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.