Tax Proposal and Compromise

I have read a lot in the media (mostly left-wing media, and I am including the official White House press release) about how President Obama offended everyone with his press conference regarding the tax cut deal he struck on Tues. night. I agreed that a lot of his comments were pretty offensive all around. He obviously was going into it with a very defensive mind set and took it too far in my opinion. However, most of the liberal media were emphasizing the Republicans staunch defense of the affluent income tax and talking about how President Obama gave up too much (most insinuated that he gave up quite a bit of his soul to have the audacity to allow the wealthy keep more of their earned wealth, but one or two didn’t go that far). I would suggest you read the transcript of his speech (you can get a copy by going here.), but there is something he said that I did like. It wasn’t necessarily how he said it, especially since I don’t agree with what the health care bill did (which is kind of his point here), but it was that he said it. It was in defense of striking a deal. He said:

“So this notion that somehow we are willing to compromise too much reminds me of the debate that we had during health care. This is the public option debate all over again. So I pass a signature piece of legislation where we finally get health care for all Americans, something that Democrats had been fighting for for a hundred years, but because there was a provision in there that they didn’t get that would have affected maybe a couple of million people, even though we got health insurance for 30 million people and the potential for lower premiums for 100 million people, that somehow that was a sign of weakness and compromise.

“Now, if that’s the standard by which we are measuring success or core principles, then let’s face it, we will never get anything done. People will have the satisfaction of having a purist position and no victories for the American people. And we will be able to feel good about ourselves and sanctimonious about how pure our intentions are and how tough we are, and in the meantime, the American people are still seeing themselves not able to get health insurance because of preexisting conditions or not being able to pay their bills because their unemployment insurance ran out.”

“That can’t be the measure of how we think about our public service. That can’t be the measure of what it means to be a Democrat. This is a big, diverse country. Not everybody agrees with us. I know that shocks people. The New York Times editorial page does not permeate across all of America. Neither does The Wall Street Journal editorial page. Most Americans, they’re just trying to figure out how to go about their lives and how can we make sure that our elected officials are looking out for us. And that means because it’s a big, diverse country and people have a lot of complicated positions, it means that in order to get stuff done, we’re going to compromise.”

Personally I don’t think it would be a big deal to allow the tax cuts for the “affluent” only to expire. It would affect things but not as greatly as many think. I also don’t think that with it in place it really affects the bottom line significantly (at the very least not enough to warrant such vehement backlash). This opinion piece agrees with me. I think it is far more important that we focus on the education system in the country and get out of the way (removing the red tape and lowering the taxes) of companies.

Clear Explanation of the Health Care Bill

This is probably the clearest explanation of the Health Care bill that I have seen. It is long and has several graphs and pictures (Particularly illustrative is the one showing the bureaucratic structure created by the bill) so I didn't copy and paste it here. Instead you'll have to visit this LINK. If you have ever wanted a clear explanation of the actual bill (If you're like me and started to look at the summary of the bill and didn't get it and didn't want to read the hundreds of pages then you too have probably been relying on the various media outlets' highlights) from someone who really gets it, then this is it. For full disclosure the author uses as a main source the Heritage Foundation which is a very conservative group and the author works for fortune 500 companies consulting them on the benefits they offer. So obviously they are very biased, but hey, so am I since my costs went up due to the bill.

One of the criticisms that I heard, which really stuck, during the presidential campaign was that President Obama had pushed as a senator a bill for equal rights for women in the workplace, which would have required all companies to submit to a government agency the number of workers on their payroll, their salaries, and the explanation of differences in pay if there were any (I know there was a consequence if the person monitoring it thought there was an inequality, but I can't remember what it was). The article I was reading referred to it as being the same as using a sledgehammer instead of a flyswatter to kill a fly. Their main point was that if elected President Obama was likely to follow the same pattern and overshoot or miss completely the mark on the major issues of the day.

To me, this Health Care bill was similar to his previous work only, instead of a sledgehammer it's as if they just decided to bulldoze the house the fly was in. Hopefully more of it can continue to be repealed.

President Obama and Foreign Policy

The following article is from Stratfor.

Global Expectations and Obama's Challenge

Having traveled a great deal in the last year and met a number of leaders and individuals with insight into the predominant thinking in their country, I can say with some confidence that the global perception of Obama today is as a leader given to rhetoric that doesn’t live up to its promise. It is not that anyone expected his rhetoric to live up to its promise, since no politician can pull that off, but that they see Obama as someone who thought rhetoric would change things. In that sense, he is seen as naive and, worse, as indecisive and unimaginative.

No one expected him to turn rhetoric into reality. But they did expect some significant shifts in foreign policy and a forceful presence in the world. Whatever the criticisms leveled against the United States, the expectation remains that the United States will remain at the center of events, acting decisively. This may be a contradiction in the global view of things, but it is the reality.

A foreign minister of a small — but not insignificant — country put it this way to me: Obama doesn’t seem to be there. By that he meant that Obama does not seem to occupy the American presidency and that the United States he governs does not seem like a force to be reckoned with. Decisions that other leaders wait for the United States to make don’t get made, the authority of U.S. emissaries is uncertain, the U.S. defense and state departments say different things, and serious issues are left unaddressed.

While it may seem an odd thing to say, it is true: The American president also presides over the world. U.S. power is such that there is an expectation that the president will attend to matters around the globe not out of charity, but because of American interest. The questions I have heard most often on many different issues are simple: What is the American position, what is the American interest, what will the Americans do? (As an American, I frequently find my hosts appointing me to be the representative of the United States.)

I have answered that the United States is off balance trying to place the U.S.-jihadist war in context, that it must be understood that the president is preoccupied but will attend to their region shortly. That is not a bad answer, since it is true. But the issue now is simple: Obama has spent two years on the trajectory in place when he was elected, having made few if any significant shifts. Inertia is not a bad thing in policy, as change for its own sake is dangerous. Yet a range of issues must be attended to, including China, Russia and the countries that border each of them.

Obama comes out of this election severely weakened domestically. If he continues his trajectory, the rest of the world will perceive him as a crippled president, something he needn’t be in foreign policy matters. Obama can no longer control Congress, but he still controls foreign policy. He could emerge from this defeat as a powerful foreign policy president, acting decisively in Afghanistan and beyond. It’s not a question of what he should do, but whether he will choose to act in a significant way at all.

This is Obama’s great test. Reagan accelerated his presence in the world after his defeat in 1982. It is an option, and the most important question is whether he takes it. We will know in a few months. If he doesn’t, global events will begin unfolding without recourse to the United States, and issues held in check will no longer remain quiet. Read more: The World Looks at Obama After the U.S. Midterm Election STRATFOR

CEOs on America

This is a must watch video. I wish we could see the whole thing with all of the interviews.

In particular I want to point out the CEO of American Express and what he said. I couldn't agree more with him. That is the primary problem we face in the U.S., I believe. We need to change our education process (for example reward the good teachers regardless of how hard it is to measure "good" and get rid of the bad ones) and people need to let go of the idea that what worked for their grandfather and father as far as careers go will work for them. There is almost no way we can compete with other countries in areas of manufacturing and still keep up with our own cost of living. We also have to understand that we are very much in competition for the same jobs with those from other countries. That has nothing to do with what the representatives in Washington can or can't do. Honestly all they can really do in my opinion is hurt us in that competition. The competition comes about due to the global nature of the economy and despite what many think it is not a bad thing.

A Republican Win

This is an excerpt from John Mauldin's weekly email. It is definitely something to focus on as you vote. The people we are voting in this week are the ones who are going to be driving local and a few national issues over the course of the next, economically critical, five years.


Be Careful What You Wish For

Everyone by now is predicting the Republicans to take the House and pick up anywhere from 6-8 Senate seats. We'll see. This is going to be a very interesting election, as there is a whole new dynamic in place.

Let's look down the road. I think we will at best be in a Muddle Through Economy for the next two years. Unemployment is going to be above 8%, best-case, in 2012. If the Bush tax cuts are not extended, in my opinion it is almost a lock that we go into recession next year, unemployment goes to 12%, and underemployment gets even worse. That is not a good climate for Obama and the Democrats in 2012. It is especially bad when you look at the number of Democratic Senate seats up for re-election that are in conservative states. The Republicans could take a serious majority in the Senate.

And then what? Right now Republicans are running on promises that they will not cut Medicare and Social Security, but are going to reduce spending and get us closer to a balanced budget. But everyone knows that the only way to get the budget into some reasonable semblance of balance will be to either cut Medicare benefits or increase taxes.

There are only the two options. Yes, you can reform medical care, and I think much of Obamacare should certainly be repealed, but that does not get us anywhere close to dealing with the real issue, and that's a fact. There are tens of trillions of unfunded liabilities in our future, which must be dealt with.

Let me be very clear on this. I am not really worried about the supposed $75 trillion in unfunded Medicare liabilities in our future. That is an impossible number. If something can't happen it won't happen. Long before we get to that apocalypse, we find a bond market that simply refuses to fund US debt at anywhere near an affordable cost. Crisis and chaos will ensue. Remember the quote that led this letter?

People only accept change when they are faced with necessity, and only recognize necessity when a crisis is upon them.
- Jean Monnet

The simple reality is that if We the People of the US want Medicare, in even a reformed and more efficient manner, we must find a way to pay for it. It will not be cheap. Raising income taxes on the "rich" is not enough. You have to go back and raise income taxes on the middle class, too. Oh, wait, that will be a drag on the economy and consumer spending. And in any event it will not be enough.

The only real way to pay for those benefits will be a value-added tax, or VAT. And while it could be introduced gradually, let there be no mistake that it will be a drag on economic growth. Government spending does not have a multiplier effect on the economy. It is at best neutral. What creates growth is private investment, increases in productivity, and increases in population. That's it. Tax increases have a negative multiplier.

A significant VAT along with our current income taxes will give us an economy that looks more like the slow-growth, high-unemployment world of Europe. Can we figure out how to deal with that? Sure. But it is not growth-neutral.

Republicans in 2013 will be like the dog that caught the car. What do you do with it? The last time they (embarrassingly, we) really screwed it up. The defining political question of this decade will not be Iraq or Afghanistan, or the environment or any of a host of other problems. The single most important question will be what do you do with Medicare? Cut it or fund it? Reform it for sure, but reform is not enough to pay for the cost increases that will come from an increasingly aging Boomer generation.

