arguments because they claim to be looking out for a greater good. The problem with this approach is that it often leads to more problems than it solves. There was a study of prohibition that found that many people started drinking during that era because they were told that they couldn’t [I wish I could remember where I read this]. I do know that I grew up in an era when New York and Louisiana were the only states with an 18 year old drinking age. Most of us didn’t even think of Binge Drinking because we could get a drink any time we wanted one. There was no “Forbidden Fruit” aspect to the consumption of alcohol. There was no sense of getting away with something.
When MADD quotes the statistics from the era of the lower drinking age are they adjusting the data for the fact that there were differing drinking ages in different states? This fact alone could account for many of the drunken driving deaths. For example: Pennsylvania never lowered its drinking age; New Jersey had a 19 year old drinking age and New York had an 18 year old drinking age. Pennsylvania kids would cross the border to either New York or New Jersey to drink. Then they would drive home and get into accidents. If they had been allowed to drink in Pennsylvania they might have stayed in someone’s home and never have been on the road. In addition there is a high likelihood that they might have had less to drink because it was legally available. Add to this that fear of getting caught drinking illegally often dissuades those who get into medical trouble through drinking from seeking help for themselves or their friends.
Looking at all of this convinces me that maintaining a 21 year old drinking age is an effort in futility. In addition, maintaining this artificially high age may actually exacerbate the problem. Remember, laws only work when the people they apply to believe in them.
The problem is that there are too many people who operate on belief rather than evidence. They let their beliefs govern policy decisions and win arguments because they claim to be looking out for a greater good. The problem with this approach is that it often leads to more problems than it solves. There was a study of prohibition that found that many people started drinking during that era because they were told that they couldn’t [I wish I could remember where I read this]. I do know that I grew up in an era when New York and Louisiana were the only states with an 18 year old drinking age. Most of us didn’t even think of Binge Drinking because we could get a drink any time we wanted one. There was no “Forbidden Fruit” aspect to the consumption of alcohol. There was no sense of getting away with something.
When MADD quotes the statistics from the era of the lower drinking age are they adjusting the data for the fact that there were differing drinking ages in different states? This fact alone could account for many of the drunken driving deaths. For example: Pennsylvania never lowered its drinking age; New Jersey had a 19 year old drinking age and New York had an 18 year old drinking age. Pennsylvania kids would cross the border to either New York or New Jersey to drink. Then they would drive home and get into accidents. If they had been allowed to drink in Pennsylvania they might have stayed in someone’s home and never have been on the road. In addition there is a high likelihood that they might have had less to drink because it was legally available. Add to this that fear of getting caught drinking illegally often dissuades those who get into medical trouble through drinking from seeking help for themselves or their friends.
Looking at all of this convinces me that maintaining a 21 year old drinking age is an effort in futility. In addition, maintaining this artificially high age may actually exacerbate the problem. Remember, laws only work when the people they apply to believe in them.
Tuesday, August 05, 2008
Once Again the Lesser of Two Evils
As I sit here reviewing e-mails from both the Obama and McCain camps I wonder how a nation of 300 million people can be faced with the choice of either continuing what has proven to be a catastrophic administration or returning the nation to the doldrums of the Carter administration. Why do I believe that these are our choices? It is simple:
1. Sen. McCain has already said that he will continue Bush’s Iraq war policies and he has also proposed that Bush’s tax cuts for the rich are his answer to our economic problems. Even when he had disagreed with Bush we find that McCain’s position has shifted to meet Bush’s. The move to allow off-shore drilling is an example of this. So a vote for McCain ends up being a vote for DubbaYa.
2. Regarding Sen. Obama I believe Rep. Charlie Rangel (D-NY) said it best when he was asked why he, as a black man, was supporting Sen. Clinton in the NY primary. His answer was [as I paraphrase it] “… a president does not act alone; A president relies on experts for advice... I know who is in Hillary’s Rolodex. I don’t know who is in Obama’s…” Looking at Sen. Obama’s appointments it looks as if he is using Jimmy Carter’s Rolodex. The Carter administration was the Democratic equivalent of the DubbaYa years. Does Obama really believe that following the Carter ways will help America? It is the Carter years that brought about the Reagan revolution. I fear a repeat of the Carter legacy could lead us to something like “The Limbaugh Regression.”
All I can say at this point is “Wake Up Barack, You said you wanted change. Why are you bringing us back to disaster?
