Canada's John Galt

"What if..." Movies reimagined for another time & place on the Behance Network

2012-01-28T08:55:00.000-05:00

"What if..." Movies reimagined for another time & place on the Behance Network

Elections, Debt, & Deficits

2011-10-10T06:35:00.000-04:00

I have finally had some time to really ponder about this past Tuesday's Ontario provincial election results. I see that Dalton McGuinty sqeaked by with a minority government, which is not really surprising from what I've read from the coverage of the election. It was an election really about nothing, with all the parties posturing about "investments" in health care, education, etc... all jockying to claim they are the best "managers" of socialism. Ontario Tory leader Tim Hudak ran a lackluster campaign (on a personal level, Hudak went to my alma matter at roughly the same time I did - funny thing is I don't remember him considering my political involvement on campus. Also, the campaign manager is another long time friend from university).

Nobody addressed the elephant in the room: Ontario is piling up debt at an alarming rate, and it's debt-to-GDP ratio is now almost 40%. Couple this with the fact that the provincial government is running up deficits as far as the eye can see, and health care spending growing out of control and is consuming a majority of the province's finances - it is apparent that a crisis will happen.

Again - nothing to see here. Did not hear a word from any of the leaders of how the piper will need to be paid sooner or later. Not a word that from the left that you can't finance socialism as he who has the debt calls the shots. Not a word about how unsustainable this reckless government spending is and how a realignment is needed of what the government should and shouldn't do with its limited fiscal resources.

I can understand why McGuinty isn't worried based on the government finances. He can keep spending like a pimp with one night to live, using record low interest rates and pawn off the consequences to his successor. Looking at the provincial debt maturity schedule, the bulk of the debt matures in the next five years. When the inflationary spike forces rates up (this is a question of when, not if now), the provinces finances will be crippled.

So much for "leadership".

40 years ago this bubble started

2011-08-14T22:15:00.004-04:00

Forty years ago today, Richard Nixon ended the link between the US dollar and gold. On August 14th, gold was $35/oz. Now it is almost $1,800. Rampant inflation, currency debasement, and debt saturation has all been the bastard children of this decision.

Bad omen?

2011-06-27T21:25:00.002-04:00

Does anyone find it somewhat disturbing the frequency of ads regarding IRS and credit card debt relief, and the implication that one can shirk their obligations.

As a tax practitioner, I can say the tax debt services are a farce. Most of the reductions are removals of interest and penalties. Second, the bulk of the reasons for tax notices are people not making estimated tax payments. Most of these people spend the money and don't understand that they have to pay their income and payroll taxes first, like all salaried people. For a lot of these people, it is self inflicted.

Thought on Walter Russell Mead's "Death of the American Dream"

2011-06-08T23:32:00.003-04:00

Walter Russell Mead of the American Interest wrote a very interesting two part post called "The Death of the American Dream" (part II, here). It discusses the upheaval that the American economy faces as it migrates to a post-Indsutrial economy in the wake of a massive, multi-generational credit bubble exploding.

Some thoughts on this came through to me:

The credit bubble will lead to a major realignment on the standard of living we are used to in many facets of our lives. Credit at all levels - government, corporate, and individual, has been growing faster than the economy since interest rates peaked in 1982. We have been borrowing against future growth in order to have consumption now. Our overall debt levels are such where we cannot grow our way out of it without either restructuring or massive inflation. This means a major overhaul of what our expectations of "the good life" is.

No longer will it be families of modest incomes driving around in BMWs and Lexues in their 4,000 square foot houses - all financed with artificially low interest rates compliments of the Federal Reserve and Asia. No longer will we have lavish entitlement programs with two plus years of unemployment benefits, lavish defined benefit pension plans and government welfare programs funded by debt.

The American Dream will be to have sufficient savings for a rainy day, levels of debt that are sustainable on one income with a margin of safety, and full contributions to the 401(k). The lucky family will be that whose house is paid off, no debts, and is maxing out their retirement contributions. As a friend of mine once said, his goal was to have his house paid off so that he would not be a slave to his job. As he put it, he could flip burgers if he wanted to and have his basic needs covered - this will be the new goal.

We will start expecting our governments to follow the discipline that we are facing. If those who work hard and play by the rules are keeping afloat, we don't want to see our tax money being pissed away on handouts and favors to politically connected constituents.

Quote of the day - IRA Analyst.

2011-06-01T10:11:00.003-04:00

I think this sums up a lot of things going on in the economy (from Chris Whalen at the Institutional Risk Analyst):

But the more imponderable factor is the prospect of a multi-generational change in savings and housing preferences by Americans, particularly away from pulling tomorrow's puchase into today with the use of debt. The weakness in the housing market suggests that Americans are increasingly unwilling to incur debt to purchases housing, especially when valuations remain so uncertain. We are not just talking about pushing out of the market new entrants into the home owner category, but also older Americans who are trying to maximize liquidity and safety. The smaller pool of available home buyers combined with a paucity of credit available spells disaster for the real estate, building and financial sectors in 2011 and beyond. "Rent to own" is the next big opportunity for Wall Street's titans.

We will continue to see real estate decline as people are more leery of debt. We will see corporate profits decline as consumers stop front loading future consumption with debt. All this de-leveraging will create significant deflationary pressure, and all the attempts by Federal Reserve to inflate their way out will fail. It will fail because of the shift in behavior above.

Reflections on the Canadian election

2011-05-03T19:56:00.003-04:00

These thoughts came to mind after digesting the Canadian election results:

The death of the Liberal party is premature. Yes, they got their asses kicked. Yes, on one level, it was sweet to witness in my lifetime. That being said, however, it would be foolish to write them off just yet. They have a long history and an established brand that still resonates with voters. They just need to get their financial house in order for the soon to be new reality that taxpayer subsidies gone with a Harper majority government. Then figure out that ideology, and not ethnic ties is what defines a party. My work in Federal campaigns in the 80's and 90s, I found that a driver in a lot of ethnic neighborhoods was that "St. Laurent/Pearson/Trudeau let me in the country, so I vote Liberal". That group twenty years later is now a shrinking portion of the electorate, and I would suspect a reason why a lot of traditional Liberal strongholds are no longer red. A new Liberal leader who can define what the party stands for can rebound from this, but it will take another election at least.
The rise of the NDP as the natural center-left party is premature. So they got 100 seats. 58 of them are from Quebec. Those 58 seats didn't come due to the hard work and determination of their candidates. Many of those candidates are recycled hacks, university students, professional 'activists' and the usual hippie slacker why-don't-you-get-a-real-job types. These folks know nothing about fundraising, constituent relations, how parliament works, etc. Some can't even speak French. Now you're giving these folks an $80,000/year job. Tell me how this doesn't spell disaster. This is what happened to the ADQ provincially - going from nothing to Official Opposition back to nothing; all because their MNAs were precisely as I described above, but with a right-of-center bias. Then factor in that a lot of this vote was a big Foxtrot Oscar to the other parties, and you start wondering how many of them will get re-elected in 4 years. Jack Layton can do the most amazing job on earth, but these candidates are so weak, a lot will not get elected due to their sheer ineptitude. Plus, they have to now behave like grownups, as they are now seen as the government in waiting. No more silly campaign promises that don't hold to up reality - they're at the grownup table, so they have to act like responsible stewards of the taxpayer. This is what they need to do to bury the Liberals once and for all, but based on the type of people they now have in caucus, I think they'll blow it.
The Tories have a unique opportunity to make lasting changes. If Harper plays the long game, I think the Tories can reverse or mitigate a lot of the problems caused by Trudeau and Pearson. It won't happen overnight (I wish!) but there is a chance to get the ball rolling. Harper can address the long term problems with health care by repealing the terrible Canada Health Act and free the provinces to experiment with more efficient and less costly mechanisms for delivering and paying for care. He can use the current fiscal problems and the electorate's embrace of austerity to shrink the size and scope of the Federal government and push more flexibility and power to the provinces.

These are just first thoughts, but I think a lot of this will flesh out over the next year.

Ditch the AMT

2011-04-04T20:42:00.003-04:00

This article by Veronique de Rugy of the American Enterprise Institute discusses the insidious Alternative Minimum Tax (AMT) and how it going to soak more and more American Taxpayers. Originally a ploy to tax a few dozen millionaires who effectively paid no income tax (primarily because their income was inherited and primary in the form of tax-free municipal bonds), it has never been adjusted for inflation and is hitting more and more taxpayers every year.

Everyone states they wish to appeal it, but none want to forego the revenues. Solution: repeal it, along with the itemized deductions for mortgage interest and state and local taxes paid, then double the personal exemptions. That should make it flat revenue wise, plus a lot fairer to people who either rent or live in low tax states.

Plus, it would make my life easier and focus on more relevant tax planning.

More on bonds

2011-03-25T20:11:00.002-04:00

Following up on my previous post on the S&P - there is another part of my entire deflation theme. Normally, one would think with the government issuing Treasuries like a pimp with one night to live would normally cause bond yields to spike once the Fed stops monetizing the debt.

However, one key thing to remember is that pension funds will have to be major purchasers of fixed income securities over the next twenty years - whether they like it or not. This will have many unintended consequences. Most major Western defined benefit pension plans are in the payout phase of their existence. With the baby boomers entering retirement - more and more of pension fund assets will be used to pay current benefits. This contrasts with the prior twenty years of the stock market boom where pension funds were more concerned with growing assets in order to meet future obligations.

As a result, pension funds will be shifting away more and more from total return models to duration based models - where the duration of the portfolio should be in the same range as the duration of the benefits paid (if you treat the obligation payments as a reverse bond). If you assume that equities exhibit behavior of an ultra-long term bond (i.e. a duration of 50+), we can see the overal duration of pension portfolios dropping dramatically to match their funding obligations.

This will mean a massive shift of pension assets from equities, private equity and other long-duration investments to shorter duration fixed income investments. This shift over the next few years means that there will be a lot of demand for high quality fixed income product that should keep yields suppressed for the immediate future.

The major unintended consequence of this will be that the actuarial assumptions of portfolio returns will have to be reduced significantly. Most U.S. public employee pension funds use unrealistic return assumptions; CALPERS (the California State Employees Pension Plan) assumes a 7.75% return. This return has shown to be unrealistic over the past ten years with the fund heavily invested in equities and "alternative investments", resulting in massive unfunded pension liabilities that the taxpayers are on the hook.

Even though the states are trying to grapple with these unfunded liabilities with modest reforms, they will get socked again as the actuaries have to start reducing their return rates as the funds shorten the duration of their portfolios to meet their current obligations. They will not be able to grow their way out of this mess as they will have significantly reduced equity exposure. State and local governments will be forced to allocate more and more scarce tax revenues to meet their obligations. Sadly, the bulk of the governments have not seriously addressed these problems, and the power of public employee unions bankrolling politicians (i.e. Democrats) will ensure that there ultimately will be tax hikes to make up the shortfall. These state and local tax increases (no deficit spending as they are required to balance their budgets - although they try with accounting gimmickry) will depress aggregate demand on top of the de-leveraging by the American consumer, making the deflationary cycle worse.

Ultimately, I am coming to the conclusion that defined benefit plans should be outlawed and transitioned in an equitable way to defined contribution plans. They are inherently risky for both the funders (as they will have the largest contributions required during down markets, when they are least able to do so) and beneficiaries (the risk of bankruptcy - ask the retired managers of Delphi who had their pensions cut). Add to that the political incentives for mischief (politicians let the Delphi management retirees take a haircut, but he UAW retirees, part of a favored political constituency, didn't; or the political deals to create obscene pension benefits for state employees that were hidden from the electorate) and the conclusion becomes clear: ALL DEFINED BENEFIT PLANS MUST GO!

When thinking of that last sentence, why does Oliver Cromwell come to mind?

Whiskey Tango Foxtrot

2011-03-24T19:50:00.003-04:00

I write this today after looking at the S&P 500 stay around 1,300 or so.

Fundamentally speaking, I do not understand how equities can keep these valuations. Under classic valuation methods, a stock should be worth the net present value of its future projected cash flows. Let's keep this simple and put the time period for projecting cash flows as the next ten years.

First we need a macroeconomic view. As we are in the midst of a massive 30 year credit bubble imploding, we need to look at previous credit bubbles for guidance. If we look at the great Depression, the 1907 banking panic, the Kansas land bubble of the 1840's, etc - what we learn if after a credit bubble, we should expect deflation from depressed demand as consumers de-leverage from high debt levels. The past 30 years of debt fueled consumption has brought future consumption into the past - whether it be houses, cars, or other goods. The consumer (especially the American consumer - who has single handedly developed the Asian export market), spooked by too much debt and fearful of his employment prospects, curtails spending in order to pay off debt and save. This will curtail demand for goods - whether it be housing, electronics, cars, or any other discretionary good. All the money printed by the government will not stimulate demand. All this reflating is doing for now is increasing the national debt; when the consumer is done saving and paying off debt, he will have more taxes to pay in order to pay off government debt. All of this will keep demand suppressed and will exacerbate the deflationary cycle. Only after years of deflation from the aftershocks of the credit bubble will rapid inflation come with a vengeance.

This means that corporate earnings will remain weak going forward. Yes, companies will still restructure and increase productivity, but will be continuously cutting prices in order to maintain capacity. Couple this with expected tax increases and earnings will not be strong going forward.

Until this credit bubble is finally resolved (which will take years to unravel as the central banks and financial institutions of the world continue their "extend and pretend" strategy), stocks cannot keep up this valuation for the foreseeable future. I see the S&P 500 challenging the early 2009 lows of 800-900 range.

I think that this will pop when people finally realize that the other shoe hasn't dropped yet. It will be the banks taking massive write-downs on commercial real estate loan portfolios and a flurry of corporate defaults. But once people realize that we're not through this mess by any stretch, the stock market will eventually tank.

Rick Santelli rages against the machine - Beautiful

2010-08-14T12:30:00.000-04:00

The natural progression of Greece

2010-05-08T12:28:00.003-04:00

Greece is the canary in the coal mine for a lot of issues. First, we have the fiscal mess caused by unsustainable government entitlements and demographic decline. For most counties in this boat (especially the UK), it is offset by currency devaluation. However, since Greece is part of the Euro, this option is not possible and has now migrated to a sovereign debt issue. This is very similar to crises in Argentina, Mexico, and Asia over the past twenty years - where profiligate fiscal pocilies are exacerbated by arbitrary monetary systems (i.e. pegged to the U.S. Dollar). Now with the rest of Europe subsidizing Greece in order to maintain monetary union, the crisis will now impact Greek banks. Greek bank depositors are fleeing the banking system for other EU banks - on the fear of a banking collapse or a forced exchange of Greek deposits if/when Greece is kicked out of the Euro.

This is having a contagion effect - as it will move to other Euro countries with sketchy fiscal situations - primarily Italy, Portugal and Spain. Although some have said Ireland should be lumped in there, I have not on the basis that their government is actually doing something about the fiscal situation, unlike their Southern European compatriots.

We have gone through a prolonged period without any significant corporate or sovereign defaults due to the easy money policies pursued by central banks worldwide. We will be seeing a prolonged period of significant default rates as we revert to the mean - possibly rates beyond the teens.

The impact of this debt, fiscal, and banking contagion will be twofold. One - the idea of monetary systems based on fiat currencies run by enlightened civil servants also known as central bankers will be discredited. Whether we go back a gold backed currency or something else that cannot be tampered with by politicians is yet unknown, but I can see a future where the Federal Reserve, the Bank of England, and the European Central Bank will have roles considerably diminished from where they are now.

Second, actuaries have been discredited in terms of being able to run defined benefit plans. These plans are cancers on the economies of the developing world as more and more resources will be diverted into propping up excessively generous plans for retirees that are retired for more years of their lives than actually working. Defined benefit pension plans will need to be outlawed in all forms. Whether funded private sector plans, government employee plans, or ponzi schemes called Social Security. This is a drastic solution, but all plans were forced converted into defined benefit plans that must be fully funded at all times - a lot of the fiscal problems that governments and large companies have would go.

The Curley Effect

2010-04-04T08:03:00.002-04:00

I found this paper about how politicians attempt to shape the electorate by Edward Glaeser and Andrei Shleifer of Harvard. The name of their effect comes from James Curley, a four-time mayor of Boston and politician on the Boston scene for the first half of the 20th century. However, a more recent reference is Detroit Mayor Coleman Young.

The Curley effect essentially is the act of politicians implementing long-term destructive policies in order to shape the electorate to ensure re-election. In the case of Coleman Young, who barely won his first election as mayor of Detroit, he deliberately raised taxes and let services (especially police) whither in order to drive more whites to the suburbs and improve his chances of re-election.

This paper is the first time I've read a scholarly discussion on this phenomenon. I think it is really relevant with this administration. They are hell bent on implementing policies that are disastrous long-term for the U.S. However, the Democrats seem to believe that if they can create a large enough class of people dependent on the government for their basic needs that they will ensure a permanent majority.

Quick take on proposed banking Regs

2010-01-23T14:40:00.002-05:00

Quick take on Obama's banking regulatory proposals:

Good:

placing limits on deposit taking institutions on leverage and size
prohibiting proprietary trading from deposit taking institutions

Bad:

does not get rid of "too big to fail" syndrome
would not have stopped firms like Bear Stearns and Lehman Brothers from failing or being propped up, even though they are not deposit taking institutions.
does not address the issue of regulatory capture
does not address culpability of SEC, congress, and Fed in causing problem.
Goldman Sachs comes off as a huge winner at the expense of its competition.

While we're at it - let's cripple the US debt markets - TEFRA proposals

2009-11-14T12:02:00.002-05:00

Here is some commentary on Barney Frank's latest proposal to now destroy the US corporate debt market overseas. This is rather arcane stuff, but has massive ramifications. All in the name to have a stealth tax grab to fund the welfare state here.

Morrison Foerrster (a top tax law firm in New York) has this to say

The Bill – Sanctions on Issuances of Bearer Bonds

The Bill would end the practice of selling bearer bonds to foreign investors under TEFRA C and TEFRA D. Thus, with respect to issuers of foreign targeted bearer bonds, the Bill would repeal the exception to (i) a denial of interest deduction for interest on bearer bonds and (ii) the 1% excise tax on the principal amount of the bonds.[1] In addition, interest paid on such bonds would no longer qualify for treatment as portfolio interest, thereby subjecting such interest to a 30% withholding tax, and any gain realized by a holder of such bonds would be treated as ordinary income.

This provision would apply to debt obligations issued after the date which is 180 days after the date of enactment of the Bill.

If enacted, the collateral damage from the Bill in the capital markets could be substantial. In the first instance, U.S. issuers would have to revise their existing programs to prohibit bearer debt. More importantly, they would have a harder time raising capital in foreign jurisdictions to the extent investors in those jurisdictions are unwilling to provide the non-U.S. person certification required for registered debt (i.e., IRS Form W-8). Also, U.S. issuers could not raise debt capital from jurisdictions (e.g., Switzerland) where investors are legally barred from certifying as to residency. Finally, foreign issuers would no longer have the protection against the excise tax of TEFRA C or TEFRA D compliance and would instead run whatever risk exists that the U.S. would attempt to impose an excise tax on a purely “foreign-to-foreign” debt offering.

