THOUGHTS ON THE ECONOMY

In Who’s Interest?

2011-10-12T09:35:00.003-04:00

The current protest, known as “Occupy Wall Street”, has engendered a growing number of epithets from the far right. Paul Krugman called it: “Panic of the Plutocrats.” The conflict arises from the fact that the interests of the plutocrats and the interests of the general investors are at odds with each other.

The Plutocrats that Krugman mentioned are comprised of three groups: The first group is the Brokerages who make more money as trading increases. Most of the stock analysts, who make recommendations, work for the brokerage firms and are prone to recommend trading as opposed to investing strategies because these increase the profits of the brokerages that they work for. Included in this first group are the stock brokers themselves who make their living off the numbers of trades they receive commissions on. The second group is comprised of the traders who have a shorter perspective and merely buy and sell based upon small movements in share prices. Neither of these groups adds any real economic value to society. They engage in financial asset swaps ignoring and some times discourage real value creation because it can lead to short-term reductions in profits. The third level of plutocrat is made up of corporate executives who, along with the boards of directors, are charged with looking out for the interests of the shareholder. There are, however, two classes of common stock ownership in most publicly traded companies. Looking out for the interest of two separate classes may lead to mutually exclusive goals.

The two groups of share holders may be classified as the investor and the trader. The investor has a long-term perspective wherein stock is purchased on the basis of expected growth and profitability over time. The trader, on the other hand, is looking for short-term profits that will lead to rapid rises in the company’s share price resulting in a rapid resale of the shares. The value of a company’s shares is often thought of as the discounted present value of future profits. The conflict between the two classes of shareholders comes from the fact that a trader puts an exceptionally high discount on future earnings thereby reducing the present value of those earnings. The trader wants it all now. As a result, a trader will put pressure on companies not to reinvest in themselves because reinvestment could lead to short-term profit reduction and leave less cash available for current distribution to the trader. This is exemplified by the last time the government allowed a tax free repatriation of foreign earnings. Companies, rather than investing in new plant and equipment, engaged in Stock Buy-Back programs which merely raised the price of stocks so traders could cash in. This lack of reinvestment is the same as disinvesting. In other words, by not reinvesting, the firm is headed toward a long-term decline. This is in direct opposition to the interests of the longer term investor.

Executives and boards are under severe pressure from broker/analysts to maximize short term profits. There is however a positive relationship between higher risk and high returns. Needing higher returns means that managements are constantly engaging in higher risk activities. Boards, looking out for the interests of traders rather than investors, issue contracts to executives that reward the high risk/return trade off and insulate management from the potential downside if the risks don’t payoff as projected. On top of all of this, companies can leverage profits up through increased borrowing. The downside is that the company is stuck with fixed cash payouts during an economic downturn. This could be harsh enough to force the company into bankruptcy. Traders don’t care. They are usually in and out so quickly that they have made their profits before the collapse. It is the investor who is stuck with worthless stock.

UPDATE AS OF 12/16/11: The New York Times has an article - "Amazon Says Long Term and Means It" which points out my contention that the market is dominated by organizations with short time horizons and therefore punishes firms such as Amazon because it has a long time horizon."Whatever they might say about long-term shareholder value, this is simply too much for many of today’s investors, many of whom are hedge funds, pension funds and institutions who measure their results — and earn their pay — based on quarterly benchmarks. “If you look at the average length of ownership of a stock, the period is declining,” Mr. Devitt said. “Amazon is marching to a different drumbeat, which is long term. Are they doing the right thing? Absolutely. Amazon is growing at twice the rate of e-commerce as a whole, which is growing five times faster than retail over all. Amazon is bypassing margins and profits for growth.” Also, according to another section of the article: " In October, when Amazon reported strong third-quarter revenue growth and earnings that were pretty much what the company had predicted, but indicated it would be spending more to support continued growth, investors hammered its stock. Amazon shares dropped nearly $30, or 13 percent, to $198 a share in just one day, Oct. 25. "

In addition, short-term profitability can be increased by reducing the company workforce. This lowers cost in the short-run but, because the layoffs are often aimed at higher paid workers, also means that the most skilled and productive workers are lost. In addition, historical knowledge is lost and firms end up repeating past mistakes because nobody still around remembers that certain activities did not work. On a national level this approach leads to falling real incomes, high levels of unemployment, and slow growth with high volatility in the value of 401ks.

Looking at all of this, is there any wonder that there is a growing anti-Wall Street movement in this country? Although the Occupy Wall Street movement has not expressed its discontent in the terms described here, the problem has gotten so bad that the participants have developed a visceral understanding of the underlying cause of the economic problems facing us all.

Hooray for the SEC

2011-10-11T17:04:00.001-04:00

The SEC has recently announced that it will be looking into the practices of Hedge Funds that seem to be consistently beating the market. The financial sector has begun to scream its collective head off at the “…effrontery of the SEC for targeting success….” They say that the successful firms are merely identifying inefficiencies in the market and are making money by capitalizing on those inefficiencies.

Efficient market theories say that this is possible in the short term, identifying market inefficiencies brings about efficient markets because those inefficiencies disappear due to the identification. However, it is hard to believe that one or more firms can consistently identify problems in a manner that lets them beat the market in the long run. According to the efficient markets theorists, long term returns in excess of the market return can come about from either trading on inside information, e.g. Raj Rajaratnam or by outright lying, ala Bernie Madoff. Either way, the means would be illegal.

In terms of the finance industry, the insistence that the market can be beaten on a consistent basis is a negation of the theory of efficient markets. Wall Street is constantly touting that the small player, the middle class saver and 401k or IRA owner, can trust in the future of their investments because the market is efficient. However, the existence of long term gains in excess of market returns is a strong indication that markets may not be efficient. Wall Street’s screaming is understandable only in the self-serving context that legal scrutiny would reduce its profits.

The Street cannot have it both ways. Either markets are efficient and long term gains in excess of the market need to be scrutinized or they are inefficient and the small player needs to stay out of the big boys’ game. In either case, Wall Street profits will suffer.

It All Nets to Zero

2011-08-21T16:15:00.003-04:00

Earlier today I watched the Governor of Virginia, Bob McDowell, expound upon the virtues of lowering taxes to stimulate employment growth. He said that every state with a Republican governor had lowered taxes and seriously increased employment.(He neglected to mention New Jersey which cut taxes and had an increase in unemployment) Therefore, the Federal Government should do the same and we'd all be better of. What he neglected to say is that this only works if you have a higher tax state from which to steal jobs. This is how it work: Assume two states with equal, including state taxes, employment costs to employers: State Goniff decides to cut its business taxes in half while state Schlemasel keeps everything the same. A business located in Schlemasel moves to Goniff in order to lower its cost. The unemployment rate in Goniff drops while the rate in Schlemasel increases. For the USA, unemployment remains unchanged. It is a zero sum game with one state winning and another losing.

The only way to make this cost cutting technique work on a national scale would be to eliminate the middle class entirely. This means paying computer programers $5,000 per year,as they do in India, or using sweat shop techniques, as it is reported are used in China. The "New Republicans" appear to be well on the road to this approach. All you need to do is listen to what they say and understand the implications.

Lets Give Them What They Ask For

2011-08-12T16:05:00.008-04:00

Mitt Romney and the U.S. Supreme Court have stated that Corporations are people. If that is so, then we should carry their options to their ultimate conclusions:

1. Corporations should be subject to the all of the rules for personal income taxation.

2. When convicted of a felony, instead of just being subject to a fine, the company should be put into a receivership, for the term of the normal prison sentence for the crime. The receiver would allow only those actions which would allow the company to continue to live and disallow those actions which would allow the company to prosper.

3. Executives of companies which are convicted should be charged as accessories to the crime and be subject to conviction and punishment as any accessory would when a crime is committed by a real person.

Let's see what the right thinks about these rules.

Update 9/27/11 I just saw a great Bumper Sticker

"I'll Believe Corporations Are People When Texas Executes One"

The Pre-Ordained Failure of the Super Debt Commission

2011-08-10T12:43:00.007-04:00

When I opened my copy of today's "The Morning Call" (Allentown, PA) I found that the lead article was a piece about Sen (R) Pat Toomey's recent meeting with local business people in Pottsville, PA. Toomey asked the loaded question of who felt that government regulations had worsened their businesses in recent years. Obviously, what followed was a litany of woes cited by the business people. They attacked labor laws and environmental laws as being costly and burdensome. What they did not address was who would pay the costs of the damages caused by the absence of the rules they criticized.Shortly after reading this I heard that Toomey has been appointed to the Super Debt Commission which is designed to create policies to reduce the Federal Deficit.

The problem ignored by Toomey is that businesses generate costs that are not included as cost of production because the consequences are external to the production process. Polluted water means that drinking water facilities have to be more robust to reduce the industrial pollution. Air pollution increases the incidence of lung diseases and subsequent medical costs. The costs of mitigating these problems are put on people who may not even be consumers of the products. Regulation puts the cost of the damages into the cost of the goods or services produced. This way, consumers pay the true cost of the products they use.

I have often heard business people state that they would not pollute because they and their families also live in this world. It may sound like a good argument until you begin to question specific actions. Several years ago a Vice-President for Manufacturing (at an unnamed company) was complaining to me that a certain state's (also unnamed) water rules were unreasonable. He said that the water his company used had come from the ground and, after being used and treated, what went back in was completely potable. I asked him if I could go to the water return system, get a glass of water, and serve it to him. His response was: "...you mean you want me to drink it?" When I said yes, his reply was: "no way in hell will I drink that stuff!" I then asked how he could state that the water was potable if he wouldn't drink? He sputtered and asked me to leave his office.