1. Sen. McCain has already said that he will continue Bush’s Iraq war policies and he has also proposed that Bush’s tax cuts for the rich are his answer to our economic problems. Even when he had disagreed with Bush we find that McCain’s position has shifted to meet Bush’s. The move to allow off-shore drilling is an example of this. So a vote for McCain ends up being a vote for DubbaYa.
2. Regarding Sen. Obama I believe Rep. Charlie Rangel (D-NY) said it best when he was asked why he, as a black man, was supporting Sen. Clinton in the NY primary. His answer was [as I paraphrase it] “… a president does not act alone; A president relies on experts for advice... I know who is in Hillary’s Rolodex. I don’t know who is in Obama’s…” Looking at Sen. Obama’s appointments it looks as if he is using Jimmy Carter’s Rolodex. The Carter administration was the Democratic equivalent of the DubbaYa years. Does Obama really believe that following the Carter ways will help America? It is the Carter years that brought about the Reagan revolution. I fear a repeat of the Carter legacy could lead us to something like “The Limbaugh Regression.”
All I can say at this point is “Wake Up Barack, You said you wanted change. Why are you bringing us back to disaster?
Sunday, July 13, 2008
MARKET DISCIPLINE MEANS ALLOWING DEPRESSIONS
Today, July 13th, the Fed and the treasury announced that they are setting up guarantees for Freddie Mac and Fannie Mae. I expect that there will be a whole set of outraged people on the left who are protesting the “bail out”. What these people do not realize is that a policy of “…let the big boys suffer…” will only lead to suffering for the little guy. The last time we had economic problems of this magnitude was in the late 1920’s and early 1930’s. At that time the Fed and the treasury took a “...let the chips fall where they may…” attitude. The Fed failed to act as a lender of last resort and there were multiple bank failures which brought the economy to a screeching halt and led to the Great Depression.
The world has changed and many of the roles played by commercial banks in the 1920’s are now played by other forms of financial institutions. The Fed’s mandate, however, was set in that earlier era. If the Fed is forced to deal only with its original mandate then massive failures of financial institutions will lead to another Great Depression. Ben Bernanke is to be commended for finding innovative methods to deal with issues that go beyond the Feds original charter.
We do need to remember how we got into this mess. The root cause of the problem is the belief that market discipline will keep excess risk under control. The problem with this attitude is that it forgets that the ultimate form of market discipline is a depression. A depression forces all those who engage in excessively risky behavior to suffer financial loss. The fact that innocents would also suffer is not included in the equation.
As the last depression was winding down, a whole set of laws and regulations were enacted. They were designed to prevent a future depression from occurring. However, the Regan Era mantra of “Market Discipline” caused us to relax or eliminate many of those regulations. People who should have known better said “…the discipline of the market will prevent a future Great Depression…” What they forgot was that the first Great Depression occurred when regulation was non existent and “Markets Ruled”. If market discipline worked to avoid depressions then the Great Depression never should have occurred. There is a simple equation:
Unregulated Market Rule = Potential Depressions
The world has changed and many of the roles played by commercial banks in the 1920’s are now played by other forms of financial institutions. The Fed’s mandate, however, was set in that earlier era. If the Fed is forced to deal only with its original mandate then massive failures of financial institutions will lead to another Great Depression. Ben Bernanke is to be commended for finding innovative methods to deal with issues that go beyond the Feds original charter.
We do need to remember how we got into this mess. The root cause of the problem is the belief that market discipline will keep excess risk under control. The problem with this attitude is that it forgets that the ultimate form of market discipline is a depression. A depression forces all those who engage in excessively risky behavior to suffer financial loss. The fact that innocents would also suffer is not included in the equation.
As the last depression was winding down, a whole set of laws and regulations were enacted. They were designed to prevent a future depression from occurring. However, the Regan Era mantra of “Market Discipline” caused us to relax or eliminate many of those regulations. People who should have known better said “…the discipline of the market will prevent a future Great Depression…” What they forgot was that the first Great Depression occurred when regulation was non existent and “Markets Ruled”. If market discipline worked to avoid depressions then the Great Depression never should have occurred. There is a simple equation:
Unregulated Market Rule = Potential Depressions
Wednesday, July 09, 2008
Politically Correct 23rd Psalm for the 21st Century
Supreme Entity you are my herder. I will consume as if resources were unlimited. You coerce me to lie down in organically grown pastures. You guide me toward stagnant pools. You reconstruct my undefined and nebulous spirit. You direct me to be right-minded to puff-up your image. Even when I am in danger of dying, I will not be afraid of the wrong minded who are not responsible for their actions due to their upbringing, for you are nearby. You comfort me with your accoutrements. You set a table for me even when I’m surrounded by those who disagree with me. You pour oil over my head to signify that I’m supposedly better than others. It’s a sure bet that good things will come as I go forward, and I will have an abode in your habitat for ever.
