Thursday, December 25, 2008

Snow in Seattle

It snowed this week in Seattle. Nestled, as we are, between two sets of snowy mountains it is probably hard for non-Seattlites to believe that this is a rare event. Nonetheless, snow itself is unusual in the city; for snow to fall and stay on the ground past noon is almost unheard of.

The last time there was a significant snow dump here, the storm gave us 31 inches in 1996. This time around we were blessed with about 9 inches, and it disrupted the city quite a bit. The disruptions lasted about a week.

I'm all for shutting things down at times like this, but I admit to be being a little tired of walking slowly over ice to get anywhere. And 4 inches of slush and compact snow on some main arterials doesn't make me so happy either. When people complain about the inconvenience the day it snows I think they need to lighten up; when people are mad at slippery roads a week later I'm a touch more sympathetic.

Thus has arisen a debate in the city as to whether our government should have done more to mitigate the effects of the storm.

One irate caller to a radio show explained that he has lived in Rochester, Concord, and Milwaukee; and that those cities remove snow from the roads immediately. The Seattle response, he said, was grossly incompetent.

But one of these things is not like the others. Rochester, Concord, and Milwaukee receive yearly average snowfall (in inches) of 92.3, 63.8, and 47. In Seattle our average is 7.3. I'll give this guy the benefit of doubt and assume he has not lived here long enough to understand that snow is unusual.

So this is not a question of whether roads should be plowed or not; it is a question about the role of government. It makes perfect sense for a citizen of Rochester, NY to expect his government to do a good job at snow removal. But in Seattle we do not elect people, at any level of government, to be competent snow removers. Nor should we. To do so would be to sacrifice some other, more relevant issue.

The average cost of removing snow in Rochester is much lower than it is in Seattle. Since the cost is high we choose to forego the service.

Saturday, December 20, 2008

So Says The Dictator

Yesterday, George W. Bush lent 13.4 billion dollars to GM and Cerberus Capital Management, whose board is chaired by Bush's old pal John Snow.

First, that money was not Bush's to lend. Eight days earlier, the Congress of the United States rejected a proposal that would lend taxpayer money to GM and Cerberus.

George Bush is the executive, meaning that his job is to execute the will of the people as expressed democratically through their elected representatives in Congress. He has no authority to take unilateral action such as this.

In order to "justify" his action, Bush had to pretend that the auto industry is made up of banks. Of course, I guess it is possible that he actually believes that General Motors is a bank.

In explaining the action, Bush said this:

"If we were to allow the free market to take its course now, it would almost certainly lead to disorderly bankruptcy and liquidation for the automakers. Under ordinary economic circumstances, I would say this is the price that failed companies must pay -- and I would not favor intervening to prevent the automakers from going out of business.

But these are not ordinary circumstances. In the midst of a financial crisis and a recession, allowing the U.S. auto industry to collapse is not a responsible course of action."

Apparently, Bush supports free market principles in good times, but not in bad. But either one supports a free market or not, and it is clear, regardless of the rhetoric he uses, that George Bush and the Republican party are not supporters of a free market.

The financial crisis is not the cause of the automaker failures. They have been dying for years. The demise actually started decades ago. They are a drain on our economy, sucking valuable resources onto showroom lots to waste away with barely a test drive.

Recession is the perfect time for automakers to go out of business. It is the liquidation of failed businesses that propels an economy out of recession. Recession and credit contraction are the mechanisms by which unproductive endeavors lose out to those which efficiently create products that people are willing to pay for.

General Motors has survived the last few years on reputation alone. Private interests have been willing to turn excess capital over to them in the mistaken belief that there would be a turnaround. Now, those private interests have finally had enough. They have given up on the U.S. auto industry and set their minds, and their capital, to other pursuits.

It is not the role of government to prop up businesses that every right-minded investor has given up on.

As for the idea that this action "saves jobs," think again. The terms of the loans are onerous. The U.S. taxpayer is getting screwed, but employees at GM and Chrysler are right on our heels (Those who bought GM stock on the news are the biggest losers, but hey, they made their own bed). Many of them will be fired regardless; those are the lucky ones. The ones who stay will endure months or years of wage cuts, benefit cuts, increasing union dues, interminable worry, and depressing work environments.

It is no fun spending your days inside a dying beast.

Thursday, December 18, 2008

Another great headline

MarketWatch gives us this after Morgan Stanley reported their quarterly results: "Morgan Stanley posts loss, but books are stronger."

Now, to me a "stronger" book means a higher book value. It is, however, impossible, to lose money over a 3-month period and have a higher book value at the end than at the beginning of that period. The net loss was 2.2 billion dollars.

Part of their income for the quarter was a decline of $2 billion in the value of some of their liabilities. That is, their own debt. A decline in the market price of a company's debt occurs because the market believes them to be a greater default risk.

Sunday, December 14, 2008

3 Million Lost Jobs. Not So Fast

General Motors employs 123,000 people. Every day I hear or read the claim that a "failure" of GM would result in the loss of over 3 million jobs.

The analysis that leads to this result relies critically on each of 2 assumptions:

1) Consumers are unwilling to purchase any American cars, at any price.

2) Those whose wages and salaries flow from revenue from car sales are incapable of providing valuable labor to any other economic sector.

The reality is that, through General Motors, our society transforms resources into a product that is less valuable than the raw resources. In other words, GM cannot sell its cars at prices that are greater than the average cost of production.

Raw resources (things like people's time, factories, steel, copper, land, energy, etc.) have value because they can be used to produce goods and services that people will pay to consume.

The fact that the inputs that GM uses command prices that exceed GM's ability to earn revenue means precisely that those resources can produce more value elsewhere. Yet we pretend that GM is vital and that those inputs would sit idle rather than be shifted to other pursuits.

It is time to recognize that, far from being a disaster for the economy, the downfall of the auto industry is a massive opportunity for growth. It will free up resources that have been stagnant or poor performers, and allow them to migrate elsewhere.

Can the automakers survive? Probably. But they likely need to make fewer cars, re-organize management, re-negotiate contracts, and make other changes.

There is absolutely no chance that the necessary changes can be managed well by Congressmen and other government officials. Neither I nor anybody else knows exactly how to fix the automakers. Certainly the people running the companies right now do not know the solution.

These businesses have already failed. The individuals who have managed them (at all levels) should be dismissed with no further compensation. The resources that the companies control should be auctioned to the highest bidders and those bidders should then be free to do with them what they will.

If they want to make cars, so be it. If not, we'll get our cars one way or another.

Saturday, December 6, 2008

Life at the Top of the Big 12

The Big 12 football conference holds its championship game today. The game features 5-3 North champion Missouri against 7-1 Oklahoma from the South.

There has been much discussion in the college football world, though, as to whether Oklahoma "should" be the South representative. After all, Texas and Texas Tech are also 7-1.

The Big 12 uses tiebreakers to determine which team goes to the game, and Oklahoma had the edge on tiebreaker b-5: "The highest ranked team in the first Bowl Championship Series Poll following the completion of Big 12 regular season conference play shall be the representative."

First, note that the Big 12 has employed an outside entity* to determine its divisional champion. Second, the use of the 6th tiebreaker implies that these teams must be pretty even.

Indeed the accomplishment's of Texas, Texas Tech, and Oklahoma, inside the Big 12, are remarkably similar. Texas beat Oklahoma; Oklahoma beat Texas Tech; Texas Tech beat Texas. Thus the 1st 3-team tiebreaker solves nothing.

In 4 of the other 6 games, both Oklahoma, Texas Tech, and Texas have victories against Kansas, Oklahoma State, Baylor and Texas A&M.

Texas beat Missouri (5-3) while Oklahoma and Texas Tech both beat Nebraska (5-3) so those victories are of equal value; Texas beat Colorado (2-6) while Oklahoma and Texas Tech both beat Kansas State (2-6) so those victories are of equal value.

Based on these simple facts, the Big 12 has a predicament. Nothing sets any team apart from the other 2 and all meaningful tiebreakers have been exhausted. At this point, it is very difficult to find a fair way to choose a team. But the conference's problem is not one of fairness but of practicality. A game is scheduled and there must be exactly 2 teams to play in it. Fair or not, they need some way to distinctly choose 1 team to play Missouri.