Toomey, and the rest of his Regressive cohorts play on a well known problem in the realm of public choice. The problem is that governments must create programs that come out somewhere in the middle of the public wants. This means that everybody is unhappy. Lets face it, when you want a cell phone there is a wide variety of models available. You can pick what you want. When the government tries to set policies regarding the parts per million that of a pollutant that are acceptable nobody is happy because some people think the level is too low and some think it is too high. The same applies to average classroom sizes in schools. In elementary schools I have seen studies indicating that 15 - 18 pupils would be optimal.However, I went to school in an era when our average class size was between 35 and 40. Most of my classmates went on to college and have entered fairly high level professions. If a school district sets a class size at 23, the only people who will be happy are those that think 23 is appropriate.

The right wing in this country, including Toomey, play up on this dissatisfaction with government decisions in an attempt to convince people that government can't do anything right. If Toomey and his cadre of conservatives continue to pander to this discontent and they only accept spending reductions, I expect that the commission is predestined to failure.

I Hope I'm Wrong

2011-08-09T15:35:00.006-04:00

As I read the news and listen to the commentators I begin to fear that a prediction I made during the election campaign of 2010 will come true. At the time I told those who asked for a forecast:"...if the Tea Party gains significant control in the new congress we can expect 14% unemployment by the time of the 2012 election." I based my conclusion on a belief, which has proven itself in the recent debt ceiling debate, that right wing obstructionism would prevent any governmental ability to bring us out of the economic doldrums.

I pointed out, at the time, that the bulk of the stimulus ended up replacing tax income that state and local governments lost during the recession; with the expiration of the stimulus spending and the subsequent cuts in state and local spending accomplished through layoffs we could expect to see a rise in unemployment and a possible double dip recession. As we have seen, the new debt ceiling legislation not only eliminates the renewal of the stimulus package, but it also cuts additional spending from the federal budget. This lowered level of spending means that there will be fewer jobs in many different sectors with a subsequent reduction in consumer spending. In addition, extended unemployment benefits have also been eliminated. Unemployment benefits act as an automatic stabilizer in that they allow the unemployed to maintain at least a minimal level of spending.

The evidence that my prediction for an economic downturn may come true came in yesterday's announcement that worker productivity dropped and today' announcement by the FED that economic growth has been less robust than they had thought.A reduction in productivity is usually an indicator that firms will be laying off more people. It is a sign that they have more workers than they need. If we add slower economic growth and state and local layoffs to this scenario it is not unreasonable to expect growth to turn negative. Given the prevailing attitude in the House of Representatives getting any type of government stimulus into effect will be virtually impossible. In the absence of government intervention to stabilize the economy we can expect an accelerated downturn.

Some might ask what the FED can do. Bernanke has said the FED will do all in its power to stabilize the economy. The problem is that the Fed's greatest tool is the ability to raise and lower interest rates. The problem is that lowering interest rates is a method of stimulating business investment and consumer purchases of homes of durable goods. Business investment is not only dependent upon the interest rate but is also dependent upon demand for the goods and services produced. If consumers are not working, or expect that hey might be laid off, they will not be buying durable goods and houses. As a result the demand that is necessary to set off business investment will not be there. Add to this the fact that banks might not want to lend if they foresee a downturn. Excess reserves, funds that banks can lend, are already extremely high and in the event that bankers are less than enthusiastic about economic prospects can go higher.

All in all, the more I observe about what is going on the more pessimistic I get. I truly hope that I am wrong and that somehow our elected representatives will wake up and do the right thing as opposed to the dogmatic. If so my predictions would not come true. If they follow the current course there is a high probability that I will be right.

The Sophistry of the Job Creator Argument

2011-08-08T17:18:00.006-04:00

About an hour ago I was on the treadmill in the gym watching Rep. Phil Gingrey (R, 11th GA) explain how he disagreed with the 63% of the American public that believes that the recent debt ceiling agreement benefited the rich at the expense of the middle and lower classes. He used the argument that people making more than $250,000 were the entrepreneurial job creators and that higher taxes would stifle job creation by this class. This is an argument that has been coming up since the Bush administration and it appears to me that hearing it while on a treadmill is extremely appropriate.

Once again, the right wing is showing that their approach to economics is religious rather than reasoned. I state this because someone once said that religion is the suspense of reason and reason based upon research shows that taxes do not have the effect that the Gingrey and his cohorts claim:

1. Around the time of the 2010 election a small business association asked its members what it would take to get them to hire more people. The response was: an increase in the demand for the goods and services that they produce.

2. A article published in CFO.com (April 2004)reported on a study entitled "Tax Breaks Don't Boost Investment". The research looked at 275 companies that were given tax breaks to stimulate investment. The smaller companies, which were closer to the entrepreneurial level, actually decreased their investment by an average of 13%. The researchers conclusion was that demand was the true determiner of planned investment.

I believe that there are only two possible explanations for the Right's persistence in their opposition to tax increases: as I stated earlier they have turned their economic philosophy into a religion or they believe that its okay because they've got theirs and '...to hell with everyone else...'. This holds true especially in light of the fact that S&P included the seeming impossibility of raising taxes in the current environment as one of their reasons for downgrading U.S. Government debt.

Capitulation

2011-08-02T15:13:00.005-04:00

Barack Obama has just given the Tea Party the Victory that they need to sell themselves in 2012 election. They can point to what has been done and say "See what we have done. Elect more of us and we'll do even better". They've already stated that this "compromise" didn't go far enough, and they mean it.

What could Obama have done? In his first two years he could have used the regular congressional sessions to obtain the needed legislation. However,he was just too accommodating to use the Bully Pulpit and the presidential "...aura..." against the Blue Dogs of his own party let alone the opposition.

In the current deal my contention is that he was open to being snookered because he truly believed that the Republicans were willing to deal. He never realized that their only goal was to see that he didn't get re-elected "...come hell or high water..." I'm afraid that he still doesn't get it. He lost not only the battle but the war.

Hello 19th century. The Republicans (... Tea Party...) want to repeal every piece of social legislation since Teddy Roosevelt. Yes, I said Teddy. There has been talk of repealing child labor laws and the anti regulation attitude will lead to the end of anti trust legislation. Remember, they see the 19th century as a Golden Age just as they falsely see the Antebellum South with slavery resulting in stable families for African Americans. They are deluded and are very good at using Goebbels methods to convince average Americans that their warped views are accurate.

For the first time I'm actually pessimistic about the country's future. In the past when my students asked about the country's economic problems I talked about the resilience of the American people and our can do attitude. Now, with our leadership believing that most of the unemployment is structural and a belief by most people who are working that the deficit is our highest priority, I think we are in for a long period of decay:

1. Reducing payments to education will reduce our competitiveness and leave our workers unprepared for the newer high tech jobs. Our best bet will be to teach students how to say "Would you like to Super Size That?"in several languages (Chinese,Spanish,and Hindi).
2. Without investment in our infrastructure we will be unable to ship our goods, keep our water clean, and maintain our cities.
3. The failures in the items listed above can lead to the USA resembling a 3rd world nation.

Ignoring Downside Risk - Again

2011-07-28T14:05:00.004-04:00

As I listen to, and read about, the debate about raising the debt limit, I am stuck by the fact that we making the same mistakes that got us into the financial crisis of 2008. That is, we are under playing the downside risk that comes from being wrong. A good chunk of the problem that led to the financial meltdown resulted from the assumption that housing prices could not fall; therefore, it was not necessary to measure the downside risk that would come from falling house prices. People therefore invested in dubious financial instruments that could only cause problems if real estate prices dropped.

Tea Party members of congress have essentially said the same thing about default. They are saying that any negative would be short term. They believe that the market knows that USA credit is sound and there would be no consequences from default. What they fail to see is that the world and the markets may not act the way the Tea Partiers suppose. Lets look at some potential consequences of default:

1. The Government could still borrow to replace debt that is maturing as long as it does not exceed the debt limit. This will lead to:

A. Buyers demanding higher interest rates because they are
unsure of the payment of interest.Increasing the deficit.

B. Because the debt sells at auction this higher interest
means that the actual collection from the auction could be
substantially less than the debt being incurred.Increasing
the deficit.

C. To offset this the government could put a higher coupon
rate on the debt. But this will result in higher annual
interest payments. Increasing the deficit.

D. Most of the debt is short term and is sold at discount.
Higher interest rates mean the discount is deeper, interest
payments are higher, and the deficit increases.

2. Rating agencies lower the rating on US debt to AA from AAA. This leads to further increases in the interest on US debt because:

A. Many Fixed Income mutual funds require that they have a
certain percentage of their portfolios in AAA debt. This
means that they would have to dump some of their USA
Securities onto the market thereby lowering the price
of US debt and raising interest rates.

B. Many insurance companies are under similar NAIC rules that
would cause similar restructuring.

C. Many countries have their reserves in U.S.Dollars that
are invested in U.S. Government Securities. They might be
tempted to move to the Euro, the Pound, or the Yen.

D. Oil and many other commodities are priced in U.S. Dollars.
If these move to other currencies, the price effects for
U.S. consumers could be extremely uncomfortable.

