Archive for February 2009

The Bank Problem

I think most people understand that banks may have a problem and they won’t lend, increasing the problems our economy is facing, but there is no real understanding of the “problem”.  So I thought that in my simple minded way I would take on the economic-babble and try to turn it into plain English.  I, of course, will oversimplify, probably to the point of actually making sense.  When you listen to the economic-babble, what gets lost are some fairly simple concepts wrapped in some deeply established conventional wisdom about free markets inculcated through years of dreary study.  As a structural engineer I liked to use terms like transverse loads and horizontal force resisting systems to hide some fairly simple concepts and always look serious so I could earn the big bucks.  It is part and parcel of the mystic of being a professional.

Okay, what is wrong with the banks and why won’t they lend money?  Because they don’t have any!  Wait, you say, what about the $350B we gave them?  Well it costs a lot of money to pay bonuses and continue with all those off-site conferences.   People are depressed with only getting six figure bonuses and motivation seminars in Vegas and Santa Monica with concerts by Chicago are not cheap.  Do you have any idea what an open-bar for 3000 costs?  Besides, corporate jets don’t run on water you know.

Seriously, they really don’t have any money because all that money they were taking in with your deposits they invested in CDOs (Collateralize Debt Obligations- Securitized Mortgages sliced and diced) to earn the maximum interest to pay for all the free services they offer you, the return on your money market accounts, and all those great bonuses.  As if those ATM fees weren’t enough.  In order to make your accounts liquid (funny how economist like to refer to cash flow as something that runs through you hands), i.e., the ability to cash you out when you want, they have to have cash on hand.

They have to borrow that money since the real money they got from you and stockholders is invested to earn them profit for what they are doing.  So when other banks look to loan them money, they want to know that their loan will be secured by the assets the bank holds so that if stuff happens, they can get their money out.  It has to be secured by the assets of the bank.  Ah and there is the rub.

If those assets are only worth about 20¢ on the dollar, your dollar that they invested in CDOs, that means that the banks liabilities exceed their assets. If things get tougher or there is a real run on the bank (people want their cash), the bank will collapse because they can’t sell the assets to cover this demand much less borrow it from anyone else.  You and anybody who loaned them money and invested in their bank will lose.  That is why the banks are holding on to the money the Fed gave them.  It improves their balance sheet and staves off the wolves.  They won’t loan it to you even if you are a good bet because they may need it to cover a run, bonuses or off-site motivation seminars.  How do you think they keep those really smart guys on their payroll that make those bad investments in the first place?

Worse, is that each of the banks also holds loans from each other.  This interconnectedness means that if one collapses, meaning their loan payback is now worthless; it impacts all the other bank’s viability.   Now comes the transparency thing.  Nobody knows who owns what and how much of a bank’s net worth is based upon these “toxic” assets.  So everybody is holding their cards close to their bodies and hanging on to their cash.

So with all this uncertainty, we have dollar constipation.  Now the way to solve the problem is to make the banks solvent again.  one way is to stop the mortgage crisis, stem falling housing prices to shore up the value of these “toxic” assets.  But that is a whole other story that I will take up later and just threw it in here to make the point that all of this is interconnected.  The other option is to increase their cash.  Secretary Paulson tried this by giving them $350 billion and it turned out not to be enough by a whole bunch.  Meanwhile taxpayers are wondering why they need to bail the banks for these bad decision on investments and want some protection on their money. The reason is that if all these banks domino, the net worth of the United States goes in the dumper and we as a country collapse.  But the concern about some return on taxpayer funding is a valid one.

Now the obvious solution is to nationalize the banks.  What this accomplishes is that the banks, now backed by resources of the federal government guaranteeing the worth of these assets, no longer fear a run, are recapitalized and can loan freely in an attempt to get back on their feet.  The government takes on and “insures” the liabilities of the banks and in an ownership role, can change management and benefit if the banks and their assets rebound.

But now comes the convention wisdom that governments just screw up markets.  This ignores the reality that the FDIC does this kind of thing all the time, but hey, when did facts and reality count for anything?   This belief in government bad, private ownership good is the result of all that dreary learning necessary to get your PhD in economics.  So here come all the exotic plans to recapitalize the banks while protecting the taxpayers where the government doesn’t really own the banks and it is left in private hands.  These go something like this and these are grossly over simplified.  There are multiple variations to either limit government control or try to change the heads banks win, tails taxpayers lose scenarios of anything less than nationalization:

  • Insurance – The government insures the banks assets so that private capital will then feel secure enough to recapitalize these institutions (selling stocks and bonds).  Downside – banks keep their existing management that got us where we are and the government takes all the risk with no pay back.  If the assets collapse taxpayers are on the hook, if they rebound, the banks gain.
  • Good Bank/Bad Bank – In this case the government establishes a “bad bank” that takes the bad assets off the hands of the bank leaving them capitalized to get back to work.  Downside – same as above, and the money to buy off all those assets comes from taxpayers.  If the assets (housing prices) come back, the government may recoup some losses, but that depends on the price the government initially pays for these assets.  Banks don’t want to admit the real price of these assets in today’s markets so this one is unlikely
  • Continuing to Capitalize the Banks through preferred stock – This is basically what TARP did but has been adjusted recently.  It buys stock that is “preferred” in that they get a guaranteed return on the sock of 5%-8%, but have no voting interest.  The banks can then choose to convert this preferred stock to common stock getting out of the burden of the dividends, but then giving the government voting interest in running the bank.  Considering the price of most banks stocks and the cash needed, this would actually nationalize the banks without calling it nationalization.  Downside – While it infuses cash, it probably is not enough and requires Congress to authorize more, and it skirts the ownership issue leaving bad management in place unless the bank opts to turn itself over to the Feds.  If you really want to have your eyes roll back in you head, clink on this link to understand the details of this type of investment (The Baseline Scenario).