No, the recession is not over. Yes, it will get a LOT worse before it gets better

2009-10-31T09:05:00.003-04:00

Don't let the recent economic numbers showing 3% + GDP growth in the US fool you. That number was a blip, primarily caused by the cash for clunkers subsidy. Things are a lot worse, and will be a lot worse - and here's why.

The stock market is considerably over-valued and will go through a significant decline. As of today, the Dow is around 9,700 and the S&P 500 is 1,036. Based on my criteria for fair value (Graham-Dodd value investing style) - we need to see at least a 20%-30% decline before we're in that territory. The reason I need to see a significant decline in valuations in order to see value is simple.

A stock is traditionally valued by determining the present value of future earning and assigning a multiple to those earnings to come to a stock price. But, both parts of this equation show that stocks are significantly overvalued. Future earnings look to be significantly lower. With credit contracting, consumers must defer spending in order to service debt, depressing earnings. With taxes, both personal and corporate going up in the future to pay for massive government spending, deficits, and entitlements - this will depress both consumer spending. It will also be a double hit for companies as not only do they get hit with lower sales due to depressed spending from taxes, and higher corporate taxes will lower earnings.

Second, inflation - which will happen - as you cannot print all this money to finance massive deficits without eventually causing it, will require a higher discount rate - thus depressing the net present value of earnings. Third, higher interest rates that are a result of inflation will also increase borrowing costs and thus lower earnings as well. Finally, with inflation being a long term issue, bond yields will eventually have to rise to account for this. This will depress the earnings multiple as it is directly related to interest rates. Low interest rates mean that earnings yield (the inverse of P/E) will be low. High interest rates mean that P/Es must drop. If long term Treasury rates hit 10% for example, the earnings yield on stocks must be at least 10% to compensate for the risks of owning stocks. This would imply a P/E of 10. Currently, the S&P 500 has a P/E of 15.44 - so with the outlook for interest rates going up - and earnings being depressed, the market will eventually have to drop significantly to reflect this reality.

Many more banks need to fail in order to get his financial mess cleaned up. The Treasury's actions in propping up de facto insolvent banks will only delay the inevitable. When you look at many of the largest banks, and you bring the liabilities for they bad CDOs back on the books, many of them are technically insolvent. What needs to happen is that bondholders for these banks need to have their debts converted into equity in order to shore up the capital to cushion these losses. Alas, the Treasury and Obama administration seem loathe to force conversions or resolutions of these Zombie banks . These inefficient banks are sucking up capital that can be better deployed better by well run banks that did not make these foolish risks.

Instead, we are now have a cabal of large banks that have the government privilege of being "too big to fail". They will have an implicit advantage in their funding costs due to their preference, and they will be able to take on additional risky behavior due to this preference. This will come at a cost to the economy as a whole, as capital will be inefficiently used to prop them up that could be used to fund other ventures.

Couple these facts with a Federal reserve that is abrogating its duties to provide a sound currency and a Congress intent on creating a welfare state via the printing press - things look pretty bleak in the near term.

The solutions, albeit unpleasant, are simple:

It is apparent that we cannot trust people with the responsibility of being guardians of currency. Fiat currency run by bureaucrats in a central bank have devastated wealth over the past century. The since the inception of the Federal Reserve in 1913 - the U.S. dollar has lost 95% of its value. Same story for the Pound Sterling. We should not be ascribing oracle like powers to men like Alan Greenspan, nor any bureaucrat. We need to go back to a gold standard. The gold standard tempers politicians. When money is backed by gold - politicians cannot print debt recklessly to bribe the electorate. If a government issues too much debt, bondholders can start demanding payment in gold rather than paper - depleting a nation's reserves. We would never be in hock to China as we are now if we had to worry about them one day demanding all our gold in lieu of paper. Gold means that politician and bureaucrats cannot debase currency and lower our standards of living. A gold standard forces governments to live within its means.

If we need a financial regulatory regime - we need to scrap the complex BASEL II schemes. BASEL II allows financial institutions to game the models, allowing excessive risk to be taken. The model itself is flawed - just due to the fact that people are not rational all the time. Complex regulation create regulatory capture, with the revolving door of experts moving back and forth between government and industry, lining their pockets at each step. Today, for all intents and purposes, the U.S. Treasury department and Federal Reserve is an agent of Goldman Sachs. Rather than make more and more complex rules - let's make a simple set of rules that apply to everyone. Simple rules for capital, and what activities may be allowed in order for a institution to be eligible for deposit insurance. Those activities not listed are not allowed and may be pursued by other firms at their own risk - if the screw up, let them fail.

Finally, we need a massive rollback on the scope of the government. A nation created on the notion of free-born citizens, free to succeed or fail and live their lives as they see fit - does not need a government that promises them a utopia free of pain or risk. This means rolling back entitlements, regulation, and the related spending. We need to remove the ability of politician and bureaucrats to meddle in private arrangements, and the opportunity for favoritism by special interests.

We can fix this now, when it will hurt a good bit, or we can fix it later, when it will be a lot more painful. Like it or not, it will need to be fixed, because all of this is not sustainable.

Arbitrage and Monopolies

2009-10-17T08:32:00.002-04:00

I cannot think of a more worthwhile read for those who are interested in credit markets and banking (and don't have the money to subscribe to Grant's Interest Rate Observer) than The Institutional Risk Analyst.

This week's article discusses credit arbitrage and bubbles. I think the key passage of this essay is:

The "bank monopoly" problem was well-outlined in Adam Smith's treatise and well-documented in the past decade by the Cruikshank Report in the U.K. (March, 2000). In simplest terms, whenever the arbitrage process that balances markets is monopolized, crises become commonplace. It is almost definitional that a financial market monopolist cannot "hedge" its "bets." As with the famous Hunt brothers' attempt to corner the silver market, when a monopolist buyer decides to sell, there are no other buyers, so the value of the monopolized commodity falls rapidly. When that commodity is loans, the result is a financial crisis. It is the alternation of "shoot the moon" and "fire sale" which arises when government policy monopolizes credit markets that causes financial markets to vacillate between euphoric bubbles and climactic crises.

I think that it is foolish for policy makers to believe that they can regulate or legislate away volatility, and absolve the markets of booms and busts. Economic booms and busts are offshoots of human behavior: human creativity, fears, greed - all these aspects lead to the change for better or worse.

Jails and Prisons - controlling the population

2009-09-05T09:56:00.003-04:00

This a very thoughtful article on maintaining order in jails from the City Journal. It brings up something that I have thought a lot of, and that is prison reform.

I am a big believer of locking up violent criminals for a long, long time. However, I think how prisons are run today is disgraceful. Gangs are the de facto rulers of many institutions. Drugs and contraband are rampant. Rapes are prevalent. We should have prisons where contraband and rape is rare, violence is minimal, and the guards control the prison, not the prisoners.

I think that it is something that needs to be addressed, but is not a priority. The electorate generally wants people locked up for crime, which is understandable. But, the current prison, as construed, just encourages recidivism, and in many cases is just another criminal location.

This is very interesting to read, and I hope it puts some spotlight on real prison and jail reforms that work.

Net migration out of New York State - and some advice.

2009-09-05T09:49:00.003-04:00

A great little article from a great periodical City Journal on the hemorrhaging of people out of New York state. Living in North Carolina - I cannot believe how many Buffalo ex-pats there are down here. It is great as I have a fondness for the city.

However, I have one piece of advice for all the New England refugees down here. Please remember that it was voting for tax and spend big government politicians in your home states that destroyed your economies, and thus the reason why you're down here. We don't want those policies here.

Elucidating Senator Kay Hagen (D-NC)

2009-08-29T09:14:00.005-04:00

I was listening to a radio interview with North Carolina Democratic senator Kay Hagen. To say the least it was amusing. She vacillated on whether she would vote for tax increases to pay for a public option. She vacillated on whether she'd vote for any bill with a public option.

What I found was most annoying was her assertion that the present proposals would cut costs by encouraging people to avoid the emergency room and visit their primary physician.

I can tell you that the opposite will happen - based on my experiences in Canada. Assuming we have a "public option" that will pay like medicare - i.e. below market rates, we will eventually see a doctor shortage as prospective doctors will see the hassles and pay not worth the time to go through the education and training required. In Canada, the provincial governments deliberately created a shortage of doctors - believing that doctors, via their billings, were the prime cost driver of public health care. The provincial governments limited the spots in medical schools and capped billings by doctors.

There are three levels of doctor shortages in Canada. If you're in a major metropolitan area - you have to book your appointment with your G.P. several months in advance. If you're in a minor city (i.e. around 100,000) - you may or may not get a doctor. In my case - I called in a few favours from some school friends to get a doctor. So your rolodex is your friend in socialized medicine.

If you're in a rural era - you're SOL. Some practices have lotteries to see which people will become patients. The rest are stuck with the emergency room.

So what happens down here is that if you force everyone to be paid at Medicare rates under a "public option" - you'll have fewer doctors practicing and those without one will be forced to the emergency room - which will raise costs. Go to an emergency room in Canada - most of the people are there for stuff that a G.P. should do - but they don't have one. Because people don't pay out of pocket - they'll abuse the E.R. You see it here with medicaid recipients clogging the emergency rooms.

So Kay Hagen doesn't know what the heck she's talking about.

So much for Keynes

2009-08-16T08:33:00.003-04:00

Over the past year or so, much of the press and the political class have been talking about how Keynesian policies are making a comeback. Things like government spending to stimulate the economy, etc are all in vogue now.

Although I think Keynes general theory does not work, I understand the intuitiveness of his theory. I think that the key premise of the his theory is that government needs to be counter-cyclical to the economy. In other words, governments should be hiking taxes/cutting spending/removing stimulus in up cycles and increasing spending/cutting taxes/adding stimulus during downcycles. The premise being, that government would temper the excesses of up cycles by pulling excess capital out of the market by fiscal policies and the severity of down cycles would be minimized as well.

Once again, the destroyer of most economic and political theories is once again - human nature. Recent history has shown how politicians cannot help themselves. During the up cycles through 1991-2007, federal and state governments slashed taxes and ramped up government programs - goosing an economy fueled by artificially low rates. Now, that times are tough - these same governments are cutting spending and raising taxes (at least on a state level, the federal government is raising taxes and increasing spending), which will not help one bit.

The problem is that politicians are incapable of not expanding the scope of government: they are addicted to increasing spending and incapable of cutting it. The taxes are just the result of this problem. This is why Keynes belief that government spending must be counter-cyclical cannot be a reality.

Missing in the "health care reform debate"

2009-06-27T07:33:00.003-04:00

I'm not the only one to notice that when the Democrats talk about how medical costs are spiraling out of control and how the government needs to fix it - they never mention the direct and indirect costs of lawsuits on costs. Notice that this is not addressed at all? Obama talks about all these "unnecessary tests being done of dubious worth" - but what he doesn't mention is that many doctors do all these questionable tests as a form a defensive medicine, i.e. to protect themselves from lawsuits. Simple example - you can thank people like John Edwards for the increase in Caesarian sections - all the lawsuits alleging cerebral palsy from normal childbirth have led more and more OB/GYNs to avoid the lawsuit risk and just go with the C-section. Yes they cost more - but it avoids all the litigation costs and the increase in malpractice insurance. Unless this is addressed - no other reform will reduce costs.

Boy I miss these ads.

2009-06-16T21:14:00.002-04:00

I certainly would rather see these ads than all the Viagara, Cialis, KY Jelly, Yaz, Trojan, and Valtrex ads currently running.

Market tidbits

2009-06-08T06:44:00.002-04:00

The equity markets are quite overvalued. When the S&P 500 was below 800, I started seeing some decent valuations of various non-financial equities. This is a bear market rally, in the sense that earnings can not, and will not, support the valuation levels of today.
Don't let bank earnings fool you - a good chunk the Q1 profits by the major banks were derived by mortgage origination fees from people refinancing into 4.5% 30-year fixed mortgages. Pretty well anybody who was creditworthy who could refinance pretty well did. Second, thanks to the Federal government going trillions of dollars into debt, long-term rates are on the upswing (I have posted earlier that I think this is the beginning of a 20-30 year trend) along with mortgage rates - so that revenue will dry up. There are still unrealized credit losses in the commercial loan sector and some parts of the home mortgage market.
Obama's tax proposals will be another job killer. Corporate tax increases like the elimination of parts of the foreign income deferral (a.k.a. Subpart F of the Internal Revenue Code), personal income tax hikes, possible cap and trade legislation, talk of a VAT, etc - this will depress earnings as the economy tanks.
Bank stress tests mean nothing - due to two key issues. First, nobody really knows the fair market value of the CDOs now on the books of these entities, and second, the problem now are Credit Default Swaps. Credit Default Swaps helped down AIG, LEH, and Bear Stearns, and there is a real need for regulatory reform here. The problem is that JP Morgan and Goldman Sachs are playing the Treasury and Fed in order to keep their market share and revenues from this business. See the Institutional Risk Analyst for more on this.

Random Thoughts

2009-05-24T08:58:00.003-04:00

Any "reform" coming out of Washington is not that. This is because Congress and the regulatory bodies are captive to the groups they regulate. Regulatory Capture is nothing new, but it will cost us more. TARP and OTC derivative "reforms" are there to benefit a handful of broker dealers. Credit Card "reform" does not really hurt the major issuers. Education "reform" will never injure the teacher's unions, etc. This leads to a fundamental question about regulation - more regulation begets more regulatory capture. Simple principle based systems may be the way to go.
Requiring U.S. based corporations to immediately pay U.S. income tax on foreign earnings is a major job killer if current rates stay. Most countries tax on a territorial basis (i.e. you earn in our country, you pay tax in our country), while the U.S. taxes on worldwide income (regardless of where it is earned, if you are a U.S. based group of companies). You will see a lot a major multinationals "invert" whereby their corporate parent becomes domiciled overseas and the U.S. operations become a subsidiary in order to avoid this onerous tax burden. You will see a lot of talent, jobs, etc move overseas - the type of people and jobs this country needs to compete going forward. Obama and Congress' punitive measure will be a huge gain for Hong Kong, Singapore, Dubai, Zurich, Dublin, and other less taxed and regulated financial centers.
How the heck does changing fuel economy standards to 39 mpg by 2016 keep any jobs here? The current cost structure for the big 3 means that they have a $1,500-$2,000 legacy cost per car for retiree pension and health care benefits (this will probably drop a bit, but the bailout of GM and MOPAR is really a bailout of the UAW as they have not made the same degree of concessions as everyone else). So the government will force the automakers here to build cars no one wants to buy at a price where they can make a profit without a huge taxpayer subsidy. The new generation of fuel efficient cars of the big 3, few will be manufactured here because of the labor costs. We, the taxpayer, will be on hook for propping up the UAW. The more sensible solution would be to jack up fuel taxes - but that won't happen, or just let the market solve it - as the spike from last summer showed that people will switch to smaller, more fuel efficient cars.
State governments will always have structural deficit problems until they get rid of defined benefit pension plans and generous retiree health care benefits for government employees. The problems that the Big 3 have with the UAW pension and benefits is a precursor of what will happen to state and local governments unless this is addressed.
I went to a mayoral candidate's debate the other day, and both the Democrat and Republican repeated pledges to "invest", whether it be "light rail", "affordable housing", or "good schools". Most of the questions were about neighborhood issues, where the candidates pandered. I stood up, and was the only one to ask "You talk about 'investing' in this and that, but I have not heard a single word of how you are going to pay for this. When I hear politicians talk about 'investment', I cringe as I know my taxes will go up to pay for this. How are you going to pay for this without going into debt or raising my taxes?"
For a good read on the follies of "light rail" and "smart growth", get Randall O'Toole's "Best Laid Plans". Seems that the common theme over light rail plans in the U.S. is that they go at least 50% over budget and never meet their overly optimistic ridership projections and are bound to be a money pit.

The illusion of CDS regulation

2009-05-18T20:35:00.002-04:00

I cannot recommend enough reading through the Institutional Risk Analytics newsletter. This is the source for understanding bank solvency and the regulatory issues surrounding the current banking problems. This particular piece discusses how the major investment banks have hijacked the process of regulating credit default swaps. Another prime example of how regulators are held captive by the industries they regulate. Here's a tidbit:

Why such a desperate battle for the OTC derivatives markets? For the world's largest banks, the OTC derivatives markets are the last remaining source of supra-normal profits - and also perhaps the single largest source of systemic risk in the global financial markets. Without OTC derivatives, Bear Stearns, Lehman Brothers and AIG would never have failed, but without the excessive rents earned by JPMorgan Chase (NYSE:JPM) and the remaining legacy OTC dealers, the largest banks cannot survive. No matter how good an operator JPM CEO Jamie Dimon may be, his bank is DOA without its near-monopoly in OTC derivatives -- yet that same business may eventually destroy JPM.
The key thing for the public and the Congress to understand is that the "profits" earned from these unregulated derivatives markets are illusory and do not cover the true risk of OTC derivatives. Put another way, on a systemic basis, risk-adjusted profits from OTC derivatives are not positive over time. As with the current crisis, the net loss from the periodic collapse of what is best described as gaming activity gets off-loaded onto the taxpayer, thus OTC derivatives must be seen as any other speculative activity, namely a net loss to the economy and society. But unlike taking a punt on a pony at the racetrack, bank dealings in OTC derivatives vastly increase systemic risk, make all banks unstable and threatens the viability of the real economy.

Bubbles

2009-04-14T20:45:00.003-04:00

This is an interesting Vanity Fair article on the financial implosion in Iceland.

Bubbles can happen anywhere. They have happened in all sorts of places, in "laissez-faire" countries like the U.S. and U.K., France under the Bourbons, collectivist Iceland, Japan, Holland, Albania.. etc.

The only thing you need for any kind of financial bubble is people. No amount of regulation or absence thereof will prevent it. Mass movements have their own lives, and no amount of reason will fix it.

If you haven't read it, get Charles Mackay "Extraordinary Popular Delusions and the Madness of Crowds."

This is not about "greed" or "capitalism" - it is about human nature and how people, when caught up in a moment, can ignore reason, common sense, reality, and let their animal spirits get the better of them. When it comes to finance, people disregards such concepts as "reversion to the mean", and "markets can remain irrational longer than I can remain solvent".

Hubris takes over voila - bad stuff happens.

The quiet coup

2009-03-29T20:24:00.002-04:00

From the Atlantic for your reading: "The Quiet Coup"

Essentially - the U.S. government is an oligarchy with financial interests not unlike Russia or any third world country.

The mythical "Systemic Risk"

2009-03-25T19:17:00.002-04:00

Does anyone have a definitive idea on what "systemic risk" is? If so, should we even try to regulate it as it is now obvious that existing regulatory regimes and human nature have shown otherwise.

The solution is to acknowledge that many believe that there is the existence of systemic risk, but that it cannot be controlled. Prudence, in the sense of being prepared for things that we cannot predict or forecast, should be the guiding principle.