E. All of the preceding items 2 A - D would lead to negative
effects on the U.S. economy. A shrinking economy means
automatic decreases in tax collections and automatic
increases in other programs. All leading to an increase in
the deficit.

The Tea Party actions, instead of helping, would lead to a long term worsening of the debt problem. There is an old saying: "Be careful of what you wish for. You may get it"

They're At It Again

2011-07-20T16:49:00.006-04:00

Einstein is credited with the statement:"...Insanity is doing the same thing over and over again expecting different outcomes...". I guess this is an apt description of the IMF. Let me explain: Yesterday, July 19th, an IMF representative said that any arrangement for a EURO bailout of Greece needs to be structured so that credit insurance will not kick-in.

It appears that European banks have continued to issue Credit Default Swaps, a form of insurance against financial instrument defaults,despite the experience of AIG in the last financial crisis. The IMF is worried that exercise of the provisions of the swaps will sink Europe's banking system.However, nobody has instituted regulations to prevent the issuance of these swaps.If the consequences of people collecting on these pseudo insurance policies are so dire then they should be banned.

The problem with banning Credit Default Swaps is that too many people are making money on them; in the event that they have to be paid on, everyone is sure that governments will bail out the issuers to prevent a financial collapse. Adding to the problem is the fact that the Swaps are in fact financial instrument and not insurance policies. They are securities which can be bought and sold on the open market. The current owners of these securities probably do not own the bonds (Greek Debt) that are being insured. Therefore,they do not have an insurable interest in debt which may default. However,if there is a default,they would get paid anyway.

Now to get back to who is making money:

1. The issuing institution is paid to write the securities.
2. The debt issuer gets a lower interest rate because the buyers of the debt can buy the Swaps.
3. The buyers of the Swaps can then sell them at a premium if it looks as if they will ever have to be paid off.
4. The original issuer gets paid off by various governments in order to avoid collapse.
5. Brokerages make commission money buying and selling the swaps to 3rd parties
6. The losers are the tax payer and the unsophisticated buyers who are holding swaps which will never be paid on because of government bailouts to the debt issuers.

So, our governments keep allowing these transactions because the Swap issuers are the same people who make large donations to their campaigns. On top of this, the government officials in charge of regulating these activities usually came from the offending financial institutions and will probably return to them when they leave government service.

"WE HAVE THE BEST GOVERNMENT MONEY CAN BUY"

THE FALLACY OF REFUSING TO RAISE TAXES FOR THE RICH

2011-07-13T13:30:00.008-04:00

In February of 2005 I wrote a blog in support of the progressive income tax. Given the current Republican refusal to consider any tax increase for the rich and the proposals to substitute a Value Added Tax for a large portion of the Income Tax, I believe that my blog comments retain their relevancy. As a result I am reprinting the original blog below with some added comments at the end:

PROGRESSIVE INCOME TAXES EQUALIZE THE PAIN
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. If possible 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 which has the capability of equalizing the pain of supporting government.

The problem with a VAT (Value Added Tax) is that it has lower income households paying a large portion of their income in taxes than higher income households. This is because all spending is taxes under a VAT. Assume that the VAT is 14% (this is low compared to most VAT countries). A family of 4 with an income of $40,000 per year will probably have no Saving. This means that the whole $40,000 would be subject to VAT and the Tax paid of $5,600 would be 14% of their income. A household with an income of $400,000 per year would have a saving rate approximately 20%. They would be spending $320,000 with a VAT of $44,800. This is 11.2% of the higher income family's gross income. In other words the low income family has a higher effective rate of taxation than the high income family.

ADDITIONAL COMMENTS REGARDING THE VAT

Please remember that the VAT results in a lower quality of life at the lower income level because the low income VAT payment means that true spending on goods and services is $34,400 which is the $40,000 less the $5,600 VAT. The higher income families can opt lower net spending of reduce their saving to maintain the quality of life. Even if this decision is made, the high income effective tax rate would still be lower than the effective rate paid by the lower income family. The numbers are slightly off for the low income family because the VAT would be applied to only their spending.The math works out to Spending of $35.087.72 and VAT Taxes of $4,912.28 or 12.2% of gross income.The high income family still has a lower effective tax rate of 11.2% if they pay the tax by reducing their saving. If they reduce their spending the would spend $280,701.75, have a VAT of $39,298.25, and have a effective tax rate of 9.82%.

All in all the lower income people pay a higher percentage of their income than the higher income people. This is the definition of a regressive tax system.

Profit vs. Value

2009-07-05T11:40:00.001-04:00

To those few of you who read my blog on a regular basis, I want to apologize in advance for what will be a fairly technical blog.

As I read about the various arguments regarding how to revise the financial regulatory system, I am amazed at the fact that the discussions never seem to get to the basis of modern financial decision making. In the modern world we use the term “Value Creation” to describe the goal of maximizing shareholder value. This means keeping the price of a stock as high as possible. Almost all of the executive compensation packages are based upon the principle that maximizing the current price of a share of stock is the goal of all companies. This is based upon the assumption that we have perfect markets with perfect information. However, as we have found out, al la ENRON, the market often does not have the information necessary to properly value a company’s shares. In fact, the management has huge incentives to engage in long run value destroying activities because they appear to add value in the short run.

The whole value maximization approach is aimed at a trading rather than an investing mentality. This is an outgrowth of the work of Nobel Laureates Miller, Modigliani, and Sharpe. Miller and Modigliani establish that the value of a company is independent of the debt/equity ratio of the firm. They even establish that the optimal financial structure in the presence of taxes is 100% debt. Sharpe, through the Capital Asset Pricing Model establishes that a firm’s expected return is related to the variability of the returns a firm earns as compared to market returns and returns on risk free assets. For both of these systems to be applicable firms need to be traded in efficient markets and risk associated with specific firms can be diversified away. It appears that the people implementing value maximization forgot these underlying assumptions.

When we look at a firm’s capital structure, i.e. debt/equity ratio, we need to remember that higher debt leads to a wider variation in the returns available to the shareholder. Higher debt equals higher risk. As more and more firms follow the approach of increasing debt the less likely it becomes that risk can be successfully diversified. As a result, we demand higher and higher returns to off-set the higher risk. In an attempt to meet these higher expectations, managements increase the risk of the projects they undertake because higher risk usually results in higher returns. The whole system becomes subject to the types of risks that, in the past, had only been associated with specific firms (Specific Risk). The Financial System starts to rise on a spiral staircase that has a drop-off at the top. The financial meltdown of 2008 was the result of the system going over the top of the staircase just described.

Going back to Miller, Modigliani, and Sharpe we find that they appear to work under the assumption that managements look toward valuing a firm as the present value of the future stream of income. In the absence of Wall Street Analysts this might be true. However, analysts seem to have a trading mentality. As a result, the concept of investing in solid profit earning firms on a long term basis is lost. Even many of our institutions, such as pension plans, which should be long-term investment oriented have turn-over ratios nearing or over 100%. The resultant trading mentality combined with higher levels of specific risk leads to very high levels of risk for the entire system. We have turned into speculators and gamblers rather than investors.

Please do not misinterpret what I am saying:

1. I do not have the hubris to place my ideas on the level of Nobel Laureates. I am, however, criticizing those who have misused their works.
2. Speculators serve an excellent purpose in an economic system. Through arbitrage, they act to effectively stabilize the markets. However, this only works if we have markets dominated by investors. When speculation dominates the system we find that we are operating a casino instead of a financial market.

Our regulation writers have to take into consideration how we got where we are. I believe that they are spending too much time looking at specifics rather than the general approach which got us into trouble to begin with. “…We can’t see the forest for the trees…”

NOT ALL MARKETS BENEFIT FROM COMPETITION

2009-06-19T13:16:00.003-04:00

Having been trained in Economics and Finance, I am a strong believer in the benefits of market based competition. However, I also recognize that there are many markets where for some reason the free market does not lead to economic efficiency which economists often define as producing at the lowest possible cost. The medical industry may fall into this category of non-market based efficiency.
This can be illustrated by the following: About 25 to 30 years ago the Blue Cross/Blue Shield system dominated the health insurance industry. There was sharp criticism because the hospital portion of medical care was paid on a cost plus basis. Those who did not understand the system assumed that this led to uncontrolled growth in hospital costs. Governments forced the Blues into a different payment system and hospital costs skyrocketed. What the critics failed to understand is that the Blues audited hospital costs and refused to include many costs in the payment base. In fact, hospitals were required to get advance approval for major capital purchases. This means that if one hospital had an underutilized MRI the blues would not reimburse another hospital in the area that acquired an additional MRI. The Blues encouraged the second hospital to contract for MRI services with the first hospital. This led to lower overall costs in the system. The elimination of the Blue Cross single payer cost-plus system led to duplication of services and higher per unit costs due to under utilization at some institutions and higher over-all costs due to scheduling of unnecessary tests designed to justify the acquisition of the equipment at others. In this case competition led to higher costs instead of economic efficiency.
Now we are hearing health insurers and their congressional apologists screaming that a single payer system would not be economically efficient because we would eliminate competition. In addition, they claim that a single payer system would lead to rationing. What they fail to consider is that we already have rationing. In a world of scarce resources the market based system allocates, i.e. rations, resources on the basis of prices. In the realm of health care, those who can afford to pay the price get the care. Medical care is rationed to those with either high wealth or good insurance. Those without either get poor or no care. In addition, as was explained earlier, market based health care leads to higher costs.
The time has come for Americans to join the rest of the developed world and treat health care as a non-market service. Those who claim that the government cannot operate efficiently just need to look at Medicare as a model. I have many friends, over 65, who rail against government involvement in health care. When I ask them if they’re going to give up their Medicare coverage their universal response is that Medicare is great. Why would they give it up? When I point out their contradictory attitudes they just ignore me. They fall into the category of those people who dislike economists because economics often disproves their preconceived notions and people are reluctant to change cherished beliefs when evidence contradicts them.