There is no free lunch. At some point, you cannot run on "no cuts in Medicare" and "no new taxes" and be honest. At least not this decade. Maybe when we have cured cancer and Alzheimer's and heart disease and the common cold at some future point, medical costs will go down, but in the meantime we have to deal with reality.

You may be able to fool the voters, but you will not be able to fool the bond market. Not dealing with reality will create a very vicious response. Ask Greece.

And that is the national conversation we must have with ourselves. There is a cost to government. There is a cost to extended Medicare benefits. (I am blithely assuming we deal with all the "easy" stuff like Social Security, and make real cuts in other areas.)

The State Income Tax Issue

"Comparing the nine states with the highest tax rates on earned income to the nine states with no income tax shows how high tax rates weaken economic performance. In the past decade, the nine states with the highest personal income tax rates have seen gross state product increase by 59.8%, personal income grow by 51% and population increase by 6.1%. The nine states with no personal income tax have seen gross state product increase by 86.3%, personal income grow by 64.1%, and population increase by 15.5%."

—Arthur Laffer, Laffer Associates, as quoted in the WSJ, 10/6/10

We Need a Real Leader

“The United States has stumbled into empire. It now faces the crisis of Rome that the empire will annihilate the republic. I argue that of all the institutions of our Constitution, it is the president who can preserve the republic while managing the empire. I also argue that the greatest threat to the republic is living in denial about what the United States has become. The issue, then, is how to manage the unintended and unwanted in the next decade.” – George Friedman, Stratfor.

I was reading this quote on the cover of an email I received from Stratfor (if you aren’t signed up for their free emails then you better get signed up!) and I immediately thought about President Lincoln. If you have never had the chance to actually read about him then I highly suggest you do. I made the mistake of just going by what I learned about him in school. I recently finished a biography on him which I really enjoyed because it would talk a good deal about his life and what was going on in the country at the time and then it would go to several pages of his letters, excerpts from talks and full speeches, and statements made to small groups of friends that illustrated his thoughts and feelings during the time period being discussed.

Our nation is being ripped apart because there is no clear and powerful leadership in the country. When Lincoln came into office the Presidency was looked at as more of a pomp role and the nation was literally being ripped apart for well known reasons. He came in and changed the role of the president and pushed the Union to be something better and led the war as wars should be led (He ran the war in the same way another hero of mine led in a war). While everything he did was not popular, in fact he was a rather embattled president, he had the reputation (and his letters reinforce that reputation) of being a man who would listen to all sides and then clearly make a decision with plenty of explanation as to why the decision was made. All of Lincoln’s decisions stuck to who he was and his core beliefs. While he was willing to listen to all sides and admit when he was wrong, he never wavered from his core belief in the constitution and his interpretation of what that document meant.

I believe President Obama started out on the campaign trail wanting to do the same thing with high hopes and a great vision but he is not strong enough of a leader and because of that he has given in on too many issues and he has allowed others to drive how things are run. He has turned the Presidency into a pomp role again. I would be interested to see if any previous President while in office sat in on so many talk shows and ran so many “town hall” meetings, in essence continuing their campaigning throughout their presidency.

My concern is that we have yet to hear about anyone from any party who would be strong enough of a leader, who could take up the mantle of being another Lincoln. Anybody know of anyone who might fit?

Barney Frank Caught in a Lie

Barney Frank, Then and Now
A news story from 2003:
The Bush administration today recommended the most significant regulatory overhaul in the housing finance industry since the savings and loan crisis a decade ago.

Under the plan, disclosed at a Congressional hearing today, a new agency would be created within the Treasury Department to assume supervision of Fannie Mae and Freddie Mac, the government-sponsored companies that are the two largest players in the mortgage lending industry....

Among the groups denouncing the proposal today were the National Association of Home Builders and Congressional Democrats who fear that tighter regulation of the companies could sharply reduce their commitment to financing low-income and affordable housing.

''These two entities -- Fannie Mae and Freddie Mac -- are not facing any kind of financial crisis,'' said Representative Barney Frank of Massachusetts, the ranking Democrat on the Financial Services Committee. ''The more people exaggerate these problems, the more pressure there is on these companies, the less we will see in terms of affordable housing.''

A news story from yesterday:
In a sharp-edged debut debate, US Representative Barney Frank, a Democrat, and Sean Bielat, his Republican challenger, squared off yesterday over national security, illegal immigration, and the roots of the mortgage crisis....

Bielat, a former Marine officer from Brookline, said Frank had contributed to the downfall and subsequent recession by supporting lenient lending standards for prospective home buyers.
“He has long been an advocate for extending homeownership, even to those who couldn’t afford it, regardless of the cost to the American people,’’ said Bielat, 35.

Frank, a leading liberal who has represented the state’s Fourth Congressional District for nearly 30 years and became chairman of the House Financial Services Committee in 2007, said he and other Democrats fought to curb predatory lending practices before the recession but were thwarted by Republicans. He said he had supported efforts to help low-income families rent homes, rather than buy them.

“Low-income home ownership has been a mistake, and I have been a consistent critic of it,’’ said Frank, 70. Republicans, he said, were principally responsible for failing to reform Fannie Mae and Freddie Mac, the mortgage giants the government seized in September 2008.

Short Post

Tell me what's wrong with this picture (if you can't see it, the top line is spending, the bottom line is revenue):

"The lessons of history, confirmed by the evidence immediately before me, show conclusively that continued dependence upon relief induces a spiritual and moral disintegration fundamentally destructive to the national fiber. To dole out relief in this way is to administer a narcotic, a subtle destroyer of the human spirit"
-- Franklin Delano Roosevelt, 1935 State of the Union address

Outside the Regular News

I read this piece this morning and thought I would share. To me it makes a lot of sense, but I don't have a law background at all. Hopefully this will generate some comments as to the reality of this. This is from John Mauldin's eLetter and he is quoting someone else within it who is quoting someone else (Isn't there some rule that by the time it passes 3rd person recounting it automatically becomes fact?)