Thursday, February 21, 2008
OBAMANIA
Barak Obama, as a presidential candidate, is a creation of the media. Outside of Illinois nobody had ever heard of the man prior to his run for the US Senate. While running for the senate, the press started to ask the question that nobody else was asking: “Could this man be the first viable “Black” candidate for president?” I doubt that even Mr. Obama was thinking about this for 2008 until the press suggested it.
Ever since, Mr. Obama has been given extreme latitude by the press. While the media went after Mrs. Clinton for her proposals they neglected to point out that Mr. Obama merely responded with platitudes. Mr. Obama is very likable and Mrs. Clinton can appear to be aloof and hard to talk to. This puts the working press into Mr. Obama’s camp. They may not even realize they are doing it. However, it is easier cast a critical eye on the proposals of someone you don’t like and be forgiving of those you do like.
The mass media needs to take a good look at itself. The last time a situation like this occurred we ended up with positive stories about G. W. Bush and negative ones about Al Gore. Although they deny it, the press’s attitudes about a candidate come through clearly in what is supposed to be pure news coverage. Even though we all want a likable person in the White House we must accept the fact that likable and competent do not always go together. There are times, when a job needs doing, that I’d rather work with someone who I know is good at what they do rather than with a good friend who may not be as capable.
Ever since, Mr. Obama has been given extreme latitude by the press. While the media went after Mrs. Clinton for her proposals they neglected to point out that Mr. Obama merely responded with platitudes. Mr. Obama is very likable and Mrs. Clinton can appear to be aloof and hard to talk to. This puts the working press into Mr. Obama’s camp. They may not even realize they are doing it. However, it is easier cast a critical eye on the proposals of someone you don’t like and be forgiving of those you do like.
The mass media needs to take a good look at itself. The last time a situation like this occurred we ended up with positive stories about G. W. Bush and negative ones about Al Gore. Although they deny it, the press’s attitudes about a candidate come through clearly in what is supposed to be pure news coverage. Even though we all want a likable person in the White House we must accept the fact that likable and competent do not always go together. There are times, when a job needs doing, that I’d rather work with someone who I know is good at what they do rather than with a good friend who may not be as capable.
Wednesday, February 20, 2008
THE ECONOMIC LEGACY OF FINANCING A WAR EXCLUSIVELY WITH DEBT
In the Spring of 1966, Temple University dedicated its new building for the “School of Business and Public Administration”. The dedication speaker was Walter Heller and his subject was “CAN THE US FIGHT THE WARS ON POVERTY AND IN VIETNAM AT HE SAME TIME?” Heller’s answer of yes had a caveat that was ignored by the press. He said that we would need adjustments to revenue in order to avoid economic adjustments when the Vietnam War ended. When it ended we were left with a period of high inflation, low economic growth, and high levels of unemployment. This is the very definition of Stagflation.
This morning, The Bureau of Labor Statistics announced that the inflation rate for January was an annualized 4.91% (the monthly rate was 0.4%). We, also, have had recent indications that the unemployment rate is rising. Combining this with Ben Benake’s prediction, also published this morning, that the country is facing a period of high inflation and low growth, we can see that we are well on the road to another period of Stagflation.
The current Stagflation is a direct result of the “Conservatives” (I call them Regressives) insistence on paying for the Iraq War exclusively with debt. Some how they believe, despite the evidence, that giving tax breaks to the most affluent of us brings about prosperity to all. Given the current economic situation, I can only conclude that support for making all of the Bush tax cuts permanent is based purely upon greed. Let the middle class and the poor pay so that the obscenely wealthy can become even more outlandishly opulent. What we need is a more equitable tax policy.
Tax policy usually relies on either of two principles: The “Ability to Pay Principle” or the “Benefit Principle”. Both of these forget the fact that paying taxes is painful. We would all like to pay as little as possible to the various levels of government. However, as long as we have to support our government we should make sure that when we pay taxes we are “equalizing the pain” to each of us. The problem with “Flat Taxes”, “Value Added Taxes”, and the various consumption taxes is that they tend to distribute the pain to the lowest economic levels in society. To see how this applies we need to look at the satisfaction people get from having income and/or wealth.