IS ECONOMICS REALLY DEAD?

2009-04-14T18:22:00.001-04:00

More and more, today, we are reading the current economic crisis proves that Market Economics is dead. Looking at the behaviors exhibited in the last twenty years, the detractors tell us, proves that people do not follow the rational economic choices that are espoused by classical economists. They claim that the new wave of economics is behaviorist and behaviorism destroys all classical analysis. In other words: “Adam Smith is no longer relevant.”
Although there are strong arguments for this approach, I believe that the classical Supply/Demand Model still works. It only needs a minor modification to remain relevant and reliable predictor of human behavior. Most of us, who only had a cursory course or two in economics, remember that the Supply/Demand approach looks at prices and quantities. There is an assumption that all of our decisions are based upon changes in prices. What we forget is that the price quantity relationships are stipulated as operating ceteris paribus. This means that everything else remains constant. Economists are not stupid. They know that people spend based upon their tastes and preferences, their income, their wealth, their expectations and many other factors. The model, however, holds these items constant and says that people will act rationally in a supply demand situation.
Where our model appears to fall apart is that people seem to be acting irrationally. If this is the case, then maybe economics is irrelevant. Looking at the same behaviors, I have come to a different conclusion. I concentrate on peoples’ expectations. I believe that people act with economic rationality based upon their expectations. However, there is nothing in the model that says peoples’ expectations have to be rational. So, if you believe that the basics of the economy have changed and there will never be a down real estate market again, you will be willing to take on an in ordinate amount of debt because the rising asset value will give you a growing net worth. Expecting a market with no down side risk is irrational. But, if you are faced with experience that has never seen a down side in real estate you will act as if the lack of a downside is reality. Your actions are rational within the context of your belief and follow standard economic models regarding supply and demand.
This approach also helps us understand why people buy high and sell low in the stock market: If the market has been growing for a long time but you are afraid of market cycles there is a high probability that you stayed out of the market during its early growth phase. As the market keeps growing you begin to experience cognitive dissonance. That is, your behavior is at odds with everything you now appear to know about the market. You finally give in and go into a buy mode. However, you waited too long and the market drops shortly after your purchases. You are now in the “…I knew I never should have done this…” mode. Your real expectations have been reinforced and you decide to “…cut your losses…” Your observed behavior is irrational. But, based upon your expectations you behaved rationally.
We do need to spend more time addressing how expectations are created. We also need to do more in the realm of education that allows expectations to be created based on rationality. The problem we have had is that the experts, who should have known better, were making so much money that they were reluctant to burst the balloon and eventually began to have irrational expectations of their own. They began to believe their own hype.

GEITHNER IS TOO CLOSE TO THE STREET

2009-03-24T13:25:00.001-04:00

Up until now I had the attitude that Secretary Geithner needed all the support we could give him. The country needed to have a solid voice that could implement plans without creating a sense of uncertainty. However, I now believe the time has come for him to go. His recent plan to deal with the “toxic assets’ is fatally flawed. It is based upon the assumption that the markets have undervalued the assets and government guarantees will get the private sector to buy them. The problem with this approach is that it relies upon the banks being willing to sell the assets at the price the market is willing to pay. The private sector which has already priced the assets at extremely low levels and the Geithner plan expects it to miraculously start buying at inflated prices due to government guarantees. There is not even an assurance that the banks holding the assets will sell them at anything less than face value.
In addition, if the assets prove to have little worth, the US government, read you and me, will have to pay off the guarantees. It would be a lot cheaper to the taxpayer if we nationalized the illiquid, read that as insolvent, banks, let the assets mature, and pay back the taxpayer to the extent that the maturing assets will allow. We, in aggregate (government), have a much greater capacity to wait out the market than do profit making institutions. In the long run a single “Bad Bank” will have a greater capacity to renegotiate loans, the disruption to the market from bank bankruptcy will be mitigated, and the costs to the tax payer will be lower.
Mr. Geithner appears to be too obsessed with preserving the current insolvent banks rather than solving the problems facing the financial system. I believe that in his role as President of the Federal Reserve Bank of New York he may have gotten too close to the “Movers and Shakers” who caused the problem to begin with. This makes him overly amenable to their approaches that are design to preserve their own positions. Once again the economics of greed is winning out over Adam Smith’s “Enlightened Self Interest”

MATERIALITY AND THE AIG BONUS PROBLEM

2009-03-21T20:17:00.003-04:00

When I was reading about the AIG bonuses I was as outraged as anyone else. The first thing that came to my mind was “How could Geithner let them get away with this?” Then I stopped and thought about the days when I managed a half-billion dollar portfolio. Number in the thousands didn’t seem very significant. The problem arises from the fact that large numbers contain a lot of digits. Most people working with large numbers drop several digits due to what accountants call immateriality. For example: Most company financial statements have (000) written under the title of the individual financial statement and all of the numbers are in thousands of dollars. So, $1,985 is really $1,985,000. We’re talking millions of dollars, not thousands and hundreds of dollars get lost in the shuffle.
So, how did Mr. Geithner miss $250 million? It is easy to do when the bailout is in the billions. Simply, most of the numbers crossing Mr. Geithner’s desk were probably written in billions. The bailout package to AIG was probably written as $185 instead of $185,000,000,000. This means that the bonuses would have been written as $0.165. This is a number that looks insignificant in the overall scheme of things and could easily be missed. Especially by a person who is dealing with a national debt number in the trillions. Let’s face it, if all day long you’re seeing number like $9,654.4 which is the national debt, $0.165 looks like peanuts. That fact that the true numbers are $9,654,400,000,000 and $165,000,000 gets become obscured.
What is needed is to have people working with the Treasury Secretary and the Fed Chairman who understand that apparent small percentage numbers have a high impact when read as whole numbers. People in the rarefied air of Washington and New York do not realize that the AIG bonuses could eliminate the debt of many smaller cities and pay for the complete budgets of many school districts. I do not blame Mr. Geithner for missing the impact news of the Bonuses would have on the public. I do blame the loud mouthed critics who would have claimed that the Obama administration was destroying the capitalist system if the bonuses had been blocked. Once the bonus contracts were written, it became a lose-lose situation for the Obama team.

THE ARROGANCE OF AIG

2009-03-15T15:09:00.001-04:00

About 15 years ago, when I was working in corporate treasury, my company’s insurance broker asked me to write a letter to him expressing my experience in dealing with AIG as the carrier of our Liability and Workers Compensation coverage. My response was that the AIG representatives behave in such an arrogant manner that one would think that you were dealing with the Department of Motor Vehicles. The recent announcement that AIG would be paying in excess of $165 million in bonuses convinces me that nothing has changed.
Remember, AIG is a company that has required tens of billions of dollars in bailouts from the government in order to avoid cascading failures to the world economic system. In addition, AIG’s losses have been larger than the GDP’s of many medium countries. Yet, the executives of AIG have the arrogance to believe that they are entitled to huge bonuses. Yes, I said entitled. Executives at AIG believe that they entitled to receive a form government transfer payments similar to the welfare system. However, these payments go to those who are well off: Welfare for the rich. The executives will claim that government money isn’t paying the bonuses. If that is the case then AIG doesn’t need the $165 million and the government payments should be reduced by value of the bonuses.
I fear for the future of the United States. We have gone from a country where Adam Smith’s enlightened self interest has changed into the arrogance of greed. I cannot think of any behavior which could do more to convince Americans that there is something wrong with the capitalist system. The executives’ actions could not do more for advancing socialism than they could if they were on the payroll of the Socialist or Communist parties.

REPUBLICAN GOVERNORS ATTEMPT TO TURN US INTO EUROPE

2009-03-13T16:05:00.000-04:00

The Republicans tell us that President Obama is attempting to adopt European socialism in the USA. However they are actually trying to establish European separatism as an alternative. Let’s face it; Europe is an amalgam of over 20 separate countries with few mechanisms for coordinated Fiscal Policy. Monetary Policy is centralized through the European Central Bank in the same manner that our Monetary Policy is centralized through the Federal Reserve System. However, Europe does not have a strong central government to design and implement fiscal policy. As a result, even the Europeans have doubts about their ability to recover. Each country is pretty much on its own regarding stimulus issues. That means if Italy tries to increase spending and create jobs the result could be that the new spending ends up creating jobs outside of Italy. This would happen if France decided not to stimulate its economy. As a result wages, and therefore, prices would be lower in France and the Italians who were hired under the stimulus would buy French goods. This would result in sporadic growth in Europe and a prolonged recession.
American governors who refuse the stimulus money would be placing our country in the same boat a Europe. The lack of spending in their own states would lead people to relocate to states where the stimulus money is working. The result would be a continued recession in their own states and a delayed recovery in the country as a whole as unemployed workers cross state lines. The only reason to seek this type of scenario is to be able to say: “See the stimulus didn’t work so vote Republican.” The Republicans are willing to see the country suffer so that they can regain power. It is this selfish approach which can threaten the state of the Union. The Republican Governors are traitors who have stronger loyalties to their party than to the country.