For some reason, they chose BCS standings. The thing about the BCS standings is that it accounts for non-conference games as well as Big 12 games. Without going into detail, the BCS has a human opinion component, which favors Texas by a very slim margin, and a computer component, which favors Oklahoma by a larger margin. Thus the tiebreaker yields Oklahoma and they play today while Texas sits idle.

Almost all commentators that I have seen or read describe this as an injustice to Texas. Life At The Margin disagrees**.

To come to their conclusion, these commentators rely on one piece of data, the Texas win over Oklahoma. But as Bob Stoops correctly points out, that logic runs into an intransitivity problem. That is, if you claim that Texas deserves it over Oklahoma, you must then conclude that Texas Tech deserves it over Texas, and that Oklahoma deserves it over Texas Tech. We must get out of this infinite loop, and they use the BCS.

Many BCS voters seem to agree with the commentators. We think the evidence clearly favors Oklahoma. Quite simply, Oklahoma accomplished more in its non-conference games.

Texas Tech's non-conference schedule is so weak that even Notre Dame would likely beat all 4 teams (Eastern Washington, Nevada, SMU, and Massachusetts). Texas beat one mediocre team (Rice) and three bad teams (Arkansas, UTEP, and Florida Atlantic); Oklahoma beat 2 really bad teams (Washington and Chattanooga), but also beat 2 really good teams (Cincinnati and TCU). TCU and Cincinnati are ranked as the 11th and 13th best teams in the country. Victories over those teams clearly set Oklahoma apart.

It is puzzling that voters and commentators ignore this comparison. they seem to ignore quite a few facts in favor of opinions that can be backed up by cherry-picking data points.

Last week, Oklahoma played Oklahoma State. This argument was in full swing even before that game, with most people assuming that Oklahoma would win. Again, those same people were dismissing Texas Tech. The interesting point here is that, since Oklahoma appears to be the nemesis of Texas, an Oklahoma loss should have been good for Texas. After all it would clearly move Texas ahead of Oklahoma. In fact, had that happened (it didn't) the argument would have been clearly resolved. Not in favor of Texas but in favor of Texas Tech. Texas Tech beat Texas head-to-head so an Oklahoma loss would have destroyed any claim that Texas thought it had.

Life At The Margin's national rankings:
1. Utah
2. Alabama (If Alabama beats Florida, Alabama would move to #1, Florida would drop out)
3. Oklahoma
4. Florida (If Florida beats Alabama, Florida would move to #2, Alabama would move to 8 or 9)
5. Penn State
6. USC
7. Texas
8. Boise State
9. Texas Tech

*Life At The Margin finds it distasteful that the Big 12 would allow their championship to be decided in this manner. They should only use criteria from inside the conference, even if it means drawing a name from a hat. The reliance on the BCS standings can create degenerate conditions. For example, in theory the Texas coach could vote (or convince other people to vote) his own team #1 and leave Oklahoma off his ballot in an attempt to influence the outcome. This did not happen, we know, but something like it can happen under this system. Indeed a less extreme version of this did happen last week: While Oklahoma easily defeated a quality team (Oklahoma State) and Texas easily beat a bad team (Texas A&M), Texas actually gained on Oklahoma in the human opinion polls. The only new piece of information clearly favored Oklahoma over Texas yet some voters switched their ranking in favor of Texas.

**Life At The Margin does not have a preference for either Oklahoma or Texas, but does prefer that the team that accomplishes more be rewarded for those accomplishments. We also find the behavior of voters and commentators more interesting than the football argument itself.

Thursday, December 4, 2008

Market Failure? Not Quite.

Ben Bernanke wants more taxpayer funds to help reduce foreclosures. Bloomberg reports:

"He called for addressing the 'apparent market failure' where lenders aren’t modifying mortgages even in cases where it’s in their own economic interest to do so."

But this is not a market failure; it is a failure of Ben Bernanke and the rest of the Federal government.

The reason lenders are not modifying mortgages is that they perceive that it is NOT in their best interest to do so. The reason they perceive that it is not in their best interest is that Bernanke and his ilk keep talking about (and in some cases, acting) throwing taxpayer funds at the mortgages.

The banks, instead of making smart business decisions, are trying to position themselves to get pieces of the bailout pie.

Think about it: If someone owes you $500,000 but cannot afford to pay, are you going to rework the mortgage to $400,000 or are you going to wait for the government to give you the whole $500,000? Or wait for the government to provide some "incentive" to rework.

You would do what is in your best interest. If you think government help is forthcoming, you try to get it. Even spend resources lobbying for it.

Evidence That No Crisis Exists

Downtown Bellevue is residue from the boom years of the 1990's and early 2000's, one of the 365-day Christmas towns that have taken over American suburbia. It lies an easy drive across the lake from Seattle, WA.

Forgetting what day it was, I trekked over to Bellevue on the Friday after Thanksgiving to see a few of John Grade's creations. While looking for coffee, I came across "The Container Store." The Container Store uses 3200 square feet of space to sell containers. The place is full of them. In fact, their primary product appears to be a large red and green plastic box, selling for $49.99, advertised as storage for Christmas decorations.

Now, back when people like Henry Paulson were telling us that the economy is strong, most of us stored our Christmas stuff in medium to large cardboard boxes. Those boxes were free.

If this store's marketing people are correct, and they actually sell hundreds, thousands of red-green monstrosities, then we have pretty strong evidence that we are going to be just fine.

Think about it. You buy food. You buy some shelter. You pay the heating bill. You down 3 or 4 chai lattes per day. Christmas time comes around so you buy some nice things for friends and family. After all that you have $50 left over to buy a container.

That last paragraph certainly doesn't apply to everybody, but our society has found it worthwhile to devote 3200 square feet of prime retail space to a container store. This is not something one expects to see in a depressionary world.

Of course, I call this bit of data evidence, not proof. Maybe hard times and container stores can coexist. Maybe, just maybe, our economic priorities are a little hard for me to grasp.

Tuesday, November 25, 2008

Obama to Antiwar Voters: Thanks Chumps, I'll Take it from Here

Apparently, change is the same Secretary of Defense.

Let me write that again: Change is the SAME Secretary of Defense.

Barack Obama announced that he will retain the services of War Secretary Robert Gates, the man George Bush turned to when Donald Rumsfeld finally lost his stomach for the Iraq war. The man whose sole purpose over the last two years has been to prop up the failed endeavor by finding yes men, mischaracterizing the state of affairs in Iraq, paying off insurgents not to kill our soldiers, and perpetuating lies to the people who bear the costs of war. The man whose very existence seems to be the antithesis of the rhetoric that propelled Obama to the presidency.

One of the worst results of the Bush presidency comes from his assault on the English language. The meanings of some of our greatest words have been lost to Bush politics. Words like freedom, democracy, liberty, and rule-of-law are now largely useless. Hell, even torture is a word now devoid of meaning.

And now, before his presidency has even begun, Obama has added this previously important word to the list of casualties: change.

Life At The Margin would like to take this opportunity to make two predictions:

1) Barack Obama will face significant opposition for his party's nomination in 2012.
2) A majority of black Americans will come to loathe this man for the remainder of the 21st century.

Monday, November 24, 2008

The Rupture of Citibank

One of the world's largest banks fell off the wall and broke yesterday.

Instead of sweeping up the mess, the king's men continue to try to put it back together again. That means you and I and every holder of U.S. Treasury securities get taken for a ride.

My reading is that the U.S. Treasury signed up for liability of about $250 billion of Citigroup; whereas the dopes who made bad investments retain about $50 billion in liability.

Some thoughts on this bailout:

1) Citigroup's common stock rallied on the news. I firmly believe that the government should stay out of this mess, but I recognize I am in the minority living in a democracy. If, however, we the people are going to bail these punks out, it should be an absolute precondition that the equity holders get wiped out. On Friday, the stock was worth zero; today it is worth slightly more than zero. Shareholders got a better deal than they deserve, but those who buy this rally are fools.

2) A condition of the deal is that Citigroup cannot pay more than $.01 each quarter in dividends. This means they can give out over $200 million per year to shareholders, and I am sure they will. It's a scam people. We are being punked. Taxpayer money is not going to sure up the financial system; it is going to limit the losses of the people who messed up the financial system.

