Oh Greg!

On Tuesday, one of my personal guides through the financial crisis demonstrated that otherwise smart people can sometimes totally not get it. Concerning the AIG bonus flap, Professor Mankiw wrote in Trivial Pursuit:

The AIG bonuses now being debated in Congress and everywhere else represent about .001 percent of annual GDP. Regardless of how outraged you are about the AIG bonuses, it is probably not an optimal allocation of resources for our elected leaders to spend large amounts of time and energy on the topic.

Conventional wisdom says that our populist rage is unleashed on this particular topic because, unlike many topics in the financial crisis, we understand it. People understand companies going insolvent, getting bailed out, then paying $400,000 bonuses to a chosen few. And they don't like it, regardless of the fact that the bonus fund is .001 percent of GDP.

Mankiw would have done better to have stuck to prior criticisms of recovery legislation, which focus on the inefficiencies and mistakes that are inevitably made when so much money is spent so quickly.

As it turns out, Mankiw's lack of faith in the wisdom of congress (evidenced by the last paragraph of his post) was supported by today's House vote to tax the AIG bonuses at 90 percent. Newsweek's Howard Fineman pointed out on Olberman that such a law is unconstitutional because it is both retroactive and targets a specific group (Article I, Section 9. No bill of attainder or ex post facto Law shall be passed.)

The Greying of Obama

People are starting to notice that President Obama is going grey. Supposedly, this started during the campaign and is noticeable now that he is President. We will never know if we would have gone grey regardless of his career choice, but we can be certain he is subject to considerable lifestyle stress.

In a post titled Obama's Ball and Chain, Thomas Friedman fears "that his whole first term could be eaten by Citigroup, A.I.G., Bank of America, Merrill Lynch, and the whole housing/subprime credit bubble." David Brooks in A Moderate Manifesto finds in the Obama budget "a promiscuous unwillingness to set priorities and accept trade-offs."

Nobel prize winning economist Paul Krugman, usually sympathetic to the left, writes in The Big Dither of "a growing sense of frustration, even panic, over Mr. Obama’s failure to match his words with deeds. The reality is that when it comes to dealing with the banks, the Obama administration is dithering. Policy is stuck in a holding pattern." Stanford economist Michael Boskin, in a piece called Obama's Radicalism Is Killing the Dow for the right-leaning Wall Street Journal, charges "that our new president's policies are designed to radically re-engineer the market-based U.S. economy, not just mitigate the recession and financial crisis." Congressional Republicans say the same thing in tweet-sized bites, accusing the President of leading us to socialism or a European-style welfare state. And then there is the comedian Rush Limbaugh, whose radio audience has climbed from 14 million to 25 million in one week.

Commenting on the budget, the conservative British journal The Economist writes in Wishful, and dangerous, thinking that "the president has not explained to Americans that if they want bigger government, they will have to pay for it." Basically, they argue that the numbers don't add up when you increase government spending year after year while lowering taxes on 98% of taxpayers and increasing the tax burden on 2% who are not as rich as they used to be.

A response comes in the Brook's piece titled When Obamatons Respond. Senior administration officials say

1. "They’re not engaged in an ideological project to overturn the Reagan Revolution."
2. "The Obama administration will not usher in an era of big government."
3. "It is going to reduce this spending to 3.1 percent [of GDP] by 2019, lower than at any time in any recent Republican administration."
4. "The Medicare reform represents a big cut in entitlement spending. Health care reform will be deficit-neutral."
5. Deficits are now at a gargantuan 12 percent of G.D.P., but the White House aims to bring this down to 3.5 percent in 2012."
6. "Obama folks feel they spend as much time resisting liberal ideas as enacting them."

In other words, the administration feels its budget is misunderstood and it probably is. On the other hand, any attempts to make statements about the future (aka predictions) must be based on economic models which have assumptions, and the validity of the assumptions is always in question. (The use of mathematical models with invalid assumptions is cited as a primary cause of the financial crisis, so far a mortgage-backed securities are concerned.)

Obama has reason to go grey. Fixing the banks is something that has eluded both Treasury Secretaries Paulson and Geithner. The mess called AIG continues to act as a cancer upon the global economy. Joe Nocera's piece on AIG in the NYT called Propping Up a House of Cards reveals the greatest financial scam in the history of the world, one for which it is unlikely that anyone will go to jail, as everyone knew what was going on and everything was legal. People just didn't anticipate or care about the consequences, as so much money was being socked away.

Yes, Obama has reason to go grey.

Keep Hope Alive!

This past week, President Clinton advised President Obama to be more hopeful about the economy. Better advice might have been to read The New York Times Sunday magazine piece about the undiagnosed diseases program of the National Institutes of Health, which presents a different paradigm for problem solving than the "blind man feeling the elephant" mode we are in (e.g. fix a bridge).