Warren Buffett Has It Right

2009-03-09T15:40:00.001-04:00

The more I read Warren Buffett’s comments regarding business and economics the more I believe that he has more practical sense than all of congress combined. Today on CNBC Mr. Buffet stated that it is time to treat our economic problems as if we were at war. In doing so our congressional political parties have to put their partisan differences aside and treat our president the way we would in a full scale war situation. In an all out war, the people need to believe that we will win and the president must be commander in chief. Buffett (along with Krugman, Stieglitz and most economists) stated that confidence is necessary for an economic recovery to take place. As long as the congressional Republicans fight everything President Obama tries to accomplish and the Democrats try to add pet projects to every piece of stimulation legislation, the public will have serious doubts about the prospects for recovery.
It is time to end the fighting if we are to preserve the nation. Recovery is a matter of national security and we should all be a part of it. The problems that will arise from the tactics used to stimulate a recovery are far more manageable than the slide that will turn into a plunge if we do not act. Monetary Policy has done well at preventing a full scale plunge. However, monetary policy has reached its limit because we are now in what economists call a liquidity trap. It is time to let Fiscal Policy do its job.

Treat Banks As You Would Treat a Heart Condition

2009-03-07T15:27:00.001-05:00

People often ask me why we can’t let banks and organizations such as CITI and AIG just fail. The answer is simpler than most of us would expect. First it is important to think of the economic system as an organism comprised of a series of interrelated systems similar to the human body. The banking system is the circulatory system of the economy; Money is the blood of the economy. If an artery, such as a major bank, gets clogged some other major organ may fail or be severely impaired. We can equate the failure of major financial institutions to the clogging of arteries that lead to cascading organ failure. Clogging of the renal artery can lead to kidney failure. We can survive with one missing kidney but a loss of both will kill the organism. A bad kidney can lead to a bad liver which can affect other organs. CITI or AIG going under can lead to a cascading collapse of other banks and financial institutions to the extent that the whole organism we call an economy can die. Therefore it is necessary to prevent the total failure of these organizations.
However, this does not mean that we must preserve the plaque that got us into trouble to begin with. Just as arteries can be opened using stints and plaque can be reduced with Statins, financial institutions may need a complete change in the clogging agent known as outdated management. In addition, a pacemaker (regulatory agency) and regular check-ups (audits) may need to be added to keep the system healthy.

REAGANOMICS AND FISCAL RESPONSIBILITY

2009-03-06T20:01:00.003-05:00

Whenever I hear the minions of the Republican Party, and the right wing goofballs such as Rush Limbaugh, screaming about the Democratic Party’s lack of fiscal responsibility I am dumbfounded by their self deception. The fact is that history shows our worst years of fiscal responsibility have occurred under Republican Administrations. Data on the Federal Debt as a percentage of GDP, generated by the OMB, demonstrates this.
From 1960 through 1980 there was a general decline in Federal Debt as a percentage of GDP from 56% to 33.1%. However, with the beginning of Reaganomics in 1981 we can see a sharp increase in this percentage. It continues to grow sharply throughout the Reagan and Bush senior years. As stated earlier in 1980 the debt was 33.1% of GDP. Republican prolificacy led the percentage to top out at 67.3% in 1996. Throughout the balance of the Clinton years the value dropped. In 2002 it was down to 59.2%. With Bush junior’s ascendance to the presidency there was a sharp increase in debt until it is projected to reach 67.5% when the final figure for fiscal 2008 is in.
Somehow the Republicans have managed to deceive the press and the public into believing their myth of Fiscal Responsibility. I guess they have learned well from Joseph Goebbels: If you tell a big enough lie often enough people will begin to believe it. When will the press start doing its job and start challenging the deceptions of the right?

HAVE WE LOST CONFIDENCE IN OBAMA?

2009-03-05T07:20:00.002-05:00

If you read the current press or watch television news you may have heard that Americans have lost confidence in President Obama's ability to engineer an economic recovery. This is despite the fact that he is very popular. The real problem is that the media in their stupidity has given credence to the latest scam of the obstructionists from the right.

The over-riding issue is that the right wing, who believe that government has no role to play, has spent so much time talking about how Obama's plans couldn't work that the economically ignorant press has begun to believe them. If Obama’s plans fail it is because the right has been obstructing so much of anything he tries to do that the people have lost confidence not in him but in the whole political process. When Rush Limbaugh says he wants Obama to fail and Rick Santorum, a light of the "Right" agrees, we find we are all in trouble. The right has learned that expectations have an awful lot to do with how an economy operates. If they can destroy positive expectations then the failure of the recovery can move the right into power in 2012.

Rush and his ilk are traitors. They are more interested in their regaining power than they are in the health of the country. Their governors’ refusal of stimulus funds borders on criminal behavior and implications that they can refuse to follow laws they believe to be unconstitutional is a step toward cession and a new civil war. They would rather see a failure of the republic than allow their opponents any semblance of success.

DO WE DESERVE THIS?

2009-02-07T09:52:00.000-05:00

Someone once said that we get the government we deserve. My problem is that I cannot fathom what grievous harm we’ve done to the world to get the congress we have today. We have both Republicans and Democrats screaming that we have a spending program instead of a recovery program on the table. My guess is that all of them failed their Introductory Economics course or they decided that nothing in the field developed after 1899 has any relevance. Our illustrious elected leaders seem to forget that spending is economic stimulus. When Republicans complain that the New Deal took too long and we needed WWII to get out of the depression, they are ignoring the fact that it was the stimulus spending for WWII that finally ended the depression. Even FDR had a tough time spending enough to end the disaster. Now Republicans and some conservative democrats are complaining that President Obama is spending too much. These naysayers are going to end up extending the problem through under spending.
I can understand why the Republicans might want to do this. They believe that they can win the mid-term congressional elections if they make sure that a recovery doesn’t take place. They are willing to see the country go down the tubes in order to gain an electoral victory in 2011. They bring out the old saw of giving money to business to get the economy moving. They believe in something called “Say’s Law” which states that supply creates its own demand. The problem is that nobody in his/her right mind is going to produce goods in the absence of demand. Without an increase in demand, reducing the cost of labor merely increases business profits without increasing employment.
It is time to get tough and call the obstructionists to the carpet. I would use their old saw and state that they are threatening the security of the United States. I would not hesitate to call them traitors who are more interested in lining the pockets of the internationalist multi-national corporations than they are in the security of America. Progressives have, for too long, been too timid in their pursuit of their goals. They have tried to appeal to the mind. It is now time to use the tactics of the conservatives and start appealing to the gut. In 1932 the USA could have gone the way of Germany and Italy or the way of Russia. We found a third way through FDR and the new deal. If the conservative have their way, I’m afraid that our fate will be to resemble Mussolini’s Italy.

THE CONSERVATIVE AGENDA

2009-01-23T18:11:00.002-05:00

Now that President Obama has submitted a stimulus package I am struck by the fact that the Republican in have returned to their standard of trying to stimulate business through tax breaks and tax credits. They use the excuse that businesses will hire more people if government would only give businesses tax credits for every additional person they hire. The problem is that this is pure bull ****. The demand for labor is derived from the demand for the goods and services businesses sell. When businesses get stimulus credits they are only applying for money based upon people they would have hired anyway. They believe that they are not doing anything wrong because they feel that the money is going for hiring people and since they’re hiring, why shouldn’t they get the stimulus money. The forms that are completed merely move numbers around to prove that the stimulus got them to do the hiring. It is a shell game on a massive scale.

To understand what I’m talking about you only need to look at the CFO.com article of Sept. 24, 2005 entitled “Tax Breaks Don’t Boost Investment.” This article looked at the effect of tax credits on business investment and found that the companies with tax breaks cut their investments by 22%. The article concluded that investment was based more on the demand for a company’s goods than on the cost of making the investment. In other words, the demand for any production input is based upon the demand for the goods and service the inputs produce not on an artificially reduced price of the input. The only effect of the incentives is to increase after tax profits. Investing in tax credits for hiring will get you the same returns as you would have earned with Bernie Madoff.

On Proportionate Responses

2009-01-07T20:58:00.000-05:00

The recent actions by Israel have been condemned by many churches and governments. Their main complaint is that the Israeli actions are out of proportion to the Hamas offenses. They imply that they would not be condemning Israel if the responses had been proportional. We need to look at this issue in light of the facts:

1. Hamas launches rockets into Israel specifically aimed at civilian targets.
2. Hamas places its leadership and military centers specifically in civilian locations
3. Hamas locates rocket launchers in or near schools, hospitals, and civilian neighborhoods
4. Israel tries to target only Hamas leadership, military, and launching sites

Given these established facts, we can only conclude that:

1. Hamas doesn’t make a distinction between civilians and combatants unless it meets its political agenda
2. This agenda places Palestinian civilian at risk intentionally.
3. Hamas wants to increase Palestinian civilian casualties because it makes Israel look bad

Given these fact and conclusions I have to conclude that the criticizing governments and churches want the following actions that would be proportional responses:

1. Israel should start lobbing rockets into civilian neighborhoods regardless of whether Hamas has facilities there
2. Israel should make elimination of any concept of a Palestinian State a part of its political goals in the same manner that Hamas has the elimination of Israel on its agenda
3. Hamas fighters captured in battle should be held without notification of their being held.
4. Bodies of Hamas fighters killed in battle should be held and implications made that they are alive and will be returned if certain concessions are made by Hamas.