3) I keep reading that allowing Lehman Bros. to go into bankruptcy was a mistake that cannot be repeated. The opposite is true. Allowing Lehman's failure to run its course is the only bright spot on the king's men's resume. Of course, there were reverberations from it. Of course, people lost money. People are supposed to lose money when their business fails. The reverberation from propping these failures up is much worse, though often unseen.

4) Most of the liability assumed by taxpayers for this bailout falls outside the lines of the $700 billion bailout that Congress passed. In fact, $700 billion is fast becoming inconsequential. Taxpayers will ultimately lose trillions, and all of it will happen without so much as a peep from Congress.

5) The world does not need Citibank. I am repeatedly baffled by the lack of imagination on the part of the economic commentariat. Of course they are an important piece in the current economic makeup; they provide a lot of important services. But we don't need the current economic makeup and it may not even be the best option. If Citibank goes away, we will not be left with a gaping hole. We'll be left with other, better banks competing to fulfill the needs of society. No cog is vital to an economy.

Saturday, November 15, 2008


Headlines amuse me. A few days ago, in the midst of a 300-point decline in the Dow, the headline on Marketwatch, was "Sellers Back In Driver's Seat."

Aren't low prices better for buyers than sellers, or did I just waste 3 years of life (studying Economics, that is)?

Saturday, November 8, 2008

Wait For It All To End

Apparently, Barack Obama has been meeting regularly with a group of financial heavyweights in order to create a strategy for dealing with our nation's economic problems.

"I want to see a stimulus package sooner rather than later," Obama said. "If it does not get done in a lame duck session [of Congress], it will be the first thing I get done as president of the United States."

Nancy Pelosi, she of the lame duck Congress, has talked about $100 billion or more of stimulus plus permanent tax cuts. In the 37 days of this fiscal year, the U.S. Treasury has already increased its net borrowing by over $600 billion. (Note that 37 is about 1/10 of 365).

Obama has also said, with regard to the economy, that he wants to "hit the ground running" when he takes office in January.

We have a group of people who have no idea what to do and a lot of power with which to do it. Economic policy, however, is best left to those who don't know what to do but have no power (Harvard professors, for instance).

This will all end in one of two ways: Somebody, perhaps Obama, will realize they are doing more harm than good, stop the interventions, and let America be America.

Or, the economy will crash under the weight of bailouts and false promises.

Until one of these things happens, Life At The Margin recommends that people with savings refrain from buying U.S. stocks, bonds, or any other promise to pay American dollars. If you cannot make it into a pretty necklace, burn it to make energy, or store it in a silo, it aint worth having.

For if pessimism is the contraction of the soul toward darkness, overoptimism is the contraction of the bank account toward zero.

As for the first thing to "get done" as president, Life At The Margin hopes the elected will reconsider. Invite some friends over, Mr.Obama, and throw a party. The White House is a beautiful place; its most productive use is entertainment. Party on, Barack. We'll all be better off.

Wednesday, November 5, 2008

Where is the Change?

Yesterday, we the people elected Barack Obama to the presidency. I believe that it is a great thing that a black man with an Arabic name can be elected president. It is shameful to look back at our history and see the extremes to which racism pervaded the society. This election is a signal and a reminder that we have come a long way and that progress continues to flow. In this sense yesterday's election was indeed, as many have written and said, historic.

But the election of Barack Obama did not change America. The changes that made it possible for a country founded with subjugation of an entire race imbedded in its constitution to elect a man of that race to its highest government office occurred over hundreds of years, in baby steps, with many failures strewn among its successes. While history may appear to have leaped forward today, we actually got here by crawling. Crawling aimlessly more often than not. Rather than change ourselves on election day we proved to ourselves and the world that we have changed.

I would like to make two important points, both of which are likely to be unpopular: First, racism, sexism, and intolerance are alive and well in America. To state just one relevant example, there was far more talk in this campaign as to whether Barack Obama was a muslim than talk about whether or not we should care if he is a muslim (We should not, in my view).

The second point is that, while the reality that a black man can be elected president is important, the fact that we did elect a black man is largely irrelevant.

We must keep in mind the role of the person we have elected. He is to be the president of the United States, the leader of the executive branch of our federal government. I am not aware of any reason to believe that skin color has any impact on the execution of that role.

What is relevant to me is what he plans to do with the power the American electorate have handed to him. In truth, I have little idea what he will do, and that scares me. It would scare me no matter who was elected. It scares me because we elected a man who constantly talked about change, but we never forced him to speak meaningfully about what, substantively, he actually plans to change. Beyond a few largely meaningless tax changes and a health care plan that we have no chance of actually implementing, he has been glaringly vague.

In my view, the most important issue facing this nation (for both the immediate future and the long run) is whether we will contract the hegemonic military empire that bankrupts our citizens, brings death and destruction to millions, and provides incentive for thousands of people around the world to devote their lives to fighting us. Let us not forget that Obama's rise to prominence was made possible by his strong opposition to the Iraq war and occupation. Unfortunately, as he became the presidential frontrunner his stance on this issue morphed quietly from "change" to something that looks a lot more like "slightly modify."

George Bush and John McCain would like to have an enduring presence in Iraq and Barack Obama is no different. Sure, he says he will draw down the number of soldiers, and I have no reason to doubt that intention. But the only appropriate number of American soldiers in Iraq is zero. Moreover, this man has been clear that he believes we should invade Pakistan and his threatening rhetoric toward Iran sounds a lot like it was written by Bush's speechwriters. He has even pledged to do everything in his power to prevent Iran from obtaining a nuclear weapon. If we think about the types of things that are in his power, this pledge is downright dangerous.

The real difference between John McCain and Barack Obama regarding the Middle East appears to be that McCain wants to threaten Iran from its western border; whereas, Obama wants to make his threats from the East. When Obama speaks of sending our troops home, he means that they will get on a plane, fly around Iran, to their new home in Afghanistan.

The reality of Iraq is that we are completely beaten and that we are likely to leave there before Obama's term is completed. He may even point to this as fulfillment of his campaign promise, but he will have had nothing to do with it. We are being thrown out of Iraq by a populace and a government that is proving far more committed to democracy than Bush or any of the neo-cons foresaw. Moreover, the Pretend War Against Terrorism is a complete failure in Afghanistan. We are beaten there as well, and throwing more soldiers, money, and hope into that debacle will not change the outcome.

The reality of our military adventures does not play well in politics. Both major candidates have told us that we are winning, must win, and will win if only. Never mind the costs. To speak of costs is to be defeatist, anti-American, and a distraction from our rhetorical message of hope and confidence. We are the greatest country in the world and nothing more needs to be said. But the realities of war are not as vulnerable to rhetoric as is the average voter. We have lost these wars. More importantly, we should have never tried to fight them.

I await with great interest Obama's choice for Secretary of State and National Security Advisor. The choice of cabinet members is the most important decision a president makes, and these two are especially important this time around. If they are filled with the likes of Richard Holbrooke and Dennis Ross, it will be a sign that the U.S. will continue the long and painful intervention in the Middle East.

The second most important issue facing our country is the role of government as it relates to the free market. I watched with amazement as Obama portrayed himself as a proponent for the little guy, even criticizing McCain repeatedly for supporting the big corporate interests like the banks who have caused so much trouble. Lost in his inconsistent rhetoric was the fact that Obama not only voted in favor of the bank handout, but also actively campaigned on its behalf.

We know more about the handout than we did when it first passed the Congress. Primarily we know that the only way the little guy is affected is that the value of his savings is declining as the owners and operators of failed banks are gorging themselves on cash. Recipients of federal money through this plan have already paid out $25 billion of it in dividends to shareholders. The other use of those funds is the consolidation of the banking system, the very opposite of what would help the little guy. What we need in this country is more, smaller, banks competing to serve customers of all types. What we are paying for is an increasingly monopolistic industry which will yield fewer benefits to its customers and fewer benefits to society as a whole. The banking industry fell apart under the weight of its own incompetence, and we are providing the money so that the same people can rebuild it for their own best interests.

As a presidential candidate, Barack Obama was in an unusually powerful position to scuttle this disastrous policy in the name of the common man (The same is true of McCain). Instead, he and a majority of the elected democrats chose to support the wealthy elite who pay for their television ads.