The media is doing it's job in deconstructing the crisis and assigning blame. Time magazine gives us a list of the 25 People to Blame for the Financial Crisis. In summary,

1. Phil Gramm, US Senate Banking Committee chairman, deregulator
   
2. Chris Cox, SEC chairman, failed to provide oversight
   
3. Angelo Mozilo, predator lender (Countrywide)
   
4. Joe Cassano, AIG exec, issued credit default swaps
   
5. Frank Raines, Fannie Mae CEO, abused position of Government Supported Enterpirse (GSE)
   
6. Kathleen Corbet, Standard & Poor, gave unreliable ratings
   
7. Ian McCarthy, predatory home builder (Beazer Homes)
   
8. Dick Fuld, led Lehman Brothers to failure
   
9. Bernard Madoff, ran fraudulent investment schemes
   
10. Herb and Marion Sandler, predatory lenders (Golden West Financial, World Savings Bank)
    
11. Stan O'Neal, created collateralized debt obligations (Merrill Lynch)
    
12. John Devaney, facilitated predatory loans as a hedge-fund manager
    
13. Sandy Weill, led Citigroup to insolvency
    
14. Jimmy Cayne, led Bear Stearns to failure
    
15. George W. Bush, US President, deregulator
    
16. American Consumers, over borrowed, under saved
    
17. Alan Greenspan, Federal Reserve chairman, deregulator and economic overstimulator
    
18. Hank Paulson, US Treasury Secretary, ineffective policies
    
19. David Lereah, National Association of Realtors economist, promoted housing bubble
    
20. Lew Ranieri, father of mortgage-backed bonds (securitization)
    
21. David Oddsson, Prime Minister of Iceland, led Iceland to bankruptcy
    
22. Fred Goodwin, predatory banker, led Royal Bank of Scotland to insolvency
    
23. Bill Clinton, US President, deregulator and politicized mortgage lending
    
24. Wen Jiabao, supplied US with cheap credit from China
    
25. Burton Jablin, TV programmer, encouraged housing bubble

The list is not "scientific" as it was created by popular vote, but that hardly matters. No matter who is on the list, the point would be same... everyone wanted more, just like Oliver Twist. This list could be easily titled "25 People Who Rose to the Top of their Field".

My favorite post-mortem works so far are Bethany McLean's Vanity Fair piece on Fannie Mae and the CNBC documentary on predatory lending, The House of Cards. As a society, we live and learn, and one must hope that these types of mistakes will not be repeated. We do live by the rule of law, and laws might prevent future tragedies of the economic commons.

So does Obama have reason to be hopeful? Can one be honest about a bleak reality and hopeful at the same time? I say yes, if you look at the world with a perspective that transcends maintenance of America-as-we-know-it. Frank Rich in a NYT opinion piece wrote that

Obama’s toughest political problem may... [be] with an America-in-denial that must hear warning signs repeatedly, for months and sometimes years, before believing the wolf is actually at the door.

But in the same piece he points us towards something hopeful, an America remade.

Writing in the Atlantic, Richard Florida presents a vision of How the Crash Will Reshape America. The world he describes is actually a place I would want to live... highly productive mega-regions, decline of the automobile, smart people being smart together. Home ownership, rather than the American dream, is recast as the bonds that hold you down.

Yes, there is hope, not for pointless attempts to save the doomed, but for nurturing new growth and way people will live in the future.

Defending Your Mankiw*, Not that he needs it

In an article titled Tax Cuts Won't Work, Newsweek's Daniel Gross argues against those who advocate tax cuts as remedy to the current financial crisis. But in a self-contradictory moment, he writes

And the way they read the relevant data, history, and experience, permanently reducing long-term tax rates has historically provided the best possible incentives to invest and spend. They may be right (emphasis mine).

Gross discusses Harvard's Greg Mankiw in ways that don't seem complimentary, which elicited a reply from Mankiw.

I take two issues with Gross.

1. Categorizing people as "Economists whose sympathies lie with the Republicans" and
2. mischaracterizing Harvard professors.

I am not one of those who sees the world as blue vs. red. There are Democrats who are fiscal conservatives (e.g. the blue dogs) and Republicans who embrace pork (e.g. ex-Senator Ted Stevens). Mankiw worked for W yet he is recommending "a gradual, permanent, and substantial increase in the gasoline tax". I did not fact check, but I cannot imagine that is in the Republican platform. Additionally, Mankiw has written that his opposition to proposed spending is for practical reasons; it is not possible for any government to spend that much money so quickly without inefficiency and waste.