Do the churches and governments really want proportional responses? If they do, they will be instrumental in perpetrating a higher level of civilian suffering than has been seen to date.

STOP BLAMING FDR

2009-01-02T19:46:00.001-05:00

Paul Krugman and other economists have been attributing the 1937 recession to actions by FDR. They say he was merely following advice regarding the attempt to cut spending and balance the budget. However, whatever FDR did, there still would have been a recession. This is because the Fed, which is independent of the executive, raised the reserve requirement substantially during the same period. From 1917 until August 1936 the Central Reserve City Banks had a reserve requirement of 13% Starting if August of 1936, through May if 1937 , the Fed raised the rate to 26%. The rate for Reserve City Banks went from 10% to 20% an d for country banks the rate went from 7% to 14%.
The reserve requirement is the percentage of deposits that banks are required to hold at the Fed. This is money that cannot be loaned out. If the reserve requirement is raised banks have to either gather in a large number of new deposits and/or reduce lending. Given that the recovery was still ongoing, substantially increasing deposits was problematical. Instead, given the substantial increase in the Reserve Requirement, banks had to virtually halt all new lending. This alone would have caused what we now call a recession. (Note: I believe that FDR coined the term "recession" as a description of a slowdown in economic activity at this time)

So stop blaming FDR.

WHAT WERE THEY THINKING

2008-12-16T12:44:00.000-05:00

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?

IS DON QUIXOTE BERNANKE FIGHTING WINDMILLS WITH HIS LOYAL SANCHO PAULSON BY HIS SIDE

2008-12-14T19:28:00.000-05:00

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.

What Fools the Conservatives Be

2008-12-10T20:40:00.001-05:00

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.

LIVING IN LA-LA LAND

2008-12-01T17:03:00.000-05:00

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.

THE CASE AGAINST AN AUTO INDUSTRY BAILOUT

2008-11-15T15:53:00.000-05:00

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.

Why Government Spending Over Tax Cuts?

2008-11-03T16:03:00.000-05:00

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 POTENTIAL FAILURE OF MONETARY POLICY

2008-11-02T13:00:00.004-05:00

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.

Mc Cain Clings to the Solutions That Even Greenspan Says were Wrong

2008-10-29T16:43:00.001-04:00

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?

The Crisis in Non-Financial Companies

2008-10-11T21:18:00.003-04:00

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.

Will Our Own Expectations Kill Us?

2008-10-10T18:21:00.002-04:00

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.

THE COMING DEPRESSION

2008-10-01T18:17:00.001-04:00

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.

EXPLAINING THE MORTGAGE MELTDOWN

2008-09-26T16:19:00.005-04:00

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

Whoops

2008-09-17T16:26:00.003-04:00

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.

There Is No Market Discipline!!

2008-09-09T20:50:00.003-04:00

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.

LAWS NEED ACCEPTENCE TO WORK

2008-08-18T16:19:00.000-04:00

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.

Once Again the Lesser of Two Evils

2008-08-05T11:11:00.001-04:00

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?

MARKET DISCIPLINE MEANS ALLOWING DEPRESSIONS

2008-07-13T20:53:00.001-04:00

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

Politically Correct 23rd Psalm for the 21st Century

2008-07-09T15:48:00.003-04:00

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.

OBAMANIA

2008-02-21T18:00:00.001-05:00

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.

THE ECONOMIC LEGACY OF FINANCING A WAR EXCLUSIVELY WITH DEBT

2008-02-20T19:34:00.000-05:00

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.

RATIONING MEDICAL CARE

2008-02-09T14:30:00.000-05:00

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!”

A NIGHTMARE OF THE FUTURE

2008-02-06T20:29:00.000-05:00

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.

ONCE MORE INTO THE BREECH WITH AN INADEQUATE PLAN

2008-01-19T15:26:00.001-05:00

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.

PENSION REFORM = WALL STREET WELFARE

2006-08-17T16:58:00.000-04:00

Cloaked in language that makes it appear to be the savior of private pensions, the new pension reform law will actually accelerate the move away from traditional pension plans. In addition, it will increase brokerage profits, increase short-run top executive bonuses paid on the basis of stock prices, and increase the long-run risk faced by average Americans.

To understand these issues we need to understand the contents of the bill and how pension funding is measured:

First, the bill will require company based defined benefit pension plans to be 100% funded in seven years as opposed to a 90% funding requirement. Although this sounds good there are two issues which make this a problem. The first issue is that full funding is based upon actuarial assumptions regarding inflation, interest rates and wage growth. These assumptions change and the level required to be fully funded changes based upon the market value of the assets in the plan. Some plans which were under-funded 2 years ago are fully funded today due to stock market growth. This means that some firms may never have to put a dime into the system. The second issue has to do with the fact that other firms are severely under-funded and, as a result of the funding requirement, will just give up the plans that they have.

Second, the bill expands the amount that may be placed into 401k and IRA retirement systems. The increase in funding to IRA’s and 401k’s, combined with the few firms increasing their defined benefit funding, will lead to increased short-term demand for stocks on Wall Street. This increased demand will drive up stock price regardless of company performances. The increased prices will benefit those who already own stock and will provide huge bonuses to corporate executives, the Bush constituency, whose incentive pay is based upon the valuation of their company’s stock. This increased demand will also lead to more transactions through brokerages and increased commissions to brokerage firms.

Third, defined benefit plans pay workers a pension based upon their earnings in the latter working years and the number of years of employment. This is a known amount and is not subject to fluctuations in the market. IRA’s and 401k’s allow either withdrawals or the purchase of annuities based upon the value in the plan at the time of retirement. IRA’s and 401k’s are invested in securities that are subject to the vagaries of the marketplace. If the market is down and interest rates are high, as we saw in the 1980’s, many people will find that they do not have enough money to retire. Cash balance plans, that many firms are using to substitute for defined benefit plans, are subject to the same market forces. The result is the shifting of risk from employers to workers.

The result of the supposed pension reform is a reverse Robin Hood effect of "taking" risk from the rich, who can afford it, and "giving" it to the poor who cannot survive it. Again the USA accelerates toward third world status.

Religious Fundamentalism and the Death of the American Economy

2006-07-18T14:50:00.000-04:00

Once again President Bush is allowing his fundamentalist beliefs to cause irreparable harm to the American economy. This time it is his threat to veto legislation that would allow federal funding for expanded Stem Cell research. Does he believe that the US position will stop the research from taking place elsewhere in the world? The fact is that Europe and Asia are already deep into Stem Cell research. Stopping the research in the USA will only promote foreign companies to be the leaders in new, potentially life saving or life improving, products which may be developed.

If Mr. Bush’s narrow minded fundamentalism is carried to its ultimate conclusion, procedures and product developed overseas would not be permitted into the USA because it violates his religious principles to use products developed from Stem Cells. How many Americans will die young or live lives of agony because a narrowly defined fundamentalist religion is becoming the guiding light of all decisions? How can we let Mr. Bush guarantee the slow death our great pharmaceutical industry because he doesn’t believe in the most promising areas of research?

Mr. Bush needs to be reminded that religion’s opposition to “…lending at usury…,” meaning any type of interest, stymied European economic growth throughout the middle ages. Our President’s myopic view of the bible will exacerbate America’s, already beginning, decline to second or third world status.

Statistics Don’t Lie But they Can Deceive

2006-01-09T14:54:00.000-05:00

Statistics Don’t Lie But they Can Deceive

By all of the traditional measures the American economy is in very good shape. Unemployment is down, GDP is growing at a rate above the long term average growth rate, and the number of jobs created is growing. Many economists believe that the poor showing for consumer confidence is merely reflecting that confidence may be a lagging indicator. However, anecdotal, and some statistical, data imply that the economic picture is less rosy than the traditional measures indicate.

Firstly, we need to look at job growth. The job growth numbers count the payrolls in one month and compare them to the payrolls in the following month. This might be good, but it ignores the question of whether the jobs are full-time or part-time. In fact there can be serious double counting in the system. For instance, I am an adjunct faculty member at several colleges. During the month of October I was added to the payrolls of four new colleges. I, therefore, accounted for five jobs in the system and four “NEW” jobs. How many people like me are out there carrying multiple jobs? In addition, how many of these new jobs were part-time?

Secondly, the reduction in unemployment can be distorted by aspects of the measurement system itself. Most people do not know that a person is considered to be employed if he received one hour’s pay in a two week period. That means if your aunt Mildred paid you $20 to move furniture to her attic, you are employed. The other problem with the measurement system is that it excludes discouraged workers. A discouraged worker is a person who wants to work but has gotten so discouraged by not finding any that they have not “actively” sought work in the last four weeks. These workers are not even counted as a part of the work force. Let alone the unemployed.

Thirdly, GDP measures the output of final goods and services in the economy and a growing GDP leads to growing disposable income. Looking at the numbers things look good. On the other hand disposable income says nothing about the distribution of that income. Median family income, however, gives us a better picture regarding distribution. Median family income is the income level where half of the families in the country earn more than this number and half earn less. Unfortunately, median family income has been decreasing over the last two years. A growing disposable income and a lowering median family income indicates that the people at the top are getting better off and those in the middle and lower income levels are become worse off.