OK, in a serendipitous moment, Maine fishing buddy David Kotok sent me this email on the mortgage foreclosure crisis just as I was getting ready to write much the same thing. It is about the best thing I have read on the topic. Saves me some time and you get a better explanation. From Kotok:
"Dear Readers, this text came to me in an email from sources that are in the financial services business and with whom I have a personal relationship. The original text was laced with expletives and I would not use it in the form I received it. Therefore the text below has had some substantial editing in order to remove that language. The intentions of the writer are undisturbed. The writer shall remain anonymous. This text echoes some of the news items we have seen and heard today; however, it can serve as a plain language description of the present foreclosure-suspension mess. There is a lot here. It takes about ten minutes to read it. - David Kotok (www.cumber.com)
"Homeowners can only be foreclosed and evicted from their homes by the person or institution who actually has the loan paper...only the note-holder has legal standing to ask a court to foreclose and evict. Not the mortgage, the note, which is the actual IOU that people sign, promising to pay back the mortgage loan
"Before mortgage-backed securities, most mortgage loans were issued by the local savings & loan. So the note usually didn't go anywhere: it stayed in the offices of the S&L down the street.
"But once mortgage loan securitization happened, things got sloppy...they got sloppy by the very nature of mortgage-backed securities.
"The whole purpose of MBSs was for different investors to have their different risk appetites satiated with different bonds. Some bond customers wanted super-safe bonds with low returns, some others wanted riskier bonds with correspondingly higher rates of return.
"Therefore, as everyone knows, the loans were 'bundled' into REMICs (Real-Estate Mortgage Investment Conduits, a special vehicle designed to hold the loans for tax purposes), and then "sliced & diced"...split up and put into tranches, according to their likelihood of default, their interest rates, and other characteristics.
"This slicing and dicing created 'senior tranches,' where the loans would likely be paid in full, if the past history of mortgage loan statistics was to be believed. And it also created 'junior tranches,' where the loans might well default, again according to past history and statistics. (A whole range of tranches was created, of course, but for the purposes of this discussion we can ignore all those countless other variations.)
"These various tranches were sold to different investors, according to their risk appetite. That's why some of the MBS bonds were rated as safe as Treasury bonds, and others were rated by the ratings agencies as risky as junk bonds.
"But here's the key issue: When an MBS was first created, all the mortgages were pristine...none had defaulted yet, because they were all brand-new loans. Statistically, some would default and some others would be paid back in full...but which ones specifically would default? No one knew, of course. If I toss a coin 1,000 times, statistically, 500 tosses the coin will land heads...but what will the result be of, say, the 723rd toss? No one knows.
"Same with mortgages.
"So in fact, it wasn't that the riskier loans were in junior tranches and the safer ones were in senior tranches: rather, all the loans were in the REMIC, and if and when a mortgage in a given bundle of mortgages defaulted, the junior tranche holders would take the losses first, and the senior tranche holder last.
"But who were the owners of the junior-tranche bond and the senior-tranche bonds? Two different people. Therefore, the mortgage note was not actually signed over to the bond holder. In fact, it couldn't be signed over. Because, again, since no one knew which mortgage would default first, it was impossible to assign a specific mortgage to a specific bond.
"Therefore, how to make sure the safe mortgage loan stayed with the safe MBS tranche, and the risky and/or defaulting mortgage went to the riskier tranche?
"Enter stage right the famed MERS...the Mortgage Electronic Registration System.
"MERS was the repository of these digitized mortgage notes that the banks originated from the actual mortgage loans signed by homebuyers. MERS was jointly owned by Fannie Mae and Freddie Mac (yes, those two again ...I know, I know: like the chlamydia and the gonorrhea of the financial world...you cure 'em, but they just keep coming back).
"The purpose of MERS was to help in the securitization process. Basically, MERS directed defaulting mortgages to the appropriate tranches of mortgage bonds. MERS was essentially where the digitized mortgage notes were sliced and diced and rearranged so as to create the mortgage-backed securities. Think of MERS as Dr. Frankenstein's operating table, where the beast got put together.
"However, legally...and this is the important part...MERS didn't hold any mortgage notes: the true owner of the mortgage notes should have been the REMICs.
"But the REMICs didn't own the notes either, because of a fluke of the ratings agencies: the REMICs had to be "bankruptcy remote," in order to get the precious ratings needed to peddle mortgage-backed Securities to institutional investors.
"So somewhere between the REMICs and MERS, the chain of title was broken.
"Now, what does 'broken chain of title' mean? Simple: when a homebuyer signs a mortgage, the key document is the note. As I said before, it's the actual IOU. In order for the mortgage note to be sold or transferred to someone else (and therefore turned into a mortgage-backed security), this document has to be physically endorsed to the next person. All of these signatures on the note are called the 'chain of title.'
"You can endorse the note as many times as you please...but you have to have a clear chain of title right on the actual note: I sold the note to Moe, who sold it to Larry, who sold it to Curly, and all our notarized signatures are actually, physically, on the note, one after the other.
"If for whatever reason any of these signatures is skipped, then the chain of title is said to be broken. Therefore, legally, the mortgage note is no longer valid. That is, the person who took out the mortgage loan to pay for the house no longer owes the loan, because he no longer knows whom to pay.
"To repeat: if the chain of title of the note is broken, then the borrower no longer owes any money on the loan.
"Read that last sentence again, please. Don't worry, I'll wait.
"You read it again? Good: Now you see the can of worms that's opening up.
"The broken chain of title might not have been an issue if there hadn't been an unusual number of foreclosures. Before the housing bubble collapse, the people who defaulted on their mortgages wouldn't have bothered to check to see that the paperwork was in order.
"But as everyone knows, following the housing collapse of 2007-'10-and-counting, there has been a boatload of foreclosures...and foreclosures on a lot of people who weren't sloppy bums who skipped out on their mortgage payments, but smart and cautious people who got squeezed by circumstances.
"These people started contesting their foreclosures and evictions, and so started looking into the chain-of-title issue, and that's when the paperwork became important. So the chain of title became crucial and the botched paperwork became a nontrivial issue.
"Now, the banks had hired 'foreclosure mills'...law firms that specialized in foreclosures...in order to handle the massive volume of foreclosures and evictions that occurred because of the housing crisis. The foreclosure mills, as one would expect, were the first to spot the broken chain of titles.
"Well, what do you know, it turns out that these foreclosure mills might have faked and falsified documentation, so as to fraudulently repair the chain-of-title issue, thereby 'proving' that the banks had judicial standing to foreclose on delinquent mortgages. These foreclosure mills might have even forged the loan note itself...
"Wait, why am I hedging? The foreclosure mills did actually, deliberately, and categorically fake and falsify documents, in order to expedite these foreclosures and evictions. Yves Smith at Naked Capitalism, who has been all over this story, put up a price list for this 'service' from a company called DocX...yes, a price list for forged documents. Talk about your one-stop shopping!
"So in other words, a massive fraud was carried out, with the inevitable innocent bystanders getting caught up in the fraud: the guy who got foreclosed and evicted from his home in Florida, even though he didn't actually have a mortgage, and in fact owned his house free -and clear. The family that was foreclosed and evicted, even though they had a perfect mortgage payment record. Et cetera, depressing et cetera.
"Now, the reason this all came to light is not because too many people were getting screwed by the banks or the government or someone with some power saw what was going on and decided to put a stop to it...that would have been nice, to see a shining knight in armor, riding on a white horse.
"But that's not how America works nowadays.
"No, alarm bells started going off when the title insurance companies started to refuse to insure the titles.
"In every sale, a title insurance company insures that the title is free -and clear ...that the prospective buyer is in fact buying a properly vetted house, with its title issues all in order. Title insurance companies stopped providing their service because...of course...they didn't want to expose themselves to the risk that the chain of title had been broken, and that the bank had illegally foreclosed on the previous owner.
"That's when things started getting interesting: that's when the attorneys general of various states started snooping around and making noises (elections are coming up, after all).
"The fact that Ally Financial (formerly GMAC), JP Morgan Chase, and now Bank of America have suspended foreclosures signals that this is a serious problem...obviously. Banks that size, with that much exposure to foreclosed properties, don't suspend foreclosures just because they're good corporate citizens who want to do the right thing, and who have all their paperwork in strict order...they're halting their foreclosures for a reason.
"The move by the United States Congress last week, to sneak by the Interstate Recognition of Notarizations Act? That was all the banking lobby. They wanted to shove down that law, so that their foreclosure mills' forged and fraudulent documents would not be scrutinized by out-of-state judges. (The spineless cowards in the Senate carried out their master's will by a voice vote...so that there would be no registry of who had voted for it, and therefore no accountability.)
"And President Obama's pocket veto of the measure? He had to veto it...if he'd signed it, there would have been political hell to pay, plus it would have been challenged almost immediately, and likely overturned as unconstitutional in short order. (But he didn't have the gumption to come right out and veto it...he pocket vetoed it.)
"As soon as the White House announced the pocket veto...the very next day!...Bank of America halted all foreclosures, nationwide.
"Why do you think that happened? Because the banks are in trouble...again. Over the same thing as last time...the damned mortgage-backed securities!
"The reason the banks are in the tank again is, if they've been foreclosing on people they didn't have the legal right to foreclose on, then those people have the right to get their houses back. And the people who bought those foreclosed houses from the bank might not actually own the houses they paid for.
"And it won't matter if a particular case...or even most cases...were on the up -and up: It won't matter if most of the foreclosures and evictions were truly due to the homeowner failing to pay his mortgage. The fraud committed by the foreclosure mills casts enough doubt that, now, all foreclosures come into question. Not only that, all mortgages come into question.
"People still haven't figured out what all this means. But I'll tell you: if enough mortgage-paying homeowners realize that they may be able to get out of their mortgage loans and keep their houses, scott-free? That's basically a license to halt payments right now, thank you. That's basically a license to tell the banks to take a hike.
"What are the banks going to do...try to foreclose and then evict you? Show me the paper, Mr. Banker, will be all you need to say.
"This is a major, major crisis. The Lehman bankruptcy could be a spring rain compared to this hurricane. And if this isn't handled right...and handled right quick, in the next couple of weeks at the outside...this crisis could also spell the end of the mortgage business altogether."

Video Link

Great follow-up video to my last post. This is an interview with Rod Smyth of Riverfront Investment Group.

Bloomberg Interview of Rod Smyth.

Two Issues

"Penny-wise but pound foolish” I’m not sure where that saying came from, and I probably misquoted it, but it is an apt description of what is currently going on worldwide, but seemingly particularly so here in the U.S. I wanted to bring a couple of issues that you may not have heard about to light.

First is something the policy makers in Europe foolishly put into place under the idea that they were protecting their citizens from a potential future crash of the insurers. They decided that they wanted insurers to have more fixed income instruments and less equity in their accounts which cover their capital adequacy requirements. Basically they want to run a “stress” test that will see if the insurers will be able to withstand a couple of financial crises like the one we just went through while still holding enough capital to pay for all policies and then some. Sounds like a decent idea right? Make the insurers carry more “stable” investments in their coffers in case large problems occur and they need to pay out. In fact it sounded like such a great idea that the policy makers are not planning on stopping there, they now want pensions to do the same thing (since they function very much the same as insurers in Europe, in fact a lot are insurers); lower their equity exposure and add fixed income. Sounds great until you realize how bonds and other fixed income funds work.

Here’s a brief snippet from Niels Jensen of Absolute Return Partners that explains a little bit of the problem created from this.

“Going forward, the main issue facing the industry (and that is the same for insurers and pension funds) is the relentless drop in bond yields. As yields come down, so does the discount rate which is used to calculate future liabilities. A lower discount rate in turn leads to a falling solvency ratio. In the first half of this year alone, solvency fell by 13% on average as a result of falling bond yields. With Solvency II only two years away, a deeply worrisome situation is developing whereby low inflation forces bond yields down which again forces insurers and at least some pension funds to re-balance their portfolios in favor of more bonds and fewer equities, which will push bond yields even lower. This self-perpetuating mechanism amplifies an already unstable situation.

I am not sure if policy makers understand how potentially dangerous this situation is. We are on the road to insolvency. And, even if pension providers manage to stay solvent, future generations of retirees are likely to run into serious financial difficulties as their retirement savings earn next to nothing, because our political leaders forced new rules on the industry, the implications of which they did not grasp.”

The second item I wanted to bring to your attention is one you have likely heard a little about. A lot of the developed and developing nations are trying to devalue their currency in order to make their exports look more attractive than those of competing nations (Brazil just came out recently and openly talked about the currency war which has been going for a while now apparently). Let’s get into a little bit of the why this is happening and then the problems it is causing and will likely cause due to policy action.

As everyone knows GDP is the measure of a countries economy. The GDP is made up of four general measurements: Consumption (by far the largest portion in our GDP), Investment, Government, and Net Exports. If you add those up you get the GDP number. Our current government had the idea that they would get out of this mess in a two step method, they would take up the slack in consumer spending with massive government spending. Obviously that hasn’t worked as well as they would have liked because due to the government’s own regulations (at least for the most part) banks are not lending the massive amount of money that they have been basically given. Because this hasn’t been working as well they now are focused heavily on part two of their plan and that is to increase the exports significantly over imports. To do that we need to have better products, fair trade agreements with lots of other countries, and a currency that’s value is hopefully lower than our competitors and the receiving country. Rather than help with the first two they have decided to play the same political games they do here and they have blamed the trade “imbalance” on others. What you have likely seen is the increasingly heated arguments between the U.S. and China. The Obama administration is pushing so much on this issue that polls are showing greater numbers of people who believe we should put in trade policies to hurt China thereby saving jobs here(future post topic).

What most haven’t realized is that even if policies were put into place they would not likely change our export numbers significantly. They might change the import numbers a little and that is where it would probably hurt U.S. consumers who rely on cheap Chinese goods and probably don’t even know it. Many also don’t know or don’t want to look at the bigger picture.

China wants to change from being primarily an exporting economy. That is how they have grown to the size they are now, but they need more stable and home grown growth and so they have begun to focus on increasing consumption. That’s not a switch that can happen overnight and definitely not one which can be made during this economic slump. It will take time, but when the switch happens we had better be in a position to capitalize on these millions of new consumers.