According to polls, the American people overwhelmingly agree with me (at least in general terms) on these two issues. Change is indeed popularly supported by the electorate. We think of Obama as a liberal like us, but the reality is that on the 2 most important issues, he is way to the right of the people who support him. Why do we hear him use the word "change" and ignore the status quo that his actions support?

In the aftermath of this election I have witnessed a great deal of optimism in my friends and in others around the country. I believe that this is a very good thing. It may well be that the optimism that this man foments induces actions in the great many individuals who make this country thrive. We face important challenges and tough decisions, but there is no need for panic. And there is no need to look to one person, any person, for hope. Hope springs forth and grows from the level of the individual; it does not shower down from above. We must not look to the president to lead us, even if he is up to that task. The president, and all elected officials, are there to follow. Follow the will of the people that is. We must lead Barack Obama. To do that we must hold him accountable. His greatest supporters must ensure that he does not speak to us of change but implements the changes that serve the people.

Furthermore, I hope that I am wrong about Obama. I hope he does serve the common man, draw down the wars, and allow the free market to work. We'll see.

Tuesday, October 28, 2008

Automakers Ready Their Begging Bowls

General Motors has asked the U.S. Treasury to provide financial help for its prospective merger with Chrysler. But rather than use taxpayer money to facilitate this merger, the government should be forbidding it. U.S. automakers are not viable businesses, and if they are to survive at all, they should get smaller, not larger.

Congress recently passed legislation providing for a bailout of the U.S. auto industry, but this law should be repealed and the automakers should be told clearly that no federal aid is forthcoming.

There was a time when automakers represented the strength of U.S. manufacturing, but that time is long past. They have failed to adapt to changing market conditions, and should not be preserved for the sake of nostalgia.

In the last 42 months GM has lost $69.74 billion and Ford has lost $22.46 billion. If they can turn things around, I’ll root for them but U.S. taxpayers should not be forced to make that bet. If they cannot save themselves, bankruptcy should take its course.

There is value in the automakers. There are factories, technology, machinery, workers and more. However, that value is not being put to its most productive use. It may be that these productive inputs could be reorganized into several competing automakers. If we allow them to fail, entrepeneurs will do the work needed to pick through the pieces and create value for consumers.

It may also be that the U.S. is simply not suited to make automobiles anymore. That, in itself, is not a bad thing. If we produce those things for which we are suited, we will benefit from trading with those countries that produces autos at lower cost.

If the industry goes under it will take a large chunk of jobs with it, and this is certainly a negative consequence, but the cost of avoiding this job loss exceeds the benefit. The industry clearly cannot afford to pay its labor costs from sales revenue, meaning that money must be diverted from profitable pursuits to keep these people employed.

Jobs are lost every day, and those people find employment elsewhere. This process is important because it is the means by which our society reallocates resources to produce the things that people actually want to consume. There is nothing special about auto industry jobs; they warrant no artificial preservation.

Sunday, October 26, 2008

Which Headline is Worst?

G7 Warns Yen Moves Excessive; Nakagawa Says Japan Ready to Act on Currency

General Motors Said to Ask U.S. Treasury for Aid in Chrysler Merger Talks

Syria Says U.S. Helicopter Attack on Village Near Iraqi Border Kills Eight

Ukraine Gets $16.5 Billion Loan From IMF; Hungary Next in Line

These are 4 of the 9 headlines currently posted on Bloomberg. They are all bad; each, in itself, is enough bad news for a week.
I would like to offer that Japan acting to contain Yen advances is the biggest problem. World governments' interventions have turned a problem into a catastrophe, and will continue to make matters worse.

Look, as well, for Ford and GM to be the next Fannie Mae / Freddie Mac. Why can't we let them die in peace?

Thursday, October 23, 2008

Greenspan Speaks. Why Do People Listen?

Alan Greenspan will tell the House Oversight Committee that "those of us who have looked to the self-interest of lending institutions to protect shareholder's equity (myself especially) are in a state of shocked disbelief."

There are many of us who are not in such a state; in fact, there is no shortage of people who saw this coming. Why then, is anyone listening to this bozo?

As long as those who hold power in this country continue to take advice from the people who got us into this mess, we will not recover. Period.

Monday, October 6, 2008

Why The Free Market Works: Part 1 of Many

One widely unappreciated aspect of true free market capitalism is the limited liability of failures. When a business fails and goes bankrupt, it is not only the owners' liability that is limited, but also society's. We don't have a bankruptcy system to keep individual's from ruining themselves; we have it to keep them from inflicting too much damage on the rest of the economy. If we give someone an infinite credit line, then in theory, that one person can take everything down.

I keep saying this, but I'm more certain every day that it's true: These guys are creating the very problems they claim to be solving.

Reserve ratio thoughts:

A bank's reserve ratio is the percentage of total demand deposits that the bank is capable of paying out now. Basically, reserves are cash in the vault plus some electronic entries at the Federal Reserve which, in theory, could be immediately delivered as cash. The rest of deposits are lent to customers and cannot be accessed by the bank. The Federal Reserve sets the minimum reserve ratio allowed.

The discount rate is the rate at which member banks can borrow from the Federal Reserve.

The federal funds rate is the rate at which banks borrow (overnight) from each other. This rate floats, but the Federal Reserve intervenes in the market, by buying or selling U.S. Treasury securities, to keep it close to a target. When reporters speak of the Fed lowering or raising rates, it is this that they refer to.

A bank executive in the current financial crisis is likely to do one of two things:

1) If the bank is in bad shape, he is going to be risky in a way that doesn't appear too reckless, lobby for federal help, and try to keep the party rolling a few more quarters to squeeze out a few more paychecks. Maybe get lucky in the process and pull the bank out of failure. There is little cost to reckless lending for a bank on the brink of failure.

2) If the bank is in good shape, he tries to ride out the storm, tighten up lending standards (but lend freely to people with secure jobs, really good credit history, etc.), try to increase the deposit base, look for really cheap acquisitions a year or two down the road.

It seems to me that keeping a low discount rate / Fed Funds rate encourages both of these, but reducing the reserve ratio only encourages the first, as the second type is likely to keep increased reserves as a matter of internal policy. This, I believe, is why the actual fed funds rate has been below 2% (the current target) for the past two weeks.

Maybe if we do see Bernanke reduce the reserve ratio, it will signal the end, that he has given up and decided to throw the Hail Mary.

Friday, October 3, 2008

Markets Say Bailout is Bad?

On Sept. 30 Bloomberg reported :

Senate Republican leader Mitch McConnell of Kentucky predicted lawmakers would wrap up work on the plan by the end of this week. A plunge in U.S. markets, partially erased today, makes it clear Congress must act, he said.

``I think the message from the markets yesterday was clear,'' McConnell said.

The "message" from the markets was that the Dow Jones Industrial Average settled that day at 10,365.45 and the S&P 500 settled at 1106.42. We are to believe that the stock market declines were due to Congressional inaction on the bailout. Christopher Dodd pointed out that many House members were having "second thoughts" after seeing the market reaction.

The media weighed in, of course. Most egregiously, David Callaway, editor-in-chief of wrote about "How rejecting a $700 billion plan cost us $1 trillion." He tells us that "Congress imperils the investments, deposits, money markets and life savings of millions of Americans, to say nothing of people around the world."

One problem: Now that the Congress has acted the Dow sits at 10,325.38 and the S&P 500 is at 1099.23.

Are our members of Congress really making decisions based on the swings of stock markets? By this logic the bailout is 40 Dow points worse than no bailout, and they should re-convene to repeal the law.

What David Callaway (editor-in-chief of, How does this happen?) fails to understand is that there is no real wealth in the stock market. Stocks represent a claim on future payment of dividends. Because those payments are in the future, they are uncertain. Stock market buyers and sellers try to evaluate how much will be paid and so sellers are willing to trade money (which can buy things today) for these future claims. The stock market stores consumption for later.

Furthermore, the stock market is not the only place where future consumption can be stored. One other example is the national debt, which is actually negative future consumption since portions of future earnings of American taxpayers must be used to pay principal and interest on the debt instead of buying goods and services.

The argument can be made that the bailout increases future earnings because it improves the cash position of (a small number of very specific) listed companies. This is true, but it also adds to the national debt in the same amount.

