Saturday, September 20, 2008

Updates on Financial Meltdown


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:
  1. 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.
  2. 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.
  3. 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.
  4. 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.   
  5. The tax system - with the mortgage interest deduction and property tax deduction is a government subsidy to home ownership that doesn't help.
  6. 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 .. 

Monday, September 01, 2008

Strange, isn't it

  • 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

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.