It is no wonder that consumer confidence is poor. The average person is losing out in this supposed growth economy. The goal of an economy is to deliver prosperity to the members of that economy. I believe that the new age of integrated world economies requires that we develop new economic statistics which measure national prosperity.
Former Secretary of the Treasury Robert Rubin has, along these lines, proposed a new economic measure which I believe he called The Median Prosperity Index.

Under Educated Secretary of Education

2005-10-19T17:33:00.000-04:00

Margaret Spellings has recently made a statement which proves that she is, as is usual for the Bush administration, unqualified for the job she holds (Secretary of Education). She asked, why do college tuition costs outstrip inflation?

The answer is simple economics. The inflation rate reflects both the cost of goods and services which are subject to productivity improvements and those that are not. The two offset each other in a way that keeps the rate of inflation lower than it would have been in the absence of productivity improvements. Educational delivery. although new methods have been developed, has proven resistant to productivity improvements. When schools use large lecture hall classes taught by senior faculty, aided by recitation sections taught by graduate students, parents and students complain. When courses are taught via TV or the internet there are also complaints.

All of this leads to costs that outstrip the rate of inflation. The same holds true in the public schools where parents want smaller class sizes, more counselors and increased extra curricular activities.

If MS. Spellings does not understand these simple facts of Educational Economics, perhaps, she should give up administration and become a teacher of something that does not require economic understanding.

Hypothesis vs. Theory

2005-10-06T14:24:00.000-04:00

Once again, we are faced with people trying to foist an Hypothesis upon us claiming that it is a Theory. An hypothesis is an unsupported statement of what you believe to be an explanation of a phenomenon. It does not yet have supporting evidence in favor of it. After significant research and evidence an hypothesis can become a theory. In order to reach this stage there has to be significant evidence that the original hypothesis can explain and often predict. In the absence of this proponderence of evidence an hypothesis never becomes an accepted scientific theory. The fact that a theory does not appear to explain every phenomenon does not invalidate it.

It is clear that Intelligent Design does not have the body of evidence to honor it with the title Theory. It is an hypothesis. Evolution, on the other hand, has developed a strong body of evidence which supports its basic tenant. It is, therefore, an accepted scientific theory.

If we were to give credence to every unproven hypothesis we would still believe in the sunspot theory of economic cycles and, like Lysenko, that acquired traits can be passed down through the generations.

We should ask ourselves if we would want our scientists trained in a country that rejects scientific evidence in favor of “Intelligent Design.” Let us put ID where it belongs: In the philosophical and religeous realm. Let us keep it out of science.

Godless? Christian? What?

2005-06-14T19:28:00.000-04:00

I've always had a problem when people say that we need to put G'd into our public life. Given the diversity of our population, are we talking about the G'd of the Hebrew Bible, the G'd of the Christian Testament, The G'd of the Koran, or the Multifaceted Hindu G'd? The fact is that any of the holy writings can be used to justify almost anything we want. All we need is to pick and choose.
When some claim that the US is a Christian nation, again, we have to ask: what kind of Christian? There are old line churches such as the Episcopal or Presbyterian churches, the new line fundamentalist churches, and of course the oldest churches: the Roman Catholic and Greek Orthodox. They all interpret Jesus' teaching in a different way.
It appears that those who want religion in government are really saying that they want their religion in government. Just look what is happening at the Air Force Academy. Do we really want the USA to be as narrow minded and prejudiced as those academy bigots?

A Change in direction

2005-06-14T19:17:00.000-04:00

When I started this BLOG I had intended to keep all of my comments in the economic realm. However, as I survey the political landscape and the social changes that are being proposed for the USA, I believe that I must speak out in the name of reason. As a result, I wrote the "Ask the Framers" piece. From time to time, I will also be writing other pieces which have nothing to do with economics, but everything to do with social justice. Please bear with me and if you agree or disagree, post your comments so that I can respond.

Ask the Framers

2005-06-09T15:59:00.000-04:00

On a recent trip to Washington, my wife and I were fortunate enough to stop at the Jefferson Memorial. While reading the writings etched into the walls I realized that the answer to the arguments regarding the strict construction of the constitution based upon the intent of the framers was written by the framers. We only need to read what they said and wrote. For example: When the strict construction people say that the constitution needs to be interpreted according to the 18th century standards that existed when it was written, we can reply with Jefferson’s statement “…laws and institutions must go hand in hand with the progress of the human mind. …institutions must advance to keep pace with the times… [or] …we might as well require…civilized society to remain ever under the regimen of their barbarous ancestors.” When the it is pointed out that the constitution does not use the phrase separation of “church and state” and school prayer should be allowed, we only need to look to Jefferson for guidance. He wrote: “No man shall be compelled to frequent or support any religious worship…” We progressives can go back to the basics by framing our own moral arguments using the words and intent of the framers of the constitution.

We Own The Government

2005-05-03T21:34:00.000-04:00

Conservatives have, in the minds of many Americans, been able to draw a line between the people and the government. They use phrases such as “It’s your money not the government’s”, “Ownership”, and “Do you want bureaucrats making your decisions” to draw a distinction between government and the citizenry. In foreign policy they tout democracy while at the same time using language that implies we don’t have it at home.

Progressives need to build on Lincoln’s “Government of the people by the people, and for the people…” comments to restore the American people’s faith in our system. We own social security, we own the congress we elect, we own the rules and regulations that enable us to breathe clean air and drink potable water.

Economic regulation is not designed to stifle growth but rather is used to ensure that we have the benefits that competition can bring. Regulations are not designed to ensnare but are written to stop those with economic power from using it to unfair advantage.
We are the government and our ownership society means we own the government

Free Trade Is Not Free

2005-05-01T20:39:00.000-04:00

The problem with "Free Trade" and how it is devastating to so many developed and undeveloped economies is not the fact that it exists. The problem is that true free trade does not exist. The third world countries that are importing lower priced food from the first world are not suffering from free trade. They are suffering from the subsidies that the developed world's governments give to their farmers. The job losses to lower wage countries suffered workers in the USA and EU are to some extent the result of fixed exchange rates by China, South Korea, and India. Some have estimated that the Chinese currency is undervalued by as much as 40%. If properly valued, the cost of Chinese goods would be higher and maybe EU and USA companies could keep more jobs at home. Fixed exchange rates and subsidies are neither free nor supporting the gains to all that are obtained from comparative advantage.

Social Security and the Politics of Greed

2005-05-01T20:15:00.000-04:00

The Social Security debate is bringing to light the Right Wing’s true colors; the colors that decorate the flag of the politics of greed. Just look at the President’s arguments every time he addresses groups of senior, and near senior, citizens. He looks at the crowd with bewilderment and says “What are you complaining about? This won’t have any effect on you!” He just doesn’t get it! He and his cohorts cannot understand anyone who looks out for anyone but themselves.

Greed permeates everything they do and everything they say. Tax cuts for the rich, refusal to look at elimination of the income cap on the Social Security payroll tax, elimination of the estate tax, and almost every other program they propose is based upon the concept that greed is good. To many Americans it is only in the Social Security debate that this is becoming obvious.

As progressives, we need to emphasize that greed and the market system do not go hand in hand. That is why Adam Smith used the term “Enlightened Self Interest” rather than greed. Smith, the holy god of the right wing, understood that greed led to self destruction of the system. He understood that “Enlightened Self Interest” meant that there was something more than pure greed involved with looking out for oneself. We need to look out for our fellow human beings, as well as looking out for ourselves.

Just as they pick and choose sections of the religious bible that support their arguments for repression of free thought, they select the portions of Smith that imply “…greed is good…” We need to use the same sources to show how the politics of greed is neither capitalist nor religious. It is, in fact, a method for creating autocracy with a spurious religious foundation.

Don't Reject Adam Smith

2005-04-25T16:31:00.000-04:00

Too often, progressives make the mistake of rejecting the work of Adam Smith out of hand. This is a mistake. The problem is with both the Neocons and the libertarians in that they don't understand the assumptions underlying Smith's work. Smith envisioned a system of perfect competition. i.e. so many buyers and sellers of a good or service that not one had the ability to influence the market price. As a result, both capital and labor would be paid according to their contribution to the process. The problem arises from the fact that the real world is made up of less than perfect markets. In a less than perfect world, monopoly selling power allows for higher prices and monopsony buying power allows for below market wages.This combination allows the rich to get richer and the keeps the poor down.
In the words of Mel Brooks "It's fun to be King!!"

World Depression

2005-04-11T19:17:00.000-04:00

Daniel Arnold [Personal Investor - February 2004] has forecast a future depression based upon a correlation between demographics and the Dow Jones Industrial Averages. Although I agree with his conclusions, I disagree with his methodology. Mr. Arnold seems to forget that correlation does not mean cause and effect. The real reason for a possible future depression is multifaceted.

First, we must remember that the economic engine driving the world economy is the American Consumer. If anything happens to this consumer’s ability to spend the whole world economy can go into a tailspin.

Second, middle class American Consumers are getting more and more hard pressed to meet their everyday obligations. They are relying on multiple incomes in households to a greater extent every day. If they cut back their spending economic shrinkage is inevitable.

Third, as manufacturing jobs move overseas we find that the economy is producing less in the way of real (tangible) goods. Tangible goods create real wealth. The service economy, on the other hand, produces only financial or paper wealth. We cannot have a thriving economy composed of Wal-Mart and Mc Donald’s employees. They don’t earn enough to keep even those low cost establishments going.