In the mean time, why don’t we focus on the other parts of the GDP equation? The rule is, if you want to change GDP you have to change the population and/or production. Increasing the population is not going to be likely (I base this judgment on the looks my wife and I get in public when out with our four kids) and wouldn’t help us immediately anyway. So, why don’t we work on increasing production? To do that we need to get out of the way of entrepreneurs (i.e., taxes, over-regulation, etc.) and stop encouraging laziness (I read that unemployment is as long as 99 weeks in one state); it’s my opinion that the government should be stingy with handouts and the private sector should be freer with them. If we allowed good business to grow then we will get out of this. The problem with this in the politicians mind is that it will take a while and we will only experience slow growth until then and we have to stop spending money. Those three combined would mean re-election would be difficult at best.

Of course, we could do something about that attitude. We could stop “rewarding” politicians for their stupid, short-sighted ideas by voting for them again. We need to ignore what the politicians are saying and take a look at what they have done and are doing to fix problems for the long-term. That includes those running for office for the first time. What have they done? What are they doing now?

Here’s hoping for some real change.

From Brian Wesbury of First Trust

"In the year 1000, the average infant could expect to live about 24 years. A third died in the first year of life. Hunger and epidemic disease ravaged the survivors. By 1820, life expectation had risen to 36 years in the west, with only marginal improvement elsewhere. After 1820, world development became much more dynamic. By 2003, income per head had risen nearly ten-fold, population six-fold. Per capita income rose by 1.2 per cent a year: 24 times as fast as in 1000-1820. Life expectation increased to 76 years in the west and 63 in the rest of the world.” Angus Maddison, Contours of the World Economy.

To paraphrase - for 1800 years, progress was virtually non-existent; then it accelerated sharply. It takes a severe case of denial for someone to ignore these lessons of history. What they show is that when freedom prevails, the ingenuity and inventiveness of people creates incredible wealth. This is the true source of improvement in the human condition.

The US Constitution was crucial in the process of freedom. It established a new country with protected property rights. The Declaration of Independence declared the “unalienable Rights” of “Life, Liberty and the Pursuit of Happiness.” It also declared that “whenever any Form of Government becomes destructive of these ends, it is the Right of the People to alter or to abolish it, and to institute new Government….”

Yes, the US has its history with slavery and women’s suffrage, but the Civil War, and 13th and 19th Amendments to the Constitution fixed those wrongs. It wasn’t easy, but the system worked. No system of social and economic organization has done more to lift living standards than the US system of “free market capitalism.” No system of governance has improved the lives of so many people.

So, why is this system under attack? Have we uncovered problems with free market capitalism that are the equivalent of slavery and women’s suffrage? President Obama thinks so. In a speech last week, he called belief in capitalism “blind faith.” He said this philosophy, of letting people “fend for themselves” has “failed.” He added that “people are frustrated, they’re anxious, they’re scared about the future. [But] now is not the time to quit....We’ve been through worse.... It took time to free the slaves. It took time for women to get the vote.”

This is the Progressive’s mantra – “Capitalism is unjust, unfair...A new system must be put in its place and this takes time.” There is only one problem with this logic. It’s not really progress and it has never, ever worked. Today’s progressives are the ones that ask for blind faith. They want people to believe that they have finally figured out how to do it right

But this is just wishful thinking. Every economic system, no matter how it is described, is a system that distributes resources among competing interests. In a Progressive system, government officials control this process. In a free market system, resources flow to those who use them best to improve the lives of others. The market votes every day on these products and services and the successful ones are given more resources. To prove how fluid this system is, more businesses fail each year than succeed.

This is not true of government. Once started, government programs rarely fail. The system perpetuates them with more money and more resources. The waste increases over time until it becomes so overwhelming that the entire system fails. The Roman Empire, the Soviet Union, Greece, California and Illinois are all the evidence needed.

The real problem with the economy these days it that we have moved too far away from free market capitalism. As government spending has increased, so has unemployment. This is not a mystery; the bigger the government, the smaller the private sector and the less dynamic the economy. If there is any emancipation needed these days it’s from the government, not from capitalism.

I can't stop laughing

I can't stop laughing at this new quote of the week:

Bill Clinton, 9/21: "Do you know how many political and economic decisions are made in this world by people who don't know what in the living daylights they are talking about?"

and then I cry a little.

Unemployment - taken from an article from Mesirow Financial

An elevated level of the “natural rate” of unemployment is a worrisome development in the United States, but it has been a sad reality in Europe for at least two decades. As is widely known, Europe has suffered higher unemployment rates than the U.S., and until recent years, European countries achieved little success in improving the performance of their labor markets.

There are at least six factors that are commonly advanced to explain this differential:

1- Generous levels of unemployment benefits
2- Longer duration of unemployment benefits
3- Higher degree of workers’ protection
4- Higher rates of unionization
5- Centralization of wage bargaining
6- Broader safety net provided by families to young adults

Overall, these six factors contributed to create and preserve a labor market significantly more rigid than the one existing in the United States. It was only after the roll-back of some of these protections that Europe began to experience some improvement in the 2000s.

Are we Europe yet? No. While recent policy decisions have moved us closer our supporting of the unemployed lifestyle it is not nearly the same as it was and is for Europe. Learning from the European mistakes, we should resist short-term fixes that would make the labor market more rigid, preventing the market to adjust to the new economic realities. Instead, we should focus on programs that facilitate, rather than hinder, the underlying changes taking place in the economy. From re-training programs to the portability of healthcare benefits, from the revision of the way unemployment benefits are calculated, to having them progressively phased-out rather than abruptly interrupted, there are many options to make incentives more aligned with the dynamics of the market process. The preservation of flexibility in the U.S. job market is of paramount importance.

From Dana Investment Newsletter

"Economic data continues to be mixed. The latest jobs report continues to be weak, depending on who spins it. Non-farm payrolls fell by 54,000 in August, however, that included 114,000 September 13, 2010 temporary census jobs lost, so you could say the private sector gained 67,000. A positive number, to be sure, but it's not near enough to indicate a robust recovery. It is still the uncertainties holding the recovery back. Calvin Coolidge once said, “The business of America is business.” Our corporate tax rate at 35% is the second highest in the free world after Japan. Congress could help by reducing that rate to at least 20%."

"CEOs speak: Paul Otellini, CEO of Intel which employs 80,000 people, worries that America will not be the center of the innovation universe much longer. Otellini said, “I can tell you definitively that it costs $1 billion more per factory for me to build, equip, and operate a semiconductor manufacturing facility in the U.S.” He further stated that 90% of the added cost is due to taxes and regulations that other countries don’t have. CEO David Speer of Illinois Tool Works, whose company employs 60,000 workers, recently stated, “I could borrow $2 billion tomorrow for 3-1/2%, but what am I going to do with it?” And Ivan Seidenberg, CEO of Verizon, said, “Tax hikes, regulations and constant policy shifts harm our ability to gain private sector jobs in the US” (Investor’s Business Daily, 8.26.10).

These people know business and our policy makers should listen."

Great Article from Stratfor

By George FriedmanWe are now nine weeks away from the midterm elections in the United States. Much can happen in nine weeks, but if the current polls are to be believed, U.S. President Barack Obama is about to suffer a substantial political reversal. While we normally do not concern ourselves with domestic political affairs in the United States, when the only global power is undergoing substantial political uncertainty, that inevitably affects its behavior and therefore the dynamics of the international system. Thus, we have to address it, at least from the standpoint of U.S. foreign policy. While these things may not matter much in the long run, they certainly are significant in the short run.

To begin thinking about this, we must bear three things in mind. First, while Obama won a major victory in the Electoral College, he did not come anywhere near a landslide in the popular vote. About 48 percent of the voters selected someone else. In spite of the Democrats’ strength in Congress and the inevitable bump in popularity Obama received after he was elected, his personal political strength was not overwhelming. Over the past year, poll numbers indicating support for his presidency have deteriorated to the low 40 percent range, numbers from which it is difficult, but not impossible, to govern.

Second, he entered the presidency off balance. His early focus in the campaign was to argue that the war in Iraq was the wrong war to fight but that the war in Afghanistan was the right one. This positioned him as a powerful critic of George W. Bush without positioning him as an anti-war candidate. Politically shrewd, he came into office with an improving Iraq situation, a deteriorating Afghanistan situation and a commitment to fighting the latter war. But Obama did not expect the global financial crisis. When it hit full blast in September 2008, he had no campaign strategy to deal with it and was saved by the fact that John McCain was as much at a loss as he was. The Obama presidency has therefore been that of a moderately popular president struggling between campaign promises and strategic realities as well as a massive economic crisis to which he crafted solutions that were a mixture of the New Deal and what the Bush administration had already done. It was a tough time to be president.

Third, while in office, Obama tilted his focus away from the foreign affairs plank he ran on to one of domestic politics. In doing so, he shifted from the area where the president is institutionally strong to the place where the president is institutionally weak. The Constitution and American tradition give the president tremendous power in foreign policy, generally untrammeled by other institutions. Domestic politics do not provide such leeway. A Congress divided into two houses, a Supreme Court and the states limit the president dramatically. The founders did not want it to be easy to pass domestic legislation, and tradition hasn’t changed that. Obama can propose, but he cannot impose.

Therefore, the United States has a president who won a modest victory in the popular vote but whose campaign posture and the reality under which he took office have diverged substantially. He has been drawn, whether by inclination or necessity, to the portion of his presidency where he is weakest and most likely to face resistance and defeat. And the weaker he gets politically the less likely he is to get domestic legislation passed, and the defeats will increase his weakness.
He does not, at the moment, have a great deal of public support to draw on, and the level of vituperation from the extremes has reached the level it was with George W. Bush. Where Bush was accused by the extreme left of going into Iraq to increase profits for Halliburton and the oil companies, Obama is being accused by the extreme right of trying to create a socialist state. Add to this other assorted nonsense, such as the notion that Bush engineered 9/11 or that Obama is a secret Muslim, and you get the first whiff of a failed presidency. This is not because of the prospect of midterm reversals — that has happened any number of times. It is because Obama, like Bush, was off balance from the beginning.

If Obama suffers a significant defeat in Congress in the November elections, he will not be able to move his domestic agenda. Indeed, Obama doesn’t have to lose either house to be rendered weak. The structure of Congress is such that powerful majorities are needed to get anything done. Even small majorities can paralyze a presidency.