Note that all these solutions have one thing in common:  Don’t violate the conventional wisdom that these banks should remain in private hands.  Those private hands did a bang up job so far.  So for the short term they need to lose their license for running banks.  In my mind the uncertainty in the market is never going to be solved by the conventional wisdom of putting on a happy face and letting banks dangle.  We need to identify the problem, nationalize them, sell off their good assets, and re-privatize them as markets improve as smaller entities.  In a sense reboot the whole system and get the pain out of the way.

Most addicts understand that before recovery, you have to hit bottom or you are not ready.  The conventional wisdom is that we need confidence in our system so people will start spending again.  But we have not hit bottom so we will make the changes necessary to really correct our present situation.  Republicans still think Ronald Reagan applies and until they face reality, we are going nowhere.  That is why this obvious solution is still going to be a hard fight.  Until then, nationalization is a dirty word.  Or for the wingnuts, be afraid, the black helicopters are coming to take over our country.  First it’s the banks, then it will be national health care.  I say bring it on.

Vine/Wine Friday

Vine: Winter continues in the foothills and the snow has been washed away by rain.  We have had a long soaking rain for the last several days that is very welcome.  Up here in the low Sierras we have been notified that the first stage of drought watch is to be instituted by raising the rates on our water.  Since I only irrigate about 3 times a year during the growing season this will have little impact on me.  The soil up here is high iron clay and it retains water and combining that with timely drip irrigation, the plants require little water.  That would have changed had we not gotten the soaking rains we are seeing right now, but the water table is being recharge and I won’t water the grapes until early July.  The lawn is a whole another issue.  Grass really has shallow roots.  Oh well.

The picture shows the vineyard after the winter snow was washed away.  You can clearly see that we have not pruned, which is a month away, and the rows have been sprayed out.  There is nothing to do before pruning but wait for the buds to swell and start to break.  Then we prune.  You can see how the cover crop of grass and clover is starting to green up nicely and holds the soils in during the rains.  It will be mowed once probably in late April before it is allowed to go to seed in late May and then a final mowing after it dies out when we start our dry season.

Wine: Last Friday for my birthday I went to San Francisco for a day of just pure enjoyment.  When we go to San Francisco we try to schedule one new adventure each trip.  On arriving in the city around noon we went to the de Young Museum to see the new building and of course the art.  By the way if you live east of San Francisco, come in over the Golden Gate Bridge, take US 1 right after you get off the bridge, follow the signs to the Golden Gate Park (Balboa Street off US 1 I think, you kind of have to loop around because there is no left turn), then take 10th street into Golden Gate Park.  It will take you directly into the parking garage for both the de Young and the Academy of Science (also a wonderful visit). Funny but the most striking thing to me was to see a beautiful silver beer tankard crafted by Paul Revere. Really gave me a thirst for a cold beer.  Actually that is not totally true and it was a great afternoon.  There is, however, some modern art I don’t think I will ever understand.

Then it was down to the Ferry Building for a couple of glasses of wine at The Ferry Building Wine Merchant after checking out the shopping.  The Ferry Building usually ends up being the center of our visit because on Saturday morning we are going to buy fresh vegetables and meat at the farmers market for dinner at home that night.  The Wine Merchant has a very good selection of wine, and I always ask for an interesting Syrah and they never let me down.

Then it was off to SPQR (SFStation) in Pacific Heights for dinner.  SPQR is a smallish restaurant opened by the people that were involved with A16.  It doesn’t take reservations so we got there about 5:45 and found a nice table for two and shortly thereafter the restaurant was full with many people waiting for tables.   The menu is fun and all Italian with some fried specials.  We ordered hors d’oeuvres of fried chicken livers and a salad of wild arugula, roasted carrots and ricotta salata that was amazing.  Candace had the Lasagna and I went for Cannelloni of pork sausage, ricotta, spinach and pecorino.  I had an Italian wine and I can’t remember the name.  I was having so much fun I forgot to write it down.  I would highly recommend SPQR.  It is very casual, small, and very good.  By the way the cab ride both to and from was a very pleasant surprise.  Both cab drivers were old time San Francisco residents who were really truly interesting and, surprise upon surprise, the ride was not a constant cycle of acceleration and braking while you swerve through traffic, but just a nice smooth ride.  What is happening to the world as we know it?

After dinner and before returning to our hotel, we had a couple of glasses of wine at a wine bar near our hotel and people watched.  All in all, it was a perfect day.  The next morning we walked over to the Ferry Building to peruse the Saturday market and pick up dinner to cook at home.  When we got home we had purchased fresh bread, olive oil, filets, cheese, and mixed greens, arugula, fruits, at the market and had a delightful dinner.  I know, it is tough duty, but somebody has to do it.  Carpe  Diem.