There should be two frameworks - regulatory and non. Two rules for non-regulated: Cannot be a publicly traded company and will not get bailed out. In other words, these non-regulated firms would normally be partnerships where the owners have all their capital at risk and then some. They are generally free of oversight except that they will not be bailed out.

The regulated companies have their deposits and custodial accounts guaranteed for a fee. In return, they are limited in the amount of leverage they may use, cannot use off balance sheet financing, and cannot engage in trading from their own account except as a market maker (i.e. no proprietary trading). The only derivatives that these firms may trade are those that go through a clearinghouse with adequate margin rules.

This keeps the "traditional" banking and investment banking side in their roles, but limits their leverage and scope of business in return for being insured by the government. The other players not covered are the wild West, whereby the players are on the hook for their losses and are not publicly traded (think the big 4 CPA firms or Goldman Sachs before it went public as a structural model).

Think this is fair enough for everyone to understand ..

AIG - the key question

2009-03-21T09:23:00.003-04:00

I guess the best way to describe this is that when you rush things, stuff gets screwed up.

During that meeting, between the Geitner, Paulson et. al. in late 2008 when it was decided that the Treasury was going to end up owning AIG, why weren't the 10 largest CDS counterparties brought in and given this simple option:

"The United States Treasury will not step and and save AIG unless all CDS counterparties agree to take a 20% haircut". This is done where AIG could not match off counterparties with offsetting swaps.

AIG at the time had $4.7 trillion in outstanding credit default swaps. I think that most of the counterparties would rather take a guaranteed 80 cents on the dollar than try their luck in bankruptcy court.

Of course, that would assume that Treasury would try to be the best stewards of taxpayers' money.

Hank Grenbeerg sues AIG

2009-03-05T07:00:00.006-05:00

This is incredible - if Greenberg is correct in saying that Tim Geitner barred AIG's former chairman and largest shareholder from discussing the company's rescue while Goldman Sachs, AIG's largest CDS counterparty is allowed. This is disgraceful and a clear conflict of interest. Geitner should resign and GS should not be bailed out .

Mr. Market Miscalculates

2009-02-28T15:27:00.003-05:00

The title of this post references a book recently written by James Grant, publisher of Grant's Interest Rate Observer and a frequent reference of this site. After reading his book (insightful and witty read), some things really struck me and warrant some discussion.

The credit bubble, which for all intents and purposes, has burst, has been the culmination of 20 plus years of credit growth in excess of GDP, fueled by easy money, and a paper currency not backed by anything.

People with advanced degrees are no better at predicting the future than you and I. Why we put faith into central bankers with regards to economic forecasts, inflation forecasts is a fool's errand. Targeting one aspect of monetary policy (e.g. inflation) will only beget more of it, as one becomes so fixed on the measure (in this case "core" CPI) that one ignore the other moving parts that will contribute (i.e. excess money channeled into financial assets and easy credit).

A gold standard, with its faults, is better than the blind faith put in oracles, as it has a built in corrective mechanism. If a country's economy or government issues too much debt, people will demand a higher return or convert their debts for gold. Either the borrower has the choice of de-leveraging, go broke on higher rates, or exhaust their gold reserves. Nations cannot have perpetual current account deficits with gold, they are forced to live within their means. Gold is a hedge against nations deliberately debasing their currency as way of avoiding the hard choices with structural issues (eg. health care in Canada, Social Security and Medicare in the U.S.) and reducing the scope of government.

Alan Greenspan, who once was a believer in Gold back in the days he hung around with Ayn Rand, oversaw this credit bubble and long-term debasement of the currency. Grant goes back through history, and shows that monetary arrangements never last long. Bretton Woods lasted barely twenty five years, and the years of the U.S. dollar being the world's reserve currency and totally backed by nothing will in all likelihood be not much longer. This will only be expedited by Obama's massive expansion of the U.S. Federal government, leading to equally massive and unheard of deficits. The tax projections outlined in his budget will not pay for this. Even if he taxed all income over $200,000 at 100%, he would still run deficits. His choices are to increase taxes on everyone or keep running deficits, debase the dollar, and let everybody's standard of living decline gradually. Sooner or later, the creditor nations, who are generally no friends of America, will demand a higher return than the paltry rates they are getting right now. They will rightfully want to be compensated for currency risk, inflation risk, and credit risk. With that in mind, interest rates have nowhere to go but up, and up a lot they will go.

People can talk about "new paradigms", "new economies", "great moderations" in markets and economics, but the reality is that there is nothing really new in economics and markets. This is because there is one constant: human behavior. People have their prejudices, change their mind on a dime, are irrational, myopic, emotional, greedy, feaful, prideful, to name a few things. This is why models do not work: even through people as a whole are constant, their behavior within their range of behavior what they do can swing wildly and without explanation. This is why "markets can remain irrational longer than I can remain solvent."

A subset of this notion is the hard reality that the vast majority of the time, everything reverts to the mean. If one has several years of above average returns, it becomes increasingly likely that it will correct itself back to the long-term trend line. The stock market, commodities markets, and housing markets are bearing this out. Specifically, think about the stock market during the tech bubble with its 20%+ returns, and how people were predicting Dow 10,000 (James Glassman really looks like a chump now!) and how with the internet and technologies were going to have the prosperity go on forever in an environment of low interest rates and inflation. Excuse me, if the markets give us 20% annual returns for the foreseeable future with low inflation, wouldn't that imply that by simply investing my money and using the power of compounding interest, I could just put in $10,000 and be a millionaire in 20 years and never work again; but if everybody was retired due to their stock market riches, who would be working for the businesses who trade on the indices that require the 20% perpetual returns??? See the inherent problem with bubble returns - when returns start exceeding fundamentals, you plant the seeds of a crash, and eventually the return to normalcy.

A brief analysis of Comrade Obama's tax proposals

2009-02-27T21:23:00.002-05:00

I have had the opportunity to digest the tax proposals in Obama's FY '10 budget proposal, and color me unimpressed. Notwithstanding the utter absurdity of their assumptions - that GDP growth will hit 5% in 2010 and that tax revenues are static (e.g. - an X% increase in tax will result in an X% increase in revenue), this is a job killer of a tax bill.

Business tax increases include:

$210 billion on increased enforcement over 10 years. This is typical of every president, problem is - over aggressive audits result in a lot of court cases, and the problem is that in order to get this money, it will cost a lot in increased manpower. Chances of meeting target -50%.
Repeal of LIFO. This was a bigger issue when manufacturing was a bigger portion of GDP and companies were not just-in-time in terms of inventories. On one level, this is a gimmick. However, since his reckless deficit spending is highly inflationary - they might make their mark of $61 billion over ten years. Chances of making target - 70%
Taxation of carried interest as ordinary income. This will be a tough one - despite the talk, the law and the courts will probably make this difficult. That, and the fact that most hedge funds and private equity funds will be significantly smaller due to the credit bubble bursting, makes it highly unlikely they will get $23.9 billion over 10 years. Chances of making target - 20%.
Cap and trade - let's call it what it is - a massive and unprecedented tax grab and intrusion of government on a hitherto unimagined scale. They expect to raise $645. 7 billion in revenues. This will kill the economy, kill jobs, hit the poor hardest (even with his dubious "make work pay" credits). Won't even come close as many industries will just close shop (e.g. autos, chemicals, energy intensive industries) and move offshore. I could pictures oil refineries closing shop and opening up in Mexico. Chances of making revenue target - 5%.

On the individual side, he is sticking it to the gainfully employed by:

Raising the top bracket to 39.6%, raising $338 billion over ten years. Won't happen. First, not enough rich people to soak (i.e. will have to raise rates to income levels of $60K), and outside of those in high cost of living jurisdictions (e.g. New York City - were $250K is barely middle class), a lot of people will take their comp in other ways or will work less. Even more odious - small business owners who own partnerships or S-Corporation will cut jobs or other investments as their taxes go up. This will be another job killer. Chance of making revenue target - 15%.
Phasing out mortgage interest and charitable deductions - aka "the only Churches and School we'll have are run by the state phase out". Won't raise much revenue ($179 billion over 10 years) as mortgage as AMT deals with some of this, plus, not enough rich people. Chance of making revenue target - 20%
Increasing capital gains and dividend tax rates to 20%. Based on this market, companies are cutting back on dividends to preserve capital and are tanking thanks in no part to Obama. Market still has a long way to go and other proposals will tank the economy and the stock market more. This is another example of static budgeting not taking into consideration economic reality, so $118 billion is unrealistic. Maybe they got the guys who figured that packaging a bunch of subprime mortgages would result in a AAA credit rating. Chances of making revenue target - 10%

We are looking at the 70% all over - debased currency, stagflation, and malaise . Gold is looking awfully good as a store of value.

Our problems - BLAME Harvard!

2009-02-19T20:25:00.002-05:00

Money quote from "Big Hollywood":

Have you ever looked over a list of Harvard graduates? George Bush got an MBA degree from Harvard Business School, the first President with an MBA. Barack Obama got a law degree there and was the Harvard Law Review’s first black president. At the then President elect Obama’s first press conference, the advisors onstage with him included Larry Summers (President of Harvard until he resigned after “women are unequal” remarks), Robert Reich (former member of the faculty of Harvard’s John F. Kennedy School of Government), former Treasury Secretary Robert Rubin (guess where he went to college), and Michigan governor Jennifer Granholm (before overseeing her economically failed state, at Harvard Law School she was editor-in-chief of the Harvard Civil Rights Civil Liberties Law Review). And let’s not forget that the architect of the first bailout, Treasury Secretary Hank Paulson, also had an MBA from Harvard Business School. Maybe the real long-term solution to America’s economic woes is to put Harvard out of business.

A simpler way to think of a credit bubble

2009-02-14T06:41:00.002-05:00

Think of the U.S. economy as a household balance sheet. You have assets, liabilities, and what is left is your net worth. Your assets are houses, equities, etc.. and the debts against them. In 1982, your assets had started appreciating in value, and your debts against those assets were modest.

However, since then, as your assets kept appreciating in value, you kept borrowing and borrowing against those assets. First you bought more assets - real estate, stocks. This was ok, as the value of these assets kept growing faster than your debt, and you were making enough in income to cover the cost of servicing that debt. So the assets grew, the liabilities grew, but your net worth grew.

This has continued for almost 25 years, more purchases, more borrowing, with one exception. Now we were just consuming on debt - buying TVs, computers, vacations, cars - spending more on stuff than what we make. But we thought it was ok, because even though we had more debt, our assets grew faster in value.

We just hit a couple of points now. First, the assets that supported all this debt dropped - so now we have more liabilities than assets: negative net worth. Second, we have income that barely covers the minimum payments. As we all know, if you stick to minimum payments, your debt takes forever to pay off. So now your income drops, and you can't even make that.

Well first and foremost, what does one do? If your debts substantially exceed the value of your assets, and you income is falling and you already have trouble making your payments, then your options are limited. Restructuring your existing debts may work by extending the term and payments. However, if the quality of the collateral will not support it - a prudent lender would not be inclined to do so unless compensated - which means higher payments. See the problem?

The solution being done by Congress is to double down on debt and spend, hoping all the consumption will pump asset prices up beyond the additional debt to bring income up to support and and to a positive net worth. Ask yourself this - if you went to a banker with this idea to fix your debt problem, you'd be laughed at.

The solution is bankruptcy in the case of the individual. Admitting that you cannot meet your debts, and having a quick and order liquidation of assets, using the proceeds to pay off creditors to the extent possible, writing off what is outstanding, and letting the individual start with a clean slate. It is relatively quick, and painful, but it is better than letting a man be crushed for years under debt.

America has one of the most dynamic economies in the world because it generally recognizes that it is better to wind up troubled enterprises quickly than let them fester and drag down everybody else. You would think our elected officials would know that.

Sadly, it comes more apparent with each day, that the longer a politican is in office, the more detached for the fundamentals of business and economics they become.

F.A. Hayek's Nobel Lecutre - The Pretence of Knowedge

2009-02-14T06:07:00.003-05:00

I cannot say enough on how appropriate this is today, much more so than in 1974 - we should know better.

The Pretence of Knowledge
The particular occasion of this lecture, combined with the chief practical problem which economists have to face today, have made the choice of its topic almost inevitable. On the one hand the still recent establishment of the Nobel Memorial Prize in Economic Science marks a significant step in the process by which, in the opinion of the general public, economics has been conceded some of the dignity and prestige of the physical sciences. On the other hand, the economists are at this moment called upon to say how to extricate the free world from the serious threat of accelerating inflation which, it must be admitted, has been brought about by policies which the majority of economists recommended and even urged governments to pursue. We have indeed at the moment little cause for pride: as a profession we have made a mess of things.

It seems to me that this failure of the economists to guide policy more successfully is closely connected with their propensity to imitate as closely as possible the procedures of the brilliantly successful physical sciences - an attempt which in our field may lead to outright error. It is an approach which has come to be described as the "scientistic" attitude - an attitude which, as I defined it some thirty years ago, "is decidedly unscientific in the true sense of the word, since it involves a mechanical and uncritical application of habits of thought to fields different from those in which they have been formed."1 I want today to begin by explaining how some of the gravest errors of recent economic policy are a direct consequence of this scientistic error.

The theory which has been guiding monetary and financial policy during the last thirty years, and which I contend is largely the product of such a mistaken conception of the proper scientific procedure, consists in the assertion that there exists a simple positive correlation between total employment and the size of the aggregate demand for goods and services; it leads to the belief that we can permanently assure full employment by maintaining total money expenditure at an appropriate level. Among the various theories advanced to account for extensive unemployment, this is probably the only one in support of which strong quantitative evidence can be adduced. I nevertheless regard it as fundamentally false, and to act upon it, as we now experience, as very harmful.

This brings me to the crucial issue. Unlike the position that exists in the physical sciences, in economics and other disciplines that deal with essentially complex phenomena, the aspects of the events to be accounted for about which we can get quantitative data are necessarily limited and may not include the important ones. While in the physical sciences it is generally assumed, probably with good reason, that any important factor which determines the observed events will itself be directly observable and measurable, in the study of such complex phenomena as the market, which depend on the actions of many individuals, all the circumstances which will determine the outcome of a process, for reasons which I shall explain later, will hardly ever be fully known or measurable. And while in the physical sciences the investigator will be able to measure what, on the basis of a prima facie theory, he thinks important, in the social sciences often that is treated as important which happens to be accessible to measurement. This is sometimes carried to the point where it is demanded that our theories must be formulated in such terms that they refer only to measurable magnitudes.

It can hardly be denied that such a demand quite arbitrarily limits the facts which are to be admitted as possible causes of the events which occur in the real world. This view, which is often quite naively accepted as required by scientific procedure, has some rather paradoxical consequences. We know: of course, with regard to the market and similar social structures, a great many facts which we cannot measure and on which indeed we have only some very imprecise and general information. And because the effects of these facts in any particular instance cannot be confirmed by quantitative evidence, they are simply disregarded by those sworn to admit only what they regard as scientific evidence: they thereupon happily proceed on the fiction that the factors which they can measure are the only ones that are relevant.

The correlation between aggregate demand and total employment, for instance, may only be approximate, but as it is the only one on which we have quantitative data, it is accepted as the only causal connection that counts. On this standard there may thus well exist better "scientific" evidence for a false theory, which will be accepted because it is more "scientific", than for a valid explanation, which is rejected because there is no sufficient quantitative evidence for it.

Let me illustrate this by a brief sketch of what I regard as the chief actual cause of extensive unemployment - an account which will also explain why such unemployment cannot be lastingly cured by the inflationary policies recommended by the now fashionable theory. This correct explanation appears to me to be the existence of discrepancies between the distribution of demand among the different goods and services and the allocation of labour and other resources among the production of those outputs. We possess a fairly good "qualitative" knowledge of the forces by which a correspondence between demand and supply in the different sectors of the economic system is brought about, of the conditions under which it will be achieved, and of the factors likely to prevent such an adjustment. The separate steps in the account of this process rely on facts of everyday experience, and few who take the trouble to follow the argument will question the validity of the factual assumptions, or the logical correctness of the conclusions drawn from them. We have indeed good reason to believe that unemployment indicates that the structure of relative prices and wages has been distorted (usually by monopolistic or governmental price fixing), and that to restore equality between the demand and the supply of labour in all sectors changes of relative prices and some transfers of labour will be necessary.

But when we are asked for quantitative evidence for the particular structure of prices and wages that would be required in order to assure a smooth continuous sale of the products and services offered, we must admit that we have no such information. We know, in other words, the general conditions in which what we call, somewhat misleadingly, an equilibrium will establish itself: but we never know what the particular prices or wages are which would exist if the market were to bring about such an equilibrium. We can merely say what the conditions are in which we can expect the market to establish prices and wages at which demand will equal supply. But we can never produce statistical information which would show how much the prevailing prices and wages deviate from those which would secure a continuous sale of the current supply of labour. Though this account of the causes of unemployment is an empirical theory, in the sense that it might be proved false, e.g. if, with a constant money supply, a general increase of wages did not lead to unemployment, it is certainly not the kind of theory which we could use to obtain specific numerical predictions concerning the rates of wages, or the distribution of labour, to be expected.

Why should we, however, in economics, have to plead ignorance of the sort of facts on which, in the case of a physical theory, a scientist would certainly be expected to give precise information? It is probably not surprising that those impressed by the example of the physical sciences should find this position very unsatisfactory and should insist on the standards of proof which they find there. The reason for this state of affairs is the fact, to which I have already briefly referred, that the social sciences, like much of biology but unlike most fields of the physical sciences, have to deal with structures of essential complexity, i.e. with structures whose characteristic properties can be exhibited only by models made up of relatively large numbers of variables. Competition, for instance, is a process which will produce certain results only if it proceeds among a fairly large number of acting persons.

In some fields, particularly where problems of a similar kind arise in the physical sciences, the difficulties can be overcome by using, instead of specific information about the individual elements, data about the relative frequency, or the probability, of the occurrence of the various distinctive properties of the elements. But this is true only where we have to deal with what has been called by Dr. Warren Weaver (formerly of the Rockefeller Foundation), with a distinction which ought to be much more widely understood, "phenomena of unorganized complexity," in contrast to those "phenomena of organized complexity" with which we have to deal in the social sciences.2 Organized complexity here means that the character of the structures showing it depends not only on the properties of the individual elements of which they are composed, and the relative frequency with which they occur, but also on the manner in which the individual elements are connected with each other. In the explanation of the working of such structures we can for this reason not replace the information about the individual elements by statistical information, but require full information about each element if from our theory we are to derive specific predictions about individual events. Without such specific information about the individual elements we shall be confined to what on another occasion I have called mere pattern predictions - predictions of some of the general attributes of the structures that will form themselves, but not containing specific statements about the individual elements of which the structures will be made up.