Under these circumstances, he would have two choices. The first is to go into opposition. Presidents go into opposition when they lose support in Congress. They run campaigns against Congress for blocking their agenda and blame Congress for any failures. Essentially, this was Bill Clinton’s strategy after his reversals in 1994, and it worked in 1996. It is a risky strategy, obviously. The other option is to shift from the weak part of the presidency to the strong part, foreign policy, where a president can generally act decisively without congressional backing. If Congress does resist, it can be painted as playing politics with national security. Since Vietnam, this has been a strategy Republican presidents have used, painting Democratic Congresses as weak on national security.

There is a problem in Obama choosing the second strategy. For Republicans, this strategy plays to their core constituency, for whom national security is a significant issue. It also is an effective tool to reach into the center. The same isn’t true for the Democrats. Obama’s Afghanistan policy has already alienated the Democratic left wing, and the core of the Democratic Party is primarily interested in economic and social issues. The problem for Obama is that focusing on foreign policy at the expense of economic and social issues might gain him some strength in the center, but probably wouldn’t pick him up many Republican votes and would alienate his core constituency.

This would indicate that Obama’s best strategy is to go into opposition, government against Congress. But there are two problems with this. One of the underlying themes of the Obama presidency is that he is ineffective in getting his economic agenda implemented. That’s not really true, given the successes he has had with health-care reform and banking regulation, but it is still a theme. The other problem he has is the sense that he has surged in Afghanistan while setting a deadline for withdrawal and that his Afghan policy is merely a political gesture.

Obama can’t escape national security issues. Clinton could. In 1996, there were no burning issues in foreign policy. There are now two wars under way. Obama can’t ignore them even if his core constituency has a different agenda. Going into opposition against Congress could energize his base, but that base is in the low 40s. He needs to get others on board. He could do that if he could pass legislation he wanted, but the scenario we are looking at will leave him empty-handed when it comes time for re-election. His strongest supporters will see him as the victim, but a victimized president will have trouble putting together a winning coalition in 2012. He can play the card, but there has to be more.

We come back to foreign policy as a place where Obama will have to focus whether he likes it or not. He takes his bearings from Franklin Roosevelt, and the fact is that Roosevelt had two presidencies. One was entirely about domestic politics and the other about foreign policy, or the Depression and then World War II. This was not a political choice for Roosevelt, but it was how his presidency worked out. For very different reasons, Obama is likely to have his presidency bifurcated. With his domestic initiatives blocked, he must turn to foreign policy.

Here, too, Obama has a problem. He ran his campaign, in the Democratic tradition, with a vague anti-war theme and a heavy commitment to the American-alliance structure. He was also a strong believer in what has been called soft power, the power of image as opposed to that of direct force. This has not been particularly successful. The atmospherics of the alliance may be somewhat better under Obama than Bush, but the Europeans remain as fragmented and as suspicious of American requests under Obama as they were under Bush. Obama got the Nobel Prize but precious little else from the Europeans. His public diplomacy initiative to the Islamic world also did not significantly redefine the game. Relations with China have improved but primarily because the United States has given up on revaluation of the yuan. It cannot be argued that Obama’s strategy outside the Islamic world has achieved much. It could be claimed that any such strategy takes time, Obama’s problem is that he is running out of political maneuvering room.

That leaves the wars that are continuing, Iraq and Afghanistan. We have argued that Afghanistan is the wrong war in the wrong place. It is difficult to know how Obama views it, given his contradictory signals of increasing the number of troops but setting a deadline for beginning their withdrawal. We have argued that a complete withdrawal from Iraq without a settlement with Iran or the decimation of Iran’s conventional forces would be a mistake, but we don’t know, obviously, what Obama’s view on this is. We do not know his view of the effect of the Afghan war on U.S. strategic posture or on Pakistan, and we do not know his view of the impact of U.S. withdrawal from Iraq on Iranian influence in the Persian Gulf.

Let’s assume that he has clear views, which is likely for a president, and he is playing a long and quiet game. This would not be a bad strategy if he were stronger and had more time. But if the polls hold he will be weaker and running out of time. It would therefore follow that Obama will come out of the November election having to turn over his cards on the only area where he can have traction — Iraq, Iran and Afghanistan. The question is what he might do.

One option is to solve the Iraq problem by attacking Iran’s nuclear facilities. This carries the risk, as I have said many times, of Iranian retaliation in the Strait of Hormuz and a massive hit on the Western economic revival. In that sense, a strike against Iranian nuclear targets alone would be the riskiest. Far safer is a generalized air campaign against both Iran’s nuclear and conventional capability.

But launching a new war, while two others go on, is strategically risky. From a political point of view, it would alienate Obama’s political base, many of whom supported him because he would not undertake unilateral military moves. The Republicans would be most inclined to support him, but most would not vote for him under any circumstances. Plus, brilliant military strokes have the nasty habit of bogging down just as mediocre ideas do. That would end the Obama presidency. Clinton’s war in Kosovo was not an easy option for him strategically or politically.
That leaves another option that we have suggested before, one that would appeal both to Obama’s sensibility and to his political situation: pulling a Nixon. In 1971, Richard Nixon reached out to China while Chinese weapons were being used to kill American soldiers in Vietnam. Roosevelt did the same with the Soviets in 1941. There is a tradition in the United States of a diplomatic stroke with ideological enemies to achieve strategic ends.

Diplomatic strokes appeal to Obama. They also would appeal to his political base, while any agreement with Iran that would contribute to an American withdrawal from Iraq and perhaps from Afghanistan would appeal to the center. The Republicans would be appalled, but Obama can’t win them over anyway so it doesn’t matter. Indeed, he can use their hostility to strengthen his own base.

What the settlement with Iran might look like is murky at best. Whether Iran has any interest in such a settlement is murkier still. But if Obama gets hammered in the midterms, his domestic agenda will be frozen. He doesn’t have the personal strength and credibility to run against Congress for two years and then get re-elected. He retains his power in foreign affairs but he has not gotten traction on a multilateral reconstruction of America’s global popularity. He has two wars ongoing, plus a major challenge from Iran. Attacking Iran from the air might or might not work, and it could weaken him politically. That leaves him with running against Congress or addressing the Middle East with a diplomatic masterstroke.

It is difficult to know the ways of presidents, particularly one who has tried hard to be personally enigmatic. But it is easier to measure the political pressures that are confronting him and shaping his decisions. I wouldn’t be so bold as to predict his actions, but I would argue that he faces some unappetizing choices that he could solve with a very bold move in foreign policy. His options on the domestic side will disappear if the polls are right.
Elections and Obama's Foreign Policy Choices STRATFOR

The Customer is Always Right

Has anyone else noticed that this has pretty much disappeared from the thought processes of most businesses out there? Or at least it hasn’t passed on to those who actually interact with the customer/client.

Today, a couple of the folks I work with were talking about an upcoming meeting with the manager during which the manager had set as an agenda item to talk about general attitude and point out that the customer is always right. The conversation between these co-workers was not how true of a statement that was but more of how much the customer is wrong. Their thoughts regarding our customers was that they were a bunch of idiots who didn’t really know anything at all and we were nice enough to explain it once so why would they still have questions.

Wal-Mart is the prime example, but it seems that everywhere we go this attitude prevails. Now obviously the customer is not always right, but it is all about the attitude. For example, the other day I went to a restaurant for a business lunch and ordered what I thought was a chimichanga lunch combo. I ordered it by just stating its combo number. When the food came out they brought me an enchilada supreme. I told them that was not my order. They apologized and pulling out the order notes they asked if it was the #23 that I had wanted. I said that is what I had ordered and they explained that the #23 was the enchilada, but they would take it back and make the chimichanga combo meal if that is what I meant. I thanked them for the offer but feeling rather stupid told them I would eat the enchilada (which was good by the way) since that is what I ordered. The entire time their attitude was that of the customer is always right, even though they pointed out how stupid I was.

It’s rare that I get this kind of service however.

Personally I think this new attitude is prevailing due to the decrease in face-to-face interaction and increase of electronic “communication” (which isn’t really communication in its truest sense). This lack of interaction is changing perspectives from looking at everyone as a human being to them just being objects. There is a great book that I would recommend you read, if you have not already, that covers changing our perspective from looking at people as objects to looking at them as who they really are. The book is called “The Anatomy of Peace: Resolving the Heart of Conflict”.

I know that you are probably now wondering what on earth this has to do with politics and the economy. Well, I actually have been thinking lately about how this attitude and this move into the information age (aka., the age of everyone getting a massive amount of their contact with the outside world through the computer) is affecting the overall economic picture of our nation. How is this changing, if at all, for good or bad our nations ability to nurture and teach the next generation of rising stars? Is there a connection between this attitude and the feeling of the now majority (according to some polls) that the government should fix some to all of their problems? [I do find it interesting that this same majority, however, does not want or agree with becoming a socialist state. Talk about disconnect]

Anyway, what are your answers/thoughts to these questions?

Government Spending Example

From Brian Wesbury at First Trust.


Christina Romer, the Chairwoman of president Obama’s Council of Economic Advisers has announced her resignation. While some people say her departure is a sign of deep divisions in the Obama team, we take her comments, about getting along with Larry Summers and enjoying every minute of her tenure, at face value. You, of course, can decide for yourself.

Romer’s infamous forecast that the $800 billion Obama stimulus bill would keep the unemployment rate at or below 8% will go down in history as one of the worst by any political economist. A 131,000 drop in jobs during July and an unemployment rate holding at 9.5% are not the headlines a president needs going into mid-term elections.

If Romer is taking the fall for all this, she has herself to blame. Her forecast of the economic benefits of government stimulus was not only wrong, but flawed. Politicians love Keynesian economists – they tell them what they want to hear – “bigger government is good.” Romer apparently fell into this trap. Now others are doing the same thing. We have one thing to say. Please, no more stimulus.

Don’t take this the wrong way. Up to a point, some government spending is good. Defending the nation and the rule of law, and helping create some national efficencies are positive additions to growth. But the US is past that point. No matter how many studies pretend that there is a positive multiplier (every dollar of government spending creates more than a dollar of GDP) they are all just political cover for expanding the size and scope of the political class.