New Thinking – Fire the Generals

We really are at a crossroad and the issues that we face will require completely new thinking.  Although our President understands this concept, he has surround himself with experts in the old thinking and this worries me greatly.  Here are some cogent examples:

  • Afghanistan cannot be solved by applying the lessons from Iraq.  In fact it is possible, that Afghanistan does not need to be solved at all, but this will require entirely new thinking about what is possible and whether it is worth the cost.
  • We are in a recession approaching a possible depression and the experts have told us that we need to stimulate the economy with spending and to err on the over spending side which is the overwhelming lesson from history.  What did we do?  We loaded up the stimulus package with questionable tax cuts and were skimpy on the infrastructure spending (Thanks Republicans) which may make it ineffective.  Why is that?
  • We all agree that the crisis is being caused by the housing/mortgage bubble.  The issue is to stabilize prices but is complicated by the way the loans were broken up in securitized debt instruments.  President Obama has offered a package that deals with the tip of the iceberg, but it needs to go deeper and allow for bankruptcy judges to modify loan agreements and principle needs to be re-evaluated.  Once again we are up against small thinkers in Congress.  Why are we afraid to be bold?
  • The banking crisis is very complicated as are the proposed solutions (insurance, more preferred stock, nationalization).  The essence of this crisis is that banks hold more liabilities than they do equity, and therefore have no ability to lend.  Many of the solutions being offered are overly protective of banks and stockholders, and not so protective of taxpayer dollars (Heads the banks win, tails the taxpayer loses).  The solution will require all to pay a dear price with the possibility of some long-term recovery for the taxpayers.  So why aren’t we nationalizing the banks and getting on with it?

I could go on and on including transportation, alternate energy, and health care.  So why when we require bold new thinking are we being so timid which will get us nowhere?  Well part of the answer is the politics.  Are people ready for big changes?  I actually think they are and Washington is way behind the power curve on this one.  The other part of this answer has to do with who we have put in policy positions to make these changes.

The problem has been eloquently presented by Gary S. Vasilash in a piece in called “Fire the Generals” sent to me by my good friend Tom Griffin.  Although the article focused on the problem of the failure of car manufactures and specifically their management to understand the new markets, it applies directly to all our great issues that are challenging us today.  The lesson goes something like this:  Using the military analogy, when the type of conflict changes and a new strategy is required, fire the old generals who are still fighting the last war and bring new generals who understand the new conditions and their new adversary.  Our Iraq strategy change followed this prescription.  Mr. Vasilash makes the point that the management that has brought the auto industry to its knees are ill-equipped to manage in a whole new direction.  They are too wedded to the culture they were brought up in.

My own experience tells me that this is a basic truth.  In my 31 years working for the Feds, change was always a buzzword, but by leaving the existing management in place that was comfortable with the old ways of doing business, we always fell back into old patterns of behavior and management.  Real change is terrifying because it is about leaving your comfort zone and it is usually accomplish only in dire circumstances.  The most afraid, apparently, are the Republicans who are sounding more hysterical and shrill as they fight to reestablish their control with old and failed policies.

So both our President and we must follow Mr. Vasilash’s truism.  We must fire the generals.  Whether it is a real war in Afghanistan, or the war to restore our economy, old thinking is no longer viable and we need new leaders who are not wedded to the status quo, who can see options we did not even consider.  For us that means firing both Democrats and especially Republicans who are not ready for bold solutions.  For our President it means getting outside the Washington think tanks and their products to put people in charge who not afraid of destroying the conventional wisdom.  When we see the solutions to the problems I have identified in the start of this piece, we will see if he has really done this or still needs to find new generals.  So far in the stimulus package we thought small.  Remember that we can fire some of the generals in 2010 if they are still resisting change.

The Un-State of the Union

Last night with President Obama’s speech to a joint session of the House and Senate followed by Bobby Jindal’s Republican rebuttal, two different paths were clearly evident.  In order to understand this you have to step back and see where we are today.  Instead of listing what most of you already know about our failure to invest in our future, let me just refer you to a report by the Information Technology and Innovation Foundation that found that the competitive edge of the United States economy has eroded sharply over the last decade (New York Times).  If this is not a wakeup call we were on the wrong path, nothing is.

But last night we heard President Obama tell us that government has to get back in the drivers seat and lead, and we have to dream big.  He told us that we have been kicking the can down the road and now it was time to tackle, energy, education, and health care.  It was time for government to take the reigns and lead us out of our doldrums.  He described a way forward that would be led by a reinvigorated government/industry partnership working in our interests.

Next up was Governor Jindal who told us that the solution is not with government, but with businesses solving our problem. “But the way to lead is not to raise taxes and put more money and power in hands of Washington politicians. The way to lead is by empowering you – the American people”.  What we saw in the last eight years of this approach was, as President Obama identified, the transfer of taxpayer money to the wealthy with nothing to show for it.   Then Jindal told us we can’t dream big because we can’t afford it.  That the very businesses that got us into our current mess are going to save us.  Then he told us the lie about the train from Disney Land to Las Vegas again, and reinvented the Katrina mess as how a state can take care of it itself without federal help.  He reinterpreted the whole mess as what happens when the Feds are involved instead of the reality of what happens when Republicans dismantle government.

So here it is as simple as I can put it.  President Obama tells us to dream big and tackle our problems by forging a partnership between an invigorated government and industry.  He points out that we cannot afford not to.  Governor Jindal tells us to not dream at all and to continue our rudderless approach to our future.  This is a choice?  If Americans are still intellectually alive, the Republican Party is finished.

Republican Lunacy

Yesterday I wrote a blog making fun of both our media for its failure to ask relevant questions and the illogic of the Republican’s economic plan or lack thereof.  Today I thought I would like to present these failures in a little more detail because the lunacy of their plan for America scares me especially as the press seems to be unable to challenge this lunacy about the Republican way forward and treats it as a viable alternative.  The Republican ideology and its implementation into policy falls into three categories:

1.    Do Nothing – This is the extreme end of Republican laissez-faire and basically says that the market must be allowed to flush out those who have made bad choices.  I have to admit that it is appealing, for about a millisecond before the reality of doing nothing hits home.  Although it would seem just desserts to see the banks, finance companies, and irresponsible home buyers get punished, this would not be the extent of it.  As housing prices are driven down, innocent homeowners bear the brunt of this.  If the banking industry collapses, which is highly probably according to most economists, well, welcome to the Great Depression.