There are also other indirect effects. That is, the bailout diverts $700 billion from productive pursuits to compensate some of those who made bad decisions in the past. This in turn makes future bad decisions more likely as people do not see the full cost of their mistakes. It also means that people with good ideas, or who want to expand existing successful business models, will find it harder to borrow money. All this adds up to an exacerbated recession.

The stock market will fall much further. Neither I nor anyone else will ever be able to say exactly how much of that fall results from the bailout and how much is due to other factors.

Nancy Pelosi: "Will it work? We'll see."

Congress passed the Paul Wellstone Mental Health and Addiction Equity Act of 2007 (also known as the Emergency Economic Stabilization Act of 2008), a bill designed to benefit the 74 senators and 263 representatives who have lost their minds.

McDermott voted no. Life At The Margin takes little solace.

Thursday, October 2, 2008

Bailout Goes Through, No Congress Needed

From the FDIC press release (September 28,2008):

"The FDIC has entered into a loss sharing arrangement on a pre-identified pool of loans. Under the agreement, Citigroup Inc. will absorb up to $42 billion of losses on a $312 billion pool of loans. The FDIC will absorb losses beyond that. Citigroup has granted the FDIC $12 billion in preferred stock and warrants to compensate the FDIC for bearing this risk."

Also from the press release:

"Congress created the Federal Deposit Insurance Corporation in 1933 to restore public confidence in the nation's banking system. The FDIC insures deposits at the nation's 8,451 banks and savings associations and it promotes the safety and soundness of these institutions by identifying, monitoring and addressing risks to which they are exposed. The FDIC receives no federal tax dollars – insured financial institutions fund its operations."

I'd like to know more about that pool of loans. This is an additional exposure of the Federal government to $270 billion in losses. If these were the worst assets Wachovia owned, a high percentage of this exposure may be realized. Remember, these guys invented the pick-a-payment loan.

This is not a case of a strong bank taking over a weak bank. This is a weak bank taking over a really weak bank. That $12 billion in preferred stock and warrants is likely to be worth zero in the end.

How long before the FDIC can no longer write "The FDIC receives no federal tax dollars – insured financial institutions fund its operations?"

What Credit Crunch?

"Right now, we can refinance up to 97% of the value of your home, with zero out-of-pocket expenses." -Paramount Equity radio commercial

"We're confident you'll find the perfect low rate at TILA mortgage" -TILA Mortgage radio commercial

My Letter to Jim McDermott

Dear Representative McDermott,

Your trust is misplaced. I urge you to reconsider your vote concerning the use of taxpayer money to buy distressed financial assets.

In your statement of Sept. 29, you wrote: “I voted in favor of H.R. 3997 because I know with certainty that House Speaker Nancy Pelosi and Financial Services Committee Chairman Rep. Barney Frank put the American people first and negotiated a bill that would have taken a first step in restoring the faith and trust of the American people. Doing nothing sends a terrible signal.”

But Rep. Frank and Speaker Pelosi have not put the interests of the American people first. Instead they are complicit in outright theft from the people. The bill gives one man, Henry Paulson, essentially unchecked power to allocate money from the public Treasury as he sees fit. Although there are rhetorical statements in the bill which purport to provide for oversight, the bill does in 110 pages what Paulson’s original proposal did in two.

Furthermore, the bill does nothing to solve the economic troubles we face; it makes them worse. It necessarily diverts at least $700 billion dollars from productive pursuits to failed investments from the past. Paulson’s rhetoric that buying bad assets will free up capital is a distortion. In fact this action restricts capital. We are in a recession. Our economy needs that $700 billion to aid the recovery.

Yet another problem is the likely irreversible nature of this action. The banking sector is set to lose far more than $700 billion. I am certain that a few months down the road, Paulson will want to throw more money at the problem. At that point it will be difficult for Congress to reverse course. In fact, it is perplexing that Congress would consider any plan that this man proposes given that he has been consistently wrong about everything since taking office. To point out just one example, it has now been 14 days since Henry Paulson told us the world would end in a couple of days without action.

The specter of this bill has already caused great damage, as many capable financial professionals have moved to position themselves to benefit from the new law, rather than putting effort into providing solutions. The most obvious case is that of Warren Buffett’s purchase of a large stake in Goldman Sachs.

The financial industry, and American society as a whole, has made a great deal of bad investments which must be flushed out of the system. This process will take work and sacrifice. There is no easy solution. You say that doing nothing sends a terrible signal, but doing something bad is much worse. The Bush Administration has used threats and unjustified predictions of impending doom to foment fear in the American people, and the Congress is panicking and rushing to “do something.”

Don’t “do something.” Do the right thing. Vote no.

Wednesday, October 1, 2008

U.S. Fiscal Deficit is 1,017,071,524,649.92, Total Debt is 10,024,724,896,912.40

That's more than one trillion dollars of taxpayer liability added in the past 12 months. This does not include the bank handout currently under consideration or future Congressional action on the so-called "financial crisis." It does not include the potential liabilities of the FDIC which the U.S. Treasury may be forced to pay on very soon. Don't be surprised if next year's fiscal deficit exceeds 2 trillion dollars. Will the world really lend us this much money? Can the U.S. dollar survive this onslaught?

Sunday, September 28, 2008

Paul Krugman Writes...

"Troubled financial institutions, by definition, don’t have capital gains to tax."

Response: They do now, Paul

"Despite some real scandals at Fannie and Freddie, they played little role in causing the crisis: most of the really bad lending came from private loan originators."

Response: Fannie and Freddie are the biggest reason for the crisis. Although they didn't originate bad loans, they purchased the bad loans. They owned sup-prime and Alt-A loans well in excess of their capital. Without these GSEs more, smaller institutions would have owned the loans, some of them would have been smart, some would have been dumb, some would have failed, and some would have thrived. Instead the mortgage market was totally dominated by the terminally flawed business model of Fannie and Freddie, and that business model was artificially supported on the backs of the taxpayers.

"Barack Obama seems well informed and sensible about matters economic and financial."

Response: Are you kidding? 

Handout Plan Limits On Executive Compensation Have No Teeth

First of all, this bill gives essentially unchecked power to Henry Paulson. It does establish an oversight board, but Paulson is on the oversight board. Ben Bernanke, who is on record saying we should overpay for troubled assets is also on it. Furthermore, even if the oversight board were legitimate, the standards that Paulson must adhere to are so vague that he’ll be able to do whatever he wants. “As determined by the Secretary” are common words in this bill. So while there are some words to the effect of preserving retirement funds and protecting homeowners and other nice-sounding rhetoric, Henry Paulson will be able to solely determine what actions meet those ctiteria.

Paulson will be able to buy equity or make loans or buy troubled assets directly. Limits on executive pay only apply while the government has an equity or debt stake, which means the banks can simply wait until that stake is sold to make exorbitant compensation payments. In addition, limits are only provided for NEW contracts. Executives who made the bad decisions that put these institutions in danger will still receive bonuses galore. In fact, this bill makes it more likely that they get exorbitant bonuses because the purchase of assets by the government will drastically increase profits and trigger bonus payouts. The only work done to earn those bonuses will have been lobbying for this bill to pass. Moreover, companies will have a 2-month window to establish contracts for executives that pay high bonuses. There is absolutely no way that any executive of a financial institution is going to be one dime poorer under this legislation.

I wish I could scream this from the top of the world: Any nominal limit, be it 250 billion, 700 billion, or any other number is completely meaningless. The bill states that any limits apply to aggregate purchase price paid for “all troubled assets held.” This means that troubled assets sold (possibly at a huge loss) no longer appear in that aggregate.

By the way, under other provisions, Paulson could easily justify selling assets at a huge loss to free up space under the limit because he is directed to use his discretion to hold those assets that do the most “good.” Who determines which assets are these? Well, it aint Barney Frank.

If Congress passes this legislation, it is nothing short of a theft from the American people. Worse still, once it is passed it leaves Congress inept to affect administration of its provisions. Congress is handing power to Henry Paulson and washing their hands of it. I have no doubt that this is intentional. When the light of day hits the results in a few months, they’ll tell us they are not to blame. It’s Paulson’s fault, they will tell us. He didn’t implement it properly. Don’t blame us.