This is particularly true of our theories accounting for the determination of the systems of relative prices and wages that will form themselves on a wellfunctioning market. Into the determination of these prices and wages there will enter the effects of particular information possessed by every one of the participants in the market process - a sum of facts which in their totality cannot be known to the scientific observer, or to any other single brain. It is indeed the source of the superiority of the market order, and the reason why, when it is not suppressed by the powers of government, it regularly displaces other types of order, that in the resulting allocation of resources more of the knowledge of particular facts will be utilized which exists only dispersed among uncounted persons, than any one person can possess. But because we, the observing scientists, can thus never know all the determinants of such an order, and in consequence also cannot know at which particular structure of prices and wages demand would everywhere equal supply, we also cannot measure the deviations from that order; nor can we statistically test our theory that it is the deviations from that "equilibrium" system of prices and wages which make it impossible to sell some of the products and services at the prices at which they are offered.

Before I continue with my immediate concern, the effects of all this on the employment policies currently pursued, allow me to define more specifically the inherent limitations of our numerical knowledge which are so often overlooked. I want to do this to avoid giving the impression that I generally reject the mathematical method in economics. I regard it in fact as the great advantage of the mathematical technique that it allows us to describe, by means of algebraic equations, the general character of a pattern even where we are ignorant of the numerical values which will determine its particular manifestation. We could scarcely have achieved that comprehensive picture of the mutual interdependencies of the different events in a market without this algebraic technique. It has led to the illusion, however, that we can use this technique for the determination and prediction of the numerical values of those magnitudes; and this has led to a vain search for quantitative or numerical constants. This happened in spite of the fact that the modern founders of mathematical economics had no such illusions. It is true that their systems of equations describing the pattern of a market equilibrium are so framed that if we were able to fill in all the blanks of the abstract formulae, i.e. if we knew all the parameters of these equations, we could calculate the prices and quantities of all commodities and services sold. But, as Vilfredo Pareto, one of the founders of this theory, clearly stated, its purpose cannot be "to arrive at a numerical calculation of prices", because, as he said, it would be "absurd" to assume that we could ascertain all the data.4 Indeed, the chief point was already seen by those remarkable anticipators of modern economics, the Spanish schoolmen of the sixteenth century, who emphasized that what they called pretium mathematicum, the mathematical price, depended on so many particular circumstances that it could never be known to man but was known only to God.5 I sometimes wish that our mathematical economists would take this to heart. I must confess that I still doubt whether their search for measurable magnitudes has made significant contributions to our theoretical understanding of economic phenomena - as distinct from their value as a description of particular situations. Nor am I prepared to accept the excuse that this branch of research is still very young: Sir William Petty, the founder of econometrics, was after all a somewhat senior colleague of Sir Isaac Newton in the Royal Society!

There may be few instances in which the superstition that only measurable magnitudes can be important has done positive harm in the economic field: but the present inflation and employment problems are a very serious one. Its effect has been that what is probably the true cause of extensive unemployment has been disregarded by the scientistically minded majority of economists, because its operation could not be confirmed by directly observable relations between measurable magnitudes, and that an almost exclusive concentration on quantitatively measurable surface phenomena has produced a policy which has made matters worse.

It has, of course, to be readily admitted that the kind of theory which I regard as the true explanation of unemployment is a theory of somewhat limited content because it allows us to make only very general predictions of the kind of events which we must expect in a given situation. But the effects on policy of the more ambitious constructions have not been very fortunate and I confess that I prefer true but imperfect knowledge, even if it leaves much indetermined and unpredictable, to a pretence of exact knowledge that is likely to be false. The credit which the apparent conformity with recognized scientific standards can gain for seemingly simple but false theories may, as the present instance shows, have grave consequences.

In fact, in the case discussed, the very measures which the dominant "macro-economic" theory has recommended as a remedy for unemployment, namely the increase of aggregate demand, have become a cause of a very extensive misallocation of resources which is likely to make later large-scale unemployment inevitable. The continuous injection of additional amounts of money at points of the economic system where it creates a temporary demand which must cease when the increase of the quantity of money stops or slows down, together with the expectation of a continuing rise of prices, draws labour and other resources into employments which can last only so long as the increase of the quantity of money continues at the same rate - or perhaps even only so long as it continues to accelerate at a given rate. What this policy has produced is not so much a level of employment that could not have been brought about in other ways, as a distribution of employment which cannot be indefinitely maintained and which after some time can be maintained only by a rate of inflation which would rapidly lead to a disorganisation of all economic activity. The fact is that by a mistaken theoretical view we have been led into a precarious position in which we cannot prevent substantial unemployment from re-appearing; not because, as this view is sometimes misrepresented, this unemployment is deliberately brought about as a means to combat inflation, but because it is now bound to occur as a deeply regrettable but inescapable consequence of the mistaken policies of the past as soon as inflation ceases to accelerate.

I must, however, now leave these problems of immediate practical importance which I have introduced chiefly as an illustration of the momentous consequences that may follow from errors concerning abstract problems of the philosophy of science. There is as much reason to be apprehensive about the long run dangers created in a much wider field by the uncritical acceptance of assertions which have the appearance of being scientific as there is with regard to the problems I have just discussed. What I mainly wanted to bring out by the topical illustration is that certainly in my field, but I believe also generally in the sciences of man, what looks superficially like the most scientific procedure is often the most unscientific, and, beyond this, that in these fields there are definite limits to what we can expect science to achieve. This means that to entrust to science - or to deliberate control according to scientific principles - more than scientific method can achieve may have deplorable effects. The progress of the natural sciences in modern times has of course so much exceeded all expectations that any suggestion that there may be some limits to it is bound to arouse suspicion. Especially all those will resist such an insight who have hoped that our increasing power of prediction and control, generally regarded as the characteristic result of scientific advance, applied to the processes of society, would soon enable us to mould society entirely to our liking. It is indeed true that, in contrast to the exhilaration which the discoveries of the physical sciences tend to produce, the insights which we gain from the study of society more often have a dampening effect on our aspirations; and it is perhaps not surprising that the more impetuous younger members of our profession are not always prepared to accept this. Yet the confidence in the unlimited power of science is only too often based on a false belief that the scientific method consists in the application of a ready-made technique, or in imitating the form rather than the substance of scientific procedure, as if one needed only to follow some cooking recipes to solve all social problems. It sometimes almost seems as if the techniques of science were more easily learnt than the thinking that shows us what the problems are and how to approach them.

The conflict between what in its present mood the public expects science to achieve in satisfaction of popular hopes and what is really in its power is a serious matter because, even if the true scientists should all recognize the limitations of what they can do in the field of human affairs, so long as the public expects more there will always be some who will pretend, and perhaps honestly believe, that they can do more to meet popular demands than is really in their power. It is often difficult enough for the expert, and certainly in many instances impossible for the layman, to distinguish between legitimate and illegitimate claims advanced in the name of science. The enormous publicity recently given by the media to a report pronouncing in the name of science on The Limits to Growth, and the silence of the same media about the devastating criticism this report has received from the competent experts6, must make one feel somewhat apprehensive about the use to which the prestige of science can be put. But it is by no means only in the field of economics that far-reaching claims are made on behalf of a more scientific direction of all human activities and the desirability of replacing spontaneous processes by "conscious human control". If I am not mistaken, psychology, psychiatry and some branches of sociology, not to speak about the so-called philosophy of history, are even more affected by what I have called the scientistic prejudice, and by specious claims of what science can achieve.

If we are to safeguard the reputation of science, and to prevent the arrogation of knowledge based on a superficial similarity of procedure with that of the physical sciences, much effort will have to be directed toward debunking such arrogations, some of which have by now become the vested interests of established university departments. We cannot be grateful enough to such modern philosophers of science as Sir Karl Popper for giving us a test by which we can distinguish between what we may accept as scientific and what not - a test which I am sure some doctrines now widely accepted as scientific would not pass. There are some special problems, however, in connection with those essentially complex phenomena of which social structures are so important an instance, which make me wish to restate in conclusion in more general terms the reasons why in these fields not only are there only absolute obstacles to the prediction of specific events, but why to act as if we possessed scientific knowledge enabling us to transcend them may itself become a serious obstacle to the advance of the human intellect.
The chief point we must remember is that the great and rapid advance of the physical sciences took place in fields where it proved that explanation and prediction could be based on laws which accounted for the observed phenomena as functions of comparatively few variables - either particular facts or relative frequencies of events. This may even be the ultimate reason why we single out these realms as "physical" in contrast to those more highly organized structures which I have here called essentially complex phenomena. There is no reason why the position must be the same in the latter as in the former fields. The difficulties which we encounter in the latter are not, as one might at first suspect, difficulties about formulating theories for the explanation of the observed events - although they cause also special difficulties about testing proposed explanations and therefore about eliminating bad theories. They are due to the chief problem which arises when we apply our theories to any particular situation in the real world. A theory of essentially complex phenomena must refer to a large number of particular facts; and to derive a prediction from it, or to test it, we have to ascertain all these particular facts. Once we succeeded in this there should be no particular difficulty about deriving testable predictions - with the help of modern computers it should be easy enough to insert these data into the appropriate blanks of the theoretical formulae and to derive a prediction. The real difficulty, to the solution of which science has little to contribute, and which is sometimes indeed insoluble, consists in the ascertainment of the particular facts.
A simple example will show the nature of this difficulty. Consider some ball game played by a few people of approximately equal skill. If we knew a few particular facts in addition to our general knowledge of the ability of the individual players, such as their state of attention, their perceptions and the state of their hearts, lungs, muscles etc. at each moment of the game, we could probably predict the outcome. Indeed, if we were familiar both with the game and the teams we should probably have a fairly shrewd idea on what the outcome will depend. But we shall of course not be able to ascertain those facts and in consequence the result of the game will be outside the range of the scientifically predictable, however well we may know what effects particular events would have on the result of the game. This does not mean that we can make no predictions at all about the course of such a game. If we know the rules of the different games we shall, in watching one, very soon know which game is being played and what kinds of actions we can expect and what kind not. But our capacity to predict will be confined to such general characteristics of the events to be expected and not include the capacity of predicting particular individual events.

This corresponds to what I have called earlier the mere pattern predictions to which we are increasingly confined as we penetrate from the realm in which relatively simple laws prevail into the range of phenomena where organized complexity rules. As we advance we find more and more frequently that we can in fact ascertain only some but not all the particular circumstances which determine the outcome of a given process; and in consequence we are able to predict only some but not all the properties of the result we have to expect. Often all that we shall be able to predict will be some abstract characteristic of the pattern that will appear - relations between kinds of elements about which individually we know very little. Yet, as I am anxious to repeat, we will still achieve predictions which can be falsified and which therefore are of empirical significance.

Of course, compared with the precise predictions we have learnt to expect in the physical sciences, this sort of mere pattern predictions is a second best with which one does not like to have to be content. Yet the danger of which I want to warn is precisely the belief that in order to have a claim to be accepted as scientific it is necessary to achieve more. This way lies charlatanism and worse. To act on the belief that we possess the knowledge and the power which enable us to shape the processes of society entirely to our liking, knowledge which in fact we do not possess, is likely to make us do much harm. In the physical sciences there may be little objection to trying to do the impossible; one might even feel that one ought not to discourage the over-confident because their experiments may after all produce some new insights. But in the social field the erroneous belief that the exercise of some power would have beneficial consequences is likely to lead to a new power to coerce other men being conferred on some authority. Even if such power is not in itself bad, its exercise is likely to impede the functioning of those spontaneous ordering forces by which, without understanding them, man is in fact so largely assisted in the pursuit of his aims. We are only beginning to understand on how subtle a communication system the functioning of an advanced industrial society is based - a communications system which we call the market and which turns out to be a more efficient mechanism for digesting dispersed information than any that man has deliberately designed.

If man is not to do more harm than good in his efforts to improve the social order, he will have to learn that in this, as in all other fields where essential complexity of an organized kind prevails, he cannot acquire the full knowledge which would make mastery of the events possible. He will therefore have to use what knowledge he can achieve, not to shape the results as the craftsman shapes his handiwork, but rather to cultivate a growth by providing the appropriate environment, in the manner in which the gardener does this for his plants. There is danger in the exuberant feeling of ever growing power which the advance of the physical sciences has engendered and which tempts man to try, "dizzy with success", to use a characteristic phrase of early communism, to subject not only our natural but also our human environment to the control of a human will. The recognition of the insuperable limits to his knowledge ought indeed to teach the student of society a lesson of humility which should guard him against becoming an accomplice in men's fatal striving to control society - a striving which makes him not only a tyrant over his fellows, but which may well make him the destroyer of a civilization which no brain has designed but which has grown from the free efforts of millions of individuals.

Great (and depressing) article on Detroit

2009-02-01T09:20:00.001-05:00

Matt Labash of the Weekly Standard's "The City where the Sirens never sleep".

The credit bubble - repeat of Japan?

2009-01-30T22:27:00.007-05:00

James Quinn at Seeking Alpha has one of the best analysis of the current economic turmoil. Best of all, he found the charts I have mentioned before!! Read his article!!

Anyhow, here are the charts I was mentioning...

Here is total government debt to GDP. Notice how it started growing faster than GDP after we started the great cyclical bull market in bonds in 1982, where interest rates peaked. This credit growth fueled bubbles in real estate in the mid to late 80s, capex in the early 90's, tech stocks in the late 90's, and real estate again just recently. Now look at just household debt...

Now this one just looks at household debt. Same trend - saving thrown out the window - Hello McMansion, new Escalade and 52" plasma TV! Down payments are for chumps!

Finally - throw that in with the fact that people don't save anymore, thanks to no money down easy credit, and the widespread attitude that the government will take care of us.. and we're gone from a nation of savers to a nation of creditors.

Do you really think the way to fix this problem is to issue even more debt and depress future consumption? Read the solutions - what should be done versus what will probably be done. It is depressing.

Great site on TARP and the financial system

2009-01-26T19:41:00.002-05:00

I cannot say enough of the great works by the people at the Institutional Risk Analytics site. They have the best insights into what is going on in the banking system and in my opinion, probably the best solutions offered. It is obvious they are not fans of the current actions being done, nor are they fans of the economic teams, recent and present, who are spearheading this.

I strongly recommend you take a look, and pour a stiff drink first and foremost.

Stimulus.

2009-01-25T19:38:00.003-05:00

The trouble we are not experiencing is the end of a credit bubble whose origins go back to the early 1980's. After record interest rates in 1982, total debt has grown at a faster rate than GDP. The past few years have shown this to be rather acute. We have sustained this all by debt financed consumption - sacrificing future economy activity for the present by the use of debt. It has finally caught up to us, and what should happen is a period of lower economic activity as we make up for all that debt financed consumption by de-leveraging the balance sheet.

So what do the wise sages of the political class propose. More debt financed consumption under the guise of "stimulus".

All we are doing is delaying the inevitable with fiscal chicanery. Switching consumer debt spending binge with a government debt buying binge to be paid for with future taxes.

So what do we call someone who does the same thing over and over and expecting a different result?

UAW troubles a harbinger of things to come

2008-12-20T06:25:00.002-05:00

While we watch the slow death of the big three from the weight of massive liabilities due to excessively generous pension and health care benefits, it should be noted that the automakers are just an illustration of what will be happening at an even larger scale across the company with another large segment of the workforce: government employees.

State employees have pension and health care benefits comparable to what the UAW has extorted from the Big 3. However, the key difference is that state employees have near iron clad job security. The Detroit News had a great report on how the Michigan Teachers' Pension plan will bankrupt many districts from their overly generous benefits (see here, here, here). This is not just a Michigan problem. Almost every state has this issue, and it will get worse over time. Most governments will not tackle this because of the power of the state employees unions (see the budget crisis in California and how there are no layoffs, just tax increases).

The difference between the Big 3 and the state governments is that we have no choice in funding the state employees. We do not have the option to not pay taxes. The solution has a ton of up front costs and would ensure a huge political and legal fight. The fair way to deal with this is to convert all defined benefit plans into defined contribution plans (e.g. 401(k)). It would apply to all workers under a certain age or seniority. Current retirees or those close to retirement would be exempted. The same actuaries that run the pension plan would figure out for each plan contributor what their current pension would be if they retired on the conversion date, and the state would pay a lump sum into their 401(k) equal to the amount necessary to buy an annuity at conversion date rates to fund that. From that point on, the risks are transferred to the employees from the taxpayers. This would need to be coupled with a plan that makes retirees responsible for their own health care expenses at retirement (like pretty well everyone else who is not a union/government employee).

This would be the mother of knock down/drag out fights, with legal challenges galore - but it has to be done. During these tough times, perhaps some forward looking state politicians will start demanding change before the structural costs cripple the economy.

UAW bailout - debating point du jour

2008-12-20T06:01:00.003-05:00

I have been listening to a lot of talk radio about the auto bailout the past few weeks, and it is always interesting when I hear some of the arguments made by UAW members as to why their perks should be subsidized by the American taxpayer. One that I have heard a few times is that it is OK for the Feds to bail out the big three because Southern States have been giving tax money to the foreign automakers to build in their states.

Is it true that foreign car makers get unfair tax incentives from Southern state governments? This is kind of half true. Now, for the record, I am not in principle a big fan of "targeted tax relief" in the form of incentives, as it reeks of state governments picking winners and losers. Plus, I think sound tax policy focuses on making taxes as low as possible for all business, not just big ones looking to invest in your state. That being said, it is true that Tennessee, Alabama, Georgia, Mississippi, and South Carolina have been very aggressive in putting together attractive tax packages to lure factories in their states.

But what is also true is that the Big three have been playing this game for years in the Mid-West and Canada. When Chrysler mulled expanding Jeep production, the State of Ohio and the City of Toledo made sure that there were ample incentives to expand on their existing site there. When the automakers consider scaling back production in Ontario. The Canadian government and the province of Ontario are there with massive packages of tax credits and loan guarantees. The state of Michigan and the City of Detroit gave some generous tax breaks when GM bought and moved its headquarters into the Renaissance center. So, when your UAW flack talks about the "unfair" tax subsidies that foreign automakers got to locate in the South, tell them they were just following the lead of the big three.

Into the Crystal Ball

2008-11-22T11:43:00.002-05:00

After being to a few investment symposiums (one of the benefits of having the CFA charter) and doing my own overview of the markets, here are a few things I think are probable:

Long term interest rates will go up significantly while short term rates will stay low (i.e. a very steep yield curve). One of the reasons is because of all the debt the U.S. government will have to issue over the next few years. Currently, the 30 year bond is yielding 3.66%. Warren Buffett got 10% yield on his preferred interest on his investment in Goldman Sachs. The Chinese, with their massive dollar reserves, will be financing this, like it or not. They will not accept a 3.66% return on their money if Buffet is getting close to 10%. The yield on a 30 year bond will be hitting 8% over the next year or so in order to pay for the TARP program and whatever else Congress dumps on us.
If we are looking at a 8% 30 year bond rate, the stock market will drop to a level relative to this. If we assume a 3% dividend yield (a bit on the hight side) to make the math earlier and a 30% risk premium, the S&P combined earnings and dividend yield (i.e. dividend yield plus the inverse of P/E) should be roughly 13%. That implies an earnings yield of 10% or a P/E of roughly 10. S&P 500 earnings will likely drop by about 30%, so that gives an implied index level of 450 as the bottom - so a worse case scenario of a 40% + drop. Mind you, that is a worse case scenario, but I can see it dropping down below 600.
Commodity prices will continue on a short term downtrend, and will start back on an upward swing once the markets start to recover from their bottom.
There will be another major bank failure in the next year.