This solution is fine if you are wealthy and can weather the storm and don’t give a damn for the general population, but for the millions who will be and are losing their jobs through no fault of their own, this is unconscionable.  Those who promote this solution really don’t care about these “little people” and assume they are either lazy or stupid.  If you want to understand this, it is from the strict father model family (George Lakoff) that believes that if you work hard, are disciplined, and follow the rules, you will be rewarded.  Those that don’t, get their just rewards.  This belief set allows one to ignore or deny empathy or to understand that this mythology of justice is just that, mythology.   Thankfully, there are not many, even in media, that don’t question this way forward.

2.    Just Cut Taxes – This is where the mainstream of what is left of the Republicans in Congress resides.  Their belief here is that taxes are the most effective way to stimulate the economy because they only believe that businesses create jobs that are permanent, and most important, tax cuts are not government spending which they hate because they see it as federal welfare.

There are many problems with this belief system.  First is the effectiveness issue.  If we are talking about tax cuts for businesses, they can be effective in small down turns, but they were mostly ineffective in the last downturn, and in a major contraction which we are in now, they may be totally ineffective. What is the benefit of tax cuts on shrinking profits and demand?  If we are talking about tax cuts for workers, if they are losing their jobs, just how stimulative can tax cuts on salary you don’t earn be?  If, in hard times, people receive a tax rebate, they usually save it or pay off debt which does nothing for stimulating the economy which requires spending to create demand.

Then there is the really big issue of spending for what.  We have had a policy of putting money back into people’s hands to spend on what they wanted for the last eight years of tax cuts.  We are living in a time when our infrastructure and way of life is crumbling around us because we didn’t keep some of that money and invest it in our future, improving our infrastructure, investing in alternate energy, and investing in our human capital (education, health care, childcare).  Said more eloquently by others, tax cuts don’t pay for police or fire protection, they don’t pay for schools, or energy research, build roads and train rails, and they don’t pay for health care, our military, or government programs to inspect our food, drugs, and imports.  They do empty out the treasury at an amazing rate and usually transfer that wealth to the wealthy if the last eight years are any indication.  Republicans never have an answer for what we are going to do about our slowly approaching third world status.  More toll roads anyone?  How about some private prisons that judges can earn kickbacks for sending minor offenders there?  I am not making this up, read the newspaper.

So what we have here is that tax cuts are very ineffective in a major contraction, they do nothing to help rebuild our aging infrastructure or invest in our future, and they push the deficits to astronomical levels.  They are a short term fix if they work that has no strategic value for our future.  So why do Republicans hang in there with them when they are obviously a short term and ineffective fix?  They require no thinking, no planning, and no sacrifice.  It is the Republican mindless ideology which is not being properly challenged by our media to debunk its false promises.

3.   Be Afraid of the Deficit – Then we have the argument in both of the above that we can’t let the deficit get any worse since it is this creation of a credit bubble that got us into this mess.  Well yes and no.  The credit bubble that created this mess was a private one that resulted from many factors, but most directly related back to Republican ideology about the infallibility of the market place and the evil of government interference (See Microeconomics).

Second, the federal deficit was a result of Republican led tax cuts in the last eight years when the economy was booming and we could have been investing for just such a rainy day that is now upon us.  All the large federal deficit says today is that we have much less ammunition to fight this down turn, but it had nothing to do with it.

Third, one has to ask Republicans what they think their tax cuts will do to the deficit?  Their proposed plan to cut taxes in lieu of the stimulus bill was estimated to cost $3 trillion dollars.  Gee, $800 billion stimulus bill or $3 trillion tax cut? Note for Republicans:  Trillion is bigger than Billion and the word tax cut does not change that.  I wonder which one will impact the deficit more with nothing to show for it?

Finally and basic to this whole argument about tax cuts, the underlying argument by most economists is that tax cuts cannot stimulate the economy when it is this constricted and continuing to falter.  Private spending simply will not be enough and if we want to cushion the blow, public spending is the only game in town.  The argument is bolstered by our spending and deficit creation in the 1930s and in World War II.  As bad as the deficit got, once the downturn was fully turned around, we managed to repay our debt.  Republicans have tried to reinvent this history and our media has been too dumbstruck to challenge some of these allegations or to even ask the obvious question, what if tax cuts are ineffective.

What is most amazing to me, with all these facts for anyone to find and examine, is how the media treats the Republican lunatic ideas with equal weight to stimulus spending supported by most economists and history.  Once again the media is falling into the same trap they did in the run up to the Iraq war where in their need to seem unbaised they are giving lunatic ideas equal weight with proven solutions.   Right now Republicans and their ideas are a grave danger to our nation’s recovery and after a few more failures when we all get on board to how bad the situation really is, we will finally push them aside and get on with the hard work that lies ahead of us.  It would be nice if the media would do its job and we could do it sooner rather than later.

Media Help

One of the primary problems with our ongoing discussions about what to do about the economy is that the underlying logic of many positions is not examined or questioned.  So to do the patriotic thing I would like to provide a question and answer scenario to help out media in their interviews with our Republican friends:

MediaSenator Foghorn Leghorn, you claim that tax cuts are the only way to fix our problem because only the private sector can create jobs.  Let me ask you this:  If people are overextended and our present bubble was based upon spending that was financed by borrowing, then aren’t people in such a financial hole that they cannot borrow anymore to spend, so how are tax cuts for businesses going to stimulate spending if buyers have no money to buy what they produce?