A good test case is Canada. It has been cutting spending and tax rates for the past decade or so. While Canada bowed to pressure from the G-20 last year and is currently running a budget deficit of about 4.5% of GDP, this is well below the US and its $1.4 trillion, 10% deficits. This Canadian stimulus is smaller than in past recessions (see budget here). Canada ran deficits of 5.6% of GDP in 1992-93 and 7.6% in 1982-83 – both larger than in the US.

If Keynesians are right, the US economy should be outperforming the Canadian economy now and Canada should have done better back in the 1980s and 1990s, right? Wrong. It’s the opposite. The unemployment rate in Canada is currently 8% (Romer’s target rate) and has been below the US level since October 2008, when government spending started to go crazy. And from 1982 to 2008, the Canadian unemployment rate was always higher than the US rate – by an average of 2.8 percentage points.

This is the fruit of trusting the market and reducing the size of government. In Canada, total government spending fell from 53.3% of GDP in 1992 to 39.2% in 2007. Since then, stimulus spending boosted it to 43.8%, but the trend is down, not up. At the same time, tax rates have continued to fall. Corporate tax rates were cut from 21% in 2006 to 19.5% in 2008, 19% in 2009 and then 18% this year. The GST (a national sales tax) was cut from 6% to 5% in 2008.

The lesson is clear. Less spending, less taxing and more freedom work. Let’s not stimulate anymore. The US economy just can’t take it.

Perfect Quote

This quote fits well with my previous post.

"I predict future happiness for Americans if they can prevent the government from wasting the labors of the people under the pretense of taking care of them." - Thomas Jefferson

Disconnect

I don’t know about anyone else who reads this blog, but I have begun to notice a major disconnect between where our government has been heading (and yes that includes the last decade, not just the current Administration), and where our businesses (both small and large) are heading. I think that the difference is explained a little in the below snippet from Riverfront (emphasis added is mine):

“Mired in debt, dysfunctional government, and poor demographics, the developed world’s growth prospects are dimming and, if not careful, it risks slipping into irrelevance. Led by Japan, which began exhibiting signs of malaise two decades ago, we think the developed world’s vitality is being surpassed by younger, more numerous, and increasingly productive and competitive emerging market upstarts. We view this as a natural progression, but one that does not necessarily have to come at the expense of economic growth in the developed world. In our view, maintaining dynamism in the developed world will require gradually reducing the size of long-term government spending, growing wages through higher productivity, and maintaining leading edges in technology, innovation, marketing and finance. With these competitive advantages, rising wealth in emerging markets can create new customers as well as new competitors. While easier said than done, we believe successful implementation of these measures will characterize those developed world countries able to maintain economic growth and relevance. The alternatives – ignoring the changing world, failing to tackle structural spending issues, falling behind in technology, closing off trade and becoming protectionist – are a recipe for economic decline, in our opinion.”

I think our businesses exhibit the very ideas that Riverfront states are necessary in order to maintain relevance – and I 100% agree with their list. However, our government seems to be mired on the failing side, and in a way they are trying to vilify our businesses for going the right way. Government is getting bigger and less sophisticated. Creating a blog for every new project and government creation is not advancing technologically, in case there was any argument there. Adding committees and people to the payroll who will work on figuring out how the rest of the government can be more productive will not increase productivity. They are constantly threatening protectionist policies, and they seem to be establishing a brand – through our “silent” marketing – that is not attractive to businesses.

In fact, our “marketing” has shown businesses that our government wants an environment where rules will change at the whim of legislators. Some companies will get preferential treatment, but only for as long as congress decides (I wonder how that decision is made….billions in lobbying…perhaps?, with the occasional peer pressure cave-in?) Taxes will constantly be increased to fund the lazy and unproductive, with a dollop of help for the actual needy. And any time problems arise the "other" party will be to blame.

So, what will it take?

“The OECD concludes: ‘Rather than see the ‘rise of the rest’ in terms of the ‘decline of the west’, policy makers should recognize that the net gains from increased prosperity in the developing world can benefit both rich and poor countries alike. Improvements in the range and quality of exports, greater technological dynamism, better prospects for doing business, a larger consumption base – all these factors can create substantial welfare benefits for the whole world.”

Put simply…Get out of the way and encourage businesses to keep going the right way! If our government doesn't do this then eventually we will fall from the top.

Guess Who?

I am currently reading a biography of Abraham Lincoln. It has definitely changed my perception of him. Not for better or worse, just different. I still respect and look at him as a great president, but now I know more of the reasons why he was.

As with a lot of people I have been doing a lot of thinking about what I personally would really want in a representative (thinking back through Lincoln and the many other greats has really brought it forward) and while it's not necessarily just what is said in the below, it definitely is how it is said. That's what I want and will be voting for. Does that make sense?

Let me know (without doing internet searches) if you know who gave this speech.

I am going to talk of controversial things. I make no apology for this.
It's time we asked ourselves if we still know the freedoms intended for us by the Founding Fathers. James Madison said, "We base all our experiments on the capacity of mankind for self government."

This idea? that government was beholden to the people, that it had no other source of power is still the newest, most unique idea in all the long history of man's relation to man. This is the issue of this election: Whether we believe in our capacity for self-government or whether we abandon the American Revolution and confess that a little intellectual elite in a far-distant capital can plan our lives for us better than we can plan them ourselves.

You and I are told we must choose between a left or right, but I suggest there is no such thing as a left or right. There is only an up or down. Up to man's age-old dream-the maximum of individual freedom consistent with order or down to the ant heap of totalitarianism. Regardless of their sincerity, their humanitarian motives, those who would sacrifice freedom for security have embarked on this downward path. Plutarch warned, "The real destroyer of the liberties of the people is he who spreads among them bounties, donations and benefits."

The Founding Fathers knew a government can't control the economy without controlling people. And they knew when a government sets out to do that, it must use force and coercion to achieve its purpose. So we have come to a time for choosing.

Public servants say, always with the best of intentions, "What greater service we could render if only we had a little more money and a little more power." But the truth is that outside of its legitimate function, government does nothing as well or as economically as the private sector.
Yet any time you and I question the schemes of the do-gooders, we're denounced as being opposed to their humanitarian goals. It seems impossible to legitimately debate their solutions with the assumption that all of us share the desire to help the less fortunate. They tell us we're always "against," never "for" anything.

We are for a provision that destitution should not follow unemployment by reason of old age, and to that end we have accepted Social Security as a step toward meeting the problem. However, we are against those entrusted with this program when they practice deception regarding its fiscal shortcomings, when they charge that any criticism of the program means that we want to end payments....

We are for aiding our allies by sharing our material blessings with nations which share our fundamental beliefs, but we are against doling out money government to government, creating bureaucracy, if not socialism, all over the world.

We need true tax reform that will at least make a start toward restoring for our children the American Dream that wealth is denied to no one, that each individual has the right to fly as high as his strength and ability will take him.... But we can not have such reform while our tax policy is engineered by people who view the tax as a means of achieving changes in our social structure....

Have we the courage and the will to face up to the immorality and discrimination of the progressive tax, and demand a return to traditional proportionate taxation? . . . Today in our country the tax collector's share is 37 cents of -very dollar earned. Freedom has never been so fragile, so close to slipping from our grasp.

Are you willing to spend time studying the issues, making yourself aware, and then conveying that information to family and friends? Will you resist the temptation to get a government handout for your community? Realize that the doctor's fight against socialized medicine is your fight. We can't socialize the doctors without socializing the patients. Recognize that government invasion of public power is eventually an assault upon your own business. If some among you fear taking a stand because you are afraid of reprisals from customers, clients, or even government, recognize that you are just feeding the crocodile hoping he'll eat you last.

If all of this seems like a great deal of trouble, think what's at stake. We are faced with the most evil enemy mankind has known in his long climb from the swamp to the stars. There can be no security anywhere in the free world if there is no fiscal and economic stability within the United States. Those who ask us to trade our freedom for the soup kitchen of the welfare state are architects of a policy of accommodation.

They say the world has become too complex for simple answers. They are wrong. There are no easy answers, but there are simple answers. We must have the courage to do what we know is morally right. Winston Churchill said that "the destiny of man is not measured by material computation. When great forces are on the move in the world, we learn we are spirits-not animals." And he said, "There is something going on in time and space, and beyond time and space, which, whether we like it or not, spells duty." You and I have a rendezvous with destiny. We will preserve for our children this, the last best hope of man on earth, or we will sentence them to take the first step into a thousand years of darkness. If we fail, at least let our children and our children's children say of us we justified our brief moment here. We did all that could be done.

Poverty Measurements

I thought this was an interesting piece and fairly enlightening on government statistics.

Why Our Poverty Measure Misleads
By Robert Samuelson

Who is poor in America? This is not an easy question to answer, and the Obama administration would make it harder. It's hard because there's no conclusive definition of poverty. Low income matters, though how low is unclear. Poverty is also a mind-set that fosters self-defeating behavior -- bad work habits, family breakdown, out-of-wedlock births and addictions. Finally, poverty results from lousy luck: accidents, job losses, disability.

Despite poverty's messiness, we've tended to measure progress against it by a single statistic, the federal poverty line. It was originally designed in the early 1960s by Mollie Orshansky, an analyst at the Social Security Administration, and became part of Lyndon Johnson's War on Poverty. She took the Agriculture Department's estimated cost for a bare-bones -- but adequate -- diet and multiplied it by three. That figure is adjusted annually for inflation. In 2008, the poverty threshold was $21,834 for a four-member family with two children under 18.

By this measure, we haven't made much progress. Except for recessions, when the poverty rate can rise to 15 percent, it has stayed in a narrow range for decades. In 2007 -- the peak of the last business cycle -- the poverty rate was 12.5 percent; one out of eight Americans was "poor." In 1969, another business cycle peak, the poverty rate was 12.1 percent. But the apparent lack of progress is misleading for two reasons.

First, it ignores immigration, which has increased reported poverty. Many immigrants are poor and low-skilled. From 1989 to 2007, about three-quarters of the increase in the poverty population occurred among Hispanics -- mostly immigrants, their children and grandchildren. The poverty rate for blacks fell during this period, though it was still much too high (24.5 percent in 2007). Poverty "experts" don't dwell on immigration, because it implies that more restrictive policies might reduce U.S. poverty.