Tax Planning tips for the new administration

2008-11-08T06:57:00.002-05:00

I have talked to CPAs who are advising this already. The consensus that taxes are going to go up a lot starting in 2009. The tax planning for anticipated rate hikes is the 180 degree opposite of traditional tax planning, which are:

Make any anticipated capital asset sales now while the 15% capital gains tax rate is still around.
If you have a C corp, and are anticipating distributing Earnings & Profits - make the dividend now while 15% dividend tax rate will be around.
Accelerate all revenue streams (i.e. complete contracts, etc) to have as much in 2008.
Exercise any employee stock options now - it might be better with 15% tax rate in a crappy market than 25% in a good market. Then again, we don't know where the dividend rates are going, they might go back to the top marginal rate.
Accelerate your gifts for 2008 and consider electing to pay gift tax. Minimize the estate and gift out as much in anticipations to changes to gift and estate taxes.

This is some of the things that people are doing right now. Miami Dolphins owner Wayne Huizenga has already said that he will now attempt to sell his remaining 50% interest in the team in 2008 rather than in risk substantially higher promised future capital gains tax hikes by the democrats. Huizenga said " He wants to double the capital gains tax, or almost double it. I'd rather give it to charity than to him."

Remember, this is generally one of the reasons why increase in marginal tax rates don't work - people with the means to plan accordingly, do so. Hint to the Democrats - if you really want to raise revenue, expand the base and lower the rate. But then again, Obama has said that he will forego revenue in the name of "fairness".

Well, the bright side is that CPA's like myself will continue to be employed and see additional work as people try to figure out the inevitable tax changes that are being anticipated.

Barrack Obama = Pierre Elliott Trudeau

2008-11-03T21:51:00.002-05:00

It has been almost 25 years since Trudeau left 24 Sussex drive, and we are still dealing with the wreckage of his policies (Constitution, NEP, welfare state). Their lives are parallel in many ways. Check out the wiki post on PET. Ignore the Liberal hagiography of his political accomplishments - ask any Albertan about the NEP.

America, you've been forewarned.

A modest tax proposal

2008-10-26T10:36:00.002-04:00

We have heard enough about what the candidate's tax plans are. We know the current system is complex, and distorts economic decisions, and on some levels - unfair.

Ideally, I think the 16th Amendment should be repealed. Washington should not have been given the ability to tax income because it gives too much money, and thus too much power to meddle in our lives. Ideally, a 10% VAT, excise taxes, and modest duties should cover the duties that are the prescribed powers of the federal government per the constitution. But let's just admit that is not happening any time soon. Sorry fair taxers, we're stuck with the income tax for a while.

So what principles do we want for an income tax system. I would propose the following:

That it raise sufficient revenue to cover necessary government expenditures (sorry - this would probably mean a realistic downsizing of the Washington - i.e. no more department of education.
Not distort economic decisions - it should try all types of income the same - a person making $100K/year only as salaries should pay the same amount of tax as someone who makes $100,000/year on dividends.
Everyone should pay a de minimis tax. I do not believe that people should not have to pay tax if their income falls below a certain level - citizens should all bear a minimum burden for the government they want so that they do not become detached from the costs of running it.
Not be burdensome on those of modest means.
Simple to administer (this is tricky, you will still need a ton of volumes to define things, even a simple income tax needs to determine a lot of things).

So this is kind of what I came up with.

Income tax with one bracket of 20%.
All income taxed at same rate - interest, dividends, capital gains, wages...
Capital gains is determined with a CPI adjustment in order not to be taxed on inflationary changes in prices.
Capital losses are 100% deductible immediately.
Only itemized deduction is charitable contributions - but with no income limitation. No more deduction for state and local taxes (subsidizing those living in high tax states) and mortgage interest (no more distorting the housing market and putting renters at disadvantage).
Standard deduction of $10,000/filer and $5,000 per dependent. Married filing joint with two children have $30,000 deduction.
Minimum tax is $250 - regardless of income.
Contributions to tax deferred retirement accounts deductible - no limitations. However, early withdrawals subject to 15% penalty.

James Grant on the credit bubble - WSJ

2008-10-19T10:55:00.002-04:00

James Grant is one of my favorite market commentators. Read his article in the Wall Street Journal on the confidence game that is the US dollar and credit markets. The key passage in my opinion:

But it wasn't the vigilance of monetary policy that facilitated the construction of the tree house of leverage that is falling down on our heads today. On the contrary: Artificially low interest rates, imposed by the Federal Reserve itself, were one cause of the trouble. America's privileged place in the monetary world was -- oddly enough -- another. No gold standard checked the emission of new dollar bills during the quarter-century on which the central bankers so pride themselves. And partly because there was no external check on monetary expansion, debt grew much faster than the income with which to service it. Since 1983, debt has expanded by 8.9% a year, GDP by 5.9%. The disparity in growth rates may not look like much, but it generated a powerful result over time. Over the 25 years, total debt -- private and public, financial and non-financial -- has risen by $45.1 trillion, GDP by only $10.9 trillion. You can almost infer the size of the gulf by the lopsided prosperity of the purveyors of debt. In 1983, banks, brokerage houses and other financial businesses contributed 15.8% to domestic corporate profits. It's double that today.

The dirty secret of Obama's job creation tax credit

2008-10-13T20:27:00.002-04:00

So Obama is now proposing a temporary tax credit of up to $3,000 for firms that hire new workers. I'll tell you why it is a scam, and is typical of the sound goods on the stump/sucks in reality:

The full credit doesn't kick in till $75K. Most new jobs are well below that.
If they business is a S-corp/partnership - Obama's proposed income tax increase and FICA limit increases will not be offset by this credit.
If you are a Schedule C/S-Corp/Partnership - the credit in all likelihood will not be creditable against AMT. Most tax credits are not good for AMT for individuals. So, you might get the credit for regular income tax, but then it'll be taxed right back under AMT.

Basically - the credit is useless for small business. When taxpayers normally talk about tax credits - they never work because the bulk of them are not creditable against AMT.

To John McCain: Campaign advice from Herm Edwards

2008-10-11T09:33:00.001-04:00

There are opportunities in the markets

2008-10-10T21:03:00.003-04:00

What I love about panics like this, is that there are some great companies now on sale. I see many well run companies now at valuations where I can envision buying them. I have become, though experience a Graham/Dodd value investor. For those of you who aren't familiar - this is classic value investing - placing emphasis on a strong balance sheet and buying stock priced with a "margin of safety".

We have been due for a sustained bear market for a while. We haven't had a real one since the 70's. The media and most people do not remember what a sustained bear market is like, as most of us were too young or not born yet to fully grasp it. It is a bit of a shock, as too many people have been conditioned to think of perpetual growth in the markets with minor dips here and there.

Everybody needs to chill out, and just understand that it is not the end of the world. The markets will eventually sort itself out as they find natural support levels and stabilize. The best things people can do is save, pay off your debts, and start looking for investment opportunities in the markets.

To paraphrase the great emerging markets manager Mark Mobius - "the best time to buy is at the point of maximum pessimism". Keep that in mind when watching the market. Those who keep their heads on a swivel and have cash available will reap the rewards.

This is what I think Obama's Tax Policy will end up being

2008-10-09T20:18:00.003-04:00

I've been a CPA for almost 6 years know, and in the financial services industry on and off for the last 15. Based on those experiences, I can say I have a good understanding of both items. Well this article about Congressional changes on pension plans show that there is no limits to the obtuseness of both Democratic Congressmen and academics. A brief passage:

“With respect to the 401(k), it appears to be a plan that is not really well-devised for the changes in the market,” Rep. George Miller, D-Calif., said.

“We’ve invested $80 billion into subsidizing this activity,” he said, referring to tax breaks allowed for 401(k) contributions and savings.

With savings rates going down, “what do we have to start to think about in Congress of whether or not we want to continue and invest that $80 billion for a policy that is not generating what we … say it should?” Mr. Miller said.

Congress should let workers trade their 401(k) assets for guaranteed retirement accounts made up of government bonds, suggested Teresa Ghilarducci, an economics professor at The New School for Social Research in New York.

When workers collected Social Security, the guaranteed retirement account would pay an inflation-adjusted annuity under her plan.

“The way the government now encourages 401(k) plans is to spend $80 billion in tax breaks,” which goes to the highest-income earners, Ms. Ghilarducci said.

That simply results in transferring money from taxed savings accounts to untaxed accounts, she said.

Where do I start on this? Needless to say, this really got me riled up. How this is so wrong:

The idea of retirement accounts and the corresponding tax deductions was to encourage people to save. Savings means capital for economic growth. The U.S. has one of the worst savings rate in the industrialized world. This would encourage consumption and deter investment. We complain now how all these Sovereign Wealth Funds are buying up all the companies and real estate in the U.S. They will own a lot more once Americans are deterred from saving.
The other part of 401(k) plans is that the taxpayer gets a deduction now, all growth in the account is tax free, but the catch is that all withdrawals from the account are taxable as income. Phasing out or eliminating the deduction for 401(k) plans would result in double taxation for many taxpayers.
Does Representative Miller mean that only 401(k) plan deductions be taxable? What about contributions by employees to big fat unionized defined benefit plans? If we are talking about taxing contributions to retirement accounts as a subsidy, shouldn't we throw in defined benefit plans, SEPs, IRAs, SIMPLE, Keogh plans as well?
The individual 401(k) limit is $15,500 if under the age of 49 and $20,500 if over 50 for 2008. An individual in the top bracket would get a reduction of income tax to the amount of $5,425 - but they would have to make at least $357,700 filing joint for the maximum bang. If someone is in that bracket, they are paying roughly north of $100,000 in federal income tax. I don't think this is such a huge "loophole for the rich"
Teresa Ghilarducci is a retard. Period. "Congress should let workers trade their 401(k) assets for guaranteed retirement accounts made up of government bonds" Hmmm.. hasn't Ghilarducci heard of social security? In case she hasn't it is essentially a guaranteed retirement account made up of government bonds (in theory, but I bet congress would raid your retirement account like it does social security). It is going insolvent in the next couple of years.
Government bonds have underperformed the stock markets historically. This plan would impoverish savers by limiting their returns to fixed income securities, even if you include this recent meltdown. Even though investors "lost" $2 trillion in the past month due to the stock market turmoil - most investors are in for the long term. They are paper losses until one sells. To reiterate - over the long run, stocks outperform bonds.

This is just wrong wrong wrong on so many levels.... cradle to grave! We're on the road to serfdom and the pedal is to the metal. Someone has to straddle this road and scream "stop"!

The End of the Beginning

2008-10-05T10:22:00.002-04:00

With the passage of the rescue package by Congress, we have started the next phase of this contagion.

I cannot say that this package will have any effect outside of psychological. It might help settle the overnight LIBOR rate drop from its record highs as some confidence comes into the system. The problem is, like a lot of things that get passed as legislation these days, is that rushed bills like this are like a condom - they let you feel good when in reality you're getting screwed. Perhaps that is a harsh judgement, but the problem we have here is primarily about capital, not illiquid assets.

Let me put it to you this way, any institution who sells their toxic assets at a fair value to the Treasury for government bonds is only exchanging an illiquid asset for a liquid asset. While this may help the liquidity of the institution in question, it does not address the problem that it is woefully undercapitalized. Insufficient capital leads to bank runs, and the inability of banks to make new loans and extend credit. In other words, we still will have a significant contraction of lending as banks still de-lever their balance sheets.

And we have not addressed how the "shadow banking system" of hedge funds and SIVs are going to get clobbered on this. They, as it stands to the best of my knowledge, are not eligible for the rescue plan. They will have to liquidate their positions as they lose capital to redemptions. Hundreds, if not thousands, of hedge fund will be going bust as they face increasing redemptions, the inability to refinance on the commercial paper market, and with large illiquid toxic assets on their balance sheets. This gradual unwinding of trillions of dollars of assets and liabilities will depress the stock markets for at least another year.

So, looking into the crystal ball, I see the following trends for the next year or two:

Several large banks will still fail and will be taken over by the FDIC. Dozens, if not hundreds, of regional and local banks will be too.
The S&P 500 will drop below 900 points by the end of 2009. We should expect a 25% decline in the markets as companies continue to de-lever.
Credit card and auto loan defaults will hit record highs over the next year.
Home prices, as measured in the S&P Case-Shiller index, will bottom out for most markets by Q1 2010.
Depressed demand will bring oil down to under $70/barrel.
Gold will be off its record high, but not much due to the debasing of the U.S. dollar that this rescue plan creates.
One of the big 3 automakers will not exist as a stand alone entity (either bought out or Chapter 11) by the end of 2010.

Updates on Financial Meltdown

2008-09-20T09:39:00.003-04:00

Wow,

There is a lot of blame to go around for what is happening. I found out from my reading that the SEC exempted 5 broker dealers (Merrill, Goldman, Morgan Stanley, Bear Stearns, and Lehman) from SEC leverage limits in 2004.

To recap, let us look at the government's role in all that (notwithstanding the fact that borrowers and lenders are just as much to blame). It is just another example of unrelated changes in government policy can cascade into financial disasters:

The Federal Reserve in the mid 1990's until recently - abandons all pretense price stability, continues to recklessly expand the money supply. The result was a weak U.S. dollar and artificially low interest rates. This encouraged financial institutions and hedge funds to significantly leverage their balance sheets to goose up returns. If we assume short term debt is at 3%, we lever 24-1 into a trade that makes 5%, our return on invested capital is 53% for the year. Trades with small returns highly levered in a low interest rate environment create massive returns on capital. However, small losses wipe out capital - which eventually happened.
Mark-to-market accounting - accelerated this, distorting equity in these firms in upswings (thus allowing firms to take on more risk) and pushing the insolvency in downswings. That, coupled with the fact that a lot of these assets have no real liquid market for determining fair market value.
Capital requirements by the Fed under BASEL II used backward looking risk models that provided a feedback loop. Using data from the last 20 years, essentially an extended bull market distorts the effects of low-probability, model changing events. These risk models helped exacerbate the Mexican Peso crisis . A risk model that is looks at the "fat tail" events and is more principal based would probably be wiser.
Congress' enforcement of the Community Reinvestment Act under the Clinton administration (I wrote about this earlier, but the best source on this is from the City Journal, which is more thorough) essentially compelled lenders to provide loans to uncreditworthy people.
The tax system - with the mortgage interest deduction and property tax deduction is a government subsidy to home ownership that doesn't help.
Freddie Mac and Fannie May were political entities that were told by their congressional masters to push more home ownership for people who shouldn't.

That's the short list ..

The Economic Case for T ax Havenx

2008-09-16T06:59:00.000-04:00

H/T: Redstate

Strange, isn't it

2008-09-01T22:07:00.002-04:00

That we find out within 48 hours of Bristol Palin's out-of-wedlock pregnancy, but it takes months for the MSM to cover John Edward's lovechild?
We hear the MSM coverage of Palin's alleged involvement in the firing of her state trooper brother-in-law and promises by the MSM to properly "vet" her, and yet, how much investigation has the MSM done regarding Obama's relationships with Tony Rezko, Jerimiah Wright, and Bill Ayers?
Hearing the MSM talking heads stating Palin is "unqualified" to be VP based on her term as Mayor and two years as governor, yet we haven't seen similar comments about Obama's experience as a state senator or less than one term in the U.S. senate.

If this isn't the media in the tank for Obama, I don't know what is...

Obama's Tax Plan - why it won't work

2008-09-01T12:37:00.003-04:00

You cannot cut taxes on the "middle class" much more than already.

What I mean by this, is that the bottom 50% of households don't pay any income taxes or very little. I calculated in a prior post that a family of four making $50,000 filing joint with two children pay roughly $1,500 in federal taxes using only the standard deduction. This would be less if they itemize. Now mind you, $50,000 is above the median income, but is a good proxy for "middle class" for most of the country. So the median family has an effective income tax rate of 3.5% How can you cut it more, Barrack? The top decile already pay the majority of income taxes.

So based on this, there is a limited amount of ways to cut taxes on the "middle class" based on this. Second, there are not enough "rich people" to soak with massive tax increases. Most of these people will just work less, thus depressing tax revenues. So the only way to the Democrat's tax plan to work is to define "rich" as low as possible - probably to the point where you're rich if you're employed.

Transformative Candidates

2008-08-31T08:26:00.002-04:00

A few days of digesting Obama's acceptance speech in Denver has brought some perspective "transformative" candidates. Everyone talks about how X or Y is "transformative" as a candidate. That is utter B.S. A candidate is never transformative, only when elected do they have the ability to become that by action, not deed.

Barack Obama is NOT a transformative politician. He is quite conventional in many ways, but he is exceptional in his ability to give prepared speeches. His acceptance speech was quite conventional, the laundry list of liberal programs, criticisms of the current administration and candidate, and platitudes of hope and unity going forward.

Transformative politicians change the political roadmap for generations. They are few and far between. Examining U.S. presidents, the truly great ones changed the political landscape for generations. Think Lincoln, FDR, and Reagan. Obama's record and rhetoric shows he only wants to transform America into a socialist state.

Classic Bob Hope

2008-08-25T17:57:00.001-04:00

I almost forgot this priceless Bob Hope clip.

H/T Dirty Harry's Place.

Barack Obama = Ron Burgundy??

2008-08-21T22:10:00.003-04:00

I'm telling you right now - Barack Obama is Ron Burgundy. He will read anything on a teleprompter like a god among men, but is useless without one. Ron Burgundy will read anything put in front of him. I'm wondering when "the one" will have his moment like poor Ron above.

Accounting gimmmickry...

2008-08-08T05:42:00.002-04:00

For those of you who like to invest in individual stocks in the market: read the financial statements. I am a traditional Graham-Dodd value type (most of the time) who likes to dig through the financial statements and find equities that trade below "intrinsic value" so that I have a margin of safety in a down market.
In light of the downturn in financial stocks as of late, and the corresponding collapse in the housing bubble, there are buying opportunities out there to purchase solid companies at discount prices. But, not all companies are created equal.
One of my biggest negatives on a company are accounting issues. During the tech bubble, a lot of companies (i.e. Nortel) were playing fast and loose with revenue recognition rules to front load as much of it as possible. Others were playing with the valuation of officer stock options. Others just took accounting policies that were too aggressive or down right misleading.
Case in point: Wells Fargo (WFC/NYSE) came out with stronger than expected second quarter earnings (i.e. a profit) on July 16th and the stock price jumped from $20.51 at the close of the prior day to $27.23. However, upon further examination of their earnings, things were not a rosy. A little change of their accounting policy for home equity loans explains it. In prior quarters, Wells Fargo would write off any home equity loan that was in arrears for greater than 120 days. However, at the start of the second quarter, they changed this to 180 days. My changing the criteria of when a loan was to be written off, they essentially added roughly $265 million to their earnings - turning a loss to a gain in the case of Wells Fargo's second quarter.
The worse part of this is that considering how many home equity loans they had in the housing bubble epicenters of California and Nevada, where the drop of home values they loans are essentially now unsecured, that the better accounting policy would be to more aggressively write off these positions? Wouldn't you, as a shareholder or depositor, show you a "worst case" balance sheet where there is less likelihood of downward surprises rather than overly optimistic guesses that have read downside?
As I said earlier, I don't like companies that play games with their accounting, as it reflects poorly on management in terms of performing their fiduciary duty to shareholders.