Remember, this is the same Congress that declared war on Iraq, yet passes all the blame for that disaster on to W.

One last thing. They keep saying this thing is urgent and necessary to unfreeze credit markets. So I ask you to ask yourself a few questions:

Has my credit card company told me to stop making charges? Am I still receiving credit card offers in the mail? How long would it take me to find internet ads for low-interest mortgages or refinancing? How many people do I know that really need a car loan in the next few months anyway?

Please call each of your 3 Congressional representatives, register your opinion, and withhold your vote pending their decisions on this bill. Tell them as well that you will not vote for their party’s presidential candidate if he supports this bill. If you are a member of one of the political parties, it is especially important to hold your own party to account.

Saturday, September 27, 2008

Issue Almost Addressed in Debate

Moderator Jim Lehrer was the big winner last night as he effectively asked the candidates that one question that should always be asked of politicians who make policy proposals: What do you want less of?

He didn’t quite phrase it in those words, but he did recognize that the federal handout to banks would restrict the ability to put resources to use elsewhere.

Barack Obama was so confused by the question that he responded with a list of things he wants MORE of: energy independence, alternative energy, fuel-efficient cars, fixes in the health care system, education, investments in technology, something about the Chinese spacewalk, affordable college, roads, bridges, broadband lines, a new electricity grid. Later, he added early childhood education.

John McCain did a little better, saying he would eliminate ethanol subsidies. He also acknowledged the out-of-control nature of defense spending.

But neither really got at the issue that Lehrer was trying to address: $700 billion spent on near-worthless mortgage assets is $700 billion made unavailable to productive uses elsewhere in the economy.

McCain did finally blurt out: “How about a spending freeze on everything but defense, veteran affairs and entitlement programs?”

I hope he takes that idea back to the handout negotiations. I would have liked to have seen Lehrer press them even more on this.

Overall, from the financial portion of this debate, McCain seems to me the least of the evils. He showed a slight, albeit very slight, propensity to restrain spending; whereas, Obama talks like there is an infinite pile of cash that he can spend without consequence.

Though I do disagree with McCain about earmarks, I admire the fervor with which he opposes them. He said that earmarks have tripled in the past 5 years to $18 billion. I don't know if that is true, but if he is right and that continues, we can expect $54 billion in 2013, $162 billion in 2018, $486 billion in 2023, and a whopping $1.46 trillion in earmarks in the year 2028. Ah, the wonders of the exponential function.

Unfortunately, it was downhill from there for old John. As the topic switched to the Iraq occupation, McCain reminded us all that he lives in a fantasy world. He sung the praises of “the surge,” and declared that we are winning in Iraq. McCain has been repeating this mantra for months, but has not yet offered support for this evaluation. I’d love to know what he means when he says the surge is working. In its first report (September 2007) on the surge, The Government Accountability Office (GAO) determined that “The Iraqi government met 3, partially met 4, and did not meet 11 of its 18 benchmarks.,” and used phrases like “violence remains high” and “It is unclear whether sectarian violence in Iraq has decreased." The GAO’s June 2008 report offers little evidence that the surge or any other aspect of our occupation could be referred to as successful.

Stupid Statements By Candidates and My Responses, Second Edition: John McCain

1. “[This package] has to have options for loans to failing businesses”

Response: John, what kind of idiot lends money to failing businesses? Oh, right…

2. “Here is … Ahmadinejad, who is now in New York, talking about the extermination of the State of Israel, of wiping Israel off the map,”

Response: This is just a bald-faced lie, and an egregious one at that. The president of Iran is probably a very bad man, but he has never talked about the extermination of the State of Israel. I can only guess that your ridiculous lie has its its origins in the October 2005 speech from which Ahmadinejad was widely misquoted. The media and politicians have continued to blatantly mis-represent him, often claiming that he “calls for the destruction of Israel” and that he “threatened to wipe Israel off the map.”

My friend, the idiom “wipe (something) off the map” does not even exist in the Persian language. Juan Cole and other experts have debunked this lie, yet you and others continue to use it to justify your ridiculous assertion that Iran is a threat to us.

What Ahmadinejad actually did in that speech amounted to predicting that the Israeli government would fall in time. He didn’t threaten the people of Israel; he is talking about regime change.

Why is it, by the way, that you fail to mention that the official position of the Iranian government toward Israel is that of the Arab League: that Israel should exist peacefully alongside a sovereign Palestinian state?

I have no intention of defending this man, but I must defend the truth. It is an embarrassment for the American people that you would make such a ridiculous, belligerent, and ignorant statement. In a presidential debate watched by people all over the world, no less.

Stupid Statements By Candidates and My Responses, First Edition: Barack Obama

1. “$700 billion, potentially, is a lot of money.”

Response: Aint no potential about it, Barack

2. “the root problem here has to do with the foreclosures that are taking place all across the country.”

Response: This is evidence that you do not understand the problem. Please don’t try to fix it. The root of the problem is that interest rates were artificially held too low for too long, leading to mis-pricing of risk in the marketplace. This led to an over-supply of loans (including, but not limited to home loans), which in turn led to massively inflated home prices. The net result is we had people who couldn’t afford a $200,000 house paying $400,000 for a house with a true value of $300,000.

We cannot undo the mistakes of the past. They will be paid for one way or another. Keeping a family in a house they cannot afford solves nothing. It makes the problem worse. Home prices have further to fall, and they will fall, no matter what you do.

There is life after foreclosure. We have enough housing in this country to put a roof over everyone’s head and then some. A person who outspent his means may need to downgrade, but that is not a catastrophe.

3. “this is a final verdict on eight years of failed economic policies promoted by George Bush.”

Response: More evidence that you do not understand the problem. No one is more critical of Bush’s policies than I, but little if any of the blame rests with him. There is plenty of blame to spread but it starts with the failed monetary policies of Alan Greenspan and Ben Bernanke and trickles down to bankers who foolishly allowed independent brokers to sell mortgages to anyone with a pulse.

To the extent that Bush is culpable, you sir share that blame as a member of the political class which keeps promoting the farce that the American dream can be had by anyone without cost or sacrifice.

Shame on you for exploiting this very real problem to score a purely political low blow.

Note: Good lord, that’s only the first of 27 pages of the transcript.

Friday, September 26, 2008

Bank Handout Plan is NOT limited to $700 Billion

"The Secretary’s authority to purchase mortgage-related assets under this Act shall be limited to $700,000,000,000 outstanding at any one time."

This statement is taken directly from Henry Paulson's original proposal. Whether it survives the bipartisan consensus I cannot predict, but it is a scary, scary authority.

Keep in mind that Secretary Paulson and Fed chairman Bernanke have already testified under oath that they intend to drastically overpay the banks for their "troubled assets."

One may me tempted to focus on the $700,000,000,000, but the real devil lies in the words "outstanding at any one time."

If this provision passes, Paulson will have the freedom to allocate much more than $700 billion of our money to this so-called crisis. For example, he could buy $100 billion of assets from Goldman Sachs, then sell it to Morgan Stanley for $5 billion. He could buy $700 billion of assets, then write the value down close to 0, then buy another $700 billion. He could even continue a buy high - sell low scheme infinitely or until he judges that banks are "adequately capitalized."

Would Henry Paulson abuse this power in such a way? I don't know. But he would be able to do it . And let us not be naive. There is a reason behind Paulson's inclusion of this other provision in his proposal:

"Decisions by the Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency."

Will Government Purchase Artwork in Bank Handout Plan?

Lindsay Pollock of Bloomberg reports that "Kathy Fuld, the art-collecting wife of Lehman Brothers Holdings Inc. Chief Executive Officer Richard Fuld, is selling a $20 million set of rare Abstract Expressionist drawings at a November auction, according to two art dealers."

Could she be positioning herself to benefit from incipient Congressional handouts?

As I think it through, I'd rather have her artwork than the worthless trash our inept Congress is planning to overpay for.

Thursday, September 25, 2008

CEO Pay Restriction is a Smokescreen

Although opposition to the banking handout appears to be widespread among taxpayers, Congressional Democrats are lining up to support it. Of course, they took the opportunity to criticize the Bush administration. No argument there. But rather than tell Treasury Secretary Henry Paulson that his Wall Street buddies will have to fend for themselves, the Dems agree to hand over our money. In return they want CEO compensation and that of other corporate executives limited.