Second, the poor's material well-being has improved. The official poverty measure obscures this by counting only pre-tax cash income and ignoring other sources of support. These include the earned-income tax credit (a rebate to low-income workers), food stamps, health insurance (Medicaid), and housing and energy subsidies. Spending by poor households from all sources may be double their reported income, reports a study by Nicholas Eberstadt of the American Enterprise Institute. Although many poor live hand-to-mouth, they've participated in rising living standards. In 2005, 91 percent had microwaves, 79 percent air conditioning and 48 percent cellphones.

The existing poverty line could be improved by adding some income sources and subtracting some expenses (example: child care). Unfortunately, the administration's proposal for a "supplemental poverty measure" in 2011 -- to complement, not replace, the existing poverty line -- goes beyond these changes. The new poverty number would compound public confusion. It also raises questions about whether the statistic is tailored to favor a political agenda.

The "supplemental measure" ties the poverty threshold to what the poorest third of Americans spend on food, housing, clothes and utilities. The actual threshold -- not yet calculated -- will almost certainly be higher than today's poverty line. Moreover, the new definition has strange consequences. Suppose that all Americans doubled their incomes tomorrow, and suppose that their spending on food, clothing, housing and utilities also doubled. That would seem to signify less poverty -- but not by the new poverty measure. It wouldn't decline, because the poverty threshold would go up as spending went up. Many Americans would find this weird: People get richer but "poverty" stays stuck.

What produces this outcome is a different view of poverty. The present concept is an absolute one: The poverty threshold reflects the amount estimated to meet basic needs. By contrast, the supplemental measure embraces a relative notion of poverty: People are automatically poor if they're a given distance from the top, even if their incomes are increasing. The idea is that they suffer psychological deprivation by being far outside the mainstream. The math of this relative definition makes it hard for people at the bottom ever to escape "poverty."

The new indicator is a "propaganda device" to promote income redistribution by showing that poverty is stubborn or increasing, says the Heritage Foundation's Robert Rector. He has a point. The Census Bureau has estimated statistics similar to the administration's proposal. In 2008, the traditional poverty rate was 13.2 percent; estimates of the new statistic range up to 17 percent. The new poverty statistic exceeds the old, and the gap grows larger over time.To paraphrase the late Sen. Daniel Patrick Moynihan: The administration is defining poverty up.

It's legitimate to debate how much we should aid the poor or try to reduce economic inequality. But the debate should not be skewed by misleading statistics that not one American in 100,000 could possibly understand. Government statistics should strive for political neutrality.

This one fails.

Why Financial Reform

I think that most believe in financial reform. As to how to do it apparently is all befudled (using a term in the below article) in Washington. I thought this article was by far the best description of our system, how the crisis was created in the system and how the system should be reformed in order to prevent and help manage future crisis.

Again, to point out, this article does not state that the system proposed will remove all crisis, it will just set up management for it. I'll also point out that my concern, as with most I talk with, is how much our befudled representatives in Washington are involved in and able to manipulate the management of our current system and the proposed system in this article. Anyway, great article, though it took me over an hour to get through it and several trips to the thesaurus, from the Managing Director of Pimco. If you are not all that interested in the banking system then don't start the article.


After the Crisis: Planning a New Financial Structure Learning from the Bank of Dad

Thank you very much. It is an absolute pleasure and honor to be here. I gave the keynote a couple years ago and it was my first time to be at the Minsky Conference. I feel that I'm part of a church, and it's a good church in that we're on the right side of history. And it's absolutely wonderful to be attending services with you again.

I want to open up with a little story that should make everybody in the room feel particularly good, and then we'll get into discussing economics. Harry Markowitz has been a friend of mine for about a decade. I became friends with Harry through two channels. Number one, Rob Arnott of Research Affiliates has an Advisory Panel of famous academics, such as Harry and Jack Treynor, that he gets together every year. I'm frequently invited to speak. We spend two or three days over a weekend together. I've also gotten to know Harry because he and the late great Peter Bernstein were very close friends. Peter and I were also very close friends.

I've been preaching the Minsky Framework at Rob's event for a number of years. And Harry's always been very, very polite. I spoke again just this past Sunday morning. After I finished, we had a nice Q&A. And Harry said, "Paul, if I had to read one book by Minsky, which one would it be?" And I said, "Harry, please, tell me that you've read at least one book by Minsky." And he says, "No, I haven't, but I think I would like to, and I think I'm probably old enough now."
I promised Harry that I would send him one personally. And I'm quite sure that if I don't follow up on that, somebody at the Levy Institute would gladly follow up. So, the bottom line is that one of the fathers of the Efficient Market Hypothesis has finally decided to attend services at the Church of Minsky. I think that is a glorious, glorious moment. Don't you? Harry is an absolutely delightful man.

From the standpoint of what I want to talk about tonight, a great deal of it has already been discussed today. I feel a little bit like St. Louis Federal Reserve President Jim Bullard did at lunch when he said that Paul Krugman, who spoke just before Jim, had already given 90% of his speech. That's basically true for me as well. Paul's speech was superb, laying out six possible culprits in the financial crisis.1

I want to focus on Paul's Number 3, the Shadow Banking System. Paul was drawing a lot of his comments today from the work of Professor Gary Gorton of Yale, which is absolutely fantastic material. Have a lot of you read Gary's essay, "Slapped in the Face by the Invisible Hand"?2 I see a lot of nods here. That's where the phrase that Paul used, "Quiet Period," came from. Gary coined it. He'd be a great person to have here next year at the Minsky Conference.
And one of the fascinating things that he details is the nature of banking. That's where I want to start tonight. Let's start with first principles. If we do, then I think we can understand why we shouldn't look at the conventional banking system and the Shadow Banking System as separate beasts, but intertwined beasts.

The essence, or the genius of banking, not just now, the last century or the century before that, but since time immemorial, is that the public's ex-ante demand for assets that trade on demand at par is greater than the public's ex-post demand for these types of assets. Let me repeat this, because this is a first principle: The public's ex-ante demand for liquidity at par is greater than the public's ex-post demand. Therefore, we can have banking systems because they can meet the ex-ante demand, but never have to pony up ex-post. In turn, the essence or the genius of banking is maturity, liquidity and quality transformation: holding assets that are longer, less liquid and of lower quality than the funding liabilities.

A second principle: A banking system is solvent only if it is believed by the public to be a going concern. By definition, if the public's ex-post demand for liquidity at par proves to be equal to its ex-ante demand, a banking system is insolvent because a banking system ends up, at its core, promising something it cannot deliver. Everyone following me here?

Professor Gorton, in his paper, goes through how that promise was dealt with during the 19th century, before the New Deal Era. There were panics all the time, otherwise known as runs, because we didn't have a lender of last resort and we didn't have deposit insurance. During the 19th century, the system dealt with its reoccurring panics in lots of novel ways, including clearing houses which would de facto be a central bank, and suspension of convertibility of deposits into cash. So the problems we've been dealing with in the last couple of years are not new. They go back to the origin of banking.

The Quiet Period, from the New Deal Era until the Panic of 2007, was actually unique in history. And the Quiet Period came about, I think, for a lot of the reasons that were articulated earlier today in that banks, conventional banks, after the Great Depression, were considered to be special. And, in fact, banks are special. If you think that the banking system can be guided to stability as if by an invisible hand, then you are deluding yourself. But, that is, in fact, what happened with the explosive growth of the Shadow Banking System.

Banking is a really profitable business. In its most simple form, think in terms of a bank issuing demand deposits, which are guaranteed to trade at par because they've got FDIC insurance around them and also because the issuing bank can rediscount its assets at the Fed in order to redeem deposits in old-fashioned money, also known as currency.

In fact, let's take a look at the $1 bill I am holding in my hand. It says right at the very top, "Federal Reserve Note." It also says right down here, "This note is legal tender for all debts, public and private." This is what the public ex-ante wants: the knowledge that they can turn their deposits into these Federal Reserve Notes. And if the public knows they can turn them into these notes, they don't. With me here? If I know I can, I don't.

Now, this is a unique note. This is a Federal Reserve liability. And, actually, it's really cool. It's missing two things. It doesn't have a maturity date on it. So, it's perpetual. And it doesn't have an interest rate on it. I would love to be able to issue these things. It would make me very, very happy to issue these things. But it would be against the law! But, in fact, that's what banks did in the 19th century. They issued currency. After the creation of the Federal Reserve, it was given monopoly power to create currency, which I think was a pretty bright idea. But demand deposits issued by banks are just one step away from a Federal Reserve Note.

Conceptually, demand deposits have a one-day maturity. I can write a check on it, and it goes out at par tomorrow, if not today. Demand deposits, conceptually, have a one-day maturity. But in aggregate, they have a perpetual maturity. So, therefore, banking can engage in maturity, liquidity and quality transformation: a very profitable business. Banks can issue, essentially, perpetual liabilities – call them demand deposits – and invest them in longer dated, illiquid loans and securities, earning a net interest margin. It's a really, really sweet business.
In the early years of the Quiet Period, we regulated that really sweet business. I think that was a really bright idea. In order for that business not to be prone to panics and, therefore, financial crises, you needed to have deposit insurance. Deposit insurance, by definition, cannot come about as if by the invisible hand. Deposit insurance cannot be, cannot be a private sector activity. It is a public good. The deposit insurer must be a subsidiary of the fiscal authority. And in extremis, the monetary authority can monetize the liabilities of the fiscal authority. I'm not saying that pejoratively. I'm not being pejorative at all. Just descriptive. Bottom line: Deposit insurance is inherently a public good.

Access to the Fed's balance sheet is also inherently a public good, because the Federal Reserve is the only entity that can print currency. So essentially, banking has two public goods associated with it. Therefore, naturally, it should be regulated.

That was the Quiet Period Model. And regulation took the form of what you could do, how you could do it and how much leverage you could use in doing it. And, as was mentioned by Paul Volcker a number of times earlier this afternoon, the regulatory burden that has historically come with being a conventional bank has been actually quite high. During the early years of the Quiet Period, however, banking was nonetheless a very profitable endeavor.

There was a quid pro quo, which actually led to the old joke – which was actually said about the savings and loan industry – that banking was a great job: Take in deposits at 3, lend them out at 6, and be on the golf course at 3. 3-6-3 banking was a pretty nice franchise. So, therefore, bankers had a pretty strong incentive not to mess it up. Essentially, there were oligopoly profits in the business. I think Gary Gorton is actually right on that proposition.