Next time Chuck, better to shut your pie hole!

2008-07-12T15:58:00.002-04:00

The seizure of IndyMac Bancorp by Federal regulators yesterday afternoon was a result of a bank run by depositors. How did this run start. Well, Senator Chuck Schumer (D-NY) commented publicly that the bank was insolvent and the regulators should take it over. When you're a prominent Senator on the finance committee, every word you say has ramificaitons. Now, your stupid comments caused a bank run.

Perhaps next time he opens his mouth, he should have to put $200,000 in each bank he mentions by name. That should help.

Freddie, Fannie, IndyMac, and one big banking mess.

2008-07-12T15:23:00.002-04:00

What a mess of a week. First Fannie Mae and Freddie Mac become technically insolvent, and the financial institution IndyMac fails and is taken over by the Fed. The problem with the GSMs is that they have over $5.1 trillion of guarantees on mortgages and under $50 billion in equity on a market cap basis. That is a leverage factor of over 100-1, greater than most hedge funds, and much greater than Bear Stearns, Lehman brothers at the beginning of their respective troubles. Add to this equation, fraudulent accounting, political cronyism, and a congress that has ordered it to start guaranteeing loans up to $700,000 (from $400,000) and passed lesiglation having it guarantee another $300 billion of the banks most toxic debt.

This is not good, and fixing it will not be cheap. If congress decides to explicitly guarantee their debts, we are looking at another $5.1 trillion of government debt. This will severely hamper the ability of the government to borrow (not necessarily a bad thing), probably result in higher taxes to service this debt (very bad), drastic reductions in government spending (good) and entitlement reform (good), but also in a real decline in American's standard of living as the dollar would tank (very bad).
The less expensive option would be for congress to shore up the GSMs balance sheet with about $100 billion of preferred equity, and slowly start winding up the two companies over time. This would take several years, but would keep all the guarantees off of the federal government's balance sheet. After the windup, the companies would be dissolved and this monstrosity of a program could be abolished.

These programs show what happens when the government creates moral hazard by distorting the credit markets with guarantees. The reality is that a lot of people who own houses should not be owning houses, and government policies (Freddie, Fannie, the mortgage interest deduction, and deductions for property taxes) distort the true cost of housing.

Confirmation of my thoughts on bumper stickers

2008-06-29T21:20:00.002-04:00

I have always thought that a factory option on a new Prius, Scion, or Honda Escape was a choice of the "Obama 2008" or "Coexist" bumper sticker. This article explains a bit more of the phenomenom.

A tip of the hat to Captain Capitalism for this.

Top Ten Communist Jokes

2008-06-20T18:08:00.001-04:00

These are classics!

1) Three workers find themselves locked up, and they ask each other what they’re in for. The first man says: “I was always ten minutes late to work, so I was accused of sabotage.” The second man says: “I was always ten minutes early to work, so I was accused of espionage.” The third man says: “I always got to work on time, so I was accused of having a Western watch.”

And here are the nine runners-up:

2) An old man is dying in his hovel on the steppes.
There is a menacing banging on the door.
‘Whose there?’ the old man asks.
‘Death ‘comes the reply.
‘Thank God for that,’ he says, ‘I thought it was the KGB.’ A KGB officer is walking in the park and he sees and old Jewish man reading a book.
The KGB says "What are you reading old man?" The old man says "I am trying to teach myself Hebrew."
KGB says "Why are you trying to learn Hebrew? It takes years to get a visa for Israel. You would die before the paperwork got done."
"I am learning Hebrew so that when I die and go to Heaven I will be able to speak to Abraham and Moses. Hebrew is the language they speak in Heaven." the old man replies.
"But what if when you die you go to Hell?" asks KGB.
And the old man replies, "Russian, I already know." Larry Rasczak
Dan Sweeney

3)Pravda announced that it welcomed letters to the editor. All correspondents were required to include their full name, address and next of kin.
Neil

4) Q. "Why do the KGB operate in groups of three?" A. "One can read, one can write and one to keep an eye on the two intellectuals."
Lee Jakeman

5) Leonid Brezhnev pays a state visit to France and he's given a VIP guided tour of Paris. He's conducted round the splendours of the Élysée Palace, but remains as stony-faced as ever. He's shown the masterpieces of the Louvre, but the curators fail to get any reaction out of him. He's taken to the Arc de Triomphe, but displays not the slightest interest. Eventually, the official motorcade drives him to the foot of the Eiffel Tower, where Brezhnev finally stares up in amazement and astonishment. He turns to his French hosts and asks in bewilderment: "But, Paris is a city of 9 million people... surely you need more than one watchtower?"
(first heard by me in the Brezhnev era)
Geraint Jennings

6) Stalin decides to go out one day and see what it's really like for the workers, so he puts on a disguise and sneaks out of the Kremlin.
After a while he wanders into a cinema. When the film has finished, the Soviet Anthem plays and a huge picture of Stalin appears on the screen. Everyone stands up and begins singing, except Stalin, who smugly remains seated.
A minute later a man behind him leans forwards and whispers in his ear: "Listen Comrade, we all feel exactly the same way you do, but trust me, it's a lot safer if you just stand up."
Robert B

7) A man saves up his ruples and is finally able to buy a car in Soviet Russia. After he pays his money the he is told he will have his car in three years.
"Three years!" he asks "What month?"
"August"
"August? What day in August?" He asks
"The Second of August" is the reply
"Morning or Afternoon?"
"Afternoon. Why do you need to know?"
"The plumber is coming in the morning."
Mark

8) Why do ex-Stasi officers make the best Berlin taxi drivers?
Because you only need to tell them your name and they'll already know where you live!
Will

9) Moscow in the 1970s. Deepest winter. A rumour spreads through the city that meat will be available for sale the next day at Butcher's Shop no. 1.

Tens of thousands turn up on the eve of the event: wrapped up against the cold, carrying stools, vodka, and chessboards, they form an orderly queue.

At 3 am the butcher comes out and says, "Comrades, I've just had a call from the Party Central Committee: it turns out there won't be enough meat for everyone, so the Jews in the queue should go home."

The Jews obediently leave the queue. The rest continue to wait.

At 7 am, the butcher comes out again: "Comrades, I've just had another call from Central Committee. It turns out there will be no meat at all, so you should all go home."

The crowd disperses, grumbling all the while: "Those bloody Jews get all the luck!"

First tech stocks, then real estate, now oil

2008-06-07T14:45:00.006-04:00

I can now say, based on the chart (left) that Oil is now in a "bubble" - where fundamentals or rational analysis have nothing to do with valuation.
The market is ignoring new significant finds in China and Brazil, declining demand due to economic softening., among other factors. Yes, the US dollar is tanking, but that does represent the run up in price (see right) over the past two years. Fundamentally, with the dollar where it is, my stab is that "fair value" is closer to $70 than $130.

Comapre with the run up of the NASDAQ 100 from 1995 through 2001 (below):

Notice the similarities - starting in 1998, the NASDAQ 100 stopped trading on fundamentals, with speculators (i.e. day traders) making wild profits, IPOs being easy money, and talk of a "new paradigm" of valuation, where analysts justify even wilder P/Es even through cash flows and sales don't support them.
My experience on this was first hand. I was working as a broker for a firm up in Canada, and I have several stories about the irrationality of investor behavior. I had one client - married couple, whom I invested their RRSP (for those of you in the US, think IRA) in a balanced portfolio of stocks - both domestic and international, some growth and some value, bonds, and cash. They had a 12% total return in 1998 and they fired me because their friends where invested in tech and were averaging 35%/year and were furious that I wasn't making them 20%+. I had another client who kept buying Nortel stock, even though I did a comprehensive analysis showing it was way overvalued - when it finally tanked in 2001, the client lost $4 million from the time I pleaded with him to sell.

Now, since I'm on a chart fetish, lets look at US real estate prices using the Case-Shiller Index. This chart from the New York Times shows you the run up through mid 2007. As we know, the index has dropped precipitously since then:
We are all aware of this chart - once again, the same facts. An asset (Oil, Tech stocks) starts showing appreciation, then speculators jump in. Initially there are easy profits and they are disproportionate relative to historic returns. As speculators continue to enter the market, pricing no longer is based on fundamentals (in the case of housing, it has no bearing on median income) driving beyond reason until there are no more marginal buyers and the prices collapse.
There is a historical pattern. It repeats itself because human nature is constant. When there is easy profits, speculators jump in, drive up the price well beyond fundamentals, until a point where there there are no marginal buyers and the price collapses from lack of demand. The question at hand, though, is when will the tipping point occur, and what will the top be. We'll only know in retrospect.

Finally.. more Shatner!!!

2008-06-02T18:56:00.003-04:00

I think this one takes the cake. If I didn't know better, I would say he was Jim Lahey drunk.

Even more craptacular - Shat-tastic!!

2008-06-02T18:51:00.001-04:00

This, I think is worse!

Craptacular Nimoy

2008-06-02T18:50:00.001-04:00

This is absolutely priceless. Nimoy at his worst!

Three Cheers for Vaclav Klaus

2008-05-31T15:13:00.002-04:00

Of course, it would take a resident of a former communist country to point out the obvious similarities between the modern environmental movement and Marxist-Leninism. But this essay is a must read!

It is a stark reminder that the green movement is a watermellon: green on the outside and red on the inside.

EU Referrendum in Ireland

2008-05-31T14:55:00.003-04:00

Voters in Ireland have an opportunity to vote on ratifying the Treaty of Lisbon on June 12. This would integrate Ireland under Brussel's control. As it has been in other countries, all the political parties are in favor of this, but it still looks possible that it could go down in flames.

The Irish would do well to cherish their hard won independence and vote "no". A yes vote would in all likelihood result in the Celtic tiger being bogged down in high taxes, excessive regulation, and a flood of immigrant - stagnating wages and the economy. On top of that, an unresponsive Brussels would dictate by fiat the end the Irish identity.

Look across the Irish Sea at Britain: do you want that kind of decay at home?

Stupid ideas week

2008-05-18T15:33:00.004-04:00

It appears that this past week has been ripe with stupid decisions. For example:

The EPA has ruled the Polar Bear is a threatened species. This is a back door implementation of Kyoto in the U.S., as almost any project can now be challenged by tree huggers by stating that any greenhouse gas emmisions anywhere in the U.S. threaten the polar bear. Never mind the dubious science, just think of the costs that consumers will pay as any electric plant, refinery, factory, oil platorm, aggregate plant will now have millions in compliance costs from lawsuits. Hugh Hewitt has more on this.
A Canadian court has delayed the Kearl oil sands development by Imperial Oil, citing environmental concerns. This will ensure that energy independence will be a pipe dream without a significant decline in standards of living. The hypocricy of the left on this matter, who decry high energy prices while doing everything in their power to prevent practical solutions.
The U.S. House of Representatives passed a pork laden farm bill, providing billions of dollars of subsidies to millionaire farmers during times of record crop prices. This is a bill that should be vetoed, as it takes tax monies from American families to subsidize millionaires while doing nothing to address rising food costs.

If I didn't know better, it is the 1970's redux. Seems like it only takes elected officials 25 years to ignore the errors of the past. I'm waiting for WIN (Whip Inflation Now) buttons, price controls, gas lines, pet rocks, and disco to come back.

Hitchens on the Obama two-fer

2008-05-06T06:28:00.002-04:00

Christopher Hitchens asks a pertinent question: with Barrack and Michelle Obama, are we getting another two-for-the-price-of-one deal like the Clintons? He digs into the Obama's background and comes up with some disturbing answers.

Joy Division - looking back

2008-04-19T09:08:00.003-04:00

I've been on a Joy Division kick the past few months, revisiting a band I used to listen to a lot when I was younger. I find that even at this stage of my life, being a lot older, wiser, etc.. I still find the band as compelling as I did then. The haunting themes of Ian Curtis' lyrics still resonate with the passage of time, and show glimpse into the tortured soul that was Curtis.

My personal favorite song is "New Dawn Fades" from the album "Unkown Pleasures". Better yet, pick up the 4 CD set called "Heart and Soul". Here is a bootleg video of the song:

The mortgage mess

2008-04-05T08:07:00.008-04:00

Listening to congress, the Federal Reserve, and the Democrats discuss "the credit/mortgage crisis" is pretty depressing at times. There is plenty of blame to go around:

The Federal Reserve has to take its share by creating a credit bubble with articifically low interest rates from 2003-2006. Their easy credit policies started the dot.com bubble then migrated towards the housing market. They created excess amounts of money which went into housing speculation. Worse of all, the Fed appeared to abandon all pretenses of protecting the integrity of the dollar from depreciation and inflation and looked to manage economic growth - a fool's errand. Part of this was using "core inflation" as a key target. Ignoring spiraling energy and commodity costs belies the real inflationary pressures that most families have to deal with in their budgets. As a result, American's have suffered a real drop in their standard of living due to this deliberate devaluation of the dollar, which must be remedied - dynamic economies do not survive on a weak dollar that masks structural weaknesses. It can also be argued that expanding the discount window to non-brokers in the circumstances it did to Bear Stearns/J.P. Morgan is unconstitutional. Although probably necessary - such actions should require an act of congress. Judge Andrew Nepalontano on Fox Business News strongly believes that such actions violate the general welfare clause of the constitution - which prohibits direct handouts to individuals and businesses.
Congress - despite all the preening about caring about the "poor homeowners" Congress did it's part in cultivating this problem. Congress had many policies to foster home ownership - often to people who should not be buyers due to bad credit. The Community Investment Act essentially forced banks to lower their credit standards to questionable borrowers to help low income communities. The mortgage interest deduction and property tax deduction gives a tax subsidy to homeowners over renters, further distorting the costs of home ownership over renting. Some of the few saner voices in Congress have noticed this. I can't believe I'm saying this, but Barney Frank (D- Mass), Chairman of the House Banking Committee has said as much, stating that government policies create too many home owners and not enough renters. Current proposals to "fix the problem" only create moral hazard for marginal borrowers who should not have been owners or speculators who could never afford the houses to begin with. Finally, the issues with the "shadow banking system" of broker-dealers were never addressed with the end of the Glass-Steagall act in 1999. Though Congress at the time did not know at the time the ability of these firms to be critical cogs in the banking system, it is another example of the unintended consequences of legislation.
Loan securitization - securitization of pools of mortgages started in the late 70's/early 80's, but really took off in the past ten years. The prime driver of this was record low long-term interest rates on Treasuries. With so many institutional investors hungry for yield, as many were required to have minimum fixed income positions, the investment banks stood ready to securitize loans to these investors. The rating agencies slapped a AAA rating on some of the tranches, pocketed the fees, and repeated. This created a viscious circle - lower interest rates created greater demand for additional yield, which created lowered lending standards to create product and nice investment and ratings fees. Securitization also created more revenue for financial institutions than holding them to maturity. If more of these loans were held on the balance sheet, they would be more thorough in terms of due diligence.
Risk models - all financial institutions use modeling to determine the amount of risk their investments have to a significant decline. These models are quite complex and use a lot of historical data and assumptions. These models, while helpful, have two fatal flaws. The first flaw is that many of these models assume that returns are normally distributed - it under-estimates losses at the extreme ends of of the curve where most statistical relationships fall apart. The second problem is that it fails to account for changes in behavior. In this case, it assumed that homeowners with zero equity in the house would behave the same as homeowners with a significant amount of of equity in the house in the form of a large down payment. People purchasing houses "no money down" have no financial incentive to stay in the homes once they are in a negative equity position - thus the "jingle mail" phenomenon. It appears that these risk models never figured that part
Developers. I worked with a lot of construction clients over the years, and many of these people are really smart and successful. What I don't understand is how they could keep building when there is all this supply lying around, thinking that it will sell quickly. The first rule of any business is to minimize inventory - and when stuff sits unsold, then it is time to stop building and take a vacation. Nope, can't do that. Then on top of it, selling properties to people probably have a good idea that they can't afford the house; no worry to them - FHA normally bailed many of these people.
Borrowers. If you are looking to buy a home, there are a few cardinal rules: (i) have a good size down payment (i.e. at least 5-10%); (ii) mortgage, taxes, and insurance should take up less than 1/3 of your gross monthly pay with a standard 30-year fixed; (iii) the maximum home price you can afford is roughly 3 1/2 times your annual pay. So, with this in mind, are we surprised that there are foreclosures involving borrowers who bought with no money down for homes that are 8-10 times their income? I have an additional rule - couples, do not buy a home assuming both of you will be working. If you buy based on one income, there is always a good cushion and it opens up more work/life options.

Interesting reading

2008-03-29T08:59:00.002-04:00

I found this Wall Street Journal article about Hyman Minsky. He was a "post-Keynesian" economist whose writings focused on the inherent instability of financial markets. I found his writings were a good summation of the behaviors that cause financial bubbles. Taken together with one of my favorite books, Mackay' s "Extraordinary Popular Delusions and the Madness of Crowds" - it gives a good explanation of how bubbles happen and burst.

What it should remind people, especially politicians, that human behavior has been a constant throughout existence. Bubbles have happened before, and will happen again.

The week in review

2008-03-29T06:44:00.002-04:00

Random observations...

I was in California for parts of last week, just North of Los Angeles. Beautiful area. I can see how living with perfect weather can make the brains go mushy with silly ideas. I found an eerie new age totalitarianism at my accommodations. The ambient music (though not as good as Brian Eno, and with hints of Zamfir) at beyond ambient volumes, the excessive notices such as "this building may contain materials, known to the State of California, to cause cancer..." These notices are the face of the maternal fascism. It explains why businesses are leaving the state in droves for more hospitable locations.

Notice the differences between Kwame Fitzpatrick and Eliot Spitzer. Spitzer resigned once all the legal troubles came out. Kwame is still fighting. Eliot couldn't tough it out because he alienated too many people in his own party - the Democratic party in Albany was not going to go to the mat for him. Kwame still has a base, one that does not show up in the polls, and was the basis of the late Detroit mayor Coleman Young's electoral success. Kwame figures he can hang tough and get support by casting himself as a victim of a media inspired "lynching" - playing that card as much as possible. It got him re-elected in a tough campaign against Freeman Hendrix where polls showed Fitzpatrick trailing significantly. Another black mark for the city of Detroit.