Neither the government nor its financiers (that is, we the people) have a financial interest in the pay of a private or publicly-traded company's employees. That is for the shareholders to decide.

Don't get me wrong, I agree that executives who implement failed business strategies should not be rewarded, and that even those who are successful are probably overpaid, but if the money doesn't come from my pocket, then it is someone else's problem.

It's an interesting topic to be sure, and no one can fault Americans for having an opinion about who is overpaid; however, we should not allow our elected representatives to prey on these emotions. After all when inflation really hits home and one banana costs $5, will any of us truly take solace in the fact that Lloyd Blankfein (current Goldman Sachs CEO) is only making $7 million per year?

The Democrats would serve us better to focus on one particular (former) Wall Street executive, Treasury Secretary Henry Paulson. He is the principal architect of the failed business model that has thrust the investment banks into insolvency. Bear Stearns and Lehman Brothers fell apart while following the lead of Paulson's Goldman Sachs in over-leveraging their capital. We now know that Paulson's failure to balance risk and reward, and his failure to consider negative consequences have doomed Goldman Sachs. He even tells us that his actions threaten our entire economic system. Though he cannot seem to offer any explanation as to how his dire predictions would actually come to pass.

The story gets worse. He tells us that he is the man to solve the problem. The initial proposal he sent to Congress would have made Henry Paulson the most powerful person in the history of the world. I am not exaggerating.

But it is not only his tenure at Goldman Sachs that is being exposed as a failure. Since joining the government he has been wrong about everything and every action he takes makes the problem worse. Yet members of congress take his statements at face value. No one has asked him (or forced him) to give a real assessment of the problem as he sees it, he has not made the case that the handout will provide tangible benefit, and there is not one shred of evidence that this man has spent any time considering the costs of his plan.

If Democrats really want to negotiate this plan in the interest of the American people, they should not start with CEO compensation. They should insist on a new Secretary of the Treasury.

Post-script: I heard Jack Welsh, former General Electric CEO, tell an NPR interviewer, that we should all be happy that Henry Paulson has agreed to work for us at the low salary that public officials are given.

So I did some checking. In reality, we the people gave Paulson an effective $200 million signing bonus in the form of a tax-break on his sale of Goldman Sachs stock.

Turns out it's not so much of a sacrifice to take that government job after all.

More Thoughts on the Federal Handout to Banks

1) Hank Paulson (already) wants to expand the program to car loans, credit cards, and other “troubled” assets. I am finding it increasingly difficult to willingly suspend my disbelief.

2) Unintended consequence alert: Debtors now have increased incentive to default as it becomes cheaper on the margin for creditors to seek recourse from the government as opposed to spending resources on collection. Collection agencies may falter as the new and improved Treasury moves in on their business model. Perhaps there is opportunity in facilitating planned defaults. Put It Back In The

3) Money market funds have been breaking the buck on a regular basis over the past 12 months; it just so happens the parent companies have all stepped in to bail them out. They did not legally have to do that, so it should have been clear that the time when one firm finds it in its best interest to let the fund's Net Asset Value drop below $1 per share would come. Anyone (in the financial industry) unprepared for this was simply not paying attention.

4) The banks are not going to take their new found wealth and lend it to a waitress who wants to buy a view condo. They’ll buy treasuries and head for the beach. The big picture is this: A large amount of financial capital is being forced to chase bad debt. Real economy capital expenditures will have to take a hit. Ironically, the broader economy may follow the banks in contracting their operations. Whole Foods will become a cheese shop. Starbucks becomes a bring-your-own-latte joint. “We supply the ambience.” Airlines will stop giving us water.

Excuse me, that last one is the result an unrelated economic crisis.

These pagliacci may well succeed in causing the very infection they claim to be saving us from.

5) Ultimately, foreigners will have to demand higher nominal returns. One would think this would be the bamboo shoot that breaks the panda's back, but maybe they hold out a bit longer. Soon enough, interest rates will soar or the Federal Reserve will significantly expand its balance sheet or a combination. If I had a lot of money to invest long-term, I’d put half in gold/oil/wheat and sell short long-dated treasuries with the rest.

6) There’s another meaningful contrast to the Japanese crisis (in addition to the vastly divergent savings/consumption cultural attitude). It is one thing for domestic banks to hoard cash; it is altogether different to expect foreigners to do the same. I’m guessing but I don’t think JGBs were bought up by foreigners. Isn’t the yen carry trade, in fact, the exact opposite?

7) What are the chances that the dictatorial powers in the initial proposal are designed to divert attention from the actual theft of taxpayer money, making the final version a “compromise?” I want to sell short the bipartisan consensus.

Risk and Money Market Funds

My first reaction after initial research is this: Money Market funds had no business buying or holding Lehman's commercial paper after March 15 (Bear Stearns’ failure). Even if it officially met their standards, the managers had to be aware of the huge risk. People who supply their money to the money market are agreeing to slightly more risk than a savings account. My position two days ago would have been that the account holders signed up for this risk, but now I'd say they have a case for negligence on the part of managers. Those funds should have begun a process to wind down exposure to Lehman on March 17. The money market is just not an appropriate place for Lehman to borrow. Yes, I'm sure this would have created a supply-demand imbalance and returns for the MM accounts would suffer in the short-run, and the managers probably thought their hands were tied, but this is what they mean by "picking up pennies in front of a steamroller." This aint rocket science.

I'm sure some would make the argument that the Bear Stearns rescue created an implied guarantee for Lehman commercial paper. More evidence that it is the government intervention that creates the ripple effect. So holders of Lehman paper pay the price for Bear Stearns' failure. There should have been some work done to re-price Lehman's debt. The MM funds could have communicated with Lehman and given them a chance to find a (more expensive) way to finance themselves. This could have happened in an orderly way and the risk could have been shifted to those more willing to bear it. Instead they all sat around doing nothing because they believed Uncle Sam and Uncle Ben would take care of them.

Tuesday, September 23, 2008

The Illiquid Asset (fiction)

I have quite a few illiquid assets in my closet and my basement. One such asset is an old pair of running shoes. They don’t look very good, and it is unhealthy for me to run in them. I know they are illiquid because I have tried to sell them to four people I know and seven strangers with no takers. I have an excel spreadsheet that says the value of the sneakers is $57.

Sometimes I find it enjoyable to lend money to friends and colleagues. For example, Joe wants $50 to buy a present for his son, but right now I don’t have the capital to support that. Since Joe’s problem is a human-interest story, I tell Vanessa, thinking she might now buy the sneakers for $57 (I’m willing to accept 55). I believe my exact words to her were ``Illiquid assets are choking off the flow of credit that is so vitally important to our economy. As illiquid footwear assets block the system, the clogging of our financial markets has the potential to have significant effects on our financial system and our economy.''

Now it gets interesting. Vanessa has the crazy idea that my sneakers couldn’t possibly be clogging anything. She says the real problem is that I actually don’t have money to lend. “Maybe you should get out of the lending business,” she says, “Stick to what you’re good at, like matchmaking for busy under-caffeinated professionals.” I don’t think she gets it. I also don’t think she cares at all about Joe’s problem, but she did mention something about simply lending him the $50 herself. Clearly she fails to understand the complexity of our sophisticated markets. So I hold an auction but no one buys the sneakers; this is a catastrophe for people like Joe. There must be some entity willing to do the right thing and free up this sneaker-constrained capital…

To be continued

It's Not a Bailout, It's a Handout

The Congress and other key members of the federal government are busily negotiating what is commonly referred to as a bailout of the financial system. In fact this is no bailout. It is a handout to certain individuals, a transfer of wealth from the many to the few, some of whom are quite wealthy already.

Moreover, the handout does not address the very real, but manageable, problems of the financial system. The proposal is backward-looking, forcibly diverting money from productive pursuits and using it to chase bad loans down the garbage disposal. The damage from the bad loans cannot be undone, and they and their associated bad assets can make it down the drain without taking taxpayer money along.