Fourth, real wealth can be generated through research and development creating new and innovative products. However, America’s best and brightest are not going into the sciences and engineering. They are going to business schools where their financial wealth can be manifested more rapidly. Just look at our engineering and science programs. They are generally populated by foreign students. But, foreign applications to our schools are beginning to fall. While there are many reasons for this, we should ask ourselves if we would want our scientists trained in a country that rejects scientific evidence and instead favors “Intelligent Design.”

Fifth, an integral part of our economy is government spending. However, the engineered deficit which took Social Security surpluses and gave them to the wealthy as income tax cuts has made sustained government spending on worthy programs almost impossible. In the current environment where tax increases are rejected, the credit worthiness of the USA comes into question. This is made even worse by a President who points to the government bonds in the Social Security Trust Fund and calls them worthless pieces of paper. If the world begins to see this as America’s attitude towards its obligations, we may find ourselves unable to refinance our current debt let alone maintain an on-going deficit.

Sixth, any depression would be long and deep because the engineered deficit created a situation where a “New Deal” approach could not be financed. Without the infusion of federal money there would be no way out of a depression.

PROGRESSIVE INCOME TAXES EQUALIZE THE PAIN

2005-02-17T16:33:00.000-05:00

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. If possible 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 which has the capability of equalizing the pain of supporting government.

Ship Out Jobs and Ship Out Intellectual Property

2005-02-06T15:11:00.000-05:00

Giving Away Intellectual Property

Recently, American businesses have been complaining that their production processes and intellectual property are being stolen by Asisn manufacurters. This is evidenced by the high volume of counterfeit goods coming out of China and, to a lesser extent, other Asian countries.

However their complaints have to be mitigated by the fact that when businesses decide to open their manufacturing processes off shore they need to assess the risk of having their proprietary processes stolen. Any business decision requires an assessment of risk. Complaining that they are being counterfeited means that they did not do a proper risk assessment, or they believed that the government would bail them out.

The choice of a manufacturing site must include an evaluation of the intellectual property protections at the off-shore site. Any company that did not know that China has limited respect for intellectual property did not do its due diligence properly and deserves what it gets.

Making Markets Work

2005-01-25T19:53:00.000-05:00

The dominant form of economic philosophy since the 1980’s has been the market system. The problem with this approach is that its advocates assume that the market always produces the most efficient solution to problems. If all of the costs and benefits of an action were included in the market process they might have a point. However, markets do not take many costs and benefits into account. These excluded items are called benefit and cost externalities.

An externality is any cost or benefit generated by a market action that is not embodied in the market’s decision making process. For example, in the past Texas considered Polio immunization to be a private benefit to the person vaccinated. As a result, many children were not vaccinated. This led to the external cost of having children in Texas exposed to Polio. As we all know, no vaccine is 100% effective. This means that some vaccinated children would contract Polio even though they were vaccinated. However, if all children had been vaccinated the probability of anyone contracting the disease and passing it on would have been very low. There is a societal benefit from universal vaccination that is not taken into account by the private market. Private markets would not have eliminated the scourge of Smallpox.

In addition, business does not include external costs in the cost of production. For example: An electrical utility using high sulfur coal to produce electricity in Ohio doesn’t include the cost of dead fish in the Adirondacks or the reduced life of a Pennsylvanian’s car finish in its production costs. These external costs are bourn by New York sportspeople and Pennsylvania car owners.

The problem is not that markets do not work. The problem is that as currently constructed there are too many externalities. Attacking markets will, to the average American, appear to be an attack on our very way of life. This approach will not get anyone anywhere in the modern world. There is a need to aim policies and attacks at improving markets by finding ways to internalize the externalities. Markets need to be modified to place external costs into the costs of production and external benefits need to be incorporated in a manner that makes sure that the benefits are realized

Workers Are Falling Behind

2005-01-06T18:34:00.000-05:00

Economic Recovery has become the latest claim to fame of our NEOCON government. They point to official figures showing a growth in the country's output (GDP). They talk about growth in the number of jobs measured by the numbers of employees that employers are reporting. If you listen to the minions of the right you would believe that we live in what Dr. Panglos call "..the best of all possible worlds.."

However, the rose colored picture takes on a different light when we dig a little deeper into the recovery. on January 5th of this year the Morning Call of Allentown, PA reported that wages were not keeping up with inflation. This means that people's real ability to spend on goods and services is falling. How are they then able to maintain their living standards? The answer is simple: They are dipping into savings and they are going deeper into debt. In many instances people are using Home Equity credit lines to maintain their current consumption spending. They are in fact mortgaging their homes to buy movie tickets, eat out, buy Christmas gifts, and go on vacation. Our NEOCON leaders keep saying that being stake holders will allow people to have a better future. However, if that stake holding is mortgaged for current consumption the retirement years will be even bleaker than the proposed cuts in Social Security would warrant. Re-mortgaging means that people who should have had their homes paid for at retirement time, will still have to pay debt while they experiencing lower incomes due to retirement.
NEOCONS tell us about job growth. However, the employment figures do not say how many of the jobs are full time and how many are part time. Several months ago the Philadelphia NPR radio station had a morning program where the guests talked about the growth in jobs. A listener called the program to find out how the number of employed people were counted. He stated that he had four part-time jobs with 4 different employers in order to make a full time income. He asked: "...How many times am I counted in the employment figures..?" After hemming and hawing and trying to distract the listeners with comments about whether the listener was paid on a W-2 or a 1099, the right wing guest admitted that the statistics would count the listener as four employed people. Given this situation, is anybody rally able to say that the country is better off?

The NEOCON Nirvana has turned out to be the 19th century. Workers' requiring multiple jobs to make ends meet, multiple income households, and falling real wages are leading the U.S.A to third world status. The third world is a place where the rich get richer and "...to hell with everybody else..."

Wall Street Welfare

2005-01-04T16:33:00.000-05:00

The NEOCON approach to Social Security is to tell us that the current surplus in the Social Security Trust Fund is irrelevant. To some extent they have a point. Whenever pensions are invested in the very organization that is issuing the pension you have what is called an unfunded plan. Since Social Security funds are invested in US Government Notes and Bonds we can say that Social Security is unfunded. That is why regular pension plans have a limit on the percentage that can be invested in the company sponsoring the plan. Bankruptcy would leave you without a pension if all you had was the company's guarantee or investment in the company's stocks and bonds. Look what happened to the ERON employees who kept their 401k money in ENRON stock.

Governments have an easier time of it when getting out from under their obligations. They merely need to change the law. If you want to get away from paying the debt to Social Security you merely need to declare that there is a crisis and tell people that they can do a better job investing their own money than government can. Then change the law. Unfortunately, many younger people who do not know history seem to fall for this argument.

Privatization can be called the "Wall Street and Corporate Welfare Act". It will help brokers, investment advisors, and current shareholders. In addition, placing government (Social Security) funds into the stock market will tend to raise stock prices. This would help firms with under funded pension plans meet their obligations through higher stock prices. It will also help top executives meet the goal of rising stock prices and increase their incentive compensation. People, on the other hand, could find that their investments are withering due to high transaction costs and fees. This is what happened when Chile converted its Social Security to private accounts.

Immigration and the Anti-Market Right

2005-01-03T16:16:00.000-05:00

Time and again the NEOCON right asserts that they are the defenders of "Free Market" ideas and the left are anti- market socialists. However, the right's support of the "Guest Worker" program and other measures to bring in cheap foreign labor is about as anti-market as any policy can be.

The claim is "Americans won't do the jobs that foreign workers are willing to do." This is a fallicy. The truth is that Americans are not willing to do those jobs at the prices (wages rates) that the employers want to pay. In a free market, this imbalance of the quantity of labor supplied and the quantity of labor needed would be accomodated through rising wages. This higher wage rate would bring out more workers. However, because the businesses involved can make higher profits through low wage rates, they ignore the immigration and hiring laws. In fact, they lobby to make their illegal practices legal.

The right seems to believe in free markets only when it suits them. They constantly emphasize the efficiency of free markets. They claim that there are no external costs that the market can't handle. However, when the free market says that they need to raise wage rates, they claim that there is a need to ignore the marketplace and change our immigration laws.

Say it like it is!

2004-12-07T21:23:00.000-05:00

Unfortunately, our news media and democrats tend to use the political labels that groups assign to themselves. Republicans are called conservatives, anti-abortion people are called pro-life, and those who are trying to dismantle Social Security are called reformers.

The democrats need to take a page out of the republican play book. Repubicans do not feel the need to use the labels that people assign to themselves. So called conservatives call liberals - tax and spend leftists and those who believe that a woman has the right to choose abortion if necessary are called killers.

It is time that Democrats start calling the conservatives what they really are: REGRESSIVES.
True conservatives believe in preserving (conserving) the status quo. They, however, believe that slow change is a part of our very system. The current crop of pseudo conservatives believe in restoring the U.S. economic system to the one we had in the latter part of the 19th and the early part of the 20th century. They are backward looking. They are regressive.

The time has come for those of us in the middle, the centrists to start using the labels that are appropriate. We should call the republicans regressives because they are looking backward to the days of the robber barons as their guide. Democrates could be called progressives because they are looking at an as yet unformed future. The vast majority of us are currently uncommitted and we are either slightly right or slightly left of center. We should be called Centrists.