During the 2008 presidential election, Republican campaign rhetoric painted Obama as an elitist, perhaps because he graduated from Harvard Law School. Gross implies that Harvard professors (and Mankiw and Barro in particular) are ensconced in a comfortable university lifestyle that has clouded their professional judgment. Obama is not an elitist because he is smart, nor is Mankiw distorted by his professorial income, which is most likely much less than many of his students who have gone on to well-compensated non-academic jobs. Tangentially, the Harvard economics department is not immune from pain.

As to the actual issue about whether or not tax cuts would help in these troubled times, I say yes. For Americans who live on anything resembling a budget, being able to keep more of your income will result in money being spent. Confidence has nothing to do with it. If you have a bill and you happen to have a few more dollars due to tax cuts, you are more likely to pay that bill.

Some people will take their tax savings and save rather than spend. Why is that a bad thing? Assuming they don't take the money in greenbacks and stuff it under their mattress, the money gets deposited in a savings account, or a CD, or whatever. The receiving institution can take that deposit and loan it out to someone who will spend it. Is this not a good thing?

Just for fun, my own stimulus bill would be structured as follows:

1. Do what it takes to keep banks working.
2. Cut taxes. I do not understand the trade offs between payroll tax cuts and income tax cuts.
3. Help state and local governments that are in imminent peril.
4. Spend on strategic projects that will help us survive over the next 50 years, such as energy, education, and transportation.

Veritas!

*the title is a riff on Defending Your Life, a movie starring Albert Brooks and Meryl Streep about dead people defending their lives in an afterlife tribunal

Catastrophe

In President Obama's weekly video address of February 7, 2009, he said

Because if we don't move swiftly to put this plan in motion, our economic crisis could become a national catastrophe. Millions of Americans will lose their jobs, their homes, and their health care. Millions more will have to put their dreams on hold.

What our president is saying is that a national catastrophe happens when unemployment reaches reaches a certain number, or foreclosures or rent evictions rise to a certain level, or some number of people cannot afford heath insurance. The common denominator is loss of income necessary to maintain the basic necessities of life. Note that this is a quantitative argument, as we have always had citizens without jobs, homes, or health insurance.

What is scary about our current economic predicament is that other types of catastrophes are looming. The one that Obama mentioned is the usual catastrophe brought on by the usual business cycle of recession, recovery, and expansion.

The other catastrophes include

(1) bank failure, where the ATMs and credit cards stop working

(2) hyperinflation, where greenbacks lose their value, absolving all dollar-based debt and wiping out all savings

(3) stock market crash, where equity-based retirement accounts get wiped out and old people must depend on the kindness of strangers and/or their families

(4) economic loss due to global climate change, that is, more devastating hurricanes, tornadoes, heat waves, and wintry weather

(5) a haves vs. have-nots scenario, where ownership of assets is concentrated in the hands of a few percent of the population and everyone else is impoverished

(6) Jim Kunstler's Long Emergency scenario, where our way of life becomes unsustainable due to the depletion of energy resources and the organization of American homes and buildings around automobiles.


As to the probability of any of these other catastrophes occurring, I have no idea. One must imagine that the transactional functions of the banking system would be maintained at all costs, as this is the circulatory system of the economic body. The fed is supposed to be keeping inflation in check. The stock market is more of a symptom than a cause, that is, when the business cycle recovers, the market should recover. A consensus on the economic effects of climate change is undeveloped.

The last two catastrophes may be the same and both concern our nation's energy policy. Breaking us of our oil addiction is the key policy we must embrace. Kudos to Mankiw for suggesting a Pigovian tax on gas but it seems not to have a snowball's chance in hell of getting enacted by a politician.

No Way Out

Today I saw Bethany McLean on PBS NOW talking about the current financial crisis. Recall that she is the Fortune reporter, now working for Vanity Fair, that initiated the exposure of Enron and wrote a book about it. She points out that the big problem we face is who pays for this mess. There are no easy answers, but once government gets involved, it gets even harder. In the real financial world that most Americans live in, if you start a business and make bad decisions and run out of money, you lose along with your stockholders. Not so if the government decides to keep you afloat, however, you are now subject to scrutiny that "the market" is not usually concerned about. If your stock portfolio is soaring, it matters little if execs got obscene bonuses.

The stimulus now be worked on by Congress is a political event, not financial. Few expect that anything can be done to save 2009 and most expect that the global economy will eventually improve. The key thing for politicians is to be perceived as doing something. What we must hope for is that Obama will go beyond that and construct a compelling vision for the future.

Martin Wolf of the Financial Times provides as good an analysis as anybody. I saw him recently on Charlie Rose and he said that we do not want to return to the way things were, that is, with the US and a few European countries driving the global economy with mass consumption and mass debt. Add to that our self-defeating energy policies and you at least have a great vision of where we don't want to be.

Stim City

Sorry if I get my titles from the Daily Show.