It is well known that as people obtain more and more of a good or service the satisfaction they get from the last unit of the good is lower than the satisfaction received from the immediately prior unit. In economics this is known as the Law of Diminishing Marginal Utility. This “law” applies to income and wealth as well as the consumption of goods and services. The more income or wealth you have, the less each additional dollar of income or wealth means to you in terms of your over all satisfaction.
Applying this to tax policy we can see that a 20% flat tax would cost $4,000 to a person with a taxable income of $20,000 per year and $20,000 to a person with a taxable income of $100,000 per year. In terms of the ability to enjoy the fruits of the economic system, the $4,000 to the low income individual is a much greater sacrifice than the $20,000 is to the high income individual. Equalizing the pain of paying taxes would require that the low-income person pays a lower tax rate or the higher income person faces a higher tax rate or some combination of lower and higher rates.
Progressive income taxation is not a “soak the rich” scheme. It is the only system that has the capability of equalizing the pain of supporting government.
This morning, The Bureau of Labor Statistics announced that the inflation rate for January was an annualized 4.91% (the monthly rate was 0.4%). We, also, have had recent indications that the unemployment rate is rising. Combining this with Ben Benake’s prediction, also published this morning, that the country is facing a period of high inflation and low growth, we can see that we are well on the road to another period of Stagflation.
The current Stagflation is a direct result of the “Conservatives” (I call them Regressives) insistence on paying for the Iraq War exclusively with debt. Some how they believe, despite the evidence, that giving tax breaks to the most affluent of us brings about prosperity to all. Given the current economic situation, I can only conclude that support for making all of the Bush tax cuts permanent is based purely upon greed. Let the middle class and the poor pay so that the obscenely wealthy can become even more outlandishly opulent. What we need is a more equitable tax policy.
Tax policy usually relies on either of two principles: The “Ability to Pay Principle” or the “Benefit Principle”. Both of these forget the fact that paying taxes is painful. We would all like to pay as little as possible to the various levels of government. However, as long as we have to support our government we should make sure that when we pay taxes we are “equalizing the pain” to each of us. The problem with “Flat Taxes”, “Value Added Taxes”, and the various consumption taxes is that they tend to distribute the pain to the lowest economic levels in society. To see how this applies we need to look at the satisfaction people get from having income and/or wealth.
It is well known that as people obtain more and more of a good or service the satisfaction they get from the last unit of the good is lower than the satisfaction received from the immediately prior unit. In economics this is known as the Law of Diminishing Marginal Utility. This “law” applies to income and wealth as well as the consumption of goods and services. The more income or wealth you have, the less each additional dollar of income or wealth means to you in terms of your over all satisfaction.
Applying this to tax policy we can see that a 20% flat tax would cost $4,000 to a person with a taxable income of $20,000 per year and $20,000 to a person with a taxable income of $100,000 per year. In terms of the ability to enjoy the fruits of the economic system, the $4,000 to the low income individual is a much greater sacrifice than the $20,000 is to the high income individual. Equalizing the pain of paying taxes would require that the low-income person pays a lower tax rate or the higher income person faces a higher tax rate or some combination of lower and higher rates.
Progressive income taxation is not a “soak the rich” scheme. It is the only system that has the capability of equalizing the pain of supporting government.
Saturday, February 09, 2008
RATIONING MEDICAL CARE
Every Monday night several of my friends and I have a “Boys Night Out.” It usually entails dinner and conversation over a wide range of topics. On a recent evening the subject moved to a discussion of the “US Health Care Crisis”. Several of the participants were also in the health care field. In fact, if we consider my own past employment in the Medical Insurance Industry to be in the field, only one person was not a current or past participant in the health care system.
When all of the discussion was done, it appeared that the main argument against a government plan was that it would lead to rationing. This is the same argument that President Bush has been using for the past seven years. The problem is that people fail to realize that we do have medical care rationing today. It is one of the fundamental principles of economics that the price mechanism serves as a method of rationing goods and services. Those who can afford the goods and services and are willing to pay for them get them.