Senator Foghorn Leghorn: Well boy, you just don’t get it.  Cutting taxes for business will make it more attractive for business to expand and hire people then they will have money to spend.

Media: But Senator Foghorn, oh, I am sorry, Senator Leghorn, if people don’t have money to spend and demand is decreasing why would a business hire people? In Japan people are saving for the bad times and private spending continues to shrink further hurting business.  Why won’t that lesson apply here?

Senator Foghorn Leghorn: Well boy, you just don’t get it. First of all these are foreigners and you can’t trust anything you learn from them.  Second, cutting taxes for the wealthy gives them money to invest in businesses that drives our economy.

Media: But Senator Leghorn, with shrinking demand why would businesses invest in new ventures when no one has money to buy the new products?  Doesn’t this mean that only government has the resources to spend, create jobs, and put money into the economy so that businesses can start growing again?

Senator Foghorn Leghorn: Well boy you just don’t get it.  Government’s don’t create jobs, they spend, especially on things I don’t approve of like unemployment benefits that just encourages joblessness, and we all know spending is evil and creates deficits.

Media: I am a little confused here Senator, doesn’t spending by the government put money into people’s hands so they can buy things, and by definition simulate buying and the economy?

Senator Foghorn Leghorn: Of course not boy.  It just creates deficits and that is what got us into this problem.

Media: Ah, Senator?   Government spending causes deficits and that is true, but didn’t the collapse of our economy come from the expansion of private debt through banks that were based upon housing prices driven by the private sector and have nothing to do with the Federal Government’s own deficit which was much smaller than the private debt?  Doesn’t having a large federal deficit just mean we can’t be as effective in stimulating the economy as we would like?

Senator Foghorn Leghorn: Say the word deficit again boy and be afraid.  It is right up there with spending and Democrat as evil things in this world.  The deficit will be out of control! Spending! Spending! Democrats everywhere!  My God boy, next thing you know they will be wanting to provide health care for everyone.  What would that do to all my fund raising with the health insurers?

Media: Well Senator, what is your plan for the way forward?

Senator Foghorn Leghorn: We do nothing boy!  That is the beauty of our ideology!  We cut taxes so there is no sacrifice and we do nothing and wait for the magic hand of the market place.  Anything else is government interference with the market place.  This whole problem has been caused by government interference and of course Bill Clinton.

Media: But Senator, how does tax cuts build new highways or schools, invest in our power grid or alternate energy, make sure our kids can afford college, build an alternate transportation system, or upgrade our water supply, or waste treatment plants?

Senator Foghorn Leghorn: Flow down boy, flow down.  Once businesses have no taxes they will be making so much money that our tax coffers will be full.  It worked perfectly from Ronald Reagan on.

Media: But Senator, first after Ronald Reagan cut taxes, he raised them, and for that time it was the largest tax hike this country had ever seen, and second, he also ran up a huge deficit.  Flow down has never worked, and when the economy was humming back in the early 2000s, Republicans were doubling that deficit.

Senator Foghorn Leghorn: Lies! Lies! Lies!  The biased liberal media will never let the truth get out.  I am terminating this interview and going over to Fox News where those people don’t asked such stupid and biased questions.  In fact they know just what questions to ask, and if they don’t we give’em talking points which they dutifully follow.  I hate undisciplined press people!

Sadly I have not heard any of these simple-minded questions posed to the Republican Noise machine as they continue to propose nothing but tax cuts and mindless do nothing.

The Republicans are Undemocratic

As I was listening to all the commentary on the Republican Governors refusing to take the stimulus money it dawned on me that this group of Republicans don’t believe in democracy.  Now this is serious charge and if understood by the country, would be the end of their party.  But consider this:  Democracy means  we  all enter into a contract to live by majority rule (or in the case of the filibuster, super-majority rule).  So clearly if we passed a law that said all men of a certain age must serve in the national service and some don’t, they are law breakers.  If we allowed this to go unpunished we would have anarchy.

We had a vigorous debate about how to stimulate the economy and the majority ruled.  Now we have some Republican governors who want to reject that stimulus package and the stimulus it might provide.  They are denying our basic rule, which is the debate is over, the majority ruled, now you must give it a chance.  In effect they are creating anarchy and submarining the stimulus package.  It is clear that this segment of the Republican Party only believes in following laws they agree with.  We never want to put these people in power.

In a related event, Senator Shelby of Alabama was caught by a local newspaper in a town hall meeting raising doubt about President Obama’s citizenship (  It is the other side of the same coin.  They don’t agree with him and therefore they will do what they can to undermine his government.  They are a great bunch.  There ideology is much more important than their country.  Ideology trumps patriotism.