On the subject of bad assets, Congressman Barney Frank would have us believe that the taxpayer stands to make a profit from this program. Impossible. Treasury Secretary Paulson and President Bush have been very clear that they intend to buy the worst financial assets available. Due to the complex securitization of mortgages and the hesitancy of the assetholders to write them off, many of our coming purchases are already worth zero, with no hope of ever appreciating in price.

Former Speaker of the House Newt Gingrich recently told NPR’s Melissa Block that “I was just reading an analysis by a very sophisticated person who said that there's been at least one leak from a congressional staff briefing by Secretary Paulson, in which he clearly indicated he intended to buy assets at above their market value.”

If the assets were in fact undervalued, as Barney Frank says, then there are people with money who should be happy to buy them of their own free will. Investors are willing to do the work needed to separate good from bad. This is the work needed to drag the system through, but it cannot happen if the Treasury hands people the opportunity to exchange nothing for something.

The Congress and the Treasury are acting in a state of panic. President Bush says that they have no choice. Secretary Paulson says this is better than the alternative. One has to wonder what “alternative” he has considered because there are plenty of better options to choose from.

One perfectly viable alternative for Congress is to do nothing. We already have a bankruptcy system that is equipped to deal with this. Banks that are insolvent should be forced to go through the bankruptcy process. There is no such thing as “too big to fail.” These banks have already failed. All that remains is to determine who will bear the consequences, those responsible for the failure or those of us who had nothing to do with it. I think I can speak for us all when I say we taxpayers have our own problems.

They tell us that inaction will lead to a complete financial meltdown, but there is no justification for this claim. Yes, there is counterparty risk, but there is no reason why it would increase if bankruptcies take their course. What’s more, those counterparties knew (or should have known) the risks and they entered into those counterparty agreements freely.

So what would happen if we say no to this handout. Shareholders of insolvent banks would lose their investment. Bondholders would lose some or all of their investment as their claim is reduced to the proceeds of the bankruptcy proceedings. This is a bad outcome for those people, but it is no catastrophe.

There is no reason to believe that economic losses would extend past the stock and bondholders. Counterparty obligations would still be met and customers need not lose because strong banks will rise up to serve them and the viable portions of the failed banks would be preserved and taken over by more competent managers.

Stocks and bonds represent ownership stakes in a risky endeavor. Gains on those stakes exist because the possibility of loss exists. These assetholders have already agreed to accept the losses in the event of failure. This has always been true and it must remain true. If we proceed with this handout, the only results will be financial loss for hard-working Americans and a windfall profit for a select few.

American People Must Stop The Bailout

The current proposal to bail out portions of the banking industry will be a disaster for the American people, and we must act immediately to prevent it from becoming law.

The plan does not do anything to address the structural economic problems we face; in fact, it exacerbates them. It does, however, transfer massive amounts of wealth from taxpayers and savers to those who made poor investment and business decisions, many of whom count themselves among the wealthiest of Americans.

Here are some important things to keep in mind when considering this plan:

1) The absence of an overt tax increase does not mean you are not being taxed. A $700 billion expenditure is a $700 billion tax. We don’t yet know how it will be collected, but it will be collected. Options include direct tax increases in the very near future or an increase in inflation which devalues savings accounts, bonds, money market accounts, social security payments, hourly wages, and salaries. The inflation tax will disproportionately hurt the elderly and those who have little bargaining power with employers.

2) The devaluation of the dollar makes it much more likely that foreign holders of U.S. dollars and dollar-denominated assets will flee the U.S currency. Foreign investors may also pull back on investments in the U.S. economy. Our system is highly dependent on foreign credit and foreign investment and a sudden massive decrease in foreign participation is a much greater risk, with much more dire consequences, than large bank failures.

3) On the subject of bank failures, there is no evidence that the losses of banks will cause economic disaster. Our policy officials and the banking executives have repeatedly claimed that the consequences of inaction would be severe, yet not one has offered any justification for this prediction. Henry Paulson even walked away in silence rather than answer a reporter’s question about this issue.

4) It is a myth that this, or any other bailout plan, will increase the value of homes or stop any declines in home prices. Real home value is a function of the stream of benefits that a home provides. Shelter, storage, family camaraderie, a place to watch TV, a yard for children to play, etc. Market prices fluctuate, but will ultimately settle at points that reflect homeowners and potential buyers’ valuation of these benefits relative to other goods and services. Home prices need to decline in order for the housing market to stabilize.

5) High home prices are bad for almost everybody, yet the political rhetoric used to justify this bailout rests heavily on the desire to prop up housing prices. Subsidizing the housing market makes homes more expensive, not more affordable. Even current homeowners gain little or nothing from appreciation because a home sale usually is coupled with a purchase of a different home. Home price appreciation is not an increase in income. Then, of course, there are property taxes, which increase with the “market value” of a home, making ownership more expensive still.

6) There are well-run banks out there. Most of them are small and mid-sized banks that did not get caught up in outsized risks. When the poorly run banks fail, the well-run banks will rise up to take their place. Of course it will take time to clear out the dead brush, but if we allow bad banks to fail and good banks to survive, the broader economy can only benefit.

This bailout does the opposite. It artificially strengthens the weakest members of our banking system and allows their poor decisions to infect the entire system. The weeds can then choke down the trees and prevent them from growing into a strong stable forest. The allowance for failure is the cornerstone of free market capitalism. If we allow this to go forward, we have no business calling ourselves a free market. Bailouts do not exist in a free market.

7) Government bailouts are not an exception; they are built into the business model of the banking system. An individual bank, under uncertainty, takes actions to maximize its own expected profit. It does not consider the overall expected welfare of society. Believing that government will backstop losses, the bank takes on more risk than is fiscally prudent. This exposes the bank to greater potential profits while exposing taxpayers to more potential losses.

Aggregated over all banks, the outcome is certain. Due to randomness some banks will win, some will lose, but the system is rigged to lose money as a whole. If we bail them out now, we will be bailing them out again. We cannot be fooled by rhetoric that tells us we must stop the bleeding now, then reform the system. The only way to reform the system is to let it sink on its own, and the only opportunity to do that is now.

8) Bailout mania is still in its infancy. Taxpayer exposure to bank losses will spiral out of control. This program will expand well beyond $700 billion. The Fannie Mae / Freddie Mac bailout will balloon from $200 billion to well over 1 trillion. And of course there will be more emergent “crises.” One need only look back at the past year’s worth of comments from Bush, Bernanke, and Paulson to see that they have systematically underestimated the level of losses in the banking industry. In March, we were told that a $29 billion loan to JPMorgan Chase would be the extent of taxpayer exposure.

9) Our politicians have no idea what they are doing. In all honesty, we should not expect them to. They are experts in getting people to vote for them, not in effective economic policy. Most of their policy advisors are experts in getting votes, not effective policy. Barack Obama, John McCain, Chuck Schumer, Barney Frank, John Boehner, and George Bush repeatedly expose their collective ignorance when they speak about this issue. They are very smart people to be sure, but they are not equipped to be reacting to this problem. The same is true for almost all of the Congressional members. They don’t even understand the problem; we should not empower them to solve it.

In a rare moment of clarity, Harry Reid did say that “no one knows what to do.” Unfortunately, he was promptly criticised by other politicians. But Reid is right. Harry Reid, you are the Senate majority leader and neither you nor your colleagues understand this, and you know it. You must fight this proposal and all Americans should stand behind you on the issue.

As noted above, even those who are supposed to be experts, Bernanke and Paulson, have shown a complete lack of competence. They are recklessly throwing our money at a problem they clearly do not understand.

This is an important time for our country and its people. We are in an economic downturn for sure and it is likely to get worse. We have spent years creating economic problems and there will not be an easy fix. Some suffering is inevitable and politicians cannot deliver us from our troubles no matter how well they can speak. But all is not lost. We can learn from mistakes, re-allocate resources and continue with strong economic growth. The human race has endured for a long time and will continue to prosper. This is not a catastrophe and we should not panic.

The problem is that the downturn hit us at the worst possible time – during a presidential election campaign. The reaction is therefore politically motivated and highly inappropriate. But there is another side to that coin. We the people have a unique capacity to veto this course of action. Every member of the House of Representatives can be fired this November, 33 senators can be sent home, and we are not limited to Obama or McCain in the White House. On November 5, 2008 100% of the power will rest with 435 representatives, 100 senators, and one president. Our time to affect policy is now.