Health Care, as a service, is subject to this same principle. However, the existence of health insurance changes the underlying rationing to those who can afford the service and those who have adequate health insurance. Those who cannot afford the service or, in this case, who don’t have adequate health insurance do are “Rationed Out” of the health care market.
So when the President and his cronies shout out their war cry: “DO YOU WANT YOUR HEALTH CARE RATIONED”? You can reply: “IT ALREADY IS!”
When all of the discussion was done, it appeared that the main argument against a government plan was that it would lead to rationing. This is the same argument that President Bush has been using for the past seven years. The problem is that people fail to realize that we do have medical care rationing today. It is one of the fundamental principles of economics that the price mechanism serves as a method of rationing goods and services. Those who can afford the goods and services and are willing to pay for them get them.
Health Care, as a service, is subject to this same principle. However, the existence of health insurance changes the underlying rationing to those who can afford the service and those who have adequate health insurance. Those who cannot afford the service or, in this case, who don’t have adequate health insurance do are “Rationed Out” of the health care market.
So when the President and his cronies shout out their war cry: “DO YOU WANT YOUR HEALTH CARE RATIONED”? You can reply: “IT ALREADY IS!”
Wednesday, February 06, 2008
A NIGHTMARE OF THE FUTURE
As I look at the current activity in the two parties, I believe that all progressives, whether Democrat or Republican, need to have grave concern for the future of the republic. There is a real possibility that we can end up with a president who advocates turning the country into a “Theocracy”.
The scenario begins with the outcome of the Democratic Convention:
Either Hillary Clinton or Barak Obama will be the party’s nominee. The candidate with the greatest chance of winning a general election, John Edwards, has dropped out.
If Hillary is nominated, her chances of winning are slim because there are so many Americans who appear to have a visceral dislike for her. When asked, most people with that attitude that I have spoken to cannot express why they feel that way. They just do! Unfortunately, there appear to be an awful lot of them. There may be enough to kill Ms. Clinton’s chances if the Republicans nominate a semi-moderate candidate.
If Obama is nominated it would show that the country has grown-up in the last 50 years. Unfortunately, I am afraid it has not grown up enough to elect him. Although there are few Americans who would state outright that they would not vote for a Black Man, in the privacy of the voting booth there are many who are just not ready to pull that lever for a minority candidate. If the Republicans nominate a semi-moderate candidate the dislike of the current administration may not be sufficient to overcome the deep seeded prejudice of many Americans.
Moving the Republicans, it looks as if John McCain, a semi-moderate, will get the party’s nomination. However, the party’s right wing believes him to be too far to the left. In order to gain the support of the conservative core McCain will have to accept Huckabee as his Vice-Presidential running mate. McCain is 72 years old and has had some health problems. The presidency, for someone who doesn’t delegate everything al la Reagan, is a psychological and physical pressure cooker. As a result there is a good chance that McCain may not survive his first term. This would leave us with President Huckabee.
Huckabee has already expressed his desire to change the constitution so that it reflects the teaching of the Bible. A constitution that expresses a particular religious viewpoint is the definition of a theocracy and is no better than the Iranian constitution that place Sharia as the guiding principle for laws. His stance doesn’t take into account that there are many different translations of the bible and they do not necessarily agree with each other. In addition, there are many non-Christians in the USA. Are we going to ignore them? Also, the bible is contradictory in many of its laws. Making the bible a part of the constitution would require that a particular sectarian approach would need to be adopted and forced upon everyone else. When this happens, American will no longer be the beacon of liberty and diversity that is the standard that the world has looked to.
The scenario begins with the outcome of the Democratic Convention:
Either Hillary Clinton or Barak Obama will be the party’s nominee. The candidate with the greatest chance of winning a general election, John Edwards, has dropped out.
If Hillary is nominated, her chances of winning are slim because there are so many Americans who appear to have a visceral dislike for her. When asked, most people with that attitude that I have spoken to cannot express why they feel that way. They just do! Unfortunately, there appear to be an awful lot of them. There may be enough to kill Ms. Clinton’s chances if the Republicans nominate a semi-moderate candidate.
If Obama is nominated it would show that the country has grown-up in the last 50 years. Unfortunately, I am afraid it has not grown up enough to elect him. Although there are few Americans who would state outright that they would not vote for a Black Man, in the privacy of the voting booth there are many who are just not ready to pull that lever for a minority candidate. If the Republicans nominate a semi-moderate candidate the dislike of the current administration may not be sufficient to overcome the deep seeded prejudice of many Americans.