Obama's stupid tax plan. Where do I start? First - exempting seniors who make under $55,000 from income tax (they'll be responsible for bankrupting Medicare and Social Security and we want to reward them by not having them pay taxes?)!? Second, he wants to raise the capital gains tax to 25% from it's current 15% - that'll kill investment in a downturn. Finally, he wants to raise taxes on the rich, whom he defines as the top 20% of all taxpayers. Grab your wallets, because that top quintile begins at $75,000. I know a lot of people who make $75,000 per year and I would not call them "rich" by any stretch of the imagination. If you live in a high tax/high cost of living area like LA, DC, or New York, seventy five grand barely keeps you afloat. And I haven't even got around about his plans on expanding FICA taxes. If I was to summarize Obama's tax plan in one word, it would be "Canadian".

We're now in a solvency problem

2008-03-15T09:59:00.003-04:00

Now that we have hear news that Bear Stearns needed to be rescued by JP Morgan and the Federal Reserve to cover its borrowings, the real depth of the credit crunch is becoming apparent. We have moved from a liquidity to a solvency issue, where many non-bank lenders are now having extreme difficulty meeting their obligations. The LBO firm Carlyle group defaulted on an investment fund heavily invested in sub prime mortgage.

More and more firms will become insolvent as the assets backing their debts fall in value, forcing loans to be called and additional defaults. Bear Stearns will in all likelihood be acquired by another firm, as will many other companies who leveraged themselves to the hilt on easy credit.

The move by the Fed is a realization that monetary policy will do little to help the situation, and that partial nationalization of bad debts is the only way to avert a full solvency crisis. Better late than never.

All of these problems materialized because of a Federal Reserve, encouraged by a U.S. government that wanted perpetual economic growth, that kept creating money and generating excess credit and a devalued currency. The problem is that the Fed must allow the market to find a bottom and facilitate an orderly liquidation - delaying the inevitable by attempting to protect people from price drops will only exacerbate the situation.

Addendum:

It also appears that Lehman Brothers is having some troubles as well after the Bear Stearns debacle. This will bear watching.

First Kwame, now Elliott

2008-03-11T03:42:00.003-04:00

First it's Detroit mayor Kwame Fitzpatrick's text messages about his illicit affair with his chief of staff and potential perjury charges. Now it's New York governor Elliott Spitzer's involvement in a prostitution ring.

As we have seen with Kwame, we will see with Elliott - neither will leave voluntarily. They will cling to whatever vestiges of power they can. They have do regard for the shame and hurt they bring their families and their respective offices. To them, it's all about "me".

BTW - this also applies to Larry Craig too!

Daylight Savings Times Sucks

2008-03-10T07:18:00.002-04:00

I'm half awake, but I know John Miller of National Review is onto something on this scam.

What I know, what I'm somewhat confident, and what I think may happen

2008-03-09T13:10:00.005-04:00

Looking around at the economic and financial situation, I am drawn into making further analysis and comment based on the all the reading I have done on the topic as of late. So kind of wrapping up all this into a general piece of scribe, I decided that it would be more coherent if I broke things up into categories.

What I know (a.k.a. things I am pretty certain about):

We are just into the beginning of the credit crunch and the looming credit crisis. The sub prime mortgage market may only be the tip of the iceberg. There are major issues around the corner involving the solvency of monoline bond insurers, a potential cascade of muni-bond defaults, counterparty risk with credit default swaps, and other bad loans on the balance sheets of banks that have not been marked to market.

The bond insurers and rating agencies made fundamental errors in judging the risk of these mortgages. Credit standards in the past few years have been so lax that there was in the sub prime arena, no real effort to have collateral or prove ability to pay. When these crappy mortgages (which coincidently, had high degrees of fraud embedded in them, whether it be on the applicant or the mortgage brokers who initiated them) were securitized, the bond insurers took the money to guarantee them and the rating agencies gave those tranches a AAA rating.

The rating agencies and insurers made, in my opinion a fundamental error in behavior: they believed that homeowners would do what they traditionally do and pay the mortgage before anything else. However, the psychology of the home buyers in this bubble behaved differently (albeit rationally) than homeowners in the past. Traditionally, homeowners had put in a significant amount of money down in a purchase of a home (15-20%); with that amount of equity in a home, there was downside cushion for the lender, and the incentive for the borrower to continue to make payments, less they lose what equity they have in their home. Plus, there was a moral incentive to pay the mortgage, as there has been traditionally a shame factor in losing one's home in foreclosure. However, that sense of shame in society is well gone, and beyond the scope of this piece. The key point is, though, that a borrower has little economic incentive to continue to throw money into a mortgage when there is negative equity in the house. Add the fact that for most states, mortgages are non-recourse loans, which means in the event of default, the lender cannot sue the borrower for any deficiency. Thus the increase of jingle mail homes, where borrowers are just mailing in the keys to the house and walking away. Outside of their credit rating taking a bath, there is no real cost for borrowers to do this.

The bubble of easy credit fueled housing is starting to cascade through the entire financial system. The municipal bond market is now looking at a spate of defaults. First, the bond insurers are teetering on the brink of collapse from the CDOs they guaranteed, and now the muni bonds they have insured have problems. Many local governments, whose coffers were flush with cash from inflated property taxes and developer fees, now are in a cash bind with regards to all the bonds they issued during the fat times. Some localities will cut spending on services and other items and ensure that they make their loan payments on time. However, some localities will rather default on their debts than make the cuts in services necessary. Bloomberg reported that Vallejo, California is looking at defaulting on its debts. This is just the tip of the iceberg, as more and more localities will be hit with declining property tax bases.
Defaults in auto loans and credit cards are increasing sharply as well, but nobody really knows how much bad credit card debt there is out there.
This is not just an American problem. Britain, Australia, Western and Eastern Europe have similar issues with their housing markets and the debt that is financing it. The credit crunch is much more global than it has been in prior time.

So, who can we blame? Predatory lenders? Greedy real estate speculators? Well, yes, and yes. But if one person, overall, had to have this simmering crisis pinned on their chest, it is none other than Alan Greenspan. The Fed has implemented a massive monetary expansion since the mid 1990s. It has manifested itself in many ways during this time. It first fueled a capex (capital expenditure) bubble in the mid-1990's, which then gravitated to financial assets (i.e. technology stocks) later on. This excess money in the capex bubble led to deflationary pressures as companies kept high production volumes to cover the fixed charges. The excess money in the economy kept interest rates artificially low, with inflation a non-factor with China and other developing economies tempering those pressures. Then September 11th punctured the tech bubble, and it looked like that saner monetary policies would prevail: that there would be sufficient liquidity to provide an orderly liquidation of bad stock positions, increase in margin requirements, and then a reduction in the money supply to allow the economy to de-leverage from its current high-debt position. Alas, Greenspan and the Federal Reserve pumped more money into the system, and the reflation has resulted in a debased U.S. dollar, inflation, and a housing bubble from easy credit.
Now Bernake and company are trying one more kick at the can with pumping even more liquidity into the economy. The Federal Reserve has abandoned any pretense of fighting inflation or following a "strong dollar" policy, but is in full Keynesian mode of using monetary policy to fight of a recession. Meanwhile, holders of American dollars are seeing their holdings frittered away from inflation and devaluation - a much more sinister remedy than allowing an orderly (albeit painful) liquidation of excess supply and nonperforming loans off the balance sheet.
On the fiscal front, the outlook is even bleaker. Congress and the White House have shown no inclination at fiscal restraint. The Democrats want to implement major tax increases that would only exacerbate a tittering economy. Of course, that didn't stop Jennifer Granholm and the Michigan Democrats implementing the largest tax increase in state history in the midst of one of the worst economic crises as well. So, 2010 (expiration of tax cuts from 2001 and 2003 tax reform bills - i.e. 15% dividend and capital gains rates) is looming as a tipping point.
Any attempt by the Federal government to "fix" the sub prime problem is moot, and will be limited. Allowing bankruptcy judges to amend mortgage agreements would be a disaster on the long run, forcing borrowers to incur additional costs for a bankruptcy premium. Any "bailout" of lenders would have to be minor and targeted, as there is a growing backlash by responsible borrows who will resist having their tax dollars subsidize those who where irresponsible in their financial decisions.

What I think will happen:

This is going to get a lot fuglier before it gets better. If we look at ARMs and sub primes independent of the greater credit markets, a lot of this will not get worked out until 2009-2010, as resets work through the system. This, coupled with excess inventories of housing, will keep additional downward pressure on housing markets and bring them back to historic averages. If we look at the Case-Shiller Index of home prices, many markets still have 20-50% downside before they meet historic averages.
Lower interest rates won't help. Even if a lower rate refinancing would save you money, good luck getting an appraisal that will hold a mortgage if you bought near the top with little money down. The tightening in credit standards mean that most people will not be able to take advantage of low rates.
Credit Card and Auto loans will have increasing defaults. This ties in with the Greenspan excess money creating easy credit. One could say that a large part of the economic expansion in the past ten years has been debt financed consumer spending. The abrupt change in consumer sentiment, coupled with the evidence of a housing correction and slower economic growth, is leading people to de-leverage. People are either paying off their debts if they have the financial wherewithal to do so, or just defaulting on it and walking away, bankruptcy be dammed. The U.S. economy, if viewed as a balance sheet had inflated asset values, large amounts of debt, and little equity; this worked as long as interest rates stayed low and asset prices continued to climb. Now the asset prices are no longer supporting the debt loads, so leverage is now exacerbating that fall in prices.
Long-term interest rates are starting a long-term uptrend. Long-term interest rates are cyclical in nature, but the cycles are generational. We are ending a cycle whereby long-term rates were on a downtrend since 1981. This uptrend could last twenty to forty years, which is the historic norm.
Inflation will be with us for a while. It seems that people forget everything that happened more than a year ago, and now it is a repeat of "That 70's show". Even though Keynesian economics has been discredited by Milton Friedman and the monetarists, the powers that be are all sharing the believe that government manipulation of fiscal and monetary policy can "prime the pump" and avert a recession. I'm still waiting for the "Whip Inflation Now" buttons to come out and then price controls.
The question is what kind of investment strategy mitigates this risk. Well commodities and non-U.S. dollar assets seems to be a start. Real return bonds is the safest bet on the fixed income side. As for stocks, "buy very very cheap" is the first answer. The second answer is to look at stocks with a very strong balance sheet: low debt, lots of cash, and no accounting gimmicks.

George McGovern said what??

2008-03-08T07:55:00.004-05:00

I had to check the author again of this Wall Street Journal article by George McGovern titled, "Freedom Means Responsibility". These nuggets of wisdom actually came from the man often labeled as the most left wing president candidate in modern time. His insight was that,

Why do we think we are helping adult consumers by taking away their options? We don't take away cars because we don't like some people speeding. We allow state lotteries despite knowing some people are betting their grocery money. Everyone is exposed to economic risks of some kind. But we don't operate mindlessly in trying to smooth out every theoretical wrinkle in life.

The nature of freedom of choice is that some people will misuse their responsibility and hurt themselves in the process. We should do our best to educate them, but without diminishing choice for everyone else.

Seems that being out of government is the best way for politicians to realize the unintended consequences of government action, as so eloquently written by Frederic Bastiat in The Law.

Obama's Mendacity on NAFTA

2008-03-01T07:39:00.004-05:00

It is fun to watch Barack Obama's contortions over NAFTA. In the Ohio debate, he talks about how is is going to scuttle the deal unless "environmental and labor standards" are changed (newspeak for forcing Mexico to lose it's competitive advantage by imposing Scandinavian union and environmental laws). He repeats during the Cleveland State debate how he is going to "unilaterally" pull out of NAFTA unless these changes are made.

Of course, it is then reported on CTV (Canadian Television Network) that a "senior Barack Obama campaign staffer" went to the Canadian consulate in Chicago to assure them that Barack's rhetoric is merely political and he has no intention of repudiating the treaty should he become president.

Let's look at all the inconsistencies on Barack's NAFTA bromides so far:

He is looking like a typical left-wing demagogue with language on this. Not very presidential. The back channel reassurances to the Canadian government illustrate that Obama is just a hypocritical as any other Democrat on trade.
The Democratic party has gone bezerk the last 7 1/2 years decrying the "Bush unilateralism" on the ABM treaty, Iraq, Afghanistan, etc. At least we can say that such unilateralism was in the sphere of what some would call America's security interests. Instead, the Democratic presidential contenders would unilaterally scuttle trade agreements it has with its neighbors. So it appears that the Democrats want to be nice to Iran, Cuba, Venezuela, and North Korea; but will jerk around Canada and Mexico.
Obama's contradictory stands on Mexico. Obama has said the best way to stop illegal immigration from Mexico into the United States is to develop the Mexican economy so that the economic incentives to illegally cross the border are gone. This is a very sensible point. However, when you then turn around and threaten to kill the trade deal that has created hundreds of thousands of good paying jobs in Mexico. Just imagine the torrent of illegals migrating Northbound if that happened.
The United States, both economically and politically, has a weak hand to force any changes. With oil north of $100 a barrel, the dollar tanking with no end in sight, and the economy weakening, what are we going to get if Obama did open up negotiations with Canada and Mexico. Mexico could turn around and say that they will sell their oil elsewhere. They could also really turn a blind eye to drug and human smuggling across the border. The Canadian government could pull the preferential treatment of oil exports to the U.S. (Canada is the largest supplier of oil to the U.S., Mexico is second - so you can see the weak hand the U.S. would have). Canada would also want to reverse the softwood lumber tariffs, put restrictions on water and oil exports to the U.S., etc. Canadian Prime Minister Stephen Harper has already made that point.

Looking Forward

2008-02-24T14:46:00.005-05:00

I have been spending a lot of time reading economic commentary for 2008 and 2009. I think the most sobering analysis has been coming from Nouriel Roubini of RGE Monitor. While a lot of economic analysis seems to form the consensus that things will slow down in 2008 and pick up in 2009, Roubini talks about the possibility of financial meltdown and the inability of the Fed to stop it. I think that Roubini and Jim Grant were amongst the minority of market watchers that were pessimistic about the financial system a few years back.

My observations on the matter are not as pessimistic. There are major stability issues of the financial markets right now. While everyone is focused on the subprime mortgages, I think what is not seen right now are the substantial increase in delinquencies and defaults of auto loans and credit card debt. All of this is the sign of reckless debt financed consumption by the American consumer. Even without the defaults, the typical consumer is over-leveraged, and more and more are in negative equity situations, thanks to falling home prices. I believe the next two years will be a period of paying off debt. The stimulus package passed by Congress will not stimulate anything; for the bulk of people, it will be used to pay off debts from consumer spending that stimulated the economy a few years ago. This definitely implies that with the consumer fixated on paying off debt versus other spending, that the economy will soften.

What will amplify this slowdown is the precipitous fall of the value of the U.S. Dollar, which is also driving inflation. The Federal Reserve has little choice right now but to provide liquidity to the banking system at the cost of inflation and further declines of the dollar. Consumers will now face a lower standard of living after years of living beyond their means. The federal government has not helped the problem with their profligate spending and deficits. If the Democrats take over the White House in 2008, and embark on a program of tax increases, this will only exacerbate the situation.

The Subprime Mortgage Crisis in Cartoon Format

2008-02-23T09:23:00.002-05:00

This is a classic, and a heartfelt thanks to Captain Capitalism for the link.

Back door Sharia in Ontario

2008-02-09T09:28:00.000-05:00

The Toronto Sun reports that Ontario muslims in polygamy are getting multiple welfare benefits, much like in the U.K. Why is the West slowly surrendering it's values in the name of multiculturalism, so a civilization intent on destroying the foundations of the West - freedom and pluralism.

Mark Steyn at CPAC

2008-02-09T09:24:00.001-05:00

A great stump speech by Mark Steyn at the Conservative Political Action Conference, yesterday in D.C.

Michael Barone on the Detroit Riots

2008-02-09T09:19:00.000-05:00

Michael writes about his first hand experience in Mayor Jerome Cavanaugh's office during the 1967 riots in The American magazine. Barone's impart is that the primary role of local government first and foremost is to preserve order.

Immature Civilization

2008-02-08T22:10:00.001-05:00

Check out this article in The City Journal by Kay Hymowitz, called "Child-Man in the Promised Land. It focused on the delayed adulthood of people today. A teaser for it:

Not so long ago, the average mid-twentysomething had achieved most of adulthood’s milestones—high school degree, financial independence, marriage, and children. These days, he lingers—happily—in a new hybrid state of semi-hormonal adolescence and responsible self-reliance. Decades in unfolding, this limbo may not seem like news to many, but in fact it is to the early twenty-first century what adolescence was to the early twentieth: a momentous sociological development of profound economic and cultural import. Some call this new period “emerging adulthood,” others “extended adolescence”; David Brooks recently took a stab with the “Odyssey Years,” a “decade of wandering.”

But while we grapple with the name, it’s time to state what is now obvious to legions of frustrated young women: the limbo doesn’t bring out the best in young men. With women, you could argue that adulthood is in fact emergent. Single women in their twenties and early thirties are joining an international New Girl Order, hyperachieving in both school and an increasingly female-friendly workplace, while packing leisure hours with shopping, traveling, and dining with friends [see “The New Girl Order,” Autumn 2007]. Single Young Males, or SYMs, by contrast, often seem to hang out in a playground of drinking, hooking up, playing Halo 3, and, in many cases, underachieving. With them, adulthood looks as though it’s receding.

It is a rather profound effect. Read Hymowitz's related article The New Girl Order. Diana West makes mention of it in her book "the Death of the Grown-Up". Mark Steyn makes comment about this in many of his writings. One of his prescriptions is to return to the idea of a thorough K-12 education, not the fixation on University; his point is with the decline in standards and achievement has made K-16 (public school and university) is now marginally poorer than K-12 of forty years ago.

More Primary-polooza

2008-02-06T19:02:00.000-05:00

It now appears that, at least on the GOP side, that things are beginning to settle and that John McCain is the presumptive nominee. What I think is the main story is two fold. The first is that until last night, no candidate was really overwhelming the primary electorate. Second, is the disconnect between Romney in the polls and Romney in the ballot box. It appears that poor Mitt has a hard 35% ceiling, and for one reason or another, is not connecting with voters.

The GOP Primaries so far - musings

2008-01-17T11:51:00.000-05:00

I have been watching the GOP primaries with a lot of attention, the political junkie that I am. With Nevada and South Carolina this Saturday, we are drawing to the end of the "retail " segment where candidates can spend a lot of face time with potential voters.