The invisible hand, however, naturally wanted to get the oligopoly profits associated with banking while reducing the impact of some regulation. Thus, the Shadow Banking System came into existence, where the net interest margin associated with maturity, liquidity and quality transformation could be earned on a much smaller capital base.

And, in fact, that's what happened starting essentially in the mid-1970s, accelerating through the 1980s and 1990s, and then exploding in the first decade of this century.

The birth of the Shadow Banking System required that capitalists be able to come up with an asset – which actually for shadow bankers is a liability – that was perceived by the public as just as good as a bank deposit. Remember, the public has an ex-ante demand for something that trades on demand at par. Therefore, shadow bankers had to be able to persuade the public that its asset – which is actually the shadow banker's liability – was just as good as the real thing. If they could do that, then they could have one whale of a good time.

That asset – which, again, is the bank's liability – needed, in Gary Gorton's terms, to be characterized by "informational insensitivity," meaning that the holder didn't need to do any due diligence, just taking it on faith that this asset could be converted at par on demand. And, in fact, money market mutual fund shares achieved that status. With one small exception prior to the Reserve Primary Fund breaking the buck, they always traded at par. And if there was any danger they wouldn't trade at par, the sponsor would step in and buy out any dodgy asset at par. So, essentially, the money market mutual fund industry was at the very core of the growth of the Shadow Banking System.

It created a liability perceived as just as good as a demand deposit wrapped with deposit insurance, issued by a bank with access to the Fed. It was a great game. But in and of itself, that didn't lead to the explosive growth in the Shadow Banking System. There needed to be another link in the chain. Yes, money market mutual funds needed an asset that the public perceived as just as good as a bank deposit. But they also had to put something on the other side of the balance sheet.

What went on the other side of the balance sheet? Money market instruments such as repo and commercial paper (CP). And under Rule 2a-7, they were allowed to use accrual accounting for their assets. The assets didn't have to be marked to market. So, therefore, 2a-7 funds could actually maintain the $1 share price, unless they did something really dumb.

At their peak, money market mutual funds were about $4 trillion. They are about $3 trillion now. They interacted with the larger Shadow Banking System. And the largest shadow banks were the vehicles of investment banks, funded heavily with repo and CP. So, explosive growth of the Shadow Banking System was logically the result of the invisible hand of the marketplace wanting to get the profitability of the regulated banking system, but without the regulation. Shadow banks created information-insensitive assets for the public that were perceived as just as good as a demand deposit, and then levered the daylights out of them into longer, less liquid, lower-quality assets. And it all worked swimmingly well, for a while. But then they embarked on the Forward Minsky Journey.3

Shadow banks were the predominant place where securitizations of subprime mortgages were placed, as well as securitizations of other types of assets. So the Shadow Banking System was, essentially, mirroring the banking model, which had deposits and loans.

Turn the deposit into asset-backed commercial paper. Turn the loan into a security. What you end up with is the same vehicle as a bank from a functional standpoint, but you have it outside the conventional bank regulatory structure. Actually, let me correct myself. There was a de facto regulator in the Shadow Banking System. They are called the rating agencies.

In order to do the trick of creating a shadow bank, you had to have the rating agencies declare that your senior short-dated liabilities were just as good as bank deposits. In fact, most money market mutual funds get themselves rated, and S&P, Moody's, and Fitch do have particular rules for giving a AAA rating to a 2a-7 money market fund, mirroring SEC Rules. But, for the rest of the Shadow Banking System, the rating agency rules evolved on the fly, often under the guidance of shadow bankers themselves. It didn't work out very well, as the Shadow Banking System became the lead owner of what was created in the originate-to-distribute model of mortgage creation.

On August 9, 2007, game over. If you have to pick a day for the Minsky Moment, it was August 9. And, actually, it didn't happen here in the United States. It happened in France, when Paribas Bank (BNP) said that it could not value the toxic mortgage assets in three of its off-balance sheet vehicles, and that, therefore, the liability holders, who thought they could get out at any time, were frozen. I remember the day like my son's birthday. And that happens every year. Because the unraveling started on that day. In fact, it was later that month that I actually coined the term "Shadow Banking System" at the Fed's annual symposium in Jackson Hole.
It was only my second year there. And I was in awe, and mainly listened for most of the three days. At the end, Marty Feldstein always does the wrap-up. Everybody wanted to talk. And since I was a newbie, I didn't say anything until almost the very end. I stood up and (paraphrasing) said, "What's going on is really simple. We're having a run on the Shadow Banking System and the only question is how intensely it will self-feed as its assets and liabilities are put back onto the balance sheet of the conventional banking system."

Now, I certainly didn't anticipate that it was going to lead to the debacle that eventually unfolded. In fact, while the run commenced on August 9th of 2007, it was pretty much an orderly run up until September 15, 2008. And it was orderly primarily because the Fed – and here I give the Fed credit, not criticism – evoked Section 13-3 of the Federal Reserve Act in March of 2008 in order to facilitate the merger of under-a-run Bear Stearns into JPMorgan. Concurrently, the Fed opened its balance sheet to the biggest shadow banks of all, the investment banks that were primary dealers, including most important, the big five. It was called the Primary Dealer Credit Facility.

I'm sure that was an incredibly difficult decision for the Federal Reserve Board to make – to open its balance sheet to borrowers it didn't regulate. But it was necessary, because runs are self-feeding; you can't stop them without the aid of somebody with the ability to print legal tender. That's the only way you can stop it, because only the Fed can create an asset that will definitionally trade at par in real time. During a run, that's what the public wants. A run turns upside down the genius of banking. A run is when the public's ex-post demand for liquidity at par equals its ex-ante demand.

Post-Bear Stearns, financial life regained some sense of normalcy. But then came the run on Lehman Brothers, and the Fed didn't have the legal power to implement a Bear-like rescue. And then the Reserve Fund broke the buck. That week will be one that we remember for the rest of our lives. It will also be one that we will remember where the Fed was at its finest hour. The Fed created a whole host of facilities to stop the run. In fact, they expanded the Primary Dealer Credit Facility to what are known as Schedule 2 assets, which meant that dealers could rediscount anything at the Fed that they could borrow against in the tri-party repo market.

Concurrently, the FDIC stepped up to the plate, doing two incredibly important things. Number one, they totally uncapped deposit insurance on transaction accounts, which meant that the notion of uninsured depositors in transaction accounts became an oxymoron. If you were in a transaction account, there was no reason to run. And then the FDIC effectively became a monoline insurer to nonbank financials with its Temporary Liquidity Guarantee Program (TGLP) allowing both banks and shadow banks to issue unsecured debt with the full faith and credit of Uncle Sam for a 75 basis points fee. No surprise some $300 billion was issued.
So, bottom line, you had the Fed step up and provide its public good to the Shadow Banking System. You had the FDIC step up and do the same thing with its public good. And as Paul Volcker was noting this afternoon, you had the Treasury step up and provide a similar public good for the money market mutual funds, using the Foreign Exchange Stabilization Fund. It was a triple-thick milk shake of socialism. And it was good. Again, I'm not being pejorative. I'm being descriptive.

Banking is inherently a joint venture between the private sector and the public sector. Banking inherently cannot be a solely capitalistic affair. I put that on the table as an article of fact. And, in fact, speaking at a Minsky Conference, I know I'm preaching to the converted. Big bank and big government are part of our catechism. And, in fact, that's exactly what came to the fore to save us from Depression 2.0.

Let me draw to a few conclusions. How should we re-regulate the financial landscape – as President Bullard was calling it today – to make sure this doesn't happen again? We must, because the collateral damage to the global economy has been truly a tragedy.

And I think the first principle is that if what you're doing is banking, de jure or de facto, then you are in a joint venture with the public sector. Period. If you're issuing liabilities that are intended to be just as good as a bank deposit, then you will be considered functionally a bank, regardless of the name on your door. That's the first principle.

Number two, if you engage in these types of activities – call it banking, without making a big distinction here between conventional banking and shadow banking, as Paul Krugman intoned this morning – in such size that you pose systemic risk, you will have higher mandated capital requirements and you will be supervised by the Federal Reserve. Yes, I just told you who I think the top-dog supervisor should be. You will have tighter leverage and liquidity restrictions: You will have to live by civilized norms. In fact, a great deal of what is on the regulatory reform table right now proceeds precisely along those lines. If you're going to act like a bank, you're going to be regulated like a bank. That simple. And maybe you just might find the time to go back to working on your golf game at 3. That is the core principle.

There truly is a devil in the details, because it's quite natural that non-bank levered-up financial intermediaries don't want to be treated like banks. I wouldn't either. But the truth of the matter is if you're going to have access to the public goods associated with banking, then you're going to be treated like a bank.

In fact, here is an example of this concept in my own life, which I'm sure most of you have experienced who have older children. When my son turned 18, he said, "Dad, I'm now the age of majority and I can do whatever I want." I said, "Son, that's absolutely true. However, I still control the Bank of Dad. And if you want to have access to the Bank of Dad, there are going to be rules. If you don't want access to the Bank of Dad, that's fine. But if you want access to the Bank of Dad, there are going to be rules."

The Federal Reserve and the FDIC and the Treasury, together, are the Bank of Dad. And Mom. I expect regulation to be similar to that which I have imposed on my son. It doesn't mean I want to stifle his innovation. That doesn't mean I want to stifle his creativity. I want him to be all he can be. But as long as he's banking at Bank of Dad, there are going to be rules.

So there's my regulatory framework for you. Yes, think in terms of the Federal Reserve and the FDIC and the Treasury as all providing public goods to banking. But the Federal Reserve has got to be at the top of the totem pole, because the Fed truly is the Bank of Dad. The entity that can print money has got to be the lead supervisor. To me, it's unambiguously clear. And the fact that it's being debated actually befuddles me. I operate on the notion that self-evident truths should be self-evident. But apparently Washington doesn't operate on that thesis.

I've talked too long. I promised you I wouldn't do this. I was going to talk short and then have a long Q&A, but I'm a Baptist minister's son, and we can't help ourselves. Regardless of how simple the sermon may be, it always goes on too long because the minister always enjoys giving it more than the audience enjoys receiving it.

Thank you very much.
Paul McCulley
Managing Director