Moving the Republicans, it looks as if John McCain, a semi-moderate, will get the party’s nomination. However, the party’s right wing believes him to be too far to the left. In order to gain the support of the conservative core McCain will have to accept Huckabee as his Vice-Presidential running mate. McCain is 72 years old and has had some health problems. The presidency, for someone who doesn’t delegate everything al la Reagan, is a psychological and physical pressure cooker. As a result there is a good chance that McCain may not survive his first term. This would leave us with President Huckabee.
Huckabee has already expressed his desire to change the constitution so that it reflects the teaching of the Bible. A constitution that expresses a particular religious viewpoint is the definition of a theocracy and is no better than the Iranian constitution that place Sharia as the guiding principle for laws. His stance doesn’t take into account that there are many different translations of the bible and they do not necessarily agree with each other. In addition, there are many non-Christians in the USA. Are we going to ignore them? Also, the bible is contradictory in many of its laws. Making the bible a part of the constitution would require that a particular sectarian approach would need to be adopted and forced upon everyone else. When this happens, American will no longer be the beacon of liberty and diversity that is the standard that the world has looked to.
Saturday, January 19, 2008
ONCE MORE INTO THE BREECH WITH AN INADEQUATE PLAN
President Bush appears to be unable to learn from the past and incapable of acting outside of his preconceived notions despite proof that he is wrong. His plan to fight recession meets the definition of insanity: “…The belief that performing the same act repeatedly will result in different outcomes.”
1. A major component of the president’s plan calls for incentives for business to invest. The problem with this is that business will only invest when there is a good business reason to do so e.g. there is a demand for the business’s product. In April of 2004 CFO.Com, hardly a liberal publication, printed an article which established that “Tax Breaks Don’t Boost Investment”. The research looked at 275 companies that had been given tax incentives to invest. The 25 companies with the largest tax breaks reduced their investment by an average of 22%. The other companies studied reduced their investment by an average of 13%. Given this data it is hard to see how the President’s plan will help boost the economy. It will only increase corporate after tax profits. In other words: rob the treasury to help the rich.
2. The second component of the President’s plan calls for a one shot tax rebate that he hopes people will put into the spending stream. However, given the record high levels of consumer debt combined with the record low savings rate and the loss of defined benefit pension plans this result is unlikely. People will probably use the rebate to lower their debt levels or add to the savings. Again, the benefit to the economy may be negligible to non-existent.
3. The best way to stimulate the economy would require putting money into the hands of those who will spend it. People spend when they internalize the fact that the money is really there. This means permanent tax cuts for the poor and middle class. The tax cuts can be offset by raising taxes on those who do not spend the bulk of their marginal income. The President, however, has proposed that expiring tax cuts to the very people who don’t spend should be made permanent. Again, he demonstrates his determination to implement plans based upon belief as opposed to fact. He reminds me of the legislature that decided because gravity was a law it could be repealed. Neither they nor he make any sense.
1. A major component of the president’s plan calls for incentives for business to invest. The problem with this is that business will only invest when there is a good business reason to do so e.g. there is a demand for the business’s product. In April of 2004 CFO.Com, hardly a liberal publication, printed an article which established that “Tax Breaks Don’t Boost Investment”. The research looked at 275 companies that had been given tax incentives to invest. The 25 companies with the largest tax breaks reduced their investment by an average of 22%. The other companies studied reduced their investment by an average of 13%. Given this data it is hard to see how the President’s plan will help boost the economy. It will only increase corporate after tax profits. In other words: rob the treasury to help the rich.
2. The second component of the President’s plan calls for a one shot tax rebate that he hopes people will put into the spending stream. However, given the record high levels of consumer debt combined with the record low savings rate and the loss of defined benefit pension plans this result is unlikely. People will probably use the rebate to lower their debt levels or add to the savings. Again, the benefit to the economy may be negligible to non-existent.
3. The best way to stimulate the economy would require putting money into the hands of those who will spend it. People spend when they internalize the fact that the money is really there. This means permanent tax cuts for the poor and middle class. The tax cuts can be offset by raising taxes on those who do not spend the bulk of their marginal income. The President, however, has proposed that expiring tax cuts to the very people who don’t spend should be made permanent. Again, he demonstrates his determination to implement plans based upon belief as opposed to fact. He reminds me of the legislature that decided because gravity was a law it could be repealed. Neither they nor he make any sense.
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