Call this an endorsement or not, here are my observations on the candidates so far:

Rudi Guilliani. He has been out of the limelight, choosing to make a stand in Florida and Super Tuesday, letting the other candidates use up cash fighting each other. This could be a brilliant move or will backfire, depending on how he does in Florida and on Feburary 5th. It is plausible that he comes out of the February 5th primaries with the delegate lead, but that remains to be seen. In terms of the debates and substance, he has done OK overall. He emphasizes his executive accomplishments, explains his liberal social views in a way that is non-threatening, while acknowledging that people with views outside of his have valid concerns. He has tried to address them without flip-flopping or out and out pandering. As to my opinion, while I have some concerns on this matter, specifically 2nd ammendment issues, I think Rudy overall has made himself an acceptable candidate. I think that he may become the compromise nominee.
Mike Huckabee. Yes, he is charming, engaging, and funny at times. He just rubs me the wrong way though. I do not trust him on policy issues - as I think he is a Christian nanny stater. His views on immigration, education, taxes, smoking, foreign policy and federalism are anathema to traditional conservatives. His fair tax proposal is pie in the sky and will not work with a federal government the size it is. Now, if you want to bring the scope of the federal government back to where it was in 1913, it would work, and I would wholeheartedly support that. But with the welfare state as it is - the fair tax will not work. He is unaceptable as the nominee and a Huckabee candidacy would be Jimmy Carter redux.
Mitt Romney. Mitt has the policies right, but his presentation is in some ways is offsetting. You would think that he would have won Iowa and New Hampshire, but somehow he has not closed the deal with primary voters - which would indicate some skepticism. I think some of this can be addressed with better communications. He has the resources to lead the delegate count after February 5th, but he has his work cut out for him. Right now, he is the de facto establishment candidate within the party. He would be an acceptable candidate, and would be a good president, but needs to do more to address concerns amongst the electorate.
Ron Paul. He is interesting to say the least. He has had the opportunity to be the figurehead of the libertarian wing of the GOP, but has thrown that out the window with his "blame America first" musings. His defense of federalism and limited government is solid, but his explanations of his isolationist tendencies come off as bitter. He could have made a more positive argument on why isolationism works. That, and his support from neo-nazis and other questionable relationships leaves him as a fringe candidate. He had an opportunity to start a real movement within the party, but has proven he is not the leader for libertarianism within the party. The GOP could use that as a counterweight to the big government Republicans in the party. Obviously, he is unacceptable as a candidate.

John McCain. He is infuriating to the party base. While nobody questions his patriotism and credentials on national security, his personality and record on domestic issues have put off large segments of the GOP electorate. His embrace of anmesty, campaign finance reform, global warming hysteria, and agnosticism on taxes. What makes it worse is they way he demonizes those who disagree with him on policy - this is particularly annoying. His ill temperment and his embrace of many liberal policies will make it difficult to gain delegates in closed primary states.
Fred Thompson. I think Fred is the total package in terms of policy and presentation. He articulates conservative principles forcefully and in a folksy, easy to understand manner. His problem is that he started too late and his campagin has fumbled to maximize their opportunities.

UPDATE: Well Fred has dropped out - so much for my endorsement! Now the question is who the bedrock conservatives go to - Mitt, Rudy, or McCain?

McCain's "blunt talk" has a blaring caveat

2008-01-12T08:19:00.000-05:00

I was reading in the Detroit News a story written by Ron French, who IMHO, the best investigative writer the paper has - always a good read). His story talks about McCains "straight talk" on how the manufacturing sector has a bleak future, and how many economists agree with that assessment. The article reminded me that McCain, if elected, would be just as detremental to Michigan's economic future. McCain's embrace of increased CAFE standards, as well as his drinking of the global warming kool aid, would just exacerbate the problem. He would be no better than the Democrats, claiming to be for the "working man" but pursuing policies that will just shutter more businesses in the United States and ship them off to where it is more feasible.

Republican primaries so far.

2008-01-09T22:23:00.000-05:00

My impressions so far:

This is still anyone's battle. The delegates are somewhat evenly spread so far. Romney has dissappointed with second place finished, but he placed to different candidates and has the money and organization to hold out for super Tuesday in February. He needs to win a few by then or there is major trouble.
Guiliani's decision to use Florida as his firewall and not contest in the early states seems strange right now. With the momentum that Huckabee and McCain have now, Rudi has his work cut out. He needs to get a good number of wins on super Tuesday or else he is in trouble.
I'm really disgusted with the MSM laying the kid glove treatment to Huckabee and McCain. Closer examination of their records would show that they have done many things that conservatives find objectionable. It seems that they want to have the most liberal Republicans win so that the conservatives stay home in November and give the Democrats a win. We have not hear anything in the MSM about Huckabee's record on tax hikes, tuition breaks for illegals, and pardons of violent offenders. Neither have we on McCain's record on amnesty, the Gang of 14, opposition to tax increases, embrace of environmental radicalism, and McCain-Fingold.
We'll know more on Super Tuesday, but I'm rooting for a Romney win in Michigan and let the chips fall where they may. I don't think McCain and Huckabee will do well in many of these states because they are closed primaries (no Independents allowed to vote) and this is where we'll see grassroot Republicans show their disdain for these CINO's (Conservative In Name Only).

In a perfect world, Fred Thompson has impressed me the most with his thoughtful policies and gravitas. Alas, his poor campaign managment skills will probably ruin any chance at the nomination. So, unless Fred proves me wrong in February, it looks like the most viable choices in my view are Romney and then Guiliani. Huckabee and McCain are unacceptable as their records show a consistent streak wholly inconsistent with conservative prinicples. Romney and Guiliani's records are not perfect, but in light of the political landscape of their respective prior positions - their accomplishments look very good. Both men have said the right things about the principles they would govern under, and have explained their executive records adequately.

So here's hoping that the MSM cheerleading squad gets proven wrong again.

Subprime bailout

2007-12-12T21:46:00.000-05:00

There is a lot written about Treasury Secretary's Hank Paulson's proposed "relief" package for subprime borrorers. It can be summed up in three points:

Moral Hazzard - this program rewards people who were foolish enough to make risky investments by financing for homes they cannot afford.
The role of the central banks on this matter, and for that matter, the government in general, is to provide liquidity so that an orderly liquidation of non-performing loans can be done.
What's wrong with falling house prices vis-a-vis other commodities. We cheer falling food, energy, and other consumer goods prices, but when the price of housing drops - the political class goes into full panic mode. Housing is subject to the same laws of supply and demand. Prices for housing must go down as well as up over the long term.

Thinking about Chuck Clough and Jim Grant

2007-11-10T08:12:00.000-05:00

      I have probably spent way too much time thinking about financial markets and my past/current employment in the financial services sector. Two common threads have been going through my mind as I go through all the turmoil and uncertainty: the first is that the political and economic climate (as well as some of the responses to it) are way to similar to the 70's, and the second is how the opinions of two prognosticators, Charles I. Clough (formerly the chief strategist of Merrill Lynch until sacked in 1999 because he was not "bullish" on equities enough) and James Grant (the long time publisher of Grant's Interest Rate Observer).

     As for the first point.   I think I'll leave it to say that history repeats itself, the first time as tragedy and the second time as farce, and will save the rest for another post.

     But back to my thoughts.   During the late 90's, I was working for a brokerage firm that beame Merrill Lynch Canada.   One of the perks of "Mother Merrill" is that they have TONS of reports at your finger tips. So I downloaded everything and anything of interest. The two people I gravitated to the most were quantitative analyst Rich Bernstein and chief investment strategist Charles Clough.

Clough was canned by Merrill for not being sufficiently bullish in the mid to late 90's during the tech bubble. He advocated then a 50/40/10 stocks/bonds/cash portfolio when most of the competitors were advocating an 80/10/10. His reasoning was as follows:

There was too much money floating around the economy. Easy credit and low interest let to a rapid cap-ex spree. Companies were financing additional capacity with debt. Companies would continue to produce products as long as they could eat into the fixed costs. This led to deflationary pressures as prices dropped to keep production at full capacity.
Inflation was not an issue because China and other emerging markets were able to absorb all this cap ex and still provide low prices, which the American consumer bought up in record amounts.
All this surplus money also found its way from capital assets to financal assets - driving up the prices of stocks beyond their fundamental fair value.
The U.S. economy, in his view, was a giant balance sheet with huge amounts of debt and equity being tied to inflated asset values. Clough figured that the day of reckoning would come soon whereby the national balance sheet would need to be de-leveraged to reflect more realistic prices.

Clough was writing this stuff in 1997-1999. He correctly forecasted the capex and financial asset bubble that was caused, and would have reasonably seen the bubble migrating from capital assets (e.g. semi-conductor factories, fibre-optic networks) to financial assets (stocks) to real assets (real estate and commodities). As we have seen, brokerage firms despise pessimism, as it cuts into their lucratvie underwriting business, so Clough was shown the door.

James Grant had similar views. I have posted previously about a luncheon meeting I was able to attend with the Detroit Financial Analsysts society. I think his comments require repeating:

Jim is/was not impressed with Alan Greenspan, calling him a "glorified civil servant". Jim believed that Greenspan pumped excess money into the system, ignoring the fact that inflationary pressures would be absorbed by emerging market trading partners like China. The problem with the U.S. economy is too much money circulating, period. Not the trade deficit, not the fiscal deficit, but too much money. Too much money causes bubbles and inflation eventually. Greenspan was lucky for most of this to happen on his successor's watch.
Interest rate cycles are long-term in nature. They are mult-generational. Interest rates were on a long-term downtrend from the end of the civil war until early in the 20th century. This was a period of overall deflation as the U.S. went to a strict gold standard. The discovery of massive gold deposits in South Africa coupled with the cyanide process of gold extraction changed all this (for additional information - see Milton Friedman's Money Mischief).
From the early 20th century until the the beginning of the great depression, interest rates went on a upward trend, culminating with the tightening of the money supply that brought about the great depression.
From the great depression until the early 1960's, interest rates went on another downturn, until the great society and the Vietnam war started another inflationary trend that started interest rates to rise - peaking in 1981 when Paul Volker vanquished rampant inflation.
The next great bull market in bonds started on that day in 1981 when long bonds were yielding in the high teens until 2004, when yields hit bottom.

Grant's point was that interest rate tends span decades, and what we are experiencing is the end of a long-term decline in rates and the beginning of a long-term increase which should last many years. We are in a period of transition where assets will start to adjust to this reality.

Although these comments were made several years ago - they are still appropriate. I share the opinion that there is too much money in the market and that the supply has to remove this excess. I also understand that in the short-term, this cannot be done without causing a major recession, as we need liquidity to clean up this mortgage mess. On the intermediate term, we will start seeing the money supply retrench as these bad loans are wound up. This will mean eventually higher interest rates, a stronger dollar, and some adjustment to commodity prices.

Paul Tibbets, RIP

2007-11-03T12:47:00.000-04:00

A man who did what he had to do. Unrepentant. Where have men like him gone these days?

Shiller-Case Housing Index

2007-11-03T12:43:00.000-04:00

Here are the housing prices per the Shiller-Case Index for major housing markets in the country. Notice how Detroit and Cleveland compare to CA and FL.

H/T to Captain Capitalism for the primer on this.

Related news:

- Michigan ranked fourth in foreclosures. Yup, Granholms massive tax hike will fix that ailing economy, riiiiiiight.

Isn't this a no brainer

2007-10-31T07:03:00.000-04:00

I got a good chuckle out of this:

Flaherty ignores pleas to control black-market cigarettes

OTTAWA — Pleas from senior federal officials for budget measures to help combat the black market in contraband native-made cigarettes went unheeded by Finance Minister Jim Flaherty, newly released documents show. ...

The documents, obtained by The Globe and Mail under the Access to Information Act, warn that Ottawa is suffering substantial tax losses as Canadian smokers switch to illegal, unregulated and untaxed cigarettes – profiting an extensive, cross-border network of organized crime using native land and operatives. ...

But figures in the government's Public Accounts released this month reveal federal tobacco revenues dropped to $1.6-billion in 2006-07, down from $2.97-billion two years earlier – suggesting a loss of more than $1-billion annually.

Count me under the "not surprised" category. Despiste the constant nattering from politicians about the "war on smoking" for "public health" reasons, the cries by revenue agents again focuses on the lost revenue.

When you raise the prices of cigarettes from roughtly $4/pack in 2001-2002 to almost $10 today (over $10 in the Maritimes and Western provinces), you should not be suprised when organized crime elements move in and take advantage of the "economic profits" you have given them. Cigarette taxes are subject to the same laws of revenue and rates that the Laffer curve predicts.

Second, this just proves that prohibition, whether the honest kind (booze in the 20's) or the more gradualist way (smoking the past 15 years) doesn't work, not to mention a gross violation of liberty.

If smoking is that much of a pox on society, then ban it and deal with the political fallout. If not, then tax is reasonably and in the same manner as booze and you'll get your money to continue being hypocrites on the issue.

Rangel's Tax "Reform"

2007-10-27T18:10:00.000-04:00

I spent some time looking over this tax "reform" package sent out by Mays and Means chairman Charlie Rangel (D-Harlem). On first look, it has potential on some items but others are awful.

The good:

Lowering corporate tax rates - these need to be brought in line with other economies. However the proposal to drop from 34 to 31% is not enough.
Getting rid of LIFO for inventory. IRS has several methods for determing COSG for tax purposes. LIFO, specifically as prescribed in the regs - is confusing, open to abuse, and doesn't always follow GAAP. This will impact a lot of manufacturing and merchandising concerns. There should be a phase in for these companies, and coupled with indexing corporate tax brackets - this isn't bad.
Elimination of section 199 manufacturers deduction. I still don't know why congress passed this monstrosity of a bill. The reason they did it was due to the WTO ruling that the extraterritorial exculsion as an unfair subsidy. Now, congress could have just lowered rates, changed the tax regime to what pretty well every other country in the world does and just tax income in the U.S. and not worlwide, but instead brought out the new manfucaturing activities deduction. This is an excessively complex and difficult deduction to figure out for the initial benefit. I know because I was responsible for figuring this out. Rangel had it right that dropping rates and getting rid of this stupid and limited deduction.
Getting rid of the AMT. This is a stupid tax, and shows what happens when politicans create tax policy to target a small number of taxpayers - sooner or later it will expand to nail a significant number of taxpayers.

The Bad:

Jacking up individual rates. With his proposal to increase the top individual rate to 44% with the addition of surtaxes, this will kill a lot of small businesses who are set up as S-corporation or partnerships. I know first hand dozens of former clients who have good job creating businesses who know will get soaked with at 25% increase in their federal taxes. Now, the tax planning will shift back to C-corporations due to the distortions in top rates between corporations and individuals. Stupid stupid stupid and will generate reduced economic growth (especially in the vulnerable construction industry, where the bulkof the business is in a S-corporation or partnership format).
Distributive share of S-corporation income subject to self-employment taxes. This now means that there will be a minimum a 4% and a maximum of 15% increase on earning on S-corporation earnings. Stupid policy again. So an S-corporation making $1,000,000 and one shareholder would have their federal tax burden go from approximately $350,000 to $440,000 due to the surtaxes on income and having it subject to self employment. Tell me that isn't a job killer.
Taxing carried interest at ordinary rates. Another investment killer. In the effort to go after "greedy" private equity managers, they want to change the investment definition of captial to be ordinary income. This could have been better achieved under the regs for active trade or business, reasonable compensation, or even active trade or business. But this proposal if expanded (and it would) could also spread out and kill the real estate sector too, which relies on carried interest to finance developments.

I agree with Rangel the tax rates should drop and all these preferences, deductions, and credits should go. A broad base and low rates should be the goal of any well thought out tax plan. But these proposals will distort economic activity, kill investment, and hamper economic growth. And I haven't even factored in the expiration of the Bush tax cuts for 2010, which the Democrats salivate on not making permanent.

There is potential for reform in this bill, but there are some things that should not be passed at all. Rangel's bill gives is telegraphing what a Deomcratic controlled congress will do with a Democrat in the white house, if you needed another reason not to vote for them.

Government Chutzpah on the subprime market

2007-10-19T20:18:00.000-04:00

My friends at The Other Club brought up how Massachusetts Governor Deval Patrick wants to force mortgage companies to forgive loans on low income borrows who bit off more than they could chew, linking to a Boston Globe article on the matter:

Governor Deval Patrick [D, Mass] plans to introduce an ambitious program today to assist Massachusetts communities in preventing foreclosures by pressing lenders to accept losses on their mortgages so that homeowners are able to sell their properties and pay off smaller loan balances....

In one key part of the plan, the state would press lenders to agree to a "short sale" with homeowners late on their monthly payments. In a short sale, lenders accept less than the full value of the loan, so that the homeowner can sell the house at today's market price - typically less than he or she paid for it - and use the proceeds to pay off the smaller loan balance. Short sales are a way for borrowers to prevent foreclosure.

But Thomas Callahan, executive director of the Massachusetts Association for Affordable Housing, which provides mortgages to homebuyers with modest incomes, said the administration does not have leverage, legally, to force lenders to cooperate. He said most subprime lenders are out-of-state companies that are not regulated by the state.

What is funny (or sad) about this is that both these initiatives had one Deval Patrick ivolved, either as a civil rights attorney for the Clinton Administration or as Governor of Massachusetts. Deval Patrick was responsible for bullying financial institutions into making loans to various preferred groups, regardless of credit history or proof of actual discrimination. From Reason Magazine:

In an October 26 Washington Post story, Deval Patrick, head of the Justice Department's civil rights division, defended the administration's aggressive stance by saying, "It's nuts to think that we could reverse the effects of 300 years of deprivation by a few court decisions and a few good statutes."...

Perhaps the most breathtaking civil- rights enforcement affects financial services. Along with the proposed CRA regulations, the Justice and Treasury departments are pursuing banks and other financial institutions that are allegedly violating fair- lending practices. Justice has already sanctioned banks in Mississippi, New England, South Dakota, Georgia, and Maryland for supposedly discriminating against members of racial minorities. Barnett Bank, Florida's largest, is under investigation.

But there's little evidence that systematic discrimination is taking place. In the Maryland case, Chevy Chase Savings Bank was forced to cough up $140 million to African Americans by, for example, offering below- market- rate loans to minorities and placing ads in black- owned newspapers. Justice showed no evidence that Chevy Chase, the largest thrift in the D area, had denied loans to individuals because of their race. Rather, Chevy Chase hadn't opened new branches in predominantly black neighborhoods. The bank had been operating branches in African- American neighborhoods, but that didn't satisfy civil- rights enforcers: Either those branches had been acquired in a merger or the neighborhoods in which these branches operated had been predominantly white when the branches opened.

Two governors of the Federal Reserve System have criticized the proposed CRA regulations, saying financial institutions will make risky loans to women or racial minorities so that they can avoid discrimination lawsuits. Fed Governor Lawrence Lindsey considers the regulations a blatant power grab by political micromanagers in Congress and the White House. He has recently encouraged public comments, presumably critical, of the regulations. And Governor John LaWare told the Dow Jones News Service, "I feel very uneasy about the de facto allocation of credit and banking resources by administrative fiat."

Let's review.   Clinton administration threatens lenders into giving sub rate loans to minority borrowers even though they would not qualify under normal lending practices.   Clinton administration, with Deval Patrick at point, states that quantative measures like credit risks and default rates don't matter - just that the loan portfolios should "look like America".
     Without going into detail on the abject stupidity of this policy, the banks did a cost benefit analysis and essentially figured it that it would be cheaper to throw the dice, loosen their credit standards to minority lenders, and risk some defaults instead of throwing a lot of money into attorney's fees fighting the government.
     Now that the governments demand for looser credit standards has played role in the sub-prime mortgage mess, these same government officials now chatise the banks for their "predatory" lending practices, and now demand regulation to "fix" the problem.

Why aren't we surpised.

The Fatherless Civilization

2007-10-16T20:25:00.001-04:00

An absolute must read from The Brussels Journal.