The House passed the stimulus bill today with zero Republicans voting for it. Have they all become dittoheads (followers of the comic Rush Limbaugh) and are hoping the economy will get even worse so they can say they didn't vote for the "bad" economic stimulus. Reminds me of a bad joke where some thugs draw a circle and tell a fellow to stand in the middle of it while they bash his car. When they are done he is laughing and they ask why and he says that while they were away he stepped out of the circle. One of the things that was eliminated was money for family planning. And maybe condoms, but not sure.

Rach opened her show tonight talking about infrastructure and how a million people are without power across the east because of a winter storm. She also said that the American Society of Engineers estimated 2 trillion is needed to repair various infrastructure. Seems we started not maintaining things during the Reagan administration.

John Stewart was going on about half a billion of bonuses being paid to Merrill Lynch employees. As if they earned it.

BOA bonuses are being deferred to future years and it seems this cash flow problem is cramping a few lifestyles. Guess the Griswolds will be getting jam instead of that new pool.

We went to Reno today and discovered that both the VW service department and a body shop can take your car at any time as they have a dearth of customers. We also saw Slumdog Millionaire at a midday showing and can report that some old people are still going to the movies. Slumdog was difficult for me to watch as I am not entertained by human brutality, however, I recognize it as an important serious work that is deserving of all the praise it is getting. It is educational for Americans to see a film like this as I am sure most of us are clueless.

The World Economic Forum in Davos has commenced and it's payback time. China and Russia are looking for a few changes in the world order.

Day Four

Obama Reverses Rules on U.S. Abortion Aid

As mentioned in a prior post, giving women control over reproduction leads to peace on earth. Well done!

Day four also included work on the next federal stimulus to improve the economy. Rachel reported that President Obama will now be receiving daily economic briefings in addition to his daily intelligence briefing. Nice to know the POTUS is paying attention.

What continues to annoy me is the lack of agreement among economists about what measures will work.

My main sources of economic news/education come from Greg Mankiw's blog and Safe Haven. Mankiw is a Harvard economics professor who worked in the  Bush administration. He links to articles across the political spectrum and has a disarming sense of humor concerning his profession. His own economic prescription is sometimes hard to discern, as Krugman points out, but it is safe to say that he is big on tax cuts.


Safe Haven is a nexus of doomsdayers, skeptics, and gold hoarders, the most celbrated contributor being Peter Schiff, famous for predicted the current global economic disaster. If you read this site, you will find those that believe hyper-inflation is in our future due to the recent gigantic increase in the US money supply, that the housing crisis had its roots in the early nineties when congress/HUD interjected politics into the mortgage business  by mandating "affordable housing",  and that the demise of the US auto industry is due to auto workers with a undeserved since of entitlement and auto execs in pursuit of perks with little regard for consumers or the competition.

So what comes of all these economic readings?

When one considers a financial stimulus, one must think ahead to what is to be improved. Economists and government officials who wish to improve the gross domestic product and the employment rate tend to favor government spending. This is because the formula for GDP is

GDP = consumption + investment + gov spending + (exports - imports)

As people are not consuming, companies are not investing, and our trade balance is negative, the only way to up the GDP is through government spending. To the extent that said spending creates jobs, then employment data is improved, and that is something that looks good on the news.

People that are looking to improve their net worth tend to be for tax cuts, as this is personal. Anyone who has taxable income will benefit, and to the extent that the cuts extend towards lower incomes, more people benefit. There is no telling what people will do with their recovered taxes, but the expectation is that some of it contributes to the consumption part of GDP.

Economists frequently mention multipliers, that is, the way when a dollar is spent, the recepient of that dollar then spends it again, and so on. The problem seems to be that economists don't really know what the mulitpliers are for different scenarios and spend a lot of time discussing methodology. This is an important issue because huge economic decisions are made based on whose numbers you believe. It appears that all must be taken with a grain of salt.

The bottom line for me is that bad (perhaps unintended) consequences happen when government tries to save us all from financial doom. Somewhere I read that the seed of our current financial crisis, as it relates to Wall Street, occurred when the Federal Reserve supervised the bailout of Long Term Capital Management, a hedge-fund that was considered too big to fail. This created a huge so-called "moral hazard", that is, an incentive for people to behave in extremely risky ways because the upside is huge and the downside is tempered by the promise of a bailout. The probability of a bailout increases with the amount of money you owe to others, so you are motivated to assume even more risk (debt) in an attempt to become too big too fail.

In hindsight, the proper role of government should be to let people experience the full consequences of risky behavior, while enforcing regulations that protect the regular investor.

Last I heard, the next phase of the stimulus will be a mixed bag: some tax cuts, some funding of local and state budgets, and some public works (17%). So there will be a little for everyone and know one knows if it will really work, but everyone knows that my childern and grandchildren will be paying for it.

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