Monday’s Bits and Pieces

Usually I write this blog with a general theme in mind, but Bits and Pieces are things that may seem unrelated, but lend to the overall malady in our country today:  So here are this weeks gems:

  • I usually watch Meet the Press, Reliable Sources, and Fareed Zakaria’s GPS on Sunday with snippets of CNN’s State of the Union.  Except for Fareed, I had to turn them off.  On Meet the Press, David Gregory is no Tim Russert.  One of Tim’s great attributes was to let the guest fully answer a question without interrupting, in a sense letting them speak for themselves and giving them all the rope they needed.  David seems to have an agenda when he continually interrupts to challenge an answer.  He needs to step back and let his guests answer the hard questions fully without his constant interrupting to challenge, usually using the other side’s talking points.  By doing this he is being controlled by the opposition instead of conducting an insightful interview.
  • Meet the Press also failed in their round table discussion as it was a reflection of the Washington echo chamber instead of reasoned consideration of the issues.  If you just repeat the arguments being made by politcal hacks, what good are you?  The hot button issue was the Obama mortgage bailout plan and the anger that some abusers might benefit.  But they focused on the anger, reinforcing it, instead of looking at the plan’s pros and cons, and alternatives, if there are any to the plan itself.  It was a waste of time, did nothing but reinforce misplaced anger, and did not inform.  Could they have one economist to bring some rationalism to this discussion of emotionalism or the political opinions of the day?
  • Reliable Sources is usually a discussion of how the press is treating a specific subject, not the subject itself.  I lost interest when it was about Roland Burris, the lady who had the litter of kids in California, and other non-sequiturs.  I just don’t care.  Both of these people are just sideshows to the real issues we face and I don’t care if I ever hear of them again.  Illinois, get your house in order, and California, we already have enough mouths to fed which we can’t afford.
  • Then we get to the bright light which was Fareed Zakaria’s GPS.  Here we had a real discussion about the efficacy of further military adventures in Afghanistan, the economy with real economists, and then a discussion of both the economy and world affairs in Asia from experts living in those areas.  It was the difference between the Washington echo chamber (just political talking points being rehashed) and real discussion of real ideas.  What a breath of fresh air.  I suggest for those who missed it, read the transcript (GPS).
  • California is in big trouble and the recent settlement of the budget resolved nothing.  Once again we are hamstrung by small minds when they negotiated away the 12¢ tax on gas giving up $2 billion in revenue per year.  Since gas went up to $4/gallon and is now down around $2.50/gallon, who would have noticed the 12¢?   Yet this tax  would have created a fairly consistent source of revenue for the state that would also reflect our long term goal of reducing global warming.  In addition there is still borrowing in the plan to make ends meet.  Just how deep a hole do we want to dig?  We need a new State Constitution that gets rid of the mandatory spending, dumps the two-thirds majority for budgets, and gets rid of the term limits.  Why is the obvious so hard to do?  I do like the idea of open primaries and a rainy day fund.  It is a start.
  • Governor Schwarzenegger noted recently that California (He is an acknowledged infrastructure fan) had a long-term transportation plan which is why the state is way ahead of any other in implementing high speed rail, but the nation does not.  If we continue to let Congress piece meal fund their states for transportation, we are never going to have an integrated, cost effective, and multi-modal transportation system.  Oh I am sorry, that smacks of government planning and is evil.  What was I thinking?
  • The Republican’s lunacy of denying the stimulus money is based upon a short-term belief that all we need is tax cuts and the giant deficit they created just can get any bigger.  As one Republican recently said on CNN that went totally unchallenged, “We all know that only businesses create jobs, not government.”  They are oblivious to what happened from 1929 till 1945 as the government spending created almost all the jobs because businesses could not stimulate demand on their own.  Almost all economists recommend deficit spending right now, with a long term plan to deal with the deficit when the economy is back on its feet.

Finally I would like to leave you with a letter that was in the San Francisco Chronicle Sunday that kind of puts the whole Republican tax cut strategy into perspective (short term, painless, benefits the wealthy, and is ineffective):

A comment on a blog included a long list of what a tax cut cannot do:  A tax cut cannot provide police protection.  A tax cut cannot provide a fire department.  A tax cut cannot build a road.  A tax cut cannot provide Social Security and Medicare.  A tax cut cannot provide care for the disabled and other vulnerable members of our society.  A tax cut cannot create city parks or preserve areas of our country’s natural beauty.  A tax cut cannot build schools or hospitals…and the list goes on.

As George Lakoff, professor of linguistics, suggested, we need to reframe the word “taxes” to take away the negative connotation.  Taxes are the dues we pay to live in a civilized society, one that does not feed selfish greed but cares for our children’s future, for those less fortunate and for the common good.”  Adeline Hope, Berkley, CA

The Republicans and their ideology are living in another time, still believing the Reagan Myth (which is a myth of giant porportions since he grew both the size of government and size of deficits), and Hoover economics which requires no sacrifice or long term plan but then miserably failed.  It is a strategy, as it was in the early 1930s, for total failure.  It appeals to the masses because it asks nothing of them, which is its appeal, while transferring wealth to the wealthy which simply makes things worse.  Haven’t we had enough?  Have we learned nothing?

Microeconomics – The Causes of our Current Meltdown

A while back as the housing bubble was deflating, I was listening to a discussion between two rather frugal and conservative friends of mine discussing how if people would have just not taken loans they couldn’t afford, this collapse would have never happened. It was the blame game that we all participate in and sadly it only touched on the final straw that broke the camel’s back, not the whole underlying failure of our system.  There are multiple causes that snowballed in the last ten years but started over 30 years ago.  By the way, there were two recent television shows that touched on all these problems, CNBC’s House of Cards, and Frontline’s Inside the Meltdown for those of you who like your information delivered by video.  The following are all of the contributing factors that built into the perfect storm:

  • “Government is the Problem” – Set the stage for an economic climate that believed that either the stockholders or the board of directors would put the brakes on risky investment and thought government regulation just hindered these natural processes
  • Arrogance of the Fed – The belief that the Fed can control all booms or busts with monetary policy (print money or raise or lower interest rates).  Said another way, a belief that Depressions are a thing of the past which led to an environment of unbridled risk taking with a belief the Fed will bail them out (Moral Hazard)
  • The Unbridled Growth of Private Debt – Between the 1980s and 2006 private debt (the debt you and I hold, not public debt by federal state and local governments) rocketed from less than 150% of GDP to over 335%.  “…credit markets increasingly are being used less to facilitate economic activity and more to leverage bets on changes in asset prices” (Bad Money, Reckless Finance, Failed Politics, and the Global Crisis of American Capitalism, Kevin Phillips)
  • Financial Sector Expansion – “Goods production lost the 2:1 edge in GDP it had enjoyed in the seventies – In 2005, on the cusp of Greenspan’s retirement, financial services – the new uber-category spanning finance, insurance, and real estate – far exceeded other sectors, totaling over one fifth of GDP against manufacturing’s gaunt shrunken 12 percent” (Bad Money).  Basically we no longer invest in goods and services, but in financial markets.  In essence what we were now importing to the world was securitized debt investments.  This one is really important if you want understand that the real money to be made in the stock market is in debit instruments not in investing in business that make anything
  • Fed Policy – Fed policy was instituted such that whenever the market’s rate of growth decreased, monetary policy was used to keep the growth strong, encouraging ever growing bubbles.  Some think that growth needs to be managed around a reasonable amount, with policy focused at deflating bubbles and not allowing them to grow out of control.  This means sometimes we have to force small recessions
  • Our Psychology of Wealth Creation – A psychological state in which those who create wealth are “the Masters of the Universe” and the wealth is good by definition because it benefits us all.  Although the reality is that only a few rich have benefited from the growing credit bubble, there is a pervasive attitude that no one should question or interfere with their wealth creation since all wealth creation is good by definition
  • Exponential increase of unregulated securitized debt instruments – Creation of debt instruments to package debt and the profits from selling these debt instruments.  This by itself is not bad since it provides money for investment, but the investment was primarily in other debt instruments grossly expanding the credit bubble without sufficient equity (in this case a realistic assessment of the equity backing these loans)
  • Lack of Regulation – No regulation of the markets selling these instruments and the multiplier effect of leveraging (using debt to invest) which allowed investments that were leverage 30:1 or greater (thirty dollars of borrowing or every one dollar of your own equity).  The effect of this multiplies the gains when your bet wins, but multiplies your losses when you lose
  • Failure to Correctly Evaluate Risk – Risky debt repackaged in CDO’s using faulty risk models that assumed normal distribution on price variations (The Origins of Economic Crises:  Central Banks, Credit Bubbles, and the Efficient Market Fallacy, George Cooper) and did not take into account black swan events. The result was a gaming of the rating system to allow these assets to be improperly rated as AAA.  Basic to this risk model was the assumption that the underlying equity backing up these risky loans, home values, would keep rising forever
  • Failure of the Rating Agencies – Rating agencies that were dependent on those they rated for their income and no regulation by the SEC which was a revolving door for the industry
  • Credit Default Swaps – Creation of “insurance” called credit default swaps which required no equity backing the insurance and no regulation of their markets.  If the market collapsed, there was no ability to pay these obligations.  You could make these bets even if you didn’t own the stock you were betting on.  Maybe even turning Wall Street into a casino
  • Interdependence of all the Banks – With these massive debt and insurance instruments held by almost everyone, based upon housing prices, there was incredible interconnectiveness of the financial institutions so that any default would ripple throughout the industry.  In other words if one institution failed, others would be dragged in
  • Greed – Then we get to greed and the idea that greed is good, part of the flow down litany and Masters of the Universe mentality.  In order to continue the amazing profits that were being made by these financial institutions, there was tremendous pressure to keep creating debt so they could repackage it and sell it.  That is when exotic loans for housing really took off
  • Risk Transfer – The transfer of risk to the investors relieved the lending agency from holding the loans or being responsible if the loans defaulted. The more loans they issued the more money they made with no risk to them
  • Housing Bubble – The belief that housing prices would always rise, allowed almost everyone, even if they couldn’t afford the loan, to take the money thinking they could bail themselves out later if they had to sell.  This is how many of these loans were fostered off on people who had no way to repay
  • International Effect – The international impact of this crisis came about because the banks were selling these toxic assets as AAA rated investments and stockholders/voters were demanding more and more return on their investments because everyone else was getting that level of return which leads to the final real straw that broke the camel’s back (bank)
  • Group-Think – Finally we have group-think throughout the whole system.  Everyone was making a bundle and everybody wanted a piece of the action.  It is easy to justify what you might consider risky or foolish if everyone around you is making a bundle and you look like a fool for not taking advantage of the easy money.  Anyone who say there is a problem and wanted to put the brakes on, put their institution at risk, not getting the return others were making and were therefore sidelined by their management.  The prevailing mentality was to take the money and run

I probably missed some stuff, but those are the major elements.  So just blaming it on the end of the chain and people who knowingly took risky loans is a grossly oversimplified view of what happened.  Yes, people lacked discipline and good judgment, but that went throughout the system.  If the system was not so tightly interconnected and we now have a world economy, maybe the damage would have been limited.

Alan Greenspan in the Frontline segment, Meltdown, said he thought that this could not happen because the board of directors would recognize the high level of risk and take the appropriate action to limit these risky bets.  They did not and he was troubled by this.  One might ask why he didn’t take the appropriate action.  The answer that he gave when asked was that he could not imagine that this could happen.  It would appear that a lack of imagination not only is fatal in our Iraq policy, but in our economic policy.

But then he said something very interesting.  To paraphrase him, even if this results in a depression, it is still the best system we have devised to create wealth for the majority of players and we will have to learn to live with it even though these contraction will occur again in the future.  I would agree with him although there are important lessons to be learned here.

First on the wealth issue he is correct and also not so much correct.  In China, millions were being pulled up to a middle class standard of living while in our country, the middle class and poor were losing ground.  One possible conclusion is that the capitalist function of manufacturing and exporting of goods works well to expand wealth in society, while the creation of financial instruments and betting on them with leveraged investments only focuses wealth on the wealthy.

Second it is clear that when we enter a bubble, greed clouds our judgment until the “house of cards” collapses (pun intended).  This says that regulation is the only way to stabilize this system.  Somehow sanity must be restored even though everyone is making money.  We thought we learned this lesson after the Great Depression, but most of these rules were cast aside as impeding profit and being out-dated.

One last thought:  In my essay on Marcoeconomics, I raised the point made by George Cooper in his book The Origins of Economic Crises:  Central Banks, Credit Bubbles, and the Efficient Market Fallacy, which is that markets are inherently unstable and maybe the real job of the Central Banks is not only to stop down turns, but to also moderate growth so that bubbles are small and will not have a destructive effect when they are deflated.

It will be interesting in the days to come to see how Republican laissez-fare dogma will argue against the needed change in rules and how the Fed and our banking system should function in the future.  Since they were the ones who mostly benefited from the old failed system, they will try to reinstitute it while reinventing history.  The question is have we learned our lesson and will we let them.

Note:  No I am not an economist and I could have this wrong but I don’t think so.  I think it is critically important that all of us understand what happened because the future of our system rests on us getting it right.  It is not and has never been about who is to blame.  There is plenty to go around.  It is about understanding what happend to prevent it in the future.  As long as we let experts talk and understand for us, we will be forever be at their mercy, thus my attempt to put into words what I understand, probably only for my own benefit.  There is a excellent web site that explains many of these basic concepts called The Baseline Scenario written by real economists.

The Enemy Within, The Enemy Without

In order to put our house in order, economically speaking, it is clear that there are three problems.  The first has been somewhat addressed by the stimulus bill.  The other two are interrelated and that is the banking problem (credit frozen) and defaulting mortgages.  Good ideas are being discussed on how to approach these later two problems (The Baseline Scenario), but there is resistance to any change in the status quo that come from two camps and I have called them the Enemy Within and the Enemy Without.

The Enemy Without has been on display during the stimulus bill debate and its aftermath and that is the Republican minority whose intransigence to any change in their economic policy of tax cuts is bordering on lunacy.  They have used the deficit as their juggernaut against further stimulus spending when they ran up a trillion dollar deficit.  Hypocrisy anyone?  They have attacked the bill as pork spending, but when you ask them to list what they considered pork, it turns out that it is spending they just don’t happen to approve of, but is stimulative according to most economists.

They have called this a spending bill, which of course is the whole point, but the word spending terrifies their base who can’t understand that tax cuts are just another form of spending with major long-term impacts to our deficit.  They have redefine history and called the stimulus spending in the 1930’s the cause of the problem.  They have offered no alternative other than tax cuts which doesn’t invest in our infrastructure or our future.  Let’s just bankrupt the government while allowing people to continue to buy crap with no strategic plan for spending to secure our future.  They have become the lunatic fringe.

We even have Republican Governors like Bobby Jindal of Louisiana who says he is considering refusing the money. “I could help my people stay employed and in their homes, but I am an ideologue so screw you” (my paraphrasing).  Pragmatism is not part of their ideology.  As an aside I have always wondered why the press always refers to Jindal as a smart new Republican.  Anyone who thinks creationism and evolution should be taught side by side doesn’t understand the difference between science and religion and raises serious questions about their other logical processes.

Anyway the point is made:  The GOP has become the Grand Obstructionist Party (MSNBC) that will compromise nothing and represents an ever shrinking and radicalized base.  The problem is that with the filibuster in the Senate and in California the two-thirds majority to pass a budget, change is being held hostage to bankrupt thinking. We are going to have to eventually get rid of these supermajority requirements for anything but constitutional changes.   So we know what the Enemy Without looks like, but then there is the Enemy Within.

We are facing a critical crisis in our banking system, but the banking system’s leverage on the Democrats with their minions filling almost all critical positions that must steward this correction, and their lobbying leverage on both Democrats and Republicans make them the Enemy Within to thwart any real change.  The Banking industry has a vested interest in returning to the status quo that made them wealthy.  Our country has a vested interest in breaking up these large banks and making them and their stockholders feel some of the pain for their toxic investments.  As Simon Johnson, former IMF chief economist wrote on his blog, The Baseline Scenario:

The banking lobby has become too powerful, in large part because big banks have balance sheets that are too big relative to the size of the economy.  If a bank has total assets of over 10% of GDP, it is obviously too big to fail.  Of course, the smart people who run these banks know this and act – politically and economically – accordingly.”

My own concern is that there is a level of arrogance in the financial and banking community that sees their interests as superseding the interest of our common good.  In fact their definition of common good is based upon them creating wealth for themselves.   The rest of us are just pheasants to serve their banking needs.  Banks are going to have to suffer the consequences of their poor management and presently they don’t see that. They are too big to fail.  In the recently rolled out mortgage plan by the Obama administration, they weren’t happy because they were asked to participate in the pain (mark down the loan balance).

Mr. Johnson’s point is that they are so intertwined into both the administration and Congress that our government may not be able to move appropriately to limit their power and influence.  If we can’t we are setting us up for more disasters in the future.  It will be interesting to see how the administration addresses this problem.

Note:  Simon Johnson appeared on the Bill Moyers Journal and